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Echelon Corp. (NASDAQ:ELON)

Q4 2008 Earnings Call

February 5, 2009 2:00 pm ET

Executives

Annie Leschin – Investor Relations

Ken Oshman – Chairman and Chief Executive Officer

Chris Stanfield – Executive Vice President and Chief Financial Officer

Analysts

Preetesh Munshi – Piper Jaffray

Joe Maxa – Dougherty & Company

[Alex Perts – American]

Carter Shoop – Deutsche Bank

Bill Gibson – Nollenberger Capital

Michael Carboy – Signal Hill Capital

Operator

Welcome to the Echelon Corporation’s fourth quarter 2008 earnings call. With us today are Kenneth Oshman, CEO and Chris Stanfield, CFO. At this time we’ll turn the call over to Annie Leschin of Investor Relations. Please proceed.

Annie Leschin

Thank you for joining us today for our fourth quarter 2008 earnings conference call. With me on today’s call are Ken Oshman, Chairman and CEO, and Chris Stanfield, EVP and CFO who will both present prepared remarks.

By now you should have received a copy of the press release that we issued early this morning. If you would like a copy please visit or website at www.echelon.com. Before we begin, I would like to let everyone know that Echelon will be participating in the Thomas Weisel Technology and Telecom Conference on February 9th in San Francisco, the Deutsche Bank Small and Mid-Cap Conference on February 12th at Naples and, the Piper Jaffray Clean Technology and Renewables Conference on February 19th in New York and the Pacific Crest Emerging Technology Summit on February 27th in San Francisco. As additional events are scheduled this quarter, we will make additional announcements.

I would like to remind everyone that during the course of this call, we may make statements relating to our business outlook, future financial and operating results, accounting matters and overall future prospects. These forward-looking statements are based on certain assumptions and are subject to a number of risks and uncertainties. We encourage you to read the risks described in our press release, dated February 5, 2009, as well as in our SEC reports including our 2008 report on Form 10-K for a more complete disclosure of the risks and uncertainties related to our business.

The financial information presented in this call reflects estimates based on information that is available to us at this time. Actual results could differ materially. Echelon undertakes no obligation to update or revise these forward-looking statements. Guidance will not be updated after today’s call until our next scheduled quarterly financial release.

I would now like to turn the call over to Ken Oshman.

Ken Oshman

I’ll begin the call with a few brief comments on our fourth quarter performance and highlights from our two product lines, LonWorks Infrastructure and Networked Energy Services, and then discuss the current environment and the factors affecting our longer term business outlook.

In summary, overall Echelon performed well in the fourth quarter meeting our projections even as the worldwide financial and economic crisis began to take hold, and our LonWorks Infrastructure business saw a drop off in December. Total sales were $36.8 million with gross margins of 35.9% resulting in a net loss of $6.3 million or $0.15 per share. Our cash position remains strong at $87.3 million in cash and marketable securities with no borrowings.

I’ll now turn to our LonWorks Infrastructure product line. On our last call we commented that while our outlook for LonWorks revenues remained cautious due to the ensuing economic slowdown, we had not yet seen any direct impact. For the first two months of the fourth quarter this remained the case as revenues were robust across industries. During December, however, that sentiment abruptly changed. The tone of our customers became extremely cautious reflected in the delay and push out of orders.

We believe that as the year ended many customers were focused on lowering inventories, conserving cash and preparing for the difficult economic times ahead. Having said that, in the first few weeks of January we saw shipments recover but it’s far too early to project a long-term trend.

There were a number of noteworthy highlights in the fourth quarter in our LWI business. After years of work in various committees and with supporting votes from countries around the world, LonWorks technology was adopted as a global control standard for building automation, control in building management by the International Organization for Standardization (ISO). This is a very significant milestone for our technology.

ISO is the highest level of standardization possible and validates the openness, enduring strength and flexibility across multiple industries of LonWorks technology. A networking technology now used by thousands of companies. Companies like Honeywell, Samsung and McDonalds. ISO standardization will help promote continued adoption of the platform in the growing market for energy management and control applications, an important growth opportunity of our LonWorks product line.

We believe LonWorks technology is gaining traction as the leading open networking standard for energy management in a wide variety of applications including street lighting, enterprise management, demand response, and commercial and home energy management.

This past quarter, we also demonstrated street lighting infrastructure using LonWorks technology at the Anchorage Street Lighting Conference. Typically accounting for roughly 40% of the city’s operating budget, street lighting represents an enormous opportunity for significant cost savings through energy conservation and reduced maintenance.

