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Echelon Corporation (NASDAQ:ELON)

Q4 2010 Earnings Call Transcript

February 10, 2011 5:00 pm ET

Executives

Annie Leschin – IR

Ron Sege – President and CEO

Chris Stanfield – EVP and CFO

Analysts

Michael Horwitz – Baird

Elaine Kwei – Jefferies

Sean Hannan – Needham & Company

Mark Siegel – Canaccord Genuity

Mike Ritzenthaler – Piper Jaffray

Craig Irwin – Wedbush

Dale Pfau – Cantor Fitzgerald

Colin Rusch – ThinkEquity

Patrick Jobin – Credit Suisse

Carter Shoop – Deutsche Bank

Joe Maxa – Dougherty & Company

Charles Fishman – Pritchard Capital Partners

Operator

Good day, ladies and gentlemen, and welcome to the Echelon quarterly earnings conference call. I would now like to turn the conference over your host for today, Annie Leschin.

Annie Leschin

Thank you, operator. And thank you, everyone, for joining us this afternoon for our fourth 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, here are few calendar items that we have in the first quarter that Echelon will be participating in. First, the Jaffray’s Global Clean Tech Conference on February 23 in New York, next Pacific Crest Emerging Technology Summit on March 1 in San Francisco, and Canaccord Sustainability Forum on March 3 in Deer Valley, Utah. As additional events are scheduled, we will make other announcements.

As a reminder, during the course of this conference call, we may make statements relating to our business outlook, future financial and operating results, accounting matters, and overall future prospects. These are forward-looking statements 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 in this call reflects estimates based on information that is available to us at this time. Actual results could differ materially. Echelon undertakes no obligation to update or revise these forward-looking statements, and guidance will not be updated after today's call until our next scheduled quarterly earnings financial release.

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

Ron Sege

Thanks, Annie. And thank you, everyone, again for joining us today. I’m pleased to report that Echelon delivered on its promise of modest revenue growth for 2010 with a 7.5% annual increase. We ended the year with a particularly strong fourth quarter, slightly exceeding our guidance of $38.8 million in revenue and with a non-GAAP net loss of 4%. We are certainly encouraged by these results, but not satisfied.

I know that growth and profitability are top priorities for our investors and they are top objectives for me and the Echelon team as well. As you will hear on this call, we are making the hard decisions and taking the right steps to drive plus-20% revenue growth in 2011 and reach profitability in 2012.

Before discussing our results for the past quarter and year, I’d like to spend a few minutes reminding you of my view of Echelon’s differentiation and the markets we serve. I will then turn to steps we are taking to better align our operations to this view and then highlight progress we made in the fourth quarter. Finally, I will offer our view of longer term path to profitability.

My ongoing meetings with Echelon’s customers, prospects and partners have convinced me of three key points. First, the smart grid, or the reliable, survivable and instantaneous management of electricity, requires control networking, which is the unique core competency of Echelon. With the control network, data is collected and decisions are made at the edge of the network, which means maximum reliability, survivability and response time across a wide range of applications. The market worldwide now recognizes that the benefits of the smart grid result from control, a very important step beyond advanced meterings.

Second, the two markets we serve, utility and commercial, are converging as utilities around the world reach into buildings and homes and pursue new business models. Third, Echelon is uniquely positioned to benefit from this convergence because of the breadth of our control networking solutions, the range of applications they support, and the strength of our customer base.

As I talk to customers and partners, I am impressed again and again by the results our products are delivering. Our systems are performing extremely well, and utilities and commercial customers alike are very satisfied with the measurable return on investments they are receiving. Our challenge is that outside of customers and partners, too few know of our success. Great products and technologies do not sell themselves. So, as we have discussed previously, Echelon needs to invest more in marketing and sales to drive growth. Therefore, we will be intelligently increasing our spending in sales and marketing in 2011.

To achieve profitability and a balanced long-term financial model, it is necessary to offset this planned increase with reduction in other areas. Therefore, after a very careful strategic review, we have made the very difficult decision to reduce spending in engineering, operations, and G&A. Since the majority of our expenses are people-related, this is resulted in a reduction of approximately 8% of full-time equivalent employees. This was obviously a very tough decision, but the right one in order to fund our growing sales effort and to better equip the people selling Echelon’s innovative solutions.

While these reductions are meaningful, the core of our capabilities in R&D and operations as well as our product roadmap remains intact. We continue to make very substantial investments in our differentiated products and solutions to ensure that we maintain and extend our lead and continue to delight our customers. We have fully aligned our investments and our execution behind our vision for a plant-to-plug multi-function open-standard energy control network.

Now let’s turn to sales and marketing alignments. In our commercial markets, we have made several organizational changes to provide more accountability and better focus on growing and converting opportunity pipeline. Large global OEMs such as Honeywell and Siemens are an important component of our commercial business, and we have now established a single sales team focused on these accounts worldwide. This team is passed with developing lighter and deeper relationships with these OEMs to drive best practices across regions and to maximize design wins and revenue.

We have also simplified our regional sales structure and focused our selling efforts on three large and growing verticals; building energy management, intelligent street lighting, and renewable energy with an emphasis on solar. In these verticals, we intend to increasingly focus on selling complete solutions so we can better serve customers and grow share of wallets. We are already seeing results from these efforts that I will share with you in a moment.

In our Utility Group, we are codifying our go-to-market approach to expand and accelerate our global market reach, which is again measured by pipeline growth and conversion. This will bring the benefits of our Utility solutions, powered by NES and the Open Smart Grid Protocol, OSGP, to more customers more quickly. We will sell our complete flagship NES system along with our new Echelon Control System, ECoS, powered Edge Control Node for low-voltage distribution automation in Europe, North America and other markets with strong product market hit. We have a strong presence in these markets and we intend to build on best.

