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ELON > SEC Filings for ELON > Form 10-Q on 9-Aug-2013All Recent SEC Filings

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Form 10-Q for ECHELON CORP


9-Aug-2013

Quarterly Report


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion should be read in conjunction with the condensed consolidated financial statements and notes thereto included elsewhere in this Quarterly Report. The following discussion contains predictions, estimates, and other forward-looking statements that involve a number of risks and uncertainties about our business. These statements may be identified by the use of words such as "we believe," "expect," "anticipate," "intend," "plan," "goal," "continues," "may" and similar expressions. Forward-looking statements include statements that refer to projections of our future financial performance, our anticipated growth and trends in our businesses, and other characterizations of future events or circumstances. In particular, these statements include statements such as: our plan to focus our product development spend in our foundational technology to broaden the applicability of our control networking platform into new markets; our predictions about the smart energy market, increased pricing pressures and worldwide macro-economic conditions; our projections of Systems and Sub-systems revenues; our expectation that we will achieve a return on our investment of resources into our products; estimates of our future gross margins and factors affecting our gross margins; statements regarding reinvesting a portion of our earnings from foreign operations; plans to use our cash reserves to strategically acquire other companies, products, or technologies; our projections of our combined cash, cash equivalent and short term investment balance; the sufficiency of our cash reserves to meet cash requirements; our expectations that our Sub-systems revenues will not fluctuate significantly from foreign currency sales; our forecasts regarding the allocation of our future product development spend; estimates of our interest income and expense; our expectations about finalizing the settlement with Finmek, and the amounts of timing of the related payments; our expectations about the amount and timing of paying out restructuring charges; our belief that we have adequately provided for legal contingencies; and our belief that we have made adequate provisions for tax exposure and legal matters. Such statements are based on our current expectations and could be affected by the uncertainties and risk factors described throughout this filing and particularly in the "Factors That May Affect Future Results of Operations" section. Therefore, our actual results may differ materially and adversely from those expressed in any forward-looking statements. We undertake no obligation to review or update publicly any forward-looking statements for any reason.

EXECUTIVE OVERVIEW
Echelon Corporation was incorporated in California in February 1988 and reincorporated in Delaware in January 1989. We are based in San Jose, California, and maintain offices in eleven foreign countries throughout Europe and Asia. We develop, market, and sell energy control networking solutions, a critical element of incorporating action-oriented intelligence into the utility grid, buildings, streetlights, and other energy devices - all components of the evolving smart grid, which encompasses everything from the power plant to the plug. Echelon's products can be used to make the management of electricity over the smart grid cost effective, reliable, survivable and instantaneous. Our products enable everyday devices - such as air conditioners, appliances, electricity meters, light switches, thermostats, and valves - to be made "smart" and inter-connected.

Our proven, open standard, multi-application energy control networking platform powers energy-savings applications for smart grid, smart cities and smart buildings that help customers save on their energy usage, reduce outage duration or prevent them from happening entirely, reduce carbon footprint and more. Today, we offer, directly and through our partners worldwide, a wide range of innovative, fully integrated products and services. We classify these products and services into two primary categories: Systems, such as our smart metering solutions, which are targeted for use by utilities; and Sub-systems that include our components, control nodes and development software, which are sold typically to OEMs who build them into their smart grid, smart cities and smart buildings solutions.

Our total revenues decreased by 39.2% during the second quarter of 2013 as compared to the same period in 2012, driven principally by decreased sales of our Systems products. Gross margins increased by 8.7 percentage points between the two periods, while overall operating expenses decreased by 30.1%. The net effect was a second quarter loss attributable to Echelon Corporation stockholders in 2013 that decreased by $1.1 million as compared to the second quarter of 2012. For the six months ended June 30, 2013, total revenues decreased by 38.4% as compared to the same period in 2012. Gross margins increased by 6.3 percentage points between the two periods, while overall operating expenses decreased by 9.6%. The net effect was a loss attributable to Echelon Corporation stockholders for the first six months in 2013 that increased by $5.6 million as compared to the same period in 2012.


