----

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**UNITED      STATES **

**SECURITIES      AND EXCHANGE COMMISSION**

**Washington,      DC 20549**

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**FORM      10-Q**

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**(Mark      one)**

| **[X]** | **QUARTERLY                REPORT PURSUANT TO SECTION 13 OR 15(d) OF                THE SECURITIES EXCHANGE ACT OF                1934** |
|---------|------------------------------------------------------------------------------------------------------------------------------------------|

**For      the quarterly period ended September 30, 2006**

**OR**

| **[  ]** | **TRANSITION                REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE                ACT OF                1934** |
|--------------------|-------------------------------------------------------------------------------------------------------------------------------------------|

**For      the transition period from _______________ to      _______________**

**000-29748**

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**ECHELON          CORPORATION**

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|  **Delaware** (State                or other jurisdiction of incorporation                or organization)  | **77-0203595**(IRS                Employer Identification                Number) |
|---------------------------------------------------------------------------------------------------------------------------------|----------------------------------------------------------------------------------|

**550      Meridian Avenue**

**San      Jose, CA 95126**

**(408)      938-5200**

|     Large                accelerated filer  ¨ |   | Accelerated                filer  x | Non-accelerated                filer  ¨ |
|-----------------------------------------------------------------------------|--------|------------------------------------------|---------------------------------------------------|

**ECHELON          CORPORATION**
**FORM          10-Q **
**FOR          THE QUARTER ENDED SEPTEMBER 30, 2006**

**INDEX**

|                             |   |                                                                                                                                                                                            | **Page** |
|----------------------------------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|----------|
| **Part                I.**       |   | **FINANCIAL                INFORMATION**                                                                                                                                                        |     |
| Item                1.           |   | Unaudited                Condensed Consolidated Financial                Statements                                                                                                             |     |
|                             |   | Condensed                Consolidated Balance Sheets as of September 30, 2006                and December                31, 2005                                                               | 3        |
|                             |   | Condensed                Consolidated Statements of Operations for the three                months and nine monthsended                September 30, 2006 and September 30,                2005 | 4        |
|                             |   | Condensed                Consolidated Statements of Cash Flows for the nine                months endedSeptember                30, 2006 and September 30, 2005                                 | 5        |
|                             |   | Notes                to Condensed Consolidated Financial Statements                                                                                                                             | 6        |
| Item                2.           |   | Management’s                Discussion and Analysis of Financial Condition                and Results ofOperations                                                                        | 27       |
| Item                3.           |   | Quantitative                and Qualitative Disclosures About Market                Risk                                                                                                        | 64       |
| Item                4.           |   | Controls                and Procedures                                                                                                                                                          | 64       |
|                             |   |                                                                                                                                                                                            |     |
| **Part                II.**      |   | **OTHER                INFORMATION**                                                                                                                                                            |     |
| Item                1.           |   | Legal                Proceedings                                                                                                                                                                | 66       |
| Item                1A.          |   | Risk                Factors                                                                                                                                                                     | 66       |
| Item                2.           |   | Unregistered                Sales of Equity Securities and Use of                Proceeds                                                                                                       | 66       |
| Item                6.           |   | Exhibits                                                                                                                                                                                        | 66       |
|                             |   |                                                                                                                                                                                            |     |
| **SIGNATURE**                    | 67     |
| **EXHIBIT                INDEX** | 68     |

**FORWARD-LOOKING      INFORMATION**

*    This      report      contains forward-looking statements within the meaning of the U.S. federal      securities laws that involve risks and uncertainties. Certain statements      contained in this report are not purely historical including, without      limitation, statements regarding our expectations, beliefs, intentions,      anticipations, commitments or strategies regarding the future that are      forward-looking. These statements include those discussed in Item 2,      Management’s Discussion and Analysis of Financial Condition and Results of      Operations, including “Liquidity and Capital Resources,” “Recently Issued      Accounting Standards” and “Factors That May Affect Future Results of      Operations,” and elsewhere in this report. These statements include statements      concerning projected revenues, international revenues, expenses, gross profit,      income, product development and market acceptance of our      products.*

**2**

**PART        I. FINANCIAL INFORMATION**

| **ITEM 1.** | **UNAUDITED CONDENSED CONSOLIDATED              FINANCIAL STATEMENTS** |
|-------------|------------------------------------------------------------------------|

**ECHELON      CORPORATION**

**CONDENSED      CONSOLIDATED BALANCE SHEETS**

**(In      thousands)**

|                                                            |   | **September                30,****2006** |     | **December                31,****2005** |   |
|-----------------------------------------------------------------|--------|------------------------------------------|----------|-----------------------------------------|--------|
| **ASSETS**                                                      |   |                                     |     |                                    |   |
|                                                            |   |                                     |     |                                    |   |
| CURRENT                ASSETS:                                  |   |                                     |     |                                    |   |   |   |
| Cash                and cash equivalents                        |   | $                                        | 54,451   |                                    | $      | 59,080 |   |
| Short-term                investments                           |   |                                     | 75,341   |                                    |   | 95,400 |   |
| Accounts                receivable, net                         |   |                                     | 17,086   |                                    |   | 11,006 |   |
| Inventories                                                     |   |                                     | 8,939    |                                    |   | 3,240 |   |
| Other                current assets                             |   |                                     | 15,557   |                                    |   | 2,289 |   |
| Total                current assets                             |   |                                     | 171,374  |                                    |   | 171,015 |   |
|                                                            |   |                                     |     |                                    |   |   |   |
| Property                and equipment, net                      |   |                                     | 15,719   |                                    |   | 14,886 |   |
| Goodwill                                                        |   |                                     | 8,180    |                                    |   | 8,018 |   |
| Other                long-term assets                           |   |                                     | 1,963    |                                    |   | 2,019 |   |
|                                                            |   |                                     |     |                                    |   |   |   |
| TOTAL                ASSETS                                     |   | $                                        | 197,236  |                                    | $      | 195,938 |   |
|                                                            |   |                                     |     |                                    |   |   |   |
| **LIABILITIES                AND STOCKHOLDERS’ EQUITY**   |   |                                     |     |                                    |   |   |   |
|                                                            |   |                                     |     |                                    |   |   |   |
| CURRENT                LIABILITIES:                             |   |                                     |     |                                    |   |   |   |
| Accounts                payable                                 |   | $                                        | 7,634    |                                    | $      | 3,972 |   |
| Accrued                liabilities                              |   |                                     | 4,767    |                                    |   | 7,473 |   |
| Deferred                revenues                                |   |                                     | 20,833   |                                    |   | 2,096 |   |
| Total                current liabilities                        |   |                                     | 33,234   |                                    |   | 13,541 |   |
|                                                            |   |                                     |     |                                    |   |   |   |
| LONG-TERM                LIABILITIES:                           |   |                                     |     |                                    |   |   |   |
| Deferred                rent                                    |   |                                     | 1,240    |                                    |   | 1,089 |   |
| Total                long-term liabilities                      |   |                                     | 1,240    |                                    |   | 1,089 |   |
|                                                            |   |                                     |     |                                    |   |   |   |
| STOCKHOLDERS’                EQUITY:                      |   |                                     |     |                                    |   |   |   |
| Common                stock                                     |   |                                     | 416      |                                    |   | 415 |   |
| Additional                paid-in capital                       |   |                                     | 281,716  |                                    |   | 278,005 |   |
| Treasury                stock                                   |   |                                     | (18,027  | )                                       |   | (12,925 | ) |
| Accumulated                other comprehensive income (loss)    |   |                                     | 667      |                                    |   | (118 | ) |
| Accumulated                deficit                              |   |                                     | (102,010 | )                                       |   | (84,069 | ) |
| Total                stockholders’ equity                 |   |                                     | 162,762  |                                    |   | 181,308 |   |
|                                                            |   |                                     |     |                                    |   |   |   |
| TOTAL                LIABILITIES AND STOCKHOLDERS’ EQUITY |   | $                                        | 197,236  |                                    | $      | 195,938 |   |

*See      accompanying notes to condensed consolidated financial      statements.*

**3**

**ECHELON      CORPORATION**

**CONDENSED      CONSOLIDATED STATEMENTS OF      OPERATIONS**

**(In      thousands, except per share amounts)**

|                                                        |   | **Three                Months Ended****September                30,** |   | **Nine                Months Ended****September                30,** |   |
|-------------------------------------------------------------|--------|-----------------------------------------------------------------------|--------|----------------------------------------------------------------------|--------|
|                                                        |   | **2006**                                                              |   | **2005**                                                             |   | **2006** |   | **2005** |   |
| REVENUES:                                                   |   |                                                                  |   |                                                                 |   |   |   |   |   |   |   |   |   |
| Product                                                     |   | $                                                                     | 13,110 |                                                                 | $      | 16,068 |   | $ | 42,893 |   | $ | 54,852 |   |
| Service                                                     |   |                                                                  | 181    |                                                                 |   | 183 |   |   | 517 |   |   | 562 |   |
| Total                revenues                               |   |                                                                  | 13,291 |                                                                 |   | 16,251 |   |   | 43,410 |   |   | 55,414 |   |
|                                                        |   |                                                                  |   |                                                                 |   |   |   |   |   |   |   |   |   |
| COST                OF REVENUES:                            |   |                                                                  |   |                                                                 |   |   |   |   |   |   |   |   |   |
| Cost                of product (1)                          |   |                                                                  | 4,936  |                                                                 |   | 7,085 |   |   | 16,802 |   |   | 23,107 |   |
| Cost                of service (1)                          |   |                                                                  | 509    |                                                                 |   | 525 |   |   | 1,406 |   |   | 1,629 |   |
| Total                cost of revenues                       |   |                                                                  | 5,445  |                                                                 |   | 7,610 |   |   | 18,208 |   |   | 24,736 |   |
|                                                        |   |                                                                  |   |                                                                 |   |   |   |   |   |   |   |   |   |
| GROSS                PROFIT                                 |   |                                                                  | 7,846  |                                                                 |   | 8,641 |   |   | 25,202 |   |   | 30,678 |   |
|                                                        |   |                                                                  |   |                                                                 |   |   |   |   |   |   |   |   |   |
| OPERATING                EXPENSES:                          |   |                                                                  |   |                                                                 |   |   |   |   |   |   |   |   |   |
| Product                development (1)                      |   |                                                                  | 6,875  |                                                                 |   | 6,170 |   |   | 21,029 |   |   | 18,747 |   |
| Sales                and marketing (1)                      |   |                                                                  | 5,076  |                                                                 |   | 5,164 |   |   | 15,312 |   |   | 15,585 |   |
| General                and administrative (1)               |   |                                                                  | 3,746  |                                                                 |   | 8,550 |   |   | 10,946 |   |   | 16,597 |   |
| Total                operating expenses                     |   |                                                                  | 15,697 |                                                                 |   | 19,884 |   |   | 47,287 |   |   | 50,929 |   |
|                                                        |   |                                                                  |   |                                                                 |   |   |   |   |   |   |   |   |   |
| LOSS                FROM OPERATIONS                         |   |                                                                  | (7,851 | )                                                                    |   | (11,243 | ) |   | (22,085 | ) |   | (20,251 | ) |
|                                                        |   |                                                                  |   |                                                                 |   |   |   |   |   |   |   |   |   |
| INTEREST                AND OTHER INCOME, NET               |   |                                                                  | 1,586  |                                                                 |   | 1,225 |   |   | 4,384 |   |   | 3,567 |   |
|                                                        |   |                                                                  |   |                                                                 |   |   |   |   |   |   |   |   |   |
| LOSS                BEFORE PROVISION FOR INCOME TAXES       |   |                                                                  | (6,265 | )                                                                    |   | (10,018 | ) |   | (17,701 | ) |   | (16,684 | ) |
|                                                        |   |                                                                  |   |                                                                 |   |   |   |   |   |   |   |   |   |
| INCOME                TAX EXPENSE                           |   |                                                                  | 80     |                                                                 |   | 100 |   |   | 240 |   |   | 300 |   |
|                                                        |   |                                                                  |   |                                                                 |   |   |   |   |   |   |   |   |   |
| NET                LOSS                                     |   | $                                                                     | (6,345 | )                                                                    | $      | (10,118 | ) | $ | (17,941 | ) | $ | (16,984 | ) |
|                                                        |   |                                                                  |   |                                                                 |   |   |   |   |   |   |   |   |   |
| NET                LOSS PER SHARE:                          |   |                                                                  |   |                                                                 |   |   |   |   |   |   |   |   |   |
| Basic                                                       |   | $                                                                     | (0.16  | )                                                                    | $      | (0.25 | ) | $ | (0.45 | ) | $ | (0.42 | ) |
| Diluted                                                     |   | $                                                                     | (0.16  | )                                                                    | $      | (0.25 | ) | $ | (0.45 | ) | $ | (0.42 | ) |
|                                                        |   |                                                                  |   |                                                                 |   |   |   |   |   |   |   |   |   |
| SHARES                USED IN COMPUTING NET LOSS PER SHARE: |   |                                                                  |   |                                                                 |   |   |   |   |   |   |   |   |   |
| Basic                                                       |   |                                                                  | 39,354 |                                                                 |   | 40,074 |   |   | 39,577 |   |   | 40,538 |   |
| Diluted                                                     |   |                                                                  | 39,354 |                                                                 |   | 40,074 |   |   | 39,577 |   |   | 40,538 |   |

