----

----

**UNITED        STATES**

**SECURITIES        AND EXCHANGE COMMISSION**

**WASHINGTON,        D.C. 20549**

|                                                                                   |
|--------------------------------------------------------------------------------------------------|
| **FORM 10-K**                                                                               |
|  **(Mark                One)**                                                              |   |
| þ                                                                                           | **ANNUAL                REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE****SECURITIES                EXCHANGE ACT OF 1934** |
| **For                the fiscal year ended December 31, 2006**                              |
| **OR**                                                                                           |
| o                                                                                                | **TRANSITION                REPORT PURSUANT TO SECTION 13 OR 15(d) OF                THE****SECURITIES                EXCHANGE ACT OF 1934** |
| **For                the transition period from __________ to                __________.**  |
|                                                                                             |
| **Commission                file number: 000-29748**                                             |
| **ECHELON                CORPORATION**                                                           |
| (Exact                name of registrant as specified in its                charter)             |

| **Delaware**                                                                                | **77-0203595**                                                       |
|---------------------------------------------------------------------------------------------|----------------------------------------------------------------------|
| (State                or other jurisdiction ofincorporation                or organization) | (I.R.S.                EmployerIdentification                Number) |

| **550                Meridian Avenue****San                Jose, California 95126**                                              |
|----------------------------------------------------------------------------------------------------------------------------------|
| (Address                of principal executive office and zip code)                                                              |
| **(408) 938-5200**                                                                                                          |
| (Registrant’s                telephone number, including area code)                                                        |
|                                                                                                         |
| Securities                registered pursuant to Section 12(b) of the Act:                None                         |
| Securities                registered pursuant to Section 12(g) of the Act: Common Stock                $0.01 par value |
| Name                of each exchange on which registered: NASDAQ National                Market                                  |

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

| **Document**                                                                                                                                  |   | **Parts                Into Which Incorporated** |
|-----------------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------------------------------------|
| Proxy                Statement for the Annual Meeting of Stockholders to be held May 16,                2007                (Proxy Statement) |   | Part                III                          |

----

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**ECHELON      CORPORATION**

**FORM      10-K **

**FOR      THE YEAR ENDED DECEMBER 31, 2006**

**INDEX**

|                             |   |                                                                                                                         | **Page** |
|----------------------------------|--------|------------------------------------------------------------------------------------------------------------------------------|----------|
|                             |   | **PART                I**                                                                                                    |     |
| Item                1.           |   | Business                                                                                                                     | 3        |
| Item                1A.          |   | Risk                Factors                                                                                                  | 10       |
| Item                1B.          |   | Unresolved                Staff Comments                                                                                     | 18       |
| Item                2.           |   | Properties                                                                                                                   | 19       |
| Item                3.           |   | Legal                Proceedings                                                                                             | 19       |
| Item                4.           |   | Submission                of Matters to a Vote of Security                Holders                                            | 19       |
|                             |   | **PART                II**                                                                                                   |     |
| Item                5.           |   | Market                for the Registrant’s Common Equity and Related                Stockholder Matters                | 20       |
| Item                6.           |   | Selected                Financial Data                                                                                       | 21       |
| Item                7.           |   | Management’s                Discussion and Analysis of Financial Condition                and Results of Operations    | 22       |
| Item                7A.          |   | Quantitative                and Qualitative Disclosures About Market                Risk                                     | 37       |
| Item                8.           |   | Financial                Statements and Supplementary                Data                                                    | 37       |
| Item                9.           |   | Changes                in and Disagreements with Accountants on Accounting                and Financial Disclosure           | 37       |
| Item                9A.          |   | Controls                and Procedures                                                                                       | 38       |
| Item                9B.          |   | Other                Information                                                                                             | 38       |
|                             |   | **PART                III**                                                                                                  |     |
| Item                10.          |   | Directors,                Executive Officers and                Corporate Governance Matters             | 39       |
| Item                11.          |   | Executive                Compensation                                                                                        | 39       |
| Item                12.          |   | Security                Ownership of Certain Beneficial Owners and                Management and Related Stockholder Matters | 39       |
| Item                13.          |   | Certain                Relationships and Related Transactions and                Director Independence                       | 39       |
| Item                14.          |   | Principal                Accountant Fees and Services                                                                        | 39       |
|                             |   | **PART                IV**                                                                                                   |     |
| Item                15.          |   | Exhibits,                Financial Statement Schedule                                                                        | 40       |
|                             |   |                                                                                                                         |     |
| **SIGNATURES**                   | 73     |
| **EXHIBIT                INDEX** | 74     |
|                             |   |

***2***

**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 or      strategies regarding the future that are forward-looking. These statements      include those discussed in Item 1, Business, including “General,” “Markets”“Products and Services”, “Product Development,” “Marketing,” and “Government      Regulation” in Item 1A, Risk Factors, in Item 2, “Properties,” in Item 7,      Management’s Discussion and Analysis of Financial Condition and Results of      Operations, including “Critical Accounting Policies,” “Results of Operations,”“Off-Balance-Sheet Arrangements and Other Contractual Obligations,” “Liquidity      and Capital Resources,” “Acquisitions,” “Related Party Transactions,” “Recently      Issued Accounting Standards,” “Equity Based Compensation,” and “Factors That May      Affect Future Results of Operations,” and elsewhere in this report. In this      report, the words “anticipate,” “believe,” “expect,” “intend,” “future,” “moving      toward” and similar expressions also identify forward-looking statements. Our      actual results could differ materially from those forward-looking statements      contained in this report as a result of a number of factors including, but      not      limited to, those set forth in the section entitled “Factors That May Affect      Future Results of Operations” and elsewhere in this report. All forward-looking      statements and reasons why results may differ included in this report are made      as of the date of this report, and we assume no obligation to update any such      forward-looking statement or reason why such results might      differ.*

**PART      I**

|  **ITEM 1.** |  **BUSINESS** |
|-------------------|--------------------|

**       **

**General**

*i*
*i*
*i*

***3***

*i*
*i*

**Markets      **

*Electric      Utilities*

***4***

*Building        Automation*

*i*

*       *

*Industrial      Automation*

*       *

*Street      Lighting*

*i*
*i*

*Home      Control*

*Transportation*

***5***

**Products        & Services**

*transceivers*
*control      modules*
*routers*
*network      interfaces*
*development      tools*
*software      tools and toolkits*
*Transceivers*
*control      modules*
*Routers*
*Network      interfaces*
*development*
*software      tools and toolkits*

*i*
*i*
*i*

***6***

**Product        Development**

**Marketing**

**Sales      and Distribution**

**Manufacturing**

**       **

**Working      Capital**

***7***

**Competition        **

| ·   | our                ability to anticipate changes in customer requirements and to develop                new                or improved products that meet these requirements in a timely                manner; |
|--------------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

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

| ·   | our                product reputation, quality, performance, and conformance with established                industry standards; |
|--------------------|----------------------------------------------------------------------------------------------------------------------------------|

| ·   | our                customer service and support; |
|--------------------|--------------------------------------------------|

| ·   | warranties,                indemnities, and other contractual terms;                and |
|--------------------|-----------------------------------------------------------------------------------------|

| ·   | customer                relationships and market awareness. |
|--------------------|-------------------------------------------------------------|

**Government      Regulation**

***8***

**Proprietary        Rights **

**  **

**Employees      **

**Where      to Find More Information **

**Executive      Officers of the Registrant**

*M.      Kenneth Oshman*

*Beatrice      Yormark*
* *

*Oliver      R. Stanfield*
* *

***9***

*Anders      B. Axelsson*

*Kathleen      Bloch*

*       *

*Frederik      Bruggink*
* *

*Russell      Harris*

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

*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 would likely decline.*

**Our      NES revenues may not be predictable.**

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

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

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

***10***

**Sales      of our NES system may fail to meet our financial targets. **

| ·   | Increase                market acceptance of our NES system products in order to increase                revenues; |
|--------------------|--------------------------------------------------------------------------------------------------------------------|

| ·   | Increase                gross margin from our NES revenues by reducing the cost of manufacturing                our NES system products; and |
|--------------------|----------------------------------------------------------------------------------------------------------------------------------------------|

| ·   | Manage                our operating expenses to a reasonable percentage of                revenues. |
|--------------------|-----------------------------------------------------------------------------------------------------|

**We      depend on a limited number of key suppliers.**

| ·   | moving                raw material and in-process inventory between locations in different                parts                of the world; |
|--------------------|----------------------------------------------------------------------------------------------------------------------------------------------|

| ·   | reestablishing                acceptable manufacturing processes with a new work force;                and |
|--------------------|------------------------------------------------------------------------------------------------------------|

| ·   | exposure                to excess or obsolete inventory held by contract manufacturers for                use in                our products. |
|--------------------|-----------------------------------------------------------------------------------------------------------------------------------------------|

***11***

**Our      products use components or materials that may be subject to price fluctuations,      shortages, or interruptions of supply.**

**The      markets for our products are highly competitive.**

| ·   | our                ability to anticipate changes in customer requirements and to develop                new                or improved products that meet these requirements in a timely                manner; |
|--------------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

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

| ·   | our                product reputation, quality, performance, and conformance with established                industry standards; |
|--------------------|----------------------------------------------------------------------------------------------------------------------------------|

| ·   | our                customer service and support; |
|--------------------|--------------------------------------------------|

| ·   | warranties,                indemnities, and other contractual terms;                and |
|--------------------|-----------------------------------------------------------------------------------------|

| ·   | customer                relationships and market awareness. |
|--------------------|-------------------------------------------------------------|

***12***

**We      may incur penalties and/or damages with respect to sales of our NES system      products.**

**If      we do not maintain adequate distribution channels, our revenues will be      harmed.**

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

***13***

| ·         | costs                of localizing products for foreign countries and lack of acceptance                of                non-local products in foreign countries;                                           |
|--------------------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                     |                                                                                                                                                                                                         |
|  ·   | inherent                challenges in managing international operations;                                                                                                                                     |
|                     |                                                                                                                                                                                                         |
| ·         | the                burdens of complying with a wide variety of foreign laws and unexpected                changes in regulatory requirements, tariffs, and other trade                barriers;              |
|                     |                                                                                                                                                                                                         |
| ·         | economic                and political conditions in the countries where we do                business;                                                                                                       |
|                     |                                                                                                                                                                                                         |
| ·         | differing                vacation and holiday patterns in other countries, particularly in                Europe;                                                                                            |
|                     |                                                                                                                                                                                                         |
| ·         | labor                actions generally affecting individual countries, regions, or any                of our                customers, which could result in reduced demand for our                products; |
|                     |                                                                                                                                                                                                         |
| ·         | international                terrorism and anti-American sentiment; and                                                                                                                                      |
|                     |                                                                                                                                                                                                         |
| ·         | potentially                adverse tax consequences, including restrictions on repatriation                of                earnings.                                                                       |

**The      sales cycle for our LWI products is lengthy and unpredictable.**

**If      we sell our NES system products directly to a utility, we will face additional      risks.**

***14***

**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; |
|--------------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| ·   | our                contract electronic manufacturers may not be able to provide quality                products on a timely basis, especially during periods where capacity                in                the CEM market is limited; |
|--------------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

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

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

| ·   | our                products may not be accepted by utilities, OEMs, systems integrators,                service providers and end-users at the levels we                project; |
|--------------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| ·   | 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; |
|--------------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| ·   | recording                of expense relating to equity compensation as required under Statement                of                Financial Accounting Standard (SFAS) 123R,*Share-Based Payment*,                will decrease our earnings; |
|--------------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| ·   | we                may incur costs associated with any future business                acquisitions; |
|--------------------|----------------------------------------------------------------------------------------------------|

| ·   | results                of impairment tests for goodwill and other intangible assets in accordance                with SFAS 142, *Goodwill                and Other Intangible Assets*,                with respect to goodwill and other identified intangible assets that                we                acquired in the past or that we may acquire in the future may negatively                affect our earnings and financial condition;                and |
|--------------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

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

**We      may be unable to promote and expand acceptance of our open, interoperable      control systems over competing protocols, standards, or      technologies.**

***15***

**Liabilities      resulting from defects in or misuse of our products, whether or not covered      by      insurance, may delay our revenues and increase our liabilities and      expenses.**

**Our      business may suffer if it is alleged or found that our products infringe the      intellectual property rights of others**
***.***

***16***

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

**Our      executive officers and technical personnel are critical to our      business.**

**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; |
|--------------------|-------------------------------------------------------------------------------------------------------------|

| ·   | investors                may be concerned about our ability to develop additional customers                for our                products and services; |
|--------------------|----------------------------------------------------------------------------------------------------------------------------------------------------------|

| ·   | volatility                in our stock price may be unrelated or disproportionate to our operating                performance; and |
|--------------------|------------------------------------------------------------------------------------------------------------------------------------|

***17***

| ·   | our                  stock has very limited analyst coverage. |
|--------------------|---------------------------------------------------------------|

**Voluntary      standards and governmental regulatory actions in our markets could limit our      ability to sell our products.**

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

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

| **ITEM              1B.** | **UNRESOLVED              STAFF              COMMENTS** |
|---------------------------|---------------------------------------------------------|

***18***

| **ITEM              2.** | **PROPERTIES** |
|--------------------------|----------------|

| **ITEM              3.** | **LEGAL                PROCEEDINGS** |
|--------------------------|--------------------------------------|

| **ITEM              4.** | **SUBMISSION                OF MATTERS TO A VOTE OF SECURITY                HOLDERS** |
|--------------------------|---------------------------------------------------------------------------------------|

