Echelon Corporation Q4 2007 Earnings Call Transcript

Feb.10.08 | About: Echelon Corporation (ELON)

Echelon Corporation (NASDAQ:ELON)

Q4 2007 Earnings Call

February 7, 2008 02:00 pm ET

Executives

Kenneth Oshman – Chairman, CEO

Beatrice Yormark – Pres Chief Operating Officer

Chris Stanfield – CFO

Analysts

Michael Carboy – Signal HillGroup LLC

Joe Maxa – Dougherty & Company LLC

Bill Gibson -NollenBerger Capital Partners

Shaun Boylan – Analyst

Mark Rogers - Arthur Andersen & Company

Chris Borat - Analyst

Operator

Welcome to the Fourth Quarter2007 Results Conference Call.

(Operator Instructions)

I will now turn the call over toMs. Bea Yormark.

Bea Yormark

During this presentation,representatives of Echelon may make statements related to future plans, events orperformance, these forward-looking statements are based on certain assumptionsand are subject to number of risks and uncertainties.  We encourage you to read the risks describedin our earnings release as well as in our SEC report, including our 2006 reporton Form 10-K and subsequent reports on Form 10-Q for more complete disclosureof the risks and uncertainties related to our business.

The financial informationpresented in this call reflects estimates based on information that is availableto us at this time.  Actual results coulddiffer materially.  Echelon undertakes noobligation to update or revise these forward-looking statements.  This presentation will also include adescription of certain non-GAAP financial measures that we believe provide ourmanagement investors with useful information relating to our financialcondition and results of operations.  Areconciliation of these non-GAAP amounts to GAAP amounts is included in thefinancial statements accompanying today’s Earnings Release and is also availableon Echelon’s website.

I will now turn the call over to Chris Stanfield, Echelon’sCFO.

Chris Stanfield

All non-GAAP amounts exclude the impact of any stock-basedcompensation charges.  For the fourthquarter of 2007, revenues were $46.9 million compared to $13.9 million for thesame period in 2006.  Echelon’s revenuesfor the fourth quarter were comprised of $27.7 million from our NES productline, $13.1 million from our LWI product line, and $6.1 million from the Enelproject.

For the full year 2007, revenues were $137.6 millioncompared to revenues of $57.3 million for 2006. Full year 2007 revenue consisted of $70.6 million from the NES productline, $52.8 million from the LWI product line and $14.2 million related to theEnel project.

While we have reported our revenues in accordance with USGAAP, we believe it is important to consider at least two factors in comparingamounts for 2006 and 2007.  We areproviding this information so that you could understand year-over-year businesslevel changes through the eyes of management.

Q1 2007 NES product line revenues included shipments ofhardware products that were accepted and in some cases paid for in 2006.  However, the company could not record thisrevenue in 2006, since all of the requirements to recognize this revenue underUS GAAP had not been met.  Had theserevenue recognition criteria have been met, NES product line revenues for 2006would have been approximately $14.4 million greater and revenues for 2007 wouldhave been approximately $14.4 million lower. This would have reduced the overall annual NES growth rate from 8820 %to 269%.

Full year LWI revenues for 2006 were reduced by a one timereduction of $3.9 million as we transitioned to sell end to sell throughaccounting for our sells through distributors.  Full year 2007 revenues for LWI productsincreased by 7% over full year 2006, however, this change would have been a 1%decrease, except for the effects of the one-time reduction in 2006.

Enel project revenue increased by 100% in 2007 from 2006levels.  Total revenue for the full year2007 increased by 140% from 2006 levels. The year-over-year growth rate would have been 63% except for thefactors I have just discussed.  Non-GAAPgross margin for the quarter and year were 41.7% and 37.1% respectively.  We had GAAP and non-GAAP profitability of$0.03 and $0.09 per share, respectively for Q4 2007.  We had a GAAP and non-GAAP loss of $0.36 and$0.20 per share respectively for full year 2007.

For ease of reference we have prepared a complete non-GAAP statementof operations for the three and 12-month periods ending December 31, 2007.  This additional information can be found bygoing to the non-GAAP financial information link in the Investor Relations sectionof our website at www.echelon.com.

For the first quarter of 2008, revenue is expected to beapproximately $32.5 million.  We expectNES product line revenues to be approximately $18 million, LWI product linerevenues to be approximately $13.5, and Enel project revenues to beapproximately $1 million.

Full year revenue is expected to be approximately $178million.  We expect NES product linerevenues to be approximately $110 million, LWI product line revenues to beapproximately $58 million dollars, and Enel project revenues to beapproximately $10 million.  On an annualbasis we expect total revenue to increase by 29%.  This is comprised of a 56% increase for NESproduct line revenues, 10% increase for LWI product line revenues and a 30%decrease for Enel project revenues.  Weexpect non-GAAP gross margin to be 37.7% for Q1 2008 and 40.7% for full year2008.

We expect non-GAAP operating expenses to be $17.5 millionfor Q1 2008 and $69 million for full year 2008. This would be a 10% increase for the quarter and a 7% increase for thefull year over the same periods in 2007. We expect interest and other income to be $1.3 million for Q1 2008 and$5 million for the full year 2008.