----

|  (1) | Amounts                  include stock-based compensation costs as follows: |
|-----------|-----------------------------------------------------------------------------|
|      | Cost                  of product                                            |   | $ | 92 |   | $ | 17 |   | $ | 307 |   | $ | 35 |   |
|      | Cost                  of service                                            |   |   | 10 |   |   | 1 |   |   | 36 |   |   | 1 |   |
|      | Product                  development                                        |   |   | 376 |   |   | 44 |   |   | 1,474 |   |   | 68 |   |
|      | Sales                  and marketing                                        |   |   | 249 |   |   | 33 |   |   | 911 |   |   | 57 |   |
|      | General                  and aministrative                                  |   |   | 275 |   |   | 75 |   |   | 989 |   |   | 195 |   |

*See      accompanying notes to condensed consolidated financial      statements.*

**4**

**ECHELON      CORPORATION**

**CONDENSED      CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(In      thousands)**

|                                                                                                                    |   | **Nine                Months Ended****September                30,** |    |
|-------------------------------------------------------------------------------------------------------------------------|--------|----------------------------------------------------------------------|---------|
|                                                                                                                    |   | **2006**                                                             |    | **2005** |   |
|                                                                                                                    |   |                                                                 |    |   |   |
| CASH                FLOWS PROVIDED BY (USED IN) OPERATING ACTIVITIES:                                                   |   |                                                                 |    |   |   |   |   |
| Net                loss                                                                                                 |   | $                                                                    | (17,941 | ) | $ | (16,984 | ) |
| Adjustments                to reconcile net loss to net cash provided by (used in) operating                activities: |   |                                                                 |    |   |   |   |   |
| Depreciation                and amortization                                                                            |   |                                                                 | 3,270   |   |   | 3,115 |   |
| Loss                on disposal of fixed assets                                                                         |   |                                                                 | --      |   |   | 45 |   |
| Recovery                of doubtful accounts                                                                            |   |                                                                 | (32     | ) |   | (1 | ) |
| Stock-based                compensation                                                                                 |   |                                                                 | 3,717   |   |   | 356 |   |
| Change                in operating assets and liabilities:                                                              |   |                                                                 |    |   |   |   |   |
| Accounts                receivable                                                                                      |   |                                                                 | (6,048  | ) |   | 7,839 |   |
| Inventories                                                                                                             |   |                                                                 | (5,699  | ) |   | 397 |   |
| Other                current assets                                                                                     |   |                                                                 | (13,268 | ) |   | (701 | ) |
| Accounts                payable                                                                                         |   |                                                                 | 3,662   |   |   | 137 |   |
| Accrued                liabilities                                                                                      |   |                                                                 | (2,706  | ) |   | 6,058 |   |
| Deferred                revenues                                                                                        |   |                                                                 | 18,737  |   |   | (160 | ) |
| Deferred                rent                                                                                            |   |                                                                 | 151     |   |   | 203 |   |
| Net                cash provided by (used in) operating activities                                                      |   |                                                                 | (16,157 | ) |   | 304 |   |
|                                                                                                                    |   |                                                                 |    |   |   |   |   |
| CASH                FLOWS PROVIDED BY (USED FOR) INVESTING ACTIVITIES:                                                  |   |                                                                 |    |   |   |   |   |
| Purchase                of available-for-sale short-term investments                                                    |   |                                                                 | (47,761 | ) |   | (92,408 | ) |
| Proceeds                from maturities and sales of available-for-sale short-term                investments           |   |                                                                 | 68,140  |   |   | 89,794 |   |
| Release                of restricted investments                                                                        |   |                                                                 | --      |   |   | 11,106 |   |
| Change                in other long-term assets                                                                         |   |                                                                 | (106    | ) |   | 250 |   |
| Capital                expenditures                                                                                     |   |                                                                 | (4,103  | ) |   | (1,464 | ) |
| Net                cash provided by investing activities                                                                |   |                                                                 | 16,170  |   |   | 7,278 |   |
|                                                                                                                    |   |                                                                 |    |   |   |   |   |
| CASH                FLOWS PROVIDED BY (USED IN) FINANCING ACTIVITIES:                                                   |   |                                                                 |    |   |   |   |   |
| Repurchase                of common stock                                                                               |   |                                                                 | (5,102  | ) |   | (7,869 | ) |
| Proceeds                from (costs associated with) issuance of common stock                                           |   |                                                                 | (5      | ) |   | -- |   |
| Net                cash used in financing activities                                                                    |   |                                                                 | (5,107  | ) |   | (7,869 | ) |
|                                                                                                                    |   |                                                                 |    |   |   |   |   |
| EFFECT                OF EXCHANGE RATE CHANGES ON CASH                                                                  |   |                                                                 | 465     |   |   | (867 | ) |
|                                                                                                                    |   |                                                                 |    |   |   |   |   |
| NET                DECREASE IN CASH AND CASH EQUIVALENTS                                                                |   |                                                                 | (4,629  | ) |   | (1,154 | ) |
|                                                                                                                    |   |                                                                 |    |   |   |   |   |
| CASH                AND CASH EQUIVALENTS:                                                                               |   |                                                                 |    |   |   |   |   |
| Beginning                of period                                                                                      |   |                                                                 | 59,080  |   |   | 35,510 |   |
| End                of period                                                                                            |   | $                                                                    | 54,451  |   | $ | 34,356 |   |
|                                                                                                                    |   |                                                                 |    |   |   |   |   |
| SUPPLEMENTAL                DISCLOSURES OF CASH FLOW INFORMATION:                                                       |   |                                                                 |    |   |   |   |   |
| Net                cash paid for income taxes                                                                           |   | $                                                                    | 183     |   | $ | 298 |   |

*See      accompanying notes to condensed consolidated financial      statements.*

**5**

**ECHELON      CORPORATION**

**NOTES      TO CONDENSED CONSOLIDATED FINANCIAL      STATEMENTS**

**(Unaudited)**

**1.**
**Basis      of Presentation**

**2.      **
**Summary      of Significant Accounting Policies**

*Principles      of Consolidation*

*Foreign      Currency Translation   *

*Use      of Estimates in the Preparation of Financial Statements*

*Revenue      Recognition *

**6**

*Software Revenue        Recognition*

*Revenue      Recognition When Right of Return Exists*

*Stock-Based      Compensation*

*Share-Based      Payment*
*Accounting      for Stock Issued to Employees,*

*Accounting      for Stock-Based Compensation*

**7**

*Accounting          for Stock-Based Compensation - Transition and Disclosure*

|                                                                                                                                                                                                    |   | **Three                Months Ended****September                30, 2005** |    |  **Nine                Months Ended****September                30, 2005** |   |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|----------------------------------------------------------------------------|---------|---------------------------------------------------------------------------------|--------|
|                                                                                                                                                                                                    |   |                                                                       |    |                                                                       |   |
| Net                loss as reported                                                                                                                                                                |   | $                                                                          | (10,118 | )                                                                               | $      | (16,984 | ) |
| Add:                Stock-based employee compensation expense included in reported net                income                (loss), net of related tax effects                                          |   |                                                                       | 170     |                                                                            |   | 356 |   |
| Deduct:                Total stock-based employee compensation expense determined under                fair                value based method for all awards, net of related tax                effects |   |                                                                       | (2,322  | )                                                                               |   | (7,264 | ) |
| Pro                forma net loss                                                                                                                                                                  |   | $                                                                          | (12,270 | )                                                                               | $      | (23,892 | ) |
|                                                                                                                                                                                                    |   |                                                                       |    |                                                                            |   |   |   |
| Basic                net loss per share:                                                                                                                                                                |   |                                                                       |    |                                                                            |   |   |   |
| As                reported                                                                                                                                                                              |   | $                                                                          | (0.25   | )                                                                               | $      | (0.42 | ) |
| Pro                forma                                                                                                                                                                                |   | $                                                                          | (0.31   | )                                                                               | $      | (0.59 | ) |
|                                                                                                                                                                                                    |   |                                                                       |    |                                                                            |   |   |   |
| Diluted                net loss per share:                                                                                                                                                              |   |                                                                       |    |                                                                            |   |   |   |
| As                reported                                                                                                                                                                              |   | $                                                                          | (0.25   | )                                                                               | $      | (0.42 | ) |
| Pro                forma                                                                                                                                                                                |   | $                                                                          | (0.31   | )                                                                               | $      | (0.59 | ) |

|                                          |   | **Three                Months Ended****September                30, 2005** |   | **Nine                Months Ended****September                30, 2005** |   |
|-----------------------------------------------|--------|----------------------------------------------------------------------------|--------|---------------------------------------------------------------------------|--------|
|                                          |   |                                                                       |   |                                                                      |   |   |   |
| Expected                dividend yield   |   |                                                                       | 0.0    | %                                                                         |   | 0.0 | % |
| Risk-free                interest rate   |   |                                                                       | 4.1    | %                                                                         |   | 4.0 | % |
| Expected                volatility       |   |                                                                       | 57.5   | %                                                                         |   | 57.7 | % |
| Expected                life (in years)  |   |                                                                       | 3.7    |                                                                      |   | 3.6 |   |

*Cash      and Cash Equivalents *

**8**

*Short-Term      Investments*

*Accounting      for Certain Investments in Debt and Equity Securities*

|                                                           |   | **Amortized****Cost** |   | **Aggregate****Fair                Value** |   | **Unrealized****Holding                Gains/****(Losses)** |   |
|----------------------------------------------------------------|--------|-----------------------|--------|--------------------------------------------|--------|-------------------------------------------------------------|--------|
| U.S.                corporate securities:                      |   |                  |   |                                       |   |                                                        |   |   |   |   |
| Commercial                paper                                |   | $                     | 13,650 |                                       | $      | 13,654                                                      |   | $ | 4 |   |
| Corporate                notes and bonds                       |   |                  | 29,622 |                                       |   | 29,573                                                      |   |   | (49 | ) |
|                                                           |   |                  | 43,272 |                                       |   | 43,227                                                      |   |   | (45 | ) |
| Foreign                corporate notes and bonds               |   |                  | 1,492  |                                       |   | 1,484                                                       |   |   | (8 | ) |
| U.S.                government securities                      |   |                  | 30,653 |                                       |   | 30,630                                                      |   |   | (23 | ) |
| Total                investments in debt and equity securities |   | $                     | 75,417 |                                       | $      | 75,341                                                      |   | $ | (76 | ) |