***19***

**PART        II**

| **ITEM 5.**  | **MARKET                FOR REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER                MATTERS** |
|-------------------|---------------------------------------------------------------------------------------------------------------|

|                                                  | **Price                Range**  |
|-------------------------------------------------------|--------------------------------------|
| ** Year                Ended December 31, 2006** |                                 | **High** |   |   | **Low** |   |
| Fourth                quarter                         | $                                    | 9.04 |   |  $ | 7.70 |   |
| Third                quarter                          |                                 | 8.99 |   |   | 6.92 |   |
| Second                quarter                         |                                 | 9.49 |   |   | 7.32 |   |
| First                quarter                          |                                 | 9.50 |   |   | 7.58 |   |
|                                                  |                                 |   |   |   |   |   |
| ** Year                Ended December 31, 2005** |                                 | **High** |   |   | **Low** |   |
| Fourth                quarter                         | $                                    | 9.27 |   | $ | 6.99 |   |
| Third                quarter                          |                                 | 9.71 |   |   | 6.65 |   |
| Second                quarter                         |                                 | 7.26 |   |   | 5.96 |   |
| First                quarter                          |                                 | 8.55 |   |   | 6.29 |   |

**       **

**Dividend      Policy**

**Equity      Compensation Plan Summary Information**

**Recent      Sales of Unregistered Securities**

***20***

| **ITEM              6.**  | **SELECTED                FINANCIAL                DATA** |
|--------------------------------|-----------------------------------------------------------|

|                                                                   | Year                Ended December 31,          |
|------------------------------------------------------------------------|------------------------------------------------------|
|                                                                   |                                                 | 2006 |   |   | 2005 |   |   | 2004 |   |   | 2003 |   |   | 2002 |   |
| **Consolidated                  Statement of Operations Data:**        | (in                thousands, except per share data) |   |
| Net                revenues:                                           |                                                 |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Product                                                                | $                                                    | 56,515 |   | $ | 73,563 |   | $ | 108,947 |   | $ | 117,153 |   | $ | 121,454 |   |
| Service                                                                |                                                 | 761 |   |   | 865 |   |   | 974 |   |   | 1,000 |   |   | 1,380 |   |
| Total                revenues                                          |                                                 | 57,276 |   |   | 74,428 |   |   | 109,921 |   |   | 118,153 |   |   | 122,834 |   |
|                                                                   |                                                 |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Cost                of revenues:                                       |                                                 |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Cost                of product                                         |                                                 | 22,032 |   |   | 30,955 |   |   | 46,110 |   |   | 49,407 |   |   | 57,059 |   |
| Cost                of service                                         |                                                 | 1,917 |   |   | 2,124 |   |   | 2,003 |   |   | 2,650 |   |   | 2,880 |   |
| Total                cost of revenues                                  |                                                 | 23,949 |   |   | 33,079 |   |   | 48,113 |   |   | 52,057 |   |   | 59,939 |   |
|                                                                   |                                                 |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Gross                profit                                            |                                                 | 33,327 |   |   | 41,349 |   |   | 61,808 |   |   | 66,096 |   |   | 62,895 |   |
|                                                                   |                                                 |    |   |   |   |   |   |   |   |   |   |   |   |   |    |
| Operating                expenses:                                     |                                                 |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Product                development                                     |                                                 | 28,357 |   |   | 25,098 |   |   | 25,262 |   |   | 35,113 |   |   | 21,456 |   |
| Sales                and marketing                                     |                                                 | 20,372 |   |   | 21,023 |   |   | 19,440 |   |   | 18,597 |   |   | 17,291 |   |
| General                and administrative                              |                                                 | 14,505 |   |   | 20,018 |   |   | 13,388 |   |   | 12,108 |   |   | 9,711 |   |
| Total                operating expenses                                |                                                 | 63,234 |   |   | 66,139 |   |   | 58,090 |   |   | 65,818 |   |   | 48,458 |   |
|                                                                   |                                                 |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Operating                income/(loss)                                 |                                                 | (29,907 | ) |   | (24,790 | ) |   | 3,718 |   |   | 278 |   |   | 14,437 |   |
| Interest                and other income, net                          |                                                 | 5,817 |   |   | 5,225 |   |   | 2,140 |   |   | 2,219 |   |   | 3,777 |   |
| Income/(loss)                before provision for income taxes         |                                                 | (24,090 | ) |   | (19,565 | ) |   | 5,858 |   |   | 2,497 |   |   | 18,214 |   |
| Provision                for income taxes                              |                                                 | 350 |   |   | 154 |   |   | 586 |   |   | 600 |   |   | 1,457 |   |
| Net                income/(loss)                                       | $                                                    | (24,440 | ) | $ | (19,719 | ) | $ | 5,272 |   | $ | 1,897 |   | $ | 16,757 |   |
|                                                                   |                                                 |   |   |   |   |   |   |    |   |   |   |   |   |   |   |
| Income/(loss)                per share (1):                            |                                                 |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Basic                                                                  | $                                                    | (0.62 | ) | $ | (0.49 | ) | $ | 0.13 |   | $ | 0.05 |   | $ | 0.42 |   |
| Diluted                                                                | $                                                    | (0.62 | ) | $ | (0.49 | ) | $ | 0.13 |   | $ | 0.05 |   | $ | 0.41 |   |
|                                                                   |                                            |   |    |   |   |   |   |   |   |   |   |   |   |   |   |
| Shares                used in per share calculation (1):               |                                                 |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Basic                                                                  |                                                 | 39,487 |   |   | 40,377 |   |   | 40,918 |   |   | 40,070 |   |   | 39,468 |   |
| Diluted                                                                |                                                 | 39,847 |   |   | 40,377 |   |   | 41,007 |   |   | 40,792 |   |   | 40,726 |   |
|                                                                   |                                                 |   |   |   |   |   |   |   |   |   |   |   |   |   |    |
| **Consolidated                Balance Sheet Data:**                    |                                                 |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Cash,                cash equivalents and short-term investments  | $                                                    | 124,157 |   | $ | 154,480 |   | $ | 160,364 |   | $ | 144,923 |   | $ | 134,489 |   |
| Working                capital                               |                                                 | 132,420 |   |   | 157,474 |   |   | 173,391 |   |   | 160,745 |   |   | 156,319 |   |
| Total                assets                                  |                                                 | 196,276 |   |   | 195,938 |   |   | 223,916 |   |   | 214,128 |   |   | 207,492 |   |
| Total                stockholders’ equity              |                                                 | 156,575 |   |   | 181,308 |   |   | 211,062 |   |   | 200,924 |   |   | 195,018 |   |

| (1)   | See                Note 2 of Notes to Consolidated Financial Statements for an explanation                of                shares used in computing basic net income/(loss) per share, and diluted                net income/(loss) per share. |
|-----------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

***21***

|  **ITEM              7.** |  **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 Annual          Report.          The following discussion contains predictions, estimates, and other          forward-looking statements that involve a number of risks and uncertainties          about our business. These statements may be identified by the use of words          such          as “we believe,” “expect,” “anticipate,” “intend,” “plan,” “goal,” “continues,”“may” and similar expressions. In addition, forward-looking statements include          statements that refer to projections of our future financial performance,          our          anticipated growth and trends in our businesses, and other characterizations          of          future events or circumstances. Such statements are based on our current          expectations and could be affected by the uncertainties and risk factors          described throughout this filing and particularly in the “Business” and “Risk          Factors” sections. Our actual results may differ materially.*

**Overview**

***22***

**Critical      Accounting Estimates**

**Stock-Based      Compensation.**

***23***

**Sales      Returns and Allowances.**

**Allowance      for Doubtful Accounts.**

***24***

**Inventory      Valuation.**

**Warranty      Reserves.**

**Deferred      Income Taxes.**

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

|  ·   | significant underperformance relative              to              expected historical or projected future operating results;                    |
|--------------------------|--------------------------------------------------------------------------------------------------------------------------------------------------|
|                          |                                                                                                                                             |
|  ·   | significant              changes in the manner or use of the acquired assets or the strategy              for              our overall business; |
|                     |                                                                                                                                             |
|  ·   | significant              negative industry or economic trends; and                                                                               |
|                     |                                                                                                                                             |
|  ·   | significant              changes in the composition of the intangible assets              acquired.                                              |

*      Goodwill and Other Intangible Assets,*

**Results      of Operations**

***25***

|                                                           |   | **Year                Ended December 31,**  |   |
|----------------------------------------------------------------|--------|--------------------------------------------------|--------|
|                                                           |   | **2006**                                         |   | **2005** |   | **2004** |   |
| Revenues:                                                      |   |                                             |        |   |   |  |   |   |  |   |
| Product                                              |   |                                             | 98.7   | % |   | 98.8 | % |   | 99.1 | % |
| Service                                              |   |                                             | 1.3    |   |   | 1.2 |   |   | 0.9 |   |
| Total                revenues                        |   |                                             | 100.0  |   |   | 100.0 |   |   | 100.0 |   |
| Cost                of revenues:                               |   |                                             |        |   |   |  |   |   |  |   |
| Cost                of product                       |   |                                             | 38.5   |   |   | 41.6 |   |   | 42.0 |   |
| Cost                of service                       |   |                                             | 3.3    |   |   | 2.8 |   |   | 1.8 |   |
| Total                cost of revenues                          |   |                                             | 41.8   |   |   | 44.4 |   |   | 43.8 |   |
| Gross                profit                          |   |                                             | 58.2   |   |   | 55.6 |   |   | 56.2 |   |
| Operating                expenses:                             |   |                                             |        |   |   |  |   |   |  |   |
| Product                development                   |   |                                             | 49.5   |   |   | 33.7 |   |   | 23.0 |   |
| Sales                and marketing                   |   |                                             | 35.6   |   |   | 28.3 |   |   | 17.6 |   |
| General                and administrative                      |   |                                             | 25.3   |   |   | 26.9 |   |   | 12.2 |   |
| Total                operating expenses                        |   |                                             | 110.4  |   |   | 88.9 |   |   | 52.8 |   |
| Income/(loss)                from operations                   |   |                                             | (52.2  | ) |   | (33.3 | ) |   | 3.4 |   |
| Interest                and other income, net                  |   |                                             | 10.1   |   |   | 7.0 |   |   | 1.9 |   |
| Income/(loss)                before provision for income taxes |   |                                             | (42.1  | ) |   | (26.3 | ) |   | 5.3 |   |
| Provision                for income taxes            |   |                                             | 0.6    |   |   | 0.2 |   |   | 0.5 |   |
| Net                income/(loss)                     |   |                                             | (42.7  | )% |   | (26.5 | )% |   | 4.8 | % |

***Revenues***

*** ** *

*Total      revenues*

|                                 | Year                  Ended December 31,  |   | 2006                  over 2005 |   | 2005                  over 2004 |   | 2006                  over 2005 |    |   | 2005                  over 2004 |    |                      |
|-------------------------------------------|------------------------------------------------|--------|---------------------------------|--------|---------------------------------|--------|---------------------------------|---------|--------|---------------------------------|---------|---------------------------|
| *(Dollars                  in thousands)* |                                           | 2006   |                            |   | 2005                            |   |                            | 2004    |   | $                  Change       |    | $                  Change |   | %                  Change |   |   | %                  Change |   |   |
| Total                  revenues           | $                                              | 57,276 |                            | $      | 74,428                          |   | $                               | 109,921 |   | ($17,152                        | )  | ($35,493                  | ) | (23.0 | %) |   | (32.3 | %) |   |

*LonWorks      Infrastructure revenues*

|                                               | Year                  Ended December 31,  |   | 2006                  over 2005 |   | 2005                  over 2004 |   | 2006                  over 2005 |   |   | 2005                  over 2004 |   |                      |
|---------------------------------------------------------|------------------------------------------------|--------|---------------------------------|--------|---------------------------------|--------|---------------------------------|--------|--------|---------------------------------|--------|---------------------------|
| *(Dollars                  in thousands)*               |                                           | 2006   |                            |   | 2005                            |   |                            | 2004   |   | $                  Change       |   | $                  Change |   | %                  Change |   |   | %                  Change |   |   |
| LonWorks                  Infrastructure Revenues  | $                                              | 49,382 |                            | $      | 46,612                          |   | $                               | 45,717 |   | $2,770                          |   | $895                      |   | 5.9 | % |   | 2.0 | % |   |

***26***

*Enel      Project revenues *

|                                 | Year                  Ended December 31,  |   | 2006                  over 2005 |   | 2005                  over 2004 |   | 2006                  over 2005 |   |   | 2005                  over 2004 |   |                      |
|-------------------------------------------|------------------------------------------------|--------|---------------------------------|--------|---------------------------------|--------|---------------------------------|--------|--------|---------------------------------|--------|---------------------------|
| *(Dollars                  in thousands)* |                                           | 2006   |                            |   | 2005                            |   |                            | 2004   |   | $                  Change       |   | $                  Change |   | %                  Change |   |   | %                  Change |   |   |
| Enel                  Project revenues    | $                                              | 7,103  |                            | $      | 26,933                          |   | $                               | 64,119 |   | ($19,830                        | )      | ($37,186                  | ) | (73.6 | %) |   | (58.0 | %) |   |

***27***

*NES      revenues*

|                                 | Year                  Ended December 31,  |   | 2006                  over 2005 |   | 2005                  over 2004 |   | 2006                  over 2005 |   |   | 2005                  over 2004 |    |                      |
|-------------------------------------------|------------------------------------------------|--------|---------------------------------|--------|---------------------------------|--------|---------------------------------|--------|--------|---------------------------------|---------|---------------------------|
| *(Dollars                  in thousands)* |                                           | 2006   |                            |   | 2005                            |   |                            | 2004   |   | $                  Change       |    | $                  Change |   | %                  Change |   |   | %                  Change |   |   |
| NES                  revenues        | $                                              | 791    |                            | $      | 883                             |   | $                               | 85     |   | ($92                            | )  | $798                      |   | (10.4 | %) |   | 938.8 | % |   |