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The following tables provide an overview of key financial metrics for the three and six months ended June 30, 2013 and 2012 that our management team focuses on in evaluating our financial condition and operating performance (in thousands, except percentages).

                                    Three Months Ended
                                         June 30,
                                  2013             2012            $ Change         % Change
Net revenues                 $     24,836     $      40,822     $    (15,986 )         (39.2 )%
Gross margin                         48.1 %            39.4 %            ---         8.7 ppt
Operating expenses           $     12,376     $      17,716     $     (5,340 )         (30.1 )%
Net loss attributable to
Echelon Corporation
Stockholders                 $       (827 )   $      (1,881 )   $      1,054           (56.0 )%
                                     Six months Ended
                                         June 30,
                                  2013             2012            $ Change         % Change
Net revenues                 $     50,018     $      81,155     $    (31,137 )         (38.4 )%
Gross margin                         47.4 %            41.1 %            ---         6.3 ppt
Operating expenses           $     33,473     $      37,020     $     (3,547 )          (9.6 )%
Net loss attributable to
Echelon Corporation
Stockholders                 $    (10,074 )   $      (4,449 )   $     (5,625 )         126.4  %
                                      Balance as of
                                June 30,       December 31,
                                  2013             2012            $ Change         % Change
Cash, cash equivalents, and
short-term investments       $     59,731     $      61,855     $     (2,124 )          (3.4 )%

Net revenues: Our total revenues decreased by 39.2% during the second quarter of 2013 as compared to the same period in 2012, driven primarily by a $14.8 million, or 52.7% decrease in sales of our Systems products and services and a $1.2 million, or 9.5% decrease in net revenues from our Sub-systems products. Our total revenues also decreased during the six months ended June 30, 2013 as compared to the same period in 2012 by 38.4%, driven primarily by a $30.2 million, or 53.2% decrease in sales of our Systems products and services and a $1.0 million, or 3.9% decrease in net revenues from our Sub-systems products. The decrease in our Systems revenues was primarily due to an overall decrease in the level of large-scale deployments in the United States and Finland of our NES system products, partially offset by an increase in sales of data concentrators made to Enel. With respect to our Sub-systems product line, the decrease in revenues was due to decreases in sales made in the Americas and APJ regions, partially offset by an increase in sales of metering kits made to Enel. These markets have yet to recover to their pre-recession levels. During 2013, we plan to reinvest in our foundational technology to broaden the applicability of our control networking platform (part of our Sub-system business) into new markets.

Gross margin: Our gross margins increased by 8.7 percentage points for the three months ended June 30, 2013 and by 6.3 percentage points during the six month period ended June 30, 2013, as compared to the same periods in 2012. The increase was primarily due to more of our 2013 sales being attributable to the higher margin Sub-system sales, including those made to Enel, combined with improved margins earned on sales of our Systems products. In addition, the impact of reduced inventory levels which resulted in lower obsolescence reserves, reduced overhead costs due to restructuring actions, and general cost reduction efforts over the past year also contributed to the improvement.

Operating expenses: Our operating expenses decreased by 30.1% during the three month period ended June 30, 2013, as compared to the same period in 2012. The decrease was primarily driven by reduced business activity in 2013 in general, combined with the impact of the May 2012 and February 2013 organizational restructurings, which reduced our overall compensation related expenses. Also contributing to the reduction was the one-time charge we booked in the second quarter of 2012 related to our restructuring efforts. Our operating expenses decreased by 9.6% during the six month period ended June 30, 2013 as compared to the same period in 2012, for the same reasons as above. This decrease was partially offset by a non recurring litigation charge for the potential settlement of the Finmek case booked in the first quarter of 2013, as well as higher overall restructuring charges booked during the first six months of 2013 as compared to the same period in 2012.

