Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message| ()  

Executives

Annie Leschin – Investor Relations

Bob Maxfield – President and Chief Executive Officer

Chris Stanfield – Executive Vice President and Chief Financial Officer

Analysts

Paul Coster – JP Morgan

Colin Rusch – ThinkEquity

Dale Pfau – Cantor Fitzgerald

Carter Shoop – Deutsche Bank

Elaine Kwei – Piper Jaffray

Joe Maxa - Dougherty & Company

Justin Cable – Global Hunter Securities

Brian Kremer – Roth Capital Partners

Ben Schuman – Pacific Crest Securities

Echelon Corporation (ELON) Q4 2009 Earnings Call Transcript February 10, 2010 5:00 PM ET

Operator

Welcome to the Q4 2009 Echelon Corporation earnings conference call. My name is Jeff, and I will be your operator for today. (Operator instructions). I would now like to turn the conference over to your host for today, Ms. Annie Leschin, Investor Relations.

Annie Leschin

Thank you for joining us this afternoon for our fourth quarter 2009 earnings conference call. With me on today's call are Bob Maxfield, President 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 that we issued a short while 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 Piper Jaffray Clean Technology and Renewables Conference on February 23rd in New York as well as the Canaccord Sustainability Forum on March 4th in Deer Valley, Utah. As additional events are scheduled, we’ll make further 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 those in our SEC reports, including our report on Form 10-K and subsequent reports on Form 10-Q 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 the 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 Bob Maxfield.

Bob Maxfield

Good afternoon and thank you for joining us. I am pleased to be with you today on my first earnings call as Echelon’s president and CEO. Though I am new to this role, I have been involved with the company as an active board member for over 20 years and a senior member of the executive team for much of 2008. That experience has enabled a smooth management transition with very little loss of momentum, having stepped into this role with knowledge of the key opportunities and issues facing the company. I am very optimistic about the opportunities that lay ahead for Echelon, and I plan to continue our investment and product development and marketing activities in order to address the enormous worldwide market opportunities in the emerging smart grid and energy management.

On to the quarter, we ended 2009 on a high note. The fourth quarter was a bright spot in an otherwise grim year, of one of the worst recessions in history. Our 2009 performance reinforced our commitment to leading the smart grid revolution by winning key NES contracts around the world and capitalizing on the growing opportunities for our LonWorks products spurred by increased economic and regulatory focus on energy efficiency.

Throughout the year, we addressed the economic difficulties through prudent cost and cash management while maintaining investments in key products, adding to our sales force, and strategically expanding Echelon’s presence worldwide. Even with these investments, we ended the year with a strong cash position and near breakeven non-GAAP operating results in the quarter.

The December quarter was stronger than expected with $38.8 million of revenues, driven by increased NES deployments in Denmark and the US. We also saw particularly high levels of revenue from Enel this quarter. GAAP gross margins were 41.6%. Our GAAP net loss was $3.7 million or $0.09 per share. We also generated $5.2 million in operating cash flow, strengthening our balance sheet to end the quarter with $80.1 million in cash and investments.

I would now like to turn to some of the highlights of the quarter. I will begin with our LonWorks product line. In the fourth quarter, we began to see pockets of improved activity in some energy-driven markets, such as demand response and street lighting. However, the weak European economy and the slowdown in LonWorks’ largest market segment, building automation, again took their toll on results this quarter. Building automation continued at its fairly flat quarterly 2009 pace, mirroring the ongoing industry wide slowdown in commercial real estate.

Given how quickly how our OEMs responded to the sharp decline in revenues beginning in late 2008 by immediately adjusting down their inventory levels, any pickup in the building automation market should flow quickly to us. The challenging part is that the recovery in this market is dependent upon improvement in the commercial real estate market, which we expect to occur slowly throughout 2010 in the US and Europe.

In other areas of the world such as China, we saw improvement this quarter. The contract equipment manufacturing market has turned its focus from building products for the European and US building controls companies to the growing domestic Chinese market. We believe the success we are experiencing today in this market segment is partly a product of the selection of LonWorks’ technology by Chinese Building Controls as a standard in 2006. China is also expanding into areas such as enterprise energy management and street lighting.

We believe this activity should translate into design wins and future revenue in 2011 and beyond, as China becomes increasingly important to the world market and a larger portion of our Asian revenues.

