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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
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FORM 10-K
(Mark one)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1998
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 333-55719
ECHELON CORPORATION
(Exact name of registrant as specified in its charter)
Delaware 77-0203595
(State of Incorporation) (I.R.S. Employee Identification Number)
4015 Miranda Avenue, Palo Alto, California 94304
(Address of principal executive offices)
Registrant's telephone number (650) 855-7400
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Name of each exchange
Title of each class which registered
Common Stock $.01 par value Nasdaq National Market
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 [_]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained to the best
of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. (X)
The aggregate market value of common stock held by non-affiliates of the
registrant as of February 28, 1999 was $116,421,183 (based on the closing sales
price of $6.813 per share as reported for the Nasdaq Market System of the
National Association of Securities Dealers Automated Quotation System on
February 26, 1999). Shares of common stock held by each officer, director, and
holder of 5% or more of the outstanding common stock has been excluded in that
such persons may be deemed to be affiliates. This determination of affiliate
status is not necessarily a conclusive determination for other purposes.
As of February 28, 1999, 32,677,851 shares of the registrant's Common Stock
were outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
(1) Portions of the Registrant's Proxy Statement related to the 1999 Annual
Meeting of Stockholders, to be held on May 11, 1999, are incorporated by
reference into Part III of this Annual Report on Form 10-K where indicated.
(2) The table of exhibits filed appears on page 27.
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PART I
Certain statements contained in this Annual Report include a number of
forward-looking statements which reflect the Company's 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-K that could cause actual results to differ materially
from historical results or those anticipated. In this report, the words
"anticipates", "believes", "expects", "future", "intends", 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 hereof.
ITEM 1. BUSINESS
Echelon Corporation ("Echelon" or the "Company") was incorporated in
California in 1988 and reincorporated in Delaware in 1989. The Company's
principal executive offices are located at 4015 Miranda Avenue, Palo Alto,
California 94304, and its telephone number is (650) 855-7400. Echelon can also
be reached by visiting its website at www.echelon.com.
The Company develops, markets and supports a family of hardware and software
products and services that enables original equipment manufacturers ("OEMs") and
systems integrators to design and implement open, interoperable, distributed
control networks. A control network enables any group of electrical devices,
called nodes, to be linked together to implement sensing, monitoring, control
and communications capabilities for a variety of applications. Control networks,
an alternative to the traditional approach of centralized control, offer
decreased costs of installation and maintenance and the ability to implement
multi-vendor systems, thereby increasing competition while providing expanded
features, flexibility and functionality. Echelon's control networking technology
allows intelligence and communications capabilities to be embedded into
individual control devices that can be connected together through a variety of
communications media, such as a twisted pair of wires (data cable) and the
existing power lines in a facility. The intelligent, networked control devices
are then able to communicate with each other, peer-to-peer, to perform the
desired control functions. In effect, the network becomes the controller,
eliminating the need for central controllers, significantly reducing wiring
costs and enhancing system functionality and flexibility.
Control systems manage key functions in virtually every type of facility that
affects our daily lives. These functions can be as simple as turning a light on
and off and as complex as operating a chemical production line. Traditionally,
most control systems have incorporated closed, centrally-controlled
architectures, where the intelligence is in the central controller and complex
wiring and customization are required for communication. These traditional
control systems share many of the same drawbacks of centralized computing
architectures that rely upon mainframes and minicomputers to communicate to
"dumb" terminals that lack independent processing capabilities. These
disadvantages, which include high installation and life-cycle costs, limited
functionality and scalability, and a single point of failure, have limited the
market opportunity for control systems because end-users find it costly and
difficult to adapt these systems to their changing needs. To overcome these
limitations, OEMs, systems integrators and end-users are increasingly moving
from closed centrally-controlled systems towards open, distributed control
networks.
The Company offers a comprehensive set of products and services, including
transceivers, control modules, routers, network interfaces, development tools
and software tools and toolkits, that provide the infrastructure and support
required to build and implement multi-vendor, open, interoperable, control
network solutions. The Company's products are based on its LonWorks networking
technology, an open standard for interoperable networked control. The Company's
objective is to establish its LonWorks technology and products as the leading
solution for networked control applications. To achieve this goal, the Company
intends to extend its technological expertise, target industry-leading OEM
customers, develop a systems integrator distribution channel, integrate LonWorks
control networks with enterprise data networks and leverage international market
opportunities.
The Company markets its products and services to OEMs and systems integrators
in the building, industrial, transportation, home and other automation markets.
The Company sells primarily through a direct sales force in North America and
other countries where it has marketing and sales operations, and augments its
direct sales efforts with distributors in Europe, Japan and Asia Pacific.
Representative customers include Bombardier Inc. ("Bombardier"), Edwards High
Vacuum International Ltd. ("Edwards"), Fuji Electric Company Limited ("Fuji
Electric"), Hitachi Limited ("Hitachi"), Honeywell, Inc. ("Honeywell"), Johnson
Controls, Inc. ("Johnson Controls"), Kawasaki Limited ("Kawasaki"), Landis &
Staefa, Staefa Control System Corporation ("Landis & Staefa") and Raytheon
Company ("Raytheon").
Industry Background
Control systems manage key functions in a variety of facilities. A common
application of a control system is to enable a thermostat to communicate with
other equipment in a building to automatically adjust temperature and airflow.
In addition to interconnecting and monitoring heating, ventilation and air
conditioning ("HVAC"), control systems are used within buildings to manage such
functions as elevators, lighting, security and access control. In industrial
facilities, these systems are used to automate semiconductor manufacturing
equipment, oil pumping stations, textile dyeing machinery and hundreds of other
applications. In transportation systems, control systems are used to regulate
such features as propulsion, braking and heating systems.
Control systems consist of an array of hardware devices and software used to
collect data from the physical world and convert that data to electrical
signals. These signals, in turn, provide information that can be used to effect
responses based upon pre-
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programmed rules and logic. Traditionally, most control systems have
incorporated closed, centrally-controlled architectures. These systems share
many of the same drawbacks of centralized computing architectures that rely upon
mainframes and minicomputers to communicate to "dumb" terminals that lack
independent processing capabilities.
Products for control systems are typically designed and manufactured by OEMs
that focus on one or more vertical markets, such as HVAC systems for buildings,
or braking control systems for trains. Control systems are typically installed
and maintained by specialty contractors, or "systems integrators," and in some
instances by the in-house installation and maintenance divisions of OEMs.
Closed, centralized control systems have a number of inherent disadvantages for
OEMs, systems integrators and end-users. OEMs, as the designers of control
systems and, in some instances, developers of their own protocols, incur
significant development and ongoing support expense to implement and maintain
their closed infrastructures. In addition, supporting such a closed
infrastructure takes valuable resources away from developing competitive
applications and limits the OEM's ability to leverage the product development
efforts of third party companies who use open platforms. Finally, centralized
systems also risk complete shutdown if the central controller fails.
For systems integrators, the installation of closed, centralized control
systems is typically characterized by the time-consuming and costly physical
task of installing large amounts of wire and conduit to connect each component
to one or more central controllers. Once the physical infrastructure is
installed, specially-trained and highly-skilled personnel must program, install
and "debug" detailed control logic software into the controllers in order to
manage the disparate components. To the extent that a facility incorporates
control systems from more than one OEM, systems integrators also spend
considerable time connecting systems that were not designed to interoperate,
such as HVAC and fire/life/safety systems. This complex process also makes
modifications to the system expensive and time consuming. Because of the
excessive costs of installing and modifying closed, centrally-controlled
systems, end-users, who ultimately must pay for these products and services,
often cannot acquire new applications at an affordable cost. The Company
believes that these factors have reduced the market opportunity for both OEMs
and systems integrators to sell new products, functions and applications to end-
users.
OEMs, systems integrators and end-users are increasingly seeking to overcome
the limitations of closed, centralized systems. As with the computer industry's
move away from centralized computing architectures, the Company believes that
across a broad range of control applications, the control industry is moving
away from custom, wiring-intensive and closed interconnection schemes among
various system components, towards open, interoperable, distributed
architectures in which the control intelligence resides among the sensors and
actuators in an intelligent network, rather than in central controllers.
The Echelon Solution
Echelon develops, markets and supports a family of hardware and software
products and services that enables OEMs and systems integrators to design and
implement open, interoperable, distributed control networks. Echelon's
networking technology allows intelligence and communications capabilities to be
embedded into individual control devices that can be connected together through
a variety of communications media such as a twisted pair of wires (data cable)
and the existing power lines in a facility. The intelligent, networked control
devices are then able to communicate with each other, peer-to-peer, to perform
the desired control functions. For example, a temperature sensor might detect a
change in temperature and send a message over the network that is received and
acted upon by other devices that have been configured to accept the message. In
effect, the network becomes the controller, eliminating the need for central
controllers, significantly reducing wiring costs and enhancing system
functionality and flexibility.
The Company offers a comprehensive set of products and services that provides
the infrastructure and support required to build and implement open, multi-
vendor, interoperable, control network solutions for building, industrial,
transportation, home and other automation markets. The Company's products are
based on its LonWorks networking technology, an open standard for interoperable
networked control. In a LonWorks control network, intelligent control devices,
called nodes, communicate using the Company's LonTalk protocol. Each node in the
network contains embedded intelligence that implements the protocol and performs
local sense and control functions. At the core of this embedded intelligence is
the Neuron Chip, an integrated circuit that was initially designed by Echelon
and is currently manufactured and sold by Motorola, Inc. ("Motorola) and Toshiba
Corporation ("Toshiba") (see "-Strategic Alliances"). In addition, the Company
offers transceivers that couple the Neuron Chip to the communications medium;
control modules that are intended to help to reduce OEM development cost;
intelligent LonWorks routers that allow users to build large systems containing
different networking media; network interfaces that connect computers to the
network; development tools that allow OEMs to design LonWorks technology into
their products; and software tools and toolkits that allow users to install,
monitor, maintain and control their systems.
Based on the Company's past experience in implementing its products, the
Company believes that its family of products and services provides the following
benefits to its customers:
. Installation Cost Savings. LonWorks based open control networks are intended
to be less expensive to install than closed, centrally-controlled systems. By
replacing individual hard-wired connections with shared network channels, the
Company believes that wiring and conduit material and labor costs can be
substantially reduced. By eliminating the need to program and debug complex
control logic software, systems can be designed and commissioned more quickly
by personnel with less specialized training. In addition, LonWorks based
networks are designed not to require expensive, performance-limiting
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gateways (which are used to enable communication between disparate systems)
to connect control systems from multiple vendors.
. Life-Cycle Cost Savings. LonWorks networks can eliminate many of the sources
of high life-cycle costs found in traditional control systems. By providing
an open, interoperable platform, LonWorks networks allow end-users to select
the most cost-effective products and services for their applications from a
broad range of OEMs. In addition, the Company believes that the inherent
flexibility of the LonWorks network architecture permits modifications to the
control system, including adding new products, features and functions, to be
made at significantly lower cost. LonWorks technology also enables devices to
be logically "rewired" across the network without the need to run new
physical wire or to replace or reprogram devices.
. Improved Quality and Functionality. With LonWorks networks, end-users may
customize their control networks to their specific needs by incorporating
products and applications from an array of applications providers. In open
LonWorks networks, any piece of information from any device can easily be
shared with any other device in the same control system, in a different
control system, or in a computer system, without the need for custom
programming or additional hardware. For example, a measurement system can
analyze information from a manufacturing system and send back improvements
within seconds if the two systems communicate directly, rather than through a
process where information is gathered and communicated manually over days or
even weeks.
. Improved Reliability. In a fully-distributed LonWorks control network, there
is no single point of failure. Typically, the failure of a device on the
network only affects a small subset of devices with which it interacts.
Unlike devices in a centrally-controlled system, devices in a LonWorks
network are "self-aware" and can take appropriate actions, such as returning
to default set-points, to adapt to the error condition. In addition, by
utilizing its built-in processing power, each device can keep track of its
own status and can report problems before they occur.
. Increased Market Demand. The Company believes that by eliminating high-cost
centralized controllers and fostering interoperability between devices,
LonWorks technology enables both OEMs and systems integrators to create low-
cost, customized solutions to satisfy market demands that have not been met
by traditional control systems.
Strategy
Echelon's objective is to be the leading supplier of products and services
used in the growing market for open, interoperable control networks. Key
elements of the Company's strategy to accomplish this objective include:
. Extend Technological Leadership. Echelon's LonWorks networking technology is
the foundation for a low-cost, flexible, interoperable and reliable platform
for implementing networked control applications. The Company intends to
leverage its position as the developer of the LonWorks platform, along with
its expertise in networking software, distributed control systems and digital
and analog circuit design, to deliver a full range of highly-functional and
cost-effective products and systems that meet its customers' needs.
. Target Industry-Leading OEM Customers. The Company seeks to develop broad
industry support for its LonWorks platform. To help accomplish this
objective, the Company works closely with industry-leading OEMs, such as
Bombardier, Edwards and Honeywell, in the product design process and invests
in programs that enable these customers to develop, market and support their
products. The Company believes that close collaborative relationships with
OEM customers will continue to accelerate the transition of its targeted
industries toward open, multi-vendor architectures for control networks.
. Develop Systems Integrator Distribution Channel. The Company believes that
end-users increasingly prefer multi-vendor control networks in order to
decrease life-cycle costs and improve the functionality of their control
systems. In order to capitalize on this opportunity, the Company complements
its OEM distribution channel by aggressively targeting independent systems
integrators as an additional channel to install, configure and maintain
highly-functional control networks for end-users. To more effectively meet
the needs of systems integrators, the Company began shipping its LonPoint
System in 1998, which provides the infrastructure needed to implement open,
interoperable, distributed control networks. The Company intends to continue
promoting the benefits of the LonWorks technology and products to systems
integrators and end-users as a means to create stronger demand for its
control network solutions.
. Increase Penetration of Existing Vertical Markets. While the Company's
control network products are applicable across a broad range of industries,
the Company intends to continue to focus its marketing efforts on those
vertical markets in which it has established a large customer base, namely
the building, industrial, transportation and home automation industries. The
Company works closely with OEMs and systems integrators in these vertical
markets to identify market needs, and targets its product development efforts
to meet those needs. For instance, in 1997, the Company began shipping its
network operating system, LonWorks Network Services, in response to the needs
of OEMs for a multi-user platform to install, maintain, monitor and interface
with control networks. In addition, the Company established the LonMark
Interoperability Association in May 1994 to facilitate the development and
implementation of interoperable LonWorks based control systems within various
industries.
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Several industry leaders in the Company's targeted markets have announced and
currently promote products that conform to these standards.
. Integrate LonWorks Control Networks with Enterprise Data Networks. The
Company believes that the seamless integration between LonWorks control
networks and enterprise data networks is important to enable end-users to
remotely monitor and manage their control networks, as well as to collect and
analyze data generated by their control networks. To meet this market demand,
the Company is developing systems and technology that combine standard data
networking and communications protocols with the Company's products and
technology. In support of this effort, the Company entered into a strategic
agreements with Toshiba and Cisco Systems, Inc. ("Cisco") to develop
products that integrate LonWorks control networks with enterprise data
networks.
. Leverage International Market Opportunities. With sales and marketing
operations in nine countries and 55.4% of the Company's total revenues in
1998 attributable to international sales, the Company has established a
significant international presence. The Company plans to continue to devote
significant resources to international sales, marketing and product
development efforts to capitalize on markets for control networks outside of
the United States. For example, the Company's most popular power line
transceiver was designed to meet the requirements imposed by regulators in
both North America and Europe, enabling OEMs to leverage their product
development programs across these markets.
Markets, Applications and Customers
The Company markets its products and services primarily in North America,
Europe, Japan and selected Asia Pacific countries. The Company's target markets
include:
Building Automation. Companies worldwide are using LonWorks control networks
in most facets of the building automation industry, including access control,
automatic doors, elevators, energy management, fire/life/safety, HVAC, lighting,
metering, security and window blinds. The Company believes that LonWorks
networks are widely accepted because they lower installed system cost, reduce
ongoing life-cycle costs and increase functionality. For example, a major
automation project has been completed for British Airways' new combined business
center, BA Waterside, near Heathrow Airport. The project uses LonWorks control
networks throughout the six-building campus to connect the building management,
lighting and access control systems together in a unified system. Echelon's OEM
customers in the building automation market include Honeywell, Johnson Controls,
Landis & Staefa, Philips Lighting B.V., Schindler Elevator Corp. and Siebe.
Industrial Automation. LonWorks control networks are found in semiconductor
fabrication plants, gas compressor stations, gasoline tank farms, oil pumping
stations, water pumping stations, textile dyeing machinery, pulp and paper
processing equipment, automated conveyor systems and many other industrial
environments. In such industrial installations, LonWorks networks can replace
complex wiring harnesses, reduce installation costs, eliminate expensive
programmable logic controllers and distribute control among sensors, actuators
and other devices, thereby reducing system costs, improving control and
eliminating the problem of a single point of failure, among other things. For
example, Edwards, a leading supplier of vacuum pumping systems to the
semiconductor industry, is using LonWorks control networks within each pumping
station to replace complex wiring used to connect various motors, sensors,
actuators and displays. The same control network is extended to connect up to
400 pumping stations together in a semiconductor fabrication plant to form a
complete pumping system. Echelon's OEM customers in the industrial automation
market include Brooks Instrument, Edwards, Fuji Electric, Hitachi, Lam Research
Corporation and Marley Pump.
