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Echelon Corporation (NASDAQ:ELON)

Q3 2009 Earnings Call Transcript

November 4, 2009 5:00 pm ET

Executives

Annie Leschin – IR

Ken Oshman – Chairman and CEO

Chris Stanfield – EVP and CFO

Analysts

Dale Pfau – Cantor Fitzgerald

Sean Hannan – Needham & Company

Elaine Kwei – Piper Jaffray

Colin Rusch - ThinkEquity

Joe Maxa - Dougherty & Company

Justin Cable – Global Hunter Securities

Carter Shoop – Deutsche Bank

Operator

Good day, ladies and gentlemen, and welcome to the third quarter 2009 Echelon Corporation's earnings conference call. My name is Anna, and I will be the coordinator for today’s call. (Operator instructions)

I would now like to turn the presentation over to Annie Leschin, Investor Relations. Please proceed.

Annie Leschin

Thank you, operator. Hello everyone and thank you for joining us this afternoon for our third quarter 2009 earnings conference call. With me on today's call are Ken Oshman, Chairman and Chief Executive Officer; and Chris Stanfield, Executive Vice President and CFO, both of whom will present prepared remarks.

By now, you should have received a copy of the press release we issued a short time ago. If you would like a copy, please visit our website at www.echelon.com.

Before we begin, I would like to let everyone know during the fourth quarter, Echelon will be participating in the Stephens Conference On November 17th in New York. As other events are scheduled, 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, 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.

The financial information presented on 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 quarterly scheduled financial release.

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

Ken Oshman

Thank you, Annie, and good afternoon everyone, and thank you for joining us. Let me begin with the announcement that we just made about the transition in its CEO at Echelon. As you know from the announcement, I will be stepping down as CEO of Echelon and Bob Maxfield will become CEO, as the Board of Directors initiates a search for a permanent CEO.

I will become the executive chairman of Echelon. I have the utmost confidence that Bob Maxfield will do an outstanding job as the CEO of Echelon, and I will do everything that I can to help him. As you may remember during the difficult period following the death of Bea Yormark, Bob immediately rose to the occasion and served as Senior Vice President of Products as we conducted a search that culminated in Bob Machlin joining Echelon to fill that role.

Since then Bob acted for a while as a consultant and subsequently as an advisor to Bob Machlin and me. Before that Bob was a founder and member with me at the top management team at ROLM Corporation. Bob will be joining us today during our Q&A session. I don't intend to leave Echelon only to transition to a different role that will allow me to be a big contributor to the future success of Echelon, while working on my medical problems.

Regarding my health, there is really nothing else beyond the press release that I can or will say at this point. I have lung cancer. Like predicting what a wild dog would do, one never can exactly foresee what will happen with cancer, but my illnesses is both treatable and curable, and I intend to fully recover from this disease.

Now I will turn to the business at Echelon. We had good news in the quarter. We signed a framework contract with Duke Energy, which was just recently awarded a $200 million stimulus package to accelerate deployments in Ohio and Indiana. We won a contract for the full deployment of a new smart grid infrastructure for Fortum, the largest utility in Finland.

We added important new partners for both our LonWorks Infrastructure and NES product lines. We managed our expenses and our manufacturing costs very well, and we slightly exceeded our financial expectations for the quarter. In the face of all this good news, the one persistent concern we have is that there is no great visibility that the traditional markets that we serve are about to return to their normal levels of activity and growth.

For our LonWorks Infrastructure product line, markets such as building, industrial and transportation controls show little signs of vibrancy yet. Having said that, we don't see further deterioration, and we expect that we have seen the bottom of this cycle. The worldwide real estate market is slow, depressing the buildings market. The semiconductor equipment industry seems poised to recover, albeit from a very low point and capital investments are simply being deferred even if they provide great short-term financial returns.

Our NES product line is the leader in the smart grid marketplace and that market continues to get a lot of press and attention, especially in the United States. For the most part however, activity remained somewhat stalled worldwide. Utilities in the US awaited results of the stimulus package, which with the recent awards by the government should have a very positive impact over the next 6 to 12 months. Elsewhere utilities awaited progress from government regulations or the availability of financing.

We are hopeful that both the LWI and NES markets will shift back into high gear in the next year, but we are cautious about making such predictions just yet. Echelon ended the September quarter with slightly higher-than-expected revenues of $23.7 million, driven largely by NES deployments in Europe, mainly Denmark.

Despite higher than expected revenues from our lower margin NES products, GAAP gross margins also stayed high at 43.5%. Through prudent management of costs, our operating expenses were better than expected as well. This led to a GAAP net loss of $8.2 million or $0.20 per share. Our cash position remains strong at $76.4 million in cash and marketable securities.

Now I will go into a little more detail. After much speculation, the Obama administration announced its grants for the smart grid last week. Largely as expected, the US Department of Energy awarded virtually all of the $3.4 billion to shovel-ready projects or those that have already been announced in framework contracts. About a quarter of the total projects that applied were given grant money. The majority was distributed to larger projects and utilities such as Duke Energy, which received $200 million for its smart metering projects in Ohio and Indiana, and a separate grant of $4 million to make improvements to the grid in the Carolinas in an area unrelated to advanced metering.

In total, projects in 49 out of 50 states received funding, ranging in amounts from $400,000 up to $200 million. One key detail is that each recipient must provide matching funding, meaning that in total the awards represent about $8 billion of investment in the smart grid. Once the money is distributed over the next two months, the expectation is that work will be completed over the next one to three years.