*EBV      revenues*
|                                         | Year                Ended December 31,  |   | 2006                over 2005 |   | 2005                over 2004 |   | 2006                over 2005 |   |   | 2005                over 2004 |    |                    |
|-----------------------------------------|----------------------------------------------|--------|-------------------------------|--------|-------------------------------|--------|-------------------------------|--------|--------|-------------------------------|---------|-------------------------|
| *(Dollars                in thousands)* |                                         | 2006   |                          |   | 2005                          |   |                          | 2004   |   | $                Change       |    | $                Change |   | %                Change |   |   | %                Change |   |   |
| EBV              Revenues               | $                                            | 15,511 |                          | $      | 15,610                        |   | $                             | 15,875 |   | ($99                          | )  | ($265                   | ) | (0.6 | %) |   | (1.7 | %) |   |

***28***

*Product        Revenues  *
|                                             | Year                Ended December 31,  |   | 2006                over 2005 |   | 2005                over 2004 |   | 2006                over 2005 |    |   | 2005                over 2004 |    |                    |
|---------------------------------------------|----------------------------------------------|--------|-------------------------------|--------|-------------------------------|--------|-------------------------------|---------|--------|-------------------------------|---------|-------------------------|
| *(Dollars                in thousands)*     |                                         | 2006   |                          |   | 2005                          |   |                          | 2004    |   | $                Change       |    | $                Change |   | %                Change |   |   | %                Change |   |   |
| Product                Revenues   | $                                            | 56,515 |                          | $      | 73,563                        |   | $                             | 108,947 |   | ($17,048                      | )  | ($35,384                | ) | (23.2 | %) |   | (32.5 | %) |   |

* *
* *

*Service      revenues*
|                                             | Year                Ended December 31,  |   | 2006                over 2005 |   | 2005                over 2004 |   | 2006                over 2005 |   |   | 2005                over 2004 |    |                    |
|---------------------------------------------|----------------------------------------------|--------|-------------------------------|--------|-------------------------------|--------|-------------------------------|--------|--------|-------------------------------|---------|-------------------------|
| *(Dollars                in thousands)*     |                                         | 2006   |                          |   | 2005                          |   |                          | 2004   |   | $                Change       |    | $                Change |   | %                Change |   |   | %                Change |   |   |
| Service                Revenues   | $                                            | 761    |                          | $      | 865                           |   | $                             | 974    |   | ($104                         | )  | ($109                   | ) | (12.0 | %) |   | (11.2 | %) |   |

***29***

***Gross      Profit and Gross Margin***
|                                         | Year                Ended December 31,  |   | 2006                over 2005 |   | 2005                over 2004 |   | 2006                over 2005 |   |   | 2005                over 2004 |    |                    |
|-----------------------------------------|----------------------------------------------|--------|-------------------------------|--------|-------------------------------|--------|-------------------------------|--------|--------|-------------------------------|---------|-------------------------|
| *(Dollars                in thousands)* |                                         | 2006   |                          |   | 2005                          |   |                          | 2004   |   | $                Change       |    | $                Change |   | %                Change |   |   | %                Change |   |   |
| Gross                Profit             | $                                            | 33,327 |                          | $      | 41,349                        |   | $                             | 61,808 |   | ($8,022                       | )  | ($20,459                | ) | (19.4 | %) |   | (33.1 | %) |   |
| Gross                Margin   |                                         | 58.2   |  %                       |   | 55.6                          | %      |                          | 56.2   | %      | —                       |    | —                 |   | 2.6 |   |   | (0.6 | ) |   |

***Operating      Expenses***

*Product      development*

|                                                | Year                Ended December 31,  |   | 2006                over 2005 |   | 2005                over 2004 |   | 2006                over 2005 |   |   | 2005                over 2004 |   |                    |
|------------------------------------------------|----------------------------------------------|--------|-------------------------------|--------|-------------------------------|--------|-------------------------------|--------|--------|-------------------------------|--------|-------------------------|
| *(Dollars                in thousands)*        |                                         | 2006   |                          |   | 2005                          |   |                          | 2004   |   | $                Change       |   | $                Change |   | %                Change |   |   | %                Change |   |   |
| Product                Development   | $                                            | 28,357 |                          | $      | 25,098                        |   | $                             | 25,262 |   | $3,259                        |   | ($164                   | ) | 13.0 | % |   | (0.6 | %) |   |

*Sales      and marketing*

|                                                | Year                Ended December 31,  |   | 2006                over 2005 |   | 2005                over 2004 |   | 2006                over 2005 |   |   | 2005                over 2004 |    |                    |
|------------------------------------------------|----------------------------------------------|--------|-------------------------------|--------|-------------------------------|--------|-------------------------------|--------|--------|-------------------------------|---------|-------------------------|
| *(Dollars                in thousands)*        |                                         | 2006   |                          |   | 2005                          |   |                          | 2004   |   | $                Change       |    | $                Change |   | %                Change |   |   | %                Change |   |   |
| Sales                and Marketing   | $                                            | 20,372 |                          | $      | 21,023                        |   | $                             | 19,440 |   | ($651                         | )  | $1,583                  |   | (3.1 | %) |   | 8.1 | % |   |

***30***

*General      and administrative*

|                                                       | Year                Ended December 31,  |   | 2006                over 2005 |   | 2005                over 2004 |   | 2006                over 2005 |   |   | 2005                over 2004 |    |                    |
|-------------------------------------------------------|----------------------------------------------|--------|-------------------------------|--------|-------------------------------|--------|-------------------------------|--------|--------|-------------------------------|---------|-------------------------|
| *(Dollars                in thousands)*               |                                         | 2006   |                          |   | 2005                          |   |                          | 2004   |   | $                Change       |    | $                Change |   | %                Change |   |   | %                Change |   |   |
| General                and Administrative   | $                                            | 14,505 |                          | $      | 20,018                        |   | $                             | 13,388 |   | ($5,513                       | )  | $6,630                  |   | (27.5 | %) |   | 49.5 | % |   |

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

|                                                     | Year                Ended December 31,  |   | 2006                over 2005 |   | 2005                over 2004 |   | 2006                over 2005 |   |   | 2005                over 2004 |   |                    |
|-----------------------------------------------------|----------------------------------------------|--------|-------------------------------|--------|-------------------------------|--------|-------------------------------|--------|--------|-------------------------------|--------|-------------------------|
| *(Dollars                in thousands)*             |                                         | 2006   |                          |   | 2005                          |   |                          | 2004   |   | $                Change       |   | $                Change |   | %                Change |   |   | %                Change |   |   |
| Interest                and Other Income, Net  | $                                            | 5,817  |                          | $      | 5,225                         |   | $                             | 2,140  |   | $592                          |   | $3,085                  |   | 11.3 | % |   | 144.2 | % |   |

***31***

*Foreign      Currency Translation*

***Provision      for Income Taxes***

|                                                 | Year                Ended December 31,  |   | 2006                over 2005 |   | 2005                over 2004 |   | 2006                over 2005 |   |   | 2005                over 2004 |   |                    |
|-------------------------------------------------|----------------------------------------------|--------|-------------------------------|--------|-------------------------------|--------|-------------------------------|--------|--------|-------------------------------|--------|-------------------------|
| *(Dollars                in thousands)*         |                                         | 2006   |                          |   | 2005                          |   |                          | 2004   |   | $                Change       |   | $                Change |   | %                Change |   |   | %                Change |   |   |
| Provision                for Income Taxes  | $                                            | 350    |                          | $      | 154                           |   | $                             | 586    |   | $196                          |   | ($432                   | ) | 127.3 | % |   | (73.7 | %) |   |

**Off-Balance-Sheet      Arrangements and Other Contractual Obligations**

*Off-Balance-Sheet      Arrangements.*

***32***

*Operating      Lease Commitments*

*Purchase      Commitments.*

*Indemnifications*

*Royalties*

*Taxes.*

***33***

*Legal      Actions. *

|                                | Payments                due by period  |
|-------------------------------------|---------------------------------------------|
|                                |                                        | Total  |   |   | Less                than 1 year |   |   | 1-3                years |   |   | 4-5                years |   |   | More                than 5 years |
| Operating                leases     | $                                           | 27,413 |   | $ | 5,258 |   | $ | 9,584 |   | $ | 9,204 |   | $ | 3,367 |
| Purchase                commitments |                                        | 23,642 |   |   | 23,642 |   |   | -- |   |   | -- |   |   | -- |
| Total                               | $                                           | 51,055 |   | $ | 28,900 |   | $ | 9,584 |   | $ | 9,204 |   | $ | 3,367 |

**Liquidity      and Capital Resources**

|                                                              | As                of December 31, |
|-------------------------------------------------------------------|-----------------------------------|
|                                                              |                              | 2006 |   |   | 2005 |   |   | 2004 |
| Cash,                cash equivalents, and short-term investments | $                                 | 124,157 |   | $ | 154,480 |   | $ | 160,364 |
| Trade                accounts receivable, net                     |                              | 13,918 |   |   | 11,006 |   |   | 17,261 |
| Working                capital                                    |                              | 132,420 |   |   | 157,474 |   |   | 173,391 |
| Stockholder’s                equity                         |                              | 156,575 |   |   | 181,308 |   |   | 211,062 |

***34***

*Cash      flows from operating activities*

*Cash      flows from investing activities.*

*Cash      flows from financing activities.*

**Related      Party Transactions**

***35***

**Recently      Issued Accounting Standards**

*Fair      Value Measurements*

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

***36***

*      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*

|  **ITEM              7A.** | **QUANTITATIVE                AND QUALITATIVE DISCLOSURES ABOUT MARKET                RISK** |
|---------------------------------|----------------------------------------------------------------------------------------------|

*Market      Risk Disclosures.*

*Interest      Rate Sensitivity.*

*Foreign      Currency Exchange Risk.*

| **ITEM              8.** | ** FINANCIAL                STATEMENTS AND SUPPLEMENTARY DATA** |
|--------------------------|----------------------------------------------------------------------|

| **ITEM              9.** | ** CHANGES                IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING                AND FINANCIAL                DISCLOSURE** |
|--------------------------|---------------------------------------------------------------------------------------------------------------------------------------------|

***37***

| **ITEM              9A.** | **CONTROLS                AND PROCEDURES** |
|---------------------------|--------------------------------------------|

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

***Disclosure      Controls and Procedures***

***Management’s      Annual Report on Internal Control Over Financial      Reporting***

*Internal      Control — Integrated Framework *
*Internal      Control — Integrated Framework*

***Changes      in Internal Control Over Financial Reporting***

| **ITEM              9B.** | **OTHER                INFORMATION** |
|---------------------------|--------------------------------------|

***38***

**PART        III**

| **ITEM              10.** | **DIRECTORS,                EXECUTIVE OFFICERS **AND CORPORATE GOVERNANCE                MATTERS**** |
|---------------------------|------------------------------------------------------------------------------------------------------|

| **ITEM              11.** | **EXECUTIVE                COMPENSATION** |
|---------------------------|-------------------------------------------|

| **ITEM              12.** | **SECURITYOWNERSHIP                OF CERTAIN BENEFICIAL OWNERS AND                MANAGEMENT** |
|---------------------------|-------------------------------------------------------------------------------------------------|

| **ITEM              13.** | **CERTAIN                RELATIONSHIPS AND RELATED TRANSACTIONS **AND                DIRECTOR                INDEPENDENCE**** |
|---------------------------|-------------------------------------------------------------------------------------------------------------------------------|

| **ITEM              14.** | **PRINCIPAL                ACCOUNTANT FEES AND                SERVICES** |
|---------------------------|--------------------------------------------------------------------------|

***39***

**PART        IV**

| **ITEM              15.** | **EXHIBITS,                FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM                8-K ** |
|---------------------------|---------------------------------------------------------------------------------------------------------|

|   | 1. | Financial                Statements |
|--------|----|-------------------------------------|

|                                                                                | **Page** |
|-------------------------------------------------------------------------------------|----------|
| Reports                of Independent Registered Public Accounting Firm   | 42       |
| Consolidated                Balance Sheets                                | 44       |
| Consolidated                Statements of Operations                      | 45       |
| Consolidated                Statements of Stockholders' Equity            | 46       |
| Consolidated                Statements of Comprehensive Income/(Loss)     | 46       |
| Consolidated                Statements of Cash Flows                      | 47       |
| Notes                to Consolidated Financial Statements                 | 48       |

|   | 2. | Financial                Statement Schedule |
|--------|----|---------------------------------------------|

| Schedule                II Valuation and Qualifying Accounts   | 72 |
|--------------------------------------------------------------------------|----|

|   |  | All                other schedules have been omitted because they are not applicable                or the                required information is included in the Consolidated Financial Statements                or the Notes thereto. |
|--------|--|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

|   | 3.  | Exhibits |
|--------|----------|----------|

|   |  | Item                601 of Regulation S-K requires the following exhibits listed below.                Each                management contract or compensatory plan or arrangement required                to be                filed as an exhibit to this Form 10-K has been identified. |
|--------|--|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| ExhibitNo. |  Description                of Document                                                                                                                 |
|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.2*       | Amended                and Restated Certificate of Incorporation of                Registrant.                                                               |
| 3.3*       | Amended                and Restated Bylaws of Registrant.                                                                                                    |
| 4.1*       | Form                of Registrant’s Common Stock Certificate.                                                                                          |
| 4.2*       | Second                Amended and Restated Modification Agreement dated May 15,                1997.                                                         |
| 10.1*      | Form                of Indemnification Agreement entered into by Registrant with each                of its                directors and executive officers. |
| 10.2*+     | 1997                Stock Plan and forms of related                agreements.                                                                               |

| 10.2(a)+ | Form                  of 1997 Stock Plan Stock Option Agreement with                  early exercise feature                                                        |
|----------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.2(b)+ | Form                  of 1997 Stock Plan Nonqualified Stock Option                  Agreement with early exercise feature                                           |
| 10.2(c)+ | Form                  of 1997 Stock Plan Nonqualified Stock Option                  Agreement                                                                       |
| 10.2(d)+ | Form                  of 1997 Stock Plan Performance Share                  Agreement                                                                               |
| 10.2(e)+ | Form                  of 1997 Stock Plan Performance Share Agreement for                  non-US employees                                                          |
| 10.2(f)+ | Form                  of 1997 Stock Plan Performance Share Agreement                  with performance based vesting criteria for non-US                  employees |
| 10.2(g)+ | Form                  of 1997 Stock Plan Stock Appreciation Right                  Agreement for non-US employees                                                   |
| 10.2(h)+ | Form                  of 1997 Stock Plan Performance Share Agreement                  with performance based vesting criteria                                       |
| 10.2(i)+ | Form                  of 1997 Stock Plan Performance Share                  Agreement                                                                               |
| 10.2(j)+ | Form                  of 1997 Stock Plan Stock Appreciation Right                  Agreement                                                                        |

| 10.3*+ | 1988                Stock Option Plan and forms of related agreements.                                                                                             |
|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.4*  | Second                Amended and Restated Modification Agreement dated May 15, 1997 (included                in Exhibit 4.2).                                     |
| 10.5*  | Form                of International Distributor Agreement.                                                                                                        |
| 10.6*  | Form                of OEM License Agreement.                                                                                                                      |
| 10.7*  | Form                of Software License Agreement.                                                                                                                 |
| 10.8*  | International                Distributor Agreement between the Company and EBV Elektronik GmbH                as                ofDecember                1, 1997. |
| 10.9*+ | 1998                Director Option Plan.                                                                                                                          |

