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ELON > SEC Filings for ELON > Form 10-Q on 9-May-2014All Recent SEC Filings

Show all filings for ECHELON CORP

Form 10-Q for ECHELON CORP


9-May-2014

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 Grid and IIoT 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 IIoT 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 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 seven foreign countries throughout Europe and Asia. Our products enable everyday devices - such as air conditioners, appliances, electricity meters, light switches, thermostats, and valves - to be made "smart" and inter-connected, part of an emerging market known as the Industrial Internet of Things (IIoT). Our products can be used to make the management of electricity over the smart grid cost effective, reliable, survivable and instantaneous.

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 products and services.

Prior to the fourth quarter of 2013, the Company operated in one operating segment. Effective in the fourth quarter of 2013, the Company changed the way it managed the business to focus the business on two operating segments based on homogeneity of products and technology. As a result of the change, a portion of the Company's personnel organization structure, as well as its products and services, were organized along the following two operating segments:

         IIoT: This division sells products and services aimed at Horizontal
          Embedded Control Platforms, such as LONWORKS and IzoT, which include
          components, control nodes and development software. These products are
          typically sold to Original Equipment Manufacturers (OEMs) to build into
          their industrial application solutions. Revenues from these products
          were previously categorized as Sub-systems revenues (including the
          majority of our revenues from the Enel project).


         Grid: This division focuses on Echelon's forward-integrated products
          such as smart meters, devices, and software that allow electric
          utilities to modernize their methods for collecting billing data and
          vital statistics on the health and performance of their smart grid.
          Previously, the majority of our revenues from our Grid solutions were
          categorized as Systems revenue, with a small portion categorized as
          Sub-system revenue.

Our total revenues decreased by 29.4% during the first quarter of 2014 as compared to the same period in 2013, driven principally by decreased sales of our Grid products. Gross margins increased by 1.8 percentage points between the two periods,


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while overall operating expenses decreased by 40.8%. The net effect was a first quarter loss attributable to Echelon Corporation stockholders in 2014 that decreased by $5.3 million as compared to the first quarter of 2013.

The following tables provide an overview of key financial metrics for the three months ended March 31, 2014 and 2013 that our management team focuses on in evaluating our financial condition and operating performance (in thousands, except percentages).

                                    Three Months Ended
                                         March 31,
                                  2014              2013            $ Change         % Change
Net revenues                 $      17,791     $      25,182     $     (7,391 )         (29.4 )%
Gross margin                          48.6 %            46.8 %            ---         1.8 ppt
Operating expenses           $      12,485     $      21,097     $     (8,612 )         (40.8 )%
Net loss attributable to
Echelon Corporation
Stockholders                 $      (3,973 )   $      (9,247 )   $      5,274           (57.0 )%
                                       Balance as of
                                March 31,       December 31,
                                  2014              2013            $ Change         % Change
Cash, cash equivalents, and
short-term investments       $      55,302     $      57,635     $     (2,333 )          (4.0 )%

Net revenues: Our total revenues decreased by 29.4% during the first quarter of 2014 as compared to the same period in 2013, driven primarily by a $6.6 million, or 48.8% decrease in sales of our Grid products and services and a $840,000, or 7.1% decrease in net revenues from our IIoT products. The decrease in our Grid revenues was primarily due to an overall decrease in the level of large-scale deployments in Finland, Austria and the United States of our NES system products, partly offset by sales to a customer in Puerto Rico and unusually high service revenues. With respect to our IIoT segment, the decrease in revenues was mainly due to decreases in sales made in the EMEA and Americas regions, as well as reductions in sales of metering kits made to Enel, partially offset by increases in sales in the Asia Pacific region. We do not expect the unusually high maintenance revenues to repeat in the future and anticipate that the service revenues for future quarters will return to more normal levels.

Gross margin: Our gross margins increased by 1.8 percentage points for the three months ended March 31, 2014 as compared to the same period in 2013. The increase was primarily due to increased service revenues from Grid customers, combined with more of our 2014 sales being attributable to the higher margin IIoT sales, including those made to Enel, and reductions in operations headcount and spending. These increases were partially offset by increases in certain indirect costs, such as reserves for excess and obsolete inventory. We do not expect any continued impact, similar to that from the increased service revenues mentioned above, in the future and anticipate that the gross margins for future quarters will be driven by the mix of segment products and services sold.

Operating expenses: Our operating expenses decreased by 40.8% during the three month period ended March 31, 2014, as compared to the same period in 2013. The decrease was primarily driven by the impact of the Finmek litigation and restructuring charges for the February 2013 organizational restructuring incurred in 2013, none of which were noted in 2014. In addition, the reduced business activity in 2014 in general reflected in lower outside services costs, combined with the impact of the reduced overall compensation related expenses associated with reduced headcount resulting from the restructuring action in 2013.