Transportation. Echelon's technology is used in important transportation
applications, including railcars, light rail, buses, motor coaches, fire trucks,
naval vessels and aircraft. LonWorks networks can be used in these
transportation systems to improve efficiency, reduce maintenance costs and
increase safety and comfort. LonWorks technology has been specified as the
standard for electro-pneumatic braking for freight transportation trains by the
American Association of Railroads, and as one of the standards by the New York
City Transit Authority for the replacement of its subway cars. Key OEMs in the
transportation market include Bombardier, Cummins Engine, Kawasaki and Raytheon.
Home Automation and Other. While the home automation market is still in its
infancy, numerous companies are now selling LonWorks based products for HVAC,
lighting, security, utility meters and whole house automation. A number of
utility companies located throughout the world, including CSW Communications
(the holding company for Central and Southwest Utilities), and Detroit Edison in
the United States, and Sydkraft and Scottish Hydro Electric in Europe, currently
are pursuing residential projects involving LonWorks networks. Other industries
in which LonWorks control networks have been utilized or are being developed for
use include telecommunications (including alarm systems for switching equipment)
and agriculture (including feeding and watering systems).
Products and Services
The Company offers a comprehensive set of over 80 products and services
marketed under the LonWorks brand name that provide 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 the LonTalk protocol. While the Company recommends broad use of
various of its products with other Echelon products, there is no inherent
requirement for a customer to do so, given the
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Company's open networking technology. For instance, a customer's product could
incorporate a transceiver purchased from the Company but could be installed with
software that did not incorporate the Company's network operating system.
LonWorks Control and Connectivity Products. This suite of hardware products,
some with embedded firmware, serves as the physical interface between the
control software resident on the managed devices and the cabling and wiring
infrastructure. These products include a variety of transceivers, control
modules, routers and network interface devices. Standard, off-the-shelf LonWorks
transceivers and control modules simplify the development of LonWorks nodes,
provide the foundation for interoperability and reduce the development cost and
time for an OEM's product development. LonWorks routers provide transparent
support for multiple media, which makes it possible to signal between different
types of media, such as twisted pair, power line, radio frequency, optical fiber
and infrared. Routers can also be used to control network traffic and partition
sections of the network from traffic in another area, increasing the total
throughput and speed of the network. Network interfaces can be used to connect
computers to a LonWorks network. The Company's FTT-10 transceiver product, one
of the LonWorks Control and Connectivity products, and the FTT-10A successor
product, which permits communication over a twisted pair of wires, together have
generated approximately 21% and 19% of the Company's revenues during the years
ended December 31, 1998 and 1997, respectively. The FTT-10 was released in May
1994 and the FTT-10A was released in May 1997.
LonWorks Network Services ("LNS"). Echelon's network operating system, LNS,
serves as the platform for installing, maintaining, monitoring and interfacing
with control networks. The LNS family of products adds the power of client-
server architecture and component-based software design into control systems and
allows tools from multiple vendors to work together. The Company's most recent
release of LNS is version 2.0, which the Company expects to ship in March 1999.
The LonMaker for Windows tool, built on the LNS network operating system and
the Visio technical drawing package, gives users a familiar, CAD-like
environment in which to design their network's control system. The graphical
nature of the LonMaker tool provides an intuitive interface for designing,
installing and maintaining multi-vendor, open, interoperable LonWorks control
networks. LNS also allows multiple users, each running their own copy of
LonMaker for Windows or other LNS-based tools, to utilize the system in
parallel, thereby streamlining the design and commissioning process, and
facilitating future adds, moves and changes. LonMaker for Windows, released in
version 1.0, was first shipped in June 1998. The Company's most recent release
of LonMaker for Windows is version 2.0, which the Company expects to ship in
March 1999.
LonPoint System Products. In the second quarter of 1998, the Company began
shipment of the LonPoint System, which provides the infrastructure to implement
open, interoperable, distributed control networks. In contrast to traditional
closed, centrally-controlled systems, the LonPoint System offers a flat network
architecture in which every device performs control processing. Distributing the
processing throughout the network lowers installation and overall life-cycle
costs, increases reliability by eliminating central points of failure, and
provides the flexibility to adapt the system to a wide variety of applications.
The LonPoint System includes a family of hardware and software products.
Hardware products include interface modules (which convert a variety of legacy
digital and analog sensors and actuators into intelligent and interoperable
network devices), routers (which provide transparent connectivity and
intelligent message passing between various combinations of standard LonWorks
media), and scheduler modules (which provide system timekeeping and state
coordination). The LonPoint System is installed using the LonMaker for Windows
tool and includes LNS software plug-ins that provide end-users with a customized
configuration view of each LonPoint module, thereby reducing the time and
training required to configure LonPoint interface modules.
Development Tools. Echelon provides development tools that are used by an OEM
to design LonWorks technology into the OEM's products. The LonBuilder
Developer's Workbench integrates a complete set of tools for developing LonWorks
based control networks. These tools include an environment for developing and
debugging applications at multiple nodes, a network manager to install and
configure these nodes, and a protocol analyzer to examine network traffic to
ensure adequate capacity and to debug errors. The Company's most recent release
of this product is version 3.01, which was first shipped in July 1996.
The NodeBuilder development tool is designed to make it easy for OEMs to
develop and test individual LonWorks nodes. It uses a familiar Windows based
development environment with easy-to-use on-line help. The NodeBuilder tool can
complement the development capabilities of the LonBuilder Developer's Workbench,
since the NodeBuilder tool can be used to develop individual nodes that are then
integrated and tested as a system using the LonBuilder tool. The Company's most
recent release of the NodeBuilder development tool is version 1.5, which was
first shipped in August 1996.
Training and Support. The Company conducts a variety of technical training
courses covering its LonWorks network technology and products. These courses are
designed to provide hands-on, in-depth and practical experience that can be used
immediately by OEMs and systems integrators of LonWorks systems. The Company
also offers technical support to its customers on a per incident and annual
contract basis. These support services are intended to ensure proper use of the
Company's products and to shorten development time for the customer's products
that use Echelon's technology through timely resolution of the customer's
technical problems. As of February 28, 1999, the Company had 13 employees in the
United States, Japan, China and the United Kingdom engaged in training and
support.
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Sales and Marketing
The Company markets and sells its products and services to OEMs and
increasingly to systems integrators to promote the widespread use of its
LonWorks technology. In addition, the Company believes that awareness of the
benefits of LonWorks networks among end-users will increase demand "pull" for
the Company's products. 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 China, France, Germany, Hong Kong, Japan, the
Netherlands, South Korea, Sweden and the United Kingdom. Each of these offices
is staffed primarily with local employees. The Company supplements its worldwide
sales personnel with application engineers and technical and industry experts
working in the Company's headquarters. The Company also leverages its selling
efforts through the use of an in-house telephone sales staff. Internationally,
the Company augments its direct sales with the use of distributors. These
distributors tend to specialize in certain geographical markets. The Company
sells its products in Europe principally through EBV Elektronik GmbH ("EBV"),
its sole independent European distributor, and through its direct sales force.
The Company relies solely on distributors in certain countries in the Asia
Pacific region, including Australia and Taiwan, and in Latin America, through
its distributor in Argentina. See "Factors That May Affect Future Results of
Operations--Dependence on OEMs and Distribution Channels."
The Company has recently implemented an authorized network integrator program
to increase the distribution of its products through systems integrators
worldwide. These systems integrators design, install and service control systems
using the Company's LonPoint System with legacy devices and other manufacturers'
products that meet the certification guidelines of the LonMark Interoperability
Association, thereby reducing dependence on single-vendor products, eliminating
the risks of centralized, closed controllers and supporting less complex, peer-
to-peer system architectures. The Company provides these systems integrators
with access to the training, tools and products required to cost-effectively
install, commission and maintain open, multi-vendor distributed control systems
based on LonWorks control networks.
The Company's marketing efforts are augmented by the LonMark Interoperability
Association and the LonUsers International group. The LonMark Interoperability
Association was formed by Echelon in May 1994 and has approximately 220 members.
This Association defines the technical standards for interoperability for
LonWorks technology and promotes the use of open control networks based on the
LonMark standard. The purpose of LonUsers International, established by Echelon
in 1991, is to provide a forum in which parties can share recent information
concerning LonWorks technology and applications, build alliances and support the
LonWorks standard for control networking. In 1998, LonUsers International
meetings in North America, Europe and Asia drew nearly 2300 participants.
Strategic Alliances
Neuron Chips, which are important components in control network nodes, are
manufactured and sold by both Motorola and Toshiba. The Company has entered into
licensing agreements with each of Motorola and Toshiba. Among other things, the
agreements grant Motorola and Toshiba the worldwide right to manufacture and
distribute Neuron Chips using technology licensed from the Company and require
the Company to provide support and unspecified updates to the licensed
technology over the terms of the agreements. The Motorola and Toshiba agreements
expire in January 2001 and January 2000 respectively, unless renewed. Motorola
has announced that it will discontinue distribution of Neuron Chips after
January 31, 2001. However, both Motorola and Toshiba have the right to terminate
the agreements at any time. While the Company developed the first version of the
Neuron Chip, Motorola and Toshiba subsequently developed improved, lower-cost
versions of the Neuron Chip that are presently utilized in products developed
and sold by the Company and its customers. The Company currently has no other
source of supply for Neuron Chips and has neither the resources nor the skills
to replace either Motorola or Toshiba as a manufacturer of Neuron Chips. The
Company is attempting to license a second source for design, development and
supply of the Neuron Chip as a replacement for Motorola. Both Motorola and
Toshiba have played, and Toshiba is expected to continue to play, a key role in
the development and marketing of LonWorks technology. The loss of Toshiba as a
supplier of the Neuron Chip, or the failure of the Company to license a second
supplier of the Neuron Chip to replace Motorola in a timely manner and on
commercially reasonable terms, could have a material adverse effect on the
business, operating results and financial condition of the Company. There can be
no assurance that the Company would be able to locate an alternate source for
the design, manufacture or distribution of Neuron Chips. See "Factors That May
Affect Future Results of Operations--Dependence on Key Manufacturers".
The Company has separate agreements with Toshiba and Cisco to develop products
that integrate LonWorks control networks into enterprise data networks.
Echelon's joint development agreement with Toshiba is intended to enable
products and technologies to be developed using the Java programming language to
program LonWorks control devices. The agreement with Cisco is intended to result
in products that simplify enterprise-wide integration of LonWorks control and
Internet protocol data networks.
Product Development
The Company's future success depends in large part on its ability to enhance
existing products, lower product cost and develop new products that maintain
technological competitiveness. The Company has made and intends to continue to
make substantial investments in product development. The Company continues to
make significant engineering investments in bringing its LNS network operating
system and LonPoint System products to market. Extensive product development
input is obtained from customers
7
<PAGE>
and by monitoring end-user needs and changes in the marketplace. See "Factors
That May Affect Future Results of Operations--New Products and Rapid
Technological Change."
The Company's total expenses for product development for fiscal 1998, 1997 and
1996 were $7.6 million, $7.1 million and $7.5 million, respectively. The Company
anticipates that it will continue to commit substantial resources to product
development in the future and that product development expenses may increase in
the future. To date, the Company's development efforts have not resulted in any
capitalized software development costs. As of February 28, 1999, the Company's
product development organization consisted of 50 personnel.
Competition
Competition in the Company's 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 its
competitive position, the Company 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 its customers. The principal competitive factors
affecting the markets for the Company's control network products are customer
service and support, product reputation, quality, performance and price, and
product features such as adaptability, scalability, ability to integrate with
other products, functionality and ease of use. The Company believes it has in
the past generally competed favorably with offerings of its competitors on the
basis of these factors. However, there can be no assurance that the Company will
continue to be able to compete effectively based on these or any other
competitive factors in the future.
In each of its markets, the Company competes with a wide array of
manufacturers, vendors, strategic alliances, systems developers and other
businesses. The Company's competitors include some of the largest companies in
the electronics industry, such as Siemens AG ("Siemens") in the building and
industrial automation industries and Allen-Bradley, a subsidiary of Rockwell
International ("Allen-Bradley"), and Groupe Schneider ("Schneider") in the
industrial automation industry. Many of the Company's competitors, alone or
together with their trade associations and partners, have longer operating
histories, significantly greater financial, technical, marketing, service and
other resources, significantly greater name recognition and broader product
offerings. As a result, such 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, centralized
proprietary systems may enjoy a captive customer base dependent on such
competitors for service, maintenance, upgrades and enhancements. Accordingly,
there can be no assurance that the Company will be able to compete successfully
with existing or new competitors, or that competition will not have a material
adverse effect on the business, operating results or financial condition of the
Company.
Many of the Company's 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, those
of the Company. In some cases, companies have established associations or
cooperative relationships to enhance the competitiveness and popularity of their
products, or to promote such different or incompatible technologies, protocols
and standards. For example, in the building automation market, the Company faces
widespread reluctance by vendors of traditional closed or proprietary control
systems (who enjoy a captive market for servicing and replacing equipment) to
utilize the Company's interoperable technologies, as well as 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 the Company's LonTalk 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 LonWorks networks. The Company works
with standards-setting organizations to establish open markets for LonWorks
products in the Company's targeted markets. There can be no assurance that the
Company's technologies, protocols or standards will be successful in any of its
markets, or that the Company will be able to compete with new or enhanced
products or standards introduced by existing or future competitors. Any increase
in competition or failure by the Company to effectively compete with new or
enhanced products or standards could result in fewer customer orders, price
reductions, reduced order size, reduced operating margins and loss of market
share, any of which could have a material adverse effect on the business,
operating results or financial condition of the Company. See "Factors That May
Affect Future Results of Operations--Competition."
LonWorks technology is open, meaning that many of the Company's key technology
patents are broadly licensed without royalties or license fees. As a result, the
Company's customers are capable of developing products that compete with some of
the Company's products. Because some of the Company's customers are OEMs that
develop and market their own control systems, these customers in particular
could develop competing products based on the Company's open technology. This
could decrease the market for the Company's products, increase competition, and
have a material adverse effect on the Company's business, operating results and
financial condition.
Manufacturing
The Company's manufacturing strategy is to outsource production to third
parties where it is more cost-effective and to limit its internal manufacturing
to such tasks as quality inspection, system integration, testing and order
fulfillment. Echelon maintains manufacturing agreements with Motorola and
Toshiba related to the Neuron Chip, an important component in many of the
Company's
8
<PAGE>
products. Additionally, for certain key products, the Company utilizes outsource
manufacturers including GET Manufacturing, Inc. ("GET") and muRata Electronics
North America, Inc. (muRata). These outsource manufacturers procure material and
assemble, test and inspect the final products to the Company's specifications.
The Company's future success will depend, in significant part, on its ability
to successfully manufacture its products cost-effectively and in sufficient
volumes. To date, the Company has not experienced any significant delays or
material unanticipated costs resulting from the use of third party
manufacturing; however, such a strategy involves certain risks, including the
potential absence of adequate capacity and reduced control over delivery
schedules, manufacturing yields, quality and costs. Currently, Motorola and
Toshiba are the Company's only source of supply for Neuron Chips. Motorola has
announced that it will discontinue distribution of Neuron Chips after January
31, 2001, and the Company is attempting to license a second source of supply for
Neuron Chips to replace Motorola. The loss of Toshiba as a supplier of the
Neuron Chip or the failure of the Company to license a second supplier to
replace Motorola could have a material adverse effect on the business, operating
results and financial condition of the Company. Further, other key components
are currently purchased only from sole or limited sources. Any interruption in
the supply of these components, or the inability of the Company to procure these
components from alternate sources at acceptable prices and within a reasonable
time, could have a material adverse effect upon the Company's business,
operating results and financial condition. See "Factors That May Affect Future
Results of Operations--Dependence on Key Manufacturers."
Government Regulation
Many of the Company's 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 the Company's products. For example, the power
line medium (the communications medium used by some of the Company's 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 the Company's competitors have
attempted to use regulatory actions to reduce the market opportunity for the
Company's products or to increase the market opportunity for the competitors'
products. For example, the Consumer Electronics Manufacturers Association
("CEMA"), a trade association that developed the CEBus protocol for use in home
automation applications, has proposed that the Federal Communications Commission
("FCC") adopt a standard for television-cable compatibility that encompasses
CEBus. CEMA has also proposed the use of such standard with respect to an
FCC rule making relating to the commercial availability of navigation devices,
such as set-top boxes. The Company has resisted these efforts and will continue
to oppose competitors' efforts to use regulation to impede competition in the
markets for the Company's products. There can be no assurance that existing or
future regulations or regulatory actions would not adversely affect the market
for the Company's products or require significant expenditures of management or
financial resources, any of which could have a material adverse effect on the
Company's business, operating results and a financial condition. See "Factors
That May Affect Future Results of Operations--Regulatory Actions."