Street lighting was another area of improvement this quarter. With over 300 cities in Europe currently conducting pilots of street lighting solutions utilizing Echelon’s solution, we anticipate a number of these will move from trial to deployment in 2010, driving growth in 2010 and beyond. One such project that was recently completed was the deployment of over 3000 lights in the city of Senart in France where they have already recognized energy savings of more than 35% and a 300-ton reduction in annual carbon emissions just by selectively dimming lights during low traffic hours.

Additionally, there were a number of important announcements made this quarter that we believe will drive adoption of the SmartServer and LonWorks’ devices in the coming year and longer term. In November, we introduced our SmartServer 2.0 product which provides the glue that connects smart devices to the internet and the smart grid. It provides improved real-time controlling monitoring of smart devices to save energy, improve operations and security, and lower maintenance cost.

Though currently a small portion of our LonWorks revenue, the SmartServer is a critical component in a number of high value growth applications, from smart street lighting to demand response, solar invertors, and enterprise energy management. Current customers include Philips Lighting, EnerNOC, Invensys, SMA Solar Technology, and Osaki Computer Engineering.

In a related announcement just a few weeks ago, we launched a new solution partner program. We have already signed Control Technologies, which is working with energy management in the New York School System, and we’re in the process of signing up several other high caliber partners. With them, we plan to expand our market presence and build ecosystems of suppliers in the enterprise energy management, building automation, and lighting controls markets.

Now, I would like to turn to our NES product line. NES performed well this quarter as deployments across Denmark and initial orders under our framework agreement from Duke Energy continued. In addition, we added key people, partners, and programs to ensure that our NES product line is a long-term growth engine for Echelon.

One of the important hires is Michael Anderson who joined us this quarter as senior vice president of sales and market development for all of NES. Michael’s international experience in the telecommunications market brings new perspectives and energy to our worldwide NES activities.

With the addition of Peter Larsson last quarter, who is leading our Asian smart grid activities, we believe we have made important strides to accelerate our sales and marketing efforts. Our success on the worldwide stage has always relied on our strategy of working through trusted and skilled partners.

In the fourth quarter, we expanded that base to include Eaton, a global leader in the utility and home controls markets, who became a worldwide value added reseller of NES solutions. Finally, we entered into an important new program with ELO, the leading meter manufacturer in Brazil. In November, ELO became a value added reseller partner of Echelon by adopting the NES system as its platform for smart grid solutions. In January of this year, we expanded that relationship to include a manufacturing agreement in which Echelon will supply technology and complements to ELO who will design and manufacture NES compatible meters. ELO will be the first such manufacturer outside of Echelon.

This was particularly timely given the October announcement by Brazil’s energy regulator for a nationwide rollout of smart metering to replace all 63 million electricity meters in Brazil from 2011 through 2021. This partnership reflects Echelon’s commitment to work with other companies to incorporate NES technology into their own solutions and establish it as a standard for the smart grid.

Because our NES systems are providing reliable benefits and working well, we anticipate that in 2010 a large portion of our NES revenues will come from volume deployments with various utilities in Denmark and Duke Energy. As we have discussed, however, the revenue in any particular quarter can be lumpy due to many factors including weather, transit times, PUC or regulatory approvals, order changes, and so forth. In Duke’s case, there is an added unknown as to the impact and timing and acceptance of smart grid stimulus funds.

Looking ahead, we anticipate that our finished project with Fortum will begin in 2010 with significant revenues beginning in 2011 as the project ramps up to volume deployment. In other regions of the world, we continue to have approximately 100 pilots running worldwide, most of which are in Europe. Exactly when they begin to convert to deployments is dependent on many factors. In countries such as Germany, the Netherlands, and the UK, governments are actively debating public policy and/or laws related to smart grid deployments. In other markets, the economic conditions remain the driving factor. Western Europe is one such location where many tenders for pilots exist, but there has been a plateau in deployment awards.

As such we expect this region to contribute much more to our revenue in 2011 than in 2010. We expect more interest in larger markets such as South America and Eastern Europe during the year where we are seeing early signs of a recovery. Echelon has been working to establish key partners and a strong presence in these regions in order to lay the groundwork for volume deployments in 2011 and beyond.

