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Echelon Corporation (NASDAQ:ELON)

Q1 2014 Earnings Conference Call

May 08, 2014 05:00 PM ET

Executives

Anne Leschin - IR

Ron Sege - Chairman and CEO

Bill Slakey - EVP and CFO

Analysts

Chip Moore - Canaccord Genuity

Mark Silk - Silk Investment Advisors

Operator

Welcome to the First Quarter 2014 Echelon Corporation Earnings Conference Call. My name is Ellen, and I'll be your operator for today's call. (Operator Instructions) Please note, this conference is being recorded. I'll now turn the call over to Anne Leschin, Investor Relations. Ms. Leschin, you may begin.

Anne Leschin

Hello, everyone, and thank you for joining us this afternoon for Echelon's first quarter 2014 earnings conference call. With me on today's call are Ron Sege, Chairman and Chief Executive Officer; and Bill Slakey, 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 time ago. If you would like a copy, please visit our website at www.echelon.com.

Additionally, we will refer to a set of slides that we have posted on the IR section of our website to help walk through the quarter's results and the outlook for our markets. During the second quarter Echelon will be participating at the 2014 Deutsche Bank, Clean Tech, Utilities and Power conference May 12 in New York City. Additionally we will be at the Ardour Capital Energy Technology and Sustainability conference on June 5 in New York. As other events come up we will make additional announcements.

Now I’d like to remind everyone that during the course of this call, we may make statements related to our overall business outlook, future financial operating results, accounting matters and future prospects. These are forward-looking statements based on certain assumptions and are subject a number of risks and uncertainties.

We encourage you to read the risks described in our press release, as well as in our SEC report, including our report on Form 10-K and subsequent reports on Form 10-Q for a more complete disclosure of the risks and uncertainty. The financial information presented in this call reflects the estimates based on information that is available to us at this time. Actual results can differ materially. Echelon undertakes no obligation to update or revise these forward-looking statements, and guidance will not be updated after today's call until our next scheduled quarterly financial release.

And now, I'd like to turn the call over to Ron Sege. Ron?

Ron Sege

Thank you, Anne. Good afternoon and thank you for joining us on our first quarter earnings conference call. I’ll begin with an overview of the quarter then provide an update on our strategic objectives. Beginning with slide three, we met our first quarter guidance with total revenues of $17.8 million and a non-GAAP loss of $0.07 per share.

Our gross margins remain healthy as they are cash balances as we ended the quarter with $55 million in cash. As we noted last quarter we had begun to report segmented financials for our two businesses to provide better transparency, these results show our solid industrial internet of things, or IIoT division gross margins, which is one of the many reasons we have chosen to reinvest in this business.

Before I move on to the progress we made during the quarter let me update you on a positive development from earlier this week in our grid business. I am pleased to report that Echelon and our consortium partners were ranked first in the published results of an important RFT process in Poland for a 330,000 meter or $21.5 million to Echelon pilot in Warsaw with a large electric utility, Tauron. I will discuss more details a bit later in my remarks.

On slide four let me first turn to the progress we have made on our strategy to drive future revenue growth by one, leveraging our assets to create new products to help industrial customers migrate to IIoT technologies; two, focusing on the most promising adjacent vertical markets such as the IT and three, maintaining our fiscal prudence by allocating investment in the grid proportionate to the timing of the opportunities we are targeting.

On slide five, this past quarter we continued to deliver next generation products and technologies designed to help our install base of new customers migrate to the IIoT. Following on the heels of our IzoT platform launch last fall we announced our local protocol embedded IIoT chipset in the first quarter the FT 6000. This IP based chipset marks the second significant new product on our roadmap and brings a number of key benefits to industrial customers including high reliability and scalability, compatibility with installed assets, pure SKUs for different protocols and flexibility to use wired or wireless technologies.

On slide six, combined with the upcoming release of our IzoT enabled Wi-Fi modules, our growing portfolio of new IIoT products can bring differentiated value to the industry installed base of almost one billion networked industrial devices. These products should enable customers to continue to realize value from their current devices as we simultaneously expand our market to encompass new deployments. Already these new products are receiving early validation from the market. Since we introduced our chipset evaluation kits approximately 20% of the early interest has come from new customers in the building and lighting markets. In the last few months, industry analysts and media have also picked up on our IIoT strategy and progress for example on slide seven, Embedded.com’s editor and industry follower Bernard Cole, commented on Echelon as the only company with a well defined strategy to define the development tool needs and address the tangled web of interactions that the IIoT could become if not done carefully.