*Computation      of Net Loss Per Share*

*Earnings      per Share*

|                                                         |   | **Three                Months Ended****September                30,** |   | **Nine                Months Ended****September                30,** |   |
|--------------------------------------------------------------|--------|-----------------------------------------------------------------------|--------|----------------------------------------------------------------------|--------|
|                                                         |   | **2006**                                                              |   | **2005**                                                             |   | **2006** |   | **2005** |   |
| Net                loss (Numerator):                         |   |                                                                  |   |                                                                 |   |   |   |   |   |   |   |   |   |
| Net                loss                                      |   | $                                                                     | (6,345 | )                                                                    | $      | (10,118 | ) | $ | (17,941 | ) | $ | (16,984 | ) |
| Shares                (Denominator):                         |   |                                                                  |   |                                                                 |   |   |   |   |   |   |   |   |   |
| Weighted                average common shares outstanding    |   |                                                                  | 39,354 |                                                                 |   | 40,074 |   |   | 39,577 |   |   | 40,538 |   |
| Shares                used in basic computation              |   |                                                                  | 39,354 |                                                                 |   | 40,074 |   |   | 39,577 |   |   | 40,538 |   |
| Common                shares issuable upon exercise of stock |   |                                                                  |   |                                                                 |   |   |   |   |   |   |   |   |   |
| options                (treasury stock method)               |   |                                                                  | --     |                                                                 |   | -- |   |   | -- |   |   | -- |   |
| Shares                used in diluted computation            |   |                                                                  | 39,354 |                                                                 |   | 40,074 |   |   | 39,577 |   |   | 40,538 |   |
| Net                loss per share:                           |   |                                                                  |   |                                                                 |   |   |   |   |   |   |   |   |   |
| Basic                                                        |   | $                                                                     | (0.16  | )                                                                    | $      | (0.25 | ) | $ | (0.45 | ) | $ | (0.42 | ) |
| Diluted                                                      |   | $                                                                     | (0.16  | )                                                                    | $      | (0.25 | ) | $ | (0.45 | ) | $ | (0.42 | ) |

**9**

*         *

*Impairment      of Long-Lived Assets Including Goodwill*

*  *

*Accounting for the Impairment of Long-Lived Assets and for Long-Lived      Assets to Be Disposed Of*

*Recently      Issued Accounting Standards*

*Fair Value Measurements*

**10**

*Considering the Effects of Prior              Year Misstatements When Quantifying Misstatements in Current Year Financial              Statements*

* Accounting for Uncertainty in Income Taxes              - an Interpretation of FASB Statement No. 109*

*Accounting for              Certain Hybrid Financial Instruments*
*Accounting for Derivative Instruments and Hedging Activities*
*Accounting for Transfers and Servicing of              Financial Assets and Extinguishments of Liabilities*

*Accounting          Changes and Error Corrections, a replacement of APB Opinion No. 20,          Accounting Changes, and Statement No. 3, Reporting Accounting Changes in          Interim Financial Statements*

**3.      Stockholders’ Equity and Employee Stock Option Plans**

**11**

*Preferred      Stock*

*Common      Stock*

*Comprehensive          Loss*

|                                                                                 |   | **Three                      Months Ended****September                      30,** |   | **Nine                      Months Ended****September                      30,** |   |
|--------------------------------------------------------------------------------------|--------|-----------------------------------------------------------------------------------|--------|----------------------------------------------------------------------------------|--------|
|                                                                                 |   | **2006**                                                                          |   | **2005**                                                                         |   | **2006** |   | **2005** |   |
|                                                                                 |   |                                                                              |   |                                                                             |   |   |   |   |   |
| Net                      loss                                                        |   | $                                                                                 | (6,345 | )                                                                                | $      | (10,118 | ) | $ | (17,941 | ) | $ | (16,984 | ) |
| Other                      comprehensive income/(loss), net of tax:                  |   |                                                                              |   |                                                                             |   |   |   |   |   |   |   |   |   |
| Foreign                      currency translation adjustment                         |   |                                                                              | (63    | )                                                                                |   | (89 | ) |   | 465 |   |   | (867 | ) |
| Unrealized                      holding gain/(loss) on available-for-sale securities |   |                                                                              | 270    |                                                                             |   | (83 | ) |   | 320 |   |   | 9 |   |
| Comprehensive                      loss                                              |   | $                                                                                 | (6,138 | )                                                                                | $      | (10,290 | ) | $ | (17,156 | ) | $ | (17,842 | ) |

*Employee            Stock Option Exchange Program*

**12**

*Option            Vesting Acceleration*

*  *

*Stock        Option Program Description*

**13**

*1997      Stock Plan*

*1998      Directors Option Plan*

**14**

*Stock        Award Activity*

|                                                     |   |                                                              |       | Options                  Outstanding |   |
|----------------------------------------------------------|--------|-------------------------------------------------------------------|------------|--------------------------------------|--------|
|                                                     |   | Shares                  Availablefor                  Grant  |       | NumberOutstanding                    |   | Weighted-AverageExercise                  Price Per Share |   |
| BALANCE                  AT JUNE 30, 2005                |   |                                                              | 7,995,704  |                                 |   | 7,346,802 |   | $ | 11.66 |   |
| Options                  granted                         |   |                                                              | (1,043,980 | )                                    |   | 1,043,980 |   |   | 8.18 |   |
| Performance                  shares granted              |   |                                                              | (305,710   | )                                    |   | --- |   |   | --- |   |
| Options                  exercised                       |   |                                                              | ---        |                                 |   | --- |   |   | --- |   |
| Options                  forfeited or expired            |   |                                                              | 177,238    |                                 |   | (177,238 | ) |   | 9.38 |   |
| BALANCE                  AT SEPTEMBER 30, 2005           |   |                                                              | 6,823,252  |                                 |   | 8,213,544 |   | $ | 11.26 |   |
|                                                     |   |                                                              |       |                                 |   |   |   |   |   |   |
| BALANCE                  AT JUNE 30, 2006                |   |                                                              | 8,930,789  |                                 |   | 7,608,798 |   | $ | 11.23 |   |
| Options                  granted                         |   |                                                              | (32,800    | )                                    |   | 32,800 |   |   | 8.33 |   |
| Performance                  shares granted              |   |                                                              | (10,934    | )                                    |   | --- |   |   | --- |   |
| Options                  exercised                       |   |                                                              | ---        |                                 |   | (11,018 | ) |   | 6.17 |   |
| Options                  forfeited or expired            |   |                                                              | 69,556     |                                 |   | (69,556 | ) |   | 18.88 |   |
| Performance                  shares forfeited or expired |   |                                                              | 1,671      |                                 |   | --- |   |   | --- |   |
| BALANCE                  AT SEPTEMBER 30, 2006           |   |                                                              | 8,958,279  |                                 |   | 7,561,024 |   | $ | 11.15 |   |

|                                                     |   |                                                              |       | Options                  Outstanding |   |
|----------------------------------------------------------|--------|-------------------------------------------------------------------|------------|--------------------------------------|--------|
|                                                     |   | Shares                  Availablefor                  Grant  |       | NumberOutstanding                    |   | Weighted-AverageExercise                  Price Per Share |   |
| BALANCE                  AT DECEMBER 31, 2004            |   |                                                              | 8,109,556  |                                 |   | 5,594,842 |   | $ | 14.91 |   |
| Options                  granted                         |   |                                                              | (3,537,064 | )                                    |   | 3,537,064 |   |   | 6.98 |   |
| Performance                  shares granted              |   |                                                              | (415,065   | )                                    |   | --- |   |   | --- |   |
| Options                  exercised                       |   |                                                              | ---        |                                 |   | --- |   |   | --- |   |
| Options                  forfeited or expired            |   |                                                              | 918,362    |                                 |   | (918,362 | ) |   | 16.98 |   |
| Additional                  shares reserved              |   |                                                              | 1,747,463  |                                 |   | --- |   |   | --- |   |
| BALANCE                  AT SEPTEMBER 30, 2005           |   |                                                              | 6,823,252  |                                 |   | 8,213,544 |   | $ | 11.26 |   |
|                                                     |   |                                                              |       |                                 |   |   |   |   |   |   |
| BALANCE                  AT DECEMBER 31, 2005            |   |                                                              | 6,949,420  |                                 |   | 8,089,473 |   | $ | 11.24 |   |
| Options                  granted                         |   |                                                              | (101,825   | )                                    |   | 101,825 |   |   | 8.21 |   |
| Performance                  shares granted              |   |                                                              | (120,601   | )                                    |   | --- |   |   | --- |   |
| Options                  exercised                       |   |                                                              | ---        |                                 |   | (115,268 | ) |   | 6.12 |   |
| Options                  forfeited or expired            |   |                                                              | 515,006    |                                 |   | (515,006 | ) |   | 13.02 |   |
| Performance                  shares forfeited or expired |   |                                                              | 24,259     |                                 |   | --- |   |   | --- |   |
| Additional                  shares reserved              |   |                                                              | 1,692,020  |                                 |   | --- |   |   | --- |   |
| BALANCE                  AT SEPTEMBER 30, 2006           |   |                                                              | 8,958,279  |                                 |   | 7,561,024 |   | $ | 11.15 |   |

**15**

| ExercisePrice                  Range               |   |   | NumberOutstanding |   |   | Weighted                  AverageRemainingContractual                  Life(in                  years) |   |   | Weighted                  AverageExercisePrice                  per Share |   |   | AggregateIntrinsicValue |   |
|----------------------------------------------------|--------|--------|-------------------|--------|--------|--------------------------------------------------------------------------------------------------------|--------|--------|---------------------------------------------------------------------------|--------|--------|-------------------------|--------|
| $6.11                                              |   |   | 1,535,311         |   |   | 3.26                                                                                                   |   | $      | 6.11                                                                      |   | $      | 3,254,859               |   |
| 6.26-8.17                                          |   |   | 274,293           |   |   | 2.41                                                                                                   |   |   | 7.20                                                                      |   |   | 281,327                 |   |
| 8.19                                               |   |   | 951,130           |   |   | 3.87                                                                                                   |   |   | 8.19                                                                      |   |   | 38,045                  |   |
| 8.24-10.65                                         |   |   | 655,640           |   |   | 3.70                                                                                                   |   |   | 9.20                                                                      |   |   | --                      |   |
| 10.89                                              |   |   | 840,920           |   |   | 2.46                                                                                                   |   |   | 10.89                                                                     |   |   | --                      |   |
| 11.14-12.88                                        |   |   | 575,132           |   |   | 4.69                                                                                                   |   |   | 11.66                                                                     |   |   | --                      |   |
| 12.91                                              |   |   | 792,870           |   |   | 1.64                                                                                                   |   |   | 12.91                                                                     |   |   | --                      |   |
| 13.00-16.06                                        |   |   | 305,200           |   |   | 4.22                                                                                                   |   |   | 14.12                                                                     |   |   | --                      |   |
| 16.35                                              |   |   | 825,562           |   |   | 4.18                                                                                                   |   |   | 16.35                                                                     |   |   | --                      |   |
| $16.36-$30.76                                      |   |   | 804,966           |   |   | 4.33                                                                                                   |   |   | 18.91                                                                     |   |   | --                      |   |
|  Outstanding                                  |   |   | 7,561,024         |   |   | 3.45                                                                                                   |   | $      | 11.15                                                                     |   | $      | 3,574,231               |   |
|  Vested                  and expected to vest |   |   | 7,489,270         |   |   | 3.44                                                                                                   |   | $      | 11.18                                                                     |   | $      | 3,547,844               |   |
|  Exercisable                                  |   |   | 6,497,776         |   |   | 3.43                                                                                                   |   | $      | 11.73                                                                     |   | $      | 2,921,352               |   |

|                                                    |   | Number                  Nonvestedand                  Outstanding |    | Weighted-AverageGrant                  Date Fair-Value |   |
|---------------------------------------------------------|--------|-------------------------------------------------------------------|---------|--------------------------------------------------------|--------|
| BALANCE                  AT JUNE 30, 2005               |   |                                                              | 109,355 |                                                   | $      | 6.77 |   |
| Performance                  shares granted             |   |                                                              | 305,710 |                                                   |   | 8.19 |   |
| BALANCE                  AT SEPTEMBER 30, 2005          |   |                                                              | 415,065 |                                                   | $      | 7.82 |   |
|                                                    |   |                                                              |    |                                                   |   |   |   |
| BALANCE                  AT JUNE 30, 2006               |   |                                                              | 500,047 |                                                   | $      | 8.07 |   |
| Performance                  shares granted             |   |                                                              | 10,934  |                                                   |   | 8.33 |   |
| Performance                  shares vested and released |   |                                                              | (71,222 | )                                                      |   | 8.19 |   |
| Performance                  shares forfeited           |   |                                                              | (1,671  | )                                                      |   | 8.19 |   |
| BALANCE                  AT SEPTEMBER 30, 2006          |   |                                                              | 438,088 |                                                   | $      | 8.05 |   |