We expect the provision for income taxes to be $100,000.00to $50,000.00 for Q1 2008 and $1 million for the full year 2008.  We expect charges for stock-basedcompensation to be $2.8 million for Q1 2008 and $13 million for the full year2008.  We expect a loss of $0.10 pershare on a non-GAAP basis and $0.17 per share on a GAAP basis for Q1 2008 basedon 40,750 primary shares.  We expectearnings of $0.16 per share on a non-GAAP basis for the full year 2008 basedupon $45 million fully diluted shares. We expect a loss of $0.14 per share on a GAAP basis for the full year 2008based upon 41 million primary shares.

I will now turn the call over to Bea.

Beatrice Yormark

Hello everyone and welcome to our Q4 conference call, as Iam sure you know if you follow the company, we set a goal at the beginning ofthe year to achieve non-GAAP profitability in the fourth quarter.  Everyone at Echelon has remained focused onthis goal throughout the year and as you saw in our earnings release and heardfrom Chris, not only did we achieve our goal, we also achieved GAAPprofitability.  Everyone at Echelonworked extraordinarily hard to accomplish this and I am both pleased and proudof their efforts.

Looking into revenue, our Networked Energy Services productline performed very well both for the quarter and the year.  We entered 2007 with a significant portion ofthe NES revenue clearly identified as part of the specific project withspecific shipment schedules or so we thought.

However, one attribute of the advance metering market thatwe have come to understand is that while schedules maybe identified, given themassive scale of the deployments being undertaken, they are subject to change,being speed up or more often slowed down based on holidays, weather,installation rates and so on.  The resultof this is that while we met our target for Q4 revenue, it came from differentsources than we had planned at the beginning of the year.

For example, at this time last year, our project with EAC inRussiawas not identified.  In fact, we had evenbegun discussions with them, yet, we ended up shifting a significant number of metersand data concentrators to them this past quarter.  Likewise, of our partners, ES-1 and wefulfilled a large portion of a project with Halmstad, a city utility in Sweden thispast quarter that was not part of our original Q4 plan.

As Chris just mentioned, we expect to generate NES revenuesof $80 million during the first quarter of 2008.  To give you an apples-to-apples comparison tothe first quarter of 2007, we would need to adjust the Q1 2007 number to removethat portion of the revenue related to revenue that was deferred from thefourth quarter of 2006 due to undelivered software and recognized at Q1 2007 asactually Chris pointed out.  On thisbasis, NES revenue associated with products accepted during the first quarterof 2007, were approximately $10.5 million. So we expect a roughly 71% increase in NES revenues for the firstquarter of 2008 as compared to Q1 2007.  Similarlyon a year-over-year basis, we currently expect full year 2008 NES revenueassociated with products accepted during the period will increase byapproximately 96% over those generated in 2007.

As we entered 2008, we have fewer NES meters in “backlog”than we did in 2007.  However, we areentering the year with at large number of partners working a larger number ofidentified prospects than we did last year, and potential for follow-on ordersfrom existing customers this time.

While we do not believe that our partners will win everyproject they are pursuing, nor do we believe that all of these will be awardedthis year, we do believe a sufficient number of these will move to volumedeployment and support the guidance Chris just provided, and as was the casethis past quarter, I am sure there are opportunities out there that we do notsee today that can become significant revenue in 2008.  The advanced metering market is evolvingrapidly across the globe.  It is reallyan exciting time.

Turning to our LonWorks Infrastructure Product Line,performance this past year was disappointing. While we saw a good growth from customers pursuing demand response andenergy management application, we saw a decline from some of our OEM in thetraditional controls industry that offset this growth.  Overall, the LonWorks Infrastructure ProductLine was virtually flat in 2007 with North Americaturning in the most disappointing results.

This is unacceptable to me and to all of us at Echelon, theability to monitor, manage and control energy consumption is becomingincreasingly important worldwide and our LonWorks Infrastructure Products arekey ingredient making this happen in commercial buildings, homes, outdoor lightingsystems and other systems.  Now is ourtime.

As I discussed in our last conference call, in a large part,this is a channel and awareness issue, where end-users are not being told andthen told again about the energy saving possible LonWorks network.  To help address this, we are stepping up bothour press outreach to help get the word out and our efforts to attractpartners.  We are also working withkey-end users to help make them successful, and like in NES we are pursuing anumber of very exciting opportunity.  Oneimportant example is McDonalds and their kitchen of the future project. Whilewe do not expect a lot of revenues in 2008 from McDonalds, we do see this yearas one where the McDonalds suppliers will begin to deliver the smart energyaware product to the market.

Looking forward to 2008, we expect our LWI product linerevenue to increase by about 10%, much of this growth will be from existingcustomers rolling out more solutions and from new customers that will begin toramp to volume.  We have some excitingnew customers and prospects with large opportunities for delivering solutionsfor energy savings around the world.

