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Executives

Annie Leschin – IR

Ron Sege – President and CEO

Chris Stanfield – EVP and CFO

Analysts

Sean Hannan – Needham & Company

Craig Irwin – Wedbush Securities

Elaine Kwei – Jefferies

Michael Cox – Piper Jaffray

Carter Shoop – Deutsche Bank

Dale Pfau – Cantor Fitzgerald

Brandon Mora [ph] – ThinkEquity

Patrick Jobin – Credit Suisse

John Quealy – Canaccord Genuity

Echelon Corporation (ELON) Q3 2010 Earnings Call Transcript November 3, 2010 5:00 PM ET

Operator

Good day, ladies and gentlemen, and welcome to the third quarter 2010 Echelon Corporation earnings conference call. At this time, all participants are in a listen-only mode. We will be conducting a Q&A session towards the end of this conference. (Operator instructions) As a reminder, this conference is being recorded for replay purposes.

I would now like to turn the presentation over to your host for today's call, Ms. 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 2010 earnings conference call. With me on today's call are Ron Sege, 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 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 that in the fourth quarter, Echelon will be participating in Stifel Nicolaus CleanTech Conference on November 9th in New York, Goldman Sachs CleanTech Conference in New York on November 11th, Stephens Fall Investment Conference on November 16th in New York, and the Robert Baird CleanTech Conference in San Francisco on December 1st. As additional events are scheduled this quarter, we will make other announcements.

Now, I would like to remind everyone that during the course of this call, we may make statements related 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 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 on this call reflects estimates based on information that's available to us at this time. Actual results could 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.

I would now like to turn the call over to Ron.

Ron Sege

Thanks, Annie. Thank you, everyone again for joining us today for my first earnings call as CEO of Echelon. I am pleased to report that Echelon delivered a solid third quarter with $27.1 million in revenue and a non-GAAP net loss of $0.11 per share, slightly exceeding our guidance. Our LonWorks product line saw its strongest quarter since the recession began nearly two years ago and our 46% gross margin was led by improvements in our NES product line. We continue to prudently manage our balance sheet this quarter and we benefited from positive cash flow in the quarter.

Before I get into the quarter highlights, I'd like to take a moment to discuss how we are evolving the way we talk about our product lines. Historically, Echelon has discussed these in terms of our device networking or LonWorks infrastructure products and our smart grid infrastructure product or Network Energy Services. This will change as Echelon pursues an important initiative of becoming even more market and customer-focused.

Going forward, we will refer to LonWorks products as commercial products, given that our target markets for this line are principally a variety of public and private companies, governments, and other commercial entities. NES products will be known as utility products, as NES end customers are various utilities and energy service providers throughout the world.

By renaming our business in terms of end markets, we believe we will give the market and our customers a more clear and straightforward understanding of Echelon.

Now, let me move to key highlights of what was an exciting quarter for Echelon with the launch of our game-changing Echelon Control System or ECoS platform and other new products and offer my perspective of what I've seen and heard in the marketplace in my first two months as CEO; obviously, all this with the caveat that I still have much to learn about our company and the industry.

One of the fun parts of this job so far is that I have talked with a great many customers, partners, regulators, and suppliers around the world in the last few weeks. During the rest of my commentary, I will try to weave in themes and real world application anecdotes, because emerging markets such as the smart grid can never get enough of these in my experience.

First, the customer themes. The good news is that they are very similar around the world. Shift peak demand; reduce operating costs; improve delivery efficiency; add flexibility to adapt to new sources of power; reduce control system stovepiping and obsolescence-prone systems using multifunctional solution based on real, open standards; provide features and open interfaces to meet new opportunities such as street lighting control and demand response; and finally, provide tools to empower end customers with the ability to see and manage their energy consumption.

In short, these are very system oriented themes which play to Echelon's strengths. This is why our new focus of moving beyond the meter and bringing intelligent distributed control to the edge of the utility grid is so timely. By combining embedded and system software with purpose-built hardware into complete energy control systems, Echelon is able to uniquely meet the emerging needs of customers worldwide.

We have the ability not only to make the meter smart, but also to extend intelligence into other grid devices the utility owns such as low-voltage transformers and devices within buildings such as those in heating and air conditioning systems. By doing this, we are able to solve a broad variety of emerging challenges and add significant value in many dimensions.

One way of thinking about these conversations is that the industry is moving away from thinking about the smart grid as solely smart metering and towards an end-to-end smart grid, something that has always been part of our vision here at Echelon.

My conversations with utility customers have reinforced the need for the very innovated additions to the NES solution that we introduced this quarter. These exciting products bring the power of control to the increasingly dynamic edge of the electric grid.

ECoS, an open software platform for intelligent distributed control and the Edge Control Node ECN 7000 enable the low-voltage neighborhood transformer to become intelligent for the first time. Publishing the Open Smart Grid Protocol, OSGP, used within the NES system ensures compatibility with other open standard systems. And finally, our new ControlPoint module allows third parties to quickly develop a wide variety of smart energy devices that become part of the NES system via OSGP. These are all examples of fantastic customer-driven innovation here at Echelon.

Arguably, one of our most advanced utilities and a leader in the smart grid, Duke Energy, is the first customer for our ECN products running the ECoS software platform. With an initial order of $14.5 million, we will provide Duke with ECN field trial units by the end of the year and with shipments of production units targeted for the second half of 2011.

Since we announced our ECoS platform in early September, we've seen a great deal of interest from partners and customers worldwide, including those that supported our launch, like Oracle, S&C Electric, SEAS, and Telvent. We've already held ECoS educational workshops with customers and prospects and I'm pleased to report that they've been very well received. Specifically, the workshops reinforced our view that distribution applications such as volt and VAR Control and theft or non-technical loss detection and reduction, which I will describe in more detail shortly, have very strong return on investments.