**16**

|                                                    |   | Number                  Nonvestedand                  Outstanding |    | Weighted-AverageGrant                  Date Fair-Value |   |
|---------------------------------------------------------|--------|-------------------------------------------------------------------|---------|--------------------------------------------------------|--------|
| BALANCE                  AT DECEMBER 31, 2004           |   |                                                              | ---     |                                                   | $      | --- |   |
| Performance                  shares granted             |   |                                                              | 415,065 |                                                   |   | 7.82 |   |
| BALANCE                  AT SEPTEMBER 30, 2005          |   |                                                              | 415,065 |                                                   | $      | 7.82 |   |
|                                                    |   |                                                              |    |                                                   |   |   |   |
| BALANCE                  AT DECEMBER 31, 2005           |   |                                                              | 412,968 |                                                   | $      | 7.82 |   |
| Performance                  shares granted             |   |                                                              | 120,601 |                                                   |   | 8.94 |   |
| Performance                  shares vested and released |   |                                                              | (71,222 | )                                                      |   | 8.19 |   |
| Performance                  shares forfeited           |   |                                                              | (24,259 | )                                                      |   | 8.04 |   |
| BALANCE                  AT SEPTEMBER 30, 2006          |   |                                                              | 438,088 |                                                   | $      | 8.05 |   |

**4.      Stock-Based Compensation:**

*Impact      of Adopting SFAS 123R*

| **Three                months ended September 30, 2006** |   |   | **Intrinsic                Value Method****(A)** |   |   | **Fair                Value Method****(B)** |   |   | **Impact                of Adoption****(A)                - (B)** |   |
|----------------------------------------------------------|--------|--------|--------------------------------------------------|--------|--------|---------------------------------------------|--------|--------|-------------------------------------------------------------------|--------|
| Loss                from continuing operations           |   | $      | (7,167                                           | )      | $      | (7,851                                      | )      | $      | (684                                                              | )      |
| Loss                before provision for income taxes    |   | $      | (5,581                                           | )      | $      | (6,265                                      | )      | $      | (684                                                              | )      |
| Net                loss                                  |   | $      | (5,661                                           | )      | $      | (6,345                                      | )      | $      | (684                                                              | )      |
| Net                loss per share - basic                |   | $      | (0.14                                            | )      | $      | (0.16                                       | )      | $      | (0.02                                                             | )      |
| Net                loss per share - diluted              |   | $      | (0.14                                            | )      | $      | (0.16                                       | )      | $      | (0.02                                                             | )      |
| Cash                flows from operations                |   | $      | (7,888                                           | )      | $      | (7,888                                      | )      | $      | --                                                                |   |
| Cash                flows from financing activities      |   | $      | (2,753                                           | )      | $      | (2,753                                      | )      | $      | --                                                                |   |

| **Nine                months ended September 30, 2006** |   |   | **Intrinsic                Value Method****(A)** |   |   | **Fair                Value Method****(B)** |   |   | **Impact                of Adoption****(A)                - (B)** |   |
|---------------------------------------------------------|--------|--------|--------------------------------------------------|--------|--------|---------------------------------------------|--------|--------|-------------------------------------------------------------------|--------|
| Loss                from continuing operations          |   | $      | (19,281                                          | )      | $      | (22,085                                     | )      | $      | (2,804                                                            | )      |
| Loss                before provision for income taxes   |   | $      | (14,897                                          | )      | $      | (17,701                                     | )      | $      | (2,804                                                            | )      |
| Net                loss                                 |   | $      | (15,137                                          | )      | $      | (17,941                                     | )      | $      | (2,804                                                            | )      |
| Net                loss per share - basic               |   | $      | (0.38                                            | )      | $      | (0.45                                       | )      | $      | (0.07                                                             | )      |
| Net                loss per share - diluted             |   | $      | (0.38                                            | )      | $      | (0.45                                       | )      | $      | (0.07                                                             | )      |
| Cash                flows from operations               |   | $      | (16,157                                          | )      | $      | (16,157                                     | )      | $      | --                                                                |   |
| Cash                flows from financing activities     |   | $      | (5,107                                           | )      | $      | (5,107                                      | )      | $      | --                                                                |   |

**17**

*Valuation      of Options Granted*

|                                          |   | **Three                Months Ended****September                30, 2006** |   | **Nine                Months Ended****September                30, 2006** |   |
|-----------------------------------------------|--------|----------------------------------------------------------------------------|--------|---------------------------------------------------------------------------|--------|
| Expected                dividend yield   |   |                                                                       | 0.0    | %                                                                         |   | 0.0 | % |
| Risk-free                interest rate   |   |                                                                       | 4.8    | %                                                                         |   | 4.8 | % |
| Expected                volatility       |   |                                                                       | 51.2   | %                                                                         |   | 48.8 | % |
| Expected                life (in years)  |   |                                                                       | 3.8    |                                                                      |   | 2.6 |   |

*Expense      Allocation  *

**18**

|                                                                                                                                      |   | **Three                Months Ended****September                30,** |   |
|-------------------------------------------------------------------------------------------------------------------------------------------|--------|-----------------------------------------------------------------------|--------|
|                                                                                                                                      |   | **2006**                                                              |   | **2005** |   |
| Cost                of sales - product                                                                                                    |   | $                                                                     | 92     |   | $ | 17 |   |
| Cost                of sales - service                                                                                                    |   |                                                                  | 10     |   |   | 1 |   |
| Stock-based                compensation expense included in cost of sales                                                                 |   |                                                                  | 102    |   |   | 18 |   |
| Product                development                                                                                                        |   |                                                                  | 376    |   |   | 44 |   |
| Sales                and marketing                                                                                                        |   |                                                                  | 249    |   |   | 33 |   |
| General                and administrative                                                                                                 |   |                                                                  | 275    |   |   | 75 |   |
| Stock-based                compensation expense included in operating expenses                                                            |   |                                                                  | 900    |   |   | 152 |   |
| Total                stock-based compensation expense related to stock options and performance                shares                      |   |                                                                  | 1,002  |   |   | 170 |   |
| Tax                benefit                                                                                                                |   |                                                                  | --     |   |   | -- |   |
| Stock-based                compensation expense related to stock options and performance shares,                net                of tax |   | $                                                                     | 1,002  |   | $ | 170 |   |

|                                                                                                                                      |   | **Nine                Months Ended****September                30,** |   |
|-------------------------------------------------------------------------------------------------------------------------------------------|--------|----------------------------------------------------------------------|--------|
|                                                                                                                                      |   | **2006**                                                             |   | **2005** |   |
| Cost                of sales - product                                                                                                    |   | $                                                                    | 307    |   | $ | 35 |   |
| Cost                of sales - service                                                                                                    |   |                                                                 | 36     |   |   | 1 |   |
| Stock-based                compensation expense included in cost of sales                                                                 |   |                                                                 | 343    |   |   | 36 |   |
| Product                development                                                                                                        |   |                                                                 | 1,474  |   |   | 68 |   |
| Sales                and marketing                                                                                                        |   |                                                                 | 911    |   |   | 57 |   |
| General                and administrative                                                                                                 |   |                                                                 | 989    |   |   | 195 |   |
| Stock-based                compensation expense included in operating expenses                                                            |   |                                                                 | 3,374  |   |   | 320 |   |
| Total                stock-based compensation expense related to stock options and performance                shares                      |   |                                                                 | 3,717  |   |   | 356 |   |
| Tax                benefit                                                                                                                |   |                                                                 | --     |   |   | -- |   |
| Stock-based                compensation expense related to stock options and performance shares,                net                of tax |   | $                                                                    | 3,717  |   | $ | 356 |   |

** **

**19**

*Comparative      Results*

|                                                                                                                                 |   |  **Three                Months Ended September                30,** |   |
|--------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------------------------------------------------------------|--------|
|                                                                                                                                 |   | **2006**                                                                 |   | **2005** |   |
| Net                loss - as reported for the prior period (1)                                                                       |   |                                                                     | N/A    |   | $ | (10,118 | ) |
| Stock-based                compensation expense related to employee stock options and performance                share awards (2)    |   | $                                                                        | 1,002  |   | $ | 2,152 |   |
| Tax                benefit                                                                                                           |   |                                                                     | --     |   |   | -- |   |
| Stock-based                compensation expense related to stock options and performance share                awards, net of tax (3) |   | $                                                                        | 1,002  |   | $ | 2,152 |   |
|                                                                                                                                 |   |                                                                     |   |   |   |   |   |
| Net                loss, including the effect of stock-based compensation expense                (4)                                 |   | $                                                                        | (6,345 | ) | $ | (12,270 | ) |
|                                                                                                                                 |   |                                                                     |   |   |   |   |   |
| Diluted                net loss per share - as reported for the prior period (1)                                                     |   |                                                                     | N/A    |   | $ | (0.25 | ) |
| Diluted                net loss per share, including the effect of stock-based compensation                expense (4)               |   | $                                                                        | (0.16  | ) | $ | (0.31 | ) |

|                                                                                                                                 |   |                                               |    |
|--------------------------------------------------------------------------------------------------------------------------------------|--------|----------------------------------------------------|---------|
|                                                                                                                                 |   | **Nine                Months Ended September 30,** |    |
|                                                                                                                                 |   | **2006**                                           |    | **2005** |   |
|                                                                                                                                 |   |                                               |    |   |   |
| Net                loss - as reported for the prior period (1)                                                                       |   |                                               | N/A     |   | $ | (16,984 | ) |
| Stock-based                compensation expense related to employee stock options and performance                share awards (2)    |   | $                                                  | 3,717   |   | $ | 6,908 |   |
| Tax                benefit                                                                                                           |   |                                               | --      |   |   | -- |   |
| Stock-based                compensation expense related to stock options and performance share                awards, net of tax (3) |   | $                                                  | 3,717   |   | $ | 6,908 |   |
|                                                                                                                                 |   |                                               |    |   |   |   |   |
| Net                loss, including the effect of stock-based compensation expense                (4)                                 |   | $                                                  | (17,941 | ) | $ | (23,892 | ) |
|                                                                                                                                 |   |                                               |    |   |   |   |   |
| Diluted                net loss per share - as reported for the prior period (1)                                                     |   |                                               | N/A     |   | $ | (0.42 | ) |
| Diluted                net loss per share, including the effect of stock-based compensation                expense (3)               |   | $                                                  | (0.45   | ) | $ | (0.59 | ) |

----

| (1)   | Net                loss and net loss per share prior to January 1, 2006 did not include                stock-based compensation expense for employee stock options under                SFAS 123                because the Company did not adopt the recognition provisions of SFAS                123.                Net loss and net loss per share prior to January 1, 2006 did include                stock-based compensation expense for performance share                awards. |
|-----------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| (2)   | Stock-based                compensation expense related to employee stock options and performance                share awards for the three and nine months ended September 30, 2005                are                net of amounts already reflected in the net loss for the respective                periods. |
|-----------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

**20**

| (3)   | Stock-based                compensation expense prior to January 1, 2006 is calculated based                on the                pro forma application of SFAS 123. |
|-----------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| (4)   | Net                loss and net loss per share prior to January 1, 2006 represents pro                forma                information based on SFAS 123. |
|-----------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------|

**5.        Significant Customers**

**             **

|   |   | **Three                      Months Ended September 30,** |   |  **Nine                      Months Ended September 30,** |   |
|--------|--------|-----------------------------------------------------------|--------|----------------------------------------------------------------|--------|
|   |   | **2006**                                                  |   | **2005**                                                       |   |  **2006** |   | **2005** |   |
| Enel   |   |                                                      | 0.40   | %                                                              |   | 27.00 | % |   | 16.40 | % |   | 37.10 | % |
| EBV    |   |                                                      | 32.00  | %                                                              |   | 22.70 | % |   | 25.30 | % |   | 20.50 | % |
| Total  |   |                                                      | 32.40  | %                                                              |   | 49.70 | % |   | 41.70 | % |   | 57.60 | % |