Before I turn the call over the Ken, I would like to closeby saying, we believe 2008 will be a very big year for Echelon.  We know we have a lot of work ahead of us tomeet the targets we have set out.  Wehave new business to book, large volumes of products to build and ship, andspecific programs to complete.  We alsoknow that we have momentum, accessible projects we can point to and marketforces on our side.  We are in the centerof the convergence between control networks and energy managementnetworks.  This is the sweet spot of ourtwo decades of experience.

Thank you all for your interest and support, have awonderful year.  Now, I will turn thecall over to Ken.

Ken Oshman

Hello everyone, thank you verymuch for joining our call today.  As youhave just heard from Chris and Bea, we are very pleased with our results for thispast quarter and excited about the outlook for 2008.  Before I share with you some insight intowhat we see driving our business in 2008. I would like to spend a few minutes reviewing 2007 against the goals weset for ourselves and shared with you throughout the past year.

At the beginning of last year, Itold you that we saw energy as a killer application, driving both our LonWorksInfrastructure and NES product lines, monitoring it, managing it, controllingit, conserving it.

As energy cost continues to rise,as concerns about the impact of global warming and carbon dioxide emissionsgrow, consumers, businesses and governments are increasingly asking what theycan do and they are finding that Echelon, our products and our partners providesolutions.  While I cannot tell you thateverything unfolded last year exactly according to plan, I can tell you, wemade very important progress in 2007.  Inour LonWorks Infrastructure product line, we saw growth among our demandresponse oriented customers, such as EnerNOC growth that we expect toaccelerate in 2008.  We introduced thenew i.LON SmartServer, which includes important new capabilities for ourpartners deploying Smart streetlighting systems and provides a platform for creating custom applications anddrivers for building advanced energy management strategies.

We expect growth in both ofthese areas as SmartServer shipments begin later this quarter.  In our NES product line, we recently reacheda very important milestone, shipping our one million Smart NES meter.  As best I know, Echelon is unique in theadvanced metering market and that we have a global platform.  All of the meters we ship worldwide are basedon the same core set of electronics, firmware and networking.  This not only gives us unmatched scale, butalso lets us put our wood behind one arrow. We can learn from the best practices of utilities and markets across theworld and focus our R&D efforts on one target platform, thereby movingforward faster and with more functionality than competitors with fragmentedregional offerings.

We also introduced our thirdgeneration metering platform this past year, third generation.  I see this as another sign of our maturityand our lead in this market.  This thirdgeneration platform offers additional functionality to our customers andincorporates learning from our first two generations of meters to reduce ourmanufacturing cost.

NES meters are currentlyapproved in 17 countries and it will take more time to bring out and certifythis GEN3 platform in each of these jurisdictions.  But as GEN3 meters become a bigger part of ourshipments.  Our gross margins willimprove.  One specific NES goal I sharedwith you last year was that we intended to establish a beachhead in North America.  Iam pleased to say that we did not just establish a beachhead, we did muchmore.  Duke Energy with their utility ofthe future project, is I believe at the leading edge of defining the Smart gridfor our country.

Duke has announced plans toinstall the NES system in about 57,500 customer sites across three differentcities.  The North American AMI market isa bit murky and it is hard to know what is real and what is just a plan, butbased on what we know, we believe that when completed, this large deploymentwould be the largest and most functional AMI system in North America.  I have heard frominvestors that they wished we had made a bigger splash to announce the Dukeproject.  I wish we could have as well.  However, as is true with every company wework with, we view our customer’s projects as their project and we respecttheir wishes with regard to how, when and if they are announced as we did inthis case.

I had the pleasure of meetingwith Jim Rogers, the CEO of Duke last week, after the DistribuTECH Conference.  I could not be more honored and pleased to beworking with such a great utility and a great partner.  DistribuTECH is a very large utility industryconference with hundreds of exhibitors and thousand of attendees.  A large focus of this year’s conference wasadvanced metering infrastructure, demand response in the Smart grid.  This was the first year, had a booth on thetrade show floor, our coming-out party for the US utility market.  We had a fantastic booth, not only in termsof how it looked but more importantly in what it showed.  The booth was very busy with visits fromutilities, potential partners and of course our competitors.  We were demonstrating how Smart utilitymetering systems, Smart street lighting systems, home networks and buildingcontrol systems, all of the devices attached to the electric grid can worktogether to create a complete Smart grid and enable utilities and energyconsumers to work together to simply and effectively manage energy consumptionand reduce demand in times of limited supply.

In other words we were showingthe power of our 20 years of device networking expertise, the power of ourproducts and our partnerships, all of the things that differentiate Echelonfrom its competitors.  It is this that wesee when we look forward to 2008.  Ibelieve energy will continue to be the driver of our growth.  Around the world our NES value added resellerpartners are working on many tenders, trials and prospects and we expect somenumber of these to begin volume deployments in 2008.

We see continuing growth fromour demand response oriented customers and in energy management applications inretail change, quick serve restaurants and commercial buildings, increased activityin street lighting systems and growth in the digital home alliance.  And most importantly we see the beginning ofutilities business and consumers looking to interlink these previouslydisparate systems to build a Smart grid which is right at the heart of ourstrength.

