Summary of Significant Accounting Policies

6 Months Ended

Jun. 30, 2018

Summary of Significant Accounting Policies [Abstract]

Summary of Significant Accounting Policies

Significant Accounting Policies

Proposed Merger with Adesto Technologies Corporation

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

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

Completion of the Merger is subject to certain conditions, including the receipt of the necessary approval from the Company’s stockholders and other customary closing conditions. The parties expect to close the Merger during the third quarter of 2018. For the three and six months ended June 30, 2018, the Company incurred costs of $906,000 and $1.3 million, respectively, related to the Merger Agreement, which are currently included in the “General and administrative expenses” line on the Condensed Consolidated Statement of Operations.

Basis of Presentation

The condensed consolidated financial statements include the accounts of Echelon Corporation, a Delaware corporation, its wholly-owned subsidiaries, and a subsidiary in which it has a controlling interest (collectively referred to as the “Company”). The Company reports non-controlling interests in consolidated entities as a component of equity separate from the Company’s equity. All material inter-company transactions between and among the Company and its consolidated subsidiaries and other consolidated entities have been eliminated in consolidation.

While the financial information furnished is unaudited, the condensed consolidated financial statements included in this report reflect all adjustments (consisting only of normal recurring adjustments) which the Company considers necessary for the fair presentation of the results of operations for the interim periods covered, and of the financial condition of the Company at the date of the interim balance sheet. The results for interim periods are not necessarily indicative of the results for the entire year. The condensed consolidated financial statements should be read in conjunction with the Company’s consolidated financial statements for the year ended December 31, 2017 included in its Annual Report on Form 10‑K.

Apart from the Company's adoption of new revenue recognition guidance discussed more fully below, there have been no material changes to the Company’s significant accounting policies as compared to the significant accounting policies described in its Annual Report on Form 10‑K for the fiscal year ended December 31, 2017.

Risks and Uncertainties

The Company’s operations and performance depend significantly on worldwide economic conditions and their impact on purchases of the Company’s products, as well as the ability of suppliers to provide the Company with products and services in a timely manner. The impact of any of the matters described below could have an adverse effect on the Company’s business, results of operations and financial condition.

•

The Company’s sales are currently concentrated, as approximately 38.2% of revenues for the six months ended June 30, 2018, were derived from two customers, Avnet Europe Comm VA ("Avnet"), the Company's primary distributor of its IIoT products in Europe and Japan; and Engenuity Systems, Inc., a reseller of the Company's products focused primarily in the United States. Customers in any of the Company’s target market sectors may experience unexpected reductions in demand for their products and consequently reduce their purchases from the Company, resulting in either the loss of a significant customer or a notable decrease in the level of sales to a significant customer. In addition, if any of these customers are unable to obtain the necessary capital to operate their business, they may be unable to satisfy their payment obligations to the Company.


•	The Company utilizes third-party contract electronic manufacturers to manufacture, assemble, and test its products. If any of these third-parties were unable to obtain the necessary capital to operate their business, they may be unable to provide the Company with timely services or to make timely deliveries of products.

•

From time to time, the Company has experienced shortages or interruptions in supply for certain products or components used in the manufacture of the Company’s products that have been or will be discontinued. In order to ensure an adequate supply of these items, the Company has occasionally purchased quantities of these items that are in excess of the Company’s then current estimate of short-term requirements. If the long-term requirements do not materialize as originally expected, or if the Company develops alternative solutions that no longer employ these items and the Company is not able to dispose of these excess products or components, the Company could be subject to increased levels of excess and obsolete inventories.


•	In an effort to manage costs and inventory risks, the Company has decreased the inventory levels of certain products. If there is an unexpected increase in demand for these items, the Company might not be able to supply its customers with products in a timely manner.

•

Due to the nature of development efforts in general, the Company can experience delays in the introduction of new or improved products beyond its original projected shipping date for such products. These delays can result in increased development costs and delays in the ability to generate revenues from these new products. Furthermore, when such new products are developed, there is no guarantee that they will meet customer requirements or will otherwise be acceptable to them, which could cause them to discontinue buying these products. This could have a material adverse effect on the Company's revenues and results of operations.

Use of Estimates

The preparation of financial statements and related disclosures in conformity with accounting principles generally accepted in the United States of America requires management to make judgments, assumptions, and estimates that affect amounts reported in the Condensed Consolidated Financial Statements and accompanying notes. Significant estimates and judgments are used for revenue recognition, performance-based equity compensation, inventory valuation, intangible asset valuation, contingent consideration valuation, allowance for warranty costs, and other loss contingencies. In order to determine the carrying values of assets and liabilities that are not readily apparent from other sources, the Company bases its estimates and assumptions on current facts, historical experience, and various other factors that it believes to be reasonable under the circumstances. Actual results experienced by the Company may differ materially from management’s estimates.