Proprietary Rights
The Company is the owner of numerous patents, trademarks and logos. As of
February 28, 1999, the Company had received 71 United States patents, and has 18
patent applications pending. Some of these patents have also been granted in
selected foreign countries. Many of the specific patents that are fundamental to
LonWorks technology have been licensed to the Company's customers with no
license fee or royalties. The principal value of the remaining patents relates
to the Company's specific implementation of its products. See "Factors That May
Affect Future Results of Operations--Competition" and "--Limited Protection of
Intellectual Property Rights."
The Company holds several registered trademarks in the United States,
including Echelon, LonBuilder, LonMark, LonTalk, LonUsers, LonWorks, Neuron and
NodeBuilder. The Company has also registered some of its trademarks and logos in
foreign countries.
Employees
As of February 28, 1999, the Company had 166 employees worldwide, of which 50
were in product development, 23 were in operations, 57 were in sales and
marketing, 13 were in customer support and training and 23 were in general and
administrative. Approximately 126 employees are located at the Company's
headquarters in Palo Alto, California. The Company has employees in nine
countries worldwide, with the largest concentrations outside the United States
in Japan, the Netherlands and the United Kingdom. None of the Company's
employees is represented by a labor union. The Company has not experienced any
work stoppages and considers its relations with its employees to be good.
Executive Officers of the Registrant
M. Kenneth Oshman has been President and Chief Executive Officer of the
Company since December 1988 (age 58). Mr. Oshman, with three associates, founded
ROLM Corporation ("ROLM"), a telecommunications equipment company, in 1969. He
was Chief Executive Officer, President, and a director at ROLM from its founding
until its merger with IBM in 1984. Following the merger, he became a Vice
President of IBM and a member of the Corporate Management Board. He remained in
that position until he left IBM in 1986. Prior to founding ROLM, Mr. Oshman was
a member of the technical staff at Sylvania Electric Products from 1963 to 1969.
In addition to his responsibilities at Echelon, Mr. Oshman serves as a director
of Sun Microsystems, Knight-Ridder, Inc. and CMC Industries, Inc. Mr. Oshman
earned B.A. and B.S.E.E. degrees from Rice University and M.S. and Ph.D. degrees
in Electrical Engineering at Stanford University.
Frederik Bruggink has been Vice President, Europe, Middle East and Africa,
since April 1996 (age 43). Mr. Bruggink joined the Company from Banyan Systems,
where he was Vice President, Europe. From 1985 to 1993, Mr. Bruggink held
several positions at Stratus Computer, including General Manager positions for
Holland, Benelux, and Northern Europe. His last position at Stratus was Vice
President, Northern Europe (including Germany). Prior to joining Stratus, he
held sales positions at Burroughs Computers. Mr. Bruggink attended the
University of Leiden.
Lawrence Y.H. Chan joined the Company in April 1997 as Vice President of Asia
Pacific and Japan and is based in Hong Kong (age 48). Prior to joining the
Company, Mr. Chan was Vice President of Asia Pacific and Japan for Banyan
Systems. Prior to that, he held management positions at Stratus Computer, both
in the U.S. and Hong Kong. Prior to joining Stratus, he held positions with
ComputerVision, Oriental Data Systems, Ltd., Hong Kong Terminals, John Swire and
Sons, Ltd., Kowloon Container Terminals Ltd. and NCR Hong Kong Ltd. Mr. Chan
received a General Certificate of Education from the University of London, a
degree in Electrical Engineering from Hong Kong Technical College and a degree
in Computer Programming from Hong Kong University.
Kenneth E. Lavezzo has been Vice President of Operations of the Company since
September 1990 and has been employed by the Company since 1989 (age 57). Mr.
Lavezzo joined the Company from ROLM, where he was the Director responsible for
Phonemail and Voice Applications. He also served as General Manager of the
Phones Division. Mr. Lavezzo joined ROLM in 1973 and held a variety of other
positions ranging from product design and program management to production and
manufacturing management. Prior to joining ROLM, he spent seven years at
Hewlett-Packard as a member of the technical staff developing medical products
and high-speed data acquisition products. Mr. Lavezzo received a B.S. degree in
Electrical Engineering from the University of California at Berkeley.
Peter A. Mehring has been Vice President, Engineering of the Company since
March 1998 (age 37). From January 1996 to March 1998, Mr. Mehring held a variety
of positions at Umax Computer Corporation ("Umax") where he was a Founder,
General Manager, and Vice President of research and development. From March 1995
to December 1995, Mr. Mehring held engineering management positions at Radius,
Inc., Power Computing Corporation, Sun Microsystems, Inc., and Wang
Laboratories, Inc. Mr. Mehring received a B.S. degree in Electrical Engineering
from Tufts University, Massachusetts.
Oliver R. Stanfield has been Vice President of Finance & Chief Financial
Officer of the Company since March 1989 (age 50). Mr. Stanfield joined the
Company from ROLM, where he served in several positions since 1980, including
Director of Pricing; Vice President, Plans and Controls; Vice President,
Business Planning; Vice President, Financial Planning and Analysis; Treasurer;
and Controller, Mil Spec Division. Prior to joining ROLM, Mr. Stanfield worked
for ITEL Corporation, Computer Automation and Rockwell International. Mr.
Stanfield began his business career with Ford Motor Company in 1969 in various
accounting positions while completing a B.S. in Business Administration and an
M.B.A. degree from the University of Southern California.
Edwin R. Sterbenc joined the Company in April 1997 as Vice President, Americas
(age 53). Prior to joining the Company, Mr. Sterbenc was with Tandem Computers,
Inc. from 1987 to 1997. At Tandem, he held positions in sales, international
sales and marketing. Prior to joining Tandem Computers, Inc., Mr. Sterbenc was
Vice President of Sales at Syntelligence. He was a Sales Manager for Cullinet
Software from 1984 to 1986, and held positions in sales, marketing and sales
management at IBM from 1973 to 1984. Mr. Sterbenc worked at Inland Steel prior
to joining IBM. Mr. Sterbenc holds a B.S. degree in Industrial Management and an
A.A.S. degree in Computer Science from Purdue University.
Beatrice Yormark has been Vice President of Marketing and Sales of the Company
since January 1990 (age 54). Ms. Yormark joined the Company from Connect, Inc.,
an on-line information services company, where she was the company's Chief
Operating Officer. Before joining Connect, Ms. Yormark held a variety of
positions, including Executive Director of Systems Engineering for Telaction
Corporation, Director in the role of Partner at Coopers & Lybrand, Vice
President of Sales at INTERACTIVE Systems Corporation, and various staff
positions at the Rand Corporation. Ms. Yormark received a B.S. degree in
Mathematics from City College of New York and an M.S. degree in Computer Science
from Purdue University.
9
<PAGE>
ITEM 2. PROPERTIES
The Company leases approximately 55,000 square feet of office, manufacturing
and distribution facilities in Palo Alto, California under two leases that
expire on June 30, 2000. The Company has an option to extend the lease of a
portion of the facilities for a five-year period. The aggregate rental expense
under these leases was approximately $1.4 million during 1998. The Company also
leases office space for its sales and marketing employees in China, France,
Germany, Hong Kong, Japan, the Netherlands and the United Kingdom. The
aggregate rental expense for such office space was approximately $400,000 during
1998. The Company believes that additional office space will be available as
required on acceptable terms. For additional information regarding the
Company's obligations under leases, see Note 4 "Commitments" on page 38.
ITEM 3. LEGAL PROCEEDINGS
There are no material legal proceedings to which the Company is a party of to
which any of its properties are subject, nor are there any material legal
proceedings known to the Company to be contemplated by any governmental
authority against the Company or any of its properties.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the fourth
quarter of the Company's fiscal year ended December 31, 1998.
10
<PAGE>
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Echelon's Common Stock is listed on the Nasdaq National Market under the
symbol ELON. As of February 28, 1999, there were approximately 567 holders of
record of the Common Stock. Because many of such shares are held by brokers and
other institutions on behalf of stockholders, the Company is unable to estimate
the total number of stockholders represented by these record holders. The
Company has never paid dividends on its capital stock and does not expect to pay
any dividends in the foreseeable future. The Company intends to retain future
earnings, if any, for use in its business.
The following table sets forth the range of high and low sales prices of the
Common Stock on the Nasdaq National Market since July 28, 1998, the date of the
Company's initial public offering, as reported by Nasdaq.
<TABLE>
<CAPTION>
Price Range
---------------------------------
Period High Low
--------------- -----------------
<S> <C> <C>
From July 28, 1998 through September
September 30, 1998 $7.25 $1.94
Quarter ended December 31, 1998 $4.25 $1.97
</TABLE>
11
<PAGE>
ITEM 6. SELECTED FINANCIAL DATA
The following selected consolidated financial data has been derived from the
audited consolidated financial statements. The information set forth below is
not necessarily indicative of results of future operations, and should be read
in conjunction with Item 7, "Management's Discussion and Analysis of Financial
Condition and Results of Operations" and the consolidated financial statements
and notes thereto in Item 8 of this Form 10-K in order to fully understand
factors that may affect the comparability of the information presented below.
<TABLE>
<CAPTION>
Year Ended December 31,
----------------------------------------------------------------
1998 1997 1996 1995 1994
----------- ------------- ----------- ----------- ----------
Consolidated Statement of Operations Data: (in thousands, except per share data)
<S> <C> <C> <C> <C> <C>
Revenues:
Product................................................. $29,163 $24,665 $ 20,708 $20,183 $ 14,368
Service................................................. 3,038 3,637 3,282 3,160 2,364
------- ------- -------- ------- --------
Total revenues......................................... 32,201 28,302 23,990 23,343 16,732
Cost of revenues:
Cost of product......................................... 12,784 11,761 10,761 9,434 6,733
Cost of service......................................... 1,836 1,810 1,142 1,141 1,006
------- ------- -------- ------- --------
Total cost of revenues................................. 14,620 13,571 11,903 10,575 7,739
------- ------- -------- ------- --------
Gross profit........................................... 17,581 14,731 12,087 12,768 8,993
------- ------- -------- ------- --------
Operating expenses:
Product development..................................... 7,564 7,121 7,526 7,355 6,658
Sales and marketing..................................... 12,535 12,128 11,577 10,881 9,317
General and administrative.............................. 4,119 4,004 3,921 4,386 3,268
------- ------- -------- ------- --------
Total operating expenses............................... 24,218 23,253 23,024 22,622 19,243
------- ------- -------- ------- --------
Loss from operations................................... (6,637) (8,522) (10,937) (9,854) (10,250)
Other income (expense):
Interest and other income, net.......................... 945 497 373 1,284 853
------- ------- -------- ------- --------
Loss before provision for income taxes................. (5,692) (8,025) (10,564) (8,570) (9,397)
Provision for income taxes............................... 159 189 152 143 86
------- ------- -------- ------- --------
Net loss................................................. $(5,851) $(8,214) $(10,716) $(8,713) $ (9,483)
======= ======= ======== ======= ========
Basic net loss per share (1)............................ $ (0.24) $ (0.44) $ (0.62) $ (0.56) $ (0.67)
======= ======= ======== ======= ========
Shares used in computing basic net loss per share (1)... 24,845 18,603 17,354 15,695 14,060
======= ======= ======== ======= ========
Pro forma basic net loss per share (1).................. $ (0.20) $ (0.32)
======= =======
Shares used in computing pro forma basic net
loss per share (1)...................................... 29,405 25,756
======= =======
Consolidated Balance Sheet Data:
Cash, cash equivalents and short-term investments......... $29,053 $ 7,853 $ 8,051 $16,044 $ 24,210
Working capital........................................... 33,733 8,883 7,905 17,653 25,120
Total assets.............................................. 41,950 16,816 15,855 24,547 31,124
Total stockholders' equity................................ 35,786 8,800 7,138 15,978 22,799
</TABLE>
(1) See Note 2 of Notes to Consolidated Financial Statements for an explanation
of shares used in computing basic net loss per share and pro forma basic net
loss per share.
12
<PAGE>
ITEM 7. 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 the
Company's 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-K that could cause actual results to
differ materially from historical results or those anticipated. In this report,
the words "anticipates", "believes", "expects", "future", "intends", 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 hereof.
OVERVIEW
Echelon Corporation develops, markets and supports a family of hardware and
software products and services that enables OEMs and systems integrators to
design and implement open, interoperable, distributed control networks. The
Company offers its products and services to OEMs and systems integrators in the
building, industrial, transportation, home and other automation markets. The
Company provides a variety of technical training courses related to its products
and underlying technology as well as customer support to its customers on a per
incident or annual contract basis.
The Company markets its products and services in North America, Europe, Japan
and selected Asia-Pacific countries through a direct sales organization
augmented with the use of third-party distributors. International sales, which
include both export sales and sales by the Company's international subsidiaries,
accounted for 55.4%, 57.5% and 53.6% of total revenues for the years ended
December 31, 1998, 1997, and 1996, respectively. For the year ended December
31, 1998, 9.1% of the Company's revenues were denominated in currencies other
than the U.S. dollar, principally the Japanese Yen. However, this percentage may
increase over time as the Company responds to market requirements to sell its
products and services in local currencies, such as the Euro. As a result, the
Company's operations and the market price of its products may be directly
affected by economic and political conditions in the countries where the Company
does business. Additional risks inherent in the Company's international business
activities include currency fluctuations, unexpected changes in regulatory
requirements, tariffs and other trade barriers. The Company expects that
international sales will continue to constitute a significant portion of total
revenues.
The Company derives its revenues primarily from the sale and licensing 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 sales of transceivers, control modules, routers, network interface devices
and development tools and from licenses for network services software products.
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. The Company recognizes revenue from product
sales at the time of shipment to the customer. 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, which have not
been material to the Company's financial results, are recorded at the time of
sale. Revenue from software sales is recognized upon shipment of the software 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 revenues are
generally recognized as the services are performed.
The Company has experienced operating losses in all prior fiscal years and
for the year ended December 31, 1998. During this period, the Company has made
significant investments in product development to implement open control
networks. Such development projects included development of transceivers,
control modules, routers, network interface devices, network management software
and the LonPoint System. Furthermore, because the Company's strategy is
significantly dependent upon achieving broad adoption of its LonWorks technology
across many industries worldwide, the Company has incurred significant selling
and marketing expense promoting its products. The Company currently believes it
is unlikely that its future rate of growth of product development, sales and
marketing expenses will fall below historical levels. Additionally, the Company
believes that it has priced its products at competitive levels to ensure broad
adoption of LonWorks technology. The Company continues to invest significantly
in product development, sales and marketing, and to the extent such expenditures
do not result in significant increases in revenues, the Company will continue to
incur operating losses for the foreseeable future and the Company's business,
operating results and financial condition will be materially and adversely
affected.
The Company has experienced, and expects to continue to experience,
significant variability in its quarterly and annual results due to a number of
factors, many of which are outside of the Company's control. The Company
believes that one of the factors in such variability is the fluctuation in the
rates at which OEMs purchase the Company's products and services, which is
impacted by OEMs' own business cycles. Another factor in such variability is the
timely introduction of new products. From time to time, the introduction of new
products by the Company has been delayed beyond the Company's projected shipping
date. In each instance, such delays have resulted in increased costs and delayed
revenues. Because future revenues are dependent on the timely introduction of
new product offerings, any such future delays could have a material adverse
effect on the Company's business, operating results and financial condition. The
Company's expense levels are based, in significant part, on the Company's
expectations of future revenues. Consequently, if revenue levels are below
expectations, expense levels could be disproportionately high as a percentage of
total revenues, and operating results would be immediately and adversely
affected. The Company has failed to meet its expectations of
13
<PAGE>
future revenues in the past. In addition, the
growth of the Company's revenues has been adversely affected by declines in
sales of existing products over time.
Results of Operations
The following table sets forth, for the periods indicated, the percentage of
total revenues represented by each item in the Company's Consolidated Statement
of Operations:
<TABLE>
<CAPTION>
Year Ended December 31,
-----------------------------------------------
1998 1997 1996
--------------- --------------- -------------
<S> <C> <C> <C>
Revenues:
Product ......................................... 90.6% 87.1% 86.3%
Service ......................................... 9.4 12.9 13.7
------ ------ ------
Total revenues ................................ 100.0 100.0 100.0
Cost of revenues:
Cost of product ................................. 39.7 41.6 44.8
Cost of service ................................. 5.7 6.4 4.8
------ ------ ------
Total cost of revenues ........................ 45.4 48.0 49.6
------ ------ ------
Gross profit .................................. 54.6 52.0 50.4
------ ------ ------
Operating expenses:
Product development ............................. 23.5 25.1 31.4
Sales and marketing ............................. 38.9 42.9 48.3
General and administrative ...................... 12.8 14.1 16.3
------ ------ ------
Total operating expenses ...................... 75.2 82.1 96.0
------ ------ ------
Loss from operations .......................... (20.6) (30.1) (45.6)
------ ------ ------
Interest and other income, net .................. 2.9 1.7 1.6
Loss before provision for income taxes ........ (17.7) (28.4) (44.0)
Provision for income taxes ....................... 0.5 0.6 0.7
------ ------ ------
Net loss ........................................ (18.2)% (29.0)% (44.7)%
====== ====== ======
</TABLE>
Comparison of Years Ended December 31, 1998 and 1997
Revenues
Total revenues for the year ended December 31, 1998 grew to $32.2 million
from $28.3 million in 1997. One customer, EBV, the sole independent distributor
of the Company's products in Europe since December 1997, accounted for 22.6% and
10.9% of total revenues for the years ended December 31, 1998 and 1997,
respectively.