By networking the lights together and remotely managing them using Echelon’s products, in addition to saving energy, cities can also provide for optimal light output for health and safety while simultaneously lowering costs and decreasing unnecessary light and CO2 emissions.

With the economic crisis significantly impacting state and local budgets, governments and utilities are looking for ways to reduce their operating costs and we’ve seen the activity in new street lighting projects increase around the world.

Next, our NES product line. The NES product line exceeded our guidance for the quarter due mostly to customer’s acceptance of some products in the fourth quarter of 2008 that were originally anticipated to be accepted in the first quarter of 2009. We also achieved an important milestone for the company and the industry in the quarter with the introduction of our next-generation 3.1 advanced metering product platform.

As we mentioned last quarter, the successful and timely shipment of this new metering platform is an integral part of our NES strategy. Our GEN 3.1 platform was particularly important to the adoption of NES by some of the utilities in Denmark and the advanced capabilities of the new product are particularly important to our future revenues as certain existing products, such as [inaudible] in Sweden come to an end.

Historically only the meter vendor could adjust a meter’s functionality to add new capabilities. With the NES system, Echelon helped pioneer a new model for meters in which functionality can be enhanced by downloading new firmware into meters already deployed in the field. With our 3.1 meter platform, we’ve raised the bar yet again. The 3.1 meter platform introduces an open secure port through which third parties can create their own add-ons that extend the capability of the NES metering system.

This open multipurpose expansion port is two-way enabling our customers to not only extract and act on information coming from NES meters, but also to publish information back into the NES system. It supports firmware download enabling the companies that build these devices to also upgrade their products remotely saving the cost of field visits.

The first company to take advantage of this new capability is our partner, Eltel with its projects in Denmark. They are providing NES meters capable of sending information into homes using the 802.15.4 wireless networking standard and the application model defined by the ZigBee contortion.

The fourth quarter also saw the first direct impact to our NES sales due to the financial crisis. Through one of our bars, Echelon had been awarded a utility project in Eastern Europe for which we had expected to begin shipments in early 2009.

However, the severity of the financial crisis in Eastern Europe left financially strong utility unable to obtain funding, and it is unclear when the order will rematerialize should conditions improve. However, thus far we have not seen the credit crisis directly impact projects in Western Europe or North America and the number of inquiries in tender activity have continued to be brisk.

In North America, our work with Duke Energy also progressed this quarter with ongoing delivery of initial deployment orders. To date, our NES metering system has performed very well delivering data and services with very high reliability and consistency. With the North American market for advanced metering just beginning to develop, Duke Energy remains a key customer for Echelon.

We are also working on other opportunities in this market and we’ve expanded our efforts with the recent hire of our new Vice President of Sales for North America for NES in the Americas, Jim Andrus. Jim brings extensive industry in North American sales experience to Echelon.

Now let me turn to the outlook. As you saw in our earnings release, given the currently unpredictable worldwide economic conditions, we are only providing quarterly guidance at this time. That said I would like to provide some view of the opportunities that lie ahead in 2009 and how we anticipate the year will play out.

As most of you know, Echelon’s LonWorks sales have often been more of a lagging indicator for the economy making it challenging for us to predict how the current conditions will affect us. The drop off we saw in LonWorks sales in December was felt across the board in Europe and North America, and it appears likely that our customers will continue to maintain tight controls over spending for at least the next quarter or more.

Current indications from our large customers are that they do not expect any significant change in their overall 2009 business versus 2008, although they have limited visibility into the second half of the year. We continue to see energy management as a key area driving LonWorks revenues in 2009 heightened in the U.S. by the new administration’s focus on initiatives for energy conservation, cost savings and intelligent infrastructure investments.

These applications include street lighting, demand response, enterprise energy, branch management and renewable energy. Energy conservation through intelligent control and monitoring is the least costly and most available and largest potential source of renewable industry energy for the next decade. We believe LonWorks products will benefit as companies are given incentives to create additional new energy efficient applications.

In addition, we expect to see some growth in our LonWorks Infrastructure product line in 2009 resulting from the market introduction of several potentially very high volume new products that have been in the design phase for several years. As for NES, we anticipate advanced metering and smart grid projects will move forward as the year progresses reflected by the continuing strength of tenders, pilots and existing projects.

The ever present challenge in predicting our NES revenue is judging the exact timing and accuracy of the deployment schedules and policy actions taken by different countries and utilities. The reality is that the advanced metering market is still very much at its nascent stages. At this point, metering projects largely come in fits and starts depending on local and regulatory issues, as well as the ability of multiple parties to reach agreement.