Given that our VARs are now asking for information about ECoS to include in their RFP responses, we expect that the new smart grid tenders will reflect demand for this functionality. Our focus for the next several months continues to be running these workshops and recruiting partners to ensure that we will offer the market a critical mass of high-value applications by mid-2011.

As I mentioned, customers are increasingly clear that they want future-proof solutions, meaning those that can truly interoperate with existing and future devices from other manufacturers, which of course has been a key element of the Internet success over the last 15 years.

OSGP reflects the growing market awareness that truly open standards drive adoption and – and adoption drives markets, giving customers the ability to buy best-of-breed products and avoid vendor lock-in, which can increase cost and reduce innovation. Most important, as a truly open standard, OSGP will enable third-part developments of interoperable meters and other smart grid devices from multiple vendors, many of whom joined with us in the OSGP announcement in September along with utilities and system integrators.

To speed development of OSGP-compatible devices, our ControlPoint module provides manufacturers a low-cost, off-the-shelf module that can embed in their products to extend smarts beyond the meter, enabling devices connected to the low-voltage grid such as electric vehicle charges to become plug-and-play intelligent endpoints.

For example, at the recent Metering Europe conference in Vienna, DIEHL Metering, a leading European provider of heat, water, and gas meters, demonstrated a device that integrates all of these meters into our system. Utilizing the wireless M-bus standard in the NES system, this allows the utility to cost-effectively extend the smart grid to include all of the meters they offer.

At the same conference, Ubitronix, an Austrian smart grid solutions provider, showed a device powered by ControlPoint that extends the smart metering network to include residential demand response.

Now, let me highlight some real world examples of how utilities are using our new and existing products. Duke Energy has a variety of challenges that they intend to address with our multipurpose ECoS-powered ECN. These include increasing the efficiency of the grid through better volt/VAR control, improving outage detection and restoration, integrating renewables and preparing for electric vehicle adoption. In fact, Duke has indicated that they see more potential savings through volt/VAR control than from those related to smart metering alone.

By putting intelligence at the transformer, coupled with the NES system's ability to understand how the grid is wired, Echelon enables utilities to perform volt/VAR control with more precision, leading to greater cost saving.

I not only heard other utilities echo Duke's challenges, I also learned that many of the richest examples of the power of a smart grid lie outside of the United States. One problem prevalent around the world is the theft of electricity. At one medium-size utility that I met with, at least 10% of their potential revenue was lost or unaccounted for in a single year. The culprit was its not-so-smart distribution automation system with no ability to measure losses at the transformer. With no low-voltage automation, this led to extremely high electricity rates for consumers.

Utilizing the distributed intelligence provided by the ECN, the NES system can easily compare the electricity that was delivered by each transformer to the total use by their customers to quickly and accurately pinpoint the source of theft. This in turn allows for reclaiming of revenues and fairer rates for all customers.

Another problem utilities face is the integration of disparate systems to efficiently offer a wider range of services. A good example of a utility moving beyond the meter to build a smart grid is the Austrian utility and Echelon customer, LINZ STROM. LINZ has three problems they need to solve. First, bringing the benefits of smart metering to their customers; second, improving their expensive residential demand response system, which provides no confirmation of load reduction commands; and third, as a city-owned utility, effectively managing their energy costs related to street lighting.

Through Echelon's infrastructure, LINZ was able to solve all three of these problems through one integrated system. They are using the complete NES system, meters, data concentrators and system software, as well as commercial SmartServer as part of their overall solution. With the open expansion port in our NES meters, our VAR partner at LINZ was able to extend the capabilities of NES meters to provide two-way, time or event based demand response with status feedback to LINZ. Now, with our ControlPoint module, LINZ can deploy these same capabilities anywhere on the grid or in the home without requiring a connection to the meter.

Given the successful results, LINZ this quarter announced that they will expand their current deployment with Echelon.

Successful installations such as LINZ are a powerful differentiator for our company. This was reinforced for me during the quarter when a major Asian utility visited and talked with a few of Echelon's existing customers at Scandinavia. Having utilities that are willing to host visitors and serve as references for Echelon is a fantastic testimony to the power of our solution.

As many of you know, yet another successful deployment of our NES solution was Vattenfall Sweden. I just returned from our annual NES partner conference where a sister utility piloting our system, Vattenfall Poland, gave a great presentation about the opportunities for the smart grid in their country. To have such a renowned company invite us to work with them again in Poland after our joint success in Sweden underscores to me the confidence that our customers have in us and our solution and how this confidence transcends geographies.

And word is apparently getting around. As I look at our utility pipeline, I'm encouraged to see multiple pilots running in Poland, Switzerland, and other countries in Europe and Asia.

Now, let me turn to our business in commercial markets or LonWorks. We had the strongest quarter since the recession hit in the fourth quarter of 2008. Steel, the largest vertical in LonWorks, the building controls market, showed improvement during the quarter, particularly in Europe. In North America, one of our largest building controls customer began high volume production of a new LonWorks based product that was launched earlier this year. Taken together, we believe this could signal the beginning of a bit of a recovery in the buildings market.

We also saw strength in our energy related verticals such as street lighting, particularly in Asia. In China, some early street lighting projects are rolling out in innovative ways. Given the opportunity for quick payback of these solutions, Echelon's Chinese partner is paying for the installation upfront and then recouping its investment through a share of the energy savings over time, the so-called ESCO [ph] model. In this way, the partner overcomes project funding challenges and absorbs the risk. In return, the city receives new and better street lights along with a portion of the energy savings.