***40***

| 21.1* | Subsidiaries                of the Registrant.                                                                                                                                                                                                                    |
|-------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 23.1  | Consent                of KPMG LLP, Independent Registered Public                Accounting Firm.                                                                                                                                                                 |
| 24.1  | Power                of Attorney (see signature page).                                                                                                                                                                                                            |
| 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. |

| * | Previously                filed.                                                                                                                                                                      |
|---|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| + | Indicates                management contract or compensatory plan or arrangement required                to be                filed as an exhibit pursuant to Item 14(c) of Form                10-K. |

***41***

**REPORT      OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**

* *

*Share-Based        Payment*

*        Internal Control—Integrated Framework *

***42***

**REPORT        OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING        FIRM**

*,        *
*        Internal Control—Integrated Framework *

*        Internal Control—Integrated Framework *
*.        *
*        Internal Control—Integrated Framework *
*.*

***43***

CONSOLIDATED      BALANCE SHEETS

|                                                                                                             |                     | As                of December 31,  |
|-----------------------------------------------------------------------------------------------------------------------|--------------------------|-----------------------------------------|
|                                                                                                        |           |                                    | 2006 |   |   | 2005 |   |
| **ASSETS**                                                                                                            |           |                                    |    |    |   |   |   |
| Current                Assets:                                                                                        |                     |                                    |    |   |   |   |   |
| Cash                and cash equivalents                                                                              |                     | $                                       | 37,412 |   | $ | 59,080 |   |
| Short-term                investments                                                                                 |                     |                                    | 86,745 |   |   | 95,400 |   |
| Accounts                receivable, net of allowances of $1,041 in 2006 and $1,511 in                2005             |                     |                                    | 13,918 |   |   | 11,006 |   |
| Inventories                                                                                                           |                     |                                    | 11,359 |   |   | 3,240 |   |
| Deferred                cost of goods sold                                                                            |                     |                                    | 19,060 |   |   | 322 |   |
| Other                current assets                                                                                   |                     |                                    | 2,359 |   |   | 1,967 |   |
| Total                current assets                                                                                   |                     |                                    |  170,853 |   |   |  171,015 |   |
|                                                                                                             |           |                          |     |     |    |    |    |
| Property                and Equipment:                                                                                |                     |                                    |   |   |   |   |   |
| Computer                and other equipment                                                                           |                     |                                    | 13,465 |   |   | 9,906 |     |
| Software                                                                                                              |                     |                                    | 4,097 |   |   | 3,852 |   |
| Furniture                and fixtures                                                                                 |                     |                                    | 2,545 |   |   | 2,486 |   |
| Leasehold                improvements                                                                                 |                     |                                    | 16,966 |   |   | 16,808 |   |
|                                                                                                                  |                     |                                    | 37,073 |   |   | 33,052 |   |
| Less:                Accumulated depreciation and amortization                                                        |                     |                                    | (21,885 | )   |   | (18,166 | )  |
| Net                property and equipment                                                                             |                     |                                    | 15,188 |   |   | 14,886 |   |
| Goodwill                                                                                                              |                     |                                    | 8,278 |   |      | 8,018 |   |
| Other                long-term assets                                                                                 |                     |                                    | 1,957 |   |   | 2,019 |   |
|  TOTAL                ASSETS                                                                                     |                     | $                                       | 196,276 |   | $ | 195,938 |   |
|                                                                                              |                |                               |      |   |   |   |    |
| **LIABILITIES                AND STOCKHOLDERS’ EQUITY**                                                         |                     |                                    |   |    |    |   |   |
| Current                Liabilities:                                                                                   |                     |                                    |   |   |   |   |   |
| Accounts                payable                                                                                       |                     | $                                       | 6,893 |   | $ | 3,972 |   |
| Accrued                liabilities                                                                                    |                     |                                    | 4,697 |   |   | 7,473 |   |
| Deferred                revenues                                                                                      |                     |                                    | 26,843 |   |   | 2,096 |   |
| Total                current liabilities                                                                              |                     |                                    | 38,433 |   |   | 13,541 |   |
|                                                                                                   |      |                     |      |      |      |      |   |
| Long-Term                Liabilities:                                                                                 |                     |                                    |   |   |   |   |   |
| Deferred                rent, net of current portion                                                                  |                     |                                    | 1,268 |   |   | 1,089 |   |
| Total                long-term liabilities                                                                            |                     |                                    | 1,268 |   |   | 1,089 |   |
|  Commitments                and Contingencies (Note 7)                                                           |                          |                                         |  |  |  |  |  |
|                                                                                                             |                |                          |     |    |     |    |   |
| Stockholders’                Equity:                                                                            |                     |                                    |   |   |   |   |   |
| Preferred                stock, $0.01 par value:                                                                      |                     |                                    |   |   |   |    |                    |
| Authorized—5,000,000                shares; none outstanding                                          |                     |                                    | — |   |   | — |   |
| Common                stock, $0.01 par value:                                                                         |                     |                                    |   |   |   |   |   |
| Authorized—100,000,000                shares                                                                    |           |                                    |     |   |   |   |   |
| Issued                - 41,576,721 shares in 2006 and 41,473,491 shares in 2005                                       |                     |                                    |    |   |   |    |   |
| Outstanding—39,107,537                shares in 2006 and 39,800,492 shares in 2005                    |                     |                                    | 416 |   |   | 415 |   |
| Additional                paid-in capital                                                                             |                     |                                    | 282,930 |   |   | 278,005 |   |
| Treasury                stock, at cost (2,469,184 and 1,672,999 shares in 2006 and 2005,                respectively) |                     |                                    | (19,259 | ) |   | (12,925 | )  |
| Accumulated                other comprehensive income/(loss)                                                          |                          |                                    | 997 |   |   | (118 | )  |
| Accumulated                deficit                                                                                    |                          |                                         | (108,509 | ) |   | (84,069 | ) |
| Total                stockholders’ equity                                                                       |                          |                                         | 156,575 |   |  | 181,308 |   |
|  TOTAL                LIABILITIES AND STOCKHOLDERS’ EQUITY                                                 |                          | $                                       | 196,276 |   | $ | 195,938 |   |

***44***

CONSOLIDATED      STATEMENTS OF OPERATIONS

|                                                           | For                the Year Ended December 31,  |
|----------------------------------------------------------------|------------------------------------------------------|
|                                                           |                                                 | 2006 |   |   | 2005 |   |   | 2004 |   |
|                                                           |                                                 |   |   |   |   |   |   |   |   |
| REVENUES:                                                      |                                                 |   |   |   |   |   |   |   |   |
| Product                                                        | $                                                    | 56,515 |   | $ | 73,563 |   | $ | 108,947 |   |
| Service                                                        |                                                 | 761 |   |   | 865 |   |   | 974 |   |
| Total                revenues                                  |                                                 | 57,276 |   |   | 74,428 |   |   | 109,921 |   |
|                                                           |                                                 |   |   |   |   |   |   |   |   |
| COST                OF REVENUES:                               |                                                 |   |   |   |   |   |   |   |   |
| Cost                of product                                 |                                                 | 22,032 |   |   | 30,955 |   |   | 46,110 |   |
| Cost                of service                                 |                                                 | 1,917 |   |   | 2,124 |   |   | 2,003 |   |
| Total                cost of revenues                          |                                                 | 23,949 |   |   | 33,079 |   |   | 48,113 |   |
| Gross                profit                                    |                                                 | 33,327 |   |   | 41,349 |   |   | 61,808 |   |
|                                                           |                                                 |   |   |   |   |   |   |   |   |
| OPERATING                EXPENSES:                             |                                                 |   |   |   |   |   |   |   |   |
| Product                development                             |                                                 | 28,357 |   |   | 25,098 |   |   | 25,262 |   |
| Sales                and marketing                             |                                                 | 20,372 |   |   | 21,023 |   |   | 19,440 |   |
| General                and administrative                      |                                                 | 14,505 |   |   | 20,018 |   |   | 13,388 |   |
| Total                operating expenses                        |                                                 | 63,234 |   |   | 66,139 |   |   | 58,090 |   |
| Income/(loss)                from operations                   |                                                 | (29,907 | )  |   | (24,790 | )  |   | 3,718 |   |
| Interest                and other income, net                  |                                                 | 5,817 |   |   | 5,225 |   |   | 2,140 |   |
| Income/(loss)                before provision for income taxes |                                                 | (24,090 | ) |   | (19,565 | )  |   | 5,858 |   |
| PROVISION                FOR INCOME TAXES                      |                                                 | 350 |   |   | 154 |   |   | 586 |   |
| Net                income/(loss)                               | $                                                    | (24,440 | )  | $ | (19,719 | )  | $ | 5,272 |   |
| Income/(loss)                per share:                        |                                                 |   |   |   |   |   |   |   |   |
| Basic                                                          | $                                                    | (0.62 | )  | $ | (0.49 | )  | $ | 0.13 |   |
| Diluted                                                        | $                                                    | (0.62 | )  | $ | (0.49 | )  | $ | 0.13 |   |
| Shares                used in per share calculation:           |                                                 |   |   |   |   |   |   |   |   |
| Basic                                                          |                                                 | 39,487 |   |   | 40,377 |   |   | 40,918 |   |
| Diluted                                                        |                                                 | 39,487 |   |   | 40,377 |   |   | 41,007 |   |