2007 was a great year forEchelon; it was great in part because we are in the right place at the righttime, but most of all, 2007 was great because of the outstanding and at timesamazing efforts of the dedicated people of Echelon, obviously from the peopleat the heart of our product development, sales finance and operations teams,but also from people everywhere in the company from shipping and receiving tocustomer support to order administration to project management to financial planning.  We have a wonderful team of people at Echelonand I am proud to be part of the team.

2007 is now in the history books,so we turn to 2008.  It will be achallenging year as we continue to strive to achieve dramatic growth andrevenue and continued improvement and profitability, but we are all dedicatedto accomplishing our goals and feel confident that we can.  Thank you again for joining our call, I wouldlike to now open it up for questions.

Question and Answer Session

Operator

(Operator Instructions)

Our first question comes fromMichael Carboy, please state your question.

Michael Carboy – Signal Hill Group LLC

Congratulations on a achievingthe profitability on both GAAP and non-GAAP this quarter.  A couple of questions for you, let us firstchat a little bit about the pace of solicitation activity that you hadmentioned Bea, I think you said it was at surprisingly high levels, can you putany metrics around that for us to help us understand how that thread ofexploration and examination of the utilities has changed over the past year?

Beatrice Yormark

Yes, you know I think what ishappening is we are seeing a lot more activity than we have before in differentparts of the world.  A little moreactivity in Asia than we have seenbefore.  In Europe,our partners are beginning to expand both in terms of utilities that werealready involved in and countries that are already involved in as is demonstratedby the Halmstad thing that we were unable to announce, but that in fact that ESdid.  ES is our partner with E.ON inSweden and they continue to get more projects in Sweden, Halmstad being thefirst of what we expect would be even more projects, so we are digging deeperby our partners and we are seeing new partners begin to expand into new anddifferent markets.

Michael Carboy – Signal Hill Group LLC

And Ken, with regard to LonWorks, in the past you have talked about theincreasing nature of some of the traditional system vendors to revert to moreclosed systems.  How are they counteringthe art of positive ROI experience?  Thepeople like Bower and McDonalds have had with the LonWorks systems.

Ken Oshman

Well, I think the best counter thatthey have is that they also provide open LonWorks systems and they can, andthey do when someone challenges the ability to do that, and in fact I just gota presentation for a large community development project that uses LonWorks andit is one of the traditional suppliers that is the supplier, but it is beingdone by an integrator, an independent integrator and they showed that there wasabout a three-year payback just from energy savings and reduced maintenancecost because of the open system.  Sothere is about a three-year payback on the control system for this new project.  And by the way, they compared it to theoriginal simple control system, closed control system that had been originallyquoted for this project.  So when peoplereally press for energy savings and are not necessarily focused on first costs,but really projects life-cycle costs, everybody or most companies will respondfor LonWorks and open LonWorks.

Michael Carboy – Signal Hill Group LLC

So, it is not really a matter ofbud being tossed out by the traditional guidance.  It sounds like it is more a matter ofcustomer awareness and knowing for something being available.

Ken Oshman

Absolutely, and that is what Beais talking about. We are going to try and get the word out better.  It hard for us to get the word out, onlybecause if you stop and think about it, every building owner, get the word butour revenues for a building, the wonderful thing is there are hundred of thousandsof LonWorks buildings today, but the bad news is that the revenue per buildingfor us is not enough that we can afford to send sales people to every building owner,every project, so we have got to find ways to leverage that word with partnersand with better PR and better presence and we are working hard on that thisnext year.

Michael Carboy – Signal Hill Group LLC

Okay, and this is the lastquestion for Chris if I may.  Chris, itlooks like, just looking at the NES business here this quarter and lookingahead of the Q1 outlook.  It appears thatthere will probably be, at least by my calculations, a pretty significantdecline in the incremental gross margin in NES, I was wondering if you couldelaborate a little bit on why we are seeing what is likely to be a prettysignificant compression in NES gross margin in Q1.

Chris Stanfield

Well, we do not really break outmargins by product line.  I think whatyou are probably referring to is simply having the effect of having a reducedrevenue level because as you know, there is a very significant portion of costthat is contained with the cost of goods sold that is effectively fixed.  And so when you are amortizing that costsover $45 million or $46 million that represents a much lower percent of salesthan when you are doing it over a lower number and that perhaps is the mostsignificant factor on a quarter-to-quarter basis.

Well, the only other thing Iwant to tell you is that, in terms of all of our businesses, we have done somecareful work and we believe we do understand our cost; we have identified thetransactions that we expect revenue in. And we think that the guidance is solid.

Michael Carboy – Signal Hill Group LLC

Okay, because I had been lookingback at Q3, when it looked liked at least from my calculations, it was kind ofabout a break even with your 4% or 5% gross margin business.  Here in Q4 it looks like the incrementalgross margin was not easing up at 40% in any aspect and then going forward,even factoring in the fixed cost and it looks like there had been somecompressions, so I was curious if there was a mix shift away from the costreduced meters of some of the older styled meters that was hitting you.