In summary, we were very pleased with Echelon’s strong finish to an otherwise challenging year. Our financial results demonstrate our ability to manage under extremely difficult economic times. In spite of these conditions, we had important contract wins in our NES product line during the year. We reduced cost and conserved cash, and we seamlessly transitioned through a change in management, all while maintaining investments in areas we believe are essential to driving long-term growth.

Our leadership team remains a strong and cohesive group, and with the addition of some new people, we are bringing new perspectives and experience to Echelon. My priorities are to grow the business and position Echelon as the smart grid infrastructure provider of choice worldwide, while focusing on long-term shareholder value.

Now that the financial crisis has abated, our outlook is cautiously optimistic, but we’re acutely aware that our end markets and geographies will recover to varying degrees and speeds depending on the evolution and condition of the markets. We expect NES to drive growth, primarily in the second half of the year and anticipate that LonWorks will also improve over the year, leading to modest overall revenue growth for Echelon for 2010.

While it is too early to form strong convictions, from our current perspective 2011 looks to be a year of good growth for both of our product lines. For LonWorks, we anticipate the effects of recession will have dissipated. In NES, we expect some of the delays in pilots, contract awards, and regulatory issues will have been resolved. Finally, I would like to thank the entire Echelon team around the world for their dedication, creativity, and hard work.

I will now the call over to Chris Stanfield, our Chief Financial Officer, to elaborate on our operating results.

Chris Stanfield

Now I will review our financial performance for the fourth quarter and provide our outlook for the first quarter of 2010. Please note that all references non-GAAP amounts exclude stock-based compensation. For ease of reference, we have prepared a complete non-GAAP statement of operations for the full year period ended December 31, 2009, which can be found on our Investor Relations section of our website.

Revenues for the quarter were ahead of expectations at $38.8 million, up from $23.7 million last quarter and $36.8 million for the same period in 2008. LonWorks infrastructure sales grew slightly to $11.4 million, compared to $11 million last quarter, though from $11.7 million in the same period last year. As Bob mentioned, the majority of our revenue increase came from very strong NES sales this quarter. Sales almost doubled to $21 million, from $11.5 million in the third quarter of 2009 and up from $20.6 million in the same period last year. Revenue from our Enel project was $6.4 million, significantly up from $1.2 million in the third quarter and $4.5 million in the same period last year.

Non-GAAP gross margin for the quarter was 42.7%, compared to 45.6% last quarter and 37.2% for the same period last year. The sequential decrease in gross margin was due to a higher percentage of revenue from our NES product line. Gross margin showed healthy increases year over year partially driven by the margin improvement in our NES product line. In addition, some one-time items impacted gross margins last year.

Non-GAAP operating expenses were $16.7 million, up from $14.7 million last quarter and $16.3 million in the fourth quarter of last year. The increase over last quarter was in line with our expectations as we continued to add key members to our team and invest strategically in emerging technologies.

Interest and other income was $130,000 for the quarter, versus a loss of $91,000 in Q3 and income of $606,000 in the same period last year. Our GAAP net loss for the fourth quarter was $3.7 million or $0.09 per share versus $8.2 million or $0.20 in the third quarter. In the same period last year, we generated a GAAP net loss of $6.3 million or $0.15 per share. Our non-GAAP net loss for the quarter was $74,000 or $0.00 per share, compared to a net loss of $4.6 million or $0.11 per share last quarter. Non-GAAP net loss for the fourth quarter of 2008 was $2.5 million or $0.06 per share.

Moving to the balance sheet and cash flow, we ended the fourth quarter with cash, cash equivalents, and short-term investments of $80.1 million, a $3.7 million decrease from last quarter. We generated $5.2 million in positive operating cash flow during the quarter, mostly due to an anticipate $8.8 decrease in our inventory balance. Overall, we were very pleased that in spite of a challenging economic environment during 2009, we managed to limit the reduction in our cash and investment portfolio to $7.2 million for the year.

Now, I would like to turn to our guidance for the first quarter of 2010. We expect total revenues for the first quarter of 2010 to be in the range of $15 million to $17 million, with LonWorks infrastructure accounting for approximately $10.7 million, NES about $5 million, and the remainder from Enel. We anticipate non-GAAP gross margin to be in the range of 41% to 43% for the quarter. Finally, we estimate our GAAP loss per share will be between $0.32 and $0.35 and our non-GAAP loss per share will be between $0.25 and $0.27.

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 the line of Paul Coster – JP Morgan.