In other markets, such as Brazil, we will partner with local suppliers to build NES and OSGP compliant solutions based on Echelon’s subsystems. In markets where alternative standards and approaches have been established, our utility and commercial sales teams will go to market with components such as our best-of-breed power line communication products and our unique power line meshing modules that have been such a key part of our performance at our customer accolades. Overall, our goal is to sell as much value as we can, but in all cases to participate and sell in substantial high growth markets.

With that as background, let me give you some examples of the progress we have made in the quarter just completed. In commercial markets, revenue for 2010 grew by more than 10% over 2009, as emerging applications for energy savings took hold. This past week at AHR Expo, the largest industry event for buildings market in North America, we introduced the Echelon Building Energy Manager, a new multi-site energy management solution in partnership with Serious Materials.

Together we deliver a cloud-based energy management system that can cut building energy costs by 20% or more. Systems that used to take days to install can now be configured and deployed in hours. The system is very powerful and easy to use. We are running the Building Energy Manager here at Echelon, and from anywhere in the world, using my iPad, I can quickly see how our buildings are using energy. This announcement also illustrates a few other things that you will see repeated in our activities; the importance of partnerships and our focus on delivering solutions to increase value to our customers and share-of-wallet to Echelon.

In the intelligent street lighting vertical, we recently announced a number of projects in China, where we are seeing rapid adoption of our solution. Our partner Rongwen, one of the largest street lighting companies in China, has already installed over 16,000 intelligent lights that use Echelon’s Power Line Transceivers for local control and communication and Echelon’s SmartServer for coordinated segment control. They have seen energy savings about 55% and expect exponential growth to 500,000 lights by 2014. Two other partners, Telth [ph] China and Shanghai Hongyuan, are also announcing projects based on our products.

China is a very exciting opportunity for our commercial products. It’s an enormous market with a government focus on saving energy to fuel this rapidly growing economy from buildings to utilities to street lighting. We believe that Echelon energy control networks can be an important part of achieving this goal.

Finally, in the renewables market, one exciting new customer is Direct Grid, a leading developer of micro-inverters for the solar industry. Unlike traditional inverters where one large unit converts the output of an entire solar array from DC to AC power, micro-inverters are located at each panel and perform local conversion at the panel. By doing so, they significantly increase the efficiency and resiliency of the entire array.

This represents an exciting step forward in the solar industry. This is also an application that needs a reliable, survivable and instantaneous energy control network. By embedding our Power Line Transceivers into each micro-inverter and managing each array with our SmartServer, Direct Grid can keep the system running at peak efficiency and drive down operating and maintenance costs.

Turning to Utility side of our business, we performed well in 2010 growing nearly 19% year-over-year. As I said at the beginning of my remarks, we are setting a very high standard for performance with our solutions. For example, SEAS, Denmark’s largest consumer-owned energy company, is seeing our lead meter reads at 99.7% to 100% performance efficiency, using our NES system. And by providing customers with detailed usage information, they have achieved energy reductions of 16%.

Across the entire range of their customer types, rural, suburban and urban, SEAS has experienced exceptional results. Our ability of our system to perform so well at scale and to deliver a unique and valuable data that helps both the utility and its customers operate more efficiently is a key differentiator for us.

Here in the US, our project with Duke Energy continues to go very well. Shipments for Duke for deployment in Ohio ramped significantly this past quarter. We also shipped initial field trial units of our edge control node to Duke at the end of last year, and they have completed initial lab casts and are now deploying in the field for extended testing. The program remains on track for initial production shipments later in 2011 with larger rollouts planned for 2012.

Through the September launch of the ECN and ECoS platform for low voltage distribution automation, we have seen strong interest from utilities around the world. Customers see the ECN and ECoS as a significant differentiator as they look to bring energy control to the edge of their grid. Applications like volt/VAR control, integrating legacy meter types and demand response are of special interest to our prospects. While we are focused on Duke right now, I am optimistic about acquiring new customers in this market.

In Europe and Asia, we continue to see demand driven by local and regional mandates, as well as the European Union smart grid 20-20-20 energy efficiency program. In North America, as some of the euphoria surrounding smart meters has dissipated after the completion of stimulus funding, we are seeing a more pragmatic approach from utilities. Some are finding that RF mesh solutions may not be sufficient, especially in more populated areas with tall buildings, and we are seeing a resurgence of interest in power line technology. This presents an opportunity to Echelon as part of larger agreements to provide a proven, highly reliable fill-in solution for these territories.

In South America, our partnership with ELO is moving forward very well. As reflected in the pipeline we are building together, we are excited about the market activity anticipated for 2011 as Brazil gears up for large-scale deployments in 2012. In Asian markets, we see areas of strong demand driven by the need for conservation, debt control and prepaid metering.

In summary, the themes we laid out last quarter and repeated today are being reinforced as the industry enters 2011. The notion of the smart grid extending beyond the meter and the need for an energy control network are becoming mainstream. The blurring of the lines between the utility and commercial applications is taking place more and more often. As these trends develop, Echelon is taking the necessary steps to accelerate growth and become profitable. We are outlining behind the common vision of ubiquitous energy control networks for the smart grid and focusing all our activities on developing and delivering that vision to our customers.

Looking at 2011, I believe we are squarely on the path to achieve plus-20% revenue growth. Our utility business should expand at a significantly faster rate than last year, led by shipments to Duke and Fortum, you should note that a majority of orders for these shipments to Duke and Fortum in 2011 are already in hand. In our commercial markets, with long design cycles, we expect growth in 2011 will be similar to last year’s, and with important initiatives underway, we are focused on adding design wins and building pipeline for 2012.

As for profitability, careful investments in sales and marketing to grow revenue have already begun. Reductions in spending has started and will continue to benefit us into the second quarter as we wrap up key projects. From there, you will start to see real progress towards profitability that should put us in the position to be profitable in 2012 and on the path to a balanced income statement model.