The convergence of multiple technologies is one of the most important drivers of the IIoT when one of our existing evolving automation customers is [Indiscernible] came to us a few months ago wanting to expand from a wired LonWorks network we introduced to our new IzoT based products. They were especially pleased that they could migrate to an IP based system without any new software, seamlessly integrate our upcoming life line modules and build a wired Ethernet based controller using our IzoT device stacks and Raspberry Pi design guidelines.

With our solutions the [Indiscernible] can lower its R&D cost get to market faster and leverage its existing investment versus with and replace all with the proven reliable and scalable solution in day one.

Moving on to our plans for target verticals on slide eight, we become increasingly enthusiastic about the role we can play in bringing open standard controls to the lighting market. In particular the rapid uptake of solid state lighting or LED is in commercial and industrial applications can create a once in a lifetime opportunity for independent controls company. Compelling applications include daylight harvesting, occupancy sensing quality and color management and maintenance optimization. In the U.S. alone some 8 billion lights have yet to be upgraded from traditional incandescent and CFL bulbs roughly a third of these are in commercial and outdoor applications. This creates a potentially enormous opportunity to upgrade and transition these lights and introduce the necessary controls and sensors.

Turning to slide nine, for example just recently at the light and building fair Xicato a leader in the professional lndoor lighting market demonstrated a new integrated control platform powered by Echelon that will turn existing lights into intelligent connected devices. By integrating controls directly into an LED module lights can be connected and proactively managed in various dimension from virtually anywhere.

With such a system future LED fixtures deployed in retail could be color controlled by time of day an application to improve the customer satisfaction. These fixtures can be fitted with sensors to measure occupancy for optimizing building utilization and safety, daylight harvesting can reduce energy consumption beyond what installing LED lights only can achieve and given its density and a typical building the controlled lighting system can be the convergent point or backbone for other building systems such as HVAC and security in the future.

In the outdoor lighting markets the number of streetlights with smart controls is expected to grow from less than 2 million today to more than 100 million in the next 10 years. That could represent a total investment of $10 billion worldwide to make streetlight smart. Of that investment nearly 40% is expected to be in North America. Historically, our participation has centered in the Asia and Europe with wired solutions. To meet the needs of the North American markets we have been developing a new auto actives lighting RF based lighting control solutions with Echelon branded commissioning monitoring and management software. This will allow us to facilitate quick pilots and deployments for potential customers so they not have to piece together a hardware and software solution from various vendors.

Our solutions will be based on open standards and published profiles and API so customers will not be locked into a single vendor solution as their networks grow. We believe that with the introduction of these solutions only Echelon will offer outdoor lighting customer the option of wired or wireless connectivity in a single system. As part of our strategy in the IIoT, it is critical that we have the right distribution channel in place to reach existing and potential customers in each of our markets.

On slide 10, we recently hired a new Vice President of sales to get us closer to our customers and integrate it into their upcoming design cycles. Additionally, we added a significant distribution partner in Digi-Key to expand the availability of our products. In this agreement, our products will now be sold on one of the largest online electronic store fronts for IIoT developers and designers. In lighting, we are expanding our U.S. sales channel to include manufacturers’ rep network through which most government highway projects and commercial parking lots are accessed. We plan to formally launch our U.S. lighting solution and the associated rep program at Light Fair coming up this June.

In the grid vertical on slide 11, we were notified this week by Tauron, a 5 million customer utility in Poland that two consortiums representing Echelon were rate first and second in the final round of bidding for its $21.5 million 330,000 meter pilot the top right consortium is led by our partner LG CNS and included our new DCN 3000 applications node and NES software, this preliminary selection now go through standard usually several week review process in accordance with Polish procurement laws. As part of the offer, both Echelon and Apator one of Poland’s leading suppliers of electric gas and water meters will supply OSGP compliant meters to the consortium. If ultimate we confirm this award can position us well for the ultimate upgrade of Tauron’s 5 million meter installed base. We expect this pilot to rollout over 28 months after the contract is signed.