Paul Coster – JP Morgan

Obviously, the guidance is going to disappoint a little bit relative to street expectations. I’m guessing that that also has to with the NES product. Can you talk to us about how the Duke contract is likely to ramp during the year and what your full year outlook is for that segment?

Chris Stanfield

First of all, as you recall when I spoke about our guidance for last quarter, I mentioned that we were going to have quite a bit of Duke revenue in the fourth quarter. That in fact happened. As we look forward to this year, we have some modest amount of Duke revenue in this quarter obviously, and then we see Duke revenue in subsequent quarters. As Bob indicated earlier, probably the biggest factors that are going to have an effect on our overall level of Duke revenue would be the timing of gaining approval in Indiana and then resolution of issues with respect to stimulus funds.

Paul Coster – JP Morgan

I’m still a little bit surprised by the guidance for the full year. Can you talk a little bit about why it is that you had such big revenues for Duke this quarter and why it falls off so significantly in the first quarter?

Chris Stanfield

As you recall, what happened was that we went through a process with Duke where Duke did initially some work a few years back in the Carolinas in which they trialed various technologies and then they took our technology and did some pilot installations. We didn’t reach agreement with Duke until I think about August of last year in terms of a definitive agreement for them to go ahead and install our technology if they choose in their 4 million homes. We got our first order about that time, went into production, and a lot of units shipped. We probably shipped on the order of two thirds of the units that we had planned to ship, not quite exactly two thirds, and moving forward in terms of this quarter’s guidance, I think what I would say is if you look back over time, the NES product line has revenue that is highly nonlinear, and that’s largely because the revenue is highly concentrated. Last year, as Bob indicated, the revenue was highly concentrated in Denmark and with Duke, and what happens when you have that circumstance is that actual product deliveries that people need vary for a number of reasons, and that become very visible when you have two or three customers constituting most of the revenue, but if you look back to last year, what you would see is that we faced a very similar situation in Q1 of 2009.

Paul Coster – JP Morgan

If I remember correctly in your press release you state that you are expecting growth this year. Can you just elaborate upon that, and then the last part of my question is when do you think that the company will reach sustainable profitability from a cash EPS perspective?

Bob Maxfield

We have based on what we can see in terms of the opportunities that we’re working with and based on what we see in the hope for economic recovery, we believe that we will have some growth in 2010. Our Enel revenue as Chris mentioned will go down in 2010, but we believe that there are sufficient opportunities in the NES and in the LWI to offset that and provide a net growth for 2010. As to your question of sustainability, in terms of profitability, we believe that in 2011 it is a definite possibility, and we’re focused on opportunities that can make that happen.

Chris Stanfield

I just want to add one thing to that. I think you recall that over time we talked about the fact that we sort of believe that we can achieve non-GAAP operating breakeven at a range of $150 million to $160 million of revenue per year, and if you look at Q4, you’ll notice that if you simply take Q4’s revenue and multiple by four, you’re in that range, and as I indicated earlier, that was a period in which we had positive cash flows and effectively a breakeven on a non-GAAP basis.

Operator

Your next question comes from the line of Colin Rusch – ThinkEquity.

Colin Rusch – ThinkEquity

Can you talk about your prospects to pick up any business as market deployments using competitor’s technology running into difficulties, and also give us an update on what you’re hearing from any of the stimulus programs that haven’t been awarded yet?

Bob Maxfield

I’m sorry I didn’t understand the first portion of your question.

Colin Rusch – ThinkEquity

As some of the other smart grid deployments roll out and some of the other technologies that have been chosen run into difficulties, are you expecting to be able to pick up any business with utilities that are using multiple technologies where you’re designed in picking up some of the market share there, and then the second part of the question was just give us an update on bids that are still out there you’re speaking with utilities.

Bob Maxfield

We certainly can’t comment on any of our competitors’ situations, but certainly we think we have a great solution that works very well, and we’re happy to talk with any customers that are interested in using our technology, and I think that’s about all I can say about that. On the stimulus, there is uncertainty in the stimulus funding in terms of various aspects of it. The utilities have been awarded stimulus funds. We’re certainly in contact with many of those, and we have discussions proceeding, but as you know, there is a considerable degree of uncertainty in terms of how the whole stimulus program is going to roll out, and we just have to wait and see what happens.