When a utility or a government decides to move ahead, significant awards can be made and a market appears, thus the importance of positioning in a variety of markets. We continue to believe that we are well positioned to capitalize in the country’s readying to adopt advanced metering. Given our current pipeline of existing and potential new projects for 2009, we anticipate a number of new and expanding opportunities throughout the year, including continued orders from Denmark and further progress in European and U.S. pilot projects.

As a result of the current timing in outlook of these contracts, we expect NES revenue to grow during the year as projects ramp up making our NES 2009 revenue back half loaded. We also see increased awareness and a growing voice from governments talking about the smart grid. While this term means many things to many people, to the extent that governments promote and utilities adopt a smart grid centric rather than meter centric orientation, this may potentially change the business case for advanced meters and expand the use of these systems playing directly to Echelon’s strengths.

That said, despite comments to the contrary of our competition, we believe that a number of utilities around the world are now taking time to re-evaluate their capital spending priorities. Transforming their utility networks into smart grids remains a very high priority and one of the most attractive ways to reduce energy consumption and CO2 emissions around the world.

A truly smart grid helps consumers understand how they’re using energy in order to help them change their usage patterns to conserve energy and to save money. A smart grid allows utilities to capitalize on alternative sources of energy, to reduce the cost of their operations, and to provide greatly improved services to their customers. Our NES system, in conjunction with LonWorks networks, does just that.

Finally, there’s a lot of anticipation around the stimulus packaging in the U.S. and similar initiatives around the world. I’m pretty confident that improving energy conservation in federal buildings and making schools green and similar initiatives will have a very positive impact on our LonWorks Infrastructure product line, which is broadly used in government and school applications today.

For our NES product line, every utility that I’ve spoken with believes that with incentives from governments around the world, they will accelerate their smart grid plans. The wild card is how the incentives will be used. Will they incentivize existing programs or new programs? The devil’s in the details and we look forward to hopefully an improvement across the world in smart grid activity.

Finally, in summary, we were pleased with our quarterly performance as we cautiously approach the first half of 2009. Overall, we see a number of positive trends. Indicators and government initiatives that we believe will drive our markets and grow revenues in the longer term. The real question, however, is how quickly these projects progress.

I’d like to thank the entire Echelon team around the world for their diligent efforts and hard work. And now I’ll turn the call over to Chris Stanfield, our CFO to elaborate on our operating results and guidance.

Chris Stanfield

Now I would like to review our financial performance during the quarter and provide some commentary on our outlook for the first quarter. Please note, that all references to non-GAAP amounts exclude stock-based compensation. For ease of reference, we have prepared a comprehensive non-GAAP statement of operations with 3 and 12-month periods ended December 31, 2008 on the investor relations section of our website.

Revenues for the quarter ended December 31, 2008 were $36.8 million compared to $46.9 million for the same period in 2007. Highlighting the fourth quarter was particular strength in our NES product line where revenue of $20.6 million exceeded our guidance, though declined from $27.7 million a year ago. As Ken mentioned, our LonWorks product line revenue experienced weakness in December due to the economic situation and decreased year-over-year to $11.7 million from $13.1 million last year.

Revenue from the Enel project was $4.5 million versus $6.1 million in the same period a year ago. For the full year 2008, revenues were $134 million compared to revenues of $137.6 million in 2007. NES revenues accounted for the largest piece at $67.1 million, followed by LonWorks revenues at $54 million and Enel at $12.9 million.

Non-GAAP gross margin for the quarter was 37.2% compared to 41.8 % for the same period last year. The gross margin decline was primarily driven by an overall reduction in revenues between the two periods. Non-GAAP operating expenses were $16.3 million compared to $16.5 million in the fourth quarter of last year. This was less than expected due to careful management of expenses given the economic condition and favorable exchange rates as the dollar grew stronger.

Interest and other income was $606,000 versus $1.4 million in the same period last year. As the reduction in average yield in our investment portfolio was partially offset by currency translation. The GAAP net loss for the quarter was $6.3 million or $0.15 per share. This compares to net income of $912,000 or $0.02 per share for the same period in 2007.

On a non-GAAP basis, the net loss for the quarter was $2.5 million or $0.06 per share compared to a non-GAAP net income of $4 million or $0.09 per share in the fourth quarter of 2007. We generated a GAAP and non-GAAP loss per share of $0.64 and $0.28 per share respectively for the full year 2008. This compares to a GAAP and non-GAAP loss of $0.39 and $0.20 per share respectively for the full year 2007.