Finally, before I turn the call over to Chris, I would like to thank all of our Echelon employees for their hard work, dedication and support of our tough decisions this quarter. Chris?

Chris Stanfield

Thanks, Ron. Good afternoon, everyone, and thank you for joining us on our fourth quarter earnings call. Please note that all references to non-GAAP amounts exclude stock-based compensation and expenses associated with restructuring actions in the last quarter. For ease of reference, we have prepared a complete non-GAAP statement of operations for the fourth quarter and full year ended December 31, 2010, which can be found on the Investor Relations section of our website.

Revenues of $38.8 million were slightly ahead of our expectations and in line with $38.8 million reported in the same period last year. Commercial revenues continued to improve year-over-year, coming in at $12.4 million for the quarter, up from $11.4 million last year. Sales of our utility products were $25.3 million this quarter, up from $21 million in the fourth quarter of 2009. Revenue from Enel in the fourth quarter was $1.2 million compared to $6.4 million in the same period last year.

Full year revenues grew 7.5% from $103.3 million in 2009 to $111.0 million in 2010. Year-over-year, revenues from Echelon’s utility product decreased 18.6% in 2010 to $57.3 million, while revenues from Echelon’s commercial products increased 10.3% to $49.1 million. And revenues from the Enel project decreased 55.8% to $4.6 million.

Fourth quarter non-GAAP gross margin was 44.3%, ahead of last year’s 42.7% and slightly better than our forecast. A 1.6 percentage point increase over the fourth quarter of 2009 was driven by a combination of improved margins from our utility products and a reduction in indirect cost of goods sold.

Non-GAAP operating expenses for the fourth quarter were $18.4 million, up from $16.7 million a year ago. Higher operating expenses were driven primarily by increased product development expenditures associated with the development of our recently announced (inaudible) the ECoS products.

Interest and other income was $13,000 in the fourth quarter, down from $130,000 in the same period last year. The reduction was driven primarily by a reduction in interest income on our investment portfolio and reduced foreign currency translation gains. Our GAAP net loss for the fourth quarter of 2010 was $6 million or $0.14 per share. This compares to a GAAP net loss of $3.7 million or $0.09 per share for the same period a year ago.

Our non-GAAP net loss for the quarter was $1.8 million or $0.04 per share compared to $74,000 or zero cents per share in the fourth quarter of 2009. GAAP net loss for the full year 2010 was $31.3 million or $0.76 per share compared to GAAP net loss of $32 million or $0.79 million during 2009. Non-GAAP net loss for the year was $17.8 million or $0.43 per share, which was in line with the same period a year ago.

Moving to the balance sheet, we ended the fourth quarter with cash, cash equivalents and short-term investments of $64.6 million, a $9.7 million decrease from last quarter. This was primarily due to cash used in our operating activities, which was driven by higher sales during the quarter.

Now I would like to turn to guidance for 2011.We expect total revenue for the first quarter of 2011 to be in the range of $27 million to $29 million with our commercial revenues accounting for approximately 45%, utility about 54%, and the remainder from Enel. We anticipate non-GAAP gross margin to be in the range of 46.1% to 47.4% for the quarter. Finally, we anticipate our GAAP loss per share will be between $0.20 and $0.23 and our non-GAAP loss per share will be between $0.13 and $0.16.

For full year 2011, we continue to believe that we are well positioned for continued improvement in both top and bottom line results. We currently expect revenue growth in the range of 20% to 30% over 2010. Within our specific markets, we expect that utility revenues will grow in the range of 25% to 40% driven by the claimants from Duke at Ohio as well as shipments to Telvent for our project at Fortum. And the commercial revenues will continue to grow in line with the 10% improvement we achieved in 2010.

Lastly, while Enel revenues declined during 2010, we expect them to increase by about 50% during 2011. We expect that our non-GAAP gross margin will slightly improve over the 45.2% generated in 2010. Lastly, in percentage terms, we expect our operating expenses will increase in the high-single digits over 2010 level. The increase is higher than our historical annual operating expense growth rates of 3% to 5% due to the fact that we anticipate significantly less customer funding of our product development expenses in 2011. This funding, which amounted to $4.5 million in 2010, was used to offset expenses we incurred during the year.

In 2011, the amount of offsetting payments is expected to decrease to $1.5 million. But all things being equal, we expect our product development expenses to increase by $3 million in 2011. This $3 million reduction in offsetting payments is contributing about one-half of the anticipated increase in 2011 operating expenses.

With that said, as Ron mentioned a few minutes ago in his remarks, we’ve undertaken the necessary actions to reduce our run rate spending in product development and G&A so that we can invest more heavily in our sales and marketing efforts, which we believe will lay the foundation for long-term growth and profitability. While we carefully lined down from the historical level of product development spending, we’ve already begun to increase our sales and marketing efforts significantly. As a result, the effects of spending reductions will have at our operating results will be taper and will become more prominent in the Q2 through Q4 timeframe.

Now I’d like to turn the call over to the operator for questions. Operator?

Question-and-Answer Session

Operator

(Operator instructions) Your first question comes from the line of Michael Horwitz of Baird. You may proceed.

Michael Horwitz – Baird

Great. Thank you. Nice call. I appreciate some of the comments that you made, Ron.

Ron Sege

Thanks, Michael.

Michael Horwitz – Baird

Just a couple – maybe a specific question and then maybe a high-level question. But can you tell us what street lighting revenue was in China in 2010?

Ron Sege

We don’t break it out, Michael, as you know.

Michael Horwitz – Baird

But when we think about the market, the overall market figures that you gave us, can you give us some idea of what kind of market share you’re striving to achieve there?