Chris Stanfield

I mean the margins in NES, youknow once again we do not state that, as Ken has stated before, we are tryingto push them towards what are viewed as the industry standards, which is a 35%to 45% range and we are certainly not in the single digits, but in terms of theproducts at this period, we are shipping GEN3 and we are shipping GEN2products.  And I think Ken made the pointor Bea made the point perhaps that you have to get these platforms promulgatedin each individual country, but I think we see solid volumes for both platformsand we expect to be shipping those platforms throughout the year.

Operator

Our next question comes from Joe Maxa, please state yourquestion.

Joe Maxa – Dougherty& Company LLC

Thank you, questions along the line of your NES revenue for2008 certainly with the guidance of $18 million in Q1 and $110 million for thefull year you have some expected ramp.  Iam looking for an idea of timing of shipments from once you get an order untilthey shift, in other words, in the back half of the year, which seems to becertainly the biggest chunk, when you need to do you need to have, or see thesecontracts in over to pick up those revenue targets.

Chris Stanfield

Well, I think as Bea has made reference to, you know, youhave this event, which is the booking of an order, but you know, often times wehave been working closely with who that partner is.  We have gone through the process so thatpartner making a proposal to its customer, its customer asking questions andthat kind of stuff.  And so, there aretimes in which we have taken action what was going to happen and a good exampleof this was the project that Bea mentioned earlier of Russia, where we know what wasgoing to happen in the summer.

We took the actions because our customer had some timingrequirements that we needed to support and we were able to do that.  This really comes down to the planning; Ithink that Kevin made reference to.  Weare fortunate that we have just a wonderful operations organization.  They work very closely with our salesteam.  They make procurements of longlead products and thus far, they have been able to respond in the needs of ourcustomers.  I do not know if that helpsbut it is not really a fixed time.

Joe Maxa – Dougherty& Company LLC

Well, you also indicted that, “backlog” was a little bitless going into 2008, compared to 2007. So, I am just kind of thinking about the timing of these revenues andknowing that there are a period of, probably months to a minimum to ship theNES because it suggests that Q2 and even though I know you are not giving guidancewould be more in line with Q1 because we are just starting to see that big rampgo up?

Beatrice Yormark

I think a good assumption is that, we will see much of thisrevenue in Q3 and Q4, certainly over to Q2. But again as Chris said, all sorts of things happen within the rush ofthings was a very good example, the Halmstad thing was a very goodexample.  Those things basically, bookedand shipped and went out in almost a quarter’s worth of time.  So anything can happen.  We are working on a lot of things, but Ithink your assumption that the last half of the year will have higher NESrevenue in the first half is a good assumption.

Joe Maxa – Dougherty& Company LLC

Can you give us a ball park with that Halmstad, what thatrevenue was to give us an idea of how big the revenue was and that you can turnaround in one quarter?

Bea Yormark

The Halmstad was 50,000 meters and so about $80.00 a meter.

Joe Maxa – Dougherty& Company LLC

Chris, on the operating expenses, it looks like Q1 is goingto be the high pointof the year based on your guidance.  Canyou walk us through that or maybe just kind of give us some commentary on whythat would be?

Chris Stanfield

Sure, as you know, one of the things that we do is carefullymanage expenses, but when you come into a quarter like this, you would have tocarry over the effect of the staffing increases that were achieved lastyear.  But the biggest effect is simplybecause that comes in such as payroll taxes that often times are concentratedin the first quarter of the year and in addition to that, just given therealities of families having children in school, vacation accruals tend toreally peak during the first three months of the quarter.

Joe Maxa – Dougherty& Company LLC

And then lastly, I will just ask another question and thenjump in the queue, can you give us an update on what you talked about before,maybe they are in your filings, your larger or your significant customers, canyou give us any breakdown on those for the quarter?

Chris Stanfield

In terms of the most recent quarter?

Joe Maxa – Dougherty& Company LLC

Yes, right Q4.

Chris Stanfield

Well, we have not done it right away but obviously, the mostsignificant customers from an NES perspective would be the people that Bea hasmentioned.  Telvent and ES and those areour partners and then EAC, these would probably be the most significant ones interms of the LonWorks product line, it is a whole range of folks ranging from Honeywellto EnerNOC.

Joe Maxa – Dougherty& Company LLC

Do you have the numbers or do we have to wait for the file?

Chris Stanfield

We do not disclose specific numbers, we sort of list them ina sequence, obviously Telvent is a very significant portion of our revenue andthen I forgot to mention Enel and obviously Enel is a very important customer.

Operator

Our next question comes from Mark Rose (ph), please state your question.