Product. Product revenues for the year ended December 31, 1998 grew to $29.2
million from $24.7 million in 1997. The 18.2% increase in product revenues
between the years was primarily a result of increasing sales of control and
connectivity products partially offset by the decrease in sales for network
services and development tools products.
Service. Service revenues for the year ended December 31, 1998 decreased to
$3.0 million from $3.6 million in 1997. The 16.5% decrease in service revenues
between the years was due to fewer participants attending the training courses
offered by the Company and reduced customer support revenues due to a change in
product offerings.
Cost of Revenues
Cost of product. Cost of product revenues consist 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 for the year ended December
31, 1998 increased to $12.8 million from $11.8 million in 1997, an increase of
8.7%, representing product gross margins of 56.2% and 52.3%, respectively. The
increase in product gross margin percentages for the annual periods was
primarily due to cost reductions for the Company's higher volume control and
connectivity products.
Cost of service. Cost of service revenues consist of employee-related costs
as well as direct costs incurred in providing training and customer support
services. Cost of service revenues for the years ended December 31, 1998 and
1997 were $1.8 million, representing service gross margins of 39.6% and 50.2%,
respectively. The decrease in service gross margin percentage in 1998 compared
to 1997 was primarily due to the decline in service revenues.
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 year ended
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December 31, 1998 increased to $7.6 million from $7.1 million in the same period
of 1997, representing 23.5% and 25.1%, respectively, of total revenues. The
dollar amount increase was primarily the result of increased salaries and other
costs related to the hiring of additional engineering personnel to support the
development of new and existing products.
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 year ended December 31, 1998 increased to $12.5 million from
$12.1 million in 1997, representing 38.9% and 42.9%, respectively, of total
revenues. The decrease in sales and marketing expense as a percentage of total
revenues was primarily due to the larger revenue base in 1998.
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 for the year ended
December 31, 1998 increased to $4.1 million from $4.0 million from the same
period of 1997, representing 12.8% and 14.1%, respectively, of total revenues.
The decrease in general and administrative expense as a percentage of total
revenues was primarily due to the larger revenue base in 1998.
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 year ended 1998 increased to $945,000 from $497,000 in 1997.
The increase in 1998 was primarily due to the higher cash and short-term
investments balances generated in the third quarter of 1998 when the Company
received net proceeds of $31.7 million from its initial public offering.
Provision for income taxes
Income taxes consist of income taxes related to certain of the Company's
foreign subsidiaries. Income taxes were $159,000 and $189,000 for the years
ended December 31, 1998 and 1997, respectively.
Comparison of Years Ended December 31, 1997 and 1996
Revenues
Total revenues for fiscal 1997 and 1996 were $28.3 million and $24.0 million,
respectively, representing an increase of 18.0%. EBV accounted for 10.9% of
total revenues in fiscal 1997. In 1996, no single customer accounted for 10% or
more of total revenues.
Product. Product revenues for fiscal 1997 and 1996 were $24.7 million and
$20.7 million, respectively, representing an increase of 19.1%. Product
revenues as a percentage of total revenues were 87.1% and 86.3% for fiscal 1997
and 1996, respectively. The increase in 1997 as compared to 1996 was due to the
market's growing acceptance of the Company's control and connectivity products
which increased by $4.4 million and an expansion of the Company's product
offerings, particularly its network services products.
Service. Service revenues for fiscal 1997 and 1996 were $3.6 million and $3.3
million, respectively, representing an increase of 10.8%. Service revenues as a
percentage of total revenues were 12.9% and 13.7% for fiscal 1997 and 1996,
respectively. The increase in 1997 service revenues as compared to 1996 reflects
increased customer support revenues as a result of the increased installed base
of the Company's products.
Cost of Revenues
Cost of product. Cost of product revenues for fiscal 1997 and 1996 were $11.8
million and $10.8 million, respectively, representing product gross margins of
52.3% and 48.0%, respectively. The increases in dollar amounts were due
primarily to the additional product costs associated with increased revenue
volumes. The increase in product gross margin in 1997 as compared to 1996 was
due primarily to decreased operations spending as a percentage of revenue
related to flat spending levels and a decrease in manufacturing variances of
$315,000.
Cost of service. Cost of service revenues for fiscal 1997 and 1996 were $1.8
million and $1.1 million, respectively, representing service gross margins of
50.2% and 65.2%, respectively. The increase in dollar amount in fiscal 1997 as
compared to 1996 was primarily the result of an increase in the number of
customer support and training personnel. The decrease in service gross margin in
1997 as compared to 1996 was due primarily to higher cost of service growth
compared to service revenue growth.
Operating Expenses
Product development. Product development expenses for fiscal 1997 and 1996
were $7.1 million and $7.5 million, respectively, representing 25.1% and 31.4%
of total revenues, respectively. The decrease in product development expenses in
1997 as compared to
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1996 was due primarily to the transition of Company personnel from product
development to the direct support of the Company's existing customers.
Sales and marketing. Sales and marketing expenses for fiscal 1997 and 1996
were $12.1 million and $11.6 million, respectively, representing 42.9% and 48.3%
of total revenues, respectively. The dollar amount increase was primarily due to
personnel related expenses. The Company's expenses in international sales
offices in 1997 were lower than 1996 primarily due to an overall strengthening
of the U.S. dollar against most of the functional currencies used in the
international sales office operations.
General and administrative. General and administrative expenses for fiscal
1997 and 1996 were $4.0 million and $3.9 million, respectively, representing
14.1% and 16.3% of total revenues, respectively. The decrease in percentage of
total revenues in 1997 compared to 1996 was due to relatively similar spending
levels spread over a larger revenue base.
Interest and other income, net
Interest and other income, net for fiscal 1997 and 1996 was $497,000 and
$373,000, respectively, representing 1.7% and 1.6% of total revenues,
respectively. The higher interest income during 1996 was partially offset by
foreign transaction losses primarily related to the fluctuations of the U.S.
dollar against the Japanese Yen. The decrease in interest income during 1997
was due to lower cash and short-term investment balances.
Provision for income taxes
Income taxes for 1997 and 1996, which consists of income taxes related to
certain of the Company's foreign subsidiaries, were $189,000 and $152,000,
respectively.
Liquidity and Capital Resources
Since its inception, the Company has financed its operations and met its
capital expenditure requirements primarily from the sale of Preferred Stock and
Common Stock. From inception through December 31, 1998, the Company had raised
$127.2 million from the sale of Preferred Stock and Common Stock.
In July 1998, the Company consummated an initial public offering of 5,000,000
shares of its Common Stock at a price to the public of $7.00 per share. The net
proceeds to the Company from the offering were approximately $31.7 million.
Concurrent with the closing of the initial public offering, 7,887,381 shares of
convertible preferred stock were converted into an equivalent number of shares
of common stock. The net proceeds received by the Company upon the consummation
of such offering were invested in short-term, investment-grade, interest-bearing
instruments.
As of December 31, 1998, the Company had working capital, defined as current
assets less current liabilities, of $33.7 million, which was an increase of
approximately $24.8 million over December 31, 1997. The increase was primarily
due to the net proceeds received from the initial public offering in July 1998.
As of December 31, 1998, the Company had cash, cash equivalents and short-
term investments of $29.1 million. Net cash used in operating activities was
$9.2 million and $9.5 million for the years ended December 31, 1998, and 1997,
respectively. Cash used in operating activities in 1998 was principally the
result of the net loss, increases in accounts receivable, inventories and other
current assets, a decrease in deferred revenue, and a partial offset with
depreciation. Cash used in operating activities in 1997 was principally the
result of the net loss, increases in accounts receivable and inventories, a
decrease in deferred revenue, and a partial offset with depreciation and
increases in accounts payable and accrued liabilities.
Net cash used in investing activities was $16.8 million and $3.6 million for
the years ended December 31, 1998 and 1997, respectively. These amounts reflect
the purchases of short-term investments with the proceeds received from the
Company's initial public offering in July 1998 and through the issuance of
Preferred Stock in May 1997. In addition, the Company had capital expenditures
in 1998 related to investments in a new enterprise resource planning system and
other equipment needs as a result of its growth.
The Company believes that its existing available cash, cash equivalents and
short-term investments will satisfy the Company's projected working capital and
other cash requirements for at least the next twelve months. However, there can
be no assurance that the Company will not require additional financing within
this period or that any such financing will be available to the Company in the
amounts or at the times required by the Company, or on acceptable terms, if at
all. The Company has terminated its revolving line of credit agreement with a
bank, which would have expired in May 1999. The failure of the Company to
obtain additional financing, when and if necessary, could have a material
adverse effect on the Company's business, operating results and financial
condition.
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Year 2000 Compliance
The information presented below related to Year 2000 compliance contains
forward-looking statements that are subject to risks and uncertainties. The
Company's actual results may differ significantly from the results discussed
below and elsewhere in this Form 10-K regarding Year 2000 compliance.
Year 2000
Computer programs that are written using two digits rather than four to
define the applicable year, may have date-sensitive software and, for instance,
may recognize a date using 00 as the year 1900 rather than the year 2000 ("Date
Code Dependency"). Additional computer problems are possible related to leap
year calculations in the year 2000. Either problem could result in a system
failure or miscalculations causing disruptions of operations, including, among
other things, a temporary inability to process transactions, send invoices, or
engage in normal business activities.
State of Readiness
Echelon has formed a cross-functional team (the "Y2K Team") including
Information Services ("IS"), Operations, Product Marketing, Product Development
and Administration to evaluate and address the compliance of its products,
internal systems, and key suppliers related to Date Code Dependencies. The Y2K
Team is in the process of documenting the results of these evaluations and
expects all such evaluations to be completed by June 1999 with any required
remediation to be completed by September 1999.
Echelon Products: All products that were available for sale beginning with
Echelon's January 1997 price list, and all subsequent versions of the price list
are being analyzed and tested to verify conformity with the Company's selected
test for Date Code Dependencies. All Echelon product tests are being performed
according to the definition set forth in the British Standards Institution
definition. In some instances, Echelon's compliance testing will depend upon
compliance certification provided by third party component vendors.
Internal Systems: IS is responsible for all corporate systems and servers
(including operating systems) and for desktop systems. The facilities located in
Palo Alto, California (the Company's corporate headquarters) are being evaluated
according to the model of the California State Year 2000 Embedded System Plan.
There is increased risk with the Company's international sales and marketing
office locations due to the individual infrastructures and varying rates of year
2000 compliance in the hosting countries. Echelon is evaluating each
international location on a case-by-case basis. In January 1999, the Company
replaced its former enterprise resource planning system with a new system which
does not have Date Code Dependencies.
Suppliers: All of the Company's key suppliers have indicated that they do not
anticipate Date Code Dependency problems. Echelon is continuing to evaluate non-
key suppliers for Date Code Dependency issues.
Customers: All of the Company's current customers are being mailed quarterly
letters updating them as to Date Code Dependencies with regard to Echelon
products. The Company's web site is also updated quarterly with this
information.
Costs and Risks Associated with Date Code Dependencies
With the exception of the new enterprise resource planning system which had
capitalized costs of approximately $1.2 million, additional costs to test and
administer the Year 2000 compliance have been done internally without any
additional outside contracted services. To date, the Company has concluded that
additional costs to test, administer, and mitigate Year 2000 issues will not be
material. However, failure of the Company's products to operate properly with
regard to the Year 2000 and thereafter could require the Company to incur
unanticipated expenses to remedy any problems. Date Code Dependency issues may
also arise with respect to any modifications made to the Company's products by a
party other than the Company or from the combination or use of the Company's
products with any other software programs or hardware devices not provided by
the Company, and therefore may result in unforeseen Year 2000 compliance
problems for some of the Company's customers, which could result in reduced
customer orders or liability to the Company. Moreover, the Company's insurance
policies contain Year 2000 exclusion provisions. The Company also faces risks
to the extent that suppliers of products, services and systems purchased by the
Company have business systems or products that have a Date Code Dependency. In
addition, some of the Company's customers or vendors could experience Date Code
Dependency problems that could result in disruptions of their internal
operations that could delay their purchases of the Company's products. Any of
these factors could result in a material adverse effect on the Company's
business, operating results and financial condition. Management expects to make
contingency plans as necessary.
New Accounting Standards
In March 1998, the AICPA issued SOP 98-1, "Accounting for the Costs of
Computer Software Developed or Obtained for Internal Use". SOP 98-1 is effective
for the Company's fiscal year beginning January 1, 1999 and provides guidance on
the capitalization of software for internal use. Management believes the
adoption of SOP 98-1 will not have a material effect on the Company's financial
statements.
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In April 1998, the AICPA issued SOP 98-5 "Reporting the Costs of Start-up
Activities". SOP 98-5 is effective for the Company's fiscal year beginning
January 1, 1999. SOP 98-5 provides guidance on the financial reporting of
start-up costs and organization costs and requires such costs to be expensed as
incurred. Management believes the adoption of SOP 98-5 will not have a material
effect on the Company's financial statements.
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
derivative portion of certain other contracts. SFAS No. 133 will become
effective for the Company's year beginning January 1, 2000. Management believes
that SFAS No. 133 will not have a material effect on the Company's financial
statements.
FACTORS THAT MAY AFFECT FUTURE RESULTS OF OPERATIONS
HISTORY OF LOSSES; ACCUMULATED DEFICIT; ANTICIPATED CONTINUING LOSSES;
UNCERTAINTY OF FUTURE OPERATING RESULTS
The Company has incurred net losses each year since its inception. At
December 31, 1998, the Company had an accumulated deficit of $90.5 million. The
Company has invested and continues to invest significant financial resources in
product development, marketing and sales, and to the extent such expenditures do
not result in significant increases in revenues, the Company's business,
operating results and financial condition will be materially and adversely
affected. Due to the limited history and undetermined market acceptance of many
of the Company's products and technologies, the rapidly evolving nature of the
Company's business and markets, potential changes in voluntary product standards
that significantly influence many of the markets for the Company's products, the
high level of competition in the industries in which the Company operates and
the other factors described elsewhere in this document, there can be no
assurance that the Company's investment in these areas will result in increases
in revenues or that any revenue growth that is achieved can be sustained. Any
revenue growth that the Company has achieved or may achieve may not be
indicative of future operating results. In addition, the Company's history of
losses make future operating results difficult to predict. The Company and its
prospects must be considered in light of the risks, costs and difficulties
frequently encountered by emerging companies. As a result, there can be no
assurance that the Company will be profitable in any future period. Future
operating results will depend on many factors, including the growth of the
markets for the Company's products, the acceptance of the Company's products,
the level of competition, the ability of the Company to develop and market new
products, and general economic conditions. In view of the uncertainties
identified herein, the Company believes that period-to-period comparisons of
financial results are not necessarily meaningful and should not be relied upon
as an indication of future performance. As of December 31, 1998, the Company had
net operating loss carryforwards for Federal and state income tax reporting
purposes of approximately $80.1 million and $5.0 million, respectively, which
expire at various dates through 2018. In addition, as of December 31, 1998, the
Company had tax credit carryforwards of approximately $4.1 million, which expire
at various dates through 2018. 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. The Company had deferred tax assets,
including its net operating loss carryforwards and tax credits, totaling
approximately $36.1 million as of December 31, 1998. A valuation allowance has
been recorded for the entire deferred tax asset as a result of uncertainties
regarding the realization of the asset balance, the history of losses and the
variability of operating results.
FLUCTUATIONS IN OPERATING RESULTS
The Company has experienced, and expects to continue to experience,
significant variability in its quarterly and annual results, as a result of a
number of factors, many of which are outside of the Company's control. The
Company believes that such variability is primarily due to the fluctuations in
the rates at which OEMs purchase the Company's products and services, the OEMs'
own business cycles, the timely introduction of new products, any downturns in
any customer's or potential customer's business, the Company's ability to
anticipate and effectively adapt to developing markets and rapidly changing or
new technologies and distribution channels, increased competition, market
acceptance of the Company's products, product life cycles, order delays or
cancellations, changes in the mix of products and services sold by the Company,
shipment and payment schedules, changes in pricing policy by the Company or its
competitors, changes in product distribution, product ratings by industry
analysts and endorsement of competing products by industry groups. Declines in
general economic conditions could also precipitate significant reductions in
capital spending, which could, in turn, affect orders for the Company's
products. The Company's expense levels are based, in significant part, on
expectations of future revenues. Consequently, if revenue levels are below
expectations, expense levels could be disproportionately high as a percentage of
total revenues, and operating results would be immediately and adversely
affected. The Company has failed to meet its expectations of future revenues in
the past. As a result of these and other factors, the Company believes that its
revenues and operating results are difficult to predict and are subject to
fluctuations from period to period, and that period-to-period comparisons of its
results of operations are not meaningful and should not be relied upon as
indications of future performance.