Net loss attributable to Echelon Corporation Stockholders: We generated a net loss of $4.0 million during the first quarter of 2014 compared to $9.2 million during the same period in 2013. This decrease in net loss was directly attributable to the 40.8% decrease in operating expenses combined with the improved margins as discussed above, which offset the impact of a $7.4 million quarter-over-quarter decrease in net revenues. Excluding the impact of litigation charges, restructuring charges and non-cash stock-compensation charges, our net loss increased by approximately $1.2 million in the first quarter of 2014 as compared to the same period in 2013.

Cash, cash equivalents, and short-term investments: During the first three months of 2014, our cash, cash equivalents, and short-term investment balance decreased by 4.0%, from $57.6 million at December 31, 2013 to $55.3 million at March 31, 2014. This decrease was primarily the result of operational losses incurred in the year to date and cash used for principal payments on our lease financing obligations the first quarter of 2014.


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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, 2013, which we filed with the Securities and Exchange Commission in March 2014, 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 months ended March 31, 2014, 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, 2013.

                             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
months ended March 31, 2014 and 2013:
                                                            Three Months Ended
                                                                March 31,
                                                             2014         2013
Revenues:
Product                                                     90.7  %      96.3  %
Service                                                      9.3          3.7
Total revenues                                             100.0        100.0
Cost of revenues:
Cost of product                                             49.1         51.9
Cost of service                                              2.3          1.3
Total cost of revenues                                      51.4         53.2
Gross profit                                                48.6         46.8
Operating expenses:
Product development                                         28.5         26.8
Sales and marketing                                         20.5         17.8
General and administrative                                  21.2         15.5
Litigation charges                                             -         13.7
Restructuring charges                                          -         10.0
Total operating expenses                                    70.2         83.8
Loss from operations                                       (21.6 )      (37.0 )
Interest and other income, net                               0.1          1.1
Interest expense on lease financing obligations             (1.6 )       (1.3 )
Loss before provision for income taxes                     (23.1 )      (37.2 )
Income tax (benefit)/expense                                (0.1 )        0.1
Net loss                                                   (23.0 )%     (37.3 )%
Net loss attributable to noncontrolling interest             0.7  %       0.6  %
Net loss attributable to Echelon Corporation stockholders  (22.3 )%     (36.7 )%


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Revenues
Total revenues
                                                  Three Months Ended
                                              March 31,       March 31,     2014 over 2013   2014 over 2013 %
(Dollars in thousands)                           2014           2013           $ Change           Change

Total revenues                               $   17,791     $    25,182     $   (7,391 )        (29.4 )%

The $7.4 million decrease in total revenues for the quarter ended March 31, 2014 as compared to the same period in 2013 was primarily due to a $6.6 million, or 48.8%, decrease in sales of our Grid products and a $840,000, or 7.1%, decrease in net revenues from our IIoT products, including sales to Enel.

Grid revenues
                                                    Three Months Ended
                                                                  March 31,     2014 over 2013   2014 over 2013 %
(Dollars in thousands)                        March 31, 2014        2013           $ Change           Change

Grid revenues                                $     6,867        $    13,418     $   (6,551 )        (48.8 )%

During the three months ended March 31, 2014 and 2013, our Grid revenues were derived primarily from a relatively small number of customers who have undertaken large-scale deployments of our NES System products. 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 Grid revenues. Further, Grid revenues also include sales of data concentrators and related services to Enel, from time to time. Grid revenues decreased during the three months ended March 31, 2014 as compared to the same period in 2013, by $6.6 million or 48.8%. This was primarily due to an overall decrease in the level of large-scale deployments of our NES system products in Finland, Austria and the United States, partly offset by sales to a customer in Puerto Rico and unusually high service revenues. We do not expect the unusually high maintenance revenues to repeat in the future and anticipate that the service revenues for future quarters will return to more normal levels. Our ability to recognize revenue for our Grid 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 Grid revenues have historically been concentrated with a relatively few customers. During the years ended December 31, 2013, 2012 and 2011 approximately 75.1%, 86.3% and 94.2%, respectively, of our Grid revenues were attributable to four customers. While our Grid customers will change over time, given the nature of the Grid market, we expect our future Grid revenues will continue to be concentrated among a limited number of customers.


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IIoT revenues
                                                       Three Months Ended
                                                                                                          2014 over
                                                                                      2014 over 2013 $     2013 %
(Dollars in thousands)                         March 31, 2014      March 31, 2013          Change          Change

IIoT revenues                                $         10,924     $        11,764     $      (840 )          (7.1 )%

Our IIoT 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 metering kits sold to Enel.
Excluding sales of metering kits to Enel, which are discussed more fully below, our IIoT revenues decreased by $499,000, or 5.1% during the three months ended March 31, 2014, as compared to the same period in 2013. For the three month period, this decrease was primarily due to a decreases in sales made in the EMEA and Americas regions, partially offset by increases in sales in the Asia Pacific region. Within the IIoT family of products, the decrease was driven primarily from decreased sales of our control and connectivity products.

