Company Quick10K Filing
Echelon
Price8.46 EPS-1
Shares5 P/E-8
MCap38 P/FCF-20
Net Debt-5 EBIT-5
TEV34 TEV/EBIT-7
TTM 2018-06-30, in MM, except price, ratios
10-Q 2018-06-30 Filed 2018-08-02
10-Q 2018-03-31 Filed 2018-05-10
10-K 2017-12-31 Filed 2018-03-27
10-Q 2017-09-30 Filed 2017-11-07
10-Q 2017-06-30 Filed 2017-08-07
10-Q 2017-03-31 Filed 2017-05-11
10-K 2016-12-31 Filed 2017-03-01
10-Q 2016-09-30 Filed 2016-11-09
10-Q 2016-06-30 Filed 2016-08-09
10-Q 2016-03-31 Filed 2016-05-11
10-K 2015-12-31 Filed 2016-03-30
10-Q 2015-09-30 Filed 2015-11-09
10-Q 2015-06-30 Filed 2015-08-10
10-Q 2015-03-31 Filed 2015-05-11
10-K 2014-12-31 Filed 2015-03-12
10-Q 2014-09-30 Filed 2014-11-10
10-Q 2014-06-30 Filed 2014-08-08
10-Q 2014-03-31 Filed 2014-05-09
10-K 2013-12-31 Filed 2014-03-10
10-Q 2013-09-30 Filed 2013-11-08
10-Q 2013-06-30 Filed 2013-08-09
10-Q 2013-03-31 Filed 2013-05-03
10-K 2012-12-31 Filed 2013-03-01
10-Q 2012-09-30 Filed 2012-11-02
10-Q 2012-06-30 Filed 2012-08-08
10-Q 2012-03-31 Filed 2012-05-10
10-K 2011-12-31 Filed 2012-03-15
10-Q 2011-09-30 Filed 2011-11-04
10-Q 2011-06-30 Filed 2011-08-05
10-Q 2011-03-31 Filed 2011-05-06
10-K 2010-12-31 Filed 2011-03-16
10-Q 2010-09-30 Filed 2010-11-03
10-Q 2010-06-30 Filed 2010-08-06
10-Q 2010-03-31 Filed 2010-05-06
10-K 2009-12-31 Filed 2010-03-16
8-K 2018-09-13 M&A, Shareholder Rights, Control, Officers, Amend Bylaw, Shareholder Vote, Exhibits
8-K 2018-08-02 Earnings, Exhibits
8-K 2018-06-28 Enter Agreement, Shareholder Rights, Amend Bylaw, Other Events, Exhibits
8-K 2018-05-17 Shareholder Vote
8-K 2018-05-10 Earnings, Exhibits
8-K 2018-02-08 Earnings, Exhibits
8-K 2018-02-05 Officers

ELON 10Q Quarterly Report

Part I. Financial Information
Item 1. Unaudited Condensed Consolidated Financial Statements
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
Item 3. Quantitative and Qualitative Disclosures About Market Risks
Item 4. Controls and Procedures
Part II. Other Information
Item 1. Legal Proceedings
Item 1A. Risk Factors
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Item 6. Exhibits
EX-31.1 exhibit311-20180630.htm
EX-31.2 exhibit312-20180630.htm
EX-32 exhibit32-20180630.htm

Echelon Earnings 2018-06-30

Balance SheetIncome StatementCash Flow
12510075502502013201520172019
Assets, Equity
3022146-2-102013201520172019
Rev, G Profit, Net Income
1593-3-9-152013201520172019
Ops, Inv, Fin

10-Q 1 elon-20180630x10q.htm 10-Q Document

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q

(Mark One)
[x]
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2018
or
[ ]
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ___________ to ___________
Commission file number     001-37755
ECHELON CORPORATION
(Exact Name of Registrant as Specified in its Charter)
Delaware
 
77-0203595
State or Other Jurisdiction of
Incorporation or Organization
 
I.R.S. Employer Identification No.
 
 
 
2901 Patrick Henry Drive
Santa Clara, CA
 
95054
Address of Principal Executive Offices
 
Zip Code
(408) 938-5200
Registrant’s Telephone Number, Including Area Code
    
Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes x     No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes x    No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer o
Accelerated filer o
Non-accelerated filer o  (Do not check if a smaller reporting company)
Smaller reporting company x
Emerging growth company o  
 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.  o 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).  Yes o   No x 
APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING THE PRECEDING FIVE YEARS:
Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Section 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court.   Yes o   No o
 
APPLICABLE ONLY TO CORPORATE ISSUERS
As of July 31, 2018, 4,542,310 shares of the registrant’s common stock were outstanding.



ECHELON CORPORATION
FORM 10‑Q
FOR THE QUARTER ENDED
JUNE 30, 2018
INDEX

 
 
 
Page
 
Item 1.
 
 
 
 
 
 
 
 
 
 
 
 
Item 2.
 
Item 3.
 
Item 4.
 
 
 
 
 
 
Item 1.
 
Item 1A.
 
Item 2.
 
Item 6.
 
 
 
 
 




FORWARD-LOOKING INFORMATION
This report contains forward-looking statements within the meaning of the U.S. federal securities laws that involve risks and uncertainties. Certain statements contained in this report are not purely historical including, without limitation, statements regarding our expectations, beliefs, intentions, anticipations, commitments or strategies, including in respect of our pending merger with Adesto Technologies Corporation, regarding the future that are forward-looking. These statements include those discussed in Item 2, Management’s Discussion and Analysis of Financial Condition and Results of Operations, including “Critical Accounting Estimates,” “Results of Operations,” “Off-Balance-Sheet Arrangements and Other Critical Contractual Obligations,” “Liquidity and Capital Resources,” and “Recently Issued Accounting Standards,” and elsewhere in this report.

In this report, the words “may,” “could,” “would,” “might,” “will,” “should,” “plan,” “ forecast,” “anticipate,” “believe,” “expect,” “intend,” “estimate,” “predict,” “potential,” “continue,” “future,” “moving toward” or the negative of these terms or other similar expressions also identify forward-looking statements. Our actual results could differ materially from those forward-looking statements contained in this report as a result of a number of risk factors including, but not limited to, those set forth in the section entitled “Factors That May Affect Future Results of Operations” and elsewhere in this report. You should carefully consider these risks, in addition to the other information in this report and in our other filings with the SEC. All forward-looking statements and reasons why results may differ included in this report are made as of the date of this report, and we assume no obligation to update any such forward-looking statement or reason why such results might differ, except as required by law.


2


PART I. FINANCIAL INFORMATION
ITEM 1.
UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
ECHELON CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands)
(Unaudited)
 
June 30,
2018
 
December 31,
2017
ASSETS
 
 
 
 
 
 
 
CURRENT ASSETS:
 
 
 
Cash and cash equivalents
$
4,920

 
$
7,261

Short-term investments
11,940

 
11,967

Restricted investments
1,250

 
1,250

Accounts receivable, net 
3,147

 
2,296

Inventories
2,951

 
3,251

Deferred cost of revenues
840

 
1,039

Other current assets
1,576

 
1,152

Total current assets
26,624

 
28,216

 
 
 
 
Property and equipment, net
438

 
458

Intangible assets, net
611

 
725

Other long‑term assets
337

 
987

Total assets
$
28,010

 
$
30,386

 
 
 
 
LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
 
 
 
 
CURRENT LIABILITIES:
 
 
 
Accounts payable
$
2,995

 
$
2,317

Accrued liabilities
1,768

 
1,878

Deferred revenues
1,088

 
1,812

Total current liabilities
5,851

 
6,007

 
 
 
 
LONG-TERM LIABILITIES:
 
 
 
Other long-term liabilities
586

 
652

Total long-term liabilities
586

 
652

 
 
 
 
STOCKHOLDERS’ EQUITY:
 
 
 
Common stock
49

 
48

Additional paid-in capital
360,223

 
359,339

Treasury stock
(28,130
)
 
(28,130
)
Accumulated other comprehensive loss
(2,005
)
 
(1,821
)
Accumulated deficit
(308,564
)
 
(305,963
)
Total Echelon Corporation stockholders’ equity
21,573

 
23,473

Noncontrolling interest in subsidiary

 
254

Total stockholders’ equity
21,573

 
23,727

Total liabilities and stockholders’ equity
$
28,010

 
$
30,386


See accompanying notes to condensed consolidated financial statements.

3


ECHELON CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
(Unaudited)
 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2018
 
2017
 
2018
 
2017

 
 
 
 
 
 
 
Revenues
$
7,917

 
$
8,337

 
$
15,754

 
$
16,040

Cost of revenues (1)
3,472

 
3,618

 
6,932

 
6,910

Gross profit
4,445

 
4,719

 
8,822

 
9,130

Operating expenses:
 
 
 
 
 
 
 
 Product development (1)   
2,449

 
2,255

 
5,454

 
4,482

 Sales and marketing (1)   
1,184

 
1,463

 
2,494

 
2,925

 General and administrative (1)   
2,380

 
1,929

 
4,085

 
3,853

Total operating expenses
6,013

 
5,647

 
12,033

 
11,260

Loss from operations
(1,568
)
 
(928
)
 
(3,211
)
 
(2,130
)
Interest and other income (expense), net
376

 
(220
)
 
634

 
(285
)
Loss before provision for income taxes
(1,192
)
 
(1,148
)
 
(2,577
)
 
(2,415
)
Income tax benefit
30

 
29

 
24

 
23

 
 
 
 
 
 
 
 
Net loss
$
(1,222
)
 
$
(1,177
)
 
$
(2,601
)
 
$
(2,438
)
 
 
 
 
 
 
 
 
Basic and diluted net loss per share
$
(0.27
)
 
$
(0.26
)
 
$
(0.57
)
 
$
(0.55
)
 
 
 
 
 
 
 
 
Shares used in computing net loss per share:
 
 
 
 
 
 
 
Basic
4,542

 
4,445

 
4,534

 
4,440

Diluted
4,542

 
4,445

 
4,534

 
4,440

(1) 
See Note 4 for summary of amounts included representing stock-based compensation expense.
See accompanying notes to condensed consolidated financial statements.

4


ECHELON CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
(In thousands)
(Unaudited)

 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2018
 
2017
 
2018
 
2017
 
 
 
 
 
 
 
 
Net loss
$
(1,222
)
 
$
(1,177
)
 
$
(2,601
)
 
$
(2,438
)
Other comprehensive income (loss), net of tax:
 
 
 
 
 
 
 
Foreign currency translation adjustment
(328
)
 
246

 
(188
)
 
329

Unrealized holding gain (loss) on available-for-sale securities
4

 
1

 
4

 

Total other comprehensive income (loss)
(324
)
 
247

 
(184
)
 
329

Comprehensive loss
$
(1,546
)
 
$
(930
)
 
$
(2,785
)
 
$
(2,109
)

See accompanying notes to condensed consolidated financial statements.

5


ECHELON CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
 
Six Months Ended
 
June 30,
 
2018
 
2017
CASH FLOWS PROVIDED BY (USED IN) OPERATING ACTIVITIES:
 
 
 
Net loss
$
(2,601
)
 
$
(2,438
)
Adjustments to reconcile net loss to net cash used in operating activities:
 
 
 
Depreciation and amortization
230

 
220

Reduction in allowance for doubtful accounts

 
(7
)
Increase in accrued investment income
(101
)
 
(40
)
Stock-based compensation
953

 
909

Gain on liquidation of joint venture
(424
)
 

Change in operating assets and liabilities:
 
 
 
Accounts receivable
(861
)
 
(724
)
Inventories
300

 
(66
)
Deferred cost of revenues
(264
)
 
(21
)
Other current assets
251

 
(398
)
Accounts payable
733

 
544

Accrued liabilities
(242
)
 
(111
)
Deferred revenues
236

 
61

Deferred rent
(31
)
 
(32
)
Net cash used in operating activities
(1,821
)
 
(2,103
)
 
 
 
 
CASH FLOWS PROVIDED BY (USED IN) INVESTING ACTIVITIES:
 
 
 
Purchases of available‑for‑sale short‑term investments
(11,869
)
 
(11,950
)
Proceeds from maturities and sales of available‑for‑sale short‑term investments
12,000

 
12,000

Change in other long‑term assets
(21
)
 
24

Capital expenditures
(139
)
 
(31
)
Net cash provided by (used in) investing activities
(29
)
 
43

 
 
 
 
CASH FLOWS PROVIDED BY (USED IN) FINANCING ACTIVITIES:
 
 
 
Repurchase of common stock from employees for payment of taxes on vesting of restricted stock units and upon exercise of stock options
(68
)
 
(64
)
Distribution of remaining cash balance to joint venture partner
(432
)
 

Net cash used in financing activities
(500
)
 
(64
)
 
 
 
 
EFFECT OF EXCHANGE RATE CHANGES ON CASH
9

 
48

 
 
 
 
NET CHANGE IN CASH AND CASH EQUIVALENTS
(2,341
)
 
(2,076
)
 
 
 
 
CASH AND CASH EQUIVALENTS:
 
 
 
Beginning of period
7,261

 
9,803

End of period
$
4,920

 
$
7,727

 
 
 
 
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
 
 
 
Cash paid for income taxes
$
68

 
$
68

See accompanying notes to condensed consolidated financial statements.

6


ECHELON CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1.    Basis of Presentation and Significant Accounting Policies
Proposed Merger with Adesto Technologies Corporation

On June 28, 2018, the Company entered into an Agreement and Plan of Merger (the “Merger Agreement”) among Adesto Technologies Corporation ("Adesto"), Circuit Acquisition Corporation ("Merger Sub"), and the Company. Pursuant to the Merger Agreement, Merger Sub will be merged with and into the Company (the “Merger”), with the Company continuing as the surviving company in the Merger and as a wholly owned subsidiary of Adesto. As a result of the Merger, Echelon Corporation will cease to be a publicly traded company.

Subject to the terms and conditions of the Merger Agreement, at the effective time of the Merger, each share of the Company's issued and outstanding common stock will be converted into the right to receive $8.50 per Company share in cash, without interest. In addition, at the effective time of the Merger, whether vested or unvested, all shares of the Company's common stock underlying (1) option awards will be converted into the right to receive the spread between the per share price of $8.50 and the applicable exercise price and (2) restricted stock unit awards will be converted into the right to receive the per share price of $8.50, with any performance targets deemed to be satisfied at the target level of performance. Options awards with an exercise price greater than the per share price of $8.50 will be cancelled. For additional information regarding the Merger, please refer to the Merger Agreement, which was filed with the Securities and Exchange Commission on June 29, 2018 as an exhibit to a Current Report on Form 8-K.