DEPENDENCE ON OEMS AND DISTRIBUTION CHANNELS
To date, substantially all of the Company's sales of its products have been
to OEMs. The rate at which the Company's products are used in control networks
is primarily subject to product and marketing decisions made by OEMs. The
Company believes that since OEMs in certain industries receive a large portion
of their revenues from sales of products and services to their installed base,
such
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OEMs have tended to moderate the rate at which they incorporate LonWorks
technology into their products. The Company has attempted to motivate OEMs, as
well as systems integrators and owners of control systems, to effect a more
rapid transition to LonWorks technology. Furthermore, OEMs that manufacture and
promote products and technologies that compete or may compete with the Company
may be particularly reluctant to employ the Company's products and technologies
to any significant extent, if at all. There can be no assurance that the Company
will be able to improve the current rate of acceptance or usage of its products
by OEMs and others, or that such usage will not decrease over time. The failure
to increase acceptance or usage of the Company's products, or any decrease in
usage of its products, would have a material adverse effect on the business,
operating results and financial condition of the Company.
Currently, a significant portion of the Company's revenues are derived from
sales by EBV, the sole independent distributor of the Company's products to OEMs
in Europe since December 1997. EBV accounted for 22.6% and 10.9% of the
Company's total revenues for the years ended December 31, 1998 and 1997
respectively. The Company's agreement with EBV will expire in December 1999. In
addition, as part of its distribution strategy, the Company intends to develop
distribution arrangements with systems integrators. In particular, the Company
expects that a significant portion of its future revenues will be derived from
sales by such systems integrators. Any failure by EBV or any other existing or
future distributor to dedicate sufficient resources and efforts to the marketing
and selling of the Company's products, or to generate significant revenues for
the Company, could have a material adverse effect on the Company's business,
operating results and financial condition. Also, the failure of the Company to
develop new distribution channels, to maintain the EBV arrangement or any other
distribution channels, or to renew the EBV arrangement on a timely basis, would
result in reduced or delayed revenues, increased operating expenses and loss of
customer goodwill, any of which could have a material adverse effect on the
business, operating results and financial condition of the Company.
DEPENDENCE ON KEY MANUFACTURERS
The Neuron Chip is an important component used by the Company's customers in
control network nodes. In addition, the Neuron Chip is an important device used
in many of the Company's products. Neuron Chips are manufactured and distributed
by both Motorola and Toshiba. The Company has entered into licensing agreements
with each of Motorola and Toshiba. The agreements, among other things, grant
Motorola and Toshiba the worldwide right to manufacture and distribute Neuron
Chips using technology licensed from the Company and require the Company to
provide support and unspecified updates to the licensed technology over the
terms of the agreements. The Motorola and Toshiba agreements expire in January
2001 and January 2000 respectively, unless renewed. Motorola has announced that
it will discontinue distribution of Neuron Chips after January 31, 2001.
However, both Motorola and Toshiba have the right to terminate the agreements at
any time. While the Company developed the first version of the Neuron Chip,
Motorola and Toshiba subsequently developed improved, lower-cost versions of the
Neuron Chip that are presently utilized in products developed and sold by the
Company and its customers. The Company currently has no other source of supply
for Neuron Chips and has neither the resources nor the skills to replace either
Motorola or Toshiba as a manufacturer of Neuron Chips. The Company is attempting
to license a second source for design, development and supply of the Neuron Chip
as a replacement for Motorola. Both Motorola and Toshiba have played, and
Toshiba is expected to continue to play, a key role in the development and
marketing of LonWorks technology. The loss of Toshiba as a supplier of the
Neuron Chip, or the failure of the Company to license a second supplier of the
Neuron Chip to replace Motorola in a timely manner and on commercially
reasonable terms, could have a material adverse effect on the business,
operating results and financial condition of the Company. There can be no
assurance that the Company would be able to locate an alternate source for the
design, manufacture or distribution of Neuron Chips.
The Company's future success will also depend, in significant part, on its
ability to successfully manufacture its products cost-effectively and in
sufficient volumes. For certain key products, the Company utilizes outsource
manufacturers including GET and muRata. These outsource manufacturers procure
material and assemble, test and inspect the final products to the Company's
specifications. Such a strategy involves certain risks, including the potential
absence of adequate capacity and reduced control over delivery schedules,
product availability, manufacturing yields, quality and costs. In addition,
several key components are currently purchased only from sole or limited
sources. Any interruption in the supply of these products or components, or the
inability of the Company to procure these products or components from alternate
sources at acceptable prices and within a reasonable time, could have a material
adverse effect upon the Company's business, operating results and financial
condition.
COMPETITION
Competition in the Company's 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 its
competitive position, the Company 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 its customers. The principal competitive factors
affecting the markets for the Company's control network products are customer
service and support, product reputation, quality, performance, price and product
features such as adaptability, scalability, ability to integrate with other
products, functionality and ease of use. The Company believes it has in the past
generally competed favorably with offerings of its competitors on the basis of
these factors. However, there can be no assurance that the Company will continue
to be able to compete effectively based on these or any other competitive
factors in the future.
In each of its markets, the Company competes with a wide array of
manufacturers, vendors, strategic alliances, systems developers and other
businesses. The Company's competitors include some of the largest companies in
the electronics industry, such as
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Siemens in the building and industrial automation industries and Allen-Bradley
and Schneider in the industrial automation industry. Many of the Company's
competitors, alone or together with their trade associations and partners,
have longer operating histories, significantly greater financial, technical,
marketing, service and other resources, significantly greater name recognition
and broader product offerings. As a result, such 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. Accordingly, there can be no assurance that the
Company will be able to compete successfully with existing or new competitors,
or that competition will not have a material adverse effect on the business,
operating results or financial condition of the Company.
Many of the Company's 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, those
of the Company. In some cases, companies have established associations or
cooperative relationships to enhance the competitiveness and popularity of their
products, or to promote such different or incompatible technologies, protocols
and standards. For example, in the building automation market, the Company faces
widespread reluctance by vendors of traditional closed or proprietary control
systems (who enjoy a captive market for servicing and replacing equipment) to
utilize the Company's interoperable technologies, as well as 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 the Company's LonTalk 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 the Company's LonTalk protocol.
There can be no assurance that the Company's technologies, protocols or
standards will be successful in any of its markets, or that the Company will be
able to compete with new or enhanced products or standards introduced by
existing or future competitors. Any increase in competition or failure by the
Company to effectively compete with new or enhanced products or standards could
result in fewer customer orders, price reductions, reduced order size, reduced
operating margins and loss of market share, any of which could have a material
adverse effect on the business, operating results or financial condition of the
Company.
LonWorks technology is open, meaning that many of the Company's key technology
patents are broadly licensed without royalties or license fees. As a result, the
Company's customers are capable of developing products that compete with some of
the Company's products. Because some of the Company's customers are OEMs that
develop and market their own control systems, these customers in particular
could develop competing products based on the Company's open technology. This
could decrease the market for the Company's products, increase competition, and
have a material adverse effect on the Company's business, operating results and
financial condition.
VOLATILITY OF STOCK PRICE
The price of the Company's common stock has been, and from time to time may
be, volatile. The stock price is subject to wide fluctuations in response to
quarterly variations in operating results, announcements of technological
innovations or new products by the Company or its competitors, changes in
financial estimates by securities analysts, or other events or factors. In
addition, there has been significant volatility in the market price of
securities of technology companies (especially those in new or emerging
industries, such as the Company), which volatility is often unrelated to the
operating performance of particular companies. In the future, the Company's
operating results could fall below analysts' expectations, which would
adversely affect the market price of the Company's Common 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 companies. If brought against the Company, regardless of outcome, the
costs and diversion of management resources of defending such litigation could
have a material adverse effect on its business, operating results and
financial condition.
DEPENDENCE ON KEY PERSONNEL
The Company's performance is substantially dependent on the performance of its
executive officers and key employees. The loss of the services of any of the
Company's executive officers or key employees could have a material adverse
effect on the business, operating results and financial condition of the
Company. The Company is particularly dependent upon its Chief Executive Officer,
as well as its technical personnel, due to the specialized technical nature of
the Company's business. The Company's future success will depend on its ability
to attract, integrate, motivate and retain qualified technical, sales,
operations and managerial personnel. There is intense competition for qualified
personnel in the areas of the Company's activities, and there can be no
assurance that the Company will be able to continue to attract and retain
qualified executive officers and key personnel necessary for the development and
success of its business. If the Company is unable to hire personnel on a timely
basis in the future, the Company's business, operating results and financial
condition will be materially and adversely affected. In addition, the departure
or replacement of key personnel could be disruptive, lead to additional
departures and therefore have a material adverse effect on the Company's
business, operating results and financial condition. The Company maintains and
is the beneficiary of life insurance policies in the amount of $2.5 million
covering each of M. Kenneth Oshman, its Chief Executive Officer, Beatrice
Yormark, its Vice President of Sales and Marketing, and Oliver R. Stanfield, its
Chief Financial Officer. There can be no assurance that such proceeds would be
sufficient to compensate the Company in the event of the death of Mr. Oshman,
Ms. Yormark or Mr. Stanfield.
20
<PAGE>
NEW PRODUCTS AND RAPID TECHNOLOGICAL CHANGE
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, the adoption of new or different standards within
industry segments may give rise to new customer requirements, which may or may
not be compatible with the Company's current or future product offerings. The
Company's future success depends in large part on its ability to continue to
enhance existing products, lower product cost and develop new products that
maintain technological competitiveness. There can be no assurance that the
Company will be successful in modifying its products and services to address
these requirements and standards. For example, certain of the Company's
competitors may develop competing technologies based on Internet protocols that
may have advantages over the Company's products in remote connection. If the
Company is unable, for technological or other reasons, to develop new products
or enhancements of existing products in a timely manner to respond to changing
market conditions, competitive factors and customer requirements, the Company's
business, operating results and financial condition would be materially
adversely affected.
From time to time, the introduction of new products by the Company has been
delayed beyond the Company's projected shipping date for such products. In each
instance, such delays have resulted in increased costs and delayed revenues.
Because future revenues are dependent on the timely introduction of new product
offerings, any such future delays could have a material adverse effect on the
Company's business, operating results and financial condition.
MARKET ACCEPTANCE OF INTEROPERABILITY
The future operating success of the Company will depend, in significant part,
on the successful development of interoperable products by the Company and OEMs,
and the acceptance of interoperable products by systems integrators and end-
users. When products or subsystems from multiple vendors can be integrated into
a control system without the need to develop custom hardware or software, they
are "interoperable". The Company has expended considerable resources to develop,
market and sell interoperable products, and has made such products a cornerstone
of its sales and marketing strategy. The Company has widely promoted
interoperable products as offering benefits such as lower life-cycle costs and
improved flexibility to owners and users of control networks. However, there can
be no assurance that OEMs who manufacture and market closed systems will accept,
promote or employ interoperable products, since doing so may expose such OEMs'
businesses to increased competition. In addition, there can be no assurance that
OEMs will, in fact, successfully develop interoperable products, or that OEMs'
interoperable products will be accepted by their customers. The failure of OEMs
to develop interoperable products, or the failure of interoperable products to
achieve market acceptance, would have a material adverse effect on the business,
operating results and financial condition of the Company.
INTERNATIONAL OPERATIONS; CURRENCY FLUCTUATIONS
The Company's sales and marketing operations are located in nine countries.
Revenues from international sales, which include both export sales and sales by
international subsidiaries, accounted for approximately 55.4%, 57.5%, and 53.6%
of the Company's total revenues during the years ended December 31, 1998, 1997
and 1996, respectively. The Company's operations and the market price of its
products may be directly affected by economic and political conditions in the
countries where the Company does business. In addition, there can be no
assurance that the Company will be able to maintain or increase the
international demand for its products. Additional risks inherent in the
Company's international business activities generally include currency
fluctuations, unexpected changes in regulatory requirements, tariffs and other
trade barriers, costs of localizing products for foreign countries, 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 transacted by the Company in
other countries in any given quarter, the timing of the Company's revenues and
its ability to forecast its projected operating results for such quarter. For
the year ended December 31, 1998, approximately 9.1% of the Company's revenues
were conducted in currencies other than the U.S. dollar, principally the
Japanese Yen. Fluctuations in the value of currencies in which the Company
conducts its business relative to the U.S. dollar could cause currency
translation adjustments. The Company has experienced and in the future may
continue to experience an increase in currency translation adjustments relative
to currencies of Asia Pacific countries, as well as order delays, cancellations
and pricing pressure in those countries as a result of general economic
conditions in that region. The introduction of the Euro as the standard
currency in participating European countries may also impact the ability of the
Company to denominate sales transactions in U.S. dollars. To the extent that
fewer of the Company's sales in Europe are denominated in U.S. dollars, the
Company may experience an increase in currency translation adjustments,
particularly as a result of general economic conditions in Europe as a whole.
The Company does not currently engage in currency hedging transactions or
otherwise cover its foreign currency exposure. There can be no assurance that
such factors will not have a material adverse effect on international revenues
and, consequently, the Company's business, operating results and financial
condition.
LENGTHY SALES CYCLE
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 the
Company's products. Subsequent purchases of the Company's products may be
delayed by prolonged product development and introduction periods for
21
<PAGE>
OEMs. Attendant delays in the Company's sales cycle can result from, among other
things, changes in customers' budgets or in the priority assigned to control
network development and to educating customers as to the potential applications
of and cost savings associated with the Company's products. The Company
generally has little or no control over these factors, which may cause a
potential customer to favor a competitor's products, or to delay or forgo
purchases altogether. Also, there can be long sales cycle between the selection
of the Company's products for use by a systems integrator, and the purchase of
such products by the systems integrator. As a result of the foregoing, the
Company's ability to forecast the timing and amount of specific sales is
limited, and the delay or failure to complete transactions could have a material
adverse effect on the Company's business, operating results and financial
condition and cause the Company's operating results to vary significantly from
period to period.
LIMITED PROTECTION OF INTELLECTUAL PROPERTY RIGHTS
The Company's success depends significantly upon its intellectual property
rights. The Company relies on a combination of patent, copyright, trademark and
trade secret laws, non-disclosure agreements and other contractual provisions to
establish, maintain and protect its intellectual property rights, all of which
afford only limited protection. The Company has 71 issued U.S. patents, 18
pending U.S. patent applications, and various foreign counterparts. There can be
no assurance that patents will issue from these pending applications or from any
future applications or that, if issued, any claims allowed will be sufficiently
broad to protect the Company's technology. Failure of any patents to protect the
Company's technology, may make it easier for the Company's competitors to offer
equivalent or superior technology. The Company has registered or applied for
registration for certain trademarks, and will continue to evaluate the
registration of additional trademarks as appropriate. Any failure by the Company
to properly register or maintain its trademarks or to otherwise take all
necessary steps to protect its trademarks may diminish the value associated with
the Company's trademarks. In addition, any failure by the Company to take all
necessary steps to protect its trade secrets or other intellectual property
rights may have a material adverse effect on the Company's ability to compete in
its markets. Despite the Company's efforts to protect its proprietary rights,
unauthorized parties may attempt to copy aspects of the Company's products or
services or to obtain and use information that the Company regards as
proprietary. There can be no assurance that any patents, trademarks, copyrights
or intellectual property rights that have been or may be issued or granted will
not be challenged, invalidated or circumvented, or that any rights granted
thereunder would provide protection for the Company's proprietary rights. In
addition, there can be no assurance that the Company has taken or will take all
necessary steps to protect its intellectual property rights. Third parties may
also independently develop similar technology without breach of the Company's
trade secrets or other proprietary rights. The Company has licensed in the past
and may license in the future its key technologies to third parties. In
addition, the laws of some foreign countries, including several in which the
Company operates or sells its products, do not protect proprietary rights to as
great an extent as do the laws of the United States. Certain of the Company's
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 the
Company's proprietary rights. Such litigation could result in substantial costs
and diversion of management resources and could have a material adverse effect
on the Company's business, operating results and financial condition, regardless
of the final outcome. Despite the Company's efforts to safeguard and maintain
its proprietary rights both in the United States and abroad, there can be no
assurance that the Company will be successful in doing so or that the steps
taken by the Company in this regard will be adequate to deter infringement,
misuse, misappropriation or independent third-party development of the Company's
technology or intellectual property rights or to prevent an unauthorized third
party from copying or otherwise obtaining and using the Company's products or
technology. Any of such events could have a material adverse effect on the
Company's business, operating results and financial condition.
RISKS OF PRODUCT DEFECTS OR MISUSE
Products developed, licensed and sold by the Company may contain errors or
failures or may be improperly installed or implemented. There can be no
assurance that errors or failures will not be found in the Company's products or
that, if discovered, the Company will be able to successfully correct such
errors or failures in a timely manner or at all. In addition, there can be no
assurance that the Company's products will be properly installed or implemented
by third parties. The occurrence of errors or failures in the Company's products
and applications, or improper installation or implementation of the Company's
products, could result in loss of or delay in market acceptance, increased
service and warranty costs or payment of compensatory or other damages. In
addition, such errors or failures may result in delays of revenue recognition by
the Company and diversion of the Company's engineering resources to correct such
defects. The Company maintains errors and omissions insurance to cover liability
associated with its operations but there can be no assurance that any such
insurance will be available or will be sufficient in amount to cover any
particular claim. Although the Company's agreements with its customers typically
contain provisions intended to limit the Company's exposure to potential claims
as well as any liabilities arising from such claims, and may in very limited
instances require that the Company be named as an additional insured under the
insurance policies carried by some of its customers, such contracts and
insurance may not effectively protect the Company against the liabilities and
expenses associated with product errors or failures. Accordingly, errors or
failures in the Company's products or applications or improper installation or
implementation of the Company's products by third parties could have a material
adverse effect on the Company's business, operating results and financial
condition. In addition, because of the low cost and interoperable nature of the
Company's products, LonWorks technology could be used in a manner for which it
was not intended, which could lead to loss of goodwill or material financial
losses for the Company, or otherwise have a material adverse effect on the
Company's business, operating results and financial condition.