***45***

CONSOLIDATED      STATEMENTS OF STOCKHOLDERS’ EQUITY

|                                                                                                                                                          | Common                Stock |    | Treasury                Stock |   | AdditionalPaid-In |    |   | Accumulated                Other Comprehensive Income/ |   |   | Accumu-lated |   |    |    |    |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------|-----------------------------|---------|-------------------------------|--------|-------------------|---------|--------|--------------------------------------------------------|--------|--------|--------------|--------|---------|---------|---------|
|                                                                                                                                                          |                        | Shares  |                          |   | Amount            |    |   | Shares                                                 |   |   | Amount       |   | Capital |    |    | (Loss) |   |   | Deficit |   |   | Total |   |
| BALANCE                AT DECEMBER 31, 2003                                                                                                                   |                        | 40,675  |                          | $      | 407               |    |   | (265                                                   | )      | $      | (3,191       | )      | $       | 272,323 |    | $ | 1,007 |   | $ | (69,622 | ) | $ | 200,924 |   |
| Exercise                of stock options                                                                                                                      |                        | 802     |                          |   | 8                 |    |   | —                                                |   |   | —      |   |    | 5,119   |    |   | — |   |   | — |   |   | 5,127 |   |
| Repurchase                of stock                                                                                                                            |                        | — |                          |   | —           |    |   | (25                                                    | )      |   | (176         | )      |    | — |    |   | — |   |   | — |   |   | (176 | ) |
| Foreign                currency translation adjustment                                                                                                        |                        | — |                          |   | —           |    |   | —                                                |   |   | —      |   |    | — |    |   | 478 |   |   | — |   |   | 478 |   |
| Unrealized                holding loss on available-for-sale securities                                                                                       |                        | — |                          |   | —           |    |   | —                                                |   |   | —      |   |    | — |    |   | (563 | ) |   | — |   |   | (563 | ) |
| Net                income                                                                                                                                     |                        | — |                          |   | —           |    |   | —                                                |   |   | —      |   |    | — |    |   | — |   |   | 5,272 |   |   | 5,272 |   |
| BALANCE                AT DECEMBER 31, 2004                                                                                                                   |                        | 41,477  |                          |   | 415               |    |   | (290                                                   | )      |   | (3,367       | )      |    | 277,442 |    |   | 922 |   |   | (64,350 | ) |   | 211,062 |   |
| Repurchase                of stock                                                                                                                            |                        | — |                          |   | —           |    |   | (1,383                                                 | )      |   | (9,558       | )      |    | — |    |   | — |   |   | — |   |   | (9,558 | ) |
| Repurchase                of employee shares                                                                                                                  |                        | (4)     |                          |   | —           |    |   | —                                                |   |   | —      |   |    | (24     | )       |   | — |   |   | — |   |   | (24 | ) |
| Stock-based                compensation                                                                                                                       |                        | — |                          |   | —           |    |   | —                                                |   |   | —      |   |    | 587     |    |   | — |   |   | — |   |   | 587 |   |
| Foreign                currency translation adjustment                                                                                                        |                        | — |                          |   | —           |    |   | —                                                |   |   | —      |   |    | — |    |   | (1,077 | ) |   | — |   |   | (1,077 | ) |
| Unrealized                holding gain on available-for-sale securities                                                                                       |                        | — |                          |   | —           |    |   | —                                                |   |   | —      |   |    | — |    |   | 37 |   |   | — |   |   | 37 |   |
| Net                loss                                                                                                                                       |                        | — |                          |   | —           |    |   | —                                                |   |   | —      |   |    | — |    |   | — |   |   | (19,719 | ) |   | (19,719 | ) |
| BALANCE                AT DECEMBER 31, 2005                                                                                                                   |                        | 41,473  |                          |   | 415               |    |   | (1,673                                                 | )      |   | (12,925      | )      |    | 278,005 |    |   | (118 | ) |   | (84,069 | ) |   | 181,308 |   |
| Exercise                of stock options                                                                                                                      |                        | 125     |                          |   | 1                 |    |   | —                                                |   |   | —      |   |    | 763     |    |   | — |   |   | — |   |   | 764 |   |
| Release                of performance shares                                                                                                                  |                        | 72      |                          |   | 1                 |    |   | —                                                |   |   | —      |   |    | (1      | )       |   | — |   |   | — |   |   | — |   |
| Stock                received for payment of option exercise price                                                                                            |                        | (61     | )                        |   | (1                | )  |   | —                                                |   |   | —      |   |    | (498    | )  |   | — |   |   | — |   |   | (499 | ) |
| Stock                received for payment of employee taxes on vesting of performance                shares                and upon exercise of stock options |                        | (29     | )                             |   | —           |    |   | —                                                |   |   | —      |   |    | (239    | )  |   | — |   |   | — |   |   | (239 | ) |
| Repurchase                of stock                                                                                                                            |                        | — |                          |   | —           |    |   | (796                                                   | )      |   | (6,334       | )      |    | — |    |   | — |   |   | — |   |   | (6,334 | ) |
| Repurchase                of employee shares                                                                                                                  |                        | (3)     |                          |   | —           |    |   | —                                                |   |   | —      |   |    | (25     | )       |   | — |   |   | — |   |   | (25 | ) |
| Stock-based                compensation                                                                                                                       |                        | — |                          |   | —           |    |   | —                                                |   |   | —      |   |    | 4,925   |    |   | — |   |   | — |   |   | 4,925 |   |
| Foreign                currency translation adjustment                                                                                                        |                        | — |                          |   | —           |    |   | —                                                |   |   | —      |   |    | — |    |   | 751 |   |   | — |   |   | 751 |   |
| Unrealized                holding gain on available-for-sale securities                                                                                       |                        | — |                          |   | —           |    |   | —                                                |   |   | —      |   |    | — |    |   | 364 |   |   | — |   |   | 364 |   |
| Net                loss                                                                                                                                       |                        | — |                          |   | —           |    |   | —                                                |   |   | —      |   |    | — |    |   | — |   |   | (24,440 | ) |   | (24,440 | ) |
| BALANCE                AT DECEMBER 31, 2006                                                                                                                   |                        | 41,577  |                          | $      | 416               |    |   | (2,469                                                 | )      | $      | (19,259      | )      | $       | 282,930 |    | $ | 997 |   | $ | (108,509 | ) | $ | 156,575 |   |

CONSOLIDATED      STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

|                                                                                 |   | For                the Year Ended December 31, |    |
|--------------------------------------------------------------------------------------|--------|------------------------------------------------|---------|
|                                                                                 |   |                                           | 2006    |   |   | 2005 |   |   | 2004 |   |
| Net                income (loss)                                           |   | $                                              | (24,440 | )  | $ | (19,719 | )  | $ | 5,272 |   |
| Other                comprehensive income (loss), net of tax                         |   |                                           |    |   |   |   |   |   |   |   |
| Foreign                currency translation adjustment                     |   |                                           | 751     |   |   | (1,077 | )  |   | 478 |   |
| Unrealized                holding gain (loss) on available-for-sale securities  |   |                                           | 364     |   |   | 37 |   |   | (563 | ) |
| Comprehensive                income (loss)                                 |   | $                                              | (23,325 | )  | $ | (20,759 | )  | $ | 5,187 |   |

***46***

CONSOLIDATED      STATEMENTS OF CASH FLOWS

|                                                                                                                   | Twelve                  Months Ended December 31, |         |
|------------------------------------------------------------------------------------------------------------------------|---------------------------------------------------|--------------|
|                                                                                                                   |                                              | 2006         |   |   | 2005 |   |   | 2004 |   |
| CASH                  FLOWS FROM OPERATING ACTIVITIES:                                                                 |                                              |         |   |   |   |   |   |   |   |
| Net                  income/(loss)                                                                           | $                                                 | (24,440      | )  | $ | (19,719 | )  | $ | 5,272 |   |
| Adjustments                  to reconcile net income/(loss) to net cash used in operating                  activities: |                                              |         |   |   |   |   |   |   |   |
| Depreciation                  and amortization                                                               |                                              | 4,396        |   |   | 4,162 |   |   | 4,922 |   |
| Increase                  in (reduction of) allowance for doubtful                  accounts                 |                                              | (23          | ) |   | 15 |   |   | (75 | )  |
| Loss                  (gain) on disposal of fixed assets                                                     |                                              | (2           | )  |   | 67 |   |   | 27 |   |
| Increase                  in accrued investment income                                                                 |                                              | (446         | ) |   | (959 | ) |   | (241 | ) |
| Stock-based                  compensation                                                                    |                                              | 4,925        |   |   | 587 |   |   | — |   |
| Change                  in operating assets and liabilities:                                                           |                                              |         |   |   |   |   |   |   |   |
| Accounts                  receivable                                                                         |                                              | (2,889       | )  |   | 6,240 |   |   | 2,924 |   |
| Inventories                                                                                                  |                                              | (8,119       | )  |   | 2,344 |   |   | 322 |   |
| Other                  current assets                                                                        |                                              | (392         | )  |   | 246 |   |   | 306 |   |
| Accounts                  payable                                                                            |                                              | 2,921        |   |   | (1,185 | ) |   | (1,765 | )  |
| Deferred                  cost of goods sold                                                                 |                                              | (18,738      | ) |   | 38 |   |   | 413 |   |
| Accrued                  liabilities                                                                         |                                              | (2,776       | )  |   | 2,021 |   |   | 659 |   |
| Deferred                  revenues                                                                           |                                              | 24,747       |   |   | 314 |   |   | 11 |   |
| Deferred                  rent                                                                               |                                              | 179          |   |   | 266 |   |   | 332 |   |
| Net                  cash provided by (used in) operating                  activities                        |                                              | (20,657      | )  |   | (5,563 | )  |   | 13,107 |   |
|                                                                                                                   |                                              |         |   |   |   |   |   |   |   |
| CASH                  FLOWS FROM INVESTING ACTIVITIES:                                                                 |                                              |         |   |   |   |   |   |   |   |
| Purchase                  of available-for-sale short-term investments                                       |                                              | (85,971      | ) |   | (94,144 | ) |   | (161,279 | ) |
| Proceeds                  from sales and maturities of available-for-sale short-term                  investments      |                                              | 95,436       |   |   | 124,594 |   |   | 162,359 |   |
| Release                  (purchase) of restricted investments                                                |                                              | —      |   |   | 11,106 |   |   | (239 | ) |
| Changes                  in other long-term assets                                                           |                                              | 37           |   |   | 335 |   |   | (310 | )  |
| Capital                  expenditures                                                                        |                                              | (4,696       | ) |   | (2,099 | ) |   | (2,224 | ) |
| Net                  cash provided by (used in) investing                  activities                        |                                              | 4,806        |   |   | 39,792 |   |   | (1,693 | ) |
|                                                                                                                   |                                              |         |   |   |   |   |   |   |   |
| CASH                  FLOWS FROM FINANCING ACTIVITIES:                                                                 |                                              |         |   |   |   |   |   |   |   |
| Proceeds                  from exercise of stock options                                                          |                                              | 265          |   |   | — |   |   | 5,127 |   |
| Repurchase                  of common stock                                                                  |                                              | (6,573       | ) |   | (9,582 | ) |   | (176 | )  |
| Net                  cash provided by (used in) financing                  activities                        |                                              | (6,308       | )  |   | (9,582 | )  |   | 4,951 |   |
|                                                                                                                   |                                              |    |   |   |    |   |   |    |   |
| EFFECT                  OF EXCHANGE RATES ON CASH                                                            |                                              | 491          |   |   | (1,077 | )  |   | 478 |   |
|                                                                                                                   |                                              |    |   |   |    |   |   |    |   |
| NET                  INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS                                             |                                              | (21,668      | )  |   | 23,570 |   |   | 16,843 |   |
|                                                                                                                   |                                              |         |   |   |   |   |   |   |   |
| CASH                  AND CASH EQUIVALENTS:                                                                            |                                              |         |   |   |   |   |   |   |   |
| Beginning                  of year                                                                           |                                              | 59,080       |   |   | 35,510 |   |   | 18,667 |   |
| End                  of year                                                                                 | $                                                 | 37,412       |   | $ | 59,080 |   | $ | 35,510 |   |
| SUPPLEMENTAL                  DISCLOSURES OF CASH FLOW INFORMATION:                                                    |                                              |         |   |   |   |   |   |   |   |
| Cash                  paid for income taxes                                                                  | $                                                 | 199          |   | $ | 449 |   | $ | 885 |   |

***47***

**ECHELON      CORPORATION**

**NOTES      TO CONSOLIDATED FINANCIAL STATEMENTS**

**December      31, 2006, 2005, and 2004**

**1.      ORGANIZATION OF THE COMPANY:**

**2.      SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND PRACTICES:**

*Principles      of Consolidation*

*Use      of Estimates*

*Reclassifications*

*Revenue      Recognition*

***48***

*Software      Revenue Recognition*
*Revenue      Recognition. *

***49***

*Revenue      Recognition When Right of Return Exists*
*Accounting      for Consideration Given by a Vendor to a Customer (Including a Reseller of      the      Vendor's Products)*

*Deferred        Revenue and Deferred Cost of Goods Sold*

*Stock-Based      Compensation*

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

***50***

*Accounting      for Stock-Based Compensation*

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

|                                                                                                                                                                                                            |   | Year                  Ended December 31, |    |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|------------------------------------------|---------|
|                                                                                                                                                                                                            |   | 2005                                     |    | 2004 |   |
| Net                  income (loss) as reported                                                                                                                                                             |   | $                                        | (19,719 | ) | $ | 5,272 |   |
| Add:                  Stock-based employee compensation expense included in reported                  net income                  (loss), net of related tax effects                                            |   |                                     | 587     |   |   | --- |   |
| Deduct:                  Total stock-based employee compensation expense determined under                  fair                  value based method for all awards, net of related tax                  effects |   |                                     | (13,002 | ) |   | (20,613 | ) |
| Pro                  forma net loss                                                                                                                                                                        |   | $                                        | (32,134 | ) | $ | (15,341 | ) |
|                                                                                                                                                                                                            |   |                                     |         |   |   |  |   |
| Basic                  net income (loss) per share:                                                                                                                                                             |   |                                     |         |   |   |  |   |
| As                  reported                                                                                                                                                                                    |   | $                                        | (0.49   | ) | $ | 0.13 |   |
| Pro                  forma                                                                                                                                                                                      |   | $                                        | (0.80   | ) | $ | (0.37 | ) |
|                                                                                                                                                                                                            |   |                                     |         |   |   |  |   |
| Diluted                  net income (loss) per share:                                                                                                                                                           |   |                                     |         |   |   |  |   |
| As                  reported                                                                                                                                                                                    |   | $                                        | (0.49   | ) | $ | 0.13 |   |
| Pro                  forma                                                                                                                                                                                      |   | $                                        | (0.80   | ) | $ | (0.37 | ) |

|                                          |   | Year                Ended December 31, |   |
|-----------------------------------------------|--------|----------------------------------------|--------|
|                                          |   | 2005                                   |   | 2004 |   |
| Expected                dividend yield   |   |                                   | 0.0    | % |   | 0.0 | % |
| Risk-free                interest rate   |   |                                   | 4.0    | % |   | 2.4 | % |
| Expected                volatility       |   |                                   | 57.5   | % |   | 78.2 | % |
| Expected                life (in years)  |   |                                   | 3.6    |   |   | 3.6 |   |

***51***

*Cash      and Cash Equivalents*

* *

*Accounting for Certain Investments in Debt and      Equity Securities*

|                                                      | December                31,  |
|-----------------------------------------------------------|-----------------------------------|
|                                                      | 2006                              |   |   | 2005 |
|                                                 |                              | Amortized                Cost |   |   | AggregateFairValue |   |   | Unrealized                Holding Gains / (Losses) |   |   | Amortized                Cost |   |   | AggregateFairValue |   |   | Unrealized                Holding Gains/ (Losses) |   |
| U.S.                corporate securities:                 |                              |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Commercial                paper                 | $                                 | 46,492 |   | $ | 46,497 |   | $ | 5 |   | $ | 5,189 |   | $ | 5,189 |   | $ | --- |   |
| Certificate                of deposit                |                              | --- |   |   | --- |   |   | --- |   |   | 1,507 |   |   | 1,508 |   |   | 1 |   |
| Corporate                notes and bonds             |                              | 20,712 |   |   | 20,684 |   |   | (28 | ) |   | 47,964 |   |   | 47,769 |   |   | (195 | ) |
|                                                      |                              | 67,204 |   |   | 67,181 |   |   | (23 | ) |   | 54,660 |   |   | 54,466 |   |   | (194 | ) |
| Foreign                corporate notes and bonds          |                              |  1,508 |   |   |  1,504 |   |   |  (4 | ) |   |  3,012 |   |   |  3,000 |   |   |  (12 | ) |
| U.S.                government securities            |                              | 18,064 |   |   | 18,060 |   |   | (4 | ) |   | 38,129 |   |   | 37,934 |   |   | (195 | ) |
| Total                investments in debt securities  | $                                 | 86,776 |   | $ | 86,745 |   | $ | (31 | ) | $ | 95,801 |   | $ | 95,400 |   | $ | (401 | ) |