Ron Sege

The markets we targeted, the three verticals in the commercial segment, are all in our view $0.5 billion or bigger. And our goal is to be a material player there. It’s particularly hard to tell exactly how the markets are growing geographically, but China is a huge one and they are investing incredibly aggressively, particularly in street lighting, both because our infrastructure is growing so fast and because the mayors in China had figured out that a lot of energy is going into lighting the streets and they have really mandated key performance indicators to get that energy usage down. So that’s in particular why we are focused on China and why we’re focused on street lighting.

Michael Horwitz – Baird

And then maybe a bigger picture question. I appreciate the hard decisions that you had to make albeit when I look at your historical R&D expense, I mean, you’ve spent quite a bit of money there over time. So it’s nice to try to harvest that. As you look at your ability to go out and convert pipeline and build pipeline, you’ve been out there talking to them. What kind of changes where we see specifically exists is definitely a different tone than perhaps just a few years ago the company had?

Ron Sege

So when you say specific changes, you’re talking about in our go-to-market?

Michael Horwitz – Baird

Yes, well, I know that you are hiring folks and hopefully you’re going to upgrade talents along with winding down some other expenses you had. But are you seeing anything specific that the company wasn’t doing, that maybe there is low-hanging fruit to go convert and build pipeline on top of quite a bit of dollars spent to develop the product line?

Ron Sege

Well, I don’t want to focus so much on the past, but going forward, a lot of this is just down to basic sales discipline. We’ve got a very rigorous pipeline management system now. We review our pipeline every week. We’re targeting on the product market fit very, very carefully. So to sell the products we’ve got into the markets that are ready to accept them. The good news is that we got great product markets in Europe in the metering space and the mandates continue to make that an attractive market. But we’ve got other great product market fits as well, and those three verticals in the commercial markets are examples.

I guess another change, Michael, is – in my view is that we’re going to sell wherever we engage, historically we’ve focused a lot on selling systems, total metering systems, for example, in Northern Europe, and we’re going to continue to do that again where there is a great product market hit. But where we can’t sell systems, we’re going to sell subsystems like we’re doing with ELO in Brazil, and where we can’t sell subsystems, we’re going to sell components. So I tell the sales force engage where you can sell and don’t walk away without selling something.

Michael Horwitz – Baird

Great. And last question for Chris, on the profitability comment, are we still working with that same level of revenue that you might had implied before, I think, a little bit, more than $160 million, $165 million?

Chris Stanfield

Yes, we have not changed that guidance.

Michael Horwitz – Baird

Great. Thank you.

Operator

Your next question comes from the line of Elaine Kwei of Jefferies. You may proceed.

Elaine Kwei – Jefferies

Hi, Ron and Chris. Thanks so much for taking my question.

Ron Sege

Hi, Elaine.

Elaine Kwei – Jefferies

On your comment earlier about potentially selling [ph] PLC components and markets where utilities are going with some of the other PLC standards, such as PRIME or G3, dot-ATM [ph] would that be a potential opportunity that you would be thinking of?

Ron Sege

Elaine, I’m not ruling anything out. And we’ve got to get in there and talk with those prospects, see how those competing products are really performing and make sure they understand the capabilities we’ve got. But like I said, one of our new emphases here is turning over every rock and sell them something.

Elaine Kwei – Jefferies

All right. And it sounds like you’ve got a lot of exciting new products coming online between ECoS as well as the new verticals in the commercial space and you’ve guided to actually – I think it was slightly higher margin for 2011. Could you help provide a little more color on this? Is it because you’re expecting new products with high margin or be able to ramp quickly without any negative impact to gross margins?

Chris Stanfield

Well, Elaine, I think one of the things that Ron mentioned earlier was that we took some headcount reductions, and some of those were operations. So those spending reductions are of course going to improve our gross margins. Our gross margins will also get better just because our revenues will be larger. And so the fixed costs that we have as a company are going to be amortized over a greater revenue base. And then I would point you to what I said about the fourth quarter in which we saw on a year-over-year basis improved margins, if you will, at out of pocket cost level with respect to our utility solutions.

Elaine Kwei – Jefferies

Okay. And just lastly, on the operating breakeven revenue level that was mentioned earlier, when you mentioned profitability, is that on a full year GAAP basis?

Chris Stanfield

Non-GAAP.

Elaine Kwei – Jefferies

Non-GAAP basis. Okay, great. Thank you so much, Chris.

Chris Stanfield

Thanks, Elaine.

Operator

Your next question comes from the line of Sean Hannan of Needham & Company. You may proceed.

Sean Hannan – Needham & Company

Yes. Good evening. Thank you.

Ron Sege

Hey, Sean.

Sean Hannan – Needham & Company

So, the question is just on your ECoS ECN platform. So, outside of Duke, can you perhaps characterize for us where we stand today in terms of differentiating the sales effort and how that may unfold domestically versus abroad in Europe or other regions?

Ron Sege

When you say differentiating the sales efforts, you’re talking about two separate sales forces or what –?

Sean Hannan – Needham & Company

Well, it’s really the color that I’m looking to you if we can get from you in terms of – as we approach the different geographic markets, is there a differentiated sales effort for that type of platform? And then perhaps considering the fact that we actually have a much stronger presence that we’re able to leverage over in Europe and if you can elaborate on that.

Ron Sege

Yes. Well, certainly we’re busy prospecting in Europe for ECN and see it as a nice complement to our existing NES metering applications. But we also see – and as you took away from DistribuTECH, there is a fantastic opportunity in the distribution automation space on a standalone basis, and in particular, we’re targeting that low voltage part of the distribution system, so the neighborhood, if you will. And we’re busy prospecting here in the United States and seeing strong interest here as well. So we’re equally excited about that ECoS and ECN in Greenfield opportunities around the world and especially here in the US.

Sean Hannan – Needham & Company

That’s helpful, Ron. And just as a follow-up to that, do you folks feel that you’re going to actually being positioned this year to recognize revenues from someone other than Duke on that platform or is it still a little bit too early to tell?