Moving on to the balance sheet, we ended the quarter with cash, cash equivalents and short-term investments of $87.3 million, a decrease of $19.9 million over the last year. This decrease in our cash position for the year was primarily driven by $8.9 million related to our stock buyback share program, capital expenditures of $4.6 million, and cash used in operations of $3.8 million.

Now I would like to turn to guidance. As Ken mentioned the current environment of impact [inaudible] and thus makes it challenging to predict the outlook for 2009. As a result, we will continue to provide one quarter of guidance. In the near-term, our LonWorks product line has been impacted by the macroeconomic conditions.

In NES, we are already seeing a number of positive catalysts that underlie our confidence in modest growth for 2009 including continued tender activity, active projects that are expected to ramp in volume during the second half of 2009, and the growing focus on energy management and the potential impact of the recent stimulus package, which are positive influences on both of our product lines longer term.

We now expect total revenue for the first quarter of 2009 to be in a range of $17 million to $19 million with LonWorks Infrastructure accounting for approximately $11.5 million, NES for $5.5 million as the timing of certain projects fluctuates and leaving the remainder to confirm Enel.

We anticipate non-GAAP gross margin to be in the range of 38% to 41% for the quarter, and non-GAAP operating expenses to be between approximately $17.5 million and $18 million. Finally we estimate our GAAP loss per share to be between $0.34 and $0.38 per share and our non-GAAP loss per share to be between $0.25 and $0.30. Now I would like to turn the call back to the operator for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Preetesh Munshi – Piper Jaffray.

Preetesh Munshi – Piper Jaffray

A couple of quick questions here, with respect to the NES business and in your discussions with the utilities, can you talk about has their tone changed over the last couple of weeks or they’re as bullish on the deployments or the trials, if you will, as they were earlier. Also, if you can talk a little more about Duke in terms of timing and when we could see this materialize into a commercial scale deployment.

Ken Oshman

I’m sorry. What was that last part?

Preetesh Munshi – Piper Jaffray

When would you expect the Duke opportunity to move from the pilot phase into a commercial deployment?

Ken Oshman

So, let me begin with the end. The Duke project is in deployment phase now. It is absolutely not in a pilot phase. It is in deployment phase and is at least as far along as I think they planned to be with their Ohio program. So it is doing fine, I think I mentioned that, so it is going and it’s doing just fine. In fact, it’s doing fabulously well. Their results are actually surprising in how good some of their results are.

Maybe I’ll tell a story if I could that I heard. In one of their installations they had a number of meters, in one area they had a number of meters installed in December, because of bad weather, they had an unusually high outage rate. In fact, in a group of about only 5,000 meters in one place, they had five outages in December. But the great story is that for three of the five, they detected the outage and repaired it before the customer even knew they had an outage.

For the fourth outage, they were repairing it at the point that the customer found out that they had an outage, and the fifth was actually not really an outage. What they did was they were looking at our power line communication signals, which are very reliable and very strong, and they just saw a small degradation in one of them. And they said hey, there might be something going on there, let’s go see. So they did. And what they found was there was a power cable about to break. So even before the outage they were able to repair it. So things are going very well there.

Preetesh Munshi – Piper Jaffray

That’s great to hear. How many other utilities are you talking to and what are you hearing today versus what you were hearing a few weeks ago in terms of their smart grid initiatives?

Ken Oshman

So what I hear and what we are quite confident of is there is still a lot of activity. We have a lot of activity in our pipeline, which looks to us to be second half loaded and I think we’ve made that clear. I hope that’s clear. I wish it were Q1 loaded but it’s going to be second half loaded. That’s just the way it’s going to be because utilities are going to move at their own paces and do what they do.

Having said that, I don’t think there are many utilities around the world that aren’t saying to themselves, geez there’s a big capital problem going on around the world. Even though we have a lot of capital, even though we have great credit, we have lots of things we want to do. Let’s just make sure we’ve got our priorities correct, and so they’re all stepping back briefly and saying what’s the first thing we should do, what’s the second thing we should do?

So I think there is definitely some slowdown in those people that aren’t underway one way or another. Their not in the procurement process or their not in the deployment process or something so, I think there is some temporary slowdown. I don’t think it will be long-term. I think it’s just prudent management on the parts of good utilities.