In total, the smart grid stimulus is expected to assist in the installation of approximately 18 million advanced meters in the United States. Specifically, as it relates to Echelon, Duke’s $200 million grant will be applied primarily to the installation cost associated with new smart meters in its 700,000 electric customers in Ohio, and once approved by the PUC its 800,000 electric customers in Indiana, where NES meters will be installed, as well as its 450,000 gas customers in Ohio.

As you all know, we announced a framework contract with Duke in August, under which Duke can purchase Echelon’s NES advanced metering system for all of its areas in which it operates now or in the future. This was a very important win for us, and one that has been a long time in the making. We received an initial order in August for 120,000 meters as part of the framework agreement on top of the approximately 100,000 meters we have already shipped.

Volume deployments are expected to begin by the end of this year. Having begun installations in Ohio, Duke has said that it anticipates installations within six months of receiving PUC approval in Indiana. Duke expects about half of its $200 million grant to be spent in Ohio, where it has already received regulatory approval to roll out its next-generation electricity meters.

According to a Duke spokesman, the utilities original plans calls for installation of the new meters over a five-year period with am installation cost of $1 billion to be allocated to the ratepayers. The utility has said it anticipates that the Federal grant will not only mitigate the need for future rate hikes, but also shorten the total timeframe to 3 years. Duke Energy is important to Echelon not only because of the revenue it brings, but also because of the model this installation will set for us in the US market.

Echelon’s unique approach to the North American smart grid market utilizes the low voltage power lines as a high-speed, highly reliable network, which none of our competitors scan match. Not only does our approach lead to lower equipment and installation cost, but by using the existing power lines, we make the grid itself smart rather than bypassing it altogether.

We bring the utility a real-time line of sight into the health, configuration and status of its network grid that RF mesh systems just cannot do. As Duke continues to move forward, we are finding more and more utilities taking a fresh look at our NES system, understanding that it is not the Powerline technology of old AMR systems, but a new high-performance way to build a smart grid.

We continue to have discussions with a number of utilities across the US, and while we have no additional projects to announce at this time, we feel very encouraged by the traction our increased sales and marketing efforts are showing in the Americas. Another important win for us this past quarter was at Fortum in Finland for the largest advanced metering deployment in Finland to date, 500,000 meters with an option for 100,000 meters in Norway.

This was a highly visible, very competitive hard-fought tender process. The contract was awarded to us through our partner Telvent, who highlighted its ongoing confidence in Echelon NES metering system that came from its past success at Vattenfall in Sweden. Having already deployed a competing system in Sweden, Fortum spent a great deal of time making its decision. Fortum carefully checked references at other utilities, researched options and sought answers to questions learnt from previous experience.

Winning in Finland was particularly important for Echelon as it demonstrated our availability to differentiate, successfully compete and penetrate a market that was otherwise occupied by local incumbents, and established us as the market leader with over 30% share of the meters awarded thus far.

The largest utility in Finland and a leading energy company in the Nordic countries, Fortum selected Echelon’s NES systems because of our reputation for reliability, rich functionality and a future proof architecture. Specifically Fortum intends to address the broad adoption of demand response and load control programs, energy saving and home automation programs, time of day energy management for customers as well as bidirectional measurement for customer owned alternative energy generation such as solar or wind.

This win was clear evidence of our market leadership in this region of the world. We continue to build our market presence worldwide by expanding both our direct sales force and building our partner channels. In this regard, we were pleased to announce that Peter Larsson has re-joined Echelon to head our business development activities in Asia. Additionally, we added another very strong bar [ph] partner, Eaton Corporation.

Eaton a large global provider to the electricity industry will focus initially on EMEA, and is looking to integrate its home automation product line for energy management with NES.

Now turning to LonWorks Infrastructure, LonWorks Infrastructure results were flat in the third quarter versus the second quarter. The building controls market continues to suffer in this economy with no real signs of recovery in sight, down about 20% from last year. Depending on the geography, it appears sales to this market are at least stabilizing at these low levels, but it remains unclear when a recovery will begin.

Let me provide a few key updates to some of our emerging LonWorks markets. A highlight of the last several quarters, demand response continues to be a vibrant area. New to this market’s seasonality, as we expected sales were lower sequentially in the third quarter, and we anticipate volumes to begin building again in the fourth quarter.

Demonstrating the ability of LonWorks networks to provide operating savings from unexpected places, we announced this quarter that Hamburg, Germany, is using LonWorks to move traffic more safely through its Elb-tunnel, which is used by 150,000 cars a day. Using our power line networking technology 650 LED lights were embedded in the road and are being used to guide cars through the 3.2 km tunnel to optimize traffic flow and reduce the pollution caused by stop starting of cars.

By using the power lines, the installation was easier and the tunnel operator can now communicate with the lights in real-time to make better decisions depending on the current traffic. Importantly, the new system replaces a mechanical guidance system with beacons for directing traffic into the correct lanes, which involve the dangerous task of manually repositioning the blocks or beacons to suit different traffic situations, a costly and time-consuming solution.

With so many potential markets to address LonWorks Infrastructure, a key strategy as we emerge from the recession is to focus on developing those vertical markets, where we see the most potential in order to optimize our revenue opportunities and to grow our distribution channels for these vertical markets. We plan to establish LonWorks in smart grid applications, and we believe much of our future growth will come from smart server opportunities such as demand response, branch enterprise energy management, and outdoor lighting.