Ron Sege

It will be in volume production in the second half of the year. We are very focused on Duke. But Sean, we’re also very focused on prospect and landing that second customer for a pilot this year.

Sean Hannan – Needham & Company

That’s helpful. And then lastly, if I can just hop to China and talk to you about the commercial side of your business, China is strategic to you. We mentioned this earlier. You expect – be it a decent player there lighting the show in good momentum, can you elaborate on other segments or sub-segments that you expect could fall on the footsteps of that region or what you expect to push?

Ron Sege

Sure. It’s the same three verticals in our commercial business, plus we’re going to be going after than metering business. China has got plus 300 million meters that they are intending to roll out as part of their current five-year plan. As you know, they are settled very firmly on PLC, and we’ve got a great solution for there. So we’re just starting to engage, but I believe that is a high priority market for us.

Sean Hannan – Needham & Company

That’s helpful, Ron. I guess where I was going was, is there a segment or sub-segment that your salespeople are telling you or your partners are telling you may take off one versus another?

Ron Sege

I can’t say there is. Obviously we’ve announced street lighting. As I said, there is a lot of political pressure on getting new street lights rolled out, and as I said, I’m optimistic and enthusiastic about metering.

Sean Hannan – Needham & Company

That’s helpful. All right. Thank you.

Operator

Your next question comes from the line of John Quealy of Canaccord Genuity. You may proceed.

Mark Siegel – Canaccord Genuity

Hi, guys. It’s Mark Siegel for John. I was wondering first on the metering side if you could just talk a bit about the RFP environment outside the US along with the measures you are taking to position the company ahead of some of the larger smart metering opportunities that are out there. Should we look to see a blend of direct sales and partnerships, or how do you think about that?

Ron Sege

Absolutely great question. We have strong partnerships, as you know, in Europe with folks like Eltel and Telvent. That’s been a tradition for us, and we expect that to continue and hopefully expand. RFP activity remains good I think in Europe, starting to move into Eastern Europe. And so we’re optimistic about that market, as we said. We are seeing good activity in Russia. We’ve got some new pilots that are going there as well, again in partnership. And then here in the US, we’ve reengaged with the market and obviously Duke is going great guns and our solution is working very well. And we’re looking to expand that. And that will be – historically we’ve gone direct. We’ll continue to go direct although we’d like to find some partners here as well. And then finally, our view is it’s always nice when your biggest customer has announced the intent to buy another big customer in the United States and I’m optimistic about the long-term potential there.

Mark Siegel – Canaccord Genuity

Okay, great. And then just a follow-up on ELO. Given the vast size of the Brazilian market, how do you think about addressable opportunity there? And then do you expect any commercial sales to come with ELO in 2011?

Ron Sege

It’s a $65 million meter market. Our expectation is that we’ll roll out over ten years. ELO has, as I think we’ve said before, has about a 30% market share in the Brazilian market in the mechanical meter space. And yes, we do expect some modest revenue here in 2011 from that partnership and that will ramp up in 2012.

Mark Siegel – Canaccord Genuity

Okay. And then just lastly, turning to the commercial side of the business, can you just talk about trends that you are seeing in the building automation market as well as in the demand response vertical? Thanks.

Ron Sege

Sure. I guess the principal trend in that – in building automation is our view is it tracks with employment and occupancy rates. And those are slowly improving. We expect faster growth in the three verticals that we’ve targeted and I described in my prepared remarks. And that’s really driven by emphasis on energy savings in many case because of mandates, as I described in China. And then the demand response business continues to be an important one for us. Obviously, EnerNOC is a great partner of ours, and you can track their business separately. I talked in my prepared remarks about starting to see the convergence of the utility and the commercial business. Demand response is an example, and we’re starting to see increased interest among utilities in getting in that demand response business themselves. So that continues to be a market that we are targeting closely.

Mark Siegel – Canaccord Genuity

All right. Thanks for all the color.

Ron Sege

Okay. My pleasure.

Operator

Your next question comes from the line of Mike Ritzenthaler of Piper Jaffray. You may proceed.

Mike Ritzenthaler – Piper Jaffray

Thanks. Good afternoon, guys.

Ron Sege

Hey, Mike, how are you?

Mike Ritzenthaler – Piper Jaffray

Good. For the ECoS software and control systems, I just wanted to get a sense of how you would quantify the opportunities of distribution automation, just kind of by geography I guess.

Ron Sege

I guess in general, we’ve said that there are approximately 70 million low-voltage transformers worldwide. And our view is that’s the total addressable market obviously over a period of time. We are sitting predominantly prospecting in North America and Europe and are seeing strong interests. However, any place the fundamentals are in place from an application perspective, we expect to see interest. So volt/VAR control improving the efficiency of distribution on that low-voltage grid, any place that there is strong electric vehicle activity. So for example, China, we’ve just started introducing the ECN over there and it’s very early days, but we’ve had enthusiastic discussions because they are of course very enthusiastic about electric vehicles. So those – it really is a global product and the problems that it’s targeting are really global problems. So that’s why I’m so eager to increase our distribution footprint starting by investing in sales and marketing and partnering more effectively worldwide.

Mike Ritzenthaler – Piper Jaffray

And then interested in the distribution agreement with ITOCHU, and I’m just wondering if that agreement was exclusive and how many other agreements like that are you pursuing.

Ron Sege

It is not exclusive. And it’s primarily focused on Japan, but not limited there either. And as you probably know, there is 80 million meters in Japan. There are some new laws that have gone into effect that require large consumers to report and reduce energy consumption. And it just – our view is that that market will develop more aggressively over the next few years and ITOCHU is one of the largest trading companies there. And we are delighted now to be part of advance [ph] card.

Mike Ritzenthaler – Piper Jaffray

Sure. And then the margins for the lighting products, how do those compare to the margins that you see in the commercial and utility segments?