**6.        Commitments and Contingencies**

**  **

*Lease        Commitments*

*         *

**21**

*Royalties*

*Guarantees*

**22**

*Legal        Actions*

**7.          **

**Inventories**

|                                       |   | **September                        30,****2006** |   | **December                        31,****2005** |   |
|--------------------------------------------|--------|--------------------------------------------------|--------|-------------------------------------------------|--------|
| Purchased                        materials |   | $                                                | 2,322  |                                            | $      | 1,064 |   |
| Work-in-process                            |   |                                             | 9      |                                            |   | 61 |   |
| Finished                        goods      |   |                                             | 6,608  |                                            |   | 2,115 |   |
|                                       |   | $                                                | 8,939  |                                            | $      | 3,240 |   |

**8.            Accrued Liabilities**

|                                                   |   | **September                      30,****2006** |   | **December                      31,****2005** |   |
|--------------------------------------------------------|--------|------------------------------------------------|--------|-----------------------------------------------|--------|
| Accrued                      payroll and related costs |   | $                                              | 3,000  |                                          | $      | 2,630 |   |
| Accrued                      taxes                     |   |                                           | 1,187  |                                          |   | 1,128 |   |
| Other                      accrued liabilities         |   |                                           | 580    |                                          |   | 3,715 |   |
|                                                   |   | $                                              | 4,767  |                                          | $      | 7,473 |   |

**23**

**9.**
**Segment            Disclosure**

*Disclosures            about Segments of an Enterprise and Related Information.*

**24**

|                                              |   | **Three                    Months Ended****September                    30,** |    | **Nine                    Months Ended****September                    30,** |   |
|---------------------------------------------------|--------|-------------------------------------------------------------------------------|---------|------------------------------------------------------------------------------|--------|
|                                              |   | **2006**                                                                      |    | **2005**                                                                     |   | **2006** |   | **2005** |   |
| Revenues                    from customers:       |   |                                                                          |    |                                                                         |   |   |   |   |   |   |   |   |   |
| Americas                                          |   | $                                                                             | 5,193   |                                                                         | $      | 4,488 |   | $ | 14,688 |   | $ | 12,568 |   |
| EMEA                                              |   |                                                                          | 5,949   |                                                                         |   | 9,341 |   |   | 23,528 |   |   | 36,817 |   |
| APJ                                               |   |                                                                          | 2,149   |                                                                         |   | 2,422 |   |   | 5,194 |   |   | 6,029 |   |
| Total                                             |   | $                                                                             | 13,291  |                                                                         | $      | 16,251 |   | $ | 43,410 |   | $ | 55,414 |   |
| Gross                    profit:                  |   |                                                                          |    |                                                                         |   |   |   |   |   |   |   |   |   |
| Americas                                          |   | $                                                                             | 3,134   |                                                                         | $      | 2,599 |   | $ | 8,875 |   | $ | 7,565 |   |
| EMEA                                              |   |                                                                          | 3,347   |                                                                         |   | 4,700 |   |   | 13,302 |   |   | 19,599 |   |
| APJ                                               |   |                                                                          | 1,365   |                                                                         |   | 1,342 |   |   | 3,025 |   |   | 3,514 |   |
| Total                                             |   | $                                                                             | 7,846   |                                                                         | $      | 8,641 |   | $ | 25,202 |   | $ | 30,678 |   |
| Income                    (loss) from operations: |   |                                                                          |    |                                                                         |   |   |   |   |   |   |   |   |   |
| Americas                                          |   | $                                                                             | 1,676   |                                                                         | $      | 1,481 |   | $ | 4,984 |   | $ | 4,172 |   |
| EMEA                                              |   |                                                                          | 2,007   |                                                                         |   | 3,352 |   |   | 9,094 |   |   | 15,239 |   |
| APJ                                               |   |                                                                          | 298     |                                                                         |   | 191 |   |   | (191 | ) |   | 68 |   |
| Unallocated                                       |   |                                                                          | (11,832 | )                                                                            |   | (16,267 | ) |   | (35,972 | ) |   | (39,730 | ) |
| Total                                             |   | $                                                                             | (7,851  | )                                                                            | $      | (11,243 | ) | $ | (22,085 | ) | $ | (20,251 | ) |

** **

**10.**
**        Income Taxes**

**11.        Related Party**

**25**

**12.**
**      Warranty Reserves**

**26**

| **ITEM 2.** | **MANAGEMENT’S DISCUSSION AND ANALYSIS              OF FINANCIAL CONDITION AND RESULTS OF              OPERATIONS** |
|-------------|---------------------------------------------------------------------------------------------------------------------------|

*The      following discussion should be read in conjunction with the consolidated      financial statements and notes thereto included elsewhere in this Quarterly      Report. The following discussion contains predictions, estimates, and other      forward-looking statements that involve a number of risks and uncertainties      about our business, including but not limited to: our belief that control      networks based on our products can reduce life-cycle costs, save energy, are      more flexible than centralized systems and permit control systems to be      comprised of products and services from a variety of vendors; our belief      that the NES system brings cost savings in a wide range of a utility’s      functions, from metering and customer services to distribution operations and      value-added services; our belief that new products and product enhancements,      such as our NES offering and Panoramix platform, will make it easier for our      customers to aggregate and process information from remote LonWorks networks,      thereby increasing overall network management capabilities; our belief that      the      benefits derived from our NES system deliver a more compelling return on      investment than “traditional” AMR systems; our expectation that Enel will      purchase spare parts from us with a value of approximately $7.1 million in      2006      and our belief that we will not be able to find one or more replacements for      the      Enel project revenue reduction; our expectation that shipments of our NES      products will increase significantly; our belief that, in general, as long      as      the current worldwide economic recovery continues to gain momentum, overall      revenues from our LonWorks Infrastructure business will continue to improve      during 2006 as compared to 2005; our belief that market conditions in Asia,      particularly Japan, will continue to be challenging in 2006; our belief that,      during 2006, our gross margin will decrease slightly as compared to      2005 levels; our belief that, during 2006, our sales and marketing and product      development expenses will increase over 2005 levels; our belief that many of      our      customers will continue to refrain from purchasing our customer support and      training offerings during 2006 in an effort to minimize their operating      expenses; our belief that our existing cash and short-term investment balances      will be sufficient to meet our projected working capital and other cash      requirements for at least the next twelve months; our belief that we will incur      a substantial loss in 2006; our belief that the amount of our LonWorks      Infrastructure revenues earned in foreign currencies will not fluctuate      significantly between 2005 and 2006; our expectation that our initial NES system      roll-out to Nuon will be completed in early 2007 and that Nuon will then issue      a      public tender for an even larger deployment; and our belief that the estimates      and judgments made regarding future events in connection with the preparation      of      our financial statements are reasonable. These statements may be identified      by      the use of words such as “we believe,” “expect,” “anticipate,” “intend,” “plan,”and similar expressions. In addition, forward-looking statements include, but      are not limited to, statements about our beliefs, estimates, or plans about      our      ability to maintain low manufacturing and operating costs and costs per unit,      our ability to estimate revenues, pricing pressures, returns, reserves, demand      for our products, selling, general, and administrative expenses, taxes,      research, development, and engineering expenses, spending on property, plant,      and equipment, expected sales of our products and the market for our products      generally and certain customers specifically, and our beliefs regarding our      liquidity needs.*

*Forward-looking      statements are estimates reflecting the best judgment of our senior management,      and they involve a number of risks and uncertainties that could cause actual      results to differ materially from those suggested by the forward-looking      statements. Our business is subject to a number of risks and uncertainties.      While this discussion represents our current judgment on the future direction      of      our business, these risks and uncertainties could cause actual results to differ      materially from any future performance suggested herein. Some of the important      factors that may influence possible differences are continued competitive      factors, technological developments, pricing pressures, changes in customer      demand, and general economic conditions, as well as those discussed above in      “Factors That May Affect Future Results of Operations.” We undertake no      obligation to update forward-looking statements to reflect events or      circumstances occurring after the date of such statements. Readers should review      the Risk Factors in Part II Item 1A in this report, as well as other documents      filed from time to time by us with the SEC.*

**OVERVIEW      **

**27**

** C**
**RITICAL      ACCOUNTING      ESTIMATES**

**28**

**Sales      Returns and Allowances.**

**Stock-Based      Compensation.**

**29**

**Allowance      for Doubtful Accounts.**

**30**

**Inventory        Valuation.**

**Warranty      Reserves.**

**Deferred      Income Taxes.**

**Valuation      of Goodwill and Other Intangible Assets.**

*      Goodwill and Other Intangible Assets,*

**31**

**R**
**ESULTS      OF      OPERATIONS**

|                                                                       |   | **Three                Months Ended****September                30,** |   | **Nine                Months Ended****September                30,** |   |
|----------------------------------------------------------------------------|--------|-----------------------------------------------------------------------|--------|----------------------------------------------------------------------|--------|
|                                                                       |   | **2006**                                                              |   | **2005**                                                             |   | **2006** |   | **2005** |   |
| Revenues:                                                                  |   |                                                                  |        |                                                                 |   |  |   |   |  |   |   |  |   |
| Product                                                               |   |                                                                  | 98.7   | %                                                                    |   | 98.9 | % |   | 98.8 | % |   | 99.0 | % |
| Service                                                               |   |                                                                  | 1.3    |                                                                 |   | 1.1 |   |   | 1.2 |   |   | 1.0 |   |
| Total                revenues                                         |   |                                                                  | 100.0  |                                                                 |   | 100.0 |   |   | 100.0 |   |   | 100.0 |   |
| Cost                of revenues:                                           |   |                                                                  |   |                                                                 |   |   |   |   |   |   |   |   |   |
| Cost                of product                                        |   |                                                                  | 37.2   |                                                                 |   | 43.6 |   |   | 38.7 |   |   | 41.7 |   |
| Cost                of service                                        |   |                                                                  | 3.8    |                                                                 |   | 3.2 |   |   | 3.3 |   |   | 2.9 |   |
| Total                cost of                revenues                  |   |                                                                  | 41.0   |                                                                 |   | 46.8 |   |   | 42.0 |   |   | 44.6 |   |
| Gross                profit                                           |   |                                                                  | 59.0   |                                                                 |   | 53.2 |   |   | 58.0 |   |   | 55.4 |   |
| Operating                expenses:                                         |   |                                                                  |   |                                                                 |   |   |   |   |   |   |   |   |   |
| Product                development                                    |   |                                                                  | 51.7   |                                                                 |   | 38.0 |   |   | 48.4 |   |   | 33.8 |   |
| Sales                and marketing                                    |   |                                                                  | 38.2   |                                                                 |   | 31.8 |   |   | 35.3 |   |   | 28.1 |   |
| General                and                administrative              |   |                                                                  | 28.2   |                                                                 |   | 52.6 |   |   | 25.2 |   |   | 30.0 |   |
| Total                operating                expenses                |   |                                                                  | 118.1  |                                                                 |   | 122.4 |   |   | 108.9 |   |   | 91.9 |   |
| Loss                from                operations                    |   |                                                                  | (59.1  | )                                                                    |   | (69.2 | ) |   | (50.9 | ) |   | (36.5 | ) |
| Interest                and other income,                net          |   |                                                                  | 12.0   |                                                                 |   | 7.5 |   |   | 10.1 |   |   | 6.4 |   |
| Loss                before provision for income                taxes  |   |                                                                  | (47.1  | )                                                                    |   | (61.7 | ) |   | (40.8 | ) |   | (30.1 | ) |
| Income                tax expense                                     |   |                                                                  | 0.6    |                                                                 |   | 0.6 |   |   | 0.5 |   |   | 0.5 |   |
| Net                loss                                               |   |                                                                  | (47.7  | %)                                                                   |   | (62.3 | %) |   | (41.3 | %) |   | (30.6 | %) |