Colin Rusch – ThinkEquity

My second question is on the ELO partnership. Can you walk us through how the economics will work for those designs were they’re buying parts from you, and what kind of market share do you expect to get in the Brazil deployment?

Bob Maxfield

They will be purchasing complements and technology from us. They are also as you know are a value-added reseller of ours, so they will be reselling our data concentrators and our system software. The meters that they build will have a considerable amount of our intellectual property and content. Of course, our net price per meter of the whole system will be down because they are providing more value add to the market. ELO as a meter manufacturer historically had approximately a 40% market share of the Brazilian market, and so what market share they get as the market switches over smart meters and so forth, we can’t predict, but certainly we believe our technology is the leader and they are certainly the leading meter manufacturer, so we are optimistic about how well they’ll do.

Colin Rusch – ThinkEquity

My final question on Latin America, what’s your expectation for converting all of the pipeline activity that you’re seeing there into numbers on the P&L? Should we be thinking about 2 to 3-year ramp or do you see some activity really hitting shorter term than that?

Chris Stanfield

I want to make sure I understand your question. Are you asking about what we see in terms of a timeline for revenue in Latin America?

Colin Rusch – ThinkEquity

Yes. I fully understand that you’ve got revenue there, but as we think about the revenue ramp in Latin America, how should we think about that from your perspective?

Bob Maxfield

Well, I think Latin America is in the early stages of smart meter activity, and it’s very difficult to predict how quickly things will ramp up. Our partner ELO is certainly active outside of Brazil and other parts of Latin America, and they intend to be aggressive in penetrating those markets, but I think at this point we can’t predict when any sizable rollouts or deployments will occur.

Colin Rusch – ThinkEquity

Just moving back to the building controls market, what would you point us to in terms of what you guys are thinking about in terms of the ramp in the commercial real estate market, things that you start to see as very early indicators that that the market may start moving forward in a bit more robust way?

Chris Stanfield

First of all I think that’s going to vary by geographic area and so I think as Bob said, we are seeing some growth in China as we speak, and that’s going to come obviously slower in Europe based upon what you know. We think that that market is going to recover over time, and our expectations are we’re going to start see signs of that recovery in the second half of this year, but of course that’s just contingent upon things moving forward in terms of the macroeconomic environment.

Operator

Your next question comes from the line of Dale Pfau with Cantor Fitzgerald.

Dale Pfau – Cantor Fitzgerald

A couple of questions here on Duke and then a followup. Where are we now in the remainder of what you expect them to deploy for Ohio, and you’ve got the release which was primarily Ohio, when do we expect to see some more releases under that this year, and then since you are probably in contact with Duke, I know there’s another evidentiary hearing coming up on Indiana here, I think in early March, what’s Duke saying about Indiana right now?

Bob Maxfield

Where we are on the Ohio deployment is that we have shipped about 30% of the meters that they will need for their Ohio deployment. We expect further releases in 2010 against the remainder. As to the situation in Indiana, as you know they’re involved in the administrative proceedings, working toward approval. We’re quite confident that they will gain that approval, but we can’t predict when that will happen.

Dale Pfau – Cantor Fitzgerald

Most of us are aware of the delays in the wonderful US Government stimulus funding program. What are your utility customers telling you about the uncertainty? Do they think this has caused a 1-month delay, a 2-month delay, and indefinite delay; what are you hearing from the utilities out there involved in this?

Christ Stanfield

As you will appreciate, many of those conversations are in confidence, and so we can’t get into details, but I think it’s the same thing that I see in the reports that many of you issue. There is uncertainty, and it’s going to take the actions of the DOE to quell that uncertainty, and trying to predict exactly when that happens is a difficult task.

Dale Pfau – Cantor Fitzgerald

And so none of them have given you any indication when they expect the logjam to break?

Christ Stanfield

No.

Dale Pfau – Cantor Fitzgerald

Onto Europe, which always seems to be a little bit of a challenge, half regulatory, half economic, you mentioned one area was picking up over there, and I missed that in my notes.

Chris Stanfield

In Eastern Europe, we’re seeing some renewed activity there.

Dale Pfau – Cantor Fitzgerald

Would you expect that to be stronger this year?

Chris Stanfield

We see signs of recovery in Eastern Europe.

Dale Pfau – Cantor Fitzgerald

Assuming that things get resolved with the stimulus, would you expect that your outlook for 2010 would be a little better?