Ron Sege

We don’t break it out, but it’s an attractive business for us.

Mike Ritzenthaler – Piper Jaffray

Okay, great. And then just one last question, about how far in the Ohio Duke project were you at the end of the fourth quarter?

Ron Sege

Could you restate the question?

Mike Ritzenthaler – Piper Jaffray

Sure. About how far in the Ohio Duke project were you at the end of the fourth quarter?

Ron Sege

They still have several hundred thousand meters to go. As you know, the deployment was delayed because of the delays in stimulus funding like many projects in the United States. And as I said previously on our last call, we expect Duke to be our largest customer in the utility space in 2011.

Mike Ritzenthaler – Piper Jaffray

Okay. Thanks.

Operator

Your next question comes from the line of Craig Irwin of Wedbush. You may proceed.

Craig Irwin – Wedbush

Thank you. I wanted to ask you a question about Fortum. Do you have any color for us about the timing for initial shipments to tell them for Fortum during this current fiscal year? And are we likely to see similar accounting or revenue recognition to what you had to use for the Vattenfall project?

Ron Sege

Let me start with – the first answer is we’ve started shipping. That’s happening now. And I’ll let Chris, of course, talk about the accounting.

Chris Stanfield

The answer is no, because as you know, there is this thing that is referred to as new gap under which hardware products that have lots of software as our products do are no longer accounted for the same reason or for the accounts for software. So the accounting is much more straightforward. And we try to point that out in our SEC filings.

Craig Irwin – Wedbush

Great. Now, can you talk a little bit about the linearity of shipments for the Fortum project? Is this likely to take place in a similar sort of cycle as the overall installation took place at Vattenfall or are we look at a more sort of measured multi-year implementation?

Chris Stanfield

Well, I think that we have a schedule obviously since we have orders. And as I think I said on the last call, we have already started shipping to Fortum. When we provided our guidance, we mentioned this as the first year of volume shipments because we didn’t want people to assume volume shipments last year. But we expect to have respectable levels of meters shipped for the quarter project in each quarter of this year.

Craig Irwin – Wedbush

Okay. Then maybe I can ask this another way. So on the Vattenfall project, apparently something like 85% of the revenue that was earned on the total project was earned really over the first four quarters. Are we likely to encounter something similar on Fortum or did that likely to be sort of equal parts over the next few years?

Ron Sege

Part of that was an artifact of the old accounting. If you recall, we had $14.4 million worth of revenue. When we delivered products, some of those to Telvent, some of those to E.ON, and we didn’t get to take any of that revenue until 2011.

Craig Irwin – Wedbush

Great. No, that of course I recall that. Thank you. So next question is sort of high-level. In the past, you’ve given us numbers of your approximate number of trials going on in Asia, in Europe, in the Americas, and was hoping you could give us an update on overall the number of trials and if you could give us color in the different geographic markets, that would be very useful.

Chris Stanfield

Well, we talk in terms of the overall trial activity and that remains strong. And I think Ron already addressed the key point, and that is that what we have seen as the recession is winding down, is we’ve seen a return of strength in Eastern Europe. But I think that’s probably the most – we're not getting into particulars, that’s probably the most prominent change. And then obviously, as a result of our partnership with ELO, we’re going to all put an enormous mark [ph].

Craig Irwin – Wedbush

Great. So in the past you’ve given us actual numbers, specific numbers. Is that something you choose not to do on this call?

Chris Stanfield

No, I just don’t have it with me.

Craig Irwin – Wedbush

Okay. That’s fair. That’s fair. And then you mentioned the strength in Eastern Europe. There was previously a customer there, I recall, about 900,000-unit potential customer that ended up being pushed because of the overall global recession. Now, is that customer still potentially available for Echelon over the next several quarters? And the same thing for the customer in Scandinavia, again, almost 1 million-unit customer that’s been delayed? Actually that company has been delayed, I think, about two years now.

Ron Sege

I’m not sure who the Scandinavian customer is. We have multiple projects underway Russia and we ended other parts of Eastern Europe, and it’s more than – in the case of Russia, it’s more than one utility.

Craig Irwin – Wedbush

Great. That’s good to hear. Thanks for taking my questions and congratulations on the progress.

Ron Sege

Great. Thanks, Craig.

Operator

Your next question comes from the line of Dale Pfau of Cantor Fitzgerald. You may proceed.

Dale Pfau – Cantor Fitzgerald

Hi, good afternoon. Thanks for taking my questions. Could you just give us a little bit of indication of what your ASPs are on the street light business? You can either give it per light or per grouping of lights.

Ron Sege

Dale, I think in terms of $10 to $15 per street light.

Dale Pfau – Cantor Fitzgerald

That’s great. And on your guidance, your rough guidance on your commercial projects, we’ve actually seen some pickup in other people’s commercial high VAC business here recently. And I know you mentioned the long cycle trends. But is it not possible that you could see that business grow a little bit faster because of some of this push toward energy efficiency?

Ron Sege

It’s possible. Frankly, the sale reorganization I described in my remarks is something that’s now just taking place were a hell of a lot more focus than we were last year and before that. And the only way I can forecast the business is what’s the effect of that new business is and that emphasis on design wins, and these are long sales cycles. So that then contributed to the guidance that we gave you. But it may well be that, as you say, the push to efficiency et cetera, the economy is picking up a little bit faster, maybe we’ll be beneficiaries of that.

Chris Stanfield

I think the other thing to point out is remember what I said previously, and that is, I don’t want to use the term building automation system. That’s a subset of the products that go into a building. But when you look at the broad area of products that are sold to building. Those people are either retrofitting or outfitting their new building. This is going to grow, as Ron said earlier, as we see employment and occupation rates recover. And so we had fabulous performance in many of these emerging markets such as demand response, street lighting, branch energy management, et cetera. But that’s in the context of the employment picture that you’re aware of.