***Revenues***

*Total      Revenues*

|                                    |   | Three                Months Ended |                             |   |   |                             |   |
|-----------------------------------------|--------|-----------------------------------|----------------------------------|--------|--------|----------------------------------|--------|
| *(Dollars                in thousands)* |   |                              | September                30,2006 |   |   | September                30,2005 |   |   | 2006                over 2005$                Change |   |   | 2006                over 2005%                Change |   |
| Total                Revenues           |   | $                                 | 13,291                           |   | $      | 16,251                           |   | $ | (2,960 | ) |   | (18.2 | %) |
|                                    |   |                              |                             |   |   |                             |   |   |   |   |
|                                    |   |                              | Nine                Months Ended |   |   |                             |   |   |   |   |
| *(Dollars                in thousands)* |   |                              | September                30,2006 |   |   | September                30,2005 |   |   | 2006                over 2005$                Change |   |   | 2006                over 2005%                Change |   |
| Total                Revenues           |   | $                                 | 43,410                           |   | $      | 55,414                           |   | $ | (12,004 | ) |   | (21.7 | %) |

**32**

*LonWorks*
*      Infrastructure revenues *

|                                            |   | Three                Months Ended |                                   |   |   |                             |   |
|-------------------------------------------------|--------|-----------------------------------|----------------------------------------|--------|--------|----------------------------------|--------|
| *(Dollars                in thousands)*         |   |                              | September                30, 2006 |   |   | September                30,2005 |   |   | 2006                over 2005$                Change |   |   | 2006                over 2005%                Change |   |
| LonWorks                Infrastructure Revenues |   | $                                 | 13,040                                 |   | $      | 11,702                           |   | $ | 1,338 |   |   | 11.4 | % |

|                                            |   | Nine                Months Ended |                             |   |   |                             |   |
|-------------------------------------------------|--------|----------------------------------|----------------------------------|--------|--------|----------------------------------|--------|
| *(Dollars                in thousands)*         |   |                             | September                30,2006 |   |   | September                30,2005 |   |   | 2006                over 2005$                Change |   |   | 2006                over 2005%                Change |   |
| LonWorks                Infrastructure Revenues |   | $                                | 35,614                           |   | $      | 34,291                           |   | $ | 1,323 |   |   | 3.9 | % |

**33**

*Enel      Project revenues*

|                                    |   | Three                Months Ended |                             |   |   |                             |   |
|-----------------------------------------|--------|-----------------------------------|----------------------------------|--------|--------|----------------------------------|--------|
| *(Dollars                in thousands)* |   |                              | September                30,2006 |   |   | September                30,2005 |   |   | 2006                over 2005$                Change |   |   | 2006                over 2005%                Change |   |
| Enel                Project Revenues    |   | $                                 | 53                               |   | $      | 4,388                            |   | $ | (4,335 | ) |   | (98.8 | %) |

|                                    |   | Nine                Months Ended |                             |   |   |                             |   |
|-----------------------------------------|--------|----------------------------------|----------------------------------|--------|--------|----------------------------------|--------|
| *(Dollars                in thousands)* |   |                             | September                30,2006 |   |   | September                30,2005 |   |   | 2006                over 2005$                Change |   |   | 2006                over 2005%                Change |   |
| Enel                Project Revenues    |   | $                                | 7,103                            |   | $      | 20,580                           |   | $ | (13,477 | ) |   | (65.5 | %) |

**34**

*NES      revenues*

|                                      |   | Three                  Months Ended |                               |   |   |                               |   |
|-------------------------------------------|--------|-------------------------------------|------------------------------------|--------|--------|------------------------------------|--------|
| *(Dollars                  in thousands)* |   |                                | September                  30,2006 |   |   | September                  30,2005 |   |   | 2006                  over 2005$                  Change |   |   | 2006                  over 2005%                  Change |   |
| NES                  revenues             |   | $                                   | 199                                |   | $      | 162                                |   | $ | 37 |   |   | 22.8 | % |

|                                      |   | Nine                  Months Ended |                               |   |   |                               |   |
|-------------------------------------------|--------|------------------------------------|------------------------------------|--------|--------|------------------------------------|--------|
| *(Dollars                  in thousands)* |   |                               | September                  30,2006 |   |   | September                  30,2005 |   |   | 2006                  over 2005$                  Change |   |   | 2006                  over 2005%                  Change |   |
| NES                  revenues             |   | $                                  | 693                                |   | $      | 543                                |   | $ | 150 |   |   | 27.6 | % |

*EBV      revenues*

|                                    |   | Three                Months Ended |                             |   |   |                             |   |
|-----------------------------------------|--------|-----------------------------------|----------------------------------|--------|--------|----------------------------------|--------|
| *(Dollars                in thousands)* |   |                              | September                30,2006 |   |   | September                30,2005 |   |   | 2006                over 2005$                Change |   |   | 2006                over 2005%                Change |   |
| EBV                Revenues             |   | $                                 | 4,255                            |   | $      | 3,686                            |   | $ | 569 |   |   | 15.4 | % |

**35**

|                                    |   | Nine                Months Ended |                             |   |   |                             |   |
|-----------------------------------------|--------|----------------------------------|----------------------------------|--------|--------|----------------------------------|--------|
| *(Dollars                in thousands)* |   |                             | September                30,2006 |   |   | September                30,2005 |   |   | 2006                over 2005$                Change |   |   | 2006                over 2005%                Change |   |
| EBV                Revenues             |   | $                                | 10,965                           |   | $      | 11,375                           |   | $ | (410 | ) |   | (3.6 | %) |

*Revenue      Recognition When Right of Return Exists*

**36**

*Product        revenues*

|                                    |   | Three                Months Ended |                             |   |   |                             |   |
|-----------------------------------------|--------|-----------------------------------|----------------------------------|--------|--------|----------------------------------|--------|
| *(Dollars                in thousands)* |   |                              | September                30,2006 |   |   | September                30,2005 |   |   | 2006                over 2005$                Change |   |   | 2006                over 2005%                Change |   |
| Product                Revenues         |   | $                                 | 13,110                           |   | $      | 16,068                           |   | $ | (2,958 | ) |   | 18.4 | % |

|                                    |   | Nine                Months Ended |                             |   |   |                             |   |
|-----------------------------------------|--------|----------------------------------|----------------------------------|--------|--------|----------------------------------|--------|
| *(Dollars                in thousands)* |   |                             | September                30,2006 |   |   | September                30,2005 |   |   | 2006                over 2005$                Change |   |   | 2006                over 2005%                Change |   |
| Product                Revenues         |   | $                                | 42,893                           |   | $      | 54,852                           |   | $ | (11,959 | ) |   | (21.8 | %) |

*Service      revenues*

|                                    |   | Three                Months Ended |                             |   |   |                             |   |
|-----------------------------------------|--------|-----------------------------------|----------------------------------|--------|--------|----------------------------------|--------|
| *(Dollars                in thousands)* |   |                              | September                30,2006 |   |   | September                30,2005 |   |   | 2006                over 2005$                Change |   |   | 2006                over 2005%                Change |   |
| Service                Revenues         |   | $                                 | 181                              |   | $      | 183                              |   | $ | (2 | ) |   | (1.1 | %) |

|                                    |   | Nine                Months Ended |                             |   |   |                             |   |
|-----------------------------------------|--------|----------------------------------|----------------------------------|--------|--------|----------------------------------|--------|
| *(Dollars                in thousands)* |   |                             | September                30,2006 |   |   | September                30,2005 |   |   | 2006                over 2005$                Change |   |   | 2006                over 2005%                Change |   |
| Service                Revenues         |   | $                                | 517                              |   | $      | 562                              |   | $ | (45 | ) |   | (8.0 | %) |

**37**

***Gross      Profit and Gross Margin***

|                                    |   | Three                Months Ended |                             |   |   |                             |   |
|-----------------------------------------|--------|-----------------------------------|----------------------------------|--------|--------|----------------------------------|--------|
| *(Dollars                in thousands)* |   |                              | September                30,2006 |   |   | September                30,2005 |   |   | 2006                over 2005$                Change |   |   | 2006                over 2005%                Change |   |
| Gross                Profit             |   | $                                 | 7,846                            |   | $      | 8,641                            |   | $ | 795 |   |   | (9.2 | %) |
| Gross                Margin             |   |                              | 59.0                             | %      |   | 53.2                             | %      |   | -- |   |   | 5.8 |   |

|                                    |   | Nine                Months Ended |                             |   |   |                             |   |
|-----------------------------------------|--------|----------------------------------|----------------------------------|--------|--------|----------------------------------|--------|
| *(Dollars                in thousands)* |   |                             | September                30,2006 |   |   | September                30,2005 |   |   | 2006                over 2005$                Change |   |   | 2006                over 2005%                Change |   |
| Gross                Profit             |   | $                                | 25,202                           |   | $      | 30,678                           |   | $ | (5,476 | ) |   | (17.8 | %) |
| Gross                Margin             |   |                             | 58.1                             | %      |   | 55.4                             | %      |   | -- |   |   | 2.7 |   |

**38**

***Operating          Expenses***

*Product      Development*

|                                      |   | Three                  Months Ended |                               |   |   |                               |   |
|-------------------------------------------|--------|-------------------------------------|------------------------------------|--------|--------|------------------------------------|--------|
| *(Dollars                  in thousands)* |   |                                | September                  30,2006 |   |   | September                  30,2005 |   |   | 2006                  over 2005$                  Change |   |   | 2006                  over 2005%                  Change |   |
| Product                  Development      |   | $                                   | 6,875                              |   | $      | 6,170                              |   | $ | 705 |   |   | 11.4 | % |

|                                    |   | Nine                Months Ended |                             |   |   |                             |   |
|-----------------------------------------|--------|----------------------------------|----------------------------------|--------|--------|----------------------------------|--------|
| *(Dollars                in thousands)* |   |                             | September                30,2006 |   |   | September                30,2005 |   |   | 2006                over 2005$                Change |   |   | 2006                over 2005%                Change |   |
| Product                Development      |   | $                                | 21,029                           |   | $      | 18,747                           |   | $ | 2,282 |   |   | 12.2 | % |

*Sales        and Marketing*

|                                      |   |  Three                  Months Ended |                               |   |   |                               |   |
|-------------------------------------------|--------|-------------------------------------------|------------------------------------|--------|--------|------------------------------------|--------|
| *(Dollars                  in thousands)* |   |                                      | September                  30,2006 |   |   | September                  30,2005 |   |   | 2006                  over 2005$                  Change |   |   | 2006                  over 2005%                  Change |   |
| Sales                  and Marketing      |   | $                                         | 5,076                              |   | $      | 5,164                              |   | $ | (88 | ) |   | (1.7 | %) |

|                                      |   | Nine                  Months Ended |                               |   |   |                               |   |
|-------------------------------------------|--------|------------------------------------|------------------------------------|--------|--------|------------------------------------|--------|
| *(Dollars                  in thousands)* |   |                               | September                  30,2006 |   |   | September                  30,2005 |   |   | 2006                  over 2005$                  Change |   |   | 2006                  over 2005%                  Change |   |
| Sales                  and Marketing      |   | $                                  | 15,312                             |   | $      | 15,585                             |   | $ | (273 | ) |   | (1.8 | %) |

**39**

*General      and Administrative*

|                                      |   | Three                Months Ended |                                   |   |   |                             |   |
|-------------------------------------------|--------|-----------------------------------|----------------------------------------|--------|--------|----------------------------------|--------|
| *(Dollars                in thousands)*   |   |                              | September                30, 2006 |   |   | September                30,2005 |   |   | 2006                over 2005$                Change |   |   | 2006                over2005%                Change |   |
| General                and Administrative |   | $                                 | 3,746                                  |   | $      | 8,550                            |   | $ | (4,804 | ) |   | (56.2 | %) |

|                                      |   | Nine                Months Ended |                             |   |   |                             |   |
|-------------------------------------------|--------|----------------------------------|----------------------------------|--------|--------|----------------------------------|--------|
| *(Dollars                in thousands)*   |   |                             | September                30,2006 |   |   | September                30,2005 |   |   | 2006                over 2005$                Change |   |   | 2006                over 2005%                Change |   |
| General                and Administrative |   | $                                | 10,946                           |   | $      | 16,597                           |   | $ | (5,651 | ) |   | (34.0 | %) |