Preetesh Munshi – Piper Jaffray

A quick question on the LonWorks business, you indicated kind of a drop off in December. Can we view this as a mere push outs, which will probably come back later in Q1 or Q2 or whatever they do. Or are you seeing cancellations and can you give us a little more color there please?

Ken Oshman

We’re not seeing cancellations. We wouldn’t see cancellations. Our business is pretty much a book and ship business. What we have seen are some push outs, as you call them, and we think this is just prudent readjustment of inventories. Our customers tend to be very well managed businesses. They do a great job of managing their inventories and their cash.

So I think the first indication is that they were just being cautious in December, and I say that because some of the things that were pushed out in December were then pulled back in in the first two weeks of January. But that’s too early for us to really know what that all is going to mean for Q1, for the rest of Q1 and for the year. That’s just all we know.

Preetesh Munshi – Piper Jaffray

Just one last question, for Chris actually. In terms of non-GAAP profitability, are we still targeting $150 to $160 million revenue run rate?

Chris Stanfield

I think it could certainly fall in that range. As you know, it depends in part upon the mix of our revenues between our product lines, and it also depends upon the speed with which we can attain some of the margin improvements that we’re going after in our NES product line.

Preetesh Munshi – Piper Jaffray

Thanks guys and we look forward to hosting you on February 19.

Ken Oshman

Can I just add to Chris’s remarks that one of the things that we are doing is in the face of this uncertain economic time, we are doing everything to manage our cash and our capital that we possibly can to hold expenses as low as we possibly can. Having said that, we are still going to be in place to compete around the world where AMI deployments happen. We are still going to add as we need to and just have to our marketing and sales activities to be a major presence in this smart grid market.

Operator

Our next question comes from [Alex Perts – American].

[Alex Perts – American]

I just want to clarify the comments about LonWorks. Do you expect that division to grow in fiscal ’09 or do you expect to see decline year-over-year?

Chris Stanfield

We’re not providing guidance for the full year. But as Ken said, I think what we see right now is a temporary process. As Ken did indicate, when you look at our customers in LonWorks, many of those are who’s who in terms of managing their business, and based upon our experience in terms of how they have dealt with other economic slowdowns, we think that they are going to be prudent here. As Ken also said when our sales people talk with those customers, those customers themselves are not out seeing full year declines.

Ken Oshman

Please remember, this is a product line, there’s not a division here. Go ahead.

[Alex Perts – American]

Could you just give us a little more clarity about the quarter-over-quarter decline in the NES business? You mentioned there was one Eastern European utility. Was that on the NES side or is that on the LonWorks side that [inaudible] on orders there.

Chris Stanfield

First are you talking about Q4 2008?

[Alex Perts – American]

Yes. Q4 they did $20 million or so in Q4 and now we’re going down to five and a half. I’m just trying to have you help me understand the dynamics there in the drop off.

Chris Stanfield

First of all, to answer your question, the customer that Ken referenced earlier was an NES customer, the customer in Eastern Europe. And in terms of what’s happening is that, as you know, we have some projects in Sweden and those projects were going through in large part of their completion last period. Furthermore, many of these projects are not linear, as we have discussed before. There will be deployments and then there will be a hiatus and then there’ll be deployment.

We may not like it, but that’s the nature of the business. And what we’re now seeing is, we’re now seeing the ramp up of some of the new opportunities that we want, particularly in Denmark. And that’s just how this business happens. I think the reason it’s more noticeable in our results is we don’t have this large base of legacy meters that we’re selling, upon which there’s this little layer of AMI activity. And so what you see in our numbers is more of the natural move that occurs in this marketplace from quarter-to-quarter.

[Alex Perts – American]

Last question, I know it’s a sensitive subject, but have you considered large group reductions in some of the operating expenses across the board to move closer to profitability sooner than maybe your initial target?

Chris Stanfield

I’ll start that and then I’ll pass it to Ken. I think as we have discussed there’s a $1.5 billion meter market that’s at stake here. It’s largely a green field opportunity. And we believe that it would not be prudent in the interest of our stockholders to not make necessary investments in marketing and sales, engineering and elsewhere, to put Echelon in a position to operate against that opportunity.

Ken Oshman

Well, let me just say, we are using this opportunity to cut every expense we can possibly cut out of anything we can possibly cut it from. But let me say that, we’re not sort of playing around here. We have enormous pressure to get lots of great products developed. We have lots of support we’re doing for our partners in the field.