So far, most of the interest in this vertical has been in Asia and Europe. However, with U.S. cities spending up to 40% of their electricity budget on street lighting, we expect to see growing interest in the coming years in United States.

Another highlight in the commercial market is our growing interest in solar applications. Companies are not only using our power line technology to communicate within solar fields, but also to remotely monitor invertors, using our LonWorks SmartServer. This allows installers to control several solar operators in remote areas from one central location monitoring the health and status of invertors to reduce maintenance cost and improve system efficiency.

Growth opportunities in demand response also continued this quarter with increasing installation in residential homes across the European market. One of our customers has developed a residential demand response system using our power line technology and an Internet connected gateway to automatically shed load during periods with high electricity cost to lower the consumers' energy bill. This reinforces Echelon's opportunity to provide energy management and control in residential locations separate from the meter, which broadens our reach across the expansive home market.

In summary, less than a quarter into my tenure at Echelon, I have learned a great deal. I've talked to real, happy customers and partners and heard about many compelling use cases for the smart grid. Thinking in our industry is evolving from the smart meter to the smart grid. ROI, customer empowerment, flexibility, and openness are increasingly driving decisions into these trends.

The new addition to our NES smart grid solutions for utilities, our ECoS platform, and our ECN product line bring the power of control to the increasingly dynamic edge of the grid. ControlPoint and OSGP extend intelligence beyond the meter by allowing third-party developers to easily build intelligent devices based on an Open Smart Grid Protocol. These pioneering technologies position Echelon for the future as not just a smart meter company, nor just a building automation company, but one company leading the way to a truly smart grid with a wide range of powerful applications. Overall, what I see is a coming together of our end markets, leading me to conclude that Echelon is in the right place at the right time.

Now, a final word on guidance. Market interest in energy efficiency continues to be solid for all the reasons we've discussed today. Though the regulatory environment is somewhat uncertain in several large countries such as Germany, the U.K., and parts of the United States, we are pleased that we are on track to achieve modest revenue growth in 2010.

While it is too early to provide any formal guidance for next year, our current view is that we should see good revenue growth as Echelon's new focus of bringing control to the edge of the grid and extending intelligence beyond the meter will drive us into the next decade. Of course, we remain committed to achieving profitability not only by growing by revenue, but also by closely managed operating expenses and finding ways to drive up margin.

Finally, I'd like to thank all of the Echelon employees for their hard work and dedication this quarter. Now, I'd like to turn the call over to Chris to review our financial results. Chris?

Chris Stanfield

Thanks, Ron. Good afternoon, everyone and thank you for joining us on our third quarter earnings call. 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 third quarter ended September 30, 2010, which can be found on the Investor Relations section of our website.

Revenues of $27.1 million were at the high end of our expectations compared with $27 million last year – last quarter and up from $23.7 million in the same period in 2009. We had our strongest LonWorks quarter since 2008 when the recession began, with third quarter revenues of $12.5 million, up from $11.9 million last quarter and $11 million in the same period last quarter. Our NES sales were $13 million in this quarter, down from $13.5 million in the second quarter, but up from $11.5 million in the same period last year.

Revenue from Enel in the third quarter was $1.5 million compared with $1.6 million in the second quarter and $1.2 million in the same period of last year. Third quarter non-GAAP gross margin was 47.3%, ahead of both last quarter's 42.2% and the year-ago period's 45.6%. The improvement was driven by higher margins in our NES product line this quarter.

Non-GAAP operating expenses were $16.4 million, up from $15.2 million last quarter and $14.7 million a year ago. Operating expenses were lower than we had expected this quarter, due to the timing variances. However, we expect that some of these expenses will shift into the fourth quarter.

Interest and other income expense was net expense of $559,000 in the third quarter, down from net income of $504,000 in the second quarter. In the same period last year, interest and other income expense was a net expense of $91,000. The weakening dollar drove unrealized currency translation losses on our short-term inter-company balances.

Our GAAP net loss for the third quarter of 2010 was $7.8 million or $0.19 per share. This compares to a GAAP net loss of $6.9 million or $0.17 per share last quarter and a GAAP net loss of $8.2 million or $0.20 per share in the same period last year.

Our non-GAAP net loss for the quarter was $4.7 million or $0.11 per share compared to $3.9 million or $0.09 per share last quarter. Non-GAAP net loss for the third quarter of 2009 was $4.6 million or $0.11 per share.

Moving to the balance sheet, we ended the third quarter with cash, cash equivalents, and short-term investments of $74.3 million, a $1.9 million increase from last quarter. The cash increase was primarily driven by positive cash flows from operations.

Now, I would like to turn to guidance for the fourth quarter of 2010. We expect total revenue for the fourth quarter of 2010 to be in the range of $36 million to $38 million, with our commercial revenue accounting for 32% and utility about 65%, with the remainder from Enel. We anticipate non-GAAP gross margin to be in the range of 43.5% to 44% for the quarter. Finally, we estimate our GAAP loss per share will be between $0.11 per share and $0.15 per share, and our non-GAAP loss per share will be between $0.04 and $0.08.

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

Question-and-Answer Session

Operator

(Operator instructions) And your first question comes from the line of Sean Hannan from Needham & Company. Please proceed.

Sean Hannan – Needham & Company

Yes, thank you. Good evening.

Ron Sege

Hi, Sean. How are you?

Sean Hannan – Needham & Company

I'm doing okay. And congratulations on a solid quarter.

Ron Sege

Great. Thank you.