We continue to seek partnerships with key system integrators such as Unitronics Communications of Spain with whom we joined forces recently. A leading Spanish IT and communications company, Unitronics will be a Spanish reseller and integrator of LonWorks in markets including building automation and branch enterprise energy management. Additionally, Chris Yelton joined Echelon this quarter as vice president of LWI channel sales, and she will focus on expanding our presence and our partners in specific vertical markets driven by energy management and control.

Let me now turn to the outlook. There were a few pockets of the world economy began to see signs of stabilization and mild recovery in the quarter. There were few and far between. Semiconductor equipment began a modest rebound, while other markets such as commercial real estate were unchanged. Our NES meter deployments continued to be the bright spot with important rollouts and key wins helping to lay the groundwork for future revenues.

The beginnings of optimism by some of our customers are evident, but with capital spending and financing still anemic, plenty of speculation surrounds the economy heading into 2010. As a result, we have continued to stress our cost management as a firm, helping to keep our operating expenses low and our margins high as we make our way through this period. We nonetheless believe that our unrelenting commitment to technological leadership and R&D investment is paying off with our recent utility wins and the expansion of our LWI product lines into emerging energy-related markets.

With all of the market seeding [ph] we are doing in our LonWorks products and the larger focus on energy efficiency and management, we believe that when the economy and financing return, both LonWorks Infrastructure and NES are poised to be leaders in the economic recovery. I'd like to thank the entire Echelon team around the world for their dedication, their creativity and their hard work.

I will now turn the call over to Chris Stanfield, our CFO, to elaborate on our operating results. Chris.

Chris Stanfield

Thanks, Ken. Now, I will review our financial performance for the third quarter and provide our outlook for the fourth quarter. Please note that all references to non-GAAP amounts, exclude stock-based compensation. For ease of reference, we have prepared a complete non-GAAP statement of operations for the three and nine month periods ended September 30, 2009, which can be found on our Investor Relations section of our website.

Revenues for the quarter were slightly ahead of expectations at $23.7 million, up from $22.6 last quarter and down from $29.5 million for the same period in 2008. LonWorks infrastructure sales were flat with last quarter at $11 million, but down from $14.7 million in the same period last year. NES sales were $11.5 million up from $10 million in the second quarter and $9.4 million a year ago. Revenue from our Enel project was $1.2 million, down from $1.7 million in the second quarter and $5.5 million in the same quarter last year.

Non-GAAP gross margin for the quarter was 45.6%, compared to 44.9% last quarter and 46.4% for the same period last year. The fluctuations in gross margin were primarily driven by product mix and overall revenue levels in the respective periods.

Non-GAAP operating expenses were $14.7 million, consistent with last quarter and down from $16 million in the third quarter of last year. We were encouraged by the improvements in our operating expenses, most notably in the product development area, which benefited from the structured salary reductions we have made earlier this year and to a lesser extent from reductions in costs incurred from third-party service providers. Overall, our operating expenses in the third quarter also benefited from a one-time property tax refund, which resulted in lower facility costs.

With that said, some of the improvements we have seen in operating expenses so far during 2009 has been due to timing of certain expenditures. We expect this will catch up with us in the fourth quarter.

Interest and other income expense was a net loss of $91,000 for the quarter, versus a loss of $377,000 in Q2 and net income of $1.1 million in the same period last year. The decrease in interest and other income from a year ago period was driven by an increase in foreign currency translation losses and a reduction in interest income.

GAAP net loss for the quarter was $8.2 million or $0.20 per share versus $9.5 million or $0.23 in the second quarter. In the same period last year, we generated a net loss of $5.4 million or $0.13 per share. On a non-GAAP basis, net loss for the quarter was $4.6 million or $0.11 per share, compared to a net loss of $5.5 million or $0.13 per share last quarter. Non-GAAP net loss for the third quarter of 2008 was $1.7 million or $0.04 per share.

Moving to the balance sheet and cash flow, we ended the third quarter with cash, cash equivalents and short-term investments of $76.4 million, or a $6 million decrease from last year. Cash flows in the third quarter were primarily affected by the net loss of $8.2 million and a change in our operating assets and liabilities of $3 million. These declines were partially offset by non-cash charges of $3.7 million in equity compensation expense and $1.6 million in depreciation and amortization.

Now, I would like to turn to our guidance. As Ken mentioned, while we were encouraged to see the US stimulus funding distributed last week, both LonWorks and NES continue to be impacted by the macroeconomic environment. We expect total revenues for the fourth quarter of 2009 to be in the range of $33 million to $35 million, with LonWorks infrastructure accounting for approximately $11 million, NES about $17 million, and the remainder from Enel. We anticipate non-GAAP gross margin to be in the range of 40% to 42% for the quarter.

Finally, we estimate our GAAP loss per share will be between $0.15 and $0.19 and our non-GAAP loss per share will be between $0.06 and $0.10.

Now, I would like to turn the call back to the operator for questions. Operator?

Question-and-Answer Session

Operator

Thank you. (Operator instructions) And our first question comes from the line of Dale Pfau with Cantor Fitzgerald. Please proceed.

Dale Pfau - Cantor Fitzgerald

Yes, good afternoon gentlemen. Yes, first of all Ken my best wishes for a very speedy recovery, and looking forward to speaking with you over the next few months.

Ken Oshman

Thank you.

Dale Pfau - Cantor Fitzgerald

First question, in the quarter, you mentioned Denmark as being strong in the NES side, can you give us any other insight into what else in the NES was shipping Chris?