Turning to slide 12, our progress in Poland highlights the growing momentum of the OSGP standard in Europe across our customer prospects and partner base. In addition, the inclusion of our DCM 3000 a fully programmable communication hub that supports a variety of grid protocols and runs multiple applications reinforces our visions of a multipurpose platform for the edge of an increasingly dynamic electricity grid. We see additional RFP activity developing in the 16 million meter Poland market during the next 12 months and activity is accelerating other target markets including Norway, Austria and Denmark. These later markets represent an additional 9 million meters to potentially be upgrade.

Our Middle East pilots continue to perform well and we hope for progress in the tender process during the balance of 2014. Even with the siding activity and the nearing of the 2020 mandates the timing of awards of course remains difficult to predict to address these market conditions and maintain our strong financial discipline we are allocating our resources carefully in the grid to align with the opportunities that we believe we have the greatest return on investment. Our sales activities remain very targeted and our important new product development efforts are aligned with the needs of our target markets.

In closing on slide 13, I am pleased with the strategic progress that we are making in developing new products to help our customers migrate to the IIoT, targeting promising verticals that are showing growth such as lighting and focusing on winning key grid awards in specific geographies. With our new chip and lighting product introductions we have begun to see validation of our strategy from the market and look forward to the impact of our expanding distribution channels. In the grid we are very excited about the preliminary results Tauron and Poland and believe they build well for the upcoming award in that large pilot. While we still have a tough few quarters to go because of the ongoing trough in the grid market winning mandates and recent increased RFP and pilot activity in Europe are signs that maybe pointing to an upturn in 2015. Overall although we still have much work ahead of us long term we believe our plans have strong potential to enhance value for our shareholders.

Before I turn the call over to Bill, let me once again thank our employees, our customers, partners and shareholders and their unending support as we transform our business in position it for growth. I’d now like to turn the call over to Bill. Bill?

Bill Slakey

Thanks Ron. Good afternoon everyone and thank you for joining us. Let me begin by noting 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 quarter ended March 31, 2014, which can be found on the Investor Relations section of our Web site.

Beginning in the slide 15, revenues for the first quarter were in line with our guidance at $17.8 million which is down 29% from $25.2 million in the first quarter of 2013 the year-over-year decline was primarily the result of lower grid revenue which totaled $6.9 million this quarter compared to 13.4 million a year ago. IIoT revenues for the first quarter were $10.9 million versus $11.8 million a year ago. Sales to Enel included in our IIoT revenues were $1.5 million in the first quarter versus $1.9 million a year ago. Sequentially, our revenues were down slightly from $18.1 million in the first quarter. This was driven by a sequential decline in Enel revenues from $3.2 million. Revenues from Enel can be lumpy quarter-to-quarter as our recently quarter’s performances demonstrate.

Sequentially, grid revenues were up from 5.6 million and IIoT revenues were flat at $9.4 million. We believe the stabilization of our core IIoT business excluding Enel over the last few quarters reflects our commitment to our customers the introduction of our new product as well as improving macroeconomic trends.

Turning to slide 17, non-GAAP gross margin for the first quarter was 49.4%, an increase from the 47.4% recorded in the first quarter a year ago and down slightly from 49.9% in the fourth quarter. Gross margin this quarter benefited from an unusually high level of service and support revenue. In Q2, we expect these revenues to return to a more typical $500,000 to $700,000 per quarter versus $1.7 million we recognized this quarter and that will result in more normalized gross margin.

Turning to expenses, this quarter’s non-GAAP operating expenses were $11.7 million a 16% reduction from $13.9 million a year ago. This was the result of the ongoing restructuring activities that we initiated last year and ongoing cost reduction efforts. On a non-GAAP basis, R&D for the quarter was $4.7 million, sales and marketing was $3.6 million and general and administrative expenses were $2.5 million. Looking at the rest of the P&L, interest and other expense totaled $277,000 this quarter compared with $37,000 in the first quarter of last year. This difference was driven by changes in exchange rates and their impact on our intercompany balances.

Our joint venture with Holley in China generated a small loss this quarter as the results are consolidated Holley’s share of the loss was $117,000 down from last year’s $148,000 in the first quarter. This is reflected as a slight benefit on our P&L. We also a slight income tax benefit of $25,000 this quarter which is an expense of $47,000 a year ago. Non-GAAP net loss for the quarter was $3.1 million or $0.07 per share compared to a non-GAAP loss of $1.9 million or $0.04 per share in the first quarter of 2013. On a GAAP basis including stock compensation expense, the net loss for the quarter was $4 million or $0.09 per share. This compared to a GAAP net loss of $9.2 million or $0.22 per share in the same quarter a year ago. As a reminder, in the first quarter of last year our GAAP results included a $2.5 million restructuring charge and a $3.5 million charge for litigation expenses. Our stock based compensation expense this quarter was $883,000 compared to $1.4 million in the same period a year ago.