Sean Hannan – Needham & Company

The first question, I was looking to see if I could put for Ron. Ron, some of your color around what you've learned since joining the company was certainly helpful. I was looking to see if perhaps you could expand on that a little bit in terms of – what have you learned so far since joining Echelon? Whether this is relevant to the merits of the company or technology or the industries Echelon is serving or even Echelon's positioning to compete, whatever would be worthwhile from your perspective would be helpful.

Ron Sege

Yes, thanks for the question, Sean. And I guess, let me make the comments specific to Echelon, because I made a lot of observations about the industry in my opening commentary. And the first point I'd make is what I think I said at our launch of ECoS in New York City, which is I think this company is a really well-kept secret. And just the richness of the commentary, the anecdotes that I shared, the number of real happy customers we have, the use cases that we are picking up, especially with our deployments that are mature in Europe, these are things that we got to do a better job of talking about.

I think I also mentioned in New York City that I have been really impressed the extent to which Echelon is a software company, because from the outside we look like a hardware company. But we've got millions of lines of codes, datacenter codes embedded, firmware, codes that run very compactly on end devices, and if the smart grid goes the way data networking did, software will be increasingly the differentiator and that's a story that we need to get out as well. So first and foremost, a really well-kept secret that we've got to change to our marketing mix.

I'd say the second thing is that we've got to continue to develop our partnerships. I sold 3Com to HP and spent almost a year there and HP spends a lot of time talking about how customers are looking for turnkey solutions. And I think the same is true increasingly in the smart grid. So, continuing to develop partnerships like – system integration partnerships like the one we have Eltel in Scandinavia in the rest of the world will be important, as well of course to the success of ECoS and the ECN.

And then finally of course, we got to grow and to me, that's – I do think we have the right product set at the right place at the right time. I think we've got to sharpen our sales execution. We've got to realize that there are more – there is more than one route to market. Systems solution turkey sold in Europe, we've got a relationship with a meter vendor ELO in Brazil where we are supplying our control networking solutions and they are going to market. In China, which I think has great opportunity for us, it will be another model because that's the way you need to do business there.

So you can expect to see increasing flexibility in how we get to market. The good news is I've got a lot of experience in all three of these areas. So I'm confident you will see progress there over the next 12 months. Does that answer the question, Sean?

Sean Hannan – Needham & Company

I think that's helpful, Ron. I actually have a second question if we have a moment.

Ron Sege

Sure.

Sean Hannan – Needham & Company

Yes, okay. I think that you folks did a great job in securing a win really out of the gate on the ECoS platform with Duke and it was a decent sized win. You've talked a little bit around some of the – I think the general activity that you are seeing today since that launch with some of your partners, I was hoping perhaps if you could elaborate around some of the – some of that activity what you are seeing that make – bring you to be a little bit more optimistic for something that could be incremental in 2011, i.e., do we expect beyond Duke that we could see some additional revenues off of that platform next year and what would be from a success standpoint – how would you measure that and view the ECoS platform?

Ron Sege

Sure. That's also a great question. Well, just to reiterate the timing of that product, it will shift for revenue in the middle of next year. So we can expect it to contribute modestly to 2011 and more to 2012. Now, longer term, I am very bullish about this platform. I've traveled around the world and there is tremendous interest in it, both among end users and among partners. There is great ROI, return on investment from investments in distribution automation and the area we are targeting, ECoS and ECN towards is the edge of the grid, the low-voltage part, the transformer, which really is kind of an uncovered area. And the fact that we've got multiple applications there from distribution automation down to powering in-home displays, aggregating up third-party meters, et cetera, to me that's where the excitement comes from. And long term, I think the TAMs of the smart meter and sort of the ECN, ECoS opportunities are approximately equal.

So – and I guess the final point I'd make, Sean, is we can sell ECN to two types of customers; customers that already have our meters and customers that don't. And so the fact that customers here particularly in the United States have perhaps selected a competing smart meter vendor, those customers are still open to us for ECN. But I guess the bottom line is expect that story to unfold most impactfully starting in 2012.

Sean Hannan – Needham & Company

Terrific. Thanks very much for the color. I'll hop back into queue.

Ron Sege

Okay. Thanks, Sean.

Operator

And your next question comes from line of Craig Irwin from Wedbush Securities. Please proceed.

Craig Irwin – Wedbush Securities

Thank you. Congratulations on the solid quarter, gentlemen.

Ron Sege

Hi, Craig. How are you? By the way, Chris is here too. So – and he is uncharacteristically quiet.

Craig Irwin – Wedbush Securities

Chris, Ron, yes, I know. Good to speak to you both. So on your utility side as we are calling it now, the margins were very, very healthy in the quarter. And I just wanted to see what you can say about how sustainable these margins are likely to be going forward and as ECoS becomes a part of the overall sales mix, I'm expecting a small part this next quarter and maybe slightly larger going forward, what is that going to mean for the gross margins on your utility customer side?

Chris Stanfield

This is Chris. Let me take the first portion of that. And I want to talk about the long-term trend first and then I'm going to speak specifically about this quarter. Long term, what has been happening here is that our margins for our NES product line have been getting better. A portion of that is driven by what's happening to pricing. And with the trend that we have seen is that customers as time moves forward are buying richer solutions.

As you know, in the United States, people often times have systems that are merely focused on meter reading and perhaps some kind of time-of-use pricing. But we have platforms, particularly in Europe in which people are doing much more than that. Those platforms are more expensive and some of those options have better margins.

So, we've seen a long-term trend in terms of pricing, which has been helpful to margins. We have also seen a long-term trend in terms of costs, which are going down and that is largely as a result of the engineering efforts we have made, as well as the efforts that our operations organization has been making from a sourcing perspective to drive down the cost of our solution.