Chris Stanfield

Denmark was the most important market in terms of Q3 in terms of revenue, but we had revenues in other European areas.

Dale Pfau - Cantor Fitzgerald

Was there any Duke revenue?

Chris Stanfield

A modest amount of Duke revenue.

Dale Pfau - Cantor Fitzgerald

A modest amount. Okay, and looking into the fourth quarter, how much are you looking for Duke to be in the fourth quarter?

Chris Stanfield

Our guidance includes a substantial amount of revenue for Duke out of 120,000 that Ken disclosed, or discussed with you earlier.

Dale Pfau - Cantor Fitzgerald

And as we are all awaiting the PUC approval for Indiana, do you have any indication from Duke when they expect that to be released?

Chris Stanfield

You know, we're going to let Duke issue its own statements with respect to the whole PUC process. We are not experts on that.

Dale Pfau - Cantor Fitzgerald

And in your prepared remarks you said that Duke expects to begin ramping up that after its – within six months of their approval from Indiana PUC, is that correct?

Ken Oshman

I believe that was the plan prior to the stimulus package. I don't know what their plan would be now that they might be able to use the stimulus to accelerate that, but that is sort of their plan. So that probably is what they will wind up doing.

Dale Pfau - Cantor Fitzgerald

Okay and then maybe just a little bit of a color here, you mentioned that you are seeing other utilities continue to talk to you because of what you are doing with Duke, has the interest increased in the past week or so because of the win of Duke?

Chris Stanfield

You know, we didn't win Duke in the last week or so. It seems to me it was years ago, but I think it was probably in August or September that we announced the frame contract that we entered into with Duke. So I think the answer, the most direct answer Dale is that no, it is not in the last week. Since, we announced the Duke contract; I think people are saying, what did Duke see that we missed? And we are finding a lot of interest and a lot of people saying, let me look again and see what it is. Maybe I didn't understand.

And it is actually quite exciting. I have to say that we are enthusiastic about our prospects. Now, you know I want to be sure you don't misunderstand me. Utilities cannot even if they wanted to move overnight to change or to make a decision or to do something, but what I think this all means is that we have a much more positive feeling about our prospects in North America in the US than we did 6 to 9 months ago.

Dale Pfau - Cantor Fitzgerald

And one final question before I turn it over, have you had any discussions at all from Duke about what their plans are for next year. Is it still little bit too early?

Ken Oshman

You know, we have had no discussions with Duke since they got the award of the stimulus package. We had – we disclosed to you what we believe that their plans shortly after we won the framed contract award of their annual ramp and annual run rates more or less as best we could understand them over a five-year period.

We now understand; we believe that Duke intends to accelerate their five-year plan to a three-year plan, but we have no direct confirmation of that yet from Duke. We're just very pleased they got the stimulus package and think they certainly deserved it. They've got undoubtedly the smartest grid application that we know of in North America.

Dale Pfau - Cantor Fitzgerald

Great. Thanks very much and good luck Ken.

Ken Oshman

Thank you.

Chris Stanfield

Dale, before I let you go, I just want to say, I noticed in my prepared remarks I made a mistake, the $6 million reduction in cash and marketable securities was from last quarter not from last year.

Dale Pfau - Cantor Fitzgerald

Okay. Thank you.

Ken Oshman

Sure. Thanks, Dale.

Operator

And the next question comes from the line of Sean Hannan with Needham & Company. Please proceed.

Sean Hannan - Needham & Company

Yes, good evening, and also a speedy recovery for you, Ken.

Ken Oshman

Thank you.

Sean Hannan - Needham & Company

So in some of this, I just want to follow up on some of the prior questions. Is there a way if we can get a little bit of color update on some of the trials that you have here in the US? Obviously the interest level has increased. I think that there have been dating back a couple of calls some trials you started to speak of, and just wanted to see if we can get an update there?

Ken Oshman

So, we really don't talk about trials, and don't want to talk about trials. I would be happy to talk about trials if everybody talked about trials, but what happens often with trials is people do trials and then the next thing you hear they win a contract. So we don't talk about our trials as such generally, unless it is some sort of competitive win that we've just recently won or something like that.

But, what I can tell you is that, I think my perspective, which I try to give in the earlier remarks was utilities are much more enthusiastic about talking with us, about understanding what we have got in the US than they were nine months ago. That said, until the stimulus funds came along, utilities weren’t doing much new, and so what we're doing is a lot of talk and a lot of dancing, a lot of education, a lot of explanation, and all of it is good, but I think we have still got sort of the same size opportunity which we are looking at which is a very large amount of uncommitted market in North America and we're still looking at a number of trials in the US, but I don't want to talk about which ones they are or where they might be or when they might be and so on at this point.

Sean Hannan - Needham & Company

Okay, that is fair. Maybe if I can switch geographies…

Ken Oshman

Sure.

Sean Hannan - Needham & Company

If you were to look at some of the lesser developed countries, for example Central and South America, some of your competitors are getting a bit more active down there, electricity theft is well-known as a major issue and you know power (inaudible) serve a pretty clear application there. Can you talk about that market in terms of NES and your degree of activity around those markets?

Ken Oshman

Sure. I agree with you. Mexico, Central and South America are enormously interesting opportunities, and opportunities that will be happening over the near term – I mean, in the near future, and so we have been actually very involved in trying to establish partnerships, establish relationships and understand the market and make sure we have the right products and the right offerings for that market – for those markets I should say.