We have lots of sales and marketing opportunities that we need to go capitalize on. It’s not as though our industry is contracting. Our industry is just at its birth. And so we think, I think, it would be a really big mistake not to be ready in these AMI markets as smart grid deployments are coming about to be a competitor, to be a player, and to be ahead of the pack. So, we’re doing everything we can to keep our expenses down. We are also trying to remain a leading competitor.

Operator

Our next question comes from Carter Shoop.

Carter Shoop – Deutsche Bank

Quickly, on NES, could you give us a regional breakout for expectations for the first quarter? I think the midpoint for guidance to be 5.6 million. Is that going to be roughly even between North America and Western Europe?

Chris Stanfield

I don’t really want to get into each of the markets that we have revenue in. All of that is in backlog. And so it just is what it is under a normal, every project sort of goes through big periods and low periods and there’s no indication in any of that.

Ken Oshman

I think it’s well known that our major, Carter, if you’re asking the question how much of that is Duke Energy because it’s well known that our largest deployment going on in North America is Duke Energy. Duke is going to operate at its own pace. That’s just what they do. And so, it will come and go as the pace of their project accelerates and plateaus.

Carter Shoop – Deutsche Bank

When we look at the full year guidance you provided for NES in the press release you said that you expect to see growth there, how confident are you that we will see growth, given the fact that overall year-over-year and fourth [inaudible] sales are down about 26% and the midpoint of guidance is down 73%, and you guys came in about 40% below expectations for 2008?

I feel that banking on a second half rebound sounds very familiar and just wanted to understand why we are setting such high expectations given such a weak start to the year?

Chris Stanfield

Well, I think that we’re not looking at this from 40,000 feet. What we’re doing is we’re getting together with our sales teams and we’re analyzing every opportunity that we’re working in the marketplace.

Those opportunities have their own timetables. In some cases, those timetables aren’t what I would choose, but that’s what the customer is going to do.

And so the number that we have been out looking for 2009 has been pretty much the same for the last several months as we go through our monthly planning process. And so as we look at that overall pipeline, that is what we see, is this modest growth that you refer to.

Ken Oshman

So we have had second half loaded revenue every year. We have also had second half loaded expectations every year. In 2007, we had some second half loaded expectations and we hit them. In fact, we exceeded them. That was just what happened. In 2008, based on what utilities had told us, we had second half even bigger loaded expectations for 2008, and the utilities just did not do exactly what they said they were going to do. We didn’t lose anything. It didn’t get canceled. But it didn’t happen. So our second half loading was what it was.

We are being, I think, quite prudent and very thorough in doing our planning for this year and it comes out to be second half loaded. If that is a concern to you, that’s fine, but that is just what we see and we think it’s good. We think it’s a good forecast.

Carter Shoop – Deutsche Bank

When we think about the way you pulled out these forecasts and the overall planning process with the sales and different customers, has that changed over the past year or are we relying on pretty much the same logic and the same inputs as we have over the past, say, 12 months?

Chris Stanfield

I think the process, of course, changes over time. In part, it changes because we get more information. In part, it changes just because of the fact that we look back at why didn’t we know something or that kind of thing?

But, as Ken said, I think the biggest issue that you have here, and I think, Carter, you know this from your early experience with the industry, is that when we start an opportunity like this we are presented with a ramp from a customer. In some cases, they operate to the ramp and in some cases they don’t. And often times, they are qualifying us to make certain that we’re going to be able to support that ramp and get us committed to that ramp. And in some instances, the customers then for their own reasons, which often times have nothing to do with us, push that ramp out and that’s just the nature of this business.

I think that it will become less visible as there are more and more insulations going across multiple opportunities. Perhaps the one thing that makes me feel best is the fact that we really have this worldwide presence. And so we are going ahead and executing these opportunities across the entire marketplace. And that’s why we can go ahead and have some bad news, as Ken referenced earlier, with a customer who had some credit concerns and still feel confident about our performance this year.

Carter Shoop – Deutsche Bank

And when we look to the second half ramp-

Ken Oshman

Let me say, Chris is confident. I think any executive in any business that is totally confident about 2009 right now is a little bit, I think all of us and everybody running any business in the world today is looking at 2009 through a very cloudy lens. And we’re doing our very best we can to project the future. And we’re trying to be very prudent and very conservative about that.

Chris Stanfield

I agree that, given the current macroeconomic conditions, it would be wise to be prudent. It just seems that starting off the first quarter that you would need to see a pretty substantial ramp to hit those numbers. It would be nice to start off the year with, in my view, maybe more realistic assumptions for the full year.