Net loss attributable to Echelon Corporation Stockholders: We generated a net loss of $827,000 during the second quarter of 2013 compared to $1.9 million during the same period in 2012. This decrease in net loss was directly attributable to


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overall reduced business activity reflected in the 30.1% decrease in operating expenses combined with the significantly improved margins as discussed above, partly offset by a $16.0 million quarter-over-quarter decrease in net revenues. Excluding the impact of non-cash stock-compensation charges and restructuring charges, our net profit decreased by approximately $1.2 million in the second quarter of 2013 as compared to the same period in 2012. Our net loss increased by $5.6 million during the six months ended June 30, 2013 as compared to the same period in 2012. This increase was attributable to the fact that the routine operating expenses reduced by 23%, while we noted a $31.1 million or 38.4% reduction in revenues. This, combined with the non routine litigation charges booked and higher severance costs in 2013 led to a higher net loss. These impacts were partially offset by improved margins as discussed above. Excluding the impact of non-cash stock-compensation charges, restructuring charges and litigation charges incurred in the first half of 2013, our net loss increased by approximately $3.4 million in the first six months of 2013 as compared to the same period in 2012.
Cash, cash equivalents, and short-term investments: During the first six months of 2013, our cash, cash equivalents, and short-term investment balance decreased by 3.4%, from $61.9 million at December 31, 2012 to $59.7 million at June 30, 2013. This decrease was primarily the result of cash used for principal payments on our lease financing obligations and capital expenditures during the first half of 2013.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

Our discussion and analysis of our financial condition and results of operations is based upon our condensed consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. Note 1, "Significant Accounting Policies" of Notes to Consolidated Financial Statements in our Annual Report on Form 10-K for the year ended December 31, 2012, which we filed with the Securities and Exchange Commission in March 2013, describes the significant accounting policies and methods used in the preparation of our consolidated financial statements. The preparation of these consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosure of contingent assets and liabilities. On an on-going basis, we evaluate our estimates, including those related to our revenues, stock-based compensation, allowance for doubtful accounts, inventories, and commitments and contingencies. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities. Actual results may differ from these estimates under different assumptions or conditions.

During the three and six months ended June 30, 2013, there were no material changes to our critical accounting policies or in the matters for which we make critical accounting estimates in the preparation of our condensed consolidated financial statements as compared to those disclosed in our Annual Report on Form 10-K for the year ended December 31, 2012.


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                             RESULTS OF OPERATIONS
The following table reflects the percentage of total revenues represented by
each item in our Condensed Consolidated Statements of Operations for the three
and six months ended June 30, 2013 and 2012:
                                          Three Months Ended              Six months Ended
                                               June 30,                       June 30,
                                         2013             2012           2013           2012
Revenues:
Product                                   97.5  %          97.6  %        96.9  %        97.8  %
Service                                    2.5              2.4            3.1            2.2
Total revenues                           100.0            100.0          100.0          100.0
Cost of revenues:
Cost of product                           50.6             59.4           51.3           57.5
Cost of service                            1.3              1.2            1.3            1.4
Total cost of revenues                    51.9             60.6           52.6           58.9
Gross profit                              48.1             39.4           47.4           41.1
Operating expenses:
Product development                       20.6             18.1           23.7           20.0
Sales and marketing                       16.2             13.6           17.0           14.4
General and administrative                13.0              8.8           14.2            9.8
Litigation charges                           -                -            6.9  %           -  %
Restructuring charges                        -              2.9            5.0            1.4
Total operating expenses                  49.8             43.4           66.9           45.6
Loss from operations                      (1.7 )           (4.0 )        (19.5 )         (4.5 )
Interest and other income (expense),
net                                       (0.7 )            0.7            0.3              -
Interest expense on lease financing
obligations                               (1.2 )           (0.8 )         (1.3 )         (0.9 )
Loss before provision for income
taxes                                     (3.6 )           (4.3 )        (20.5 )         (5.4 )
Income tax expense                         0.4              0.4            0.3            0.1
Net loss                                  (4.0 )%          (4.6 )%       (20.8 )%        (5.5 )%
Net loss attributable to non
controlling interest                       0.7  %             -  %         0.7  %           -  %
Net loss attributable to Echelon
Corporation stockholders                  (3.3 )%          (4.6 )%       (20.1 )%        (5.5 )%