**40**

***Interest        and Other Income, Net***

|                                              |   | Three                    Months Ended |                                 |   |   |                                 |   |
|---------------------------------------------------|--------|---------------------------------------|--------------------------------------|--------|--------|--------------------------------------|--------|
| *(Dollars                    in thousands)*       |   |                                  | September                    30,2006 |   |   | September                    30,2005 |   |   | 2006                    over 2005$                    Change |   |   | 2006                    over 2005%                    Change |   |
| Interest                    and Other Income, Net |   | $                                     | 1,586                                |   | $      | 1,225                                |   | $ | 361 |   |   | 29.5 | % |

|                                              |   | Nine                    Months Ended |                                 |   |   |                                 |   |
|---------------------------------------------------|--------|--------------------------------------|--------------------------------------|--------|--------|--------------------------------------|--------|
| *(Dollars                    in thousands)*       |   |                                 | September                    30,2006 |   |   | September                    30,2005 |   |   | 2006                    over 2005$                    Change |   |   | 2006                    over 2005%                    Change |   |
| Interest                    and Other Income, Net |   | $                                    | 4,384                                |   | $      | 3,567                                |   | $ | 817 |   |   | 22.9 | % |

**41**

***Provision        for Income Taxes***

|                                          |   | Three                    Months Ended |                                 |   |   |                                 |   |
|-----------------------------------------------|--------|---------------------------------------|--------------------------------------|--------|--------|--------------------------------------|--------|
| *(Dollars                    in thousands)*   |   |                                  | September                    30,2006 |   |   | September                    30,2005 |   |   | 2006                    over 2005$                    Change |   |   | 2006                    over 2005%                    Change |   |
| Provision                    for Income Taxes |   | $                                     | 80                                   |   | $      | 100                                  |   | $ | (20 | ) |   | (20.0 | %) |

|                                          |   | Nine                    Months Ended |                                 |   |   |                                 |   |
|-----------------------------------------------|--------|--------------------------------------|--------------------------------------|--------|--------|--------------------------------------|--------|
| *(Dollars                    in thousands)*   |   |                                 | September                    30,2006 |   |   | September                    30,2005 |   |   | 2006                    over 2005$                    Change |   |   | 2006                    over 2005%                    Change |   |
| Provision                    for Income Taxes |   | $                                    | 240                                  |   | $      | 300                                  |   | $ | (60 | ) |   | (20.0 | %) |

**O**
**FF-BALANCE-SHEET        ARRANGEMENTS        AND OTHER        CONTRACTUAL        OBLIGATIONS **

*Off-Balance-Sheet      Arrangements.*

*Operating      Lease Commitments*

*Purchase      Commitments.*

**42**

*Indemnifications*

*Royalties*

*Legal        Actions. *

**43**

|                                |   | Payments                due by period |   |
|-------------------------------------|--------|---------------------------------------|--------|
|                                |   | Total                                 |   | Less                than1                year |   | 1-3                years |   | 3-5                years |   | More                than 5                years |   |
| Operating                leases     |   | $                                     | 27,828 |   | $ | 5,050 |   | $ | 9,385 |   | $ | 9,440 |   | $ | 3,953 |   |
| Purchase                commitments |   |                                  | 24,265 |   |   | 24,130 |   |   | 135 |   |   | -- |   |   | -- |   |
| Total                               |   | $                                     | 52,093 |   | $ | 29,180 |   | $ | 9,520 |   | $ | 9,440 |   | $ | 3,953 |   |

**L**
**IQUIDITY      AND CAPITAL      RESOURCES**

**  **

**44**

|                                                              |   | September                30,2006 |    | 2005   |   | 2004    |   | 2003   |    |
|-------------------------------------------------------------------|--------|----------------------------------|---------|--------|--------|---------|--------|--------|---------|
| Cash,                cash equivalents, and short-term investments |   | $                                | 129,792 |   | $      | 154,480 |   | $      | 160,364 |   | $ | 144,923 |   |
| Trade                accounts receivable, net                     |   |                             | 17,086  |   |   | 11,006  |   |   | 17,261  |   |   | 20,110 |   |
| Working                capital                                    |   |                             | 138,140 |   |   | 157,474 |   |   | 173,391 |   |   | 160,745 |   |
| Stockholders’                equity                         |   |                             | 162,762 |   |   | 181,308 |   |   | 211,062 |   |   | 200,924 |   |

***Net      cash provided by (used in) operating activities.***

***Net      cash provided by (used for) investing activities***
*.*

***Net        cash provided by (used in) financing activities.***

**45**

*“Factors          That May Affect Future Results of Operations.”*

**R**
**ELATED      PARTY      TRANSACTIONS**

**46**

**R**
**ECENTLY      ISSUED      ACCOUNTING      STANDARDS**

*Fair      Value Measurements*

*Considering      the Effects of Prior Year Misstatements When Quantifying Misstatements in      Current Year Financial Statements*

*      Accounting for Uncertainty in Income Taxes - an Interpretation of FASB Statement      No. 109*

**47**

*Accounting          for Certain Hybrid Financial Instruments*
*Accounting          for Derivative Instruments and Hedging Activities*
*Accounting          for Transfers and Servicing of Financial Assets and Extinguishments of          Liabilities*

*Accounting        Changes and Error Corrections, a replacement of APB Opinion No. 20,        Accounting Changes, and Statement No. 3, Reporting Accounting Changes in        Interim Financial Statements*

**F****ACTORS      THAT      MAY      AFFECT      FUTURE      RESULTS      OF OPERATIONS**

*        *

*Interested      persons should carefully consider the risks described below in evaluating our      company. Additional risks and uncertainties not presently known to us, or that      we currently consider immaterial, may also impair our business operations.      If      any of the following risks actually occur, our business, financial condition      or      results of operations could be materially adversely affected. In that case,      the      trading price of our common stock could decline.*

*        *

**Now      that the deployment phase of the Enel project has been completed, our overall      revenue has declined. Due to the lengthy sales cycle and timing of revenues      for      our NES business, our revenues may decline further. **

**  **

**48**

**Our      utility market product offerings may fail to meet customers’ expectations, or      may fail to meet our financial targets. If we incur penalties and/or damages      with respect to sales of the NES system, such penalties and/or damages could      have an adverse effect on our financial condition, revenues, and operating      results.**

**49**

**Effective        January 1, 2006, we began recording compensation expense for the calculated        fair        value of stock options and other compensatory equity-based awards that we        issue        to our employees, which has harmed our results of        operations.**

*Share-Based        Payment: an amendment of FASB Statements No. 123 and 95*

**Our      markets are highly competitive. Many of our competitors have longer operating      histories and greater resources than we do. If we are unable to effectively      compete in the industry, our operating results would be      harmed.**

** **

| ·   | our                ability to develop and introduce new products on a timely                basis; |
|--------------------|----------------------------------------------------------------------------------------------------|

| ·   | our                product reputation, quality, and performance; |
|--------------------|------------------------------------------------------------------|

**50**

| ·   | the                    price and features of our products such as adaptability, scalability,                    functionality, ease of use, and the ability to integrate with                    other                    products; |
|--------------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| ·   | our                    customer service and support; and |
|--------------------|----------------------------------------------------------|
| ·   | warranties,                    indemnities, and other contractual                    terms. |
|--------------------|---------------------------------------------------------------------------------------------|

**As      a      result of our lengthy sales cycle, we have limited ability to forecast the      amount and timing of revenue related to specific sales. If we fail to complete      or are delayed in completing transactions, our revenues could vary significantly      from period to period.**

**                            **

| ·   | changes                in our customers’ budgets;  |
|--------------------|---------------------------------------------------------------|

| ·   | changes                in the priority our customers assign to control network                development; |
|--------------------|------------------------------------------------------------------------------------------------------------|

| ·   | the                time it takes for us to educate our customers about the potential                applications of and cost savings associated with our products; |
|--------------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| ·   | the                deployment schedule for projects undertaken by our utility or systems                integrator customers; |
|--------------------|-------------------------------------------------------------------------------------------------------------------------------|

| ·   | the                actions of utility regulators or management boards regarding investments                in metering systems; |
|--------------------|---------------------------------------------------------------------------------------------------------------------------------|

| ·   | delays                in installing, operating, and evaluating the results of NES system                field                trials; and |
|--------------------|------------------------------------------------------------------------------------------------------------------------------------------|

| ·   | the                time it takes for utilities to evaluate multiple competing bids,                negotiate                terms, and award contracts for large scale metering system                deployments. |
|--------------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

**If      we do not maintain adequate distribution channels for our LONWORKS      Infrastructure products or our NES system products, our revenues will be      significantly harmed.**

**51**

**The      undetermined market acceptance of our products makes it difficult to evaluate      our future prospects.**

| ·   | some                of our targeted markets have not yet accepted many of our products                and                technologies; |
|--------------------|----------------------------------------------------------------------------------------------------------------------------------------|

| ·   | many                of our customers do not fully support open, interoperable networks,                and                this reduces the market for our                products; |
|--------------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| ·   | we                may not anticipate changes in customer requirements and, even if                we do so,                we may not be able to develop new or improved products that meet                these                requirements in a timely manner, or at                all; |
|--------------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| ·   | the                markets in which we operate require rapid and continuous development                of                new products, and we have failed to meet some of our product development                schedules in the past; |
|--------------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| ·   | potential                changes in voluntary product standards around the world can significantly                influence the markets in which we operate;                and |
|--------------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| ·   | our                industry is very competitive and many of our competitors have far                greater                resources and may be prepared to provide financial support from their                other businesses in order to compete with                us. |
|--------------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

**We        depend on a limited number of key manufacturers and use contract electronic        manufacturers for most of our products requiring assembly. If any of these        manufacturers terminates or decreases its relationships with us, we may not        be        able to supply our products and our revenues would suffer.**

**52**

**Because      we depend on sole or a limited number of suppliers, and because our products      may      use components or materials that are subject to price fluctuations, any price      increases, shortages, or interruptions of supply would adversely affect our      revenues and/or gross profits.**

**53**

**Our      business may suffer if it is alleged or found that our products infringe the      intellectual property rights of others or if our customers are concerned about      the potential for such infringement**
***.***
** **

**      **

**We      have a history of losses and, although we achieved profitability in prior years,      we expect to incur substantial losses again in 2006.**

** **

| ·   | adoption                of our NES solution and other products by service providers for use                in                utility and/or other home automation                projects; |
|--------------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| ·   | the                timing of revenue recognition related to sales of our NES system                products; |
|--------------------|--------------------------------------------------------------------------------------------------------------|

**54**

| ·   | revenue                  growth of our LONWORKS Infrastructure                  products; |
|--------------------|-------------------------------------------------------------------------------------------|
| ·   | continuation                  of worldwide economic growth, particularly in certain industries                  such as                  semiconductor manufacturing                  equipment; |
|--------------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| ·   | the                  ability of our contract electronic manufacturers to provide quality                  products on a timely basis, especially during periods where excess                  capacity in the contract electronic manufacturing market is                  reduced; |
|--------------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| ·   | growth                in acceptance of our products by OEMs, systems integrators, service                providers and end-users; |
|--------------------|-----------------------------------------------------------------------------------------------------------------------------------|

| ·   | the                effect of expensing stock option grants or other compensatory awards                to                our employees; |
|--------------------|-----------------------------------------------------------------------------------------------------------------------------------------|

| ·   | our                ability to attract new customers in light of increased                competition; |
|--------------------|-------------------------------------------------------------------------------------------------------|

| ·   | our                ability to develop and market, in a timely and cost-effective way,                new                products that perform as designed; |
|--------------------|------------------------------------------------------------------------------------------------------------------------------------------------------------|

| ·   | costs                associated with any future business acquisitions, including up-front                in-process research and development charges, ongoing amortization                expenses                related to other identified intangible assets, and ongoing operational                expenses associated with the acquired                entity; |
|--------------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| ·   | results                of impairment tests that we will perform from time to time in the                future,                in accordance with SFAS 142, with respect to goodwill and other identified                intangible assets that we acquired in the past or that we may acquire                in                the future. If the results of these impairment tests indicate that                an                impairment event has taken place, we will be required to take an                asset                impairment charge that could have a material adverse effect on our                operating results; and |
|--------------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| ·   | general                economic conditions. |
|--------------------|---------------------------------------------|