On slide 19 and 20 as we reported in our 10-K filed in March, we began segmenting our financial information for our IIoT and grid businesses. IIoT includes the sales of our embedded control platforms, LonWorks and IzoT, including components controlling both and development software. These are typically sold to OEMs and built into their industrial application. Our grid business includes sales of smart meters, devices and software for electric utilities. Looking at the business individually our $10.9 million of IIoT revenue generated gross margins of 63.9% in the first quarter, after deducting IIoT related R&D sales and marketing expenses this business generated a strong contribution margin up to $2.7 million for the quarter.

Grid revenues were $6.9 million this quarter driving gross margins up 27.8%, with grid related R&D and sales and marketing expenses deducted this business generated a negative contribution of $2.1 million of these relatively low revenue levels. In both cases, the segment contribution margin does not include stock compensation expenses, general and administrative expenses or other income and expense.

Moving to the balance sheet on slide 21, we ended the quarter with a healthy $55.3 million in cash, cash equivalents in short term investments. A sequential decrease of $2.3 million in the fourth quarter, working capital accounts were well managed which muted the impact of the operating loss on our cash during the quarter. New capital expenditures totaled $302,000. Going forward we expect our cash usage for the year to approximate our non-GAAP operative loss.

Let me turn now to guidance for the second quarter on slide 22, we expect total revenue in the range of $15 million to $16.5 million due to slightly lower grid revenues and lower revenues from Enel, which can be lumpy quarter to quarter. We anticipate approximately 65% of our revenue will come from sales of our IIoT products including Enel and approximately 35% from sales of our grid products and systems. We expect non-GAAP gross margins to return to a more normalized range of 45% to 47% of revenue. We anticipate non-GAAP operating expenses to be in line with spending in the first quarter at approximately $11.5 to $12.5 million.

We estimate our non-GAAP earnings per share for the second quarter excluding stock compensation and other items to be a loss of between $0.09 and $0.13 per share, including approximately $1 million or $0.02 a share in stock based compensation expense, we expect our GAAP loss per share to be between $0.11 and $0.15.

Let me summarize by saying that with the softness in the grid markets we’ve been very circumspect about the timing of opportunities and therefore very judicious with our spending.

But we are not out of the woods on that yet, the increased tender activity that Ron spoke about earlier is a promising sign that the grid market may be poised for better things beginning in 2015. To diversify our opportunities we have made significant strides along our IIoT roadmap to expand our business. Early positive feedback on our new products and growing market interest are positioning Echelon to capture emerging high margin IIoT opportunity.

I would now like to turn the call over to the operator for questions, operator?

Question-and-Answer Session

Operator

Thank you, we will now begin the question and answer session, (Operator Instructions). We have a question that comes from Chip Moore with Canaccord. Please go ahead.

Chip Moore - Canaccord Genuity

Hey folks nice to see some encouraging signs on the grid side in Europe. Maybe you could touch a little more on the opportunity in Poland, sort of next steps? I think you said there's a process over the next couple weeks. Just walk us through where you have come from on that RFP, and what we should be looking for there.

Ron Sege

Yup, sure so there were -- its Ron, by the way. There were two rounds of responses so there was one down selections a few months back as the final selection process so there were three consortiums that were bidding for the final and we were ranked our consortiums the ones we participated and we’re ranked one and two. So the top consortium which is led by LG CNS now goes through a kind of a mandatory standard protest period where other vendors are allowed to comment and protest on the award or on the pending award I should say we expect that to take a few weeks and then it builds into contracting which should follow to be fair with that process that follows the final RFP submission. So, our expectation is that that this would go to contract and the contract is sometime in the summer assuming we get to the process period successfully and that’s 330,000 meter pilot in Warsaw or a 5 million customer utility. So we’re successful with this pilot or when we’re successful with this pilot then we’re optimistic this positions us well for a much bigger rollout through to 2020.