22
<PAGE>
REGULATORY ACTIONS
Many of the Company's 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 the Company's products. For example, the power
line medium (the communications medium used by some of the Company's 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 the Company's competitors have
attempted to use regulatory actions to reduce the market opportunity for the
Company's products or to increase the market opportunity for the competitors'
products. For example, CEMA, a trade association that developed the CEBus
protocol, an alternative to the Company's LonTalk protocol for use in home
automation applications, has proposed that the FCC adopt a standard for
television-cable compatibility that encompasses CEBus. CEMA has also proposed
the use of such standard with respect to an FCC rulemaking relating to the
commercial availability of navigation devices, such as set-top boxes. The
Company has resisted these efforts and will continue to oppose competitors'
efforts to use regulation to impede competition in the markets for the
Company's products. There can be no assurance that existing or future
regulations or regulatory actions would not adversely affect the market for
the Company's products or require significant expenditures of management,
technical or financial resources, any of which could have a material adverse
effect on the Company's business, operating results and financial condition.
VOLUNTARY STANDARDS
Standards bodies, which are formal and informal associations that attempt to
set voluntary, non-governmental product standards, are influential in many of
the Company's target markets. Some of the Company's competitors have attempted
to use voluntary standards to reduce the market opportunity for the Company's
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 the Company's products. The Company participates in many voluntary
standards processes both to avoid adoption of exclusionary standards and to
promote voluntary standards for the Company's products. However, the Company
does not have the resources to participate in all voluntary standards processes
that may affect its markets. The adoption of voluntary standards that are
incompatible with the Company's products or technology could have a material
adverse effect on the Company's business, operating results and financial
condition.
CONTROL BY EXISTING STOCKHOLDERS
As of February 28, 1999, the directors and executive officers of the Company,
together with certain entities affiliated with them, beneficially own 47.5% of
the Company's outstanding Common Stock and Motorola, a principal stockholder of
the Company, owns 12.0% of the Company's outstanding Common Stock. Further,
pursuant to the terms of the stock purchase agreement under which Motorola
initially acquired its shares, Motorola and two other stockholders which
combined with Motorola own approximately 16.0% of the Company's outstanding
Common Stock have agreed to vote (i) all of their 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 the Company's
charter, liquidations, a sale of the Company or a merger of the Company into
another entity), as recommended by a majority of the Board of Directors. As a
result, these stockholders would be able to control substantially all matters
requiring approval by the stockholders of their Company, including the
election of all directors and approval of significant corporate transactions.
23
<PAGE>
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Interest Rate Risk. Echelon's exposure to market risk for changes in
interest rates relate primarily to its investment portfolio. Echelon does not
use derivative financial instruments in its investment portfolio. All
investments are in high-credit quality issuances and, by policy, are limited in
the amount of credit exposure to any one issuer. Echelon ensures the safety and
preservation of the invested principal funds by investing in safe and high-
credit quality securities which includes only marketable securities with active
secondary or resale markets to ensure portfolio liquidity.
The table below presents principal amounts and related weighted average
interest rates for Echelon's investment portfolio at December 31, 1998. All
investments mature, by Company policy, in two years or less.
(in thousands, except average interest rates)
<TABLE>
<CAPTION>
Average
Carrying Interest
Amount Rate
Cash Equivalents: -------- --------
<S> <C> <C>
U.S. corporate securities..................................................................... $ 7,740 5.36 %
------- -----
Total cash equivalents................................................................... 7,740 5.36 %
------- -----
Short-term Investments:
U.S. corporate securities..................................................................... 16,503 5.60 %
Foreign securities............................................................................ 998 5.03 %
------- -----
Total short-term investments............................................................. 17,501 5.57 %
------- -----
Total investment securities.............................................................. $25,241 5.50 %
======= =====
</TABLE>
Foreign Currency Exchange Risk. Echelon transacts business in various
foreign countries. Its primary foreign currency cash flows are in Japan and
Western Europe. Currently, the Company does 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.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Financial Statements and Supplementary Data required by this item are set
forth at the pages indicated at Item 14(a).
ITEM 9. CHANGE IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
24
<PAGE>
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Reference is made to the information regarding Directors appearing under
the captions "Election of Directors" and "Other Information-Compliance with
Section 16(a) of the Securities Exchange Act of 1934" in the Company's proxy
statement to be filed with the Securities and Exchange Commission within 120
days after the end of the Company's fiscal year ended December 31, 1998, which
information is incorporated herein by reference; and to the information under
the heading "Executive Officers of the Registrant" in Part I hereof.
ITEM 11. EXECUTIVE COMPENSATION
The information appearing under the caption "Executive Compensation" in the
Company's proxy statement to be filed with the Securities and Exchange
Commission within 120 days after the end of the Company's fiscal year ended
December 31, 1998, is incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT
The information appearing under the caption "Share Ownership by Principal
Stockholders and Management" in the Company's proxy statement to be filed with
the Securities and Exchange Commission within 120 days after the end of the
Company's fiscal year ended December 31, 1998, is incorporated herein by
reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information appearing under the caption "Other Information-Certain
Transactions" in the Company's proxy statement to be filed with the Securities
and Exchange Commission within 120 days after the end of the Company's fiscal
year ended December 31, 1998, is incorporated by reference.
25
<PAGE>
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) The following documents are filed as part of this Form:
1. Financial Statements
<TABLE>
<CAPTION>
Page
------
<S> <C>
Report of Independent Public Accountants......................................................................... 28
Consolidated Balance Sheets...................................................................................... 29
Consolidated Statements of Operations............................................................................ 30
Consolidated Statements of Stockholders' Equity.................................................................. 31
Consolidated Statements of Cash Flows............................................................................ 32
Notes to Consolidated Financial Statements....................................................................... 33
</TABLE>
2. Financial Statement Schedules
<TABLE>
<S> <C>
Schedule II Valuation and Qualifying Accounts.................................................................... 42
</TABLE>
All other schedules have been omitted because they are not applicable or
the required information is included in the Consolidated Financial
Statements or Notes thereto.
3. Exhibits
<TABLE>
<CAPTION>
Exhibit
No. Description of Document
- -------------------- --------------------------------------------------------------------------------------------------------
<S> <C>
1.1* Form of Underwriting Agreement.
3.1* Amended and Restated Certificate of Incorporation of Registrant.
3.2* Amended and Restated Certificate of Incorporation of Registrant (to be effective upon closing of
Offering).
3.3* Amended and Restated Bylaws of Registrant.
4.1* Form of Registrant's Common Stock Certificate.
4.2* Second Amended and Restated Modification Agreement dated May 15, 1997.
5.1* Opinion of Wilson Sonsini Goodrich & Rosati P.C., regarding the legality of the securities being issued.
10.1* Form of Indemnification Agreement entered into by Registrant with each of its directors and executive
officers.
10.2* 1997 Stock Plan and forms of related agreements.
10.3* 1988 Stock Option Plan and forms of related agreements.
10.4* Second Amended and Restated Modification Agreement dated May 15, 1997 (included in Exhibit 4.2).
10.5* Form of International Distributor Agreement.
10.6* Form of OEM License Agreement.
10.7* Form of Software License Agreement.
10.8* International Distributor Agreement between the Company and EBV Elektronik GmbH as of
December 1, 1997.
10.9* 1998 Director Option Plan.
</TABLE>
26
<PAGE>
<TABLE>
<S> <C>
21.1* Subsidiaries of the Registrant.
23.1 Consent of Arthur Andersen LLP.
24.1 Power of Attorney (see page 43).
27.1 Financial Data Schedule (available in EDGAR format only).
</TABLE>
------------------------------------------
* Previously filed.
(b) Reports on Form 8-K
None.
27
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Echelon Corporation:
We have audited the accompanying consolidated balance sheets of Echelon
Corporation (a Delaware corporation) and subsidiaries as of December 31, 1998
and 1997, and the related consolidated statements of operations, stockholders'
equity and cash flows for each of the three years in the period ended December
31, 1998. These financial statements and the schedule referred to below are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Echelon Corporation and
subsidiaries as of December 31, 1998 and 1997, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1998 in conformity with generally accepted accounting principles.
Our audits were made for the purpose of forming an opinion on the basic
financial statements taken as a whole. The schedule listed under Item 14(a) is
presented for purposes of complying with the Securities and Exchange
Commission's rules and is not part of the basic financial statements. This
schedule has been subjected to the auditing procedures applied in our audits of
the basic financial statements and, in our opinion, fairly states in all
material respects the financial data required to be set forth therein in
relation to the basic financial statements taken as a whole.
ARTHUR ANDERSEN LLP
San Jose, California
January 18, 1999
28
<PAGE>
ECHELON CORPORATION
CONSOLIDATED BALANCE SHEETS
(in thousands, except share and per share amounts)
<TABLE>
<CAPTION>
As of December 31,
--------------------------------
1998 1997
-------------- ----------------
ASSETS
CURRENT ASSETS:
<S> <C> <C>
Cash and cash equivalents .................................... $ 11,552 $ 4,872
Short-term investments ....................................... 17,501 2,981
Accounts receivable, net of allowances of $1,182 and $562, 4,559 3,810
respectively .............................................
Inventories .................................................. 3,364 2,444
Other current assets ......................................... 2,170 1,196
-------- --------
Total current assets ...................................... 39,146 15,303
-------- --------
PROPERTY AND EQUIPMENT:
Computer and other equipment ................................. 8,665 6,816
Furniture and fixtures ....................................... 1,339 1,323
Leasehold improvements ....................................... 528 548
-------- --------
10,532 8,687
Less: Accumulated depreciation and amortization .............. (7,728) (7,174)
-------- --------
Net property and equipment ................................ 2,804 1,513
-------- --------
$ 41,950 $ 16,816
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable ............................................. $ 1,787 $ 2,081
Accrued liabilities .......................................... 2,067 1,988
Current portion of deferred revenues ......................... 1,559 2,351
-------- --------
Total current liabilities ................................. 5,413 6,420
-------- --------
LONG-TERM LIABILITIES:
Deferred rent, net of current portion ........................ 76 246
Deferred revenues, net of current portion .................... 675 1,350
-------- --------
Total long-term liabilities ............................... 751 1,596
-------- --------
STOCKHOLDERS' EQUITY:
Convertible preferred stock, $.01 par value:
Authorized--5,000,000 shares in 1998 and 11,000,000 shares
in 1997
Outstanding--(Series B, C, D and E), none in 1998 and
7,887,381 shares in 1997.................................. -- 79
Common stock, $.01 par value:
Authorized--100,000,000 shares in 1998 and 50,000,000
shares in 1997
Outstanding--32,542,859 and 18,832,430 shares in 1998 and
1997...................................................... 325 188
Additional paid-in capital ................................... 126,844 93,532
Cumulative translation adjustment ............................ (314) (351)
Deferred compensation ........................................ (597) --
Unrealized holding gain on available-for-sale securities ..... 27 --
Accumulated deficit .......................................... (90,499) (84,648)
-------- --------
Total stockholders' equity ................................ 35,786 8,800
-------- --------
$ 41,950 $ 16,816
======== ========
</TABLE>
The accompanying notes are an integral part of these consolidated balance
sheets.
29
<PAGE>
ECHELON CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
<TABLE>
<CAPTION>
For the Year Ended December 31,
---------------------------------------------
1998 1997 1996
-------------- -------------- -------------
REVENUES:
<S> <C> <C> <C>
Product ............................................. $29,163 $24,665 $ 20,708
Service ............................................. 3,038 3,637 3,282
------- ------- --------
Total revenues ..................................... 32,201 28,302 23,990
------- ------- --------
COST OF REVENUES:
Cost of product ..................................... 12,784 11,761 10,761
Cost of service ..................................... 1,836 1,810 1,142
------- ------- --------
Total cost of revenues ............................. 14,620 13,571 11,903
------- ------- --------
Gross profit ....................................... 17,581 14,731 12,087
------- ------- --------
OPERATING EXPENSES:
Product development ................................. 7,564 7,121 7,526
Sales and marketing ................................. 12,535 12,128 11,577
General and administrative .......................... 4,119 4,004 3,921
------- ------- --------
Total operating expenses ........................... 24,218 23,253 23,024
------- ------- --------
Loss from operations ............................... (6,637) (8,522) (10,937)
Interest and other income, net ...................... 945 497 373
------- ------- --------
Loss before provision for income taxes ............. (5,692) (8,025) (10,564)
PROVISION FOR INCOME TAXES ........................... 159 189 152
------- ------- --------
Net loss ............................................ $(5,851) $(8,214) $(10,716)
======= ======= ========
Basic net loss per share ............................ $(0.24) $(0.44) $(0.62)
======= ======= ========
Shares used in computing basic net loss per share .... 24,845 18,603 17,354
======= ======= ========
Pro forma basic net loss per share .................. $(0.20) $(0.32)
======= =======
Shares used in computing pro forma basic .............
net loss per share ................................. 29,405 25,756
======= =======
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
30
<PAGE>
ECHELON CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(in thousands)
<TABLE>
<CAPTION>
Convertible
Preferred Stock Common Stock Additional Cumulative
----------------------- ----------------------- Paid-In Translation
Shares Amount Shares Amount Capital Adjustment
------------ --------- ----------- ----------- ---------- -----------
<S> <C> <C> <C> <C> <C> <C>
BALANCE AT DECEMBER 31, 1995................... 5,887 $ 59 16,877 $169 $ 81,464 $ 4
Exercise of stock options...................... -- -- 630 6 514 --
Sale of common stock, net...................... -- -- 987 10 1,381 --
Comprehensive income (loss):
Net loss..................................... -- -- -- -- -- --
Other comprehensive loss:....................
Foreign currency translation adjustment.... -- -- -- -- -- (35)
Comprehensive income (loss)..................
------- ---- ------ ---- -------- -----
BALANCE AT DECEMBER 31, 1996................... 5,887 59 18,494 185 83,359 (31)
Exercise of stock options...................... -- -- 354 3 289 --
Repurchase of common stock, net................ -- -- (16) -- (16) --
Sale of Series E preferred stock............... 2,000 20 -- -- 9,900 --
Comprehensive income (loss):
Net loss..................................... -- -- -- -- -- --
Other comprehensive loss:....................
Foreign currency translation adjustment.... -- -- -- -- -- (320)
Comprehensive income (loss)..................
------- ---- ------ ---- -------- -----
BALANCE AT DECEMBER 31, 1997................... 7,887 79 18,832 188 93,532 (351)
Exercise of stock options, net of repurchases.. -- -- 824 8 860 --
Issuance of common stock in connection with
public offering, net of issuance costs of
$3,253....................................... -- -- 5,000 50 31,697 --
Conversion of preferred stock to common
stock........................................ (7,887) (79) 7,887 79 -- --
Deferred compensation.......................... -- -- -- -- 755 --
Amortization of deferred compensation............ -- -- -- -- -- --
Comprehensive income (loss):
Net loss....................................... -- -- -- -- -- --
Other comprehensive income:....................
Foreign currency translation adjustment...... -- -- -- -- -- 37
Unrealized holding gain on available-for-sale
securities................................. -- -- -- -- -- --
Comprehensive income (loss)....................
------- ---- ------ ---- -------- -----
BALANCE AT DECEMBER 31, 1998..................... $ -- $ -- 32,543 $325 $126,844 $(314)
======= ==== ====== ==== ======== =====
</TABLE>
<TABLE>
<CAPTION>
Unrealized
Holding
Gains on
Available- Comprehensive
Deferred for-Sale Income Accumulated
Compensation Securities (Loss) Deficit Total
-------------- ------------ ------------- ----------- ---------
<S> <C> <C> <C> <C> <C>
BALANCE AT DECEMBER 31, 1995................... $ -- $ -- $(65,718) $ 15,978
Exercise of stock options...................... -- -- -- 520
Sale of common stock, net...................... -- -- -- 1,391
Comprehensive income (loss):
Net loss..................................... -- -- $(10,716) (10,716) (10,716)
Other comprehensive loss:....................
Foreign currency translation adjustment.... -- -- (35) -- (35)
--------
Comprehensive income (loss).................. $(10,751)
----- --- -------- --------
BALANCE AT DECEMBER 31, 1996................... -- -- (76,434) 7,138
Exercise of stock options...................... -- -- -- 292
Repurchase of common stock, net................ -- -- -- (16)
Sale of Series E preferred stock............... -- -- -- 9,920
Comprehensive income (loss):
Net loss..................................... -- -- (8,214) (8,214) (8,214)
Other comprehensive loss:....................