Chris Stanfield

We have factored in our assumption of the stimulus and our outlook. That doesn’t mean that we’re right, and I think what will happen is that we’ll sort of revisit that estimate just like you will your estimate once we know exactly what happens.

Operator

Your next question comes from the line of Carter Shoop – Deutsche Bank.

Carter Shoop – Deutsche Bank

NES revenue in Q1 is supposed be $5 million. Should investors be thinking about that being evenly split between Duke and other NES customers?

Chris Stanfield

We’re not going to give a precise on that. Part of it is Duke; part of it is the Danish projects; part of it is all the other things that we don’t generally talk about, but there is a mix of all of those; the same folks that were part of that earlier total. Carter, as you recognize, we over-achieved our NES guidance in the fourth quarter, and as you know, there is always this issue of predicting exactly when a ship docks and when goods get accepted, and so part of what’s happening in Q1 is that we have more NES revenue in Q4 and without that the comparison would look better.

Carter Shoop – Deutsche Bank

In regards to ELO in Brazil, how smart meters do you envision them going to market with?

Chris Stanfield

We’re not going to predict that. I think what we’ve tried to do is we’ve tried to pick the market we believe is positioned for success, and we think their market position together with our technology creates a great team.

Carter Shoop – Deutsche Bank

Are you familiar with ELO also working with another technology provider to develop a different meter to go to market with?

Chris Stanfield

Not that we are aware of.

Carter Shoop – Deutsche Bank

In regards to the CEO search, could we get an update on that?

Bob Maxfield

Our board of directors has the CEO search ongoing. We are interviewing both external and internal candidates. We have a very strong and cohesive team here, and so it’s very important that we find just the right person, and we don’t feel an overwhelming sense of urgency to do something quickly. It’s more important to find the right person. I’m committed to be here as long as it takes until we can find the right person, and so it’s an ongoing process.

Carter Shoop – Deutsche Bank

Are there any internal goals that you have set up for a search—be it a year from now, or it seems like your having that kind of uncertainty would be a detriment to winning new contracts—be it announcing that you’re going to be the CEO for at least one or two years and then finding someone else. It seems like a little clarity there would be beneficial. Are you guys willing to put any kind of timetable out there?

Bob Maxfield

We have seen absolutely no impact in the market place on our management transition. Our internal team is quite stable, and so we don’t have a timetable in mind. It will take us as long as it takes, and that’s about all I can say.

Operator

Your next question comes from the line of Elaine Kwei – Piper Jaffray.

Elaine Kwei – Piper Jaffray

I think you mentioned earlier that you’d shipped about 30% of the Ohio deployment of Duke, but based on NES revenue in Q4 it seems like you’ve actually recognized much more than that. Could you please help us understand that or clarify, and also give us some color on what’s in deferred revenue?

Chris Stanfield

I want to make sure we’re talking about the same markets. Duke has about 700,000 customers in Ohio, and as you know, we had made shipments to them earlier, and I was counting that shipment. That’s back when they did their pilot. Duke was certainly a portion of our revenue in the fourth quarter, but it was in the order of half of the revenue for NES.

Elaine Kwei – Piper Jaffray

The deferred revenue on the balance sheet, is that also Duke primarily?

Chris Stanfield

No. It’s a variety of customers. We tend to talk about what’s going on at Duke and what’s going on in Denmark because those projects are larger this time, but there’s a broad list of customers that are contributing to that.

Elaine Kwei – Piper Jaffray

We can understand the traditional meters being more of a turns business, but with AMAI deployments, it seems that we typically see contracts or entire projects enter into backlog, and with this Duke project, are we correct in assuming that there has not been any order beyond the initial 120,000 that was announced, and is there any reason that Duke would not want to do that and just get those locked in in advance?

Chris Stanfield

Duke has the right to purchase meters for all 4.1 million of its customers. Duke has given us an order that we talked about previously for about 122,000 meters. Our anticipation is that they will place orders from time to time. I know that there are other companies that have an approach that if there is PUC approval in that particular state and if they have a blanket purchase agreement, then in their view, that is “backlog,” or I’ve been told so. That’s not our view. Backlog is when we have a shippable order.

Operator

Your next question comes from the line of Joe Maxa - Dougherty & Company.

Joe Maxa - Dougherty & Company

What does it really take to hit the revenue for 2010? Does Duke have to come back with another order, or can you get there if you’re not seeing Indiana?