Recently Issued Accounting Standards

(i) New Accounting Standards Recently Adopted

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

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

Adoption of the standard using the full retrospective method required the Company to restate certain previously reported results. In summary, adoption of the standard resulted in the recognition of modestly higher revenues for the three and six months ended June 30, 2017. In addition, as of December 31, 2017, adoption of the standard resulted in a reduction of deferred revenues driven by the recognition of revenues associated with on-hand distributor inventory as of that date, the revenue for which was deferred under previous guidance; a decrease of deferred cost of goods sold, again driven by the recognition of revenue that was deferred under previous guidance; and a decrease in accounts receivable, driven by the incremental reserves required for estimated price adjustments that will be issued to the distributors in the future based on the additional revenue recognized under the new guidance. Adoption of the standard impacted our previously reported results as follows (in thousands, except earnings per share amounts):



	Three Months Ended June 30, 2017
	As Reported			New Revenue Standard Adjustment		As Adjusted
Statement of Operations:
Revenue	$	8,021		$	316	$	8,337
Net loss	(1,370		)	193		(1,177		)
Basic and diluted loss per share	$	(0.31	)	$	0.05	$	(0.26	)



	Six Months Ended June 30, 2017
	As Reported			New Revenue Standard Adjustment		As Adjusted
Statement of Operations:
Revenue	$	15,820		$	220	$	16,040
Net loss	(2,569		)	131		(2,438		)
Basic and diluted loss per share	$	(0.58	)	$	0.03	$	(0.55	)



	December 31, 2017
	As Reported		New Revenue Standard Adjustment			As Adjusted
Balance Sheets:
Accounts receivable, net	$	2,721	$	(425	)	$	2,296
Deferred cost of goods sold	1,767		(728		)	1,039
Deferred revenues	4,805		(2,993		)	1,812
Stockholders' equity	21,887		1,840			23,727

(ii) New Accounting Standards Not Yet Effective

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

Revenue Recognition

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

The Company recognizes revenue upon transfer of control of promised products or services to customers in an amount that reflects the consideration the Company expects to receive in exchange for those products or services. The Company enters into contracts that can include various combinations of products and services, which in most instances are capable of being distinct and accounted for as separate performance obligations. In the case of product sales, the Company's performance obligations are generally met and revenue is recognized at the time of shipment of the products to the customer because the customer has significant risks and rewards of ownership of the asset and the Company has a present right to payment at that time. For service revenues, these criteria are generally met at the time the services have been performed for the same reasons. Revenue is recognized net of allowances for returns and any taxes collected from customers, which are subsequently remitted to governmental authorities.

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

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

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

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

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

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

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



	Six Months Ended
	June 30, 2018			June 30, 2017

Beginning balance	$	1,812		$	1,057
Deferred revenues added	600			313
Elimination of deferred revenues due to joint venture liquidation	(986		)	—
Previously deferred revenues recognized	(338		)	(311		)
Ending balance	$	1,088		$	1,059

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

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

In adopting ASC 606, the Company has elected the following practical expedients:


•	In accordance with Subtopic 340-40 "Other Assets and Deferred Costs - Contracts with Customers," the Company has elected to expense the incremental costs of obtaining a contract when the amortization period for such contracts would have been one year or less.


•	In accordance with ASC 606-10-50-14, the Company has elected not to disclose the remaining performance obligations where the underlying contract's original expected duration is one year or less and revenue from the satisfaction of the performance obligations is recognized in the amount invoiced in accordance with ASC 606-10-55-18.


•	The Company has made an accounting policy election to exclude all taxes by governmental authorities from the measurement of the transaction price.

Deferred Revenue and Deferred Cost of Revenues

Deferred revenue consists of amounts billed or payments received in advance of revenue recognition. Deferred cost of revenues related to deferred product revenues includes direct product costs and applied overhead. Deferred cost of revenues related to deferred service revenues includes direct labor costs and applied overhead. Once all revenue recognition criteria have been met, the deferred revenues and associated cost of revenues are recognized.

Restricted Investments

As of June 30, 2018, restricted investments consist of balances maintained by the Company with an investment advisor in money market funds and permitted treasury bills. These balances represent collateral for a $1.0 million operating line of credit issued to the Company by its primary bank for credit card purchases. Because the Company’s agreement with the lender prevents the Company from withdrawing these funds, they are considered restricted.

Fair Value Measurements

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


•	Level 1 - Quoted prices for identical instruments in active markets;


•	Level 2 - Quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-derived valuations in which all significant inputs and significant value drivers are observable in active markets; and


•	Level 3 - Valuations derived from valuation techniques in which one or more significant inputs or significant value drivers are unobservable.

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

Long-Lived Assets

We perform periodic reviews to determine whether facts and circumstances exist that would indicate that the carrying amounts of property, plant and equipment and long-lived intangible assets might not be fully recoverable. If facts and circumstances indicate that the carrying amount of these assets might not be fully recoverable, we compare projected undiscounted net cash flows associated with the related asset or group of assets over their estimated remaining useful lives against their respective carrying amounts. In the event that the projected undiscounted cash flows are not sufficient to recover the carrying value of the assets, the assets are written down to their estimated fair values based on the expected discounted future cash flows attributable to the assets. Evaluation of impairment of property, plant and equipment and long-lived intangible assets requires estimates in the forecast of future operating results that are used in the preparation of the expected future undiscounted cash flows. Actual future operating results and the remaining economic lives of our property, plant and equipment and long-lived intangible assets could differ from our estimates used in assessing the recoverability of these assets. These differences could result in impairment charges, which could have a material adverse impact on our results of operations.

ECHELON CORP 10-Q