And we are very active in trying to cultivate future opportunities in South and Central America. So we agree with you, it's a great opportunity. As we have something in place, and as we do things, we will certainly announce them and make sure you that you hear all about them and what we're doing. But right now we're really in the market development stage.

Sean Hannan - Needham & Company

Fair enough. And then if I could switch into the model for a moment, you have been making some might I think some decent progress around the margins on the NES meters. I know you don't break it out, but is there a way if you can comment on how you are making progress towards your target range, and is this really a function of manufacturing efficiencies or a function of better component supplier or what is happening there?

Ken Oshman

I think, maybe Chris wants to add to what I say, but let me just say we are making progress on all fronts. We are making progress in our efficiencies; we are making progress in our component costs. We are making progress in our pricing models and sort of across all fronts that are part of the whole makeup of margins. Having said that, we are not where we want to be. I want to be sure you understand. We are not where we want to be. We're just heading in the right direction, and we're working hard on continuing the same path.

Chris Stanfield

I think the only thing I would add is that as you know the most significant factor in our margins are total gross margins in any given quarter, tends to be the relative mix of NES margins versus LonWorks margins and in this quarter with our guidance – as with our guidance has a much greater number in terms of NES that accounts for most of the change in gross margin rate of Q3.

Ken Oshman

Having said that, underlying it all, we are making improvements in our NES gross margins and we feel good about that.

Sean Hannan - Needham & Company

That's terrific. Thanks very much.

Operator

And the next question comes from the line of Elaine Kwei with Piper Jaffray. Please proceed.

Elaine Kwei - Piper Jaffray

Hi, Ken and Chris. Ken, thank you for your services to the company and best wishes also for your recovery.

Ken Oshman

Thank you.

Elaine Kwei - Piper Jaffray

Have you identified any specific markets or utility demographics that see more recessive position on power line solution, and then in addition to that have you refined or developed any additional marketing that might target those markets and also highlight Echelon’s advantages for those particular utilities?

Ken Oshman

Well, first of all absolutely, there is one demographic that is worldwide pervasive and that is the entire IEC market place, which means everything outside of the US virtually, a market in which meters typically are inside homes. They are not an outside kind of a meter. They are often in basements. They are often stacked together in the basement of an apartment building. Our technology is not only great there, it is probably the only darn thing that is going to work there reliably, at least work fairly reliably without spending a fortune to make something happen by putting lots and lots of alternative kinds of technology in place, radios and antennas and cutting down trees and building high towers and so on.

So, I think that first of all and that of course is almost obvious, but we feel very strongly that our approach to smart grid applications in the IEC market is the approach is the way to go, and most of our competition in the IEC market, of course is the same thing, almost all of it is.

In the North American market – demographics, I think that for sure we believe that our technology ironically, because in the past power line technology was sort of a rural kind of technology, but we think ironically today with our high-speed technology and our architecture, we are particularly attractive to metropolitan and urban areas that are very challenging to radio technology.

We are also of course very, very – I mean so first of all utilities with much of an urban footprint are a great opportunity for us, but we haven't – I mean I hate to say this Elaine, but we haven't really found a utility that we don't think should be used in our technology. So I think it's not a question of the demographics as much as it is a question of just our getting in there and explaining how our technology will work for the utility.

If there is a place that we probably – that I would probably give up a little bit on its very, very rural technology one home per transformer or something like that, a 1% part of the market kind of thing. I wouldn't give up on it. We work beautifully there but there maybe other – if you wanted not much functionality there are probably other ways of at least reading the leaders in those kinds of applications.

Elaine Kwei - Piper Jaffray

Okay. Well, related to this, how much traction are you seeing in the market now for the new NES Smart IP meters and how do those compare versus other AMI offerings out there in terms of price to performance and is this something that's being used in the Duke deployments, and you know does it also make up a portion of your European project as well?

Ken Oshman

So let me say there is one very interesting demographic that we are almost sort of slam-dunk for. And that's anybody that happens to have an IP network of one sort or another installed of its own, if fiber network for utilities is bringing a fiber network to the customers or a – any kind of if they have already installed some sort of IP network into their utility, we are pretty much slam-dunk, a very cost-effective solution for that kind of – I mean in fact unbelievably good solution for that kind of an application.

Our IP meters are being tested by multiple utilities. We – as you know it is a new product for us. It has just come out. We think it's going to be a fabulous product. Duke does at the present time use our concentrators. They use the entire NES system. They use a separate concentrator along with our regular NC [ph] meters and our NES system software. So they have the full system infrastructure but they don't use the IP meter. The IP meter will be a great advantage to Duke in some of their demographics and in some of theirs, it will be better for them to stick with the concentrator. We don't care one way or the other, but I think in general for most – the simplest solution is with the IP meter. It is with the IP meter and our standard NC meters and our NES system software that we think we are very cost-effective.

Elaine Kwei - Piper Jaffray

Great, and just lastly could you give us an update on the geographic breakdown of revenue and how that's looking now in Europe, North America and Asia?

Ken Oshman

With respect to the NES product line, the revenue was largely in Europe as you know. With respect to the LonWorks Infrastructure, the largest single market would be in EMEA, than Americas, and then APJ.

Elaine Kwei - Piper Jaffray

Great. Thank you so much.

Operator

And the next question comes from the line of Colin Rusch with ThinkEquity. Please proceed.