Mark Rose - Analyst

Congratulations on a great year.  Letme try another NES feasibility question if I may, I appreciate Bea’s discussionof this in her prepared comments.  In thesecond half of last year, you told investors that about 90% of your NES revenueguidance was booked or in backlog under contract and that was veryhelpful.  I realized it is very early in2008 so much smaller percentage would be in that category now.  But I wonder if you can be so kind as todivide up your $110 million NES guidance into perhaps three buckets.  Bucket one would be again booked or inbacklog under contract, bucket two would be orders that you can specificallyidentify and you expect that they will come through, get filled and berecognized in 2008 but there is no signed PO yet.  And bucket three is stuff you have to scramblefor and cannot specifically identify with confidence.  Could you divide this 2008 NES guidance anddo those three buckets?

Chris Stanfield

Sure, about 30% of our guidance is currently booked.  That means we have a purchase order in-house,against which we are performing, in some obviously those good have alreadyleft.  The remainder of our guidance isidentified by customer.  Now that doesnot mean that it is going to be just as we had said it would be, but we haveidentified projects with specific products and specific timing that we areplanning to.

Like any forecasting process, what we do in that process is we de-rateopportunities, we exclude some opportunities from our analysis and we includeothers and that was the reason for Bea’s comments because as hard we worked onall of it, I am sure that one or more of those customers will do better than wethought and there will be somebody who will come in and do much better than wethought, and some people will not do as well, and even if we had all of theorders and backlog as Bea has indicated, we would still have changes because werespond to the market place and so to the extent that there are weatherproblems, that other factors happen, actual installation schedules sometimesget pulled in and sometimes get pushed out, but we have a plan as a managementteam that we believe is credible that would lead us to the guidance that we hadprovided to you.

Mark Rose - Analyst

So, in that 70% you were talking about, are there projectsthat you are simply bidding on and competing with other meter companies at thispoint in time that you are just hoping that you will get or is it moredefinitive than that?

Bea Yormark

We try not to put in a bunch of things that we just hopethat we are going to get, in our forecasting have looked at the opportunities,both the ones that we hope that we are going to get and the ones that we feelwe are a little further down that they had gone and the 70% includes more ofthe ones that were further down the pygon which includes the kinds of thingsthat I had mentioned in my call notes, expected or hoped for additional ordersfrom existing customers and then some of the things where we already passed oneor two of the hurdles and so those are what is in there.

In addition to that, I think what Chris alluded to is wehave got a lot of other things in the hopper which I believe would be and hopedfor competitive kinds of things that should one of these things fall out or nothappen as we expect them, by the way, expect it, we would turn to those.  So the 70% I would think is in that firstcategory, less open and more knowledge and not certainty.  I just want to be careful about that.

Mark Rose - Analyst

Ken, in the Q4 conference call, you indicated that there wasno sign of price erosion in the Smart metering businesses around theworld.  Is that still the case?

Ken Oshman

Certainly, we have not seen around the world any priceerosion.  I would say that prices arepretty steady; I have to tell you that in North America,things are very murky.  It is very hardfor us to see, what actually is happening, what the costs really are or whatprices really are, but we do not think and I mean it is hard to see anywhere, butwe do not think there has been any price erosion.

Mark Rose - Analyst

I presume that $20 million increase in the accountsreceivables from Q3 was related to the recent large NES shipments, but is thereanything you can comment on with regards to that?

Chris Stanfield

Yes, it is exactly as you state, in a sense that yourreceivables tend to be comprised of your most recent transactions and we do avery careful job of monitoring our accounts receivable and we do not see anyissue there and that was expected and I think as I had said in the previouscall, since we knew that the timing of GEN3, we had expected a concentration ofactivity in Q4 that was sort of driven by one week of chip GEN3.

Mark Rose - Analyst

Sometimes one sees in a newspaper or magazine a columnentitled “Whatever happened to blank?” And I wonder if in that spirit, if I could ask whatever happened tofirst the deal with Kolon Data Communicationsin Korea and two, the SAMS opentender in Sweden and thenthree, the opportunity for a really big order from Nuon in Netherlands.

Chris Sanfield

Let me think, the Koreaguys.  They are doing fine, they areproceeding.  Our business in Korea isdoing well and they are a part of our continued Korean business, so they aredoing fine.  The SAMS order, actuallypretty much, it is still in place.  Thereare some people that under the SAMS order bought very simple systems and wethink eventually they are going to regret that. There are some people that bought LonWorks System and Hamstad is a verygood example of that.  That is one of thereasons, this was something that was sort of unexpected happened and thenquickly shipped because there was a contract in place, the SAMS contract was inplace, so the SAMS contract is still going on, but surprisingly, the leadingutility in creating the SAMS proposal went off and did something totallyoutside of SAM, so it was crazy, but I am sitting in a room with Bea and Beajust looked at me and gave me a look when I said crazy because I am going toget a letter from somebody, it was not crazy, it was surprising what they did.  They are going to attempt to put a differentkind of system than they were originally thinking.

But anyway, SAMS isstill there and still available for utilities to use if they want to purchasethrough that.

Nuon is still theretoo and Nuon is doing fine.  We thinkthey are very happy customer of ours.  Weknow that they are in the process of preparing their next tender, their nexttender documents.  We believe it is goingto be somewhat substantially larger than their last tender was.  We cannot tell you exactly what the timing ofthat, we wish we could.  We do not know,we think we are in a very good position to win a large portion of whatever theydo going forward this year.  We do notactually believe much of Nuon will ship this year.  I mean we are forecasting some but notgigantic Nuon revenues this year.