Carter Shoop – Deutsche Bank

When we think about the second half of ’09 for NES, how many key customers do you see ramping in the second half of the year to help you make that number? Are you looking at two in particular contracts, or is it five different contracts that are going to all be meaningfully contributing to that substantial second half ramp?

Ken Oshman

We see multiple opportunities. Carter, I want to go back to the previous question, though. Please recognize that one of the reasons that the ramp seems steeper is because there were some NES transactions that we had expected we’re going to get completed that is expected in Q1. And those particular transactions were actually accepted early.

That’s not the complete answer to your question, but I wanted to make sure that you recognize that.

Carter Shoop – Deutsche Bank

The last question is the Eastern European push out, can you give us a sense of how large of a contract that was or potentially will be?

Ken Oshman

It was a pretty large contract. It was probably for us, in total over some period of time probably somewhere between $30 and $40 million.

Operator:

Our next question comes from Mr. Bill Gibson – Nollenberger Capital.

Bill Gibson – Nollenberger Capital

I want to switch away from NES into LonWorks, Ken. You talked about some new products that have been years in the gestation that are coming out. Can you share with us a little more detail on what those might be?

Ken Oshman

No. I so wish I could, but I cannot. Our customers do not want us to talk about them, but I can tell you they’re cool. One of them is especially cool and I can’t wait until it gets out, but I can’t tell you anymore about it.

Bill Gibson – Nollenberger Capital

Then one other quick one back to NES, with Jim Andrus on board, is there any new outlooks or new ways of looking at the U.S. market as the new kid on the block to crack the market?

Ken Oshman

Well, he’s been here four days and he has been absolutely inundated with [inaudible] with people congratulating him on his great wisdom and drawing Echelon and we are so delighted that he’s joined Echelon. I think the main thing that Jim will bring is experience in the utility industry. He’s been in the utility industry for twenty years.

He also is the capstone of tripling higher sales presence in North America, and, I think he has lots and lots of good ideas and good contacts and good down and out sales management experience. So we’re looking forward to great success for Jim.

Operator:

(Operator Instructions) Our next question comes from Michael Carboy – Signal Hill.

Michael Carboy – Signal Hill Capital

Ken, I’d like you to elaborate a little bit on the pipeline that we’re looking at here in ’09, could you give us an idea in terms of how many utilities are reflected in the potential aggregate bidding for that total pipeline or how many total metering points might be in that pipeline?

Ken Oshman

Oh gosh no, I don’t know how to do that in a way that wouldn’t be totally misleading and confusing. Let me just talk about our process a little bit. We put into our process those opportunities that we have been told for sure are going to happen at some for sure date at some for sure size and for which we think we have almost a dead synch of winning.

That’s the beginning point. Then we add to that those that we’re less certain about the timing and then we add to those, those that we’re less certain about winning and then we, and it goes on from there, and it is a very complex process. I wish we were perfect at predicting I wish we could get more perfect at predicting.

I don’t think we are bad at it, I just think the variables in the process are such that it’s very hard to be perfect. But I think that the aggregate and the activity of our pipeline are fine for us to feel reasonably confident about the fact that ’09 will have some growth in NES revenue. That’s about the most we can say at this time.

Look, at this point we’ve got pilots and deployments and things going on at utilities around the world that represent 60 million customers, a $6 billion opportunity to us if we were to capture all of that. So out of all of that we’re not saying that a whole hell of a lot is going to happen this year.

Michael Carboy – Signal Hill Capital

Well maybe we could narrow it down to just the U.S. then. Can you give us an idea of how many projects or RFPUs you’re bidding into?

Ken Oshman

Well we expect that there will be a number of tenders I think most people know about the tenders and the things that are going on in the U.S., most of our competition knows about them, and we’re going to bid on them and there are a few of them. I don’t think deployments outside of those that are underway will have enormous impact on revenues in ’09 for anybody, for anybody whether we win them or lose them.

Michael Carboy – Signal Hill Capital

So the last thing here on NES, do you get the sense that [inaudible] utilities that they fully appreciate some of the IT challenges that they may face in their back offices with regard to either their business information systems or customer innovation systems, or SCADA systems as they move to smart grid and might the pause that you have earlier described for reflection for those utilities that haven’t decided that this fits in a plan. Might that perhaps be a bit longer than we might now think?

Ken Oshman

Let me say that I have been very impressed with the IT infrastructure planning that the utilities we have been involved with for deployments have done. They’ve done a very good job. I mean for Duke to tell me that they were detecting a slight decline in power line communication levels at some customers and able to go find an outage potential, is saying they’re taking this data and they’re looking at it and they’re using it and that’s all we can require and request and hope for.