Colin Rusch - ThinkEquity

Good afternoon and congratulations on the results. Can you talk about the development of your VAR partners and the (inaudible) lot of smarter companies are making analysis with the stimulus awards, and what do you expect out of those partners over the next couple of years and (inaudible) coming soon?

Ken Oshman

You know there is something wrong with my telephone for some reason. I couldn't quite understand. Can you say – can you ask that question again. I didn't understand.

Colin Rusch - ThinkEquity

And I'll try and make it a little bit shorter. Essentially what I'm trying to get at is –

Ken Oshman

Are you on a speakerphone?

Colin Rusch - ThinkEquity

I'm on a cell phone. Can you talk about your partnerships and the evolution of those partnerships over the next several years and where you see your potential additions and expansions?

Ken Oshman

Oh, so you want the sort of the outlook with our partnerships. So you know, I hope we will never be finished with partnerships ever. The market is so large. There are so many opportunities and so many places for us to go. As you know, we just announced a partnership with Eaton Corporation recently. That's a very important partnership for us in EMEA and Europe.

We – one of the major focuses of Peter Larsson who's now heading our business development in Asia and has rejoined the company will be looking for additional partners in Asia Pacific region, and there are – we are always looking for partners in North America. The partners in North America, the market is different – let me just say the way product is taken to the market seems to be somewhat different in North America, at least for the time being than it is in the rest of the world.

And so we have actually deemphasized our partner program to a certain extent in the US, and are eagerly bidding directly to utilities that want us to bid directly to them, but then partnering with people to provide the total solution. So it's a little bit different model in North America. We had tried to use a model like the rest of the world but the US is just a little different. So we are adding partners and working on adding partners in North America of a wide variety of types, but a little different flavor from the rest of the world kinds of partners. I hope that's not too big. But I don't have to say much. Sorry.

Colin Rusch - ThinkEquity

And then the stimulus awards, (inaudible) a limited amount of the grid capacity in the US.

Ken Oshman

Absolutely.

Colin Rusch - ThinkEquity

(inaudible) applying for those funds and then you know, activity if you could comment on activity for new projects and interest level trajectories since the stimulus package was announced last – earlier this year.

Ken Oshman

So, are you asking about the people that applied for stimulus funds but didn't get any?

Colin Rusch - ThinkEquity

Yes, and the other opportunities outside the 400 applications for…

Ken Oshman

Right. So the people that applied for stimulus funds and didn't get any, I think won't get any. That's just sort of the bottom line. Now there is some stimulus kind of loan packages there are some loan packages that the government is putting together and companies are applying for those. Even the companies that applied for stimulus packages will be applying for these loan packages, but in terms of stimulus, actual smart grid stimulus funds, I don't think there will be any more.

That's not to say there won't, but there certainly has been no discussion of more funds and they used them all up in the first tranche as opposed to their expectation of three tranches of awards. So there are the rest of the companies that applied. You're right. But more importantly there is something like 50 million meters that need to be replaced in the US that are not even part of any of the stimulus packages, any of their awards that are underway, any of the – that are just not smart grid ready – that are not smart grid installation.

So we see plenty of opportunity in North America. The good thing about the stimulus package is it acted as a what I call an honest (inaudible) for some of the utilities, but they're still going to want to put together – I think they want to put together programs which are cost-effective, save energy, save money, and that are part of the smart grid vision of the future. So there's going to be lots of opportunities.

Colin Rusch - ThinkEquity

And what do you expect on the pricing for those projects the 50 plus million meters. Are you expecting those kind of take a couple of years for those opportunities to start to emerge or could it be longer than that or do you think, you know, with the utilities getting their applications and if they're ready to move now and start making deployments even without the stimulus funds.

Ken Oshman

Well, we are working with a few utilities that had hoped to get stimulus funds, it didn't get stimulus funds, and they're now sort of contemplating their navels a little bit, and they are saying to themselves what should we now do, and so I wish I knew the answer to that, and I wish that – I'm sure they wish they knew the answer to that. And so they're going to – they want – they didn't apply for stimulus funds because they didn't want this. So they still want a smart grid installation and implementation I think.

Colin Rusch - ThinkEquity

Thank you so much.

Ken Oshman

Sure.

Operator

And the next question comes from the line of Joe Maxa with Dougherty & Company. Please proceed.

Joe Maxa - Dougherty & Company

Thank you. And Ken, again, best wishes for the speediest of recoveries.

Ken Oshman

Thanks Joe.

Joe Maxa - Dougherty & Company

I wanted to take another stab at the Duke expectations for Q4. Chris when you said substantial amount, were you talking more than half of those meters that they put on order?

Chris Stanfield

Yes. It'll be some number that is equal to or more than half. Yes.

Joe Maxa - Dougherty & Company

I see. In the balance would you expect that in Q1 or how do you see the balance?

Chris Stanfield

Q1 or Q2, yes.

Joe Maxa - Dougherty & Company

Got it. Okay. And Ken just looking at Europe in general, take the way with your success right now in the Nordic regions are Denmark, Finland. How do you see or what do you see as a timeline for maybe some other countries coming up with some significant deployments?

Ken Oshman

So, I think there is let me call it southern Europe, which is Spain and France and Italy which is already done, and so Spain and France are both seem to be headed in sort of strange directions, which have a lot of momentum behind them but I have no idea how they are going to do actually in these deployments, and we're not particularly participating in any of those simply because they are about building a special meter to somebody else's speck.