Mark Rose - Analyst

One really quickquestion, Do you know how many meter companies Duke is working with right now?

Chris Stanfield

Only us, I believeso, now understand they work with lots of meter companies in replacing theirelectro mechanical and solid state straightforward meters as they fail and asthey need some replacement, but in terms of the utility of the future project,it is my understanding that we are currently the only meter company that theyare with.

Operator

We have Bill Gibsonon line with a question.

Bill Gibson - NollenBergerCapital Partners

Just a little finetuning, Chris, in regards to your operating expense guidance, is there more ofa waiting for an increase in R&D versus sales and marketing or is thatspread between the two?

Chris Stanfield

You know that is avery good question.  I think that on afull year basis, it is pretty much spread across the business, there are someincreases in sales and marketing particularly in the NES base, but here arealso healthy increases in R&D.  Thelowest increase would be in G&A.

Bill Gibson - NollenBergerCapital Partners

We saw that stock comp number, but in terms of Enel, I knowthe CEO had been in London speaking of installing Smart meters in Spain, hadthere been any follow on conversations with them about that or anythingdefinite on that front?

Bea Yormark

Actually there is nothing definite, as far as I know I donot know that Enel has made any decisions on how to move forward on what theyare going to do in Spain and yes we continued to have ongoing discussions with Enelon a variety of things, but as far as I know, there are no decisions that havebeen made.

Bill Gibson - NollenBergerCapital Partners

You guys left me up there in the hope for a category.

Beatrice Yormark

That is the hope for category that is about 70% I can tellyou that.

Operator

We have Shaun Boylan on line with a question, please state your question.

Shaun Boylan – Analyst

If I could I want to go back to one of the first questions in which wetalked about the gross margin, I just want to confirm, so the drop in grossmargins from the fourth quarter to the first is primarily scale rather thanmixed shift within Enel?

Chris Stanfield

A very significant portion of the effect is simply the factthat we have so much more revenue in Q4, I mean that is one important factor, butthere is also as you note, a less Enel revenue in the first quarter too.

Shaun Boylan – Analyst

Okay, and as we go through 2008, given stronger revenues inthe back half, is it fair to think about the NES revenues and gross marginsramping quarter to quarter through the year?

Chris Stanfield

Well, you know, there is sort of what is the if you will themargin on the average dollar of revenue for each of the product lines and then thereis the companies results and so, I think, if you are looking from the NES area,what we expect is those margins will tend to improve over time as the extent ofpeople moving to GEN3 increases, but we have encouraged people to assume thatthat will be a gradual change, because inertia being what it is, people tend totake what they bought yesterday.

Having said that what is going to happen is that, Bea talkedearlier about the fact that we expect once again this year that our revenues inNES are going to be highly variable between quarters and obviously in quartersin which NES revenues represent a much greater percentage of total revenues,that will tend to hold down our overall average gross margin as a company.  Does that make sense?

And then the last part is obviously to the extent that wehave big revenue quarters than those fixed cost that I alluded to, drop rathersignificantly as a percentage of revenue.

Shaun Boylan – Analyst

So maybe the way to get the final clarity on this is in terms of just theNES revenues, with the mixture toward GEN3, do we expect to be at that 35% to45% target may be by the back half of the year in its heavier quarter.

Chris Stanfield

I do not want to get there yet in terms of that because asBea said, as time moves on we move away from the stuff that we have actuallybooked to the stuff that we are planning to book and so, we will provide thatclarity when we can see it.

Shaun Boylan – Analyst

On LonWorks if I may, can you just comment on the linearity within the year?

Chris Stanfield

Yes, well the effects that we do have is that there is an effect that wesometimes see in the summer, often times see in the summer associated withEuropean vacation periods, as you know a very significant portion of ourrevenue for the LonWorks infrastructure product line across in Europe and thereis often times an effect in the fourth quarter associated with the holidayperiod, it is not unusual that in Europe they take off from before Christmasthrough Epiphany and so those are probably the things that you can count onyear in and year out.

Shaun Boylan – Analyst

So maybe a drop in third quarter?

Chris Stanfield

Well, I do not know, as Ken said earlier, we are having a change in mixhere.  Historically, our revenue has beendriven by the sale of components to people who are running the production linethat are building products for shipment and increasingly we are selling systemproducts like i.LON’s and I have no idea what the seasonality for those willbe.

Shaun Boylan – Analyst

In terms of, Bea, your comment on the weakness in LonWorks infrastructurelast year and the OEMs in North America, was that company specific or was itmore related to perhaps a slow down in spending, I am just wondering on thegrowth of economic sensitivity here with LonWorks Infrastructure.

Bea Yormark

I actually looked at that very, very carefully and I have not been able toconvince myself that it was a lot about economic slow down.  I think in some cases it was, but in some cases,we actually saw some increases in some of our OEM as well as decreases withsome of the OEM’s were higher and I think that in North America, that may havebeen reflective of a slow down from the capital spending on building growth.