Dale Pfau – Cantor Fitzgerald

Okay. Thanks very much, gentlemen.

Ron Sege

Thanks, Dale.

Operator

Your next question comes from the line of Colin Rusch of ThinkEquity. You may proceed.

Colin Rusch – ThinkEquity

Thank you. Can you clarify the revenue model with the solar business? It looks like you are selling some servers. Is there a SaaS component or a licensing component for any of the other branch that you are looking at pushing into the market?

Ron Sege

Right. There are three components to it. There is the server, there is the submeter, submeters that are distributed throughout the building, and then there is the Serious Energy Manager. So we get revenue from the equipment and then the Serious Energy Manager, we are a reseller of that. It is a SaaS business. And most of the recurring revenue accrues to Serious although we get a piece of that as well.

Chris Stanfield

In the case you were asking about solar, with respect to solar, what would typically occur is that someone would be using our Power Line Transceiver in conjunction with either a micro or regular inverter. And then they would of course be used for servers as well.

Colin Rusch – ThinkEquity

Great. And can you discuss the sense of how many other vendors you are working with besides the ones you’ve already mentioned?

Ron Sege

In respect of those two verticals or in general?

Colin Rusch – ThinkEquity

Just in solar, I mean, how many other inverter companies are you working with right now or prospecting?

Ron Sege

Well, we talked specifically about Direct Grid, but this is a high priority for us to identify and penetrate the inverter markets as well. I mean, I guess one other I’m reminding here is the SMA, which is an inverter, a big inverter company. It’s more focused on inverters, not micro-inverters.

Colin Rusch – ThinkEquity

Right. And can you talk a little bit about the potential for financing mechanisms to enable some of your lighting business? We’ve seen a fair amount of performance contract in driving efficiency – sales and efficiency projects. So you’re seeing anything like that through municipal lighting applications that are enabling the sale or anything that we might think of as the catalyst for that business to accelerate.

Ron Sege

Yes. And in fact, Rongwen is an ESCO. So they are using exactly that model. And I think that will be a popular vehicle and one that we are seeing interest in other parts of the world as well.

Colin Rusch – ThinkEquity

Perfect. Thanks a lot, guys.

Ron Sege

Okay. Thanks.

Operator

Your next question comes from the line of Patrick Jobin of Credit Suisse. You may proceed.

Patrick Jobin – Credit Suisse

Hi, Ron and Chris. Thanks for taking my question.

Ron Sege

Hi, Patrick.

Patrick Jobin – Credit Suisse

I was hoping you could provide some additional color on that 20% to 30% top line growth in ’11? What, just in qualitative terms, are you expectations for the level of revenue maybe from street lighting, renewable and the branch energy management grouped together? I guess, said another away, those markets have, at least you’ve spoken to historically, been a pretty small part of revenue. Does that contribute more or is that kind of what’s driving your enthusiasm for ’12?

Chris Stanfield

I think those will continue to grow, but if you go back to what I said in my prepared remarks, we expect the overall revenue increase for commercial solutions to be about the same as it was last year. The real growth is being driven mostly by improvements with our utility solutions, and then to a lesser extent, by the fact that Enel is going to simply purchase more spare parts this year. And so, as I said in my prepared remarks, we expect our level of revenues from our utility solutions to increase from between 25% and 40%.

Ron Sege

And the commercial market, 10%. But obviously we are focused on these verticals for a reason, and we do expect them to contribute increasingly to the overall number as sign goes on. But it’s a brand new sales emphasis from my perspective, and we really talked about it in the past. We’ve got great products. Now we’re putting sale focus on it, salespeople, sales process, pipeline management partnership, et cetera. So my expectation is that those verticals go faster for us and contribute materially.

Chris Stanfield

And remember, we had a solid year in utility last year. Our revenues grew by almost 19%, but you didn’t really see that because we have a 56% decrease in our spare parts and other revenues from Enel. And that is turned this period because we believe those Enel revenues will go up by 50%.

Patrick Jobin – Credit Suisse

Okay. Thank you. And then just a follow-up on a slightly different topic. Am I correct assuming the operating expense realignment is now complete? I was somewhat surprised to see the product development expense tick up. But is that only reflecting now the reduction in, say, the R&D spend or –?

Ron Sege

I’ll let Chris make sure you understand the specifics about the tick-up and all that. But just a couple points from me to make it clear as to hit the highest level. First, to answer the specific question, Patrick, we are finishing projects so the complete benefit of that realignment will start to take effect in Q2. But then the other points I want to make clear before Chris goes into the details is that year-on-year gross spending in product development will be down. Year-on-year total headcount in the company will be down. Inside of those two things, we will spend more on sales and marketing. So I want you to understand the significance of the pain we’ve gone through here. And now Chris will tell you why it doesn’t reflect exactly as crisply [ph] in our guidance.

Chris Stanfield

Certainly. So, as I said in my prepared remarks, you can think about product development expenses being comprised of spending. That’s the money we spend. And then there is offset, the extent to what your customer offsets that with payments. And we expect the amount of offset to be down significantly, as I pointed out in my comments. If you look at total spending, I think what you will find if you sort of study my remarks is that overall total spending, the money that Ron authorizes in terms of salaries and wages, materials, et cetera, will increase this year on the order of 3% to 4% as it has on average for the last four years. But what’s going to happen is that, as I indicated in my remarks, that will be reflected as an overall high-digit, say, 8% or 9% increase in product development expense simply because we have less offset. Does that make sense?

Patrick Jobin – Credit Suisse

Yes. Thank you.

Ron Sege

Okay. Thanks, Patrick.

Operator

Your next question comes from the line of Carter Shoop of Deutsche Bank. You may proceed.

Carter Shoop – Deutsche Bank

Just quickly on the OpEx comment, if we look at total OpEx dollars in 2010 versus 2011, you’re expecting a high-single digit increase there?