It's like a contract manufacturing operation. We are certainly not in that business. So we are not – we have not in general participated, although we are eager to sell what we think would be a less expensive, higher performance, better reliability system for anybody in those parts of the world that would like to buy them, but those markets are sort of marching toward doing some level of deployments, I would say in 2011, they're aiming for 2010.

They probably won't make it, probably 2011, probably 2012 beginning some deployments. Those are not of major interest to us for the reasons I mentioned. We are much more interested in the markets of Germany, of Poland, of Central Europe, and of Eastern Europe where the utilities seem to be much more interested in buying products from reliable suppliers, full system products that are not designing their own system as a utility, not getting involved in designing what kind of meter they want to make.

So we see much more opportunity in Benelux and Eastern Europe and Germany and Austria and Switzerland and so on. And that's where we have a lot of pilots going on. We have a number of partners there. We have a lot of new product development targeted at that area. It is an area that is let me call it a little less mature in terms of its regulatory processes, but it does an area that is committed to and destined to have smart metering infrastructure in the near future.

So these are good opportunities. They're not going to pop next week, but they are going to happen, and so we are very focused on those. England is also another opportunity that we care about, that we are interested in, that we are working on, but England has a lot of regulatory issues as far as we're concerned that make it still despite a will to do something great. It still makes it as a matter of practical fact very difficult to put in smart metering infrastructure in England at this point. But we are very involved there and we have partners in England and we're working there. Is that what you wanted?

Joe Maxa - Dougherty & Company

Well, I was just looking for maybe a timeframe on some of these Eastern Europe or Central Europe…

Ken Oshman

Oh, Eastern Europe and Central Europe, time frame. You tell me when the currencies and the financing of Eastern Europe and Central Europe is going to be strong and vibrant, and I'll tell you that's the time frame.

Joe Maxa - Dougherty & Company

So we're looking at least a year or two probably?

Ken Oshman

I guess. You know, there's going to be stuff happening, but I mean to be the great big market that it has the potential to be I think we need strong financial recovery.

Joe Maxa - Dougherty & Company

Okay, one last question. The Enel revenue, looks like you can tick-up here in Q4. I mean is this continuing to be something that's very difficult to predict or are you seeing you know, should we think this is going to stay at this higher level, you know next year?

Ken Oshman

Joe, as we have discussed this revenue has always been lumpy, and so you know, I don't think this is any necessary indicator of what revenues are going to be in the future. You know, as you know the revenue has been a little more 1 million for the first three quarters and so there is no pattern issue concerned.

Joe Maxa - Dougherty & Company

Okay, just wanted to verify. Thank you.

Operator

And the next question comes from the line of Justin Cable with Global Hunter Securities. Please proceed.

Justin Cable - Global Hunter Securities

Thank you. And Ken, well, best wishes towards a very speedy recovery. I did want to ask maybe to get some clarification on the benefit of stimulus program beyond Duke. How you might be exposed there and wouldn’t you be able to capture additional opportunities or you had mentioned earlier these are shovel-ready projects. So should we look outside of the stimulus package, i.e., with these other utilities that did not win awards in North America?

Ken Oshman

I think in my earlier remarks I mentioned that it appeared most of the stimulus awards were made to utilities that already had contracts underway that were doing things, like Duke had with us, and so it didn’t – I mean I don't think it's going to open up a lot of new opportunities for anybody. I think it's going to accelerate the market uptake of smart metering across the US, make it a very much more mature market, all of which is good for us. We think the more mature the market is the more it really understands scalability, reliability, functionality, future proofing, all the things that we've been doing for so many years now that provide – make the NES system very outstanding and unique system.

We think maturity is one of the best things that can happen in this marketplace, and I think it'll be good for us. So we are by maturity I don't mean end of market, I mean maturity and sophistication of the buyers, but we're – we think this is all good. The stimulus package is all good for the marketplace, but I don't think it creates a lot of new opportunities especially the large awards, almost all of the large awards were to utilities that already had plans, already had programs in place, were already in the process of deployment.

Justin Cable - Global Hunter Securities

Okay, thank you. And then just a couple questions for Chris, you mentioned that there was some probably tax refund benefit and timing of expenditures that sort of benefited OpEx, but OpEx should come up and it looks like that's the case for your Q4 guidance. Is Q4 start of a new level going forward and can you also just kind of review what the benefit in Q3 was?

Chris Stanfield

Sure. First of all the benefit as it relates to the taxes was approximately $300,000 or $400,000 [ph] I believe, and the – as it relates to this being a new baseline, no because as you know there are discretionary expenditures that can vary by period and they can come in periods. Right now a lot of those expenditures have been put off in the first three quarters than they will have but I wouldn't say that this is absolutely a new number you should use, but we really don't have guidance for next year, as well as you know.

Justin Cable - Global Hunter Securities

Okay, so basically Q4 will be some catch up, you know, on the baseline.

Chris Stanfield

Yes.

Justin Cable - Global Hunter Securities

And then in terms of Duke revenues obviously seeing that contribution in Q4, but should we view Duke's contribution will be lumpy as we look at the next four or five quarters or would it be more of a kind of consistent rollout or uptake?

Chris Stanfield

Well, I think most of our projects have been lumpy as you know, and so I think in two years even otherwise you should assume the projects will be lumpy.

Justin Cable - Global Hunter Securities

Okay, great. Thank you.

Operator

And the next question comes from the line of Carter Shoop with Deutsche Bank. Please proceed.