Chris Stanfield

Can I add to that?  For sure at theend of the third quarter we did not believe that this was the result of aneconomic slow down.  However, we still donot have enough evidence one way or the other, and Bea is absolutely right, Iagree with her a hundred percent, we cannot really see that, but I think wehave seen as we have said in our call, as we have seen a negative growth.  We have seen a slow down in some of ourtraditional customers.  We do not think,we do not have enough information to tell you exactly why that is, we do notthink it is the result of their not using LonWorks, in fact we are prettyconfident that is not the issue.  Wethink that it could be just seasonal things, but there definitely was a slowdown in the traditional customers.  Italso could be, it very well could be economic because after all, the building industry of all the places thatis questionable in this economic turbulence that we are certainly livingthrough, the building industry is part of that, and so it could very well bethat we are seeing economic slow down in the building controls business andsuch.

That is a very hard industry to use as an economic indicator, however, Iwill tell you because, it is a lagging industry, money gets put in place tobuild a building and the controls piece of that happens two years later and so,what really may happen is two years from now, we will see the economic effects ora year from now.

Shaun Boylan – Analyst

So, the 10% growth that we are forecasting now in 2008 is based on this kindof current view of the world as we know it based on the tough environment weare looking at right now.

Ken Oshman

And it is also but based on our expectation that our mix inour LonWorks infrastructure business will begin to shift toward energy management.  The worse the economy, the more pressurethere is to save money and it becomes actually, a bad economy becomes a driver,high energy cost become a driver and so, we actually think there will begrowth, it is just a question of how much of the other traditional sorts ofcontrol systems because economic things might see declines.

Shaun Boylan – Analyst

Last question on the LWI, in terms of the win with McDonaldsand moving toward the kitchen of the future, and that not being a materialcontributor to revenues in 2008, can you just help us a little bit if we thinkabout wins like this and let us talk about the time line here and what it takesto get these to the point of deployment where we do start to see these materialrevenues.

Beatrice Yormark

That is a pretty hard question to answer only because McDonalds, a lot ofthat would also have to do with some of the economic slow downs in business ingeneral because McDonalds is not forcing a change through all of thestores.  Stores can make these changes asthey see fit.  So there may be some oftheir franchisees, for example, that decide to put this off for a while.  I believe we will start seeing revenue fromthe manufacturers of the equipment as the equipment stores roll them in, butthen as they tie those into their energy management and some of their otherthings with the i.LON, I cannot really predict. I certainly think that we will see more revenue in 2009.

Chris Stanfield

If I could add something I would say that what we see is thesignificance of McDonalds.  I mean, thereare a number of things that are very important about the McDonald’s decision,but one of the main the main things is we see McDonalds a leader in thequick-serve industry and a good model for the rest of the industry and so we arevery excited about McDonalds from that perspective.

We also see McDonalds as doing fundamental change in the waythey are going to procure equipment for their kitchens and so on.

And so the result is that the design cycle and productioncycle for McDonalds are quite long.  Bycontrast, we have worked with other quick-serve restaurant chains, and in amatter of months we are installing i.LONs to integrators of ours, who areproviding some sort of energy management or control system service for them as aretrofit to their existing establishment. So there is a long design cycle when one type of equipment is beingturned into Smart communicating equipment there is another design cycle andsomeone is just going to work within existing air-conditioning system andlighting system and are along with its infrastructure.

Operator

Our next question comes from Mark Rogers, please state your question.

Mark Rogers - Arthur Andersen &Company

I was just trying to get an idea because it sounds like the hardest thing youguys have in front of you is convincing your customers that indeed there is apayback and that that payback is a short enough period that this investment isworthwhile.  So with that said, are youtargeting areas where the rates are high and at the same time budgets forcommercial construction are strong enough that they can afford to pay for thisinvestment.

Ken Oshman

The answer is that I think your first assumptions are wrong, it turns out itis not hard at all to convince an end user of the value of an open line systemboth for saving money and energy and for saving money in the long-term cost system.

The difficulty is getting the word to the end user.  And so, we are working on that and the energyrates all over the world are adequate to make these systems have goodpayback.  It is not hard to convincesomebody of that.  We just have to tellthem it is possible and more importantly our partners have to go in and seewhat they are doing and how they are doing it and find ways for them to improvetheir energy usage and change their energy, and reduce other costs along theway, so it is not dependent on variable and energy rates from place to placeand it is actually not a hard story to tell, it is just a story that we need tofind a better way of telling.

I think, ladies and gentlemen that we try and hold these calls to about anhour and so, I think it is probably time to take one more question and thenconclude, if there is another question.

Operator

Our next question Chris Barrack (ph), please state your question.

Chris Borat - Analyst

I think you guys have mostly covered it but if I could come at the pipelineactivity in a slightly different way, if you look at the un-booked portion interms of booking at the pipeline versus this point last year, where would youput it across the various levels of the bucket set where an earlier participantasked, multiple relative to that in terms of