Chip Moore - Canaccord Genuity

Sure. Yes, that makes sense and that would be great. And moving over to the IIoT side, obviously the lighting market we've seen a lot of acquisitions in the space recently from some competitors. What do you think? Do you think you need to do anything? Whether it's partnerships or are you pretty comfortable with the framework right now looking forward?

Ron Sege

Well, partnerships have to sure as I said in my prepared remarks we see the potential great power ending really there is only independent controls company that’s partnering with multiple lighting companies we talked about partnerships with the Xicato so certainly partnerships are something that we’re keen on. And as I’ve mentioned previously we are also looking at M&A and lighting would be certainly a vertical we would explore.

Chip Moore - Canaccord Genuity

And I guess along those lines you talked about building out some manufacturers’ reps, introducing that at Lightfair. Maybe just walk us through that process?

Ron Sege

Yeah, that’s really how lighting is sold around the work especially in the U.S. so as I mentioned we’ve brought on a new sales leader he’s got a lot of experience with manufacturers’ reps program both in the lighting business and in semiconductor business it’s frankly something that Echelon has not taken advantage of in the past so I view this as a potential to be a significant force multiplier so we’re just getting started with it we signed up our first few we’ve got a pretty aggressive target we’re siding up more here in the U.S. and more feet on the street is one of the ways that we drive top line.

Operator

(Operator Instructions) Our next question is from Mark Silk with Silk Investment Advisors. Please go ahead.

Mark Silk - Silk Investment Advisors

Hi Ron thanks for taking my call. So, my question was on the IIoT. Can you kind of maybe clarify for me -- is there any areas that maybe there's some low hanging fruit that maybe might not, let me say, push the needle but at least get your foot in the door for future opportunities?

Ron Sege

I’d say -- thanks for the call. I’d say that our first release which was IzoT software stack which runs on third party products including Raspberry Pi is a way to get the IzoT technology this concept of multi protocol migration kind of embedded in customers’ minds both on intendance, so that’s what we calculated to be a way to gain mind share and so we’ve had a good number of downloads there and I think that have some effect. Obviously the fastest way to revenue is through our street lighting business where we’ve got products outside the U.S. and those use our embedded IIoT chipsets we will be introducing as I mentioned in my prepared remarks an RF based system in the U.S. the sales cycle is there our nine to 12 months was not -- is not going to have immediate impact but with the manufacturers’ reps with the market appearing to accelerate the street lighting in the U.S. I would say that’s a relatively near term opportunity, certainly compared with the chip business where it’s six months eval period and nine months designing cycle and then you get revenue.

Mark Silk - Silk Investment Advisors

Okay. Sticking to the IIoT, besides Google buying out Nest, can you show us an inflection point or what you think of an external force that might happen that can shed light on IIoT and, more importantly, on Echelon?

Ron Sege

I’m not sure I really, I’m sure I understand that.

Mark Silk - Silk Investment Advisors

Like in the grid, there's a mandate to be a smart grid. Is there something that you can foresee like in the US, whether -- if there's anything that might come out in the press or something that might just give people more awareness of IIoT and what's going on?

Ron Sege

You know I can’t speak to the specifics, you know the same kind of thing can happen from an M&A perspective, with some of these main lines, big industrials, looking to buy more technology oriented companies obviously can’t speculate on Echelon, I think beyond that we’re working very hard than others in the industry to get use cases out, examples were the IIoT is adding value in industrial settings, I will say this that if people can relate to Nest and Fitbits and Pebbles and that kind of thing because they see them on the list and what have you, but study, you have to study for the real economic value, the real return on investment is in the industrial and commercial side so that’s where we’re going to see the real productivity benefits and that’s where the real, the real studies will start appearing.

Operator

We have no further questions at this time, I’ll turn the call back to Ron Sege for closing remarks.

Ron Sege

Okay, listen, thank you I know it’s a busy day and we appreciate you joining the conference call, just to echo my prepared remarks we’re optimistic about the progress we’re making in our IIoT business, we’re excited about the potential in lighting and thankfully the progress with Tauron in Poland, the increased RFP activity in pilots in Europe is really, we’re starting to feel like these mandates are taken in and that give me cautious optimism that this market will start growing again in 2015. So thank you all very much and we’ll talk to you soon.

Operator

Thank you ladies and gentlemen, this concludes the first quarter 2014 Echelon Corporation’s Earnings Conference Call. Thank you for participating, you may now disconnect.

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