Completion of the Merger is subject to certain conditions, including the receipt of the necessary approval from the Company’s stockholders and other customary closing conditions. The parties expect to close the Merger during the third quarter of 2018. For the three and six months ended June 30, 2018, the Company incurred costs of $906,000 and $1.3 million, respectively, related to the Merger Agreement, which are currently included in the “General and administrative expenses” line on the Condensed Consolidated Statement of Operations.
Basis of Presentation
The condensed consolidated financial statements include the accounts of Echelon Corporation, a Delaware corporation, its wholly-owned subsidiaries, and a subsidiary in which it has a controlling interest (collectively referred to as the “Company”). The Company reports non-controlling interests in consolidated entities as a component of equity separate from the Company’s equity. All material inter-company transactions between and among the Company and its consolidated subsidiaries and other consolidated entities have been eliminated in consolidation.
While the financial information furnished is unaudited, the condensed consolidated financial statements included in this report reflect all adjustments (consisting only of normal recurring adjustments) which the Company considers necessary for the fair presentation of the results of operations for the interim periods covered, and of the financial condition of the Company at the date of the interim balance sheet. The results for interim periods are not necessarily indicative of the results for the entire year. The condensed consolidated financial statements should be read in conjunction with the Company’s consolidated financial statements for the year ended December 31, 2017 included in its Annual Report on Form 10‑K.
Apart from the Company's adoption of new revenue recognition guidance discussed more fully below, there have been no material changes to the Company’s significant accounting policies as compared to the significant accounting policies described in its Annual Report on Form 10‑K for the fiscal year ended December 31, 2017.
Risks and Uncertainties
The Company’s operations and performance depend significantly on worldwide economic conditions and their impact on purchases of the Company’s products, as well as the ability of suppliers to provide the Company with products and services in a timely manner. The impact of any of the matters described below could have an adverse effect on the Company’s business, results of operations and financial condition.
The Company’s sales are currently concentrated, as approximately 38.2% of revenues for the six months ended June 30, 2018, were derived from two customers, Avnet Europe Comm VA ("Avnet"), the Company's primary distributor of its IIoT products in Europe and Japan; and Engenuity Systems, Inc., a reseller of the Company's products focused primarily in the United States. Customers in any of the Company’s target market sectors may experience unexpected reductions in demand for their products and consequently reduce their purchases from the Company,

7


resulting in either the loss of a significant customer or a notable decrease in the level of sales to a significant customer.  In addition, if any of these customers are unable to obtain the necessary capital to operate their business, they may be unable to satisfy their payment obligations to the Company.
The Company utilizes third-party contract electronic manufacturers to manufacture, assemble, and test its products.   If any of these third-parties were unable to obtain the necessary capital to operate their business, they may be unable to provide the Company with timely services or to make timely deliveries of products. 
From time to time, the Company has experienced shortages or interruptions in supply for certain products or components used in the manufacture of the Company’s products that have been or will be discontinued. In order to ensure an adequate supply of these items, the Company has occasionally purchased quantities of these items that are in excess of the Company’s then current estimate of short-term requirements. If the long-term requirements do not materialize as originally expected, or if the Company develops alternative solutions that no longer employ these items and the Company is not able to dispose of these excess products or components, the Company could be subject to increased levels of excess and obsolete inventories.
In an effort to manage costs and inventory risks, the Company has decreased the inventory levels of certain products. If there is an unexpected increase in demand for these items, the Company might not be able to supply its customers with products in a timely manner.
Due to the nature of development efforts in general, the Company can experience delays in the introduction of new or improved products beyond its original projected shipping date for such products. These delays can result in increased development costs and delays in the ability to generate revenues from these new products. Furthermore, when such new products are developed, there is no guarantee that they will meet customer requirements or will otherwise be acceptable to them, which could cause them to discontinue buying these products. This could have a material adverse effect on the Company's revenues and results of operations.
Use of Estimates
The preparation of financial statements and related disclosures in conformity with accounting principles generally accepted in the United States of America requires management to make judgments, assumptions, and estimates that affect amounts reported in the Condensed Consolidated Financial Statements and accompanying notes. Significant estimates and judgments are used for revenue recognition, performance-based equity compensation, inventory valuation, intangible asset valuation, contingent consideration valuation, allowance for warranty costs, and other loss contingencies. In order to determine the carrying values of assets and liabilities that are not readily apparent from other sources, the Company bases its estimates and assumptions on current facts, historical experience, and various other factors that it believes to be reasonable under the circumstances. Actual results experienced by the Company may differ materially from management’s estimates.
Recently Issued Accounting Standards

(i) New Accounting Standards Recently Adopted

In May 2014, the FASB issued a new standard related to revenue recognition, ASC 606 - Revenue from Contracts with Customers ("ASC 606"). Under the standard, revenue is recognized when a customer obtains control of promised goods or services in an amount that reflects the consideration the entity expects to receive in exchange for those goods or services. In addition, the standard requires disclosure of the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers.

The Company adopted ASC 606 effective January 1, 2018, using the full retrospective method, which required the Company to restate each prior reporting period presented. The most significant impact of the standard relates to the Company's accounting for sales made to distributors under agreements that contain a limited right to return unsold products and price adjustment provisions. Under previous revenue guidance, the Company historically concluded that the price to these distributors was not fixed or determinable at the time it delivers products to them. Accordingly, revenue from sales to these distributors has not historically been recognized until the distributor resells the product. By contrast, under the new standard, the Company will recognize revenue, including estimates for applicable variable consideration, predominately at the time of shipment to these distributors, thereby accelerating the timing of revenue for products sold through the distribution channel. Revenue recognition related to transactions not involving the Company's distributor partners remains substantially unchanged.

Adoption of the standard using the full retrospective method required the Company to restate certain previously reported results. In summary, adoption of the standard resulted in the recognition of modestly higher revenues for the three and six months ended June 30, 2017. In addition, as of December 31, 2017, adoption of the standard resulted in a reduction of deferred

8


revenues driven by the recognition of revenues associated with on-hand distributor inventory as of that date, the revenue for which was deferred under previous guidance; a decrease of deferred cost of goods sold, again driven by the recognition of revenue that was deferred under previous guidance; and a decrease in accounts receivable, driven by the incremental reserves required for estimated price adjustments that will be issued to the distributors in the future based on the additional revenue recognized under the new guidance. Adoption of the standard impacted our previously reported results as follows (in thousands, except earnings per share amounts): 

Three Months Ended June 30, 2017

As Reported

New Revenue Standard Adjustment

As Adjusted
Statement of Operations:





Revenue
$
8,021


$
316


$
8,337

Net loss
(1,370
)

193


(1,177
)
Basic and diluted loss per share
$
(0.31
)

$
0.05


$
(0.26
)
 
Six Months Ended June 30, 2017
 
As Reported
 
New Revenue Standard Adjustment
 
As Adjusted
Statement of Operations:
 
 
 
 
 
Revenue
$
15,820

 
$
220

 
$
16,040

Net loss
(2,569
)
 
131

 
(2,438
)
Basic and diluted loss per share
$
(0.58
)
 
$
0.03

 
$
(0.55
)

 
December 31, 2017
 
As Reported
 
New Revenue Standard Adjustment
 
As Adjusted
Balance Sheets:
 
 
 
 
 
Accounts receivable, net
$
2,721

 
$
(425
)
 
$
2,296

Deferred cost of goods sold
1,767

 
(728
)
 
1,039

Deferred revenues
4,805

 
(2,993
)
 
1,812

Stockholders' equity
21,887

 
1,840

 
23,727


(ii) New Accounting Standards Not Yet Effective

In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842), which requires, among other things, the recognition of lease assets and lease liabilities on the balance sheet by lessees for certain leases classified as operating leases under previous GAAP.  ASU 2016-02 is effective for annual and interim periods beginning after December 15, 2018.  ASU 2016-02 mandates a modified retrospective transition method with early adoption permitted.  The Company is currently evaluating the effect that ASU 2016-02 will have on its consolidated financial statements and related disclosures. 

Revenue Recognition

The Company’s revenues are derived from the sale and license of its products and, to a lesser extent, from fees associated with training, technical support, and other services offered to its customers. Product revenues consist of revenues from hardware sales and software licensing arrangements. Service revenues consist of product technical support and training.

The Company recognizes revenue upon transfer of control of promised products or services to customers in an amount that reflects the consideration the Company expects to receive in exchange for those products or services. The Company enters into contracts that can include various combinations of products and services, which in most instances are capable of being distinct and accounted for as separate performance obligations. In the case of product sales, the Company's performance obligations are generally met and revenue is recognized at the time of shipment of the products to the customer because the customer has

9


significant risks and rewards of ownership of the asset and the Company has a present right to payment at that time. For service revenues, these criteria are generally met at the time the services have been performed for the same reasons. Revenue is recognized net of allowances for returns and any taxes collected from customers, which are subsequently remitted to governmental authorities.

The Company's contracts with customers often include promises to transfer multiple products and services to a customer. Determining whether products and services are considered distinct performance obligations that should be accounted for separately versus together may require significant judgment. For example, in certain instances, the Company's outdoor lighting control customers may contract with the Company to perform certain services when deploying the Company's outdoor lighting control solution. These services require that the Company "commission" the outdoor lighting control system by integrating the hardware (purchased from the Company and installed by the customer) with the Company's Central Management System ("CMS") software. These systems depend on a significant level of integration and interdependency between the hardware and the CMS. Judgment is required to determine whether the commissioning services are considered distinct and accounted for separately, or not distinct and accounted for together with the system hardware and CMS.

The transaction price for a contract is allocated to each distinct performance obligation and recognized as revenue when, or as, each performance obligation is satisfied. For contracts with multiple performance obligations, the Company allocates the transaction price to each performance obligation using the best estimate of the standalone selling price ("SSP") of each distinct good or service in a contract. Judgment is required to determine the SSP for each distinct performance obligation. The primary method used to estimate the SSP is the observable price when the good or service is sold separately in similar circumstances and to similar customers. If the SSP is not directly observable, it is estimated using either a market adjustment or cost plus margin approach.

The Company's products are generally sold without a right of return. However, the Company may provide other credits or incentives, which are accounted for as variable consideration when estimating the amount of revenue to recognize. For example, in many instances, the Company issues Point of Sale ("POS") credits to its distributors when they sell certain of the Company's products to their end use customers. In these cases, the Company is required to estimate (and reserve for) the amount of future POS credits it will issue to the distributors associated with unsold inventory they have on hand at the end of the period. The Company also grants its distributor partners a limited ability to return unsold product in the form of stock rotation rights. Judgment is required to determine the amount of variable consideration associated with these POS credits and stock rotation rights, which are estimated at contract inception and updated at the end of each reporting period as additional information becomes available and only to the extent that it is probable that a significant reversal of any incremental revenue will not occur.

In accordance with ASC 606, the Company disaggregates its revenue from contracts with customers into geographical regions as the Company determined that disaggregating revenue into these categories meets the disclosure objective in ASC 606, which is to depict how the nature, amount, timing and uncertainty of revenue and cash flows are affected by regional economic factors. Information regarding revenues disaggregated by geographic area can be found in Note 10 - Segment Disclosure. The Company has not provided disaggregation information associated with product and service revenues as the amount of service revenues are immaterial in the periods presented. Similarly, no disaggregation information has been provided for revenues based on the timing of when goods and services are transferred as the amount of revenue associated with products and services recognized over time is also immaterial.

The Company invoices its customers upon shipment in the case of hardware sales, and upon the completion of the required services for service revenues. These invoices are generally issued with net 30 day payment terms. However, in certain instances, the Company may offer payment terms of up to 75 days.

The Company generally sells its hardware products with a one-year warranty against defects or failure. However, in some cases, the Company's hardware products come with a standard five-year warranty. As of June 30, 2018 and December 31, 2017, the Company's warranty reserves totaled $402,000 and $350,000, respectively, and are included in Accrued liabilities and Other long-term liabilities on the unaudited condensed consolidated balance sheets.

The Company's contract assets were immaterial at both June 30, 2018 and December 31, 2017. The Company's contract liabilities consist generally of deferred revenue where the Company has unsatisfied performance obligations, and are classified as such on the unaudited condensed consolidated balance sheets. The following table reflects changes in contract balances for the six months ended June 30, 2018 and 2017 (in thousands):

10



Six Months Ended

June 30, 2018

June 30, 2017




Beginning balance
$
1,812


$
1,057

Deferred revenues added
600


313

Elimination of deferred revenues due to joint venture liquidation
(986
)


Previously deferred revenues recognized
(338
)

(311
)
Ending balance
$
1,088


$
1,059


During the six months ended June 30, 2018 and 2017, deferred revenues increased primarily as a result of sales of products where cash payments are received or due for hardware products in advance of satisfying the service related performance obligation associated with those hardware products. Similarly, previously deferred revenues were recognized during the six months ended June 30, 2018 and 2017 once the underlying service related performance obligations were completed.

The Company recognizes an asset for the incremental costs of obtaining a contract with a customer if it expects the benefit of those costs to be longer than one year. These assets are then amortized over the period of benefit of the related revenue. The Company expenses immediately any incremental costs of obtaining a contract when the amortization period would be one year or less. These costs are recorded within sales and marketing expenses. As of June 30, 2018 and December 31, 2017, there were no customer contracts in effect that had incremental costs meeting the requirement for capitalization.

In adopting ASC 606, the Company has elected the following practical expedients:
In accordance with Subtopic 340-40 "Other Assets and Deferred Costs - Contracts with Customers," the Company has elected to expense the incremental costs of obtaining a contract when the amortization period for such contracts would have been one year or less.
In accordance with ASC 606-10-50-14, the Company has elected not to disclose the remaining performance obligations where the underlying contract's original expected duration is one year or less and revenue from the satisfaction of the performance obligations is recognized in the amount invoiced in accordance with ASC 606-10-55-18.
The Company has made an accounting policy election to exclude all taxes by governmental authorities from the measurement of the transaction price.
Deferred Revenue and Deferred Cost of Revenues
Deferred revenue consists of amounts billed or payments received in advance of revenue recognition. Deferred cost of revenues related to deferred product revenues includes direct product costs and applied overhead. Deferred cost of revenues related to deferred service revenues includes direct labor costs and applied overhead. Once all revenue recognition criteria have been met, the deferred revenues and associated cost of revenues are recognized.
Restricted Investments
As of June 30, 2018, restricted investments consist of balances maintained by the Company with an investment advisor in money market funds and permitted treasury bills. These balances represent collateral for a $1.0 million operating line of credit issued to the Company by its primary bank for credit card purchases. Because the Company’s agreement with the lender prevents the Company from withdrawing these funds, they are considered restricted.

Fair Value Measurements
The Company measures at fair value its cash equivalents and available-for-sale investments using a valuation hierarchy based on whether the inputs to those valuation techniques are observable or unobservable. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect the Company's own assumptions. These two types of inputs have created the following fair value hierarchy:

Level 1 - Quoted prices for identical instruments in active markets;
Level 2 - Quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-derived valuations in which all significant inputs and significant value drivers are observable in active markets; and
Level 3 - Valuations derived from valuation techniques in which one or more significant inputs or significant value

11


drivers are unobservable.
This hierarchy requires the Company to minimize the use of unobservable inputs and to use observable market data, if available, when estimating fair value. Other than cash and money market funds, the Company's only financial assets and liabilities required to be measured at fair value on a recurring basis at June 30, 2018, are its fixed income available-for-sale debt securities. See Note 2 of these Notes to condensed consolidated financial statements for a summary of the input levels used in determining the fair value of these assets and liabilities as of June 30, 2018.

Long-Lived Assets
    
We perform periodic reviews to determine whether facts and circumstances exist that would indicate that the carrying amounts of property, plant and equipment and long-lived intangible assets might not be fully recoverable. If facts and circumstances indicate that the carrying amount of these assets might not be fully recoverable, we compare projected undiscounted net cash flows associated with the related asset or group of assets over their estimated remaining useful lives against their respective carrying amounts. In the event that the projected undiscounted cash flows are not sufficient to recover the carrying value of the assets, the assets are written down to their estimated fair values based on the expected discounted future cash flows attributable to the assets. Evaluation of impairment of property, plant and equipment and long-lived intangible assets requires estimates in the forecast of future operating results that are used in the preparation of the expected future undiscounted cash flows. Actual future operating results and the remaining economic lives of our property, plant and equipment and long-lived intangible assets could differ from our estimates used in assessing the recoverability of these assets. These differences could result in impairment charges, which could have a material adverse impact on our results of operations. 
2. Financial Instruments:
The Company’s financial instruments consist of cash equivalents, restricted investments, short-term investments, accounts receivable, and accounts payable. The carrying value of the Company’s financial instruments approximates fair value. Financial instruments that potentially subject the Company to concentrations of credit risk consist principally of investments, which are classified as either cash equivalents, restricted investments, or short-term investments, and accounts receivable. With respect to its investments, the Company has an investment policy that limits the amount of credit exposure to any one financial institution and restricts placement of the Company’s investments to financial institutions independently evaluated as highly creditworthy. With respect to its accounts receivable, the Company performs ongoing credit evaluations of each of its customers’ financial condition. For a customer whose credit worthiness does not meet the Company’s minimum criteria, the Company may require partial or full payment prior to shipment. Alternatively, prior to shipment, customers may be required to provide the Company with an irrevocable letter of credit or arrange for some other form of coverage to mitigate the risk of uncollectibility, such as a bank guarantee. Additionally, the Company establishes an allowance for doubtful accounts and sales return allowances based upon factors surrounding the credit risk of specific customers, historical trends, and other available information.

Assets and Liabilities Measured at Fair Value on a Recurring Basis
On a recurring basis, the Company measures certain of its financial assets, namely its cash equivalents and available-for-sale debt securities, at fair value. The fair value of the Company’s financial assets measured at fair value on a recurring basis was determined using the following inputs at June 30, 2018 (in thousands):
 
Fair Value Measurements at Reporting Date Using
 
 
 
Quoted Prices in Active Markets for Identical Assets
 
Significant Other Observable Inputs
 
Significant Unobservable Inputs
 
Total
 
(Level 1)
 
(Level 2)
 
(Level 3)
Assets:
 
 
 
 
 
 
 
Money market funds (1)
$
2,665

 
$
2,665

 
$

 
$

U.S. government securities(2)
13,190

 

 
13,190

 

Total
$
15,855

 
$
2,665

 
$
13,190

 
$

The fair value of the Company’s financial assets measured at fair value on a recurring basis was determined using the following inputs at December 31, 2017 (in thousands):

12


 
Fair Value Measurements at Reporting Date Using
 
 
 
Quoted Prices in Active Markets for Identical Assets
 
Significant Other Observable Inputs
 
Significant Unobservable Inputs
 
Total
 
(Level 1)
 
(Level 2)
 
(Level 3)
Assets:
 
 
 
 
 
 
 
Money market funds (1)
$
4,515

 
$
4,515

 
$

 
$

U.S. government securities(2)
13,217

 

 
13,217

 

Total
$
17,732

 
$
4,515

 
$
13,217

 
$

(1)    Included in cash and cash equivalents in the Company’s condensed consolidated balance sheets
(2) 
Represents the portfolio of available for sale securities that is included in restricted investments and short-term investments in the Company’s condensed consolidated balance sheets
Cash equivalents consist of either investments with remaining maturities of three months or less at the date of purchase, or money market funds for which the carrying amount is a reasonable estimate of fair value.
The Company’s available-for-sale securities consist of U.S. government securities with a minimum and weighted average credit rating of A-1+. The Company values these securities based on pricing from pricing vendors, who may use quoted prices in active markets for identical assets (Level 1 inputs) or inputs other than quoted prices that are observable either directly or indirectly (Level 2 inputs) in determining fair value. However, the Company classifies all of its fixed income available-for-sale securities as having Level 2 inputs. The valuation techniques used to measure the fair value of the Company’s financial instruments having Level 2 inputs were derived from non-binding market consensus prices that are corroborated by observable market data, quoted market prices for similar instruments, or pricing models, such as discounted cash flow techniques. The Company's procedures include controls to ensure that appropriate fair values are recorded by comparing prices obtained from a third party independent source.
As of June 30, 2018, the Company’s available-for-sale securities had contractual maturities of six months and an average remaining term to maturity of three months. As of June 30, 2018, the amortized cost basis, aggregate fair value, and gross unrealized holding gains and losses of the Company’s short-term investments by major security type were as follows (in thousands):
 
Amortized Cost
 
Aggregate Fair Value
 
Unrealized Holding Gains
 
Unrealized Holding Losses
U.S. government securities
$
11,939

 
$
11,940

 
$
1

 
$

The amortized cost basis, aggregate fair value and gross unrealized holding gains and losses for the Company’s available-for-sale short-term investments, by major security type, were as follows as of December 31, 2017 (in thousands):
 
Amortized Cost
 
Aggregate Fair Value
 
Unrealized Holding Gains
 
Unrealized Holding Losses
U.S. government securities
$
11,970

 
$
11,967

 
$

 
$
3

Market values were determined for each individual security in the investment portfolio. The Company reviews its investments on a regular basis to evaluate whether or not any have experienced an other-than-temporary decline in fair value.
3. Earnings Per Share:

The computation of diluted net loss per share does not include stock options and performance shares of 995,154 and 923,306 for the three and six months ended June 30, 2018 and 2017, respectively, because the effect of their inclusion would be anti-dilutive based on their respective exercise prices.
4. Stockholders’ Equity and Employee Stock Option Plans:
On April 17, 2017, the Company's Board of Directors approved an amendment to the Tax Benefit Preservation Plan (the "Tax Plan"), dated as of April 22, 2016, by and between the Company and Computershare Inc., as rights agent (the “Rights Agent”), to extend the Final Expiration Date (as such term is defined in the Tax Plan) to April 25, 2019.


13


Stock-based Compensation Expense

The following table summarizes stock-based compensation expense for the three months ended June 30, 2018 and 2017 and its allocation within the condensed consolidated statements of operations (in thousands):

 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2018
 
2017
 
2018
 
2017
 
 
 
 
 
 
 
 
Cost of revenues
$
60

 
$
45

 
$
118

 
$
74

Product development
105

 
119

 
199

 
243

Sales and marketing
91

 
27

 
179

 
129

General and administrative
253

 
251

 
457

 
463

Total
$
509

 
$
442

 
$
953

 
$
909


Stock Award Activity
 
There were no options exercised during the three and six months ended June 30, 2018 and 2017.

The total fair value of RSUs vested and released during the three and six months ended June 30, 2018 was $4,000 and $173,000, respectively. The total fair value of RSUs vested and released during the three and six months ended June 30, 2017 was approximately $147,000 and $196,000, respectively. The fair value is calculated by multiplying the fair market value of the Company’s common stock on the vesting date by the number of shares of common stock issued upon vesting.
5.    Significant Customers:
The Company markets its products and services throughout the world to original equipment manufacturers (OEMs) and systems integrators in the building, industrial, transportation, utility/home, and other automation markets. During the three and six months ended June 30, 2018 and 2017, the Company had two customers that accounted for a significant portion of its revenues: Avnet Europe Comm VA (“Avnet”), the Company’s primary distributors of its IIoT products in Europe and Japan; and Engenuity Systems, Inc. ("Engenuity), a reseller of the Company's products focused mainly in the United States. For the three and six months ended June 30, 2018 and 2017, the percentage of the Company’s revenues attributable to sales made to these customers was as follows:
 
Three Months Ended
 
Six Months Ended
 
June 30, 2018
 
June 30, 2017
 
June 30, 2018
 
June 30, 2017
 
 
 
 
 
 
 
 
Avnet
27.7
%
 
29.4
%
 
27.6
%
 
27.4
%
Engenuity
8.2
%
 
6.1
%
 
10.6
%
 
7.7
%
 
35.9
%
 
35.5
%
 
38.2
%
 
35.1
%
6. Commitments and Contingencies:

Legal Actions
From time to time, in the ordinary course of business, the Company may be subject to certain legal proceedings, claims, investigations, and other proceedings, including claims of alleged infringement of third-party patents and other intellectual property rights, and commercial, employment, or other matters. In accordance with generally accepted accounting principles, the Company makes a provision for a liability when it is both probable that a liability has been incurred and the amount of the loss can be reasonably estimated. These provisions are reviewed at least quarterly and adjusted to reflect the impacts of negotiations, settlements, rulings, advice of legal counsel, and other information and events pertaining to a particular case. While the Company believes it has adequately provided for such contingencies as of June 30, 2018, the amounts of which were immaterial, it is possible that the Company’s results of operations, cash flows, and financial position could be harmed by the resolution of any such outstanding claims.

14


Litigation Relating to the Merger

On June 28, 2018, the Company entered into the Merger Agreement. On July 20, 2018, and July 26, 2018, putative class action lawsuits were filed by purported stockholders of the Company in the United States District Court for the Northern District of California and in the United States District Court for the District of Delaware (the “Lawsuits”). The Lawsuits are captioned Aducci v. Echelon Corporation, et al., No. 5:18-cv-4415 (N.D. Cal.) and Rosenblatt v. Echelon Corporation, et al., No. 1:18-cv-01103-UNA (D. Del.). The Lawsuits assert claims under Section 14(a) and Section 20(a) of the Securities Exchange Act of 1934 in connection with the disclosures contained in the preliminary proxy statement filed by the Company with the Securities and Exchange Commission on July 16, 2018. The Lawsuits name the Company and its directors as defendants. The complaints seek a variety of equitable and injunctive relief including, among other things, enjoining the consummation of the merger and awarding the plaintiffs costs and attorneys’ fees. The Company’s management believes that the plaintiffs’ claims are without merit and the defendants intend to defend the Lawsuits vigorously. As of June 30, 2018, no amounts have been provided for the Lawsuit.
Line of Credit
As of June 30, 2018, the Company maintained an operating credit line of $1.0 million with its primary bank for company credit card purchases. This line of credit is secured by a collateral of the first priority on $1.3 million of the Company's investments (presented as restricted investments in the condensed consolidated balance sheets). The restricted investments are classified as current assets due to the contractual duration of the underlying credit agreement.
7. Accumulated Other Comprehensive Income (Loss), Net of Tax (Amounts in thousands):
 
Foreign currency translation adjustment
 
Unrealized gain (loss) on available-for-sale debt securities
 
Accumulated Other Comprehensive Income (Loss)
Beginning balance at December 31, 2017
$
(1,818
)
 
$
(3
)
 
$
(1,821
)
Change during January - June 2018
(188
)
 
4

 
(184
)
Balance at June 30, 2018
$
(2,006
)
 
$
1

 
$
(2,005
)

None of the above amounts have been reclassified in the condensed consolidated statement of operations.
8.     Inventories:

Inventories are stated at the lower of cost (first‑in, first‑out) or net realizable value and include material, labor and manufacturing overhead. When required, provisions are made to reduce excess and obsolete inventories to their estimated net realizable value. Inventories consist of the following (in thousands):
 
June 30,
2018
 
December 31,
2017
 
 
 
 
Purchased materials
$
622

 
$
148

Finished goods
2,329

 
3,103

 
$
2,951

 
$
3,251

9. Accrued Liabilities:

Accrued liabilities consist of the following (in thousands):
 
June 30,
2018
 
December 31,
2017
 
 
 
 
Accrued payroll and related costs
$
1,046

 
$
1,088

Warranty reserve
187

 
142

Restructuring charges
185

 
185

Other accrued liabilities
350

 
463

 
$
1,768

 
$
1,878


15


10.    Segment Disclosure:

ASC Topic 280, Segment Reporting, establishes standards for reporting information about operating segments, products and services, geographic areas of operations and major customers. Operating segments are defined as components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision maker in deciding how to allocate resources and in assessing business performance. The Company’s chief operating decision-making group is the Executive Staff, which is comprised of the Chief Executive Officer and his direct reports (CODM). The Company operates in one principal industry segment - the IIoT segment, which is its reportable segment.

The Company operates in three main geographic areas: the Americas; Europe, Middle East and Africa (“EMEA”); and Asia Pacific / Japan (“APJ”). Each geographic area provides products and services to the Company’s customers located in the respective region. The Company’s long-lived and other assets include property and equipment, acquired intangible assets, and deposits on its leased facilities. Long-lived assets are attributed to geographic areas based on the country where the assets are located. As of June 30, 2018 and December 31, 2017, long-lived assets of approximately $1.4 million and $2.1 million, respectively, were domiciled in the United States. Long-lived assets for all other locations are not material to the condensed consolidated financial statements.

In North America, the Company sells its products primarily through a direct sales organization and select third-party electronics representatives. Outside North America, the Company sells its products through direct sales organizations, value-added resellers, and local distributors, primarily in EMEA and APJ. Revenues are attributed to geographic areas based on the country where the products are shipped to or the services are delivered. Summary revenue information by geography for the three and six months ended June 30, 2018 and 2017 is as follows (in thousands):
 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2018
 
2017
 
2018
 
2017
Americas
$
3,279

 
$
3,468

 
$
6,770

 
$
6,718

EMEA
2,587

 
2,881

 
5,132

 
5,487

APJ
2,051

 
1,988

 
3,852

 
3,835

Total
$
7,917

 
$
8,337

 
$
15,754

 
$
16,040


For information regarding the Company’s major customers, please refer to Note 5, Significant Customers.
11. Income Taxes:
The provision for income taxes for the three months ended June 30, 2018 and 2017 was $30,000 and $29,000, respectively. The provision for income taxes for the six months ended June 30, 2018 and 2017 was $24,000 and $23,000, respectively. The difference between the statutory rate and the Company’s effective tax rate is primarily due to the impact of foreign taxes, changes in the valuation allowance on deferred tax assets, and changes in the accruals related to unrecognized tax benefits.
As of June 30, 2018 and December 31, 2017, the Company had gross unrecognized tax benefits of approximately $9.4 million and $9.3 million, respectively, of which $317,000 and $332,000, respectively, if recognized, would impact the effective tax rate on income from continuing operations. The Company’s policy is to recognize interest and/or penalties related to unrecognized tax benefits in income tax expense. As of June 30, 2018 and December 31, 2017, the Company had accrued $46,000 and $56,000, respectively, for interest and penalties. The $10,000 reduction in interest and penalties on gross unrecognized tax benefits during the six months ended June 30, 2018 was primarily attributable to the expiration of the statute of limitations in certain foreign jurisdictions.     
12. Related Parties:
In June 2000, the Company entered into a stock purchase agreement with Enel pursuant to which Enel purchased 300,000 newly issued shares of its common stock for $130.7 million. To the Company’s knowledge, Enel has disposed of none of its 300,000 shares. Under the terms of the stock purchase agreement, Enel has the right to nominate one member of the Company’s board of directors. While a representative of Enel served on the board until March 14, 2012, no Enel representative is presently on the board.
In October 2006, the Company entered into a new development and supply agreement with Enel. Under the development and supply agreement, Enel and its contract manufacturers purchase additional electronic components and finished goods from the Company. The development and supply agreement expired in March 2016.

16


For the three and six months ended June 30, 2018 and 2017, the Company recognized no revenue from products sold to Enel and its designated manufacturers.
As of June 30, 2018 and December 31, 2017, none of the Company’s total accounts receivable balance related to amounts owed by Enel and its designated manufacturers.
13. Joint Venture:
On March 23, 2012, the Company entered into an agreement with Holley Metering Limited (“Holley Metering”), a designer and manufacturer of energy meters in China, to create a joint venture, Zhejiang Echelon-Holley Technology Co., Ltd. (“Echelon-Holley”). The joint venture's intended focus was on the development and sales of smart energy products for China and rest-of-world markets. The Company had a 51.0% ownership interest in the joint venture and exercised controlling influence. Therefore, Echelon-Holley’s accounts have been included in the Company’s condensed consolidated financial statements up until the point of its liquidation (see below). Holley Metering’s interests in Echelon-Holley’s net assets were reported in the non-controlling interest in subsidiary on the condensed consolidated balance sheet as of December 31, 2017. Net loss attributable to the non-controlling interest in Echelon-Holley was $0 and $0 during the three and six months ended June 30, 2018 and 2017, respectively.
As of March 23, 2018, Echelon and Holley Metering had contributed in cash a total of approximately $4.0 million in Share Capital, as defined in the joint venture agreement, to Echelon-Holley in proportion to their respective ownership interests.
In connection with the decision to sell the Grid business announced in the third quarter of 2014, the Company undertook a process to sell the remaining net assets of the joint venture and recorded the net assets and liabilities of the joint venture at the lower of their carrying amount or fair value less cost to sell, and classified them as held for sale on the accompanying balance sheet at December 31, 2014. The major classes of assets and liabilities that were classified as held for sale were inventory, deferred revenues and the related deferred costs of sales, and accrued liabilities.
During the quarter ended September 30, 2015, the Company concluded that it would no longer pursue a sale, but would instead work with Holley Metering to shut the joint venture down. The remaining net assets of the joint venture were immaterial as of September 30, 2015.
In early April 2018, the Company was informed by the Chinese authorities that the liquidation of Echelon-Holley had been completed on March 23, 2018. This resulted in a gain on liquidation of approximately $424,000, which is reflected in the Interest and other income (expense), net line in the Company's Condensed Consolidated Statement of Operations for the six months ended June 30, 2018.
14. Restructuring:
During the fourth quarter of 2016, the Company undertook restructuring actions affecting approximately 7 employees to be terminated between October 2016 and November 2018, as part of an overall plan to reshape the Company for the future. In connection with this restructuring, the Company recorded restructuring charges of approximately $286,000 related to termination benefits for these personnel during the year ended December 31, 2016.
The following table sets forth a summary of restructuring activities related to the Company's 2016 restructuring program in 2018 (in thousands):
    
December 31, 2017
 
Costs Incurred
 
Cash Payments
 
June 30, 2018
Termination benefits
$
185

 
$

 
$

 
$
185

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,” "target"," and similar expressions. Forward-looking statements include statements that refer to projections of our future

17


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 IIoT revenues; our expectations on shipments to Enel and revenues from Enel; 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; estimates of our interest income and expense; our belief that we have adequately provided for legal contingencies; our belief that we have made adequate provisions for tax exposure and legal matters; and statements regarding our pending merger with Adesto Technologies Corporation. 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, except as required by law.

EXECUTIVE OVERVIEW
Echelon Corporation was incorporated in California in February 1988 and reincorporated in Delaware in January 1989. We went public on the NASDAQ market under the symbol "ELON" in July, 1998. We are based in Santa Clara, California, and maintain offices in several foreign countries throughout Europe and Asia. Our products enable "things" in commercial and industrial applications — such as air conditioners, lighting, manufacturing equipment, 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 widely deployed, open standard, multi-vendor energy control networking platform powers applications for smart cities, smart buildings, and smart campuses that help customers save on their energy usage; prevent failure or reduce failure duration; reduce carbon footprint; improve safety, comfort, and convenience; and more. Our solutions, which feature a programmable, distributed intelligence architecture that is designed for both high reliability and fast action, are implemented over the powerline or through wireless communication systems for flexibility in installation and operation.

We offer two product lines, the first of which is comprised of chips, modules, gateways, and design and management software that enables Original Equipment Manufacturers ("OEMs") to quickly design and bring to market interoperable smart systems for their commercial and industrial customers. These products are generally marketed under the LONWORKS and IzoT brand names. We refer to revenues from these products as "embedded systems" revenues.

Our second product line is a range of control networking solutions designed specifically for the lighting market within the IIoT. As this market continues its transition to solid state lighting, or LEDs, we have focused our initial offerings on outdoor lighting control solutions, as we believe that the incremental energy savings, maintenance benefits, and safety improvements resulting from the implementation of controls offers a compelling return on investment. In addition, due to the abundance of lighting fixtures in most locations, the lighting control system can host a variety of "smart" applications that can further improve safety and comfort on roadways, in parking lots and garages, on campuses, in tunnels, and more. Our lighting control solutions consist of wired and wireless control nodes placed at the lighting fixtures of a wide variety of manufacturers, “smart” gateways for interconnecting the control nodes, and a software-based Central Management System, or CMS, which is used for startup, commissioning, management, and monitoring of the lighting network. These solutions are sold to end users typically through manufacturers' representatives, energy services companies, and distributors, and are generally marketed under the LumInsight and Lumewave by Echelon brand names. We refer to revenues from these products as "outdoor lighting" revenues.

The following tables provide an overview of key financial metrics for the three and six months ended June 30, 2018 and 2017 that our management team focuses on in evaluating our financial condition and operating performance (in thousands, except percentages).

18


 
Three Months Ended
June 30,
 
 
 
 
 
2018
 
2017
 
$ Change
 
% Change
Revenues
$
7,917

 
$
8,337

 
$
(420
)
 
(5.0
)%
Gross margin
56.1
%
 
56.6
%
 
---

 
(0.5 ppt)

Operating expenses
$
6,013

 
$
5,647

 
$
366

 
6.5
 %
Net loss
$
(1,222
)
 
$
(1,177
)
 
$
(45
)
 
3.8
 %
 
 
 
 
 
 
 
 
 
Six Months Ended
June 30,
 
 
 
 
 
2018
 
2017
 
$ Change
 
% Change
Revenues
$
15,754

 
$
16,040

 
$
(286
)
 
(1.8
)%
Gross margin
56.0
%
 
56.9
%
 
---

 
(0.9) ppt

Operating expenses
$
12,033

 
$
11,260

 
$
773

 
6.9
 %
Net loss
$
(2,601
)
 
$
(2,438
)
 
$
(163
)
 
6.7
 %
 
 
 
 
 
 
 
 
 
Balance as of
 
 
 
 
 
June 30,
2018
 
December 31,
2017
 
$ Change
 
% Change
Cash, cash equivalents, and short-term investments *
$
18,110

 
$
20,478

 
$
(2,368
)
 
(11.6
)%
* As of June 30, 2018 and December 31, 2017, includes $1.3 million of restricted investments presented separately on condensed consolidated balance sheet
Revenues: Our revenues decreased by 5.0% during the second quarter of 2018 as compared to the same period in 2017, and by 1.8% during the six months ended June 30, 2018 as compared to the same period in 2017. The decrease in revenues between the two six month periods was mainly due to a decrease in sales to customers in the EMEA region. In addition, between the two quarterly periods, a slight reduction in sales made to customers in the Americas also contributed to the decline. For further analysis please see the topic Revenues in the Results of Operations discussion later in this section.
Gross margin: Our gross margins decreased by 0.5 percentage points during the second quarter of 2018 as compared to the same period in 2017, and by 0.9 percentage points during the six months ended June 30, 2018 as compared to the same period in 2017. These fluctuations were primarily due to lower overall revenues and an increase in the indirect costs in our cost of goods sold departments. For further analysis please see the topic Gross Profit and Gross Margin in the Results of Operations discussion later in this section.
Operating expenses: Our operating expenses increased by 6.5% during the three months ended June 30, 2018, as compared to the same period in 2017, and by 6.9% during the six month ended June 30, 2018, as compared to the same period in 2017. These increases were primarily due to increases in our general and administrative spending, which was directly attributable to costs we've incurred associated with our pending merger (see further discussion below). For further analysis please see the topic Operating Expenses in the Results of Operations discussion later in this section.
Net loss: We generated a net loss of $1.2 million during the second quarter of 2018 compared to $1.2 million during the same period in 2017. During the six months ended June 30, 2018, we generated a net loss of $2.6 million as compared to $2.4 million during the same period in 2017. These increases in our net loss were mainly attributable to reductions in our revenues (and the corresponding gross profit), as well as increases in our operating expenses.
Cash, cash equivalents, and short-term investments: During the first six months of 2018, our cash, cash equivalents, and short-term investment balance decreased by 11.6%, from $20.5 million at December 31, 2017 to $18.1 million at June 30, 2018. This decrease was primarily the result of cash used in operations of $1.8 million (driven primarily by our net loss of $2.6 million) and a $432,000 distribution of the remaining cash at our liquidated Chinese joint venture to our joint venture partner, Holley Metering.
Recent Merger Announcement

On June 28, 2018, Adesto Technologies Corporation (“Adesto”), Circuit Acquisition Corporation and we entered into an Agreement and Plan of Merger (the “Merger Agreement”) pursuant to which Adesto will acquire us for $8.50 per share in an

19


all-cash transaction valued at approximately $45 million. Completion of the transaction is subject to approval by our stockholders and other customary closing conditions. The parties expect to close the transaction during the third quarter of 2018, at which time we will become a wholly owned subsidiary of Adesto and will cease to be a publicly traded company.
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. For further information on our significant accounting policies, see the Notes to our condensed consolidated financial statements included in Part 1 of this Report. Our critical accounting policies and estimates are also described in Item 7 "Management's Discussion and Analysis of Financial Condition and Results of Operations" and 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, 2017, which we filed with the Securities and Exchange Commission in March 2018. 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.

With the exception of our adoption of new revenue recognition guidance effective January 1, 2018 (which is discussed more fully below), during the six months ended June 30, 2018, 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, 2017.

Revenue Recognition. Our contracts with customers often include promises to transfer multiple products and services to a customer. Determining whether products and services are considered distinct performance obligations that should be accounted for separately versus together may require significant judgment. Judgment is required to determine the level of integration and interdependency between individual components of the products and services that we sell. This determination influences whether the hardware and software products we sell to the outdoor lighting market are considered distinct and accounted for separately, or not distinct and accounted for together with certain services sold to these customers and recognized once the services have been delivered.

Judgment is also required in determining the amount of variable consideration associated with sales to our distributor partners. In many instances, we issue Point of Sale ("POS") credits to our distributors when they sell certain of our products to their end use customers. In these cases, we are required to estimate (and reserve for) the amount of future POS credits we will issue to the distributors associated with unsold inventory they have on hand at the end of the period. To determine the amount of this variable consideration, we use a combination of historical average selling prices and future forecasts to calculate how much of the original sale price is subject to refund.

Our products are generally sold without a right of return. However, we do grant limited rights of return to our distributor partners. As such, we use historical distributor return rates to determine the amount of variable consideration to account for when estimating the amount of revenue to recognize.

Please refer to Note 1 – Basis of Presentation and Significant Accounting Policies in the Notes to Condensed Consolidated Financial Statements (Part I, Item 1 of this Form 10-Q) for further discussion.

20


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 June 30, 2018 and 2017:
 
Three Months Ended
June 30,
 
Six Months Ended
June 30,
 
2018
 
2017
 
2018
 
2017
Revenues
100.0
 %
 
100.0
 %
 
100.0

 
100.0

Cost of revenues
43.9

 
43.4

 
44.0

 
43.1

Gross profit
56.1

 
56.6

 
56.0

 
56.9

Operating expenses:
 
 
 
 
 
 
 
Product development
30.9

 
27.0

 
34.6

 
27.9

Sales and marketing
15.0

 
17.5

 
15.8

 
18.2

General and administrative
30.1

 
23.1

 
25.9

 
24.0

Total operating expenses
76.0

 
67.7

 
76.4

 
70.2

Loss from operations
(19.8
)
 
(11.1
)
 
(20.4
)
 
(13.3
)
Interest and other income (expense), net
4.7

 
(2.6
)
 
4.0

 
(1.8
)
Loss before provision for income taxes
(15.1
)
 
(13.8
)
 
(16.4
)
 
(15.1
)
Income tax expense (benefit)
0.4

 
0.3

 
0.2

 
0.1

Net loss
(15.4
)%
 
(14.1
)%
 
(16.5
)%
 
(15.2
)%
Revenues
Total revenues
 
Three Months Ended
 
 
 
 
(Dollars in thousands)
June 30, 2018
 
June 30, 2017
 
2018 over 2017 $ Change
 
2018 over 2017 % Change
 
 
 
 
 
 
 
 
Total revenues
$
7,917

 
$
8,337

 
$
(420
)
 
(5.0
)%


Six Months Ended
 
 
 
 
(Dollars in thousands)
June 30, 2018
 
June 30, 2017
 
2018 over 2017 $ Change
 
2018 over 2017 % Change
 
 
 
 
 
 
 
 
Total revenues
$
15,754

 
$
16,040

 
$
(286
)
 
(1.8
)%
Our 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.
Our revenues decreased during the three months ended June 30, 2018, as compared to the same period in 2017, by $420,000, or 5%. During the six months ended June 30, 2018, our revenues decreased by $286,000, or 1.8%, as compared to the same period in 2017. These decreases were primarily due to decreases in sales made to customers in the EMEA region, and for the three months ended June 30, 2018, a slight decrease in sales made to customers in the Americas.

The portion of our revenues conducted in currencies other than the United States dollar, principally the Japanese Yen, was about 3.9% for the six months ended June 30, 2018. Our revenues will continue to be subject to 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. To date, we have not hedged any of these foreign currency risks. We do not currently expect that, during the remainder of 2018, the amount of our 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

21


were to grow significantly, we would re-evaluate these exposures and, if necessary, enter into hedging arrangements to help minimize these risks.

Gross Profit and Gross Margin
 
Three Months Ended
 
 
 
 
(Dollars in thousands)
June 30, 2018
 
June 30, 2017
 
2018 over 2017 $ Change
 
2018 over 2017 % Change
 
 
 
 
 
 
 
 
Gross Profit
$4,445
 
$4,719
 
$
(274
)
 
(5.8
)%
Gross Margin
56.1%
 
56.6%
 
N/A

 
(0.5
)


Six Months Ended
 
 
 
 
(Dollars in thousands)
June 30, 2018
 
June 30, 2017
 
2018 over 2017 $ Change
 
2018 over 2017 % Change
Gross Profit
$8,822
 
$9,130
 
$
(308
)
 
(3.4
)%
Gross Margin
56.0%
 
56.9%
 
NA

 
(0.9
)

Gross profit is equal to revenues less cost of revenues. Cost of revenues associated with sales of our products includes direct costs associated with the purchase of components, sub-assemblies, 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 revenues associated with sales of our services includes employee-related costs such as salaries and fringe benefits as well as other direct and indirect costs incurred in providing training and customer support. Gross margin is equal to gross profit divided by revenues.
Our gross margins decreased by 0.5 percentage points for the three months ended June 30, 2018, and by 0.9 points for the six months ended June 30, 2018, as compared to the same periods in 2017. These decreases are primarily due to a mix of lower revenues and slightly higher indirect costs incurred during both the three and six months ended June 30, 2018.

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, changes in our distribution strategy and use of distributors, changes in the prices charged by our suppliers, periodic charges related to excess and obsolete inventories, warranty expenses, introductions of cost reduced versions of our products, changes in the average selling prices of the products we sell, purchase price variances, and fluctuations in the level of indirect overhead spending. 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.


22


Operating Expenses
Product Development
 
Three Months Ended
 
 
 
 
(Dollars in thousands)
June 30, 2018
 
June 30, 2017
 
2018 over 2017 $ Change
 
2018 over 2017 % Change
Product Development
$
2,449

 
$
2,255

 
$
194

 
8.6
%


Six Months Ended
 
 
 
 
(Dollars in thousands)
June 30, 2018
 
June 30, 2017
 
2018 over 2017 $ Change
 
2018 over 2017 % Change
Product Development
$
5,454

 
$
4,482

 
$
972

 
21.7
%
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.
During the three and six months ended June 30, 2018, our product development expenses increased by $194,000, or 8.6%, and $972,000, or 21.7%, respectively, as compared to the same periods in 2017. These increases were driven primarily by an increase in fees paid to third party product development service providers, and to a lesser extent, by equipment and supplies used in the product development process.
We expect our product development expenses will decline to more recent historical levels during the second half of 2018.
Sales and Marketing
 
Three Months Ended
 
 
 
 
(Dollars in thousands)
June 30, 2018
 
June 30, 2017
 
2018 over 2017 $ Change
 
2018 over 2017 % Change
Sales and Marketing
$
1,184

 
$
1,463

 
$
(279
)
 
(19.1
)%


Six Months Ended
 
 
 
 
(Dollars in thousands)
June 30, 2018
 
June 30, 2017
 
2018 over 2017 $ Change
 
2018 over 2017 % Change
Sales and Marketing
$
2,494

 
$
2,925

 
$
(431
)
 
(14.7
)%
Sales and marketing expenses consist primarily of payroll, commissions, and related expenses for sales and marketing personnel, travel and entertainment, facilities costs, advertising and product promotion, and other costs associated with our sales and marketing activities.
During the three and six months ended June 30, 2018, our sales and marketing expenses decreased by $279,000, or 19.1%, and $431,000, or 14.7%, respectively, as compared to the same periods in 2017. The primary causes of these decreases were reduced fees paid to third party consultants, reduced travel and entertainment costs, and a decrease in compensation charges for our sales and marketing personnel.

23


General and Administrative
 
Three Months Ended
 
 
 
 
(Dollars in thousands)
June 30, 2018
 
June 30, 2017
 
2018 over 2017 $ Change
 
2018 over 2017 % Change
General and Administrative
$
2,380

 
$
1,929

 
$
451

 
23.4
%


Six Months Ended
 
 
 
 
(Dollars in thousands)
June 30, 2018
 
June 30, 2017
 
2018 over 2017 $ Change
 
2018 over 2017 % Change
General and Administrative
$
4,085

 
$
3,853

 
$
232

 
6.0
%
General and administrative expenses consist primarily of payroll and related expenses for executive, finance, and administrative personnel, professional fees for legal and accounting services rendered to the company, facility costs, insurance, and other general corporate expenses.
During the three and six months ended June 30, 2018, our general and administrative expenses increased by $451,000, or 23.4%, and by $232,000, or 6.0%, respectively, as compared to the same periods in 2017. These increases were driven primarily by costs incurred in conjunction with our planned merger with Adesto. During the three and six months ended June 30, 2018, we incurred transaction related costs of approximately $906,000 and $1.3 million, respectively. Excluding these charges, our general and administrative expenses would have been lower during 2018 as compared to the same periods in 2017.
We expect to continue incurring expenses associated with the merger during the third quarter of 2018, which will likely result in an increase in our general and administrative expenses as compared to 2017.
Interest and Other Income (Expense), Net
 
Three Months Ended
 
 
 
 
(Dollars in thousands)
June 30, 2018
 
June 30, 2017
 
2018 over 2017 $ Change
 
2018 over 2017 % Change
Interest and Other Income (Expense), Net
$
376

 
$
(220
)
 
$
596

 
270.9
%


Six Months Ended
 
 
 
 
(Dollars in thousands)
June 30, 2018
 
June 30, 2017
 
2018 over 2017 $ Change
 
2018 over 2017 % Change
Interest and Other Income (Expense), Net
$
634

 
$
(285
)
 
$
919

 
322.5
%

Interest and other income (expense), net, primarily reflects interest earned by our company on cash and short-term investment balances as well as foreign exchange translation gains and losses related to short-term intercompany balances.
Interest and other income, net, increased by $596,000 during the three months ended June 30, 2018 as compared to the same period in 2017. This increase was primarily attributable to foreign currency exchange gains. During the second quarter of 2018, we recognized approximately $306,000 of foreign currency exchange gains, whereas in the second quarter of 2017, we recognized approximately $253,000 of exchange losses. These foreign currency fluctuations are primarily attributable to our foreign currency denominated short-term intercompany balances. We account for translation gains and losses associated with these balances by reflecting these amounts as either other income or loss in our condensed consolidated statements of operations. During periods when the U.S. dollar weakens in value against these foreign currencies, the associated translation losses negatively impact other income. Conversely, when the U.S. dollar strengthens, the resulting translation gains favorably impact other income.
During the six months ended June 30, 2018, interest and other income, net, increased by $919,000 as compared to the same period in 2017. This increase is primarily due to the fact that, during the quarter ended March 31, 2018, we completed the liquidation of our Chinese joint venture, Zhejiang Echelon-Holley Technology Co., Ltd. The liquidation resulted in a gain of approximately $424,000, which has been reflected in the Interest and other income (expense), net line in the Company's

24


Condensed Consolidated Statement of Operations. For more information on our joint venture with Holley Metering, please refer to Note 13 - Joint Venture, in the Notes to our Condensed Consolidated Financial Statements. Also contributing to the year over year fluctuation was an increase in foreign currency translation gains during 2018. During the first six months of 2018, we recognized foreign currency translation gains of $83,000, whereas during the same period in 2017, we recognized translation losses of $341,000.
We do not currently anticipate interest income on our investment portfolio will improve during 2018 as we expect interest rates to remain historically low. Future gains or losses associated with translating our foreign currency denominated short-term intercompany balances will depend on exchange rates in effect at the time of translation.
Income Tax Expense
 
Three Months Ended
 
 
 
 
(Dollars in thousands)
June 30, 2018
 
June 30, 2017
 
2018 over 2017 $ Change
 
2018 over 2017 % Change
Income Tax Expense (Benefit)
$
30

 
$
29

 
$
1

 
3.4
%


Six Months Ended
 
 
 
 
(Dollars in thousands)
June 30, 2018
 
June 30, 2017
 
2018 over 2017 $ Change
 
2018 over 2017 % Change
Income Tax Expense
$
24

 
$
23

 
$
1

 
4.3
%

Income tax expense for the three months ended June 30, 2018 was $30,000 compared to $29,000 for the same period in 2017, and was $24,000 for the six months ended June 30, 2018 compared to $23,000 for the same period in 2017. The difference between the statutory rate and our effective tax rate is primarily due to the impact of foreign taxes, changes in the valuation allowance on deferred tax assets, and changes in the accruals related to unrecognized tax benefits.
OFF-BALANCE-SHEET ARRANGEMENTS AND OTHER CONTRACTUAL OBLIGATIONS
Off-Balance-Sheet Arrangements. We have not entered into any transactions with unconsolidated entities whereby we have financial guarantees, subordinated retained interests, derivative instruments, or other contingent arrangements that expose our company to material continuing risks, contingent liabilities, or any other obligation under a variable interest in an unconsolidated entity that provides financing, liquidity, market risk, or credit risk support to us.
Lease Commitments. In September 2015, we entered into a lease agreement for our corporate headquarters facility in Santa Clara, California. This lease commenced in November 2015 and will expire in July 2019. In addition, we lease facilities under operating leases for our sales, marketing, and product development personnel located elsewhere within the United States and in several foreign countries throughout Europe and Asia. These operating leases expire on various dates through 2019, and in some instances are cancelable with advance notice. Lastly, we also lease certain equipment and, for some of our sales personnel, automobiles. These operating leases are generally less than five years in duration.
Purchase Commitments. We utilize several contract manufacturers who manufacture and test our products requiring assembly. These contract manufacturers acquire components and build product based on demand information supplied by us in the form of purchase orders and demand forecasts. These purchase orders and demand forecasts generally cover periods up to twelve months, and in rare cases, up to eighteen months. We also obtain individual components for our products from a wide variety of individual suppliers. We generally acquire these components through the issuance of purchase orders, and in some cases through demand forecasts, both of which cover periods up to twelve months.
We also utilize purchase orders when procuring capital equipment, supplies, and services necessary for our day-to-day operations. These purchase orders generally cover periods ranging up to twelve months, but in some instances cover a longer duration.
Indemnifications. In the normal course of business, we provide indemnifications of varying scope to customers against claims of intellectual property infringement made by third parties arising from the use of our products. Historically, costs related to these indemnification provisions have not been significant. However, we are unable to estimate the maximum potential impact of these indemnification provisions on our future results of operations.

25


As permitted under Delaware law, we have agreements whereby we indemnify our officers and directors for certain events or occurrences while the officer or director is, or was serving, at our request in such capacity. The indemnification period covers all pertinent events and occurrences during the officer’s or director’s lifetime. The maximum potential amount of future payments we could be required to make under these indemnification agreements is unlimited; however, we have director and officer insurance coverage that would enable us to recover a portion of any future amounts paid. We believe the estimated fair value of these indemnification agreements in excess of the applicable insurance coverage is minimal.
Royalties. We have certain royalty commitments associated with the shipment and licensing of certain products. Royalty expense is generally based on a U.S. dollar amount per unit shipped or a percentage of the underlying revenue. Royalty expense, which is recorded as cost of revenues in our condensed consolidated statements of operations, was approximately $40,000 and $165,000 for the three and six months ended June 30, 2018, respectively, and $80,000 and $160,000 for the same periods in 2017.
We will continue to be obligated for royalty payments in the future associated with the shipment and licensing of certain of our products. While we are currently unable to estimate the maximum amount of these future royalties, such amounts will continue to be dependent on the number of units shipped or the amount of revenue generated from these products.
Taxes. We conduct our operations in many tax jurisdictions throughout the world. In many of these jurisdictions, non-income based taxes such as property taxes, sales and use taxes, and value-added taxes are assessed on Echelon’s operations in that particular location. While we strive to ensure compliance with these various non-income based tax filing requirements, there have been instances where potential non-compliance exposures have been identified. In accordance with generally accepted accounting principles, we make a provision for these exposures when it is both probable that a liability has been incurred and the amount of the exposure can be reasonably estimated. To date, such provisions have been immaterial, and we believe that, as of June 30, 2018, we have adequately provided for such contingencies. However, it is possible that our results of operations, cash flows, and financial position could be harmed if one or more non-compliance tax exposures are asserted by any of the jurisdictions where we conduct our operations.
Legal Actions. From time to time, in the ordinary course of business, we are subject to legal proceedings, claims, investigations, and other proceedings, including claims of alleged infringement of third-party patents and other intellectual property rights, and commercial, employment, and other matters. In accordance with generally accepted accounting principles, we make a provision for a liability when it is both probable that a liability has been incurred and the amount of the loss can be reasonably estimated. These provisions are reviewed at least quarterly and adjusted to reflect the impacts of negotiations, settlements, rulings, advice of legal counsel, and other information and events pertaining to a particular case. While we believe we have adequately provided for such contingencies as of June 30, 2018, it is possible that our results of operations, cash flows, and financial position could be harmed by the resolution of any such outstanding claims.
Litigation Relating to the Merger. On June 28, 2018, we entered into the Merger Agreement. On July 20, 2018 and July 26, 2018, putative class action lawsuits were filed by purported stockholders of ours in the United States District Court for the Northern District of California and in the United States District Court for the District of Delaware (the “Lawsuits”). The Lawsuits are captioned Aducci v. Echelon Corporation, et al., No. 5:18-cv-4415 (N.D. Cal.) and Rosenblatt v. Echelon Corporation, et al., No. 1:18-cv-01103-UNA (D. Del.). The Lawsuits assert claims under Section 14(a) and Section 20(a) of the Securities Exchange Act of 1934 in connection with the disclosures contained in the preliminary proxy statement we filed with the Securities and Exchange Commission on July 16, 2018. The Lawsuits name us and our directors as defendants. The complaints seek a variety of equitable and injunctive relief including, among other things, enjoining the consummation of the merger and awarding the plaintiffs costs and attorneys’ fees. Our management believes that the plaintiffs’ claims are without merit and the defendants intend to defend the Lawsuits vigorously. As of June 30, 2018, no amounts have been provided for the lawsuit.
LIQUIDITY AND CAPITAL RESOURCES
 Since our inception, we have financed our operations and met our capital expenditure requirements primarily from the sale of preferred stock and common stock, although during 2012 and certain earlier years, we were also able to finance our operations through operating cash flows.


26


The following table presents selected financial information as of June 30, 2018, and for each of the last three fiscal years (dollars in thousands):
 
June 30,
December 31,
 
2018
2017
2016
2015
Cash, cash equivalents, and short-term investments*
$
18,110

$
20,478

$
23,036

$
26,070

Trade accounts receivable, net
3,147

2,296

2,695

4,030

Working capital
20,773

22,209

23,083

26,713

Stockholders’ equity
21,573

23,727

24,678

28,921

* As of June 30, 2018 and December 31, 2017, includes $1.3 million of restricted investments presented separately on condensed consolidated balance sheet

As of June 30, 2018, we had $18.1 million in cash, cash equivalents, restricted cash and short-term investments, a decrease of $2.4 million as compared to December 31, 2017. Historically, our primary source of cash, other than stock sales, has been receipts from revenue, and to a lesser extent, proceeds from the exercise of stock options by our employees and directors, and the exercise of warrants. Our primary uses of cash have been cost of product revenue, payroll (salaries, commissions, bonuses, and benefits), general operating expenses (costs associated with our offices such as rent, utilities, and maintenance; fees paid to third party service providers such as consultants, accountants, and attorneys; travel and entertainment; equipment and supplies; advertising; and other miscellaneous expenses), acquisitions, capital expenditures, and purchases under our stock repurchase programs.
Cash flows from operating activities. Cash flows from operating activities have historically been driven by net income (loss) levels; adjustments for non-cash charges such as stock-based compensation, depreciation, and amortization; changes in accrued investment income; and fluctuations in operating asset and liability balances. Net cash used in operating activities was $1.8 million for the six months ended June 30, 2018, a decrease in cash outflows of approximately $282,000 as compared to the same period in 2017. During the six months ended June 30, 2018, net cash used in operating activities was primarily the result of our net loss of $2.6 million and the non-cash gain on liquidation of our joint venture with Holley Metering of $424,000; partially offset by stock-based compensation expenses of $953,000, depreciation and amortization expense of $230,000, and changes in our operating assets and liabilities of $122,000. The primary components of the $122,000 net change in our operating assets and liabilities were a $733,000 increase in accounts payable, a $300,000 increase in inventories, a $251,000 decrease in other current assets, and a $236,000 decrease in deferred revenues; all of which was partially offset by an $861,000 increase in accounts receivable, a $242,000 decrease in accrued liabilities, and a $264,000 decrease in deferred cost of revenues. Accounts payable increased based on the timing of purchases and services received in the second quarter. Inventories increased in anticipation of additional product shipments in the second half of the year. Other current assets decreased primarily as a result of a reduction in prepaid expenses. Deferred revenues decreased primarily due to the elimination of deferred revenues in conjunction with the liquidation of our joint venture with Holley Metering in China.Accounts receivable increased based on the timing of shipments during the quarter and the corresponding due dates of the receivables. Deferred cost of revenues decreased in conjunction with a decrease in deferred revenues.
During the six months ended June 30, 2017, net cash used in operating activities of $2.1 million was primarily the result of our net loss of $2.4 million, and changes in our operating assets and liabilities of $747,000; partially offset by stock-based compensation expenses of $909,000, and depreciation and amortization expense of $220,000. The primary components of the $747,000 net change in our operating assets and liabilities were a $724,000 increase in accounts receivable, a $398,000 increase in other current assets, and a $111,000 decrease in accrued liabilities; all of which was partially offset by a $544,000 increase in accounts payable. Accounts receivable increased primarily as a result of the timing of shipments to and corresponding collections from our customers during the first six months of 2017. Other current assets increased primarily as a result of an increase in prepaid expenses. Accrued liabilities decreased primarily due to the payment of bonuses that were accrued as of December 31, 2016. Accounts payable increased due to the timing of receipt and payment of invoices we received from our vendors during the period.
Cash flows from investing activities. Cash flows from investing activities have historically been driven by transactions involving our short-term investment portfolio, capital expenditures, changes in our long-term assets, and acquisitions and divestitures. Net cash used in investing activities was $29,000 for the six months ended June 30, 2018, an increase in cash outflows of $72,000 from the same period in 2017. During the six months ended June 30, 2018, net cash used in investing activities was primarily the result of purchases of available-for-sale short-term investments of $11.9 million and capital expenditures of $139,000, partially offset by proceeds from maturities and sales of available-for-sale short-term investments of $12.0 million.

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During the six months ended June 30, 2017, net cash provided by investing activities of $43,000 was primarily the result of proceeds from maturities and sales of available-for-sale short-term investments of $12.0 million, partially offset by purchases of available-for-sale short-term investments of $12.0 million, and capital expenditures of $31,000.
Cash flows from financing activities. Cash flows from financing activities have historically been driven by the proceeds from issuance of common and preferred stock offset by transactions under our stock repurchase programs and principal payments on our lease financing obligations. Net cash used in financing activities was $500,000 for the six months ended June 30, 2018, an increase in cash outflows of $436,000 as compared to the same period in 2017. During the six months ended June 30, 2018, net cash used in financing activities was primarily the result of our distribution of $432,000 to our Chinese joint venture partner, Holley Metering, and $68,000 worth of shares repurchased from employees for payment of employee taxes on vesting of performance shares.
During the six months ended June 30, 2017, net cash used in financing activities of $64,000 was primarily the result of $64,000 worth of shares repurchased from employees for payment of employee taxes on vesting of performance shares.
As noted above, our cash and investments totaled $18.1 million as of June 30, 2018. Of this amount, approximately 1% was held by our foreign subsidiaries. Our intent is to permanently reinvest a significant portion of our earnings from foreign operations, and current plans do not anticipate that we will need funds generated from foreign operations to fund our domestic operations. In the event funds from foreign operations are needed to fund operations in the United States and if U.S. tax has not already been previously provided, we would provide for and pay any additional U.S. taxes due in connection with repatriating these funds.
We use well-regarded investment managers to manage our invested cash. Our portfolio of investments managed by these investment managers is primarily composed of highly rated U.S. government securities, and to a lesser extent, money market funds. All investments are made according to guidelines and within compliance of policies approved by the Audit Committee of our Board of Directors.
We maintain an operating credit line of $1.0 million with our primary bank for company credit card purchases. This line of credit continues to be secured by a collateral of the first priority on $1.3 million of our investments (presented as restricted investments in the condensed consolidated balance sheets).
In the future, our cash reserves may be used to strategically acquire or invest in other companies, products, or technologies that are complementary to our business. In addition, our combined cash, cash equivalents, and short-term investments balances could be negatively affected by various risks and uncertainties, including, but not limited to, the risks detailed in this Quarterly Report in the section titled “Factors That May Affect Future Results of Operations.” For example, any continued weakening of economic conditions or changes in our planned cash outlay could negatively affect our existing cash reserves.
Based on our current business plan and revenue prospects, we believe that our existing cash reserves will be sufficient to meet our projected working capital and other cash requirements for at least the next twelve months. However, we currently expect that our combined cash, cash equivalent, and short-term investment balance will decline during the remainder of 2018. In the event that we require additional financing, such financing may not be available to us in the amounts or at the times that we require, or on acceptable terms. If we fail to obtain additional financing, when and if necessary, our business would be harmed.
RELATED PARTY TRANSACTIONS
In June 2000, we entered into a stock purchase agreement with Enel pursuant to which Enel purchased 300,000 newly issued shares of our common stock for $130.7 million. The closing of this stock purchase occurred on September 11, 2000. At the closing, Enel had agreed that it would not, except under limited circumstances, sell or otherwise transfer any of those shares for a specified time period. That time period expired September 11, 2003. To our knowledge, Enel has not disposed of any of its 300,000 shares. Under the terms of the stock purchase agreement, Enel has the right to nominate a member of our board of directors. A representative of Enel served on our board until March 14, 2012; no Enel representative is presently serving on our board.
At the time we entered into the stock purchase agreement with Enel, we also entered into a research and development agreement with an affiliate of Enel (the “R&D Agreement”). Under the terms of the R&D Agreement, we cooperated with Enel to integrate our LONWORKS technology into Enel’s remote metering management project in Italy, the Contatore Elettronico. We completed the sale of our components and products for the deployment phase of the Contatore Elettronico project during 2005. During 2006, we supplied Enel and its designated manufacturers with limited spare parts for the Contatore Elettronico system.

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In October 2006, we entered into a new development and supply agreement and a software enhancement agreement with Enel. Under the development and supply agreement, Enel and its contract manufacturers purchase additional electronic components and finished goods from us. Under the software enhancement agreement, we provided software enhancements to Enel for use in its Contatore Elettronico system. The software enhancement was assigned to S&T as part of the sale of our Grid division in September 2014. The development and supply agreement expired in March 2016.
For the three and six months ended June 30, 2018 and 2017, the Company recognized no revenue from products and services sold to Enel and its designated manufacturers. As of June 30, 2018 and December 31, 2017, none of the Company’s total accounts receivable balance related to amounts owed by Enel and its designated manufacturers.
RECENTLY ISSUED ACCOUNTING STANDARDS
During the six months ended June 30, 2018, there have been no new recent accounting pronouncements or changes in accounting pronouncements, other than those noted in Note 1 in the Notes to Condensed Consolidated Financial Statements in Part I, Item 1 of this report, that are of significance, or potential significance, to our company.
FACTORS THAT MAY AFFECT FUTURE RESULTS OF OPERATIONS
Interested persons should carefully consider the risks described below in evaluating our company. Additional risks and uncertainties not presently known to us, or that we currently consider immaterial, may also impair our business operations. If any of the following risks actually occur, our business, financial condition or results of operations could be materially adversely affected. In that case, the trading price of our common stock would likely decline. Before deciding to purchase, hold or sell our common stock, you should carefully consider the risks described in this section. This section should be read in conjunction with the condensed consolidated financial statements and accompanying notes thereto, and Management’s Discussion and Analysis of Financial Condition and Results of Operations included in this Quarterly Report on Form 10-Q.

The announcement and pendency of our agreement to be acquired by Adesto could adversely affect our business.

On June 29, 2018, we announced that we had entered into a definitive agreement to be acquired by Adesto. Uncertainty about the effect of the proposed acquisition on our customers, employees, partners and other parties may adversely affect our business. Our employees may experience uncertainty about their roles or seniority following the acquisition. There can be no assurance that our employees, including key personnel, can be retained, or that we will be able to attract and retain employees to the same extent that we have previously been able to. Any loss or distraction of such employees could adversely affect our business and operations. In addition, we have diverted, and will continue to divert, significant management resources toward the completion of the acquisition, which could adversely affect our business and operations. Parties with which we do business may experience uncertainty associated with the acquisition, including with respect to current or future business relationships with us. Uncertainty may cause customers to refrain from doing business with us, which could adversely affect our business, results of operations and financial condition.

The failure to complete the acquisition by Adesto could adversely affect our business.

Completion of the acquisition by Adesto is subject to several conditions beyond our control that may prevent, delay, or otherwise adversely affect its completion, including our need to obtain stockholder approval of the acquisition. If any of these conditions are not satisfied or waived, it is possible that the acquisition will not be consummated in the expected time frame (or at all) or that the definitive agreement may be terminated. If the proposed acquisition is not completed, the share price of our common stock may decrease to the extent that the current market price of our common stock reflects an assumption that a transaction will be completed. In addition, under circumstances specified in the definitive agreement, we may be required to pay a termination fee of up to $1.54 million to Adesto or reimburse up to $440,000 of Adesto’s expenses. Further, a failed transaction may result in negative publicity and a negative impression of us in the investment community. Any disruption to our business resulting from the announcement and pendency of the transaction and from intensifying competition from our competitors, including any adverse changes in our relationships with our customers, employees, partners and other parties, could continue or accelerate in the event of a failed transaction. There can be no assurance that our business, relationships with other parties, liquidity or financial condition will not be adversely affected, as compared to the condition prior to the announcement of the acquisition, if the acquisition is not consummated.

While the acquisition by Adesto is pending, we are subject to business uncertainties and contractual restrictions that could harm our operations and the future of our business or result in a loss of employees.


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The definitive agreement for the acquisition by Adesto includes restrictions on the conduct of our business prior to the completion of the acquisition. These restrictions generally require us to conduct our businesses in the ordinary course, consistent with past practice, and subject us to a variety of specified limitations. We may find that these and other contractual arrangements may delay, prevent or limit us from responding effectively to competitive pressures, industry developments and future business opportunities that may arise during such period, even if our management and board of directors think that they may be advisable. The pendency of the acquisition may also divert management’s attention and our resources from ongoing business and operations. Our customers, employees, partners and other parties may have uncertainties about the effects of the acquisition. In connection with the acquisition, it is possible that some customers and other persons with whom we have a business relationship may delay or defer certain business decisions or might decide to seek to terminate, change or renegotiate their relationship with us as a result of the acquisition. If any of these effects were to occur, it could materially and adversely impact our revenue, earnings and cash flows and other business results and financial condition, as well as the market price of our common stock and our perceived acquisition value, regardless of whether the acquisition is completed. In addition, whether or not the acquisition is completed, while it is pending we will continue to incur costs, fees, expenses and charges related to the acquisition, which may materially and adversely affect our financial condition.

Litigation may arise in connection with the acquisition by Adesto, which could be costly, prevent consummation of the acquisition, divert management’s attention and otherwise materially harm our business.

Regardless of the outcome of any future litigation related to the acquisition by Adesto, such litigation may be time-consuming and expensive and may distract our management from running the day-to-day operations of our business. The litigation costs and diversion of management’s attention and resources to address the claims and counterclaims in any litigation related to the acquisition by Adesto may materially adversely affect our business, financial condition and operating results. If the acquisition is not consummated for any reason, litigation could be filed in connection with the failure to consummate the acquisition. Any litigation related to the acquisition may result in negative publicity or an unfavorable impression of us, which could adversely affect the price of our common stock, impair our ability to recruit or retain employees, damage our relationships with our customers and suppliers, or otherwise materially harm our operations and financial performance.

There can be no guarantee that the IIoT market in general, and the lighting market segment in particular, will develop as expected, or that we will be successful in pursuing these market opportunities.

We have devoted and will continue to devote significant effort and resources to leverage our technology and develop and launch our platform to customers within the IIoT market. However, to date, the market for our products has not developed as quickly as anticipated, and our efforts to capitalize on these opportunities have not produced the results we anticipated. Our efforts to capitalize on these opportunities may not be successful in the near term, or at all.

Although revenues from our legacy embedded systems products have been increasing in recent quarters, prior to 2017 they had been declining annually for several years. We cannot guarantee that the recent improvement in sales of these products will continue.

We have decided to focus heavily on lighting controls within the IIoT as our targeted market. As we have a limited operating history in this market segment, we are subject to a number of risks and uncertainties that may impact our ability to gain market acceptance for our lighting control products.

In recent years, we have invested substantial resources in the development and commercialization of control networking solutions for the lighting market. However, we have a limited operating history in this market segment, and we may not recognize a meaningful amount of revenues from these efforts in the near future, or at all. Our efforts to gain market acceptance for our lighting control products and solutions are subject to considerable risk and uncertainty, including:

the risk of competition and emerging technologies (see “If we do not develop and maintain adequate distribution channels, our revenues will be harmed” for additional information on the risks associated with competing for market share);
the risk that we will not be able to develop adequate sales channels for these new products and services (see “Our IIoT revenues may not meet expectations, which could cause volatility in the price of our stock” for additional information on the risks associated with establishing new sales channels);
the risk that we misjudge the market and fail to develop solutions that meet the requirements of our existing or potential customers;
the risk that our solutions will suffer security breaches or otherwise allow unauthorized access to, or acquisition of, data;

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the risk that our products will not perform adequately due to defect or misuse by customers (see “Liabilities resulting from defects in or misuse of our products, whether or not covered by insurance, may delay our revenues and increase our liabilities and expenses” for additional information on the risks associated with defective or misused products); and
the risk that our supply chain for components is unable to meet our demand (see “Because we depend on a limited number of key suppliers and in certain cases, a sole supplier, the failure of any key supplier to produce timely and compliant products could result in a failure to ship products, or could subject us to higher prices, which would harm our results of operations and financial position” for additional information on the risks associated with manufacturing).

We have changed our business model significantly in recent years, which makes it difficult to evaluate our prospects and forecast our future results of operations.
Although we commenced our business in 1988, we have made significant changes to our business model in recent years. Historically, we derived all of our revenues from our embedded systems and Grid businesses. However, in 2014, we sold our Grid business, and prior to 2017, we had been experiencing a decline in revenues from our legacy embedded systems products and services, including a cessation in our shipments to Enel.
In recent years, we have shifted our focus to networking solutions for the outdoor lighting market. Unlike our legacy embedded systems products, which are typically sold to OEMs for incorporation into their products, which are then sold to their commercial and industrial customers, our lighting solutions products are more project based, being sold through energy services companies and distributors to municipalities, enterprise and educational campuses, retailers, and other end users. In addition, our outdoor lighting solutions typically generate lower overall gross margins than do our embedded systems products.
As we have a limited operating history with our lighting solutions, our ability to evaluate our current business and forecast our future results of operations and effectively assess our future prospects is subject to a number of uncertainties that may impact our ability to plan for and model future growth. Our historical revenue growth should not be considered indicative of our future performance and such growth may stagnate or decline over time. Further, in future periods, our revenues could decline for a number of reasons, including the failure to offset the expected decline in revenues from our embedded systems products by an increase in sales of our lighting solutions, changes in our pricing structure, increased competition in the IIoT market generally or in the lighting market in particular, or our failure, for any reason, to capitalize on growth opportunities. We have encountered and will continue to encounter risks and uncertainties frequently experienced by companies in rapidly changing industries. If our assumptions regarding these risks and uncertainties, which we use to plan our business, are incorrect or change, or if we do not address these risks successfully, our operating and financial results could differ materially from our expectations, and our business could suffer.
Our revenues may not meet expectations, and our operating expenses may be higher than we anticipate, which could cause volatility in the price of our stock.
As we attempt to grow our IIoT business, we expect to commit significant resources developing new products in emerging markets. In addition, our IIoT business operates in nascent markets, such as outdoor lighting and controls, in which we have yet to build a reliable customer base. As a result, sales of our products are unpredictable and yet to be proven, and sales and marketing costs related to our products may be significant. These factors could have a negative impact on our revenues and make it difficult to project our financial results, which could cause declines and volatility in our stock price. Additionally, because we are operating in an emerging market, risks that we are not currently able to identify are likely to materialize and could negatively impact our operations and financial condition.
Emerging markets are particularly dynamic and highly competitive, and we may lose sales to our competitors, which would harm our revenues and results of operations.
Competition in the IIoT market is intense and involves rapidly changing technologies, evolving industry standards, frequent new product introductions, industry consolidations, effective management of distribution channels, rapid changes in customer or regulatory requirements, and localized market requirements. In each of our existing and target markets, we compete with a wide array of manufacturers, vendors, strategic alliances, systems developers and other businesses. The future of our IIoT business depends significantly on our ability to react to changing customer needs by enhancing our existing products and developing new products. There can be no guarantee, however, that new products and product enhancements will be accepted by businesses and consumers. If we make investments in technologies that do not gain market acceptance, our business may not grow as anticipated. In addition, future product offerings by our competitors can render our products obsolete. Any failure to evolve with emerging technologies and our competitors could cause a loss of market share and result in declining revenues.

The principal competitive factors that affect the markets for our products include the following:


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our ability to anticipate changes in customer or regulatory requirements and to develop, or improve, our products to meet these requirements in a timely manner;
the price and features of our products such as adaptability, scalability, functionality, ease of use, and the ability to integrate with other products;
our product reputation, quality, performance, and conformance with established industry standards;
our ability to expand our product line to address our customers’ requirements;
our ability to effectively manage and expand our distribution channels to address new markets for current and future products;
our ability to meet a customer’s required delivery schedules;
a customer’s willingness to do business with us because of our size and perceived concerns regarding our liquidity and financial strength relative to our competitors;
the risk of industry consolidation, which is particularly high in emerging markets such as the IIoT;
our customer service and support;
warranties, indemnities, and other contractual terms; and
customer relationships and market awareness.
Competitors for our IIoT products include some of the largest companies in the electronics industry, operating either alone or together with trade associations and partners. Key company competitors include companies such as Cimcon Lighting, Inc., Cree Inc., Digi International, General Electric, LED Roadway Lighting, Maxim Integrated Products, Philips, Siemens, Silver Spring Networks, STMicroelectronics, Telensa, Texas Instruments, and Tridium. Key industry standard and trade group competitors include BACnet, DALI, DeviceNet, HART, Konnex, Profibus, ZigBee, and the ZWave Alliance in the IIoT market. Each of these standards and/or alliances is backed by one or more competitors. For example, the ZigBee alliance includes over 300 member companies with promoter members, such as Ember, Emerson, Freescale, Kroger, Landis+Gyr (a subsidiary of Toshiba), Philips, Reliant Energy, Schneider Electric, STMicroelectronics, Tendril, and Texas Instruments. Additionally, because we are operating in an emerging market, it is likely that additional competitors could surface and rapidly gain market share.
Many of our competitors, alone or together with their trade associations and partners, have significantly greater financial, technical, marketing, service and other resources, significantly greater name recognition, and broader product offerings, all of which may impact the willingness of customers and potential customers to do business with us. Our future success will depend on our ability to enhance our existing products, to introduce new products to meet changing customer requirements and emerging technologies, and to demonstrate the performance advantages and cost-effectiveness of our products over competing products.  If we are unable to do so and thus are unable to compete effectively in any of the markets we serve, our revenues, results of operations, and financial position would be harmed.
Fluctuations in our results of operations may cause our stock price to decline.

Our quarterly and annual results of operation have varied significantly from period to period, and we have sometimes failed to meet market expectations. Moreover, we have a history of losses and negative cash flow and cannot assure you that we will achieve sustained profitability in the future. We expect that our results of operations will continue to vary as a result of a number of factors, many of which are outside of our control, including the following:

orders may be cancelled;
the mix of products and services that we sell may change to a less profitable mix;
shipment, payment schedules, and product acceptance may be delayed;
our products may not be purchased by OEMs, systems integrators, service providers and end-users at the levels we project;
our ability to develop products that comply with future regulations and trade association guidelines;
the revenue recognition rules relating to certain of our products could require us to defer some or all of the revenue associated with product shipments until certain conditions, such as delivery and acceptance criteria for our software and/or hardware products, are met in a future period;
our CEMs may not be able to provide quality products on a timely basis, especially during periods where capacity in the CEM market is limited;
our products may not be manufactured in accordance with specifications or our established quality standards, or may not perform as designed;
downturns in any customer’s or potential customer’s business, or declines in general economic conditions, could cause significant reductions in capital spending, thereby reducing the levels of orders from our customers;
we may incur costs associated with any future business acquisitions; and
any future impairment charges related to our intangible assets that are required to be recorded under generally accepted accounting principles in the United States may negatively affect our earnings and financial condition.

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Any of the above factors could, individually or in the aggregate, have a material adverse effect on our results of operations and our financial condition, which could cause our stock price to decline
If we are not able to develop, enhance, or deploy our products in a timely manner, our revenues will suffer.
Due to the nature of development efforts in general, we can experience delays in the introduction of new or improved products beyond our original projected shipping date for such products. Historically, when these delays have occurred, we experienced an increase in our development costs and a delay in our ability to generate revenues from these new products. In addition, such delays could cause us to incur penalties if our deliveries are delayed, could otherwise impair our relationship with any of our customers that were relying on the timely delivery of our products in order to complete their own products or projects, or could cause the customer to cancel orders or to seek alternate sources of supply or other remedies. Any delay in the introduction of new products could impact future revenue targets or forecasts.

In addition, in some instances our customers rely on us to provide configuration and commissioning services to them when they are installing our outdoor lighting control products. In these instances, technical and project challenges, some of which may be beyond our control, can prevent us from completing these efforts in the originally planned for time frame. When this happens, we must defer the recognition of revenue associated with these deployments until such time as the service component has been completed. Additionally, with our limited resources, we may only be able to work on a limited number of deployments at any given time. As such, if any single deployment takes longer to complete than expected, it could negatively impact our ability to make progress on or accept configuration and commissioning service obligations for other projects.
We are also sometimes required to modify our products to meet local rules and regulations. Given the competitive nature of these markets, we may not be able to increase the price of such products to reflect the costs of such modifications. In addition, given the long-term nature of development activities, we may be required to undertake such modifications prior to receiving firm commitments or orders from our customers. In either of these or other similar scenarios, we may not be able to recover our costs attributable to required product modifications.
When we develop new products, there is no guarantee that these new products will meet our customers' requirements or will otherwise be acceptable to them, which could cause them to discontinue buying our products. This could have a material adverse effect on our revenues and results of operations.
We intend to continue investing resources in our development activities, which could expose us to risks, such as protection of intellectual property, investment risk, and labor costs and other matters. We could also be adversely affected by delays or cost increases experienced by third parties that are developing products on our behalf.
The sales cycle for our products is often lengthy and unpredictable.
The sales cycle between initial customer contact and execution of a contract or license agreement with a customer or purchaser of our products can vary widely. Initially, we must educate our customers about the potential applications of and cost savings associated with our products.
If we are successful in this effort for our embedded systems products, OEMs will typically conduct extensive and lengthy product evaluations before making a decision to design our products into their offerings. Once the OEM decides to incorporate our products, volume purchases of our products are generally delayed until the OEM’s product development, system integration, and product introduction periods have been completed. In addition, changes in our customers’ budgets, or the priority they assign to control network development, could also affect the sales cycle.
For our outdoor lighting controls products, the sales cycle can also be extended. As a nascent market, many of our sales channel partners, as well as end use customers, are not aware of the benefits our controls technology can bring to their lighting systems. This requires extensive educational efforts on our part and these efforts may not be successful or meet our objectives. Even with the benefit of this education, when dealing with larger projects such as to municipalities, the post-education sales cycle typically commences with a trial deployment of relatively low value to us. If the trial is successful, the end use customer may commence a full scale deployment that could take months or years to complete, if at all.
In addition, potential customers for our products, both embedded systems and outdoor lighting controls, include local, state and federal government authorities. Sales to government authorities can be extended and unpredictable. Government authorities generally have complex budgeting, purchasing, and regulatory processes that govern their capital spending, and their spending is likely to be adversely impacted by economic conditions. In addition, in many instances, sales to government authorities may

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require field trials and may be delayed by the time it takes for government officials to evaluate multiple competing bids, negotiate terms, and award contracts. We further face the risk of cancellation during development and production due to regulatory, government and geopolitical changes, and delays in installing, operating, and evaluating the results of any field trials before full implementation of our products.
For these reasons, the sales cycle associated with our IIoT products is subject to a number of significant risks that are beyond our control. Consequently, if our forecasted customer orders are not realized, or are delayed, our revenues and results of operations could be materially and adversely affected. In addition, an extended sales cycle may result in our inability to recognize revenue from existing or new projects until the end of several fiscal quarters. This may also make it difficult to predict our financial results and increase the volatility of our stock price.
If we do not develop and maintain adequate distribution channels, our revenues will be harmed.
The market for our products is new and unproven, and we cannot rely solely on our existing distributors to sell our products. Therefore, we are focused on expanding our distribution channel to include new distributors in order to generate revenue from product sales. We expect that the distribution channel for our products will be dispersed and it is difficult to predict how long it will take and how costly it will be to develop. We may not be successful in developing and maintaining an adequate distribution channels within our expected timeframe and cost expectations, if at all. In addition, if any of our new or existing distributor partners fail to dedicate sufficient resources to market and sell our products, our revenues could suffer. Furthermore, if our existing distributor partners were to significantly reduce their inventory levels for our products, we could expect a decrease in service levels to our end-use customers.
Sales of our products may fail to meet our financial targets, which would negatively impact our results of operations and expected return on investment in the IIoT market.
We have invested and intend to continue to invest significant resources in the development and sales of products in the emerging IIoT market, particularly in the outdoor lighting market segment. If we are unable to receive orders for, ship, and recognize revenue for our products in a timely manner, and in the quantities and at prices in line with our targets, our financial results will be harmed. Our long-term financial goals include expectations for a return on these investments, but we may or may not ever realize any return whatsoever on this investment of resources.
Over the last several years, our market share in our existing embedded systems business has declined due to increased competition, reduced levels of investment in our LONWORKS product line, and pricing pressures faced around the world. However, during 2017, our embedded systems revenues grew across a broad base of customer applications, ranging from semiconductor manufacturing monitoring, to building automation, HVAC controls, and more. We believe this trend may be taking hold and working to Echelon's benefit, as companies expand into IIoT deployments and leverage LONWorks' capability.
Prior to 2017, annual revenues generated from our embedded systems business failed to meet our expectations. If this revenue decline were to return, our ability to continue funding our entry into the outdoor lighting segment could be harmed.

In order to achieve our financial targets, we believe that we must meet the following objectives:

achieve acceptance of our products in the IIoT market, particularly the outdoor lighting market, in order to increase our revenues;
manage our operating expenses to a reasonable percentage of revenues; and
manage our cash resources prudently.

Even if we meet these objectives, there can be no assurance that we will meet our overall financial targets and objectives.
A significant portion of our operating expenses are fixed. Therefore, if we cannot achieve our revenue targets, our use of cash balances would increase, our losses would increase, and/or we would be required to take additional actions necessary to reduce expenses. We cannot assure you that we will meet any or all of these objectives to the extent necessary to achieve our financial goals and, if we fail to achieve our goals, our results of operations are likely to be harmed.
In our legacy embedded systems business, we may be unable to promote and expand acceptance of our open, interoperable control systems over competing protocols, standards, or technologies.
LONWORKS and IzoT technology are open, meaning that many of our technology patents are broadly licensed without royalties or license fees. As a result, our IIoT customers are able to develop hardware and software solutions that compete with some of

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our products. Because some of our customers are OEMs that develop and market their own control systems, these customers, in particular, could develop competing products based on our open technology. For instance, we have published all of the network management commands required to develop software that competes with our LNS software.
In addition, many of our IIoT competitors are dedicated to promoting closed or proprietary systems, technologies, software and network protocols or product standards that differ from or are incompatible with ours. We also face strong competition from large trade associations that promote alternative technologies and standards for particular vertical applications or for use in specific countries. These include BACnet, DALI, and KNX in the buildings market; DeviceNet, HART, and ProfiBus in the industrial controls market; TCN in the rail transportation market; and Echonet, ZigBee, and Z-Wave in the home control markets.
The ability of our IIoT products to interoperate with multiple standards is important to our success. Our technologies, protocols, or standards may not be successful or we may decide not to invest our resources at the levels required in order to compete with new or enhanced products or standards introduced by our IIoT product line competitors, which would have a material adverse effect on our revenues, results of operations, and financial condition.
We are increasingly dependent on third-party developers.
We are increasingly reliant on various third parties for the development of software used in our products. There is a risk that the software provided by these third parties could contain errors or defects that could adversely impact the quality of our products. In addition, these third parties may use open source or other code that contains security flaws, which may cause our products to be more prone to hacking or other security incidents. We may also be negatively impacted by employee turnover or other challenges that these third-party developers face in their own businesses. Third parties may also choose not to develop software for our products if we do not have adequate market share or sufficient perception of future success. The materialization of any of these risks would impact our ability to deliver quality products on a timely basis, which could adversely impact our reputation and brand and harm our business and results of operations.
In addition, many of these third-party developers are located in markets that are subject to political risk, intellectual property misappropriation, corruption, infrastructure problems and natural disasters, in addition to country specific privacy and data security risks, given current legal and regulatory environments. The failure of these third parties to meet their obligations and adequately deploy business continuity plans in the event of a crisis and/or the development of significant disagreements, natural or man-made disasters or other factors that materially disrupt our ongoing relationship with these developers could negatively affect our operations.

Because we depend on a limited number of key suppliers and, in certain cases, a sole supplier, the failure of any key supplier to produce timely and compliant products could result in a failure to ship products, or could subject us to higher prices, which would harm our results of operations and financial position.

Our future success will depend significantly on our ability to timely manufacture our products cost effectively, in sufficient volumes, and in accordance with quality standards. For most of our products requiring assembly, we rely on a limited number of contract electronic manufacturers (CEMs), principally Bel-Fuse. These CEMs procure material and assemble, test, and inspect the final products to our specifications. This strategy involves certain risks, including reduced control over quality, costs, delivery schedules, availability of materials, components, finished products, and manufacturing yields. For example, an extended delay in the supply of a key component could disrupt the manufacturing of our products. Any such interruption in the supply of key components could therefore have a material adverse effect on our customer relationships and revenues. As a result of these and other risks, our CEMs could demand price increases for manufacturing our products. The Bel-Fuse factories, where our products are manufactured, are located in China. The Chinese government maintains programs, whereby labor rates for the manufacture of our products will increase over time. In addition, our agreements with our CEMs make us responsible for components and subassemblies purchased by the CEMs when based on our forecasts or purchase orders. Accordingly, we will be at risk for any excess and obsolete inventory purchased by our CEMs. Lastly, CEMs can experience turnover, instability, and lapses in manufacturing or component quality, exposing us to additional risks as well as missed commitments to our customers.
We also maintain manufacturing agreements with a limited number of semiconductor manufacturers for the production of key products. Cypress Semiconductor is the sole licensee, manufacturer and distributor for the Cypress Neuron, which is an important part of the LONWORKS portfolio. As a result, we or our customers may experience longer lead times and higher pricing for these parts, which could result in reduced orders for our products from these same customers. In addition, Cypress Semiconductor could decide to reduce or cease production of the Neuron chip in the future, at any time, with or without advance notice to us.
The FT 5000 free topology transceiver and the Neuron 5000 are sole sourced from the Taiwan Semiconductor Manufacturing Company (TSMC) foundry through our aggregator Open Silicon. In addition, we currently purchase several key products and

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components from sole or limited source suppliers with which we do not maintain signed agreements that would obligate them to supply to us on negotiated terms. Any sole source relationship could make us vulnerable to price increases, particularly where we do not maintain long-term supply agreements with the supplier, or to supply disruptions that would result if the supplier issued an end of life notice with respect to a key product.
We are continuing to review the impact that economic factors are having on our suppliers. Some of these suppliers are large, well-capitalized companies, while others are smaller and more highly leveraged. In order to mitigate these risks, we may take actions such as increasing our inventory levels and/or adding additional sources of supply. Such actions may increase our costs and increase the risk of excess and obsolete inventories. Even if we undertake such actions, there can be no assurance that we will be able to prevent any disruption in the supply of goods and services we receive from these suppliers.

We may also elect to change any of these key suppliers. As part of such a transition, we may be required to purchase certain raw material and in-process inventory from the existing supplier and resell it to the new source. In addition, if any of our key suppliers were to stop manufacturing our products or supplying us with our key components, it could be expensive and time consuming to find a replacement. Also, as our business grows, we will be required to expand our business with our key suppliers or find additional sources of supply. There is no guarantee that we would be able to find acceptable alternative or additional sources. Additional risks that we face if we must transition between CEMs include:

moving raw material, in-process inventory, and capital equipment between locations, some of which may be in different parts of the world;
reestablishing acceptable manufacturing processes with a new work force; and
exposure to excess or obsolete inventory held by contract manufacturers for use in our products.
The failure of any key manufacturer to produce a sufficient number of products on time, at agreed quality levels, and fully compliant with our product, assembly and test specifications could result in our failure to ship products in a timely manner or at all, which would adversely affect our revenues and gross profit, and could result in claims against us by our customers, which could harm our results of operations and financial position. Any such failures could also have a negative impact on our ability to project our financial results, which could result in volatility in our stock price.
Because our products use components or materials that may be subject to price fluctuations, shortages, interruptions of supply, or discontinuation, we may be unable to ship our products in a timely fashion, which would adversely affect our revenues, harm our reputation, and negatively impact our results of operations.

We may be vulnerable to price increases for products, components, or materials, such as silver, copper, and cobalt. We generally do not enter into forward contracts or other methods of hedging against supply risk for these items. In addition, we have in the past and may in the future experience shortages or interruptions in supply for certain of these items, including products or components that have been or will be discontinued, which can cause us to delay shipments beyond targeted or announced dates. We have also reduced our inventory levels from historical levels, which could impact our ability to supply our customers with products in a timely manner if there was an unexpected increase in demand. Such shortages or interruptions could result from events outside our control, as was the case with the earthquake and tsunami in Japan in March 2011. To help address these issues, we may decide from time to time to purchase quantities of these items that are in excess of our estimated requirements. As a result, we could be forced to increase our excess and obsolete inventory reserves to provide for these excess quantities, which could harm our results of operations. In addition, if a component or other product goes out of production, we may be required to requalify substitute components or products, or even redesign our products to incorporate an alternative component or product.
If we experience any shortage of products or components of acceptable quality, or any interruption in the supply of these products or components, or if we are not able to procure them from alternate sources at acceptable prices and within a reasonable period of time, our revenues, gross profits or both could decrease. In addition, under the terms of some of our contracts with our customers, we may also be subject to penalties if we fail to deliver our products on time.
Our business depends on the Internet and its continued and unimpeded access and development.
The Internet is crucial to the operations of many of our IIoT products and is a key component of the IIoT market as a whole. Our reliance on the Internet exposes us to a number of risks and uncertainties that are beyond our control, including risks related to privacy and data security. It is difficult to quantify the impact that any future security or performance problems associated with the Internet may have on our products and revenues.
In addition, state, federal and foreign regulators could adopt laws and regulations that impose additional burdens on companies that conduct business over the Internet. The growth and development of the market for online services may prompt calls for more

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stringent consumer protection laws or laws that may inhibit the use of Internet-based communications or the information contained in these communications. The adoption of any additional laws or regulations may impact the growth of the IIoT market. Any new legislation or regulations, application of laws and regulations from jurisdictions whose laws do not currently apply to our business, or application of existing laws and regulations to the IIoT and other related services could increase our costs and harm our growth.
In particular, there is increasing focus on privacy and data security laws and regulations applicable to the IoT. A wide variety of provincial, state, national, and international laws and regulations apply to the collection, use, retention, protection, disclosure, transfer and other processing of personal data. Regulatory authorities have increased their privacy - and data security - related activity in the IoT domain in recent years. For example, the Federal Trade Commission released a report on January 27, 2015 with recommendations for privacy and data security applicable to connected devices, objects and sensors. We also may become obligated to comply with, or may choose to comply with, self-regulatory or other requirements applicable to privacy or data security.

The privacy- and data security-related laws and regulations that may apply to us are evolving and subject to differing interpretation and enforcement, and may result in ever-increasing regulatory and public scrutiny and escalating levels of enforcement and sanctions. For example, the European Union General Data Protection Regulation, which becomes fully effective in May 2018, imposes more stringent data protection requirements and provides for greater penalties for noncompliance. Our actual or perceived failure to comply with applicable laws and regulations or other actual or alleged obligations relating to privacy or data security, or to protect personal data, could result in regulatory investigations or regulatory enforcement actions and remedies against us, including fines, imprisonment of company officials and public censure, private litigations, claims for damages, damage to our reputation and loss of goodwill (both in relation to existing end use customers and prospective end use customers), any of which could have a material adverse effect on our operations, financial performance, and business. 

If our IIoT solutions become subject to cyber-attacks, or if public perception is that they are vulnerable to cyber-attacks, our reputation and business would suffer.

We have designed our IIoT products, including our outdoor lighting solutions products, to interoperate with other third-party products and systems.  Although we attempt to safeguard our products and solutions from cybersecurity threats, the potential for cyber security attacks and other incidents continues to evolve in scope and frequency.

Advances in and expanding availability of technical tools to enable cybersecurity attacks, and increasing sophistication of the threats, deepen the risk of potential security incidents.  This risk expands as new protocols and devices are implemented into our products and systems, and as customer requirements evolve.  Should our products, or the combination of our products into third party systems, fail to prevent or be unable to withstand any such threats or cyber-attacks, or if our partners or customers fail to safeguard applicable technologies, products or the systems with adequate security policies and measures or otherwise, our business and reputation may be harmed.

We have attempted to design certain of our products to prevent and monitor unauthorized access, misuse, modification or other activities related to those products and the systems into which the products are intended to be placed. Despite our security measures, our products or systems may be subject to unauthorized break ins, viruses, disruptions, high-jacking, cyber terrorism, misuse, tampering, other unauthorized access or modification, or unauthorized access to, or acquisition, loss, or alteration of, data. Should our products fail to perform, be unable to withstand a cyber-attack, or otherwise suffer a security incident, or be perceived to have suffered any kind of security vulnerability or cyber incidents, we could face legal liability, and encounter material adverse financial and reputational harm.

In addition, we believe that there could be incidents of security breaches in the future which could receive significant publicity and visibility. Any such publicity or visibility, regardless of whether the problem is due or related to the performance or security measures of our products or systems, could have a negative effect on public confidence, or cause a perception that our solutions are or could be subject to similar attacks or breaches, and our business, results of operations and financial condition may be materially and adversely affected. Such an event could also result in a material adverse effect on the market price of our common stock, independent of the direct effects on our business.

Furthermore, because some of the information collected by some of our solutions is or may be considered personal data or otherwise may be alleged to be confidential or proprietary to our customers or third parties, a cyber-attack or other data security incident, including any unauthorized access to, loss of, or acquisition of data collected or maintained by our solutions, could violate, or be alleged to violate, applicable privacy, consumer or information security laws, regulations or other obligations. Any of the foregoing could cause us to face regulatory investigations and enforcement actions, private litigation, and other financial or legal

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liability, as well as harm to our reputation and business, any of which could have a material adverse effect on our business and financial performance.
We are dependent on technology systems and third-party content that are beyond our control.
Our success in the IIoT market will depend in part on the availability of online services and Internet connections to facilitate data transmission.  In most instances, these services will be provided by third parties and will be outside of our control.  Even when we are not responsible for connectivity or other problems, users of our products may attribute the problem to us. For example, many of our customers rely on the capacity, reliability and security of wireless networks owned and controlled by third parties to use our IIoT products. However, the price of access and operational integrity of online services, wireless networks and Internet connections are beyond our control. As a result, it may be difficult to identify the source of problems if they occur. This could diminish our brand and harm our business, divert the attention of our technical personnel from our product development efforts or cause significant customer relations problems.

Information Technology system security failures, cyber-attacks, and other technological breaches could cause harms to our business.

We also rely on the security of our third party providers to protect our proprietary information and information of our customers.  Information technology system failures, including a breach of our or our third party providers’ data security, could disrupt our ability to function in the normal course of business by potentially causing, among other things, an unintentional disclosure of customer information.  Despite our implementation of security measures or those of our third party providers, information systems may be vulnerable to threats such as computer hacking, cyber-terrorism or other unauthorized attempts by third parties to access, modify or delete our or our customers’ data or otherwise disrupt our systems.   Any such breach could have a material adverse effect on our business, results of operations, and our reputation as a provider of data collection, and secure and reliable device connection, collaboration and communications solutions, including legal claims for damages or injunctive relief under state, federal and foreign laws, reputational damage, and decreased revenues.

We have designed our IIoT products and solutions products to interoperate with other third party products and systems.  Although we attempt to safeguard our products and solutions from cybersecurity threats, the potential for cyber security attacks continues to evolve in scope and frequency.
We face operational and other risks associated with our international operations, which may adversely affect our revenues, results of operations, and financial condition.
We have operations located in seven countries and our products are sold in many more countries around the world. Revenues from international sales, which include both export sales and sales by international subsidiaries, accounted for about 60.9% and 68.2% of our total revenues for the years ended December 31, 2017 and 2016, respectively. We expect that international sales will continue to constitute a significant portion of our total revenues. Given our high dependency on sales of our products into Europe, the ongoing financial crisis in that region, which may be adversely impacted by the "Brexit" vote in the United Kingdom, could adversely affect our financial results.

Other risks inherent in our international business activities include, but are not limited to, the following:

timing of and costs associated with localizing products for foreign countries and lack of acceptance of non-local products in foreign countries;
that the nature and composition of our products may subject us to any number of additional legal requirements, which might include, but are not limited to, data privacy regulations, import/export regulations and other similar requirements;
challenges in managing international operations;
the burdens of complying with a wide variety of foreign laws and any related implementation costs;
the applicability of foreign laws that could affect our business or revenues, such as laws that purport to require that we return payments that we received from insolvent customers in certain circumstances; and unexpected changes in regulatory requirements, tariffs, and other trade barriers;
cultural differences that could make it more difficult to sell our products or could result in allegations that sales activities have violated the U.S. Foreign Corrupt Practices Act or similar laws that prohibit improper payments in connection with efforts to obtain business;
exchange rate fluctuations;
the imposition of tariffs or other trade barriers on the importation of our products;
potentially adverse tax consequences, including restrictions on repatriation of earnings;
economic and political conditions in the countries where we do business;

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differing vacation and holiday patterns in other countries, particularly in Europe;