*The      Meaning of Other-Than-Temporary Impairment and Its Application to Certain      Investments*

|                                                 | December                31, 2006 |                               |
|------------------------------------------------------|----------------------------------|------------------------------------|
|                                                 |                             | Less                than 12 Months |   |   | More                than 12 Months |   |   | Total |   |
|                                                 |                             |                               | Fair                Value |   |   | Unrealized                Loss |   |   |   | Fair                Value |   |   | Unrealized                Loss |   |   |   | Fair                Value |   |   | Unrealized                Loss |   |
| Corporate                notes and bonds   |                             | $                                  | 13,394 |   | $ | (28 | ) |   | $ | 2,095 |   | $ | (3 | ) |   | $ | 15,489 |   | $ | (31 | ) |
| Foreign                corporate notes and bonds     |                             |                               |  --- |   |   | --- |   |   |   | 1,504 |   |   |  (4 | ) |   |   |  1,504 |   |   |  (4 | ) |
| U.S.                government securities       |                             |                               | 3,281 |   |   | (6 | ) |   |   | 3,627 |   |   | (11 | ) |   |   | 6,908 |   |   | (17 | ) |
| Total                                                |                             | $                                  | 16,675 |   | $ | (34 | ) |   | $ | 7,226 |   | $ | (18 | ) |   | $ | 23,901 |   | $ | (52 | ) |

***52***

|                                                 | December                31, 2005 |                               |
|------------------------------------------------------|----------------------------------|------------------------------------|
|                                                 |                             | Less                than 12 Months |   |   | More                than 12 Months |   |   | Total |   |
|                                                 |                             |                               | Fair                Value |   |   | Unrealized                Loss |   |   |   | Fair                Value |   |   | Unrealized                Loss |   |   |   | Fair                Value |   |   | Unrealized                Loss |   |
| Corporate                notes and bonds   |                             | $                                  | 28,118 |   | $ | (155 | ) |   | $ | 7,533 |   | $ | (43 | ) |   | $ | 35,651 |   | $ | (198 | ) |
| Commercial                paper                      |                             |                               |  3,000 |   |   | (12 | ) |   |   | --- |   |   |  --- |   |   |   |  3,000 |   |   |  (12 | ) |
| U.S.                government securities       |                             |                               | 32,034 |   |   | (161 | ) |   |   | 4,497 |   |   | (34 | ) |   |   | 36,531 |   |   | (195 | ) |
| Total                                                |                             | $                                  | 63,152 |   | $ | (328 | ) |   | $ | 12,030 |   | $ | (77 | ) |   | $ | 75,182 |   | $ | (405 | ) |

*Inventories*

|                                           | December                31, |
|------------------------------------------------|-----------------------------|
|                                           |                        | 2006 |   |   | 2005 |
| Purchased                materials   | $                           | 3,378 |   | $ | 1,064 |
| Work-in-process                      |                        | 107 |   |   | 61 |
| Finished                goods        |                        | 7,874 |   |   | 2,115 |
|                                           | $                           | 11,359 |   | $ | 3,240 |

*Property      and Equipment*

*Impairment      of Long-Lived Assets Including Goodwill*

***53***

*Goodwill      and Other Intangible Assets, *

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

*Software      Development Costs*

*Accrued      Liabilities*

|                                                         | December                31,  |
|--------------------------------------------------------------|-----------------------------------|
|                                                         |                              | 2006 |   |   | 2005 |
| Accrued                payroll and related costs   | $                                 | 2,776 |   | $ | 2,630 |
| Accrued                taxes                       |                              | 1,307 |   |   | 1,128 |
| Other                accrued liabilities           |                              | 614 |   |   | 3,715 |
|                                                         | $                                 | 4,697 |   | $ | 7,473 |

*Foreign      Currency Translation*

*Foreign      Currency Translation*

***54***

*Concentrations      of Credit Risk*

|                                                                         |   | December                31, |   |
|------------------------------------------------------------------------------|--------|-----------------------------|--------|
|                                                                         |   | 2006                        |   | 2005 |   |
| Telvent                Energia Y Medio Ambeinte                              |   |                        | 51.8   | % |   | 0.0 | % |
| EBV                                                                |   |                        | 15.3   | % |   | 22.2 | % |
| Enel                (and its contract manufacturers)     |   |                        | 0.0    | % |   | 36.5 | % |
| Total                                                              |   |                        | 67.1   | % |   | 58.7 | % |

*Computation      of Basic and Diluted Net Income Per Share and Pro Forma Basic Net Loss Per      Share*

*Earnings      per Share*

|                                                                                                               | Year                Ended December 31,  |
|-------------------------------------------------------------------------------------------------------------------------|----------------------------------------------|
|                                                                                                                    |                                         | 2006 |   |   | 2005 |   |   | 2004 |
| Net                income/(loss) (Numerator):                                                                           |                                         |   |   |   |   |   |   |   |
| Net                income/(loss), basic & diluted                                                         | $                                            | (24,440 | )  | $ | (19,719 | ) | $ | 5,272 |
| Shares                (Denominator):                                                                                    |                                         |   |   |   |   |   |   |   |
| Weighted                average shares used in basic computation                                              |                                         | 39,487 |   |   | 40,377 |   |   | 40,918 |
| Common                shares issuable upon exercise of stock options (treasury stock                method)   |                                         | ¾ |   |   | ¾ |   |   | 89 |
| Weighted                average shares used in diluted computation                                            |                                         | 39,487 |   |   | 40,377 |   |   | 41,007 |
| Net                income/(loss) per share:                                                                             |                                         |   |   |   |   |   |   |   |
| Basic                                                                                               | $                                            | (0.62 | ) | $ | (0.49 | ) | $ | 0.13 |
| Diluted                                                                                             | $                                            | (0.62 | ) | $ | (0.49 | ) | $ | 0.13 |

***55***

*Income      Taxes*

*Comprehensive      Income/(Loss)*

*Recent      Accounting Pronouncements*

*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*

*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*

***56***

*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**

*Preferred      Stock*

*Common      Stock*

*Stock      Option Program Description*

*1997      Stock Plan*

***57***

*       *

*1998      Directors Option Plan*

***58***

*Employee      Stock Option Exchange Program*

*Option      Vesting Acceleration *

***59***

*Stock      Award Activity*

|                                                                       |                                            |   | Options                Outstanding  |
|----------------------------------------------------------------------------|-------------------------------------------------|--------|------------------------------------------|
|                                                                       | Shares                Available for Grant  |   |                                     | Number                Outstanding |   |   | Weighted-Average                Exercise Price Per Share |
| BALANCE                AT DECEMBER 31, 2003                      | 3,601,792                                       |   |                                     | 8,944,182 |   | $ | 16.49 |
| Options                granted                                   | (2,066,475                                      | )      |                                     | 2,066,475 |   |   | 10.78 |
| Options                cancelled                                 | 4,453,741                                       |   |                                     | (4,453,741 | ) |   | 17.83 |
| Options                exercised                                 | ---                                             |   |                                     | (962,074 | ) |   | 7.22 |
| Additional                shares reserved                        | 2,120,498                                       |   |                                     | --- |   |   | --- |
| BALANCE                AT DECEMBER 31, 2004                      | 8,109,556                                       |   |                                     | 5,594,842 |   | $ | 14.91 |
| Options                granted                                   | (3,575,814                                      | )      |                                     | 3,575,814 |   |   | 6.99 |
| Performance                shares granted                        | (417,949                                        | )      |                                     | --- |   |   | --- |
| Options                cancelled                                 | 1,081,183                                       |   |                                     | (1,081,183 | ) |   | 16.22 |
| Performance                shares cancelled                      | 4,981                                           |   |                                     | --- |   |   | --- |
| Additional                shares reserved                        | 1,747,463                                       |   |                                     | --- |   |   | --- |
| BALANCE                AT DECEMBER 31, 2005                      | 6,949,420                                       |   |                                     | 8,089,473 |   | $ | 11.24 |
| Options                and stock appreciation rights granted     | (852,734                                        | )      |                                     | 852,734 |   |   | 8.40 |
| Performance                shares granted                        | (387,909                                        | )      |                                     | --- |   |   | --- |
| Options                and stock appreciation rights cancelled   | 534,902                                         |   |                                     | (534,902 | ) |   | 12.94 |
| Performance                shares cancelled                      | 25,896                                          |   |                                     | --- |   |   | --- |
| Options                exercised                                 | ---                                             |   |                                     | (124,625 | ) |   | 6.13 |
| Additional                shares reserved                        | 1,692,020                                       |   |                                     | --- |   |   | --- |
| BALANCE                AT DECEMBER 31, 2006                      | 7,961,595                                       |   |                                     | 8,282,680 |   | $ | 10.91 |

|                                                  | Number                Nonvested and Outstanding |    |   | Weighted-Average                Grant Date Fair-Value |
|-------------------------------------------------------|-------------------------------------------------|---------|--------|-------------------------------------------------------|
| BALANCE                AT DECEMBER 31, 2004           | ---                                             |    | $      | ---                                                   |
| Performance                shares granted             | 417,949                                         |    |   | 7.82                                                  |
| Performance                shares forfeited           | (4,981                                          | )       |   | 7.85                                                  |
| BALANCE                AT DECEMBER 31, 2005           | 412,968                                         |    | $      | 7.82                                                  |
| Performance                shares granted             | 387,909                                         |    |   | 8.59                                                  |
| Performance                shares vested and released | (71,945                                         | )  |   | 8.19                                                  |
| Performance                shares forfeited           | (25,896                                         | )       |   | 8.05                                                  |
| BALANCE                AT DECEMBER 31, 2006           | 703,036                                         |    | $      | 8.20                                                  |

***60***

|                                             |   |    ExercisePrice                Range |   | NumberOutstanding |   | WeightedAverageRemainingContractual                Life(in                years) |   |  WeightedAverageExercisePrice                per Share |   |  Aggregate                Intrinsic Value |
|--------------------------------------------------|--------|------------------------------------------------------|--------|-------------------|--------|----------------------------------------------------------------------------------|--------|-------------------------------------------------------------|--------|------------------------------------------------|
|                                             |   | $6.11                                                |   | 1,526,933         |   | 3.01                                                                             |   | $                                                           | 6.11   |                                           | $ | 2,885,903 |
|                                             |   | 6.26-8.17                                            |   | 281,593           |   | 3.58                                                                             |   |                                                        | 7.23   |                                           |   | 219,000 |
|                                             |   | 8.19                                                 |   | 948,480           |   | 3.62                                                                             |   |                                                        | 8.19   |                                           |   | --- |
|                                             |   | 8.24-8.52                                            |   | 1,079,624         |   | 4.00                                                                             |   |                                                        | 8.46   |                                           |   | --- |
|                                             |   | 8.58-10.65                                           |   | 315,525           |   | 4.81                                                                             |   |                                                        | 9.96   |                                           |   | --- |
|                                             |   | 10.89                                                |   | 837,220           |   | 2.21                                                                             |   |                                                        | 10.89  |                                           |   | --- |
|                                             |   | 11.14-12.91                                          |   | 1,359,202         |   | 2.66                                                                             |   |                                                        | 12.39  |                                           |   | --- |
|                                             |   | 13.00-16.35                                          |   | 1,129,137         |   | 3.94                                                                             |   |                                                        | 15.75  |                                           |   | --- |
|                                             |   | $16.36-$30.76                                        |   | 804,966           |   | 4.07                                                                             |   |                                                        | 18.91  |                                           |   | --- |
|  Outstanding                                |   | 8,282,680                                            |   | 3.39              |   | $                                                                                | 10.91  |                                                        | $      | 3,104,903                                      |
|  Vested                and expected to vest |   | 8,149,281                                            |   | 3.39              |   | $                                                                                | 10.95  |                                                        | $      | 3,089,863                                      |
|  Exercisable                                |   | 6,536,484                                            |   | 3.23              |   | $                                                                                | 11.68  |                                                        | $      | 2,664,121                                      |

**4.      STOCK-BASED COMPENSATION:**

*Impact      of Adopting SFAS 123R*

|                                                  |   | **Intrinsic                Value Method (A)** |    | **Fair                Value Method****(B)** |   | **Impact                of Adoption****(A)                - (B)** |   |
|-------------------------------------------------------|--------|-----------------------------------------------|---------|---------------------------------------------|--------|-------------------------------------------------------------------|--------|
|                                                  |   |                                          |    |                                        |   |                                                              |   |
| Loss                from continuing operations        |   | $                                             | (26,329 | )                                           | $      | (29,907                                                           | )      | $ | (3,578 | ) |
| Loss                before provision for income taxes |   | $                                             | (20,512 | )                                           | $      | (24,090                                                           | )      | $ | (3,578 | ) |
| Net                loss                               |   | $                                             | (20,862 | )                                           | $      | (24,440                                                           | )      | $ | (3,578 | ) |
| Net                loss per share - basic             |   | $                                             | (0.53   | )                                           | $      | (0.62                                                             | )      | $ | (0.09 | ) |
| Net                loss per share - diluted           |   | $                                             | (0.53   | )                                           | $      | (0.62                                                             | )      | $ | (0.09 | ) |
| Cash                flows from operations             |   | $                                             | (20,211 | )                                           | $      | (20,211                                                           | )      | $ | -- |   |
| Cash                flows from financing activities   |   | $                                             | (6,333  | )                                           | $      | (6,333                                                            | )      | $ | -- |   |