Foreign currency translation adjustment.... -- -- (320) -- (320)
--------
Comprehensive income (loss).................. $ (8,534)
----- --- ======== -------- --------
BALANCE AT DECEMBER 31, 1997................... -- -- (84,648) 8,800
Exercise of stock options, net of repurchases.. -- -- -- 868
Issuance of common stock in connection with
public offering, net of issuance costs of
$3,253....................................... -- -- 31,747
Conversion of preferred stock to common
stock........................................ -- -- -- --
Deferred compensation........................ (755) -- -- --
Amortization of deferred compensation.......... 158 -- -- 158
Comprehensive income (loss):
Net loss..................................... -- -- (5,851) (5,851) (5,851)
Other comprehensive income:..................
Foreign currency translation adjustment.... -- -- 37 -- 37
Unrealized holding gain on available-for-sale
securities............................... -- 27 27 -- 27
--------
Comprehensive income (loss).................. $ (5,787)
----- --- ======== -------- --------
BALANCE AT DECEMBER 31, 1998................... $(597) $27 $(90,499) $ 35,786
===== === ======== ========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
31
<PAGE>
ECHELON CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
<TABLE>
<CAPTION>
For the Year Ended December 31,
--------------------------------------------
1998 1997 1996
------------- -------------- -------------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss...................................................... $ (5,851) $ (8,214) $(10,716)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization............................... 962 715 771
Deferred compensation expense............................... 158 -- --
Loss (gain) on disposal of fixed assets..................... 7 -- (13)
Change in operating assets and liabilities:
Accounts receivable....................................... (749) (579) 332
Inventories............................................... (920) (852) 319
Other current assets...................................... (974) 150 149
Accounts payable.......................................... (294) 281 (439)
Accrued liabilities....................................... 73 252 104
Deferred revenues......................................... (1,467) (1,177) 552
Deferred rent............................................. (137) (57) (69)
-------- -------- --------
Net cash used in operating activities................... (9,192) (9,481) (9,010)
-------- -------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of held-to-maturity short-term investments........... -- (10,740) (10,068)
Purchase of available-for-sale short-term investments......... (54,579) -- --
Proceeds from maturities of held-to-maturity short-term
investments................................................. 2,981 7,759 22,117
Proceeds from sales and maturities of available-for-sale
short-term investments...................................... 37,078 -- --
Capital expenditures.......................................... (2,263) (628) (872)
Proceeds from sale of fixed assets............................ 3 35 13
-------- -------- --------
Net cash provided by (used in) investing activities..... (16,780) (3,574) 11,190
-------- -------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of preferred and
common stock, net of offering costs......................... 32,615 10,196 1,911
-------- -------- --------
EFFECT OF EXCHANGE RATES ON CASH................................ 37 (320) (35)
-------- -------- --------
NET INCREASE (DECREASE) IN CASH AND
CASH EQUIVALENTS.............................................. 6,680 (3,179) 4,056
CASH AND CASH EQUIVALENTS:
Beginning of year............................................. 4,872 8,051 3,995
-------- -------- --------
End of year................................................... $ 11,552 $ 4,872 $ 8,051
======== ======== ========
SUPPLEMENTAL DISCLOSURES OF CASH
FLOW INFORMATION:
Cash paid for income taxes.................................... $ 196 $ 185 $ 123
======== ======== ========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
32
<PAGE>
ECHELON CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1998
1. ORGANIZATION OF THE COMPANY:
Echelon Corporation (the "Company") was incorporated in Delaware in January
1989. The Company develops, markets and supports a family of hardware and
software products and services that enable OEMs and systems integrators to
design and implement open, interoperable, distributed control networks. The
Company's products are based on its LonWorks networking technology, an open
standard for interoperable networked control developed by the Company. In a
LonWorks control network, intelligent control devices, called nodes, communicate
using the Company's LonTalk protocol. The Company sells its products and
services to the building, industrial, transportation, home and other automation
markets.
The Company emerged from the development stage during 1990. However, the
Company continues to be subject to the risks and challenges associated with
other companies in a comparable stage of development including among others:
history of losses; fluctuation in operating results; dependence on OEMs and
distribution channels; dependence on key manufacturers; competition; volatility
of stock price; dependence on key personnel; new products and rapid
technological change; market acceptance of interoperability; international
operations and currency fluctuations; lengthy sales cycle; limited protection of
intellectual property rights; risks of product defects or misuse; regulatory
actions; voluntary standards and control by existing stockholders.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
Principles of Consolidation
The Company's consolidated financial statements reflect operations of the
Company and its wholly owned subsidiaries. All significant intercompany
transactions and balances have been eliminated.
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 are 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. Revenue from software sales,
including sales to distributors, are recognized upon shipment of the software 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 training services are performed, or ratably over the term of
the support period.
During 1990, the Company entered into separate licensing agreements with
Motorola, Inc. ("Motorola") and Toshiba Corporation ("Toshiba") which expire in
January 2001 and January 2000, respectively, unless renewed. Motorola and
Toshiba have the right to terminate the agreement at any time. Motorola has
announced that it will discontinue distribution of Neuron Chips after January
31, 2001. Motorola is a significant stockholder and is also a related party to
the Company due to its representation on the Company's Board of Directors during
1998, part of 1997 and 1996. The agreements provide, among other things, for the
worldwide right to manufacture and distribute products subject to the licensed
technology and requires the Company to provide support and unspecified updates
to the licensed technology over the terms of the agreements, including support
relating to compatibility testing and qualification of updates to the licensed
technology. The agreements also provide for nonrefundable advance royalty
payments aggregating $6,750,000, which were received by the Company in 1990 and
1991. These payments are being recognized as revenue ratably over the ten-year
royalty period due to the ongoing obligation to provide support and unspecified
updates to the licensed technology. As of December 31, 1998, the Company has
deferred $1,350,000 (of which $675,000 is classified as a long-term liability)
of royalty payments that will be recognized in future periods. Any additional
royalties that are reported by Motorola or Toshiba are recognized as revenue
upon receipt of such royalties by the Company. Product revenues for the years
ended December 31, 1998, 1997 and 1996 each include $675,000 related to these
advance royalty payments. For the years ended December 31, 1998, 1997 and 1996,
Motorola accounted for approximately $282,000, $360,000 and $845,000 of total
revenues, respectively.
33
<PAGE>
Cash and Cash Equivalents
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.
Short-Term Investments
The Company classifies its investments in debt and equity securities as
available-for-sale in accordance with Statement of Financial Accounting
Standards No. 115, "Accounting for Certain Investments in Debt and Equity
Securities." Securities classified as available-for-sale are reported at fair
market value with the related unrealized holding gains and losses, net of tax,
being included in other comprehensive income (loss) in the accompanying
consolidated statement of stockholders' equity.
As of December 31, 1998, the Company's available-for-sale securities had
contractual maturities of from three to twenty months and an average maturity of
ten 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 December 31, 1998 the amortized cost basis, aggregate fair value and gross
unrealized holding gains and losses by major security type were as follows (in
thousands):
<TABLE>
<CAPTION>
Unrealized
Amortized Aggregate Holding Gain
Cost Fair Value (Loss)
---------- --------------- ------------
<S> <C> <C> <C>
U.S. corporate securities:
Commercial paper $ 5,160 $ 5,160 $ --
Certificates of deposit 2,001 2,001 --
Corporate notes and bonds 9,315 9,342 27
------- ------- --
16,476 16,503 27
Foreign securities 998 998 --
------- ------- ------
Total investments in debt and equity
securities $17,474 $17,501 $ 27
======= ======= ======
</TABLE>
At December 31, 1997, short-term investments consisted of U.S. government
securities with original maturities of approximately five months. These short-
term investments were classified as held-to-maturity and were valued using the
amortized cost method, which approximated the fair market value.
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):
<TABLE>
<CAPTION>
December 31,
----------------------------------------
1998 1997
------------------- -------------------
<S> <C> <C>
Purchased materials............ $1,671 $1,791
Work-in-process.............. -- 130
Finished goods............... 1,693 523
------ ------
$3,364 $2,444
====== ======
</TABLE>
Property and Equipment
Property and equipment are stated at cost. Depreciation is provided using the
straight-line method over the estimated useful lives of two to five years for
computer and other equipment and furniture and fixtures. Leasehold improvements
are amortized over the shorter of the remaining lease term or the estimated
useful life of the improvements using the straight-line method.
Software Development Costs
The Company capitalizes eligible computer software development costs upon the
establishment of technological feasibility, which the Company has defined as
completion of a working model. For the years ended December 31, 1998, 1997 and
1996, costs that were eligible for capitalization were insignificant and, thus,
the Company has charged all software development costs to product development
expense in the accompanying consolidated statements of operations.
34
<PAGE>
Accrued Liabilities
Accrued liabilities consisted of the following (in thousands):
<TABLE>
<CAPTION>
December 31,
----------------------------------
1998 1997
---------------- ----------------
<S> <C> <C>
Accrued payroll and related costs.......... $1,008 $1,081
Accrued marketing costs.................... 354 334
Other accrued liabilities.................. 705 573
------ ------
$2,067 $1,988
====== ======
</TABLE>
Foreign Currency Translation
The functional currency of the Company's subsidiaries is the local currency.
Accordingly, all assets and liabilities are translated into U.S. dollars at the
current exchange rate as of the applicable balance sheet date. Revenues and
expenses are translated at the average exchange rate prevailing during the
period. Gains and losses resulting from the translation of the financial
statements are included in other comprehensive income (loss) in the accompanying
consolidated statement of stockholders' equity. Currently, the Company does 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.
Concentrations of Credit Risk
Financial instruments which potentially subject the Company to concentrations
of credit risk consist principally of temporary cash investments and trade
receivables. The Company has cash investment policies that limit the amount of
credit exposure to any one financial institution and restrict placement of these
investments to financial institutions evaluated as highly creditworthy.
Concentrations of credit risk with respect to trade receivables are limited due
to the large number of customers comprising the Company's customer base and
their dispersion across many different industries and geographies. With respect
to trade receivables, the Company performs ongoing credit evaluations of its
customers' financial condition. Additionally, the Company establishes an
allowance for doubtful accounts based upon factors surrounding the credit risk
of specific customers, historical trends and other available information. No
single accounts receivable balance was greater than 10% as of December 31, 1998
and 1997, respectively.
Computation of Basic Net Loss Per Share and Pro Forma Basic Net Loss Per Share
Historical net loss per share has been calculated under Statement of Financial
Accounting Standards (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 the
conversion of preferred stock, stock options and warrants are antidilutive. The
Company evaluated the requirements of the Securities and Exchange Commission
Staff Accounting Bulletin No. 98 ("SAB 98"), and concluded that there are no
nominal issuances of common stock or potential common stock which would be
required to be shown as outstanding for all periods as outlined in SAB 98.
Pro forma basic net loss per share has been calculated assuming the conversion
of the outstanding preferred stock into an equivalent number of shares of common
stock, as if the shares had been converted on the dates of their issuance.
New Accounting Pronouncements
In March 1998, the AICPA issued SOP 98-1, "Accounting for the Costs of
Computer Software Developed or Obtained for Internal Use". SOP 98-1 is effective
for the Company's fiscal year beginning January 1, 1999 and provides guidance on
the capitalization of software for internal use. Management believes the
adoption of SOP 98-1 will not have a material effect on the Company's financial
statements.
In April 1998, the AICPA issued SOP 98-5 "Reporting the Costs of Start-up
Activities". SOP 98-5 is effective for the Company's fiscal year beginning
January 1, 1999. SOP 98-5 provides guidance on the financial reporting of
start-up costs and organization costs and requires such costs to be expensed as
incurred. Management believes the adoption of SOP 98-5 will not have a material
effect on the Company's financial statements.
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
derivative portion of certain other contracts. SFAS No. 133 will become
effective for the Company's year beginning January 1, 2000. Management believes
that SFAS No. 133 will not have a material effect on the Company's financial
statements.
35
<PAGE>
3. SEGMENT DISCLOSURE:
In 1998, the Company adopted SFAS 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 131 also
requires disclosures about products and services, geographic areas and major
customers. The adoption of SFAS 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 control 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 the LonTalk 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 approximately 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 segments primarily on a geographic basis.
The Company's reportable segments are comprised of the Americas, Europe, Middle
East and Africa ("EMEA") and Asia Pacific/ Japan. Each geographic segment
provides products and services as further described in Note 1. The Company
evaluates the performance of its geographic segments based on profit or loss
from operations. Profit or loss for each geographic segment includes sales and
marketing expenses and other charges directly attributable to the segment and
excludes certain expenses which are managed outside the reportable segments.
Costs excluded from segment 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 December 31, 1998 and 1997, long-
lived assets of approximately $2.4 million and $1.2 million were domiciled in
the United States. Long-lived assets for all other locations is not material to
the consolidated financial statements. Assets and the related depreciation and
amortization are not being reported by segment because the information is not
reviewed by the Executive Staff to make decisions about resources to be
allocated to the segments based on their performance.
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 segment for the
years ended December 31, 1998, 1997 and 1996 is as follows (in thousands):
<TABLE>
<CAPTION>
Year Ended December 31,
------------------------------------------------------------
1998 1997 1996
---------------------- ------------------ -----------------
<S> <C> <C> <C>
Revenues from customers:
Americas....................... $ 13,447 $ 11,219 $ 10,354
EMEA........................... 13,484 12,226 9,100
APJ............................ 4,338 3,758 3,751
Unallocated.................... 932 1,099 785
-------- -------- --------
Total..................... $ 32,201 $ 28,302 $ 23,990
======== ======== ========
Gross profit (loss):
Americas....................... $ 8,377 $ 7,020 $ 6,204
EMEA........................... 6,467 6,034 4,822
APJ............................ 2,721 2,519 2,536
Unallocated.................... 16 (842) (1,475)
-------- -------- --------
Total..................... $ 17,581 $ 14,731 $ 12,087
======== ======== ========
Income (loss) from operations:
Americas....................... $ 5,085 $ 3,560 $ 2,854
EMEA........................... 3,496 2,835 1,046
APJ............................ 329 620 585
Unallocated.................... (15,547) (15,537) (15,422)
-------- -------- --------
Total..................... $ (6,637) $ (8,522) $(10,937)
======== ======== ========
</TABLE>
One customer, the sole independent distributor of the Company's products in
Europe since December 1997, accounted for 22.6% and 10.9% of total revenues for
the years ended December 31, 1998 and 1997, respectively. No single customer
accounted for 10% or more of total revenues for the year ended December 31,
1996.
36
<PAGE>
4. COMMITMENTS:
The Company leases its facilities under operating leases which expire on
various dates through 2003. As of December 31, 1998, future minimum lease
payments under such agreements were as follows (in thousands):
1999...................................... $1,629
2000...................................... 840
2001...................................... 70
2002...................................... 70
2003...................................... 35
------
$2,644
======
Rent expense for the years ended December 31, 1998, 1997 and 1996 was
approximately $1,802,000, $1,818,000 and $1,768,000, respectively. Certain lease
agreements provide for escalating rent payments over the term of the lease. Rent
expense under these agreements is recognized on a straight-line basis. As of
December 31, 1998 and 1997, the Company has accrued approximately $246,000 and
$383,000, respectively, of deferred rent related to these agreements of which
$170,000 and $137,000 is included in accrued liabilities as of December 31, 1998
and 1997, respectively, in the accompanying consolidated balance sheets.
5. STOCKHOLDERS' EQUITY:
Preferred Stock
With the closing of the Company's initial public offering ("IPO") in July
1998, all of the outstanding preferred stock automatically converted into
7,887,381 shares of common stock. Upon conversion of the outstanding preferred
stock to common stock, such preferred stock was retired. As of December 31,
1998, the Company was authorized to issue 5,000,000 shares of new $0.01 par
value preferred stock, of which none was outstanding as of December 31, 1998.
Common Stock
Upon completion of the Company's IPO, the Company was authorized to issue
100,000,000 shares of $.01 par value common stock. During 1998, 1997 and 1996,
the Company sold 4,000, 5,000 and 1,005,000 shares of common stock,
respectively, at the fair value, as determined by the Board of Directors of
$2.00 per share during 1998, $1.40 per share during 1997 and $1.29 per share to
$1.40 per share during 1996 under stock purchase agreements, primarily to
certain officers of the Company. The stock purchased under these agreements
vests annually over four years. As of December 31, 1998, 742,500 shares of
common stock issued and outstanding under these stock purchase agreements and
previous stock purchase agreements were unvested and subject to repurchase by
the Company, at the Company's discretion, at prices ranging from $1.10 to $1.40
per share and a weighted average price of $1.31 per share.
Warrants
In connection with the issuance of the Series D preferred stock in 1994, the
Company granted certain investment bankers warrants to purchase 30,000 shares of
the Company's common stock at $12.00 per share. These warrants expired on
February 2, 1999.