So the long-term trend is very, very good. This quarter, there were some – also some positive one-time effects. We are not projecting those to recur and when you look at the guidance that I gave a few moments ago for the next quarter, you – that isn't the – my view of those margins is reflected in that, but the point that I'll make that I know you would understand, but other people need to understand is that this quarter we had a roughly comparable level of revenue between our commercial and utility products and our guidance is for sharply increased utility revenues next quarter. So, that will affect overall weighted gross margins. Does that help?

Craig Irwin – Wedbush Securities

That helps a lot. That actually helps a whole lot. So then, if we can talk a little bit more specifically about your utility products, the guidance that you issued sort of indicates that at the midpoint of the range, we'd have roughly $24 million. That's a very substantial ramp from the $13.1 million in the third quarter. Can you give us any color on the major contributions to the sequential strength there? I mean, is ECoS a big part here? Is Duke a big part here? Are there other customers that we aren’t already talking about that make up a material portion of that sequential increase?

Chris Stanfield

ECoS is not a big portion of that revenue. What we are going to be delivering this period are some units that Duke is going to be using for some testing. With respect to the overall marketplace, yes, we anticipate a sequential increase in our revenues from Duke. We – I think we are going to have a solid quarter in Europe and we are also seeing some recovery in Eastern Europe. And as you recall, prior to the recession, Eastern Europe was a bright market for us, and we think we are going to have a good quarter in Eastern Europe in the fourth quarter.

Craig Irwin – Wedbush Securities

Great. And then, last quarter, if I may. The ECoS product that you are shipping to Duke, can you tell us whether or not this is going to be used in maybe Indiana, Ohio, or possibly on their phasers [ph] project in the Carolinas?

Chris Stanfield

Yes, it's going to be used obviously wherever Duke chooses to use it. But I think what it does is it measures exactly what their vision of the smart grid and so, I would expect it to be used in every area in which they provide service.

Craig Irwin – Wedbush Securities

So am I correct in my (Multiple Speakers) –

Chris Stanfield

I don't know what the initial timing will be of each market obviously.

Craig Irwin – Wedbush Securities

Okay. Am I correct in my understanding that this is a product that could also integrate with what they are doing on the phaser side?

Chris Stanfield

I think you are getting beyond my –

Ron Sege

Yes. Well, I mean, let me remind you that it's an open programmable software platform with open hardware interfaces. So, it's got very broad applicability, some of which I described in my opening commentary, but we stated quite explicitly that, think iPhone, think Android, we expect our customers to deploy this platform in ways that we could only speculate about today. So, I would think broadly in terms of ECoS and ECN with respect to Duke and other prospective customers.

Craig Irwin – Wedbush Securities

Great. Thank you and congratulations again on the strong traction.

Ron Sege

Okay. Thanks, Craig.

Operator

And your next question comes from the line of Elaine Kwei from Jefferies. Please proceed.

Elaine Kwei – Jefferies

Hi, Ron. Hi, Chris. Thanks so much for taking my question. You have a lot of exciting new product developments going on and are you exploring any alternative sales and distribution channels to broaden your exposure such as partnering with other vendors or perhaps expanding on the ELO model and also recruiting additional VARs?

Ron Sege

Yes, good question, Elaine. So as I mentioned to Sean, so one of my three top priorities is to expand our partnerships and to do it in multiple dimensions. So in one dimension are the ECoS partners, some of which we announced in New York, S&C Electric, Oracle, et cetera. They will be writing applications into ECoS and there is the network effect there. The more applications they get written, the more powerful that solution is.

Then there are sell with partners like Eltel and Telvent. And then, there are our sort of joint-development partners like ELO in Brazil. And we are working hard to expand in all three dimensions. By the way, I should mention Ubitronix, which is both a VAR and a kind of a joint-development partner because they've taken our ControlPoint and developed it into their own devices that sit on premise.

So, we are going to aggressively pursue partnerships in all those dimensions, because it's a force multiplier and because I saw it work so well in Datacom and 3Com in the '09s and we definitely want to emulate that.

Elaine Kwei – Jefferies

Great. It sounds great, Ron. And just as second here. In Europe, we are seeing some of the large utilities, they are promoting their power line protocols and some of the standards or innovations are doing this as well. And how do you see Echelon fitting into this landscape and would you potentially have any plan to join any other protocol alliances or to potentially recruit other vendors as part of the Echelon standard?

Ron Sege

We are – this is the early stage of an industry and if you sort of remember back to the late '80s or early '90s in data communications, there were lots of competing standards and all sorts of claims made about them, most of them were paper tigers. And in my experience and I saw this up close and personal, the most important thing to focus on is satisfying the customer and driving the business success, right, because ultimately the standards end up settling around those technologies that are doing the best.

Now, having said that, we believe strongly in open standards. In fact, this is why we published through Open Smart Grid Protocol. So, we are out there with Echelon's power line technology, which by the way, I'd remind you, powers mid-30 – 30x million meters today, it's arguably the most successful and proven power line technology now. We published it; we are making it a standard. So we will be out there too and frankly, the market is going to decide. But we will do what our customers tell us and we'll do – we'll go where the market tells us to go. Does that make sense?

Chris Stanfield

Elaine, I would add to that. When you look at what our customers are getting, they are getting on the order of 99.6, 99.7 levels of daily rates [ph]. And so, we are the gold standard when it comes to power line communication and other people have to measure themselves to us.

Ron Sege

Yes. And in fact, we were at – I was at our annual VAR partner conference in Barcelona last week and our customers were showing us tests that they have run on our power line technology versus others and let's just put it this way. I am very confident in the capabilities of our solution.

Elaine Kwei – Jefferies

Great. Thanks so much again, Ron and Chris.

Chris Stanfield

Okay. Thanks, Elaine.