Our future IIoT 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 IIoT revenues conducted in currencies other than the United States dollar, principally the Japanese Yen, was about 4.2% for the three months ended March 31, 2014 and 6.3% for the same period in 2013. To date, we have not hedged any of these foreign currency risks. We do not currently expect that, during 2014, the amount of our IIoT 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 Grid and IIoT)

                                                    Three Months Ended
                                                                  March 31,     2014 over 2013 $   2014 over 2013 %
(Dollars in thousands)                        March 31, 2014        2013             Change             Change

Enel Grid revenues                           $        -         $         -     $         -               -  %
Enel IIoT revenues                           $    1,549         $     1,890     $      (341 )         (18.0 )%
Total Enel revenues                          $    1,549         $     1,890     $      (341 )         (18.0 )%

In October 2006, we entered into two agreements with Enel, a development and supply agreement and a software enhancement agreement. Under the development and supply agreement, Enel is purchasing additional metering kit and data concentrator products from us. Under the software enhancement agreement, we are providing software enhancements to Enel for use in its Contatore Elettronico system. Enel Project revenues recognized during the three months ended March 31, 2014 and 2013, related primarily to shipments of metering kits under the development and supply agreement. The software enhancement agreement expired in December 2012 and the development and supply agreement expires in December 2015, although delivery of products and services can extend beyond those dates and the agreements may be extended under certain circumstances.

We sell our products to Enel and its designated manufacturers in U.S. dollars. Therefore, the associated revenues are not subject to foreign currency risks.


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Gross Profit and Gross Margin
                                              Three Months Ended
                                              March     March 31,   2014 over 2013   2014 over 2013 %
(Dollars in thousands)                       31, 2014     2013         $ Change           Change

Gross Profit                                  $8,647     $11,776    $   (3,129 )        (26.6 )%
Gross Margin                                  48.6%       46.8%            N/A            1.8

Gross profit is equal to revenues less cost of goods sold. Cost of goods sold for product revenues includes direct costs associated with the purchase of components, subassemblies, and finished goods, as well as indirect costs such as allocated labor and overhead; costs associated with the packaging, preparation, and shipment of products; and charges related to warranty and excess and obsolete inventory reserves. Cost of goods sold for service revenues consists of employee-related costs such as salaries and fringe benefits as well as other direct and indirect costs incurred in providing training, customer support, and custom software development services. Gross margin is equal to gross profit divided by revenues.
Gross margins increased by 1.8 percentage points for the three month period ended March 31, 2014 as compared to the same period in 2013. This was primarily due to increased service revenues from Grid customers, which typically generate higher gross margins for us than do product revenues. Gross margins were also favorably impacted by the change in mix of revenues in 2014. The higher margin IIoT revenues (including those made to Enel) comprise approximately 61% of total revenues for the quarter ended March 31, 2014, compared to approximately 47% of total revenues for the quarter ended March 31, 2013. Further, margins improved due to headcount and spending reductions in operations. These increases were partially offset by increases in reserves for excess and obsolete inventory. We do not expect any continued impact, similar to that from the increased service revenues mentioned above, in the future and anticipate that the gross margins for future quarters will be driven by the mix of segment products and services sold.
Our future gross margins will continue to be affected by several factors, including, but not limited to: overall revenue levels, changes in the mix of products sold, periodic charges related to excess and obsolete inventories, warranty expenses, introductions of cost reduced versions of our Grid and IIoT products, changes in the average selling prices of the products we sell, purchase price variances, unexpected increases in demand which could impact our ability to supply our customers in a timely manner due to reduced inventory levels, and fluctuations in the level of indirect overhead spending that is capitalized in inventory. In addition, the impact of foreign exchange rate fluctuations and labor rates may affect our gross margins in the future. We currently outsource the manufacturing of most of our products requiring assembly to CEMs located primarily in China. To the extent labor rates were to rise further, or to the extent the U.S. dollar were to weaken against the Chinese currency, or other currencies used by our CEMs, our costs for the products they manufacture could rise, which would negatively affect our gross margins. Lastly, many of our products, particularly our Grid products, contain significant amounts of certain commodities, such as silver, copper, and cobalt. Prices for these commodities have been volatile, which in turn have caused fluctuations in the prices we pay for the products in which they are incorporated.

Operating Expenses
Product Development
                                                    Three Months Ended
                                                                  March 31,     2014 over 2013   2014 over 2013 %
(Dollars in thousands)                        March 31, 2014        2013           $ Change           Change

Product Development                          $    5,073         $     6,744     $   (1,671 )        (24.8 )%

Product development expenses consist primarily of payroll and related expenses for development personnel, facility costs, expensed material, fees paid to third party service providers, depreciation and amortization, and other costs associated with the development of new technologies and products. Our product development expenses decreased during the three months ended March 31, 2014 as compared to the same period in 2013. These decreases were . . .

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