Carter Shoop - Deutsche Bank

Good afternoon, Ken, best wishes for a rapid recovery. Wanted to follow up on Duke a little bit here, we saw the initial order for roughly $16 million and given the fact that it sounds like Duke is partnering with you for Indiana and Ohio. You know, why aren’t we seeing a follow-on order in particular in Ohio, given that it's already past the PUC?

Chris Stanfield

Well, Carter I think the answer to that is obvious. They had already taken 100,000 meters, as you know and now they've ordered some addition meters and they've said that they are going to install over a five-year period. That was all the plan prior to having received an award from the stimulus package.

Carter Shoop - Deutsche Bank

When they gave you the award here back in August, I mean is there any particular reason why they didn’t just give you the entire order right away because there is no time constraint on that?

Chris Stanfield

That's just not normally the way that people or the products Carter. You know what happens here is the Duke is following standard practice. You know, they're ordering according to their installation plans. Our products have lead times like all other products.

Carter Shoop - Deutsche Bank

Okay, so going forward should investors expect you know, a new award from Duke kind of based on every six months or so kind of a product reorder there?

Chris Stanfield

I think that they will place orders from time to time. I think the wild card is what Ken described earlier and that is Duke has said previously they would install their program over five years and (inaudible), and so right now they're installing at that level, and if they were to pick up that level then you would expect more orders from –

Ken Oshman

Carter, very simply 600,000 meters in Ohio divided by five years is 120,000 a year. I think we said that early, right after the announcement of the printed contract.

Carter Shoop - Deutsche Bank

Okay, I didn't see that in the contract.

Ken Oshman

Well, you didn’t see the contract, but that's what we said was it's about 600,000 more meters in Ohio. It was for deployment over five years at 120,000 that was about 120,000 a year for five years. So, and they're going right along with their plan.

Carter Shoop - Deutsche Bank

Okay, that makes sense. And then going back to now – I mean is that not related to (inaudible) at all there in regards to what they're trying to do.

Ken Oshman

No, it's relating to Italy.

Carter Shoop - Deutsche Bank

Okay. And then can you talk a little bit about breakeven levels. You previously provided guidance in regards to when you expect to get to breakeven. Can you reiterate that or comment on that guidance.

Chris Stanfield

I don’t think I've said when. What I said is I would expect that given our expense control programs that we should be able to achieve Non-GAAP breakeven at a revenue level between $150 million and $160 million.

The most important factor in terms of when that occurs is of course when the economic situation improves. So if the LonWorks begins growing again such that utility markets particularly in Eastern Europe opened up, et cetera. But I mean I think the breakeven point on a non-GAAP basis remains where I've stated.

Carter Shoop - Deutsche Bank

Okay. So if we see the current mix where any assets about half of sales and we get to those revenue ranges you'd feel comfortable on a non-GAAP basis?

Chris Stanfield

Revenue range I would expect anyhow to be more than half of sales.

Carter Shoop - Deutsche Bank

Okay. And then last question in regards to the pipeline in Europe, can you discuss what you're seeing there in regards to near-term bidding activity. How many projects do you expect to be awarded over the next six months? That's not necessarily just to you but to the industry overall.

Ken Oshman

You know, Carter, I don't know how to answer that question. There's not – there has been in the last two years, a year and a half there has been a fairly substantial sort of malaise or just flat, nothing much happening in Europe and this economic situation has certainly not helped any of that. Having said that there's so much pilot activity and testing, and so on going on in many of the northern European countries and eastern European countries that we're confident there will be a lot of activity, but there is just not a lot of, I mean there is not a whole lot of tendering going on right now. It's all public. All of the tenders in general in Europe unlike the US, they're all listed on our website. You can see every one of them. I'm not sure. I don't know that website but…

Carter Shoop - Deutsche Bank

If you find that website, let me know [ph]. I think that each country does have a regulatory framework where they do talk about that. One more if I may, talking about more and more utilities taking a second look at the Echelon solution, is there any way to kind of quantify that and could you talk about how many large utilities – I guess when I say large, it's over 1 million point utilities have been to Duke to look at your solution, say over the past three months, a way to quantify that renewed interest.

Ken Oshman

You know, I don't know the way to answer that question, but I can tell you a hell of a lot of people have been to the Duke demo center. It is a magnet for other utility executives and other – and regulatory people to come to see what they're doing about the smart grid in their demo center. So there are an awful lot of people who have seen that. I think what I'm saying is that what we have found is that some of the utilities thought they had – they knew exactly what they were doing, had made their final decisions are now seeing that maybe in their early stages of deployment there are some questions they haven't quite answered, and they are sort of saying, maybe Duke did answer some of these questions, and maybe NES actually does do some of these things, and so we are having people who would have turned their backs on us six months ago. There are at least open to and eager to understand exactly what is it we are offering and that feels like a big change.

Carter Shoop - Deutsche Bank

Definitely, it sounds like it. Congratulations on that. And Ken, once again, best of luck for a speedy recovery.

Ken Oshman

Thank you very much, Carter.

Operator

Ladies and gentlemen, this concludes today's question-and-answer session. I would now like to turn the call back over to Mr. Ken Oshman for closing remarks.

Ken Oshman

I just want to thank everybody for joining us on the call today. We'll have another call of course at the end of next quarter. Thank you. Bye-bye.

Operator

Ladies and gentlemen thank you for your participation in today's conference. This concludes the presentation and you may now disconnect. Have a good day.

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Source: Echelon Corporation Q3 2009 Earnings Call Transcript
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