Revenues
Total revenues
                                                   Three Months Ended
                                                                  June 30,     2013 over 2012    2013 over 2012 %
(Dollars in thousands)                         June 30, 2013        2012          $ Change            Change

Total revenues                               $        24,836     $  40,822     $   (15,986 )        (39.2 )%
                                                    Six Months Ended
                                                                  June 30,     2013 over 2012    2013 over 2012 %
(Dollars in thousands)                         June 30, 2013        2012          $ Change            Change

Total revenues                               $        50,018     $  81,155     $   (31,137 )        (38.4 )%

The $16.0 million decrease in total revenues for the quarter ended June 30, 2013 as compared to the same period in 2012 was primarily due to a $14.8 million, or 52.7%, decrease in sales of our Systems products and services and a $1.2 million, or


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9.5%, decrease in net revenues from our Sub-systems products, including sales to Enel. The $31.1 million decrease in total revenues for the six months ended June 30, 2013 as compared to the same period in 2012 was primarily the result of a $30.2 million decrease in Systems revenues and a $1.0 million decrease in Sub-systems revenues.

As we look forward to the remainder of 2013, the smart energy market remains relatively stagnant, with no particular large growth drivers being noted. Macro-economic conditions remain tentative in Europe, and competition for the existing business is heightened. New tender activity for smart-metering deployments, while marginally improved from 2012, continues to be slow, especially in Europe, and pricing pressures are increasing. In this challenging environment, we expect our revenues in the third quarter of 2013 to be lower than the first two quarters of 2013 revenues.

Systems revenues
                                                   Three Months Ended
                                                                  June 30,     2013 over 2012    2013 over 2012 %
(Dollars in thousands)                         June 30, 2013        2012          $ Change            Change

Systems revenues                             $        13,263     $  28,028     $   (14,765 )        (52.7 )%



                                                    Six Months Ended
                                                                  June 30,     2013 over 2012    2013 over 2012 %
(Dollars in thousands)                         June 30, 2013        2012          $ Change            Change

Systems revenues                             $        26,534     $  56,720     $   (30,186 )        (53.2 )%

During the three and six months ended June 30, 2013 and 2012, our Systems revenues were derived primarily from a relatively small number of customers who have undertaken large-scale deployments of our NES System products, as well as sales of data concetrators to Enel. These deployments generally come to fruition after an extended and complex sales process, and each is relatively substantial in terms of its revenue potential. They vary significantly from one another in terms of, among other things, the overall size of the deployment, the duration of time over which the products will be sold, the mix of products being sold, the timing of delivery of those products, and the ability to modify the timing or size of those projects. This relative uniqueness among each deployment results in significant variability and unpredictability in our Systems revenues. Excluding sales of products and services to Enel, which are discussed more fully below, Systems revenues decreased during the quarter and six months ended June 30, 2013 as compared to the same periods in 2012, by $17.1 million and $32.6 million, or 61.2% and 57.4%, respectively. This was primarily due to an overall decrease in the level of large-scale deployments in Finland, Germany and the United States of our NES system products, partly offset by an increase in sales to our customers in Austria.
Our ability to recognize revenue for our Systems products depends on several factors, including, but not limited to, the impact on delivery dates of any modifications to existing shipment schedules included in the contracts that have been awarded to us thus far, and in some cases, certain contractual provisions, such as customer acceptance. For arrangements that contain contractual acceptance provisions, revenue recognition may be delayed until acceptance by the customer or the acceptance provisions lapse unless we can objectively demonstrate that the contractual acceptance criteria have been satisfied, which is generally accomplished by establishing a history of acceptance for the same or similar products.

Our Systems revenues have historically been concentrated with a relatively few customers. During the years ended December 31, 2012, 2011 and 2010 approximately 86.3%, 94.2% and 85.4%, respectively, of our Systems revenues were attributable to four customers. While our Systems customers will change over time, given the nature of the Systems market, we expect our future Systems revenues will continue to be concentrated among a limited number of customers.