Operator

And your next question comes from the line of Michael Cox from Piper Jaffray. Please proceed.

Michael Cox – Piper Jaffray

Thanks. Good afternoon, guys.

Ron Sege

Hi, Michael.

Michael Cox – Piper Jaffray

My first question is on the project activity you talked about it in Europe and some of the upstarts you are seeing here once again in Eastern Europe. I was wondering if you could talk a little bit more about that and how advanced the restarts are at this point.

Chris Stanfield

Well, I think what we are – this is Chris, what we are seeing is a very, very solid pipeline and I'm going to let Ron go into that more detail. But we have had these pilots underway, but I think as someone else observed in the industry, people were sort of staying in pilot mode through much the period of the financial pressure that we were going through.

And I think what makes me feel good is when we look at the pipeline activity in each one of our markets, we see it very solid. Specifically, in Eastern Europe, it wasn't an issue so much of people not being able to prove out business cases. It was an issue of availability of capital and that seems to be relaxing. But I'll let Ron to finish that.

Ron Sege

Yes. So Michael, I don't know how much you know about my background. But I grew up in sales management at 3Com in Rome before that and I'm a big believer that pipeline ultimately drives revenue. So I've been around the world doing what we call here quarterly business reviews crawling through the pipeline with each of our sales reps and I have to say I'm quite impressed with the level of activity really everywhere, but especially in Europe and Eastern Europe.

Now, look, I'm – you are never going to have enough pipeline and we are focused on building more. But I am pleased with the level of activity. Now, obviously the pipeline we are developing today is going to primarily drive revenue in 2012, but that gives me confidence even out there for our business prospects.

Chris Stanfield

I think another key point is a point that Ron made earlier in the call. And that is that we benefit from the fact that we have happy customers and those customers can act as references. And I think it's somewhat extraordinary when you think of else is going on in the industry that you have a utility from Asia come to Europe and meet with our customers to understand just how effectively our solution is working. And that's just a tremendous advantage we have.

Michael Cox – Piper Jaffray

That's very helpful. Thanks. And my – I guess, my follow-up question is, as you are looking at 2011, I understand it's early goings in terms of planning, but you mentioned good growth – good revenue growth in 2011. I guess, to size it up, is this something you think 2011 could get back to where you were in 2008 in terms of revenue or is that too aggressive?

Chris Stanfield

Well, we are not going to get into a specific sizing. I think what's happening next year is we are seeing continuing performance in the markets in which we performed, but we've told people that we expect to have significantly more revenue from Duke next year and we've told people obviously we are going to have much more revenue from the Fortum project. And so that's what gives us the confidence to talk about that strong revenue growth.

From a LonWorks product line perspective, as Ron said earlier, we've been through a tough recession, it was great to have the quarter that we had in Q3, and we see early signs that our main market, the market for products that go into commercial buildings is coming back. And I would remind you that that's about 65% of our revenue for our commercial product set. And so we see a lot of good things.

Michael Cox – Piper Jaffray

Okay. Thank you.

Operator

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

Carter Shoop – Deutsche Bank

Good afternoon. I was hoping to spend a few minutes just talking about the profitability of the company and I'd be curious, Ron, to hear your thoughts on getting this company back in the block here. It looks like based on 4Q guidance, you are going to lose about $0.70, haven't turned to profit since 2004. But I haven't heard a whole lot about the strategy in regards to getting this company profitable again. Is there a strategy right now in addition to driving the top line to get back to profitability or is it the focus right now more in the top line and then we'll worry about the OpEx, et cetera later?

Ron Sege

Well, it's certainly – it's a little bit of both, but we are certainly not going to worry about OpEx later. So first of all, I'm as incented as anybody to get this company to profitability as quickly as we can. Now, we have to be prudent and we are investing for expected return and I am very optimistic about the potential for this market that we are participating in and it's very early days.

So, certainly growth is key and I have mentioned that being a sales management guy, I think we can execute better and we will. We'll QVR sales playbooks focused on geography and vertical selling, what we have today, where customers want to buy, et cetera, et cetera. So sales and marketing execution is key and I think as the consequence of that, we can grow faster. I've been spending a lot of time crawling through spending, both on the OpEx side and in the cost of goods sold line. And we are turning over every rock to try to find places to save money.

Now, having said that, I mean, I don't – I haven’t – there is no magic bullet, right? I haven't identified any tremendous opportunity where we are squandering money and we can just cut it away. I think there is probably some opportunity to sort of refocus our spend to perhaps grow faster and perhaps expand gross margins a little bit more. But, Carter, rest assured that I'm focused – this management team is focused on both expenses and revenue simultaneously and we are all incented to get this company to profitability as quickly as is reasonably possible.

Carter Shoop – Deutsche Bank

And then maybe a follow-up. How critical is it in your view, Ron, to have the commercial and utility businesses together? Can an Echelon play out just focusing on the utility market?

Ron Sege

Look, Carter, as I mentioned in my prepared remarks, the market is sort of starting to realize that the smart grid is not just metering and that the smart grid is expanding simultaneously sort of back towards the low-voltage grid and into the building and utilities are realizing that their revenue opportunity also extends beyond just selling electricity. So we talked about LINZ STROM being in the demand response business as an example, being in the street lighting business.

So my view, our view is that the smart grid and kind of the commercial and the utility markets are actually coming together from a technical perspective and from a solution perspective. So I actually see our broad product line as a source of strength and differentiation and that increasingly our ability to offer a system solution that by the way is a control network, which is different than what Cisco for example provides, that's a communication network, is going to be seen as quite unique in the marketplace. So I think all our piece parts will increasingly come together.