Chris Stanfield

Yes.

Carter Shoop – Deutsche Bank

And backlog, can we talk about backlog today relative to where it was a year ago?

Chris Stanfield

Yes. (inaudible) As Ron said in his prepared remarks, we have a very high percentage of the orders in for Duke and Fortum, and we’ve been clear that those are two projects that are driving well. And it’s just a much better market, and of course, we don’t have the overhang of everyone waiting for the Department of Energy to issue the final moves of what it takes to get (inaudible).

Carter Shoop – Deutsche Bank

Can you quantify the backlog either in with the total dollar amount today or a percentage of your revenue guidance?

Chris Stanfield

Well, we have a very significant portion of our full year guidance that is in backlog, and it’s a much higher percentage than it was last year.

Carter Shoop – Deutsche Bank

10% customers in the quarter?

Ron Sege

In terms of 10%, I know them for the year, and so that’s what I’m going to give you. And so for the year – first of all, going back to 2009, it was of course Eltel, Duke Energy, and EBB. EBB is our Pan-European distributor for those who are familiar with that name. And for 2010, that will be Eltel and it will be EBB. Duke Energy falls below that level for the reasons you understand. If we were to look to 2011, I believe you will be adding Duke Energy back to that list and then of course Telvent with respect to its project in Finland.

Carter Shoop – Deutsche Bank

Could we see Duke up in that 20% range for 2011?

Chris Stanfield

I’m not going to get into particulars of our Duke forecast, because as I said many times, we expect Duke to be our largest utility customer in 2011. And we have some large customers there obviously in Finland and in Denmark.

Carter Shoop – Deutsche Bank

Great. And just last question, in regards to Duke, can you talk a little bit about the regulatory hurdles that still need to be overcome in the Ohio region?

Chris Stanfield

In Ohio, they are going to have a regular filing just showing the progress of their work. We don’t anticipate any issue there. I think you may have been referring to Indiana, and of course, we’re waiting for the pilot. And we don’t have any better information than you do in terms of when that will get approved.

Carter Shoop – Deutsche Bank

Great. I was referring to Ohio. And just so we’re clear, you don’t think we’re going to have any kind of issue with the review this summer?

Chris Stanfield

No. I think –

Carter Shoop – Deutsche Bank

Okay. (inaudible) progress acquisition?

Chris Stanfield

Yes. I would reflect back on what Ron had told you about the SEAS had said about their network. Our solutions work, and we deliver (inaudible).

Carter Shoop – Deutsche Bank

Great. Thank you very much.

Chris Stanfield

Thanks, Carter.

Operator

The next question comes from the line of Joe Maxa of Dougherty & Company. You may proceed.

Joe Maxa – Dougherty & Company

Thank you. Back on the Duke and Fortum, a significant of your business or your orders for 2011, do you need to have another large customer come in in order to hit your lofty – you know, your increased expectations or can these two customers pretty much drive it all?

Chris Stanfield

No, they cannot drive it all. We have a broad list of customers that as we go through every week, as Ron indicated, and we know who they are. Much of that product backlog exists. We don’t announce every deal that we do in every part of the world, and we have in backlog many customers beyond the two that you mentioned.

Joe Maxa – Dougherty & Company

Great. Understand. And just for clarification, the profitability comment for fiscal year 2012, is that for the entire year or –?

Chris Stanfield

Yes. And that’s non-GAAP.

Ron Sege

Non-GAAP for the entire year.

Joe Maxa – Dougherty & Company

Perfect. Thank you

Ron Sege

And by the way, just a little bit more – somebody asked earlier about what are we doing different in sales and marketing, and I mentioned pipeline management. Well, one of the staples of good pipeline management is to compare the size of your pipeline to the size of the revenue that you need in any given period, and that’s something that I am adamant we have to keep growing that ratio. So we get more and more pipeline covering the revenue expectations that we set for you, and that’s an important and somewhat new discipline here as well.

Joe Maxa – Dougherty & Company

Let me ask one more. The linearity of revenue through the year, would you expect that to be similar to 2010?

Chris Stanfield

Well, obviously we didn’t start off similar, because as you know, we’re having a very significant $9.9 million, I think, year-over-year increase in revenues from last year – from Q1 of last year. But I think we’re going to continue to see obviously stronger results in the Q2, Q3, Q4 periods.

Joe Maxa – Dougherty & Company

Okay. So, sequential growth is expected each quarter?

Chris Stanfield

Well, sequential growth, we expect Q1 to be below of the three quarters. I can’t speak to each of those quarters because this is a project business and revenues move in and move out, little bit lumpy.

Joe Maxa – Dougherty & Company

Okay. Very good. Thank you.

Operator

Your next question comes from the line of Charles Fishman of Pritchard Capital Partners. You may proceed.

Ron Sege

Hey, Charles.

Charles Fishman – Pritchard Capital Partners

Hi. You really iterated your $150 million to $160 million revenue level in order to achieve breakeven non-GAAP net income. And your goal for 2012 is to be non-GAAP profitable. I appreciate you’re not giving 2012 guidance, but is it unreasonable for one to think that that’s the kind of revenue level we should be thinking of for 2012?

Ron Sege

I think another way of thinking about it is if you take my earlier comments and take the 20% to 30% on top of $111 million, that gets you from the low-130s to the low-140s. And so with similar growth, obviously, we intend to be in that range.

Charles Fishman – Pritchard Capital Partners

Okay. Fair enough. Thank you.

Operator

This conclude the question-and-answer section of the call. I would now like to turn the conference over to management for closing remarks.

Ron Sege

Thank you very much. I appreciate your continued interest in Echelon, and we look forward to talking to you again next quarter. Bye-bye.

Operator

Ladies and gentlemen, thank you for your participation in today’s conference. This concludes the presentation. You may now disconnect. Have a great day.

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