***61***

*Valuation        of Options Granted*

|                                          | **Year                Ended December 31, 2006** |
|-----------------------------------------------|-------------------------------------------------|
| Expected                dividend yield   | 0.0%                                            |
| Risk-free                interest rate   | 4.6%                                            |
| Expected                volatility       | 50.5%                                           |
| Expected                life (in years)  | 3.6                                             |

*Expense      Allocation *

***62***

|                                                                                                                                      |   | **2006** |   | **2005** |   | **2004** |   |
|-------------------------------------------------------------------------------------------------------------------------------------------|--------|----------|--------|----------|--------|----------|--------|
| Cost                of sales - product                                                                                                    |   | $        | 429    |     | $      | 60       |   | $ | -- |   |
| Cost                of sales - service                                                                                                    |   |     | 49     |     |   | 3        |   |   | -- |   |
| Stock-based                compensation expense included in cost of sales                                                                 |   |     | 478    |     |   | 63       |   |   | -- |   |
| Product                development                                                                                                        |   |     | 1,935  |     |   | 143      |   |   | -- |   |
| Sales                and marketing                                                                                                        |   |     | 1,205  |     |   | 111      |   |   | -- |   |
| General                and administrative                                                                                                 |   |     | 1,307  |     |   | 270      |   |   | -- |   |
| Stock-based                compensation expense included in operating expenses                                                            |   |     | 4,447  |     |   | 524      |   |   | -- |   |
| Total                stock-based compensation expense related to stock options and performance                shares                      |   |     | 4,925  |     |   | 587      |   |   | -- |   |
| Tax                benefit                                                                                                                |   |     | --     |     |   | --       |   |   | -- |   |
| Stock-based                compensation expense related to stock options and performance shares,                net                of tax |   | $        | 4,925  |     | $      | 587      |   | $ | -- |   |

** **

*Comparative      Results*

|                                                                                                                                 |   | **Year                Ended December 31,** |    |
|--------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------------------------------|---------|
|                                                                                                                                 |   | **2006**                                   |    | **2005** |   | **2004** |   |
|                                                                                                                                 |   |                                       |    |   |   |   |   |
| Net                income (loss) - as reported for the prior period (1)                                                              |   |                                       | N/A     |   | $ | (19,719 | ) | $ | 5,272 |   |
| Stock-based                compensation expense related to employee stock options and performance                share awards (2)    |   | $                                          | 4,925   |   | $ | 12,415 |   | $ | 20,613 |   |
| Tax                benefit                                                                                                           |   |                                       | --      |   |   | -- |   |   | -- |   |
| Stock-based                compensation expense related to stock options and performance share                awards, net of tax (3) |   | $                                          | 4,925   |   | $ | 12,415 |   | $ | 20,613 |   |
|                                                                                                                                 |   |                                       |         |   |   |  |   |   |  |   |
| Net                loss, including the effect of stock-based compensation expense                (4)                                 |   | $                                          | (24,440 | ) | $ | (32,134 | ) | $ | (15,341 | ) |
|                                                                                                                                 |   |                                       |         |   |   |  |   |   |  |   |
| Diluted                net income (loss) per share - as reported for the prior period (1)                                            |   |                                       | N/A     |   | $ | (0.49 | ) | $ | 0.13 |   |
| Diluted                net loss per share, including the effect of stock-based compensation                expense (4)               |   | $                                          | (0.62   | ) | $ | (0.80 | ) | $ | (0.37 | ) |

| (1)   | Net                income (loss) and net income (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 year ended December 31, 2005 are net of amounts                already reflected in the net loss for the respective                periods. |
|-----------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

***63***

| (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:**

|                         |   | Year                Ended December 31,  |   |
|------------------------------|--------|----------------------------------------------|--------|
|                         |   | 2006                                         |   | 2005 |   | 2004 |   |   |
| Enel     |   |                                         | 12.4   | % |   | 36.2 | % |   | 58.3 | % |
| EBV                |   |                                         | 27.1   | % |   | 21.0 | % |   | 14.4 | % |
| Total              |   |                                         | 39.5   | % |   | 57.2 | % |   | 72.7 | % |

**6.      GOODWILL AND INTANGIBLE ASSETS:**

***64***

|                                                   |   | **Amount**  |   |
|-------------------------------------------------------------|--------|------------------|--------|
| Balance                as of December 31, 2004              | $      | 8,344            |   |
| Unrealized                foreign currency translation gain |   | (326             | )      |
| Balance                as of December 31, 2005              |   | 8,018            |   |
| Unrealized                foreign currency translation loss |   | 260              |   |
| Balance                as of December 31, 2006              | $      | 8,278            |   |

**7.      COMMITMENTS AND CONTINGENCIES:**

*Lease      Commitments*

| 2007                               | $      | 5,258  |
|------------------------------------|--------|--------|
| 2008                               |   | 4,848  |
| 2009                               |   | 4,736  |
| 2010                               |   | 4,867  |
| 2011                               |   | 4,337  |
| 2012                and Thereafter |   | 3,367  |
| Total                              | $      | 27,413 |

***65***

*Royalties*

*Guarantees*

*Taxes*

*Legal      Actions*

***66***

**8.      INCOME TAXES:**

|                 | Year                Ended December 31,  |    |
|----------------------|----------------------------------------------|---------|
|                 |                                         | 2006    |   |   | 2005 |   |   | 2004 |   |
| Domestic   | $                                            | (23,922 | )  | $ | (18,933 | )  | $ | 5,985 |   |
| Foreign    |                                         | (168    | ) |   | (632 | ) |   | (127 | ) |
|                 | $                                            | (24,090 | )  | $ | (19,565 | )  | $ | 5,858 |   |

|                                                        | Year                Ended December 31, |   |
|-------------------------------------------------------------|----------------------------------------|--------|
|                                                        |                                   | 2006   |   |   | 2005 |   |   | 2004 |   |
| Federal:                                          |                                   |   |   |   |   |   |   |   |   |
| Current                                           | $                                      | ---    |   | $ | --- |   | $ | 94 |   |
| Deferred                                          |                                   | ---    |   |   | --- |   |   | --- |   |
| Total                federal provision            |                                   | ---    |   |   | --- |   |   | 94 |   |
|                                                        |                                   |   |   |   |   |   |   |   |   |
| State:                                            |                                   |   |   |   |   |   |   |   |   |
| Current                                           |                                   | 10     |   |   | 20 |   |   | 30 |   |
| Deferred                                          |                                   | ---    |   |   | --- |   |   | --- |   |
| Total                state provision              |                                   | 10     |   |   | 20 |   |   | 30 |   |
|                                                        |                                   |   |   |   |   |   |   |   |   |
| Foreign:                                          |                                   |   |   |   |   |   |   |   |   |
| Current                                           |                                   | 340    |   |   | 134 |   |   | 462 |   |
| Deferred                                          |                                   | ---    |   |   | --- |   |   | --- |   |
| Total                foreign provision            |                                   | 340    |   |   | 134 |   |   | 462 |   |
|                                                        |                                   |   |   |   |   |   |   |   |   |
| Total                provision for income taxes   | $                                      | 350    |   | $ | 154 |   | $ | 586 |   |

|                                                            | Year                Ended December 31, |   |
|-----------------------------------------------------------------|----------------------------------------|--------|
|                                                            |                                   | 2006   |   |   | 2005 |   |   | 2004 |   |
| Federal                tax at statutory rate of 35%   | $                                      | (8,432 | )  | $ | (6,848 | )  | $ | 2,050 |   |
| State                taxes, net of federal benefit    |                                   | 10     |   |   | 20 |   |   | 30 |   |
| U.S.-Foreign                rate differential         |                                   | 311    |   |   | 355 |   |   | 106 |   |
| Change                in Valuation Allowance          |                                   | 9,059  |   |   | 6,663 |   |   | (1,673 | ) |
| Others                                                |                                   | (598   | )  |   | (36 | )  |   | 73 |   |
| Total                provision for income taxes       | $                                      | 350    |   | $ | 154 |   | $ | 586 |   |

***67***

|                                                                           | December                31,  |    |
|--------------------------------------------------------------------------------|-----------------------------------|---------|
|                                                                           |                              | 2006    |   |   | 2005 |   |
| Net                operating loss carry forwards                     | $                                 | 34,702  |   | $ | 28,772 |   |
| Foreign                net operating loss carry forwards             |                              | 2,247   |   |   | 2,744 |   |
| Tax                credit carry forwards                             |                              | 11,635  |   |   | 10,792 |   |
| Fixed                and intangible assets                           |                              | 5,580   |   |   | 4,961 |   |
| Capitalized                research and development costs            |                              | ---     |   |   | 42 |   |
| Reserves                and other cumulative temporary differences   |                              | 6,987   |   |   | 4,935 |   |
| Gross                deferred income tax assets                      |                              | 61,151  |   |   | 52,246 |   |
| Valuation                allowance                                        |                              | (61,151 | ) |   | (52,246 | ) |
| Net                deferred income tax assets                        | $                                 | --      |   | $ | -- |   |

|                                           |  Net                operating loss carryforwards  |    |   | Federal |   |
|------------------------------------------------|-------------------------------------------------------------|---------|--------|---------|--------|
|                                           |                                                        | Federal |   |    | State  |   |   | Research                Tax Credit |   |
| 2007                                 | $                                                           | ---     |   | $       | ---    |   | $ | 322 |   |
| 2008                                 |                                                        | ---     |   |    | ---    |   |   | 332 |   |
| 2009                                 |                                                        | ---     |   |    | ---    |   |   | 354 |   |
| 2010                                 |                                                        | 6,489   |   |    | ---    |   |   | 179 |   |
| 2011                                 |                                                        | 9,753   |   |    | 8,140  |   |   | 221 |   |
| 2012                and Thereafter   |                                                        | 81,012  |   |    | 17,051 |   |   | 5,187 |   |
| Total                                | $                                                           | 97,254  |   | $       | 25,191 |   | $ | 6,595 |   |

***68***

**9.      WARRANTY RESERVES:**

**10.      RELATED PARTIES:**

**11.      SEGMENT DISCLOSURE:**

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

***69***

|                                          | Year                Ended December 31, |    |
|-----------------------------------------------|----------------------------------------|---------|
|                                          |                                   | 2006    |   |   | 2005 |   |   | 2004 |   |
| Revenues                from customers:       |                                   |    |   |   |   |   |   |   |   |
| Americas                            | $                                      | 19,748  |   | $ | 17,052 |   | $ | 16,227 |   |
| EMEA                                |                                   | 29,991  |   |   | 46,600 |   |   | 82,187 |   |
| APJ                                 |                                   | 7,537   |   |   | 10,776 |   |   | 11,507 |   |
| Total                               | $                                      | 57,276  |   | $ | 74,428 |   | $ | 109,921 |   |
| Gross                profit:                  |                                   |    |   |   |   |   |   |   |   |
| Americas                            | $                                      | 11,953  |   | $ | 10,500 |   | $ | 10,530 |   |
| EMEA                                |                                   | 16,975  |   |   | 24,936 |   |   | 44,374 |   |
| APJ                                 |                                   | 4,399   |   |   | 5,913 |   |   | 6,904 |   |
| Total                               | $                                      | 33,327  |   | $ | 41,349 |   | $ | 61,808 |   |
| Income                (loss) from operations: |                                   |    |   |   |   |   |   |   |   |
| Americas                            | $                                      | 7,156   |   | $ | 5,961 |   | $ | 6,378 |   |
| EMEA                                |                                   | 11,201  |   |   | 18,876 |   |   | 38,554 |   |
| APJ                                 |                                   | (35     | ) |   | 1,295 |   |   | 2,899 |   |
| Unallocated                              |                                   | (48,229 | ) |   | (50,922 | ) |   | (44,113 | ) |
| Total                               | $                                      | (29,907 | )  | $ | (24,790 | )  | $ | 3,718 |   |