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Sub-systems revenues
                                                   Three Months Ended
                                                                                                 2013 over
                                                                  June 30,     2013 over 2012     2012 %
(Dollars in thousands)                         June 30, 2013        2012          $ Change        Change

Sub-systems revenues                         $        11,573     $  12,794     $   (1,221 )         (9.5 )%



                                                    Six Months Ended
                                                                                                   2013 over
                                                                  June 30,     2013 over 2012 $     2012 %
(Dollars in thousands)                         June 30, 2013        2012            Change          Change

Sub-systems revenues                         $        23,484     $  24,435     $      (951 )          (3.9 )%

Our Sub-systems revenues are primarily comprised of sales of our hardware products, and to a lesser extent, revenues we generate from sales of our software products and from our customer support and training offerings. Included in these totals are products and services sold to Enel.
Excluding sales of products and services to Enel, which are discussed more fully below, our Sub-systems revenues decreased by $1.5 million, or 13.3% during the three months ended June 30, 2013, as compared to the same period in 2012. For the three month period, this decrease was primarily due to a decrease in revenues in Americas and APJ, partially offset by increase in revenues in EMEA. Within the Sub-systems family of products, the decrease was driven primarily from decreased sales of our control and connectivity and SmartServer products. Excluding sales of products and services to Enel, which are discussed more fully below, our Sub-systems revenues decreased by $2.9 million, or 12.8% during the six months ended June 30, 2013, as compared to the same period in 2012. For the six month period, this decrease was primarily due to a decrease in revenues in Americas and APJ regions. These decreases were attributable, we believe, to the depressed Sub-systems market in Americas during 2013 and ongoing market share loss. Within the Sub-systems family of products, the year-over-year decrease was also driven primarily from decreased sales of our control and connectivity and SmartServer products.

Our future Sub-systems revenues will also be subject to further fluctuations in the exchange rates between the United States dollar and the foreign currencies in which we sell these products and services. In general, if the dollar were to weaken against these currencies, our revenues from those foreign currency sales, when translated into United States dollars, would increase. Conversely, if the dollar were to strengthen against these currencies, our revenues from those foreign currency sales, when translated into United States dollars, would decrease. The extent of this exchange rate fluctuation increase or decrease will depend on the amount of sales conducted in these currencies and the magnitude of the exchange rate fluctuation from year to year. The portion of our Sub-systems revenues conducted in currencies other than the United States dollar, principally the Japanese Yen, was about 7.0% for the six months ended June 30, 2013 and 8.8% for the same period in 2012. To date, we have not hedged any of these foreign currency risks. We do not currently expect that, during 2013, the amount of our Sub-systems revenues conducted in these foreign currencies will fluctuate significantly from prior year levels. Given the historical and expected future level of sales made in foreign currencies, we do not currently plan to hedge against these currency rate fluctuations. However, if the portion of our revenues conducted in foreign currencies were to grow significantly, we would re-evaluate these exposures and, if necessary, enter into hedging arrangements to help minimize these risks.
Enel project revenues (included in Systems and Sub-systems)

                                                   Three Months Ended
                                                                  June 30,       2013 over       2013 over
(Dollars in thousands)                        June 30, 2013         2012       2012 $ Change   2012 % Change

Enel System revenues                         $    2,376         $        -     $     2,376        100.0 %
Enel Sub-system revenues                     $    1,811         $    1,532     $       279         18.2 %
Total Enel revenues                          $    4,187         $    1,532     $     2,655        173.3 %


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                                                     Six Months Ended
                                                                   June 30,       2013 over       2013 over
(Dollars in thousands)                         June 30, 2013         2012       2012 $ Change   2012 % Change

Enel System revenues                         $         2,376     $        -     $     2,376        100.0 %
Enel Sub-system revenues                     $         3,701     $    1,759     $     1,942        110.4 %
Total Enel revenues                          $         6,077     $    1,759     $     4,318        245.5 %

In October 2006, we entered into two agreements with Enel, a development and . . .

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