In addition, in connection with the issuance of the Series E preferred stock
in 1997, warrants to purchase an aggregate of 400,000 shares of common stock at
a per share exercise price of $5.00 were issued (the "Series E Warrants" and
together with the Common Stock Warrants, the "Warrants"). The Series E Warrants
are exercisable at any time until their expiration on the earlier of May 15,
2002 or a Change in Control. Each Warrant contains a cashless conversion right
that allows the holder to receive a number of shares of the Company's common
stock equal to the quotient obtained by dividing the value of the Warrant on the
date of exercise, which value is determined by subtracting (i) the aggregate
exercise price of the Warrant from (ii) the aggregate fair market value of the
Warrant shares on the date of exercise, by the fair market value of one share of
the Company's common stock on the date of exercise, as determined by the market
price generally determined with reference to the closing price of the common
stock as reported on the Nasdaq National Market. As of December 31, 1998, these
Series E Warrants are exercisable but no warrants had been exercised. At the
date of issuance, the fair market value of these Warrants was deemed to be
immaterial.
1988 Stock Option
During 1988, the Company adopted the 1988 Stock Option Plan (the "1988 Plan")
for key employees, officers and directors. The Company has reserved 8,900,000
shares under the 1988 Plan. Incentive stock options to purchase shares of common
stock were granted at not less than 100% of the fair market and generally have a
term of five years from the date of grant, not to exceed ten years. The 1988
Plan also provides for holders of non-qualified stock options to purchase shares
at not less than 85% of the fair market value. Options generally vest ratably
over four years. Fair market value for these grants was determined by the Board
of Directors prior to the stock becoming available on a public market.
37
<PAGE>
The 1988 Plan also allows for the issuance of options which are immediately
exercisable through execution of a restricted stock purchase agreement. Shares
purchased pursuant to a stock purchase agreement generally vest over four years.
In the event of termination of employment, the Company, at its discretion, may
repurchase unvested shares at a price equal to the original issue price. Options
granted under the 1988 Plan will remain outstanding in accordance with their
original terms. However, effective April 1997, the Board of Directors determined
that no further options will be granted under the 1988 Plan.
1997 Stock Plan
During 1997, the Company adopted the 1997 Stock Plan (the "1997 Plan") for key
employees, officers and directors. A total of 6,200,000 shares of Common Stock
are currently reserved for issuance pursuant to the 1997 Plan, plus annual
increases on the first day of the Company's fiscal year (beginning in 1999)
not to exceed the lesser of (i) 5,000,000 shares or (ii) 5% of the outstanding
shares on such date. Incentive stock options to purchase shares of common
stock may be granted at not less than 100% of the fair market value and
generally have a term of five years from the date of grant, not to exceed ten
years. The exercise price of nonstatutory stock options and SPRs granted
under the 1997 Plan is determined by the Administrator, but will also be at
least equal to 100% of the fair market value per share of Common Stock on the
grant or issue date, except that up to 10% of the aggregate number of shares
reserved for issuance under the 1997 Plan (including shares that have been
issued or are issuable in connection with options exercised or granted under
the 1997 Plan) may have exercise prices that are from 0% to 100% of the fair
market value of the Common Stock on the date of grant. Options generally vest
ratably over four years. Fair market value is determined with reference to the
closing price of the common stock as reported on the Nasdaq National Market on
the date immediately preceding grant date.
The 1997 Plan also allows for the issuance of options which are immediately
exercisable through execution of a restricted stock purchase agreement. Shares
purchased pursuant to a stock purchase agreement generally vest annually over
four years. In the event of termination of employment, the Company, at its
discretion, may repurchase unvested shares at a price equal to the original
issuance price. As of December 31, 1998, 335,250 shares of common stock issued
and outstanding under these restricted stock purchase agreements and previous
stock purchase agreements were unvested and subject to repurchase by the
Company, at the Company's discretion, at prices ranging from $1.00 to $5.00 per
share and a weighted average price of $1.47 per share.
1998 Directors Option Plan
Non-employee directors are entitled to participate in the 1998 Director Option
Plan (the "Director Plan"). The Director Plan was adopted by the Board of
Directors in May 1998 and became effective upon the closing of the stock
offering in July 1998. The Director Plan has a term of ten years, unless
terminated sooner by the Board. A total of 300,000 shares of Common Stock have
been reserved for issuance under the Director Plan, plus an increase each year
equal to 100,000 shares or such lesser amount as the Board may determine. The
Director Plan provides for the automatic grant of 25,000 shares of common stock
(the "First Option") to each non-employee director on the date he or she first
becomes a director. Each non-employee director shall also automatically be
granted an option to purchase 10,000 shares (a "Subsequent Option") on the date
of the Company's Annual Stockholder Meeting provided that he or she is re-
elected to the Board or otherwise remains on the Board, if on such date he or
shall have served on the Board for at least the preceding six months. Each First
Option and each Subsequent Option shall have a term of five years and the shares
subject to the option shall vest as to 25% of the shares subject to option on
each anniversary of the date of grant. The exercise price of each First Option
and Subsequent Option shall be 100% of the fair market value per share of the
common stock, generally determined with reference to the closing price of the
common stock as reported on the Nasdaq National Market on the date preceding
grant date. During 1998, options to purchase an aggregate of 60,000 shares were
granted under the Director Plan, with an exercise price equal to $7.00 per
share.
In the event of a merger of the Company with or into another corporation or
the sale of substantially all of the assets of the Company, each option shall be
assumed or an equivalent option may be substituted by the successor corporation.
Following such assumption or substitution, if the optionee's status as a
director of the successor corporation terminates other than upon a voluntary
resignation by the optionee, the option shall become fully exercisable,
including as to shares as to which it would not otherwise be exercisable. If the
outstanding options are not assumed or substituted, the options shall become
fully vested and exercisable. Options granted under the Director Plan must be
exercised within three months of the end of the optionee's tenure as a director
of the Company, or within twelve months after such director's termination by
death or disability, but in no event later than the expiration of the option's
five year term; provided, however, that shares subject to an option granted to a
director who has served as a director with the Company for at least five years
shall become fully vested and exercisable for the remainder of the option's five
year term upon such director's termination. No option granted under the Director
Plan is transferable by the optionee other than by will or the laws of descent
and distribution, and each option is exercisable, during the lifetime of the
optionee, only by such optionee.
38
<PAGE>
The following table summarizes option activity under all plans (prices are
weighted average prices):
<TABLE>
<CAPTION>
Year Ended December 31,
----------------------------------------------------------
1998 1997 1996
------------------ ------------------ ------------------
Shares Price Shares Price Shares Price
---------- ------ ---------- ------ ---------- ------
<S> <C> <C> <C> <C> <C> <C>
Options outstanding,
Beginning of year............... 4,316,432 $1.28 2,851,514 $1.14 1,993,876 $0.84
Granted....................... 1,707,450 5.07 2,185,700 1.40 1,618,700 1.38
Cancelled..................... (613,413) 5.51 (386,626) 1.29 (130,938) 1.07
Exercised..................... (824,915) 1.19 (354,156) 0.83 (630,124) 0.83
--------- ----- --------- ----- --------- -----
Options outstanding,
end of year..................... 4,585,554 $2.18 4,316,432 $1.28 2,851,514 $1.14
========= ===== ========= ===== ========= =====
Exercisable, end of year............ 3,891,704 $2.03 4,280,307 $1.29 2,754,149 $1.16
========= ===== ========= ===== ========= =====
</TABLE>
Certain options issued under the 1988 and 1997 Plans may be exercised any time
prior to their expiration. In addition, the Company has the right, upon
termination of an option holder's employment or service with the Company, at its
discretion, to repurchase any unvested shares issued under the 1988 and 1997
Plans at the original purchase price. As of December 31, 1998, 335,250 shares
were subject to repurchase by the Company at prices ranging from $1.00 to $5.00
per share and a weighted average repurchase price of $1.47. Of the 3,891,704
options exercisable as of December 31, 1998, 1,361,858 were vested.
On December 14, 1998, the Board of Directors authorized the repricing of
393,350 options to purchase the Company's common stock at $3.125 price per share
(the fair market value as reported on the Nasdaq National Market on the date
immediately preceding the authorized date) that were previously priced at $7.00
per share. The Board action excluded options granted to all the officers and
directors of the Company.
In connection with the issuance of stock options during 1998, the Company has
recorded deferred compensation in the aggregate amount of approximately
$755,000, representing the difference between the deemed fair value of the
Company's common stock and the exercise price of the stock options at the date
of grant. The Company is amortizing the deferred compensation expense over the
shorter of the period in which the employee provides services or the applicable
vesting period, which is typically 48 months. For the year ended December 31,
1998, amortization expense was approximately $158,000. Deferred compensation is
decreased in the period of forfeiture arising from the early termination of an
option holder's services.
39
<PAGE>
The Company accounts for the Plans under APB Opinion No. 25, "Accounting for
Stock Issued to Employees." Had compensation expense for the Plans been
determined consistent with SFAS No. 123, "Accounting for Stock-Based
Compensation," the Company's net loss and basic net loss per share would have
been increased to the following pro forma amounts (in thousands, except per
share amounts):
<TABLE>
<CAPTION>
Year Ended December 31,
-----------------------------------------------------------
1998 1997 1996
------------------- -------------------- ----------------
<S> <C> <C> <C>
Net loss:
As reported................................. $(5,851) $(8,214) $(10,716)
Pro forma................................... (6,636) (8,626) (10,992)
Basic net loss per share:
As reported................................. $ (0.24) $ (0.44) $ (0.62)
Pro forma................................... (0.27) (0.46) (0.63)
</TABLE>
The weighted-average grant date fair value of options granted during 1998,
1997 and 1996 was $0.87, $0.19 and $0.17, respectively. The fair value of each
option grant is estimated on the date of grant using the minimum value method
and the Black-Scholes option pricing model with the following weighted average
assumptions used for grants in 1998, 1997 and 1996: risk-free interest rates of
5.15%, 5.60% and 6.10%, respectively; expected dividend yields of zero percent;
expected lives of 4 years. The expected volatility for 1998 was calculated at
70%. Because the Company was a non-public entity in 1996 and 1997, it has
omitted expected volatility in determining a value for its options during those
years.
The following table summarizes the stock options outstanding as of December
31, 1998:
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
- -------------------------------------------------------- ----------------------
Weighted
Number Average Weighted Number Weighted
Outstanding at Remaining Average Exercisable Average
Exercise December 31, Life Exercise December 31, Exercise
Price Range 1998 (in years) Price 1998 Price
- ------------------ -------------- ---------- -------- ------------ --------
<S> <C> <C> <C> <C> <C>
$0.15 22,500 0.64 $0.15 22,500 $0.15
0.77-1.29 750,766 1.44 1.08 750,766 1.08
1.40-2.00 2,832,188 3.17 1.45 2,606,188 1.40
2.63-3.88 453,850 4.54 3.10 36,500 2.95
5.00-7.00 526,250 4.49 6.93 475,750 6.99
--------- ---- ----- --------- -----
4,585,554 3.16 $2.18 3,891,704 $2.03
========= ==== ===== ========= =====
</TABLE>
Shares Reserved
As of December 31, 1998, the Company had shares of common stock reserved for
future issuance as follows:
<TABLE>
<CAPTION>
<S> <C>
Stock Option Plans............................................. 7,843,854
Warrants to Purchase Common Stock.............................. 430,000
---------
8,273,854
=========
</TABLE>
6. INCOME TAXES:
The Company accounts for income taxes using SFAS No. 109, "Accounting for
Income Taxes". SFAS No. 109 provides for an asset and liability approach under
which deferred income taxes are based upon enacted tax laws and rates applicable
to the periods in which the taxes become payable.
Income taxes for the years ended December 31, 1998, 1997 and 1996 primarily
consist of taxes related to foreign subsidiaries.
40
<PAGE>
The components of the net deferred income tax asset are as follows (in
thousands):
<TABLE>
<CAPTION>
December 31,
1998 1997
--------------- -------------
<S> <C> <C>
Net operating loss carryforwards................................... $ 28,333 $ 26,315
Deferred revenue................................................... 601 940
Tax credit carryforwards........................................... 4,063 3,537
Capitalized research and development costs......................... 1,678 1,852
Reserves and other cumulative temporary differences................ 1,379 906
-------- --------
36,054 33,550
Valuation allowance................................................ (36,054) (33,550)
-------- --------
Net deferred income tax asset...................................... $ -- $ --
======== ========
</TABLE>
As of December 31, 1998, the Company had net operating loss carryforwards for
Federal and state income tax reporting purposes of approximately $80.1 million
and $5.0 million, respectively, which expire at various dates through 2018. In
addition, as of December 31, 1998, the Company had tax credit carryforwards of
approximately $4.1 million, which expire at various dates through 2018. The
Internal Revenue Code of 1986, as amended, contains provisions that may limit
the net operating loss and credit carryforwards available for use in any given
period upon the occurrence of certain events, including a significant change in
ownership interests, such as the IPO completed in July 1998.
A valuation allowance has been recorded for the entire deferred tax asset as a
result of uncertainties regarding the realization of the asset balance due to
the history of losses and the variability of operating results. As of December
31, 1998 and 1997, the Company had no significant deferred tax liabilities.
41
<PAGE>
SCHEDULE II
ECHELON CORPORATION
VALUATION AND QUALIFYING ACCOUNTS
(in thousands)
<TABLE>
<CAPTION>
ALLOWANCE FOR DOUBTFUL ACCOUNTS AND SALES ALLOWANCES
- ----------------------------------------------------
Charged to
Beginning Revenues and Ending
Description Balance Expenses Deductions Balance
- -------------------------------------------------------- -------------------- --------------- ------------- ----------------
<S> <C> <C> <C> <C>
Year ended December 31, 1996: $478 $341 $ -- $ 819
Year ended December 31, 1997: 819 35 292 562
Year ended December 31, 1998: $562 620 -- $1,182
</TABLE>
42
<PAGE>
SIGNATURES
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
By: /s/ Oliver R. Stanfield
-------------------------------------
Oliver R. Stanfield
Vice President Finance, and Chief
Financial Officer (Duly Authorize
Officer and Principal Financial and
Accounting Officer)
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears
below constitutes and appoints M. Kenneth Oshman and Oliver R. Stanfield his
true and lawful attorney-in-fact and agent, with full power of substitution and,
for him and in his name, place and stead, in any and all capacities to sign any
and all amendments to this Report on Form 10-K, and to file the same, with all
exhibits thereto and other documents in connection therewith, with the
Securities and Exchange Commission, granting unto said attorney-in-fact and
agent full power and authority to do and perform each and every act and thing
requisite and necessary to be done in connection therewith, as fully to all
intents and purposes as he might or could do in person, hereby ratifying and
confirming all that said attorney-in-fact and agent, or his substitute or
substitutes, may lawfully do or cause to be done by virtue hereof.
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, THIS
REPORT HAS BEEN SIGNED BY THE FOLLOWING PERSONS ON BEHALF OF THE REGISTRANT AND
IN THE CAPACITIES AND ON THE DATES INDICATED.
<TABLE>
<CAPTION>
Signatures Title Date
---------- ----- ----
<S> <C> <C>
/s/ M. Kenneth Oshman Chairman of the Board, March 29, 1999
- -------------------------------------- President and Chief
M. Kenneth Oshman Executive Officer
(Principal Executive
Officer)
/s/ Oliver R. Stanfield Vice President of Finance March 29, 1999
- -------------------------------------- and Chief Financial
Oliver R. Stanfield Officer (Principal
Financial and Principal Accounting
Officer)
/s/ Armas Clifford Markkula, Jr. Vice Chairman March 29, 1999
- --------------------------------------
Armas Clifford Markkula, Jr.
/s/ Bertrand Cambou Director March 29, 1999
- --------------------------------------
Bertrand Cambou
/s/ Robert R. Maxfield Director March 29, 1999
- --------------------------------------
Robert R. Maxfield
/s/ Richard M. Moley Director March 29, 1999
- --------------------------------------
Richard M. Moley
/s/ Arthur Rock Director March 26, 1999
- --------------------------------------
Arthur Rock
/s/ Larry W. Sonsini Director March 29, 1999
- --------------------------------------
Larry W. Sonsini
</TABLE>
43
<PAGE>
EXHIBIT 23.1
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the incorporation of
our report included in this Form 10-K into the Company's previously filed
Registration Statement No. 333-62045 on Form S-8.
ARTHUR ANDERSEN LLP
San Jose, California
March 29, 1999
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> DEC-31-1998
<CASH> 11,552
<SECURITIES> 17,501
<RECEIVABLES> 5,741
<ALLOWANCES> (1,182)
<INVENTORY> 3,364
<CURRENT-ASSETS> 39,146
<PP&E> 10,532
<DEPRECIATION> (7,728)
<TOTAL-ASSETS> 41,950
<CURRENT-LIABILITIES> 5,413
<BONDS> 0
0
0
<COMMON> 325
<OTHER-SE> 35,461
<TOTAL-LIABILITY-AND-EQUITY> 41,950
<SALES> 29,163
<TOTAL-REVENUES> 32,201
<CGS> 12,784
<TOTAL-COSTS> 14,620
<OTHER-EXPENSES> 23,938
<LOSS-PROVISION> 280
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> (5,692)
<INCOME-TAX> 159
<INCOME-CONTINUING> (5,851)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (5,851)
<EPS-PRIMARY> (0.24)
<EPS-DILUTED> 0
</TABLE>