Chris Stanfield

We’re going to have to obviously have continued success with Duke in Ohio, and we believe that we’ll have some success with them in Indiana as well. We need the Denmark projects to continue to progress as they have been doing very well for us. We have other identified opportunities. From the LonWorks product line, I think the biggest portion of that simply relates to the continued improvement of the macroeconomic environment, and as Bob said, we’re hopeful that we’re going to see some improvement in that market place in the second half of the year.

Joe Maxa - Dougherty & Company

The guidance for Q1, obviously Duke will be a lot less, but Denmark as well? Is it like they’ve got a bunch of product, and so now they’re kind of backing off till they get them installed, or what’s the status? It seemed like Eltel was doing pretty strong last couple of quarters here.

Chris Stanfield

They’re doing fine. It’s the nature of how these projects go. I look forward into their backlog. That’s just the nature of the business. It’s been the nature of the business since April 2006, and as you and I have spoken, these systems are being installed in geographic areas, people place orders, and then they place other orders, and I wish it was otherwise, but the business is like that.

Joe Maxa - Dougherty & Company

On the gross margins, the guidance you’ve given there, Q1 of 2010 looks very similar to Q1 of 2009 with similar shipments of meters, yet your margin is going to be down quite a bit. Why is that?

Chris Stanfield

In terms of what overall is happening, I think that what we gave you is our best view in terms of things that will happen, in terms of margins. I think we did have a little bit greater revenue in Q1 of 2009 in the midpoint of our guidance, and that certainly is a factor because as you’ve recognized we have a number of fixed costs within cost of goods sold, and even a couple of million dollars affects because you’re amortizing that cost over a much smaller number, but as I look at the number, there is nothing that stands out as being outstanding, other than the fact that there were probably some nonrecurring things that arose as a result of inventory movements, but I don’t think that that’s the driver.

Joe Maxa - Dougherty & Company

Are you expecting additional orders out of Ohio, or just the balance of what’s left in your current contract in 2010?

Chris Stanfield

As I said earlier, Duke has 700,000 meters, and we’re expecting them to eventually need all of them.

Joe Maxa - Dougherty & Company

So you’d expect additional orders.

Chris Stanfield

Yes.

Operator

Your next question comes from the line of Justin Cable – Global Hunter Securities.

Justin Cable – Global Hunter Securities

You mentioned in your prepared remarks that there is possibility of weather impacting NES, and I was curious if weather is a significant impact at all in your guidance for Q1?

Chris Stanfield

I think weather can affect the rate of installation. For example, if there is a large scale power outage for extended periods due to snow storms and so forth, it can slow down the installation of meters and therefore postpone the rate at which the utility wants to accept them. It has no affect of course on our system in terms of performance of the system. My comment on weather was just related to the spikiness of the deliveries that we make.

Justin Cable – Global Hunter Securities

Were there any kind of pushouts of anticipated orders as a result of weather that might have materially hit your expectations for Q1?

Chris Stanfield

Not recently at all.

Bob Maxfield

In fact, as you noticed, we actually exceeded our guidance for the quarter.

Justin Cable – Global Hunter Securities

Yes, for Q4, but the guidance for Q1 is primarily what we’re focusing on here. Separately on ELO, I was curious if this is the start of a new strategic partnership model. It seems that it’s somewhat differentiated from other partners.

Bob Maxfield

Our approach has always been to figure out what each market area that we go into what the right business model is, what the right partner should be. In Europe we started out in the early days, and as we got started we realized that it was a value reseller market. As we moved into the US, we realized it was more direct, and in Brazil, it turns out that having manufacturing partners is an appropriate way to go into that market, and we expect that will probably be the case in other markets as well. Our approach has always been to figure out what’s needed in each market, establish the right partnerships, and the right strategies and proceed. For example, as we move into Asia, we’re in sort of a business development mode, and so we’re absolutely interested in having manufacturing partners in all aspects of both our businesses, both NES and of course LonWorks is based on a whole series of partners for product development and so forth. Another requirement in some markets is to have multiple suppliers in a given system for meters, and so where that’s a requirement, that will be part of our long-term product strategy.

Justin Cable – Global Hunter Securities

Did you mention what the contribution was in Q4 from Duke?