Now, can we do a better job of reuse, developing things once and using them in multiple places? Absolutely. And in fact, I mentioned in New York City that ECN and ECoS borrow heavily from the technology that's been deployed in our commercial business segment. So we will continue to look for ways to leverage our R&D across these two segments.

Chris Stanfield

Let me add one thing to that, Carter. At the launch – the product launch for ECoS, one of the utilities spoke and I thought one of their statements was very important. And that was that in speaking about the capability of the ECN to be able to go ahead and perform control applications at the transformer, his comment was that we can neither afford a latency, nor the cost of making every decision back at the datacenter. And I think that's key.

In our history in terms of managing control networks, whether those being commercial buildings, factories, utility systems, or otherwise, is unparalleled. And so what we have is a strong leg up. Everyone can tape their own solution for the communications that occurs from a residence back to a datacenter. We are unique in terms of the control applications that we know how to implement when you are on that low-voltage grid.

Ron Sege

So in fact – and that brings me back to how I started with Sean. We are a really well-kept secret and this difference between control and communication is something we got to do a much better job talking about in the industry.

Carter Shoop – Deutsche Bank

Great. Last question, if I may. In regards to Brazil, can you talk a little bit about your expectations on timing there? And then as a follow-up in Brazil, can you help us understand the revenue opportunity at least per meter for a company like Echelon? Is this going to be more of a licensing agreement or are you going to be actually reselling the meter, et cetera?

Ron Sege

Well, I'll let Chris talk about the business model, which I suspect he won't have much to say. But in terms of Brazil, overall it's a very good market for us and fortunately, it's big, it's a booming economy, they've got lots of incentive to manage energy usage better, the election – we had our election here, they had their election there. It went the right way. The candidate who won is definitely favorable to building out of a smart grid.

And in terms of revenue, we will – it will be a modest contribution in 2011 and then, it will be more in the out years. But I'm excited about this go-to-market model and I think it's one that can work for us in other developing countries as well.

Chris Stanfield

The – yes, let me – this is Chris. Let me start to talk a little bit about the business model. It's sort of all of the above in terms of what you said previously. We will be selling some hardware products. We will also be providing portions of the meter to ELO, who themselves as you know is a very large meter manufacturer and they will finish off the meter around it. And as you recall, that was really necessary so as to not burden the price of the product with too much duty. And then we are also licensing software.

So, we are going to have a revenue component that will not be the same as if we had sold a – the system in its entirety, but it would still be a healthy contributor. And I don't want to think about the opportunity in South America as being limited to Brazil.

Carter Shoop – Deutsche Bank

Great. That's helpful. Best of luck.

Ron Sege

Okay. Thanks.

Operator

And your next question comes from the line of Dale Pfau from Cantor Fitzgerald. (Operator instructions)

Dale Pfau – Cantor Fitzgerald

Good afternoon, gentlemen.

Chris Stanfield

Hi, Dale.

Dale Pfau – Cantor Fitzgerald

I actually have a couple of questions here. One is a minor one. At the end, if you could just give me the break out of who your major customers in your utility group are? But first of all, could you talk a little bit about the strength in the commercial and I know you highlighted to maybe specific things, but are you getting a sense that this is a general uptick in that overall demand profile for your LonWorks products?

Ron Sege

Well, I mentioned in the prepared remarks that there are a number of indicators suggesting that we are seeing a bit of a recovery. Having said that, I'm no better an economic prognosticator than anybody else. But I would say we are cautiously optimistic and nothing drives our commercial business more than economic recovery.

Now, having said that, I think there is an opportunity for us to sell more effectively into verticals that we are targeting on kind of the Echelon branded side of the house. And again, I described some of those in my prepared remarks.

Dale Pfau – Cantor Fitzgerald

And then as a follow-up, could you talk a little bit about the competitive landscape for the utility products in the U.S.? Outside of Duke, we haven't heard about a whole lot of progress there and now you've had a couple of months under your belt. What's your feeling there?

Ron Sege

Well, again, Dale, I crawled through the pipeline in the U.S. I see lots of engagements here. I don't have anything specific to announce or to talk about. I will say that, again, we are effectively in two segments, in the utility space, the smart metering business, and now the ECoS, ECN business. In some cases, they go together. But in other cases, we have some strong interest from U.S. utilities in the ECN products.

So, we are focused on North America. I mean, I'd also say that, as I said in my prepared remarks, that as I've traveled around the world, it again strikes me that the – many other parts of the world are farther ahead in terms of smart grid deployment, seeing the benefits of smart grid, et cetera than here in the United States and we've had some false starts in some of the states and in some cases, I think the use cases haven’t been effectively articulated. So we run a global business and our pipeline is global and last time I checked, the money is green everywhere and we are going to deploy our sales resources where we think we can get the best and fastest revenue return.

Dale Pfau – Cantor Fitzgerald

Great, thanks. And then, Chris, could you just comment upon the customers in utility business?

Chris Stanfield

Yes. I think the customers this quarter were largely – the largest strength was in Scandinavia as you would expect; more specifically, in Denmark. And as you move into next year, as I already said, we think the strength will move to Finland and to Duke.

Dale Pfau – Cantor Fitzgerald

Thank you very much.

Ron Sege

Thanks, Dale.

Operator

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

Brandon Mora – ThinkEquity

Hi. This is actually Brandon Mora [ph], calling for Colin. Thank you very much for taking my question. And I just have two questions, which is – the first one is, I know you guys have spoken a bit on the call so far about some interesting stuff going on in China and then also some stuff in Brazil. But I was wondering if you might have any – anything to say any color to give about maybe quotation activity or either just some interesting stuff that you see going on in the rest of Asia and in the rest of South America.