**We      face operational and financial risks associated with international      operations.**

**           **

| ·   | international                terrorism and anti-American                sentiment; |
|--------------------|------------------------------------------------------------------------------------|

| ·   | currency                fluctuations; |
|--------------------|---------------------------------------|

| ·   | unexpected                changes in regulatory requirements, tariffs and other trade                barriers; |
|--------------------|----------------------------------------------------------------------------------------------------------------|

| ·   | costs                  of localizing products for foreign countries and lack of acceptance                  of                  non-local products in foreign countries; |
|--------------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| ·   | longer                  accounts receivable payment cycles; |
|--------------------|-------------------------------------------------------------|

| ·   | difficulties                  in managing international operations; |
|--------------------|---------------------------------------------------------------------|

**55**

| ·   | labor                  actions generally affecting individual countries, regions, or any                  of our                  customers which could result in reduced demand for our                  products; |
|--------------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| ·   | potentially                  adverse tax consequences, including restrictions on repatriation                  of                  earnings; and |
|--------------------|--------------------------------------------------------------------------------------------------------------------------------------------------|

| ·   | the                  burdens of complying with a wide variety of foreign laws. |
|--------------------|--------------------------------------------------------------------------------|

**Fluctuations      in our operating results may cause our stock price to      decline.**

**   **

| ·   | the                complex revenue recognition rules relating to products such our NES                system                could require us to defer some or all of the revenue associated with                NES                product shipments until certain conditions, such as acceptance                criteria, are met in a future period; |
|--------------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

**56**

| ·   | our                    products may not be manufactured in accordance with specifications                    or our                    established quality standards, or may not perform as                    designed; |
|--------------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| ·   | our                  future operating results will continue to be materially adversely                  effected                  by the expense required to be recorded under SFAS 123R, *Share-Based                  Payment*,                  which became effective in 2006; |
|--------------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| ·   | we                  may fail to meet analysts’ expectations relating to our NES system and                  additional utility customers and                  applications; |
|--------------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| ·   | we                  may fail to meet analysts’ expectations for revenue growth in our sales of                  LONWORKS Infrastructure products to OEMs, systems integrators,                  and other                  customers; |
|--------------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| ·   | market                  prices for components or materials that we use in our products                  could                  fluctuate; |
|--------------------|-------------------------------------------------------------------------------------------------------------------------------------------|

| ·   | the                rates at which OEMs purchase our products and services may                fluctuate; |
|--------------------|---------------------------------------------------------------------------------------------------------|

| ·   | we                may fail to introduce new products on a timely basis or before the                end of                an existing product’s life cycle; |
|--------------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| ·   | downturns                in any customer’s or potential customer’s business, or declines in general                economic conditions, could cause significant reductions in capital                spending, thereby reducing the levels of orders from our                customers; |
|--------------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| ·   | we                may face increased competition for both our LONWORKS Infrastructure                products and our NES products; |
|--------------------|-------------------------------------------------------------------------------------------------------------------------------------|

| ·   | market                acceptance of our products may decrease; |
|--------------------|----------------------------------------------------------------|

| ·   | our                customers may delay or cancel their orders; |
|--------------------|----------------------------------------------------------------|

| ·   | the                mix of products and services that we sell may change to a less profitable                mix; |
|--------------------|------------------------------------------------------------------------------------------------------------------|

| ·   | shipment                and payment schedules may be delayed; |
|--------------------|---------------------------------------------------------------|

| ·   | our                pricing policies or those of our competitors may change; |
|--------------------|-----------------------------------------------------------------------------|

| ·   | we                could incur costs associated with future business acquisitions, including                up-front in-process research and development charges, ongoing amortization                expenses related to other identified intangible assets, and                ongoing operational expenses associated with the acquired                entity; |
|--------------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| ·   | our                product distribution may change; |
|--------------------|-----------------------------------------------------|

| ·   | product                ratings by industry analysts and endorsements of competing products                by                industry groups could hurt the market acceptance of our products;                and |
|--------------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ·   | the                results of impairment tests that we will perform from time to time                in the                future, in accordance with SFAS 142, with respect to goodwill and                other                identified intangible assets that we acquired in the past or that                we may                acquire in the future may indicate that an impairment event has taken                place. If so, we will be required to take an asset impairment charge                that                could have a material adverse effect on our operating                results. |
|--------------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

**Many      of our competitors develop, support, and promote alternative control systems.      If      we are unable to promote and expand acceptance of our open, interoperable      control systems, our revenues and operating results may be harmed.**

**57**

**Defects          in or misuse of our products or other liabilities not covered by insurance          may          delay our ability to generate revenues and may increase our liabilities          and          expenses.**

**           **

**We      promote an open technology platform that could increase our competition.**

**58**

**Downturns        in the control network technology market and        related markets may decrease our revenues and margins.**

**      **

**If        our        OEMs do not employ our products and technologies our revenues could decrease        significantly. **

**We      have limited ability to protect our intellectual property      rights.**

**       **

**59**

**If          OEMs fail to develop interoperable products or if our targeted markets          do not          accept our interoperable products, we may be unable to generate sales of          our          products.**

**Our            executive officers and technical personnel are critical to our business,            and if            we lose or fail to attract key personnel, we may not be able to successfully            operate our business.**

**60**

**The        markets for our products are rapidly evolving. If we are not able to develop        or        enhance products to respond to changing market conditions, our revenues will        suffer. **

**The        trading price of our stock has been volatile, and may fluctuate due to factors        beyond our control.**

** **
| ·   | significant                stockholders may sell some or all of their holdings of our stock.                For                example, Enel presently owns 3,000,000 shares, or approximately 7.6%                of                our outstanding common stock. Enel is generally free to sell these                shares                at its discretion. In the event Enel, or any other significant                stockholder, elects to sell all or a portion of their holdings in                our                shares, such sale or sales could depress the market price of our                stock                during the period in which such sales are                made; |
|--------------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| ·   | investors                may be concerned about our ability to develop additional customers                for our                NES system products and the success we have selling our LONWORKS                Infrastructure products and services to OEMs, systems integrators,                and                other customers; |
|--------------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| ·   | investors                may be concerned about the expense that we will be required to record                for                stock options and other stock-based incentives provided to our                employees; |
|--------------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| ·   | securities                analysts may change their estimates of our financial results;                and |
|--------------------|------------------------------------------------------------------------------------------------------------|

| ·   | increases                in market interest rates, which generally have a negative impact                on stock                prices. |
|--------------------|------------------------------------------------------------------------------------------------------------------------------------------|

**Voluntary      standards that are established in our markets could limit our ability to sell      our products and reduce our revenues.**

**61**

**Regulatory          actions could limit our ability to market and sell our          products.**

**Our          existing stockholders control a significant percentage of our stock, which          will          limit other stockholders’ ability to influence corporate          matters.**

**62**

**Potential      conflicts of interest could limit our ability to act on opportunities that      are      adverse to a significant stockholder or its affiliates.**

**Natural      disasters, power outages, and other factors outside of our control such as      widespread pandemics could disrupt our business. **

**63**

| **ITEM              3.** | **QUANTITATIVE                AND QUALITATIVE DISCLOSURES ABOUT MARKET                RISKS** |
|--------------------------|-----------------------------------------------------------------------------------------------|

*Market      Risk Disclosures.*

*Interest      Rate Sensitivity.*

*Foreign      Currency Exchange Risk.*

| **ITEM              4.** | **CONTROLS              AND              PROCEDURES** |
|--------------------------|-------------------------------------------------------|

***Limitations      on the Effectiveness of Controls***

**64**

***Conclusions      Regarding Disclosure Controls and Procedures and Internal Controls Over      Financial Reporting***

***Changes      in Internal Controls Over Financial Reporting***

**65**

**PART        II. OTHER INFORMATION**

| **ITEM 1.** | **LEGAL                PROCEEDINGS** |
|-------------|--------------------------------------|

| **ITEM 1A.**  | **RISK                FACTORS** |
|--------------------|---------------------------------|

| **ITEM                2.** | **UNREGISTERED                SALES OF EQUITY SECURITIES AND USE OF                PROCEEDS** |
|----------------------------|-----------------------------------------------------------------------------------------------|

| **Period**                                 |   | **Total                  Number of Shares Purchased** |    | **Average                  Price Paid per Share** |   | **Total                  Number of Shares Purchased as Part of Publicly Announced Plans                  or                  Programs** |   | **Maximum                  Number of Shares that May Yet Be Purchased Under the Plans or                  Programs** |      |
|--------------------------------------------|--------|-------------------------------------------------------|---------|---------------------------------------------------|--------|-----------------------------------------------------------------------------------------------------------------------------------------|--------|----------------------------------------------------------------------------------------------------------------------|-----------|
| July                  1- July 31           |   |                                                  | 111,090 | (1)                                               | $      | 7.82                                                                                                                                    |   |                                                                                                                 | 1,838,544 | (1) |   | 1,161,456 |   |
| August                  1- August 31       |   |                                                  | 211,522 |                                              | $      | 7.98                                                                                                                                    |   |                                                                                                                 | 2,050,066 |   |   | 949,934 |   |
| September                  1- September 30 |   |                                                  | ---     |                                              |   | ---                                                                                                                                     |   |                                                                                                                 | 2,050,066 |   |   | 949,934 |   |
| Total                                      |   |                                                  | 322,612 |                                              | $      | 7.92                                                                                                                                    |   |                                                                                                                 | 2,050,066 |   |   | 949,934 |   |

| (1) | Shares repurchased in open-market              transactions under the stock repurchase program approved by our board              of              directors in March and August 2004 and March 2006. The program authorizes              us to repurchase up to 3.0 million shares of our common stock, in              accordance with Rule 10b-18 and other applicable laws, rules and              regulations. During              the quarter ended September 30, 2006, we repurchased 322,612 shares              under              the program at a cost of $2.6 million. Since              inception, we have repurchased a total of 2,050,066 shares under the              program at a cost of $14.8 million. The              stock repurchase program will expire in March              2007. |
|-----|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| **ITEM 6.** | **EXHIBITS** |
|-------------|--------------|

| ExhibitNo. |  Description                of Document                                                                                                                                                                                                                           |
|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 31.1       | Certificate                of Echelon Corporation Chief Executive                Officer pursuant to Section 302 of the Sarbanes-Oxley Act of                2002.                                                                                                     |
| 31.2       | Certificate                of Echelon Corporation Chief Financial                Officer pursuant to Section 302 of the Sarbanes-Oxley Act of                2002.                                                                                                     |
| 32         | Certification                by the Chief Executive Officer and the                Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted                pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, furnished                herewith. |

**66**

**SIGNATURE**

|                                       |   |   | **ECHELON                CORPORATION**                                                                                                                                                                                       |
|--------------------------------------------|--------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| Date: November                9, 2006 |   | By:    | /s/                Oliver R. Stanfield                                                                                                                                                                                       |
|                                       |   |   | Oliver                R. Stanfield,Executive                Vice President and Chief Financial Officer (Duly Authorized Officer                and                Principal Financial and Accounting                Officer) |

**67**

----

**EXHIBIT      INDEX**

| ExhibitNo. |  Description                of Document                                                                                                                                                                                                                                          |
|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 31.1       | Certificate                of Echelon Corporation Chief Executive Officer pursuant to Section                302 of                the Sarbanes-Oxley Act of 2002.                                                                                                                    |
| 31.2       | Certificate                of Echelon Corporation Chief Financial Officer pursuant to Section                302 of                the Sarbanes-Oxley Act of 2002.                                                                                                                    |
| 32         | Certification                by the Chief Executive Officer and the Chief Financial Officer pursuant                to                18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the                Sarbanes-Oxley Act of 2002, furnished                herewith. |