UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 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 March 31, 2000
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 000-29748
ECHELON CORPORATION
(Exact name of registrant as specified in its charter)
Delaware 77-0203595
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification Number)
4015 Miranda Avenue
Palo Alto, CA 94304
(Address of principal executive office and zip code)
(650) 855-7400
(Registrant's telephone number, including area code)
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 filing requirements
for the past 90 days.
YES [X] NO [ ]
As of April 30, 2000, 34,453,051 shares of the Registrant's common stock were
outstanding.
ECHELON CORPORATION
FORM 10-Q FOR THE QUARTER ENDED MARCH 31, 2000
INDEX
Page
----
Part I. FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Balance Sheets as of
March 31, 2000 and December 31, 1999 3
Condensed Consolidated Statements of Operations
for the three months ended March 31, 2000 and
March 31, 1999 4
Condensed Consolidated Statements of Cash Flows for the
three months ended March 31, 2000 and March 31, 1999 5
Notes to Condensed Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 10
Item 3. Quantitative and Qualitative Disclosures About Market Risk 13
Part II. OTHER INFORMATION
Item 1. Legal Proceedings 22
Item 2. Changes in Securities 22
Item 3. Defaults upon Senior Securities 22
Item 4. Submission of Matters to a Vote of Security Holders 22
Item 5. Other Information 22
Item 6. Exhibits and Reports on Form 8-K 22
SIGNATURE 22
2
PART I. FINANCIAL INFORMATION
-----------------------------
ITEM 1. FINANCIAL STATEMENTS
ECHELON CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands)
March 31, December 31,
2000 1999
--------- -----------
(Unaudited)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents ........................................ $ 17,402 $ 9,336
Short-term investments ........................................... 6,628 14,968
Accounts receivable, net ......................................... 7,394 7,303
Inventories ...................................................... 4,387 3,159
Other current assets ............................................. 2,155 2,297
--------- ---------
Total current assets ............................................. 37,966 37,063
Property and equipment, net ...................................... 2,657 2,648
--------- ---------
$ 40,623 $ 39,711
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable ................................................. $ 2,858 $ 2,586
Accrued liabilities .............................................. 2,446 2,540
Deferred revenues ................................................ 1,419 1,647
--------- ---------
Total current liabilities ........................................ 6,723 6,773
--------- ---------
STOCKHOLDERS' EQUITY:
Common stock ..................................................... 340 332
Additional paid-in capital ....................................... 129,170 127,613
Accumulated other comprehensive loss ............................. (200) (202)
Deferred compensation ............................................ (353) (399)
Accumulated deficit .............................................. (95,057) (94,406)
--------- ---------
Total stockholders' equity ....................................... 33,900 32,938
--------- ---------
$ 40,623 $ 39,711
========= =========
The accompanying notes are an integral part of these condensed consolidated
financial statements.
3
ECHELON CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(in thousands, except per share amounts)
Three Months Ended March 31,
---------------------------
2000 1999
-------- --------
REVENUES:
Product ...................................................... $ 10,940 $ 8,173
Service ...................................................... 503 635
-------- --------
Total revenues ............................................... 11,443 8,808
-------- --------
COST OF REVENUES:
Cost of product .............................................. 4,284 3,325
Cost of service .............................................. 482 380
-------- --------
Total cost of revenues ....................................... 4,766 3,705
-------- --------
Gross profit ................................................. 6,677 5,103
-------- --------
OPERATING EXPENSES:
Product development .......................................... 2,363 2,440
Sales and marketing .......................................... 4,078 3,500
General and administrative ................................... 1,169 1,039
-------- --------
Total operating expenses ..................................... 7,610 6,979
-------- --------
Loss from operations ......................................... (933) (1,876)
-------- --------
INTEREST AND OTHER INCOME, NET
322 362
-------- --------
Loss before provision for
income taxes .............................................. (611) (1,514)
Provision for income taxes ................................... 40 59
-------- --------
Net loss ..................................................... $ (651) $ (1,573)
======== ========
Basic net loss per share ..................................... $ (0.02) $ (0.05)
======== ========
Shares used in computing
basic net loss per share .................................. 33,651 32,639
======== ========
The accompanying notes are an integral part of these condensed consolidated
financial statements.
4
ECHELON CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(in thousands)
Three Months Ended March 31,
---------------------------
2000 1999
----------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss ................................................................... $ (651) $ (1,573)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization............................................... 298 245
Deferred compensation expense............................................... 46 47
Change in operating assets and liabilities:
Accounts receivable......................................................... (91) (1,044)
Inventories................................................................. (1,228) 646
Other current assets 142 671
Accounts payable............................................................ 272 335
Accrued liabilities......................................................... (94) (336)
Deferred revenues........................................................... (228) (332)
Deferred rent............................................................... -- (42)
-------- --------
Net cash used in operating activities ...................................... (1,534) (1,383)
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of available-for-sale short-term investments ...................... (509) (4,047)
Proceeds from maturities and sales of available-for-sale
short-term investments ............................................... 8,849 6,481
Unrealized gains (losses) on securities..................................... (8) 16
Capital expenditures........................................................ (307) (187)
-------- --------
Net cash provided by investing activities................................... 8,025 2,263
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of common stock ..................................... 1,565 173
-------- --------
EFFECT OF EXCHANGE RATES ON CASH............................................ 10 (107)
-------- --------
NET INCREASE IN CASH AND CASH EQUIVALENTS 8,066 946
CASH AND CASH EQUIVALENTS:
Beginning of period ........................................................ 9,336 11,552
-------- --------
End of period .............................................................. $ 17,402 $ 12,498
======== ========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid for income taxes ................................................. $ 31 $ 37
======== ========
The accompanying notes are an integral part of these condensed consolidated
financial statements.
5
ECHELON CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. BASIS OF PRESENTATION:
The condensed consolidated financial statements include the accounts of
Echelon Corporation (the Company), a Delaware corporation, and its wholly owned
subsidiaries. Significant intercompany accounts and transactions have been
eliminated.
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 Echelon
Corporation consolidated financial statements for the year ended December 31,
1999 included in its Form 10-K.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
Use of Estimates in the Preparation of Financial Statements
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosures of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Revenue Recognition and Product Warranty
The Company's revenues are derived from the sale and license of its
products and to a lesser extent, from fees associated with training and
technical support offered to its customers. Product revenues consist of revenues
from hardware sales and software licensing arrangements. Revenues from software
licensing arrangements have not been significant to date. Service revenues
consist of product support (including software post-contract support services)
and training.
Revenue from hardware sales is recognized upon shipment to the customer.