And I can tell you that Duke and Kelvin and the Danish utilities that we deal with and Nuon and all of these utilities are well aware of the fact that an Echelon smart grid product is not about meter reading and ringing the cash register, it’s about a whole lot of services and integrating outage response systems and all kinds of activities within a utility into a single, an expanded IT system, and so they know all of that. That in part can from time to time I think pace the speed of deployment, but it is not something that I think comes as a surprise to most of the people we deal with.

I am surprised with some of the utilities that think they’re doing smart grids and when in fact all they’re doing is a sort of fancy meter reading system. And I know they will be very disappointed when they take the next step to trying to figure out how to do a lot more things that a feature-rich function-rich system like NES can do. But I think our customers have been pretty darn good about thinking through what they’re going to do and how they’re going to do it.

Michael Carboy – Signal Hill Capital

The last numbers question for Chris, Chris could you elaborate on the dollar magnitude of the foreign exchange impact in OpEx and also give us a specific update on how many shares have been bought back under the buyback program?

Chris Stanfield

There was no change in the buyback program and so last year we repurchased 750,000 shares for $8.9 million going back to 2001 we’ve repurchased 3.2 million for $28 million. Then in terms of the interest income, for Q4 I think the FX was about two-thirds of the total. But that was as you know that it has bounced around in the year as the dollar has been weak and then strong.

Michael Carboy – Signal Hill Capital

I’m not certain I understand exactly what you mean by two-thirds.

Chris Stanfield

Of the $600,000.

Operator

Our next question comes from Joe Maxa – Dougherty & Company

Joe Maxa – Dougherty & Company

Ken, Chris the two half back of ramp that you were expecting, I know you don’t want to give specific guidance, but does that suggest that the second quarter is going to be similar to the first? Would you expect that or should we start to see some ramping as we get to the back half in your NES business.

Ken Oshman

I don’t think we want to get into second quarter guidance right now and we’re trying to paint a general picture but not provide real guidance for the year. If we could provide real guidance for the year and felt comfortable doing that we would do it. What we’re trying to do is sort of paint a picture of how we see possible things going.

Joe Maxa – Dougherty & Company

I would imagine to get to your modest growth you would need to have both Duke and your wins in Denmark be pretty meaningful this year?

Ken Oshman

Denmark we think will be meaningful this year. At every utility things can happen, but we do think Denmark will be meaningful and we do think there will be some business this year from Duke, new business this year from Duke.

Joe Maxa – Dougherty & Company

I wanted to just to talk about your operating expense guidance, you have made several comments that you’re trying to conserve cash but your guidance for operating expenses is up significantly in Q2. Can you talk a little bit about why that’s so much higher than previous quarters, and then would we expect it to stay at those levels if it is more of a one-time event?

Chris Stanfield

Well once again we’re not going to provide guidance for the year, but in terms of our operating expenses, that we did get some benefit with FX as we’ve talked about in the fourth quarter in terms of translating expenses. We also have some expenses that are more front end loaded and I’m not trying to turn into an accountant but that would be things like vacation accruals and taxes and that kind of things.

What I can tell you is that we’ve done a very extensive forecasting process for the expenses and what we’re telling you is what our models give us. Those planning models also include the staffing that Ken has described, in which we’ve made important additions particularly to our marketing and sales organization.

Ken Oshman

You said Q2 I don’t think anything was about Q2. Joe said Q2 I don’t think he maybe meant Q1.

Joe Maxa – Dougherty & Company

I did mean Q1 yes, what did you end the quarter at with your headcount then?

Chris Stanfield

That’s about the only number I haven’t checked in the last few days.

Ken Oshman

I can tell you every name.

Chris Stanfield

It’s 300 and something but I don’t know the exact number.

Joe Maxa – Dougherty & Company

Chris, what would you expect to utilize in cash during the quarter?

Chris Stanfield

I think we view that this will a cash quarter that will be nominal because we’re going to obviously be collecting those receivables from last quarter. You saw that that was our principal factor in the last quarter’s cash flow, and so I think we’re going to see a pretty nominal quarter this quarter.

Operator

At this time we have no additional questions.

Ken Oshman

Thank you everybody for joining the call. We look forward to updating you again at the end of this quarter and talk to you in Q2. Thank you.

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Source: Echelon Corp. Q4 2008 Earnings Call Transcript
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