Update: Echelon's Q2 Earnings - Sales And Margins Continue Falling, Outlook Expects More Weakness

| About: Echelon Corporation (ELON)


Total revenues fell 40% Y/Y, especially on weak smart grid sales. Company plans to downsize the Grid business after a failed attempt to sell. Restructuring costs can be expected.

Investors should wait for a clear confirmation that the sales and margins stopped deteriorating. More stock weakness may be ahead due to restructuring and falling sales before things get better.

My thesis worked extremely well in terms of the advice to wait for a 20% pullback. After the dip, the stock skyrocketed 100% but later fell to the original level.

Echelon Corporation (NASDAQ:ELON) reported mixed second quarter 2014 results (SEC filing, press release, conference call). Total revenues were $15.0M, down 40% Y/Y. Revenues from Echelon's Grid business were $6.1M, down 54% Y/Y. Revenues from Echelon's IIoT (Industrial Internet of Things) business were $9.0M, down 21% Y/Y. GAAP gross margins were 50.0%, up from 48.1% a year ago, driven by higher software revenue and improved inventory management. GAAP net loss was $8.6M, or $0.20 per share, versus loss of $0.02 last year. Non-GAAP net loss was $4.2M, or $0.10 per share, versus a loss of $0.02 a year ago. ELON made a strategic decision to focus all of its resources on the opportunity in the Industrial Internet of Things. After being unable to find a suitable buyer or other solution to the divestiture of its Grid business, ELON decided to scale back this business substantially, unless it is still able to find a buyer in the very near term, which is very unlikely. As a result of the poor Grid performance, ELON had to record a $4.1M impairment in the quarter. Further restructuring charges are expected in this quarter.

In terms of the business outlook, the company's guidance for the third quarter of 2014 is for revenues to reach $13.5M to $15.0M, or another 0% to 10% sequential fall, with approximately 65% coming from the IIoT. Non-GAAP gross margin is expected to be in a range of 45% to 47% of revenue, also down sequentially and Y/Y. The company also anticipates recording restructuring and other related charges in connection with the strategic decision to downsize the Grid business, the size of which is still undetermined.

The advice in the conclusion of my original thesis, to wait for a pullback or confirmation of the sales turnaround, paid off extremely well: "investors are better to stay on the sidelines and wait for a sales rebound to get a confirmation of the turnaround, or wait for a further 20% stock price pullback to get better risk-to-reward ratio." A month later, the stock dipped ~20%, triggering my buy signal, and then skyrocketed ~100% up in less than five weeks. What a trade. On the other hand, ELON is a very speculative stock built around the trend of the Internet of Things, so investors learnt the hard way that taking profits is a must with such a volatile stock, and it is definitely a buy-and-hold investment. A year after the huge 100% spike, the stock is trading back at the levels from December 2013. In fact, after the recent dip below $2 per share, ELON again offers a relatively attractive entry point, however, it is a more risky investment today due to current restructuring woes and falling sales. My target price is ~$2.5 per share within two years. However, investors should still wait for a clear confirmation that the sales and margins stopped deteriorating. More price weakness can be expected because due to the planned further restructuring and continued sales and margin deterioration, things are likely to get worse before they get better. The stock can be really volatile and is operating in a very cyclical and competitive industry.

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