Ron Sege

Sure. So first of all, let's start with South America and I – the question before was asked specifically about Brazil. However, our partnership with ELO extends beyond Brazil and we see good opportunity in other parts of South America. And I mentioned in my prepared remarks that drivers such as prepaid electricity and theft control, those are really important in developing markets and certainly in parts of South America.

I'd also say that we are seeing some interesting activity in Southeast Asia and in India for a broad variety of applications. But again, in India, there is a fair amount of non-technical losses or theft of electricity in India and that's driving interest in the smart grid. And then of course, in Europe and in particular in the Nordics and Eastern Europe, we are seeing continued interest, partially public policy, but partially they have a broader set of use cases and I think frankly they are marketing and consuming smart grid technology more effectively and more broadly there.

Brandon Mora – ThinkEquity

Okay. That's great. And then just my last question is, with the ECoS solution, I know you say it's – the revenue is really going to start hitting it sounds like about the middle of 2011. But as far as your sales cycle will go for the utility side of your business, are you seeing the ECoS solution is going to do something to I guess maybe get a little bit more of an acceleration or a deceleration to the sales cycle?

Ron Sege

Look, I think the sales cycles to utilities are long and I don't have any reason to believe that ECoS and ECN is any shorter than anything else you would sell the utility, which – by the way, this is the primary reason we announced that in September and shipping for revenue in the middle of next year to give ourselves time to ramp up both the pipeline and partner relationships. But this is also why sort of we are guiding you to revenue contribution from that product in '12 rather than so much in '11.

Brandon Mora – ThinkEquity

All right. Well, thank you very much again and congratulations.

Ron Sege

Okay. Thanks, Brandon.

Operator

And your next question comes from the line of Patrick Jobin from Credit Suisse. Please proceed.

Patrick Jobin – Credit Suisse

Hi. Thanks for taking my question. My first question is about your LonWorks, I guess now the commercial business. You mentioned that a few end markets saw strength, especially in Europe and that a new product is being produced by an OEM in North America, yet you are guiding to what looks like a downtick in the fourth quarter. Could you help us reconcile that? Is it just a healthy amount of conservatism or is it seasonal? And then lastly, could you break out sales this quarter for solar monitoring and demand response markets?

Chris Stanfield

The – let me start with the first question. This is Chris. The – we have some seasonality in Europe in the fourth quarter and that has to do with the fact that often times, companies would shut down in mid to late December and then stay closed through early January. And so, we try to balance for that when we provide our guidance. And so, that's just – that is the nature of our business weave.

And then I think as it relates to the strength of the markets, I really can't give you a complete summary. I can tell you with respect to demand response clearly, EnerNOC was our largest customer. But as you know, in – particularly in the investment community, people think of demand response in terms of the application you are familiar with in a commercial building. But as Ron said earlier, we've had people doing demand response in homes for years using our technology.

And so, that's one of the things that Ron is doing as we collect this data in these quarterly business reviews, is trying to get a more complete view of the entire demand response, both obviously on the commercial sector, but also home markets and elsewhere.

Patrick Jobin – Credit Suisse

Okay. Thanks, Chris. And then just very briefly on your OpEx line, you said that there was some seasonality going on in the third quarter and that you would actually expect potentially some timing to shift into the fourth quarter. Which line in particular and should we look at the new G&A line as a better run rate going forward?

Chris Stanfield

The – well, the line that will be most impacted will be product development and that's because product development has expenditures that are not related to the number of people working here in terms of project related expenses. And frankly, all year long we have been under-running that. We've done our checks. It looks like that expense is going to still happen and so, it means that we will see an uptick in product development expense.

The – I would – yes, G&A is going to be a little greater than it has been historically. I'm not sure that the Q3 would be the basis that I would use for that, because that's a period if you recall, in which we had two CEOs.

Patrick Jobin – Credit Suisse

Right. I appreciate your color. Thank you.

Operator

And your last question comes from the line of John Quealy from Canaccord Genuity. Please proceed.

John Quealy – Canaccord Genuity

Hi, everyone. Congratulations and thanks for taking the call. So, two questions. First, with regard to Finland next year, what – is it going to be a top five customer in '11 or how should we think about Fortum in Finland moving forward? And then secondly, I have a follow-up on the commercial side.

Ron Sege

Yes, I think that if things work out as we believe they will, we believe that Finland will probably be – maybe our second largest customer for our smart metering solution next year.

John Quealy – Canaccord Genuity

Okay, great. And then back on the commercial side, if I understood you correctly or actually reading some of the Q, the transceiver business along with SmartServers really drove some of the increase, maybe $1.5 million over the previous year. On the transceiver side of it, is it new products in new OEM products or is it existing products? What's the mix here for the OEM business?

Chris Stanfield

Well, if you go back to when the recession took place or first occurred, what we saw was in the factories that are building products using our technology, we saw across the board their levels of production slipped often times by 20%. And we've seen those levels come back. So, I think the principal factor has been just an increase in the production levels at our customers.

But then on top of that of course, yes, we have new products and I think one of the happy things is one Ron can talk about the fact that one of the contributors in North America was a product that got designed very recently and just went into volume production. And you'd like to see that, you'd like to have this continuing annuity of revenue of revenue that arises from these design-ins.

John Quealy – Canaccord Genuity

Great. Thanks, folks.

Operator

And I would now like to turn the call back over to Chris Stanfield for closing remarks.

Chris Stanfield

Well, thank you, everyone and Ron wants to say good-bye as well.

Ron Sege

Okay, thank you all very much and thanks for your ongoing interest and we'll talk to you in a quarter. Bye-bye.

Operator

Thank you for your participation in today's conference. This concludes the presentation and you may now disconnect. Have a great day.

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