**12.      SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED):**

***70***

|                                                          |                                                       | Q4                ‘06 |   |   | Q3                ‘06 |   |   | Q2                ‘06 |   |   | Q1                ‘06 |   |   | Q4                ‘05 |   |   | Q3                ‘05 |   |   | Q2                ‘05 |   |   | Q1                ‘05 |   |
|---------------------------------------------------------------|------------------------------------------------------------|-----------------------------|--------|--------|-----------------------------|--------|--------|-----------------------------|--------|--------|-----------------------------|--------|--------|-----------------------------|--------|--------|-----------------------------|--------|--------|-----------------------------|--------|--------|-----------------------------|--------|
| **Consolidated                Statement of Operations Data:** | (in                thousands, except per share data)  |
| Revenues:                                                     |                                                       |                        |   |   |                        |   |   |                        |   |   |                        |   |   |                        |   |   |                        |   |   |                        |   |   |                        |   |
| Product                                             | $                                                          | 13,622                      |   | $      | 13,110                      |   | $      | 19,209                      |   | $      | 10,574                      |   | $      | 18,711                      |   | $      | 16,068                      |   | $      | 17,268                      |   | $      | 21,516                      |   |
| Service                                             |                                                       | 244                         |   |   | 181                         |   |   | 165                         |   |   | 171                         |   |   | 303                         |   |   | 183                         |   |   | 212                         |   |   | 167                         |   |
| Total                revenues                       |                                                       | 13,866                      |   |   | 13,291                      |   |   | 19,374                      |   |   | 10,745                      |   |   | 19,014                      |   |   | 16,251                      |   |   | 17,480                      |   |   | 21,683                      |   |
| Cost                of revenues:                              |                                                       |                        |   |   |                        |   |   |                        |   |   |                        |   |   |                        |   |   |                        |   |   |                        |   |   |                        |   |
| Cost                of product                      |                                                       | 5,230                       |   |   | 4,936                       |   |   | 7,303                       |   |   | 4,563                       |   |   | 7,848                       |   |   | 7,085                       |   |   | 7,315                       |   |   | 8,707                       |   |
| Cost                of service                      |                                                       | 511                         |   |   | 509                         |   |   | 452                         |   |   | 445                         |   |   | 495                         |   |   | 525                         |   |   | 598                         |   |   | 506                         |   |
| Total                cost of revenues               |                                                       | 5,741                       |   |   | 5,445                       |   |   | 7,755                       |   |   | 5,008                       |   |   | 8,343                       |   |   | 7,610                       |   |   | 7,913                       |   |   | 9,213                       |   |
| Gross                profit                         |                                                       | 8,125                       |   |   | 7,846                       |   |   | 11,619                      |   |   | 5,737                       |   |   | 10,671                      |   |   | 8,641                       |   |   | 9,567                       |   |   | 12,470                      |   |
| Operating                expenses:                            |                                                       |                        |   |   |                        |   |   |                        |   |   |                        |   |   |                        |   |   |                        |   |   |                        |   |   |                        |   |
| Product                development                  |                                                       | 7,328                       |   |   | 6,875                       |   |   | 7,163                       |   |   | 6,991                       |   |   | 6,351                       |   |   | 6,170                       |   |   | 6,360                       |   |   | 6,217                       |   |
| Sales                and marketing                  |                                                       | 5,060                       |   |   | 5,076                       |   |   | 5,089                       |   |   | 5,147                       |   |   | 5,438                       |   |   | 5,164                       |   |   | 5,396                       |   |   | 5,025                       |   |
| General                and administrative           |                                                       | 3,559                       |   |   | 3,746                       |   |   | 3,798                       |   |   | 3,402                       |   |   | 3,421                       |   |   | 8,550                       |   |   | 3,596                       |   |   | 4,451                       |   |
| Total                operating expenses             |                                                       | 15,947                      |   |   | 15,697                      |   |   | 16,050                      |   |   | 15,540                      |   |   | 15,210                      |   |   | 19,884                      |   |   | 15,352                      |   |   | 15,693                      |   |
| Loss                from operations                 |                                                       | (7,822                      | )      |   | (7,851                      | )      |   | (4,431                      | )      |   | (9,803                      | )      |   | (4,539                      | )      |   | (11,243                     | )      |   | (5,785                      | )      |   | (3,223                      | )      |
| Interest                and other income, net       |                                                       | 1,433                       |   |   | 1,586                       |   |   | 1,404                       |   |   | 1,394                       |   |   | 1,658                       |   |   | 1,225                       |   |   | 1,281                       |   |   | 1,061                       |   |
| Loss                before provision for income taxes    |                                                       | (6,389                      | )      |   | (6,265                      | )      |   | (3,027                      | )      |   | (8,409                      | )      |   | (2,881                      | )      |   | (10,018                     | )      |   | (4,504                      | )      |   | (2,162                      | )      |
| Income                tax expense/(benefit)         |                                                       | 110                         |   |   | 80                          |   |   | 80                          |   |   | 80                          |   |   | (146                        | )      |   | 100                         |   |   | 100                         |   |   | 100                         |   |
| Net                loss                             | $                                                          | (6,499                      | )      | $      | (6,345                      | )      | $      | (3,107                      | )      | $      | (8,489                      | )      | $      | (2,735                      | )      | $      | (10,118                     | )      | $      | (4,604                      | )      | $      | (2,262                      | )      |
| Loss                per share:                                |                                                       |                        |   |   |                        |   |   |                        |   |   |                        |   |   |                        |   |   |                        |   |   |                        |   |   |                        |   |
| Basic                                               | $                                                          | (0.17                       | )      | $      | (0.16                       | )      | $      | (0.08                       | )      | $      | (0.21                       | )      | $      | (0.07                       | )      | $      | (0.25                       | )      | $      | (0.11                       | )      | $      | (0.06                       | )      |
| Diluted                                             | $                                                          | (0.17                       | )      | $      | (0.16                       | )      | $      | (0.08                       | )      | $      | (0.21                       | )      | $      | (0.07                       | )      | $      | (0.25                       | )      | $      | (0.11                       | )      | $      | (0.06                       | )      |
| Shares                used in net loss per share calculation: |                                                       |                        |   |   |                        |   |   |                        |   |   |                        |   |   |                        |   |   |                        |   |   |                        |   |   |                        |   |
| Basic                                               |                                                       | 39,220                      |   |   | 39,354                      |   |   | 39,615                      |   |   | 39,767                      |   |   | 39,900                      |   |   | 40,074                      |   |   | 40,528                      |   |   | 41,023                      |   |
| Diluted                                             |                                                       | 39,220                      |   |   | 39,354                      |   |   | 39,615                      |   |   | 39,767                      |   |   | 39,900                      |   |   | 40,074                      |   |   | 40,528                      |   |   | 41,023                      |   |

***71***

**SCHEDULE      II**

|                                                  |   |   | **Balance                at****Beginning****of                Period**  |   |   | **Charged/****(Credited)                to Revenues and Expenses** |    |   | **Write-Off                of****Previously****Provided****Accounts** |   |   | **Balance                at****End                of****Period** |   |
|-------------------------------------------------------|--------|--------|------------------------------------------------------------------------------|--------|--------|--------------------------------------------------------------------|---------|--------|-----------------------------------------------------------------------|--------|--------|------------------------------------------------------------------|--------|
| **Year                Ended December 31, 2004**  |   |   |                                                                         |   |   |                                                               |    |   |                                                                  |   |   |                                                             |   |
| Allowance                for Doubtful Accounts        |   | $      | 500                                                                          |   | $      | (75                                                                | )  | $      | 125                                                                   |   | $      | 300                                                              |   |
| **Year                Ended December 31, 2005**  |   |   |                                                                         |   |   |                                                               |    |   |                                                                  |   |   |                                                             |   |
| Allowance                for Doubtful Accounts        |   | $      | 300                                                                          |   | $      | 15                                                                 |    | $      | 15                                                                    |   | $      | 300                                                              |   |
| **Year                Ended December 31, 2006**       |   |   |                                                                         |   |   |                                                               |    |   |                                                                  |   |   |                                                             |   |
| Allowance                for Doubtful Accounts        |   | $      | 300                                                                          |   | $      | (23                                                                | )       | $      | 27                                                                    |   | $      | 250                                                              |   |

|                                                            |   |   | **Balance                at****Beginning****of                Period** |   |   | **Charged                to Revenues and Expenses** |   |   | **Write-Off                of****Previously****Provided****Accounts** |   |   | **Balance                at****End                of****Period** |   |
|-----------------------------------------------------------------|--------|--------|------------------------------------------------------------------------|--------|--------|-----------------------------------------------------|--------|--------|-----------------------------------------------------------------------|--------|--------|------------------------------------------------------------------|--------|
| **Year                Ended December 31, 2004**            |   |   |                                                                   |   |   |                                                |   |   |                                                                  |   |   |                                                             |   |
| Allowance                for Customer Returns and Sales Credits |   | $      | 874                                                                    |   | $      | 4,608                                               |   | $      | 4,168                                                                 |   | $      | 1,314                                                            |   |
| **Year                Ended December 31, 2005**            |   |   |                                                                   |   |   |                                                |   |   |                                                                  |   |   |                                                             |   |
| Allowance                for Customer Returns and Sales Credits |   | $      | 1,314                                                                  |   | $      | 4,739                                               |   | $      | 4,842                                                                 |   | $      | 1,211                                                            |   |
| **Year                Ended December 31, 2006**                 |   |   |                                                                   |   |   |                                                |   |   |                                                                  |   |   |                                                             |   |
| Allowance                for Customer Returns and Sales Credits |   | $      | 1,211                                                                  |   | $      | 5,673                                               |   | $      | 6,093                                                                 |   | $      | 791                                                              |   |

***72***

----

**SIGNATURES**

|   |  ECHELON              CORPORATION                                                                                                                                                                       |
|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                                         |
|   | By:                        /s/ Oliver R. Stanfield                                                                                                                             |
|   | Oliver                R. StanfieldExecutive                Vice President and Chief Financial Officer (Duly                Authorized Officer and Principal Financial and                Accounting Officer) |

**POWER      OF ATTORNEY**

| Signatures                                      |   | Title                                                                                                      |   | Date                                 |
|-------------------------------------------------|--------|------------------------------------------------------------------------------------------------------------|--------|--------------------------------------|
|                                            |   |                                                                                                       |   |                                 |
| /s/                M. Kenneth Oshman            |   | Chairman                of the Board and Chief                                                             |   | March                16, 2007        |
| M.                  Kenneth Oshman              |   | Executive                  Officer(Principal                  Executive Officer)                           |   |                                 |
|                                            |   |                                                                                                       |   |                                 |
| /s/                Oliver R. Stanfield          |   | Executive                Vice President and Chief                                                          |   | March                16, 2007        |
| Oliver                  R. Stanfield            |   | Financial                  Officer (Principal Financial and                  Principal Accounting Officer) |   |                                 |
|                                            |   |                                                                                                       |   |                                 |
| /s/                Armas Clifford Markkula, Jr. |   | Vice                Chairman                                                                               |   | March                9, 2007         |
| Armas                  Clifford Markkula, Jr.   |   |                                                                                                       |   |                                 |
|                                            |   |                                                                                                       |   |                                 |
| /s/                Robert R. Maxfield           |   | Director                                                                                                   |   | March                8, 2007         |
| Robert                  R. Maxfield             |   |                                                                                                       |   |                                 |
|                                            |   |                                                                                                       |   |                                 |
| /s/                Richard M. Moley             |   | Director                                                                                                   |   | March                10, 2007        |
| Richard                M. Moley                 |   |                                                                                                       |   |                                 |
|                                            |   |                                                                                                       |   |                                 |
| /s/                Larry W. Sonsini             |   | Director                                                                                                   |   |  March                  9, 2007 |
| Larry                W. Sonsini                 |   |                                                                                                       |   |                                      |

***73***

**EXHIBIT      INDEX**

| ExhibitNo. |  Description                  of Document                                                                                                                                                                                                                              |
|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.2*       | Amended                  and Restated Certificate of Incorporation of                  Registrant.                                                                                                                                                                          |
| 3.3*       | Amended                  and Restated Bylaws of Registrant.                                                                                                                                                                                                                 |
| 4.1*       | Form                  of Registrant’s Common Stock Certificate.                                                                                                                                                                                                       |
| 4.2*       | Second                  Amended and Restated Modification Agreement dated May 15,                  1997.                                                                                                                                                                    |
| 10.1*      | Form                  of Indemnification Agreement entered into by Registrant with each                  of its                  directors and executive officers.                                                                                                          |
| 10.2*+     | 1997                  Stock Plan and forms of related agreements.                                                                                                                                                                                                           |
| 10.2(a)+   | Form                  of 1997 Stock Plan Stock Option Agreement with                  early exercise feature                                                                                                                                                                |
| 10.2(b)+   | Form                  of 1997 Stock Plan Nonqualified Stock Option                  Agreement with early exercise feature                                                                                                                                                   |
| 10.2(c)+   | Form                  of 1997 Stock Plan Nonqualified Stock Option                  Agreement                                                                                                                                                                               |
| 10.2(d)+   | Form                  of 1997 Stock Plan Performance Share                  Agreement                                                                                                                                                                                       |
| 10.2(e)+   | Form                  of 1997 Stock Plan Performance Share Agreement for                  non-US employees                                                                                                                                                                  |
| 10.2(f)+   | Form                  of 1997 Stock Plan Performance Share Agreement                  with performance based vesting criteria for non-US                  employees                                                                                                         |
| 10.2(g)+   | Form                  of 1997 Stock Plan Stock Appreciation Right                  Agreement for non-US employees                                                                                                                                                           |
| 10.2(h)+   | Form                  of 1997 Stock Plan Performance Share Agreement                  with performance based vesting criteria                                                                                                                                               |
| 10.2(i)+   | Form                  of 1997 Stock Plan Performance Share                  Agreement                                                                                                                                                                                       |
| 10.2(j)+   | Form                  of 1997 Stock Plan Stock Appreciation Right                  Agreement                                                                                                                                                                                |
| 10.3*+     | 1988                  Stock Option Plan and forms of related agreements.                                                                                                                                                                                                    |
| 10.4*      | Second                  Amended and Restated Modification Agreement dated May 15, 1997                  (included                  in Exhibit 4.2).                                                                                                                         |
| 10.5*      | Form                  of International Distributor Agreement.                                                                                                                                                                                                               |
| 10.6*      | Form                  of OEM License Agreement.                                                                                                                                                                                                                             |
| 10.7*      | Form                  of Software License Agreement.                                                                                                                                                                                                                        |
| 10.8*      | International                  Distributor Agreement between the Company and EBV Elektronik GmbH                  as                  ofDecember                  1, 1997.                                                                                                  |
| 10.9*+     | 1998                  Director Option Plan.                                                                                                                                                                                                                                 |
| 21.1*      | Subsidiaries                  of the Registrant.                                                                                                                                                                                                                            |
| 23.1       | Consent                  of KPMG LLP, Independent Registered Public                  Accounting Firm.                                                                                                                                                                       |
| 24.1       | Power                  of Attorney (see signature page).                                                                                                                                                                                                                    |
| 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. |

*74*