Christ Stanfield

They were a very significant portion of our revenue for the NES system in Q4 as I said they were going to be when we had our call in fourth quarter.

Justin Cable – Global Hunter Securities

No specific number or percentage?

Christ Stanfield

They were probably on the order of, I don’t have it in front of me, half.

Justin Cable – Global Hunter Securities

Half of NES?

Christ Stanfield

NES.

Operator

Your next question comes from the line of Brian Kremer with Roth Capital Partners.

Brian Kremer – Roth Capital Partners

I have a couple of quick questions on the income statement. The product development seems to be running pretty flat here, but sales and marketing and G&A were up pretty significantly in the fourth quarter. G&A has been bouncing between $4.1 million, 3.7, 4.1, 3.7, back to 4.1. Sales and marketing, significant increase in the fourth quarter. We didn’t see that last year. Can you comment going forward how we should be looking at these?

Christ Stanfield

First of all, let me tell you that the overall spending level was amazingly close to our guidance. Part of that was driven by what Bob talked about in the sense that we’ve been making investments in our sales and marketing capabilities and those obviously are going to be very important to us. There is a lot of nonlinearity in expenses. Talking to the first quarter, this quarter as you know, this is when payroll taxes start anew, and so expenses go up. This is also when a lot of things like audit expenses hit, and so I think if you look back at our expenses, what I would suggest you do is you look at the non-GAAP expenses because you have a lot of noise that is created by stock-based compensation, and when you look at that, you see the real spending rates. If you look over the last five years, you’ll see for the first four of those, there was single digit kind of increases that occurred. Obviously, we were able to drive down expenses last year, partly because of some of the action that we took. We’ve been operating in a very moderate form as we try to carefully manage our expenses in anticipation of greater revenue.

Brian Kremer – Roth Capital Partners

Inventories, is that related to the Enel?

Christ Stanfield

No, I think it was related to the whole effect of the economic slowdown. As you know, most of our customers try and do buy products in less than the actual manufacturing time for those products. To that end, we have a very good forecasting system, but it wasn’t so good that it forecasted the economic crisis, and so what happened this time, as Bob said in his prepared remarks, our customers in LonWorks acted very quickly to push down their inventory levels. That meant that inventory ended up on our books. That also happened in NES and to some extent it happened in the Enel program, and so we had long known that we were going to work off that inventory, and as I said in my remarks, there was no surprise that we had the strong operating cash performance that we had in the fourth quarter.

Brian Kremer – Roth Capital Partners

On Duke, in terms of the stimulus, a lot of questions about that, but my take is that do you view that as impacting Ohio necessarily in terms of what you would with or without the stimulus have done basically the same amount of work this year in Ohio, or do you view that as really impacting it?

Chris Stanfield

With respect to the stimulus spending, Duke has said previously that they were on a schedule and they said that they would advance the schedule if they received stimulus funding. And so I think whether or not they receive stimulus funding will have an impact on what they would do in both Ohio and Indiana.

Operator

Your next question comes from the line of Ben Schuman – Pacific Crest Securities.

Ben Schuman – Pacific Crest Securities

When I look at your contracts in Denmark, it looks like a couple of them were supposed to tail off in 2010 or finish in 2010, maybe a couple more in 2011. As those contracts ramp, maybe they ramp a little bit later than some of us had originally expected, so can we see the completion of those contracts pushing out, or will we seem them more pressed into this year and next year?

Chris Stanfield

With respect to the Danish projects, they’re continuing on, and we anticipate having revenue this year from those projects where we had revenue last year. I think as you move forward to 2011, we do expect revenue in Denmark, but also very importantly as you pointed out in one of your reports, we expect revenue in Finland.

Ben Schuman – Pacific Crest Securities

So in terms of linearity, maybe Denmark and Finland together up 2011 over 2010, but Denmark kind of tailing off offset by Finland?

Chris Stanfield

As you know, we’ve done very well in Denmark, but not all of the decisions have been made there, so I wouldn’t be prepared to concede today that we would have a down year in Denmark. There are other utilities in the mix.

Operator

We have no further questions. I’d now like to turn the call back over to Ms. Annie Leschin.

Annie Leschin

Thank you everyone for joining. Apologies for the conference company’s power outage interrupting our call. We look forward to seeing you at upcoming conferences and events.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Echelon Corporation Q4 2009 Earnings Call Transcript
This Transcript
All Transcripts