Estimated reserves for warranty costs as well as reserves for sales returns and
allowances related to anticipated return of products sold to distributors with
limited rights of return, which are not material to the consolidated financial
statements, are recorded at the time of sale. Revenues from software sales,
including sales to distributors, are recognized upon shipment of the software to
licensees if there are no significant post-delivery obligations and if
collection is probable. The Company generally has not had any significant
post-delivery obligations associated with the sale of its products. Service
revenue is recognized as the services are performed, or ratably over the term of
the support period.
Cash, Cash Equivalents and Short-Term Investments
The Company considers bank deposits, money market investments and all debt
and equity securities with an original maturity of three months or less as cash
and cash equivalents. The Company classifies its investments in debt and equity
securities as available-for-sale in accordance with Statement of Financial
Accounting Standards (SFAS) No. 115, "Accounting for Certain Investments in Debt
and Equity Securities."
6
As of March 31, 2000, the Company's available-for-sale securities had
contractual maturities from eight to twenty-three months and an average maturity
of six months. The fair value of available-for-sale securities was determined
based on quoted market prices at the reporting date for those instruments. As of
March 31, 2000, the amortized cost basis, aggregate fair value and gross
unrealized holding losses by major security type were as follows (in thousands):
Unrealized
Amortized Aggregate Holding
Cost Fair Value Losses
---------- ---------- ----------
U.S. corporate securities:
Corporate notes and bonds........ $ 6,653 $ 6,628 $ (25)
=========== =========== =========
Computation of Basic Net Loss Per Share and Pro Forma Basic Net Loss Per Share
Historical net loss per share has been calculated under SFAS No. 128,
"Earnings per Share." SFAS No. 128 requires companies to compute earnings per
share under two different methods (basic and diluted). Basic net loss per share
is calculated by dividing net loss by the weighted average shares of common
stock outstanding during the period. No diluted loss per share information has
been presented in the accompanying consolidated statements of operations since
potential common shares from stock options and warrants are antidilutive.
New Accounting Standards
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivative Investments and Hedging Activities," which
establishes standards for the accounting for derivative transactions and the
derivative portion of certain other contracts. SFAS No. 133 will become
effective for the Company's fiscal year beginning January 1, 2001. Management
believes that SFAS No. 133 will not have a material effect on the Company's
financial statements.
In December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 101 ("SAB 101"), "Revenue Recognition in Financial
Statements." SAB 101 provides guidance on applying generally accepted accounting
principles to revenue recognition in financial statements. We will adopt SAB 101
as required in the second quarter of 2000. Management has evaluated the effect
of the adoption and has determined that financial results for the first quarter
of 2000 will not be materially effected.
3. INVENTORIES:
Inventories are stated at the lower of cost (first-in, first-out) or market
and include material, labor and manufacturing overhead. Inventories consist of
the following (in thousands):
March 31, December 31,
2000 1999
----------------- -----------------
(Unaudited)
Purchased materials................... $ 1,881 $ 1,674
Work-in-process....................... 17 51
Finished goods........................ 2,489 1,434
--------- ---------
$ 4,387 $ 3,159
========= =========
7
4. ACCRUED LIABILITIES:
Accrued liabilities consist of the following (in thousands):
March 31, December 31,
2000 1999
------ -----------
(Unaudited)
Accrued payroll and related costs .............................. $1,446 $1,191
Accrued marketing costs ........................................ 366 372
Other accrued liabilities ...................................... 465 428
Accrued non-recurring charges .................................. 169 549
------ ------
$2,446 $2,540
====== ======
5. SEGMENT DISCLOSURE:
In 1998, the Company adopted SFAS No. 131, "Disclosures about Segments of
an Enterprise and Related Information." 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 the Vice Presidents. SFAS No. 131
also requires disclosures about products and services, geographic areas and
major customers. The adoption of SFAS No. 131 did not affect results of
operations or the financial position of the Company but did affect the
disclosure of segment information.
The Company operates in one principal industry segment: the design,
manufacture and sale of products for the controls network industry, and markets
its products primarily to the building automation, industrial automation,
transportation, and home automation markets. The Company's products are marketed
under the LONWORKS brand name, which provides the infrastructure, and support
required to implement and deploy open, interoperable, control network solutions.
All of the Company's products either incorporate or operate with the Neuron Chip
and/or the LONWORKS protocol. The Company also provides services to customers
which consist of technical support and training courses covering its LONWORKS
network technology and products. The Company offers about 80 products and
services that together constitute the LONWORKS system. Any given customer
purchases a small subset of such products and services that are appropriate for
that customer's application.
The Company manages its business primarily on a geographic basis. The
Company's geographic areas are comprised of the Americas, Europe, Middle East
and Africa ("EMEA") and Asia Pacific/ Japan ("APJ"). Each geographic area
provides products and services as further described in Note 1. The Company
evaluates the performance of its geographic areas based on profit or loss from
operations. Profit or loss for each geographic area includes sales and marketing
expenses and other charges directly attributable to the area and excludes
certain expenses that are managed outside the geographic area. Costs excluded
from area profit or loss primarily consist of unallocated corporate expenses,
comprised of product development costs, corporate marketing costs and other
general and administrative expenses, which are separately managed. The Company
has no long-lived assets, other than property and equipment. Long-lived assets
are attributed to geographic areas based on the country where the assets are
located. As of March 31, 2000 and December 31, 1999 long-lived assets of about
$2.3 million were domiciled in the United States. Long-lived assets for all
other locations are not material to the consolidated financial statements.
Assets and the related depreciation and amortization are not being reported by
geography because the information is not reviewed by the Executive Staff to make
decisions about resources to be allocated to the geographic areas based on their
performance.
8
In North America, the Company sells its products through a direct sales
organization. Outside the United States, direct sales, applications engineering
and customer support are conducted through the Company's operations in Europe,
Japan and China. Revenues are attributed to geographic areas based on the
country where the customer is domiciled. Summary information by geography for
the three months ended March 31, 2000 and 1999 is as follows (unaudited, in
thousands):
Three months ended
March 31,
----------------------
2000 1999
-------- --------
Revenues from customers:
Americas ...................... $ 4,099 $ 2,909
EMEA .......................... 5,138 4,311
APJ ........................... 2,000 1,375
Unallocated ................... 206 213
-------- --------
Total .................... $ 11,443 $ 8,808
======== ========
Gross profit (loss):
Americas ...................... $ 2,385 $ 1,907
EMEA .......................... 2,922 2,494
APJ ........................... 1,164 984
Unallocated ................... 206 (282)
-------- --------
Total .................... $ 6,677 $ 5,103
======== ========
Income (loss) from operations:
Americas ...................... $ 1,347 $ 1,025
EMEA .......................... 1,997 1,706
APJ ........................... 225 258
Unallocated ................... (4,502) (4,865)
-------- --------
Total .................... $ (933) $ (1,876)
======== ========
One customer, the sole independent distributor of the Company's products in
Europe, accounted for 27.3% and 25.3% of total revenues for the quarters ended
March 31, 2000 and 1999, respectively.
6. INCOME TAXES:
Income taxes for the three-month periods ended March 31, 2000 and 1999
primarily consist of taxes related to foreign subsidiaries.
9
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
This Management's Discussion and Analysis of Financial Condition and
Results of Operations includes a number of forward-looking statements which
reflect our current views with respect to future events and financial
performance. These forward-looking statements are subject to certain risks and
uncertainties, including those discussed in the "Factors That May Affect Future
Results of Operations" and elsewhere in this Form 10-Q that could cause actual
results to differ materially from historical results or those anticipated. In
this report, the words "believes," "future," and similar expressions identify
forward-looking statements. Readers are cautioned not to place undue reliance on
these forward-looking statements, which speak only as of the date of this Form
10-Q.
The following management's discussion and analysis of financial condition
and results of operations should be read in conjunction with management's
discussion and analysis of financial condition and results of operations
included in our Form 10-K for the year ended December 31, 1999.
OVERVIEW
We develop, market and support a family of hardware and software products
and services that enables OEMs and systems integrators to design and implement
open, interoperable, distributed control networks. We offer our products and
services to OEMs and systems integrators in the building, industrial,
transportation, home and other automation markets. We provide a variety of
technical training courses related to our products and underlying technology. We
also provide customer support on a per-incident or annual contract basis.
We market our products and services in North America, Europe, Japan, South
America and selected Asia-Pacific countries through a direct sales organization
augmented with the use of third-party distributors and systems integrators.
International sales, which include both export sales and sales by international
subsidiaries, accounted for 62.4% and 64.6% of our total revenues for the first
quarters of 2000 and 1999. The percentage of our revenues that was denominated
in currencies other than the U.S. dollar, principally the Japanese Yen, was
10.3% and 10.9% for the first quarter of 2000 and 1999. However, this percentage
may increase over time as we respond to market requirements to sell our products
and services in local currencies, such as the Euro. As a result, our operations
and the market price of our products may be directly affected by economic and
political conditions in the countries where we do business. We expect that
international sales will continue to constitute a significant portion of total
revenues.
We derive our revenues primarily from the sale and licensing of our
products and, to a lesser extent, from fees associated with training and
technical support offered to our customers. Our product revenues consist of
revenues from sales of transceivers, control modules, routers, network interface
devices and development tools and from licenses of network services software
products. We have not had significant revenues from software licensing
arrangements to date. Our service revenues consist of product support (including
software post-contract support services) and training. We recognize revenue from
product sales at the time we ship the products to the customer. We record
estimated reserves for warranty costs as well as for sales returns and
allowances related to anticipated return of products sold to distributors with
limited rights of return, at the time we sell the products. We recognize revenue
from software sales when we ship the software if we have no significant
post-delivery obligations and if we determine that collection is probable. We
generally have not had any significant post-delivery obligations associated with
the sale of our products. We recognize service revenues as we perform the
services, or ratably over the term of the support period.
We have experienced operating losses in all prior years and for the first
three months of 2000. During this period, we have invested significantly in
product development to implement open control networks. Our development projects
included development of transceivers, control modules, routers, network
interface devices, network management software, LonPoint products and the i.LON
1000 Internet Server. Furthermore,
10
because our strategy depends significantly on achieving broad adoption of our
LONWORKS technology across many industries worldwide, we have incurred
significant selling and marketing expenses to promote our products. We currently
believe it is unlikely that our future rate of growth of product development,
sales and marketing expenses will fall below their historical levels. In
addition, we believe that our products are priced competitively to ensure that
our LONWORKS technology is broadly adopted in many industries. We plan to
continue to invest significantly in product development, sales and marketing,
and to the extent such expenditures are accelerated to exploit market
opportunities, or do not result in significant increases in revenues, we may
continue to incur operating losses for the foreseeable future.
Our quarterly and annual results have varied significantly, and we expect
our results to continue to vary. Many of the factors that can cause our results
to vary are outside of our control. For example, the rates at which OEMs
purchase our products and services can fluctuate. These rates are affected by
the OEMs' own business cycles. Another factor is whether we can introduce new
products in a timely manner. From time to time, we have delayed introducing new
products beyond our projected shipping date. These delays have increased costs
and postponed revenues. Because our future revenues depend on our ability to
timely introduce new product offerings, any future delays could harm our
business. Our expense levels are based substantially on the levels of future
revenues that we expect to generate. Consequently, if our revenues are less than
we expect, our expense levels could be disproportionately high as a percentage
of total revenues, and our operating results could be harmed. In the past, we
have sometimes failed to meet our expected targets for revenues. In addition,
declines in sales of our existing products over time have hurt the growth of our
revenues.
Revenues
Total revenues grew to $11.4 million in the first quarter of 2000 from $8.8
million in the first quarter of 1999. One customer, EBV, the sole independent
distributor of our products in Europe, accounted for 27.3% and 25.3% of total
revenues for the first quarters of 2000 and 1999.
Product. Product revenues grew to $10.9 million in the first quarter of
2000 from $8.2 million in the first quarter of 1999. The 33.9% increase in
product revenues between the two quarters was primarily a result of an increase
in sales of control and connectivity products as well as the revenues generated
from the sales of the new i.LON 1000 Internet Servers.
Service. Service revenues decreased to $503,000 in the first quarter of
2000 from $635,000 in the first quarter of 1999. The 20.8% decrease in service
revenues between the two quarters was primarily due to reduced customer support
revenues partially offset by a slight increase in training revenue.
Cost of Revenues
Cost of product. Cost of product revenues consists of costs associated with
the purchase of components and subassemblies, as well as allocated labor,
overhead and manufacturing variances associated with the packaging, preparation
and shipment of products. Cost of product revenues in the first quarter of 2000
was $4.3 million compared to $3.3 million in 1999, representing product gross
margins of 60.8% and 59.3%. The increase in product gross margin percentage
between the two quarters was primarily due to improved overhead spending rates.
Cost of service. Cost of service revenues consists of employee-related
costs as well as direct costs incurred in providing training and customer
support services. Cost of service revenues increased to $482,000 for the first
quarter of 2000 from $380,000 for the comparative period in 1999, representing
service gross margins of 4.2% and 40.2%, respectively. The decline in service
gross margins for the quarter periods was due to a decline in service revenues
along with an increase in the cost of providing those services due primarily to
increased personnel costs.
11
Operating Expenses
Product development. Product development expenses consist primarily of
payroll and related expenses, expensed material and facility costs associated
with the development of new technologies and products. Product development
expenses for the first quarter of 2000 and 1999 were $2.4 million, representing
20.7% and 27.7% of total revenues for the first quarter of 2000 and 1999.
Sales and marketing. Sales and marketing expenses consist primarily of
payroll and related expenses, including commissions to sales personnel, travel
and entertainment, advertising and product promotion and facilities costs
associated with the Company's sales and support offices. Sales and marketing
expenses for the first quarter of 2000 increased to $4.1 million from $3.5
million in the first quarter of 1999, representing 35.6% and 39.7% of total
revenues. The increase in sales and marketing expenses for the comparison
periods was primarily the result of increased worldwide personnel expenses,
including new employees in the sales and marketing areas as well as increased
commissions related to increased revenues.
General and administrative. General and administrative expenses consist
primarily of payroll and related expenses for executive, accounting and
administrative personnel, insurance, professional fees and other general
corporate expenses. General and administrative expenses in the first quarter of
2000 increased slightly to $1.2 million from $1.0 million in the first quarter
of 1999, representing 10.2% and 11.8% of total revenues.
Interest and other income, net
Interest and other income, net primarily reflects interest earned by the
Company on its cash and short-term investment balances. Interest and other
income, net for the first quarter of 2000 decreased slightly to $322,000 from
$362,000 for the comparable period in 1999, primarily due to a lower cash and
short-term investments balance during the first quarter of 2000 compared to the
first quarter of 1999.
Provision for income taxes
Income taxes consist of taxes related to certain of the Company's foreign
subsidiaries. Income taxes were $40,000 and $59,000 for the first quarters of
2000 and 1999.
LIQUIDITY AND CAPITAL RESOURCES
Since its inception, we have financed our operations and met our capital
expenditure requirements primarily from the sale of preferred stock and common
stock. From inception through March 31, 2000, we had raised $129.5 million from
the sale of preferred stock and common stock.
As of December 31, 1999, we had cash, cash equivalents and short-term
investments of $24.0 million. Net cash used in operating activities was $1.5
million in the first quarter of 2000 compared to $1.4 million in the first
quarter of 1999. Cash used in 2000 was principally the result of a planned
increase in inventories and the net loss. Cash used in 1999 was principally the
result of increases in receivables and the net loss.
Net cash provided by investing activities of $8.0 million in the first
quarter of 2000 and $2.3 million in the first quarter of 1999 was principally
due to the net proceeds from maturities and sales of available-for-sale
investments, slightly offset by capital expenditures of $307,000 in the first
quarter of 2000 and $187,000 in the first quarter of 1999.
Net cash provided by financing activities of $1.6 million and $173,000 for
the first quarters of 2000 and 1999 was principally due to the proceeds from the
exercise of stock options by employees.
12
We believe that our existing available cash, cash equivalents and
short-term investments will satisfy our projected working capital and other cash
requirements for at least the next twelve months. However, we may require
additional financing within this period, but 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.
Year 2000 Compliance
We did not experience any system problems relating to the Year 2000 issue.
To our knowledge, none of our material suppliers or vendors experienced any
material Year 2000 problems. We do not expect to incur any material expenditures
relating to Year 2000 systems remediation.
New Accounting Standards
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivative Investments and Hedging Activities," which
establishes standards for the accounting for derivative transactions and the
derivative portion of certain other contracts. SFAS No. 133 will become
effective for our fiscal year beginning January 1, 2001. We believe that SFAS
No. 133 will not have a material effect on our financial statements.
In December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 101 ("SAB 101"), "Revenue Recognition in Financial
Statements." SAB 101 provides guidance on applying generally accepted accounting
principles to revenue recognition in financial statements. We will adopt SAB 101
as required in the second quarter of 2000. We have evaluated the effect of the
adoption and have determined that financial results for the first quarter of
2000 will not be materially effected.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS
There has not been any material change in our exposure to interest rate and
foreign currency risks since the date of the 1999 Form 10-K.
Interest Rate Risk. Our exposure to market risk for changes in interest
rates relates primarily to our investment portfolio. All investments are in
high-credit quality issuances, and, by our company policy, are limited in the
amount of credit exposure to any one issuer. We ensure the safety and
preservation of the invested principal funds by investing only in marketable
securities with active secondary or resale markets to maintain portfolio
liquidity. The table below presents principal amounts and related weighted
average interest rates for our investment portfolio at March 31, 2000. According
to our policy, all investments mature in two years or less.
Average
Carrying Amount Interest Rate
--------------- --------------
(in thousands)
Cash Equivalents:
U.S. corporate securities............ $15,033 6.16%
------- ----
Total cash equivalents ......... $15,033 6.16%
------- ----
Short-term Investments:
U.S. corporate securities ........... $ 6,628 6.11%
------- ----
Total short-term investments... $ 6,628 6.11%
------- ----
Total investment securities.... $21,661 6.14%
======= ====
13
Foreign Currency Exchange Risk. We transact business in various foreign
countries. Our primary foreign currency cash flows are in Japan. Currently, we
do not employ a foreign currency hedge program utilizing foreign currency
exchange contracts as the foreign currency transactions and risks to date have
not been significant.
FACTORS THAT MAY AFFECT FUTURE RESULTS OF OPERATIONS
WE HAVE A HISTORY OF LOSSES, AND WE EXPECT TO INCUR LOSSES IN THE FUTURE.
We have incurred net losses each year since our inception. At March 31,
2000, we had an accumulated deficit of $95.1 million. We have invested and
continue to invest significant financial resources in product development,
marketing and sales. If our revenues do not increase significantly as a result
of these expenditures, our financial results could decline. We may not achieve
profitability if our revenues increase more slowly than we expect or do not
increase at all. Even if we achieve profitability, we may not be able to sustain
or increase profitability on a quarterly or annual basis. Our future operating
results will depend on many factors, including:
. the growth of the markets for our products;
. the acceptance of our products;
. the level of competition that we face;
. our ability to develop and market new products; and
. general economic conditions.
As of December 31, 1999, we had net operating loss carryforwards for
Federal income tax reporting purposes of about $83.9 million and for state
income tax reporting purposes of about $4.9 million, which expire at various
dates through 2019. In addition, as of December 31, 1999, we had tax credit
carryforwards of about $4.4 million, which expire at various dates through 2019.
The Internal Revenue Code of 1986, as amended, contains provisions that may
limit the use in any future period of net operating loss and credit
carryforwards upon the occurrence of certain events, including a significant
change in ownership interests. We had deferred tax assets, including our net
operating loss carryforwards and tax credits, totaling about $37.9 million as of
December 31, 1999. A valuation allowance has been recorded for the entire
deferred tax asset as a result of uncertainties regarding the realization of the
asset balance, our history of losses and the variability of our operating
results.
OUR LIMITED HISTORY AND THE UNDETERMINED MARKET ACCEPTANCE OF OUR PRODUCTS MAKE
IT DIFFICULT TO EVALUATE OUR FUTURE PROSPECTS.
We have only a limited operating history on which you can base your
evaluation of our business. We face a number of risks as an emerging company in
a new market, and you must consider our prospects in light of these risks. Our
future operating results are difficult to predict due to many factors, including
the following:
. our targeted markets have not yet accepted many of our products and
technologies;
. the nature of our business and markets require rapid progress;
. potential changes in voluntary product standards can significantly influence
many of the markets for our products; and
. our industry is very competitive.
FLUCTUATIONS IN OUR OPERATING RESULTS MAY CAUSE OUR STOCK PRICE TO DECLINE.
Our quarterly and annual results have varied significantly, and we have
failed to meet securities analysts' expectations in the past. Our future results
may fluctuate and may not meet those expectations in some future
14
period. As a result, the price of our common stock could fluctuate or decline.
The factors that could cause this variability, many of which are outside of our
control, include the following:
. fluctuations in the rates at which OEMs purchase our products and services;
. OEMs' own business cycles;
. our ability to introduce new products on a timely basis;
. any downturns in any customer's or potential customer's business, or
declines in general economic conditions that cause significant reductions in
their capital spending;
. increased competition;
. market acceptance of our products;
. product life cycles;
. order delays or cancellations;
. changes in the mix of products and services that we sell;
. shipment and payment schedules;
. changes in our pricing policies or those of our competitors;
. changes in product distribution; and
. product ratings by industry analysts and endorsement of competing products
by industry groups.
In addition, our expense levels are based, in significant part, on the
future revenues that we expect. Consequently, if our revenues are less than we
expect, our expense levels could be disproportionately high as a percentage of
total revenues.
IF OUR OEMS DO NOT EMPLOY OUR PRODUCTS AND TECHNOLOGIES, OR IF WE DO NOT
MAINTAIN AND EXPAND OUR DISTRIBUTION CHANNELS, OUR REVENUES COULD DECREASE
SIGNIFICANTLY.
To date, substantially all of our product sales have been to OEMs. The
product and marketing decisions made by OEMs significantly affect the rate at
which our products are used in control networks. We believe that since OEMs in
certain industries receive a large portion of their revenues from sales of
products and services to their installed base, these OEMs have tended to
moderate the rate at which they incorporate LONWORKS technology into their
products. We have attempted to motivate OEMs, as well as systems integrators and
owners of control systems, to transition more rapidly to LONWORKS technology.
Furthermore, OEMs that manufacture and promote products and technologies that
compete or may compete with us may be particularly reluctant to employ our
products and technologies to any significant extent, if at all. We may not be
able to maintain or improve the current rate at which our products are accepted
by OEMs and others, which could decrease our revenues.
Currently, significant portions of our revenues are derived from sales by
EBV, the sole independent distributor of our products to OEMs in Europe. EBV
accounted for 27.3% and 25.3% of our total revenues for the first quarter of
2000 and 1999. Our current agreement with EBV expires in December 2000. In
addition, as part of our distribution strategy, we intend to develop
distribution arrangements with systems integrators. In particular, we expect
that a significant portion of our future revenues will be derived from sales by
such systems integrators. If EBV or any other existing or future distributor
fails to dedicate sufficient resources and efforts to marketing and selling our
products, our revenues could decrease. If EBV significantly reduces the stocking
levels for our products, both revenues and customer service levels would be
decreased. In that case, we might be required to add our own pan-European
distribution capability to meet the needs of our customers. Our business will be
harmed if we fail to do any of the following:
. develop new distribution channels;
. maintain the EBV arrangement or any other distribution channels; or
. renew the EBV arrangement on a timely basis.
15
WE DEPEND ON A LIMITED NUMBER OF KEY MANUFACTURERS FOR NEURON CHIPS AND USE
CONTRACT ELECTRONIC MANUFACTURERS FOR MOST OF OUR PRODUCTS REQUIRING ASSEMBLY.
IF ANY OF THESE MANUFACTURERS TERMINATES OR DECREASES ITS RELATIONSHIPS WITH US,
WE MAY NOT BE ABLE TO SUPPLY OUR PRODUCTS AND OUR REVENUES WOULD SUFFER.
The Neuron Chip is an important component that our customers use in control
network nodes. In addition, the Neuron Chip is an important device that we use
in many of our products. Neuron Chips are currently distributed by both Motorola
and Toshiba. We have entered into licensing agreements with each of Motorola,
Toshiba and Cypress. The agreements, among other things, grant Motorola, Toshiba
and Cypress the worldwide right to manufacture and distribute Neuron Chips using
technology licensed from us and require us to provide support and unspecified
updates to the licensed technology over the terms of the agreements. The
Motorola agreement expires in January 2001, the Cypress agreement expires in
April 2009 and the Toshiba agreement expires in January 2010. Motorola has
announced that it will discontinue distribution of Neuron Chips after January
31, 2001, although Motorola has the right to terminate the agreement at any
time. While we developed the first version of the Neuron Chip, Motorola and
Toshiba subsequently developed improved, lower-cost versions of the Neuron Chip
that are presently used in products that our customers and we develop and sell.
We currently have no other source of supply for Neuron Chips and have neither
the resources nor the skills to replace Toshiba or Cypress as a manufacturer of
Neuron Chips. Both Motorola and Toshiba have played, and Toshiba and Cypress are
expected to play, a key role in the development and marketing of LONWORKS
technology. If we lose Toshiba or Cypress as a supplier, we may not be able to
locate an alternate source for the design, manufacture or distribution of Neuron
Chips.
Our future success will also depend significantly on our ability to
successfully manufacture our products cost-effectively and in sufficient
volumes. For most of our products requiring assembly, we use contract electronic
manufacturers, including Able Electronics, Jabil Circuits and muRata
Electronics. These contract electronic manufacturers procure material and
assemble, test and inspect the final products to our specifications. This
strategy involves certain risks. By using third parties to manufacture our
products, we have reduced control over delivery schedules, product availability,
manufacturing yields, quality and costs. In addition, contract electronic
manufacturers can themselves experience turnover and instability exposing us to
additional risks as well as missed commitments to our customers. We will also
face risks if and when we transition between contract electronic manufacturers.
For example, we may have to move raw material and in process inventory between
locations in different parts of the world. Also, we would be required to
reestablish acceptable manufacturing processes with a new work force. We
currently purchase several key components only from sole or limited sources. 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 these products or components from alternate sources at
acceptable prices and within a reasonable period of time, our revenues and/or
gross profits could decrease.
MANY OF OUR CURRENT COMPETITORS HAVE LONGER OPERATING HISTORIES AND
SIGNIFICANTLY GREATER FINANCIAL, TECHNICAL, MARKETING AND OTHER RESOURCES THAN
WE DO, AND MAY BE MORE SUCCESSFUL AT SELLING THEIR PRODUCTS THAN WE ARE.
Competition in our markets is intense and involves rapidly changing
technologies, evolving industry standards, frequent new product introductions
and rapid changes in customer requirements. To maintain and improve our
competitive position, we must continue to develop and introduce, on a timely and
cost-effective basis, new products, features and services that keep pace with
the evolving needs of our customers. The principal competitive factors that
affect the markets for our control network products are the following:
. our customer service and support;
16
. our product reputation, quality, performance; and
. the price and features of our products such as adaptability, scalability,
the ability to integrate with other products, functionality, and ease of use.
In each of our markets, we compete with a wide array of manufacturers,
vendors, strategic alliances, systems developers and other businesses. Our
competitors include some of the largest companies in the electronics industry,
such as Siemens in the building and industrial automation industries and
Allen-Bradley, a subsidiary of Rockwell, and Group Schneider in the industrial
automation industry. 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. As a result, these competitors may be able to
devote greater resources to the development, marketing and sale of their
products, and may be able to respond more quickly to changes in customer
requirements or product technology. In addition, those competitors that
manufacture and promote closed, proprietary control systems may enjoy a captive
customer base dependent on such competitors for service, maintenance, upgrades
and enhancements. Products from emerging companies such as emWare could also
compete with our products, especially in the home market. Even if we believe
that the products offered by some of these emerging companies do not provide the
robust and open networking solutions offered by LONWORKS networks, we would be
required to educate our customers about what we believe are the long-term cost
and potential function problems inherent in such alternative solutions. However,
our customers may believe that these alternative products are satisfactory for
their needs.
Many of our current and prospective 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. In some
cases, companies have established associations or cooperative relationships to
enhance the competitiveness and popularity of their products, or to promote
these different or incompatible technologies, protocols and standards. For
example, in the building automation market, we face widespread reluctance by
vendors of traditional closed or proprietary control systems, who enjoy a
captive market for servicing and replacing equipment, to use our interoperable
technologies. We also face strong competition by large trade associations that
promote alternative technologies and standards in their native countries, such
as the BatiBus Club International in France and the European Installation Bus
Association in Germany, each of which has over 100 members and licensees. Other
examples include the CEBus Industry Council, which is the proponent of an
alternative protocol to our LONWORKS protocol for use in the home automation
industry, and a group comprised of Asea Brown Boveri, ADtranz AB, Siemens, GEC
Alstrom and other manufacturers that support an alternative rail transportation
protocol to our LONWORKS protocol. Our technologies, protocols or standards may
not be successful in any of our markets, and we may not be able to compete with
new or enhanced products or standards introduced by existing or future
competitors.
LONWORKS technology is open, meaning that many of our technology patents
are broadly licensed without royalties or license fees. As a result, our
customers are capable of developing products that compete with some of 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. This could decrease the market for our
products and increase the competition that we face.
THE TRADING PRICE OF OUR STOCK HAS BEEN VOLATILE, AND MAY FLUCTUATE DUE TO
FACTORS BEYOND OUR CONTROL.
The trading price of our common stock is subject to significant
fluctuations in response to numerous factors, including:
. our quarterly operating results may vary widely;
. our customers or we may announce technological innovations or new products;
. securities analysts may change their estimates of our financial results; and
17
. significant stockholders may sell some or all of their holdings of our stock.
In addition, the market price of securities of technology companies,
especially those in new or emerging industries such as ours, has been very
volatile in the past. This volatility is often unrelated to the operating
performance of particular companies. In the future, our operating results may
fall below analysts' expectations, which could adversely affect the market price
of our stock. In the past, following a period of volatility in the market price
of a company's securities, securities class action lawsuits have often been
instituted against such companies. If such a lawsuit were brought against us,
regardless of its outcome, we would incur substantial costs and our management
resources would be diverted in defending such litigation.
OUR EXECUTIVE OFFICERS AND TECHNICAL PERSONNEL ARE CRITICAL TO OUR BUSINESS, AND
WITHOUT THEM WE MAY NOT BE ABLE TO EXECUTE OUR BUSINESS STRATEGY.
Our performance depends substantially on the performance of our executive
officers and key employees. We are dependent in particular on our Chief
Executive Officer, as well as our technical personnel, due to the specialized
technical nature of our business. Our future success will depend on our ability
to attract, integrate, motivate and retain qualified technical, sales,
operations and managerial personnel. Competition for qualified personnel in our
business areas is intense, and we may not be able to continue to attract and
retain qualified executive officers and key personnel necessary to enable our
business to succeed. Our product development and marketing functions are largely
based in Silicon Valley, a highly competitive marketplace. It is particularly
difficult to recruit, relocate, and retain qualified personnel in this
geographic area. In addition, if we lose the services of any of our key
personnel and are not able to find replacements in a timely manner, business
could be disrupted, other key personnel may decide to leave, and we may incur
increased operating expenses in finding and compensating a replacement. We
currently maintain and are the beneficiary of three life insurance policies
totaling $2.5 million each covering M. Kenneth Oshman, our Chief Executive
Officer, Beatrice Yormark, our Vice President of Sales and Marketing, and Oliver
R. Stanfield, our Chief Financial Officer. However, all three life insurance
policies expire in May 2000 and we will not renew any of these policies for
future periods.
THE MARKET FOR OUR PRODUCTS IS NEW AND RAPIDLY EVOLVING. IF WE ARE NOT ABLE TO
DEVELOP OR ENHANCE PRODUCTS TO RESPOND TO CHANGING MARKET CONDITIONS, OUR
REVENUES WILL SUFFER.
Customer requirements for control network products can change as a result
of innovations or changes within the building, industrial, transportation, home
and other industries. For example, new or different standards within industry
segments may be adopted, giving rise to new customer requirements. These
customer requirements may or may not be compatible with our current or future
product offerings. Our future success depends in large part on our ability to
continue to enhance existing products, lower product cost and develop new
products that maintain technological competitiveness. We may not be successful
in modifying our products and services to address these requirements and
standards. For example, certain of our competitors may develop competing
technologies based on Internet Protocols (IP) that may have advantages over our
products in remote connection. In addition, from time to time, we have delayed
introducing new products beyond our projected shipping date for such products.
In each instance, these delays increased our costs and delayed our revenues.
IF OUR INTEROPERABLE PRODUCTS ARE NOT ACCEPTED BY OUR TARGETED MARKETS, WE MAY
BE UNABLE TO GENERATE SALES OF OUR PRODUCTS.
Our future operating success will depend, in significant part, on the
successful development of interoperable products by us and OEMs, and the
acceptance of interoperable products by systems integrators and end-users. We
have expended considerable resources to develop, market and sell interoperable
products,
18
and have made such products a cornerstone of our sales and marketing strategy.
We have widely promoted interoperable products as offering benefits such as
lower life-cycle costs and improved flexibility to owners and users of control
networks. However, OEMs that manufacture and market closed systems may not
accept, promote or employ interoperable products, since doing so may expose
their businesses to increased competition. In addition, OEMs might not, in fact,
successfully develop interoperable products, or their interoperable products
might not be accepted by their customers. If OEMs fail to develop interoperable
products, or interoperable products are not accepted by our markets, our
revenues will suffer.
WE FACE OPERATIONAL AND FINANCIAL RISKS ASSOCIATED WITH INTERNATIONAL
OPERATIONS.
Our sales and marketing operations are located in eight countries. Revenues
from international sales, which include both export sales and sales by
international subsidiaries, accounted for 62.4% and 64.6% of our revenues in the
first quarter of 2000 and 1999. Our operations and the market price of our
products may be directly affected by economic and political conditions in the
countries where we do business. In addition, we may not be able to maintain or
increase the international demand for our products. Additional risks inherent in
our international business activities generally include the following:
. currency fluctuations;
. unexpected changes in regulatory requirements, tariffs and other trade
barriers;
. costs of localizing products for foreign countries and lack of acceptance of
non-local products in foreign countries;
. longer accounts receivable payment cycles;
. difficulties in managing international operations;
. potentially adverse tax consequences, including restrictions on repatriation
of earnings; and
. the burdens of complying with a wide variety of foreign laws.
Differing vacation and holiday patterns in other countries, particularly in
Europe, may also affect the amount of business that we transact in other
countries in any quarter, the timing of our revenues and our ability to forecast
our projected operating results for such quarter. The portion of our revenues
that were conducted in currencies other than the U.S. dollar, principally the
Japanese Yen, was 10.3% and 10.9% in the first quarter of 2000 and 1999.
Fluctuations in the value of currencies in which we conduct our business
relative to the U.S. dollar could cause currency translation adjustments. The
introduction of the Euro as the standard currency in participating European
countries may also impact our ability to transact sales in U.S. dollars. We have
agreed with EBV, our European distributor, that upon notice from EBV, we will
sell our products to EBV in Euros rather than U.S. dollars. We do not know when
or if EBV will give such notice. If fewer of our sales in Europe are transacted
in U.S. dollars, we may experience an increase in currency translation
adjustments, particularly as a result of general economic conditions in Europe
as a whole. We do not currently engage in currency hedging transactions or
otherwise cover our foreign currency exposure.
AS A RESULT OF OUR LENGTHY SALES CYCLE, WE HAVE LIMITED ABILITY TO FORECAST THE
AMOUNT AND TIMING OF SPECIFIC SALES. IF WE FAIL TO COMPLETE OR ARE DELAYED IN
COMPLETING TRANSACTIONS, OUR REVENUES COULD VARY SIGNIFICANTLY FROM PERIOD TO
PERIOD.
The sales cycle between initial customer contact and execution of a
contract or license agreement with a customer can vary widely. OEMs typically
conduct extensive and lengthy product evaluations before making initial
purchases of our products. Subsequent purchases of our products may be delayed
by prolonged product development and introduction periods for OEMs. Attendant
delays in our sales cycle can result from, among other things, changes in
customers' budgets or in the priority assigned to control network development
and the need to educate customers about the potential applications of and cost
savings associated with our products. We generally have little or no control
over these factors, which may cause a potential customer to favor a
19
competitor's products, or to delay or forgo purchases altogether. Also, there
can be long sales cycles between the selection of our products for use by a
systems integrator, and the purchase of such products by the systems integrator.
WE HAVE LIMITED ABILITY TO PROTECT OUR INTELLECTUAL PROPERTY RIGHTS.
Our success depends significantly upon our intellectual property rights. We
rely on a combination of patent, copyright, trademark and trade secret laws,
non-disclosure agreements and other contractual provisions to establish,
maintain and protect our intellectual property rights, all of which afford only
limited protection. We have 76 issued U.S. patents, 15 pending U.S. patent
applications, and various foreign counterparts. It is possible that patents will
not issue from these pending applications or from any future applications or
that, if issued, any claims allowed will not be sufficiently broad to protect
our technology. If any of our patents fail to protect our technology, our
competitors may find it easier to offer equivalent or superior technology. We
have registered or applied for registration for certain trademarks, and will
continue to evaluate the registration of additional trademarks as appropriate.
If we fail to properly register or maintain our trademarks or to otherwise take
all necessary steps to protect our trademarks, the value associated with the
trademarks may diminish. In addition, if we fail to take all necessary steps to
protect our trade secrets or other intellectual property rights, we may not be
able to compete as effectively in our markets. Despite our efforts to protect
our proprietary rights, unauthorized parties may attempt to copy aspects of our
products or services or to obtain and use information that we regard as
proprietary. Any of the patents, trademarks, copyrights or intellectual property
rights that have been or may be issued or granted to us could be challenged,
invalidated or circumvented, and any of the rights granted may not provide
protection for our proprietary rights. In addition, there can be no assurance
that we have taken or will take all necessary steps to protect our intellectual
property rights. Third parties may also independently develop similar technology
without breach of our trade secrets or other proprietary rights. We have
licensed in the past and may license in the future our key technologies to third
parties. In addition, the laws of some foreign countries, including several in
which we operate or sell our products, do not protect proprietary rights to as
great an extent as do the laws of the United States. Certain of our products are
licensed under shrink-wrap license agreements that are not signed by licensees
and therefore may not be binding under the laws of certain jurisdictions.
From time to time, litigation may be necessary to defend and enforce our
proprietary rights. As a result of this litigation, we could incur substantial
costs and divert management resources, which could harm our business, regardless
of the final outcome. Despite our efforts to safeguard and maintain our
proprietary rights both in the United States and abroad, we may be unsuccessful
in doing so. Also, the steps that we take to safeguard and maintain our
proprietary rights may be inadequate to deter infringement, misuse,
misappropriation or independent third-party development of our technology or
intellectual property rights or to prevent an unauthorized third party from
copying or otherwise obtaining and using our products or technology.
DEFECTS IN OR MISUSE OF OUR PRODUCTS COULD RESULT IN A LOSS OF OR DELAY IN
MARKET ACCEPTANCE, INCREASED SERVICE AND WARRANTY COSTS, AND INCREASED LIABILITY
FOR COMPENSATORY OR OTHER DAMAGES.
The products that we develop, license and sell may contain errors or
failures or may be improperly installed or implemented. Errors or failures may
be found in our products, and we may not be able to successfully correct those
errors or failures in a timely manner or at all. In addition, our products may
not be properly installed or implemented by third parties. In addition, such
errors or failures may delay our revenue recognition and divert our engineering
resources to correct such defects. We maintain errors and omissions insurance to
cover liability associated with our operations but it is possible that such
insurance may not be available or may be insufficient in amount to cover any
particular claim. Although our agreements with our customers typically contain
provisions intended to limit our exposure to potential claims as well as any
liabilities arising from such claims, and may in very limited instances require
that we be named as an
20
additional insured under the insurance policies carried by some of our
customers, such contracts and insurance may not effectively protect us against
the liabilities and expenses associated with product errors or failures.
Accordingly, errors or failures in our products or applications or improper
installation or implementation of our products by third parties could harm our
operating results. In addition, because of the low cost and interoperable nature
of our products, LONWORKS technology could be used in a manner for which it was
not intended. As a result, our reputation could be harmed and we might suffer
material financial losses.
REGULATORY ACTIONS COULD AFFECT OUR ABILITY TO MARKET AND SELL OUR PRODUCTS.
Many of our products and the industries in which they are used are subject
to U.S. and foreign regulation. Government regulatory action could greatly
reduce the market for our products. For example, the power line medium, which is
the communications medium used by some of our products, is subject to special
regulations in North America, Europe and Japan. These regulations limit the
ability of companies in general to use power lines as a communication medium. In
addition, some of our competitors have attempted to use regulatory actions to
reduce the market opportunity for some of our products or to increase the market
opportunity for the competitors' products. In the late 1990's, we experienced
efforts by CEMA, a trade association that developed a competing home automation
protocol, to persuade the FCC to mandate use of its protocol in analog
television and set-top box applications. We remain involved in litigation
arising from a related FCC proceeding concerning commercial availability of
these "navigation devices." That case is currently on appeal, and a decision is
expected this year. Although these specific FCC and judicial proceedings are not
a significant threat to our digital and Internet-based products, existing or
future regulations or regulatory actions could adversely affect the market for
our products or require us to expend significant management, technical or
financial resources.
VOLUNTARY STANDARDS THAT ARE ESTABLISHED IN OUR MARKETS COULD LIMIT OUR ABILITY
TO SELL OUR PRODUCTS AND REDUCE OUR REVENUES.
Standards bodies, which are formal and informal associations that attempt
to set voluntary, non-governmental product standards, are influential in many of
our target markets. Some of our competitors have attempted to use voluntary
standards to reduce the market opportunity for our products, or to increase the
market opportunity for the competitors' products, by lobbying for the adoption
of voluntary standards that would exclude or limit the use of our products. We
participate in many voluntary standards processes both to avoid adoption of
exclusionary standards and to promote voluntary standards for our products.
However, we do not have the resources to participate in all voluntary standards
processes that may affect our markets. The adoption of voluntary standards that
are incompatible with our products or technology could limit the market
opportunity for our products.
OUR EXISTING STOCKHOLDERS CONTROL A SIGNIFICANT PERCENTAGE OF OUR STOCK, WHICH
WILL LIMIT YOUR ABILITY TO INFLUENCE CORPORATE MATTERS.
As of April 30, 2000, our directors and executive officers, together with
certain entities affiliated with them, beneficially owned 32.4% of our
outstanding stock. Under the terms of a stock purchase agreement, one other
stockholder that owns about 1% of our outstanding common stock has agreed to
vote (i) all of its shares in favor of the slate of director nominees
recommended by the Board of Directors, and (ii) a number of shares equal to at
least that percentage of shares voted by all other stockholders for or against
any given matter, as recommended by the Board of Directors (except certain
matters relating to certain changes to our charter, liquidations, a sale of our
company or a merger of our company into another entity), as recommended by a
majority of our Board of Directors. As a result, these stockholders may be able
to control substantially all matters requiring approval by our stockholders,
including the election of all directors and approval of significant corporate
transactions.
21
PART II. OTHER INFORMATION
--------------------------
ITEM 1. LEGAL PROCEEDINGS
None.
ITEM 2. CHANGES IN SECURITIES
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Company held its annual meeting of stockholders on April 27,
2000 (the "Annual Meeting"). At such meeting, the following
directors were elected: Robert J. Finocchio, Jr., Armas Clifford
Markkula, Jr. and Robert R. Maxfield. The only other matter
submitted to stockholder vote at the Annual Meeting was the
ratification of the appointment of Arthur Andersen LLP as
independent public accountants of the Company for the fiscal year
ending December 31, 2000. Voting results for the Arthur Andersen
LLP appointment were as follows: For: 30,774,501; Against: 9618;
Abstain: 18,212; Broker Non-Votes: 0. Voting results for the
election of the directors were as follows:
Votes For: Votes Withheld
---------- --------------
Robert J. Finocchio, Jr ........... 30,770,037 32,294
Armas Clifford Markkula, Jr ....... 30,771,508 30,823
Robert R. Maxfield ................ 30,772,054 30,277
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBIT AND REPORTS ON FORM 8-K
(a) Exhibit
27.1 Financial data schedule
(b) Reports on Form 8-K
None.
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Echelon Corporation
Date: May 9, 2000 By /s/ Oliver R. Stanfield
---------------------------------
Oliver R. Stanfield,
Vice President Finance and Chief Financial Officer (Duly
Authorized Officer and Principal Financial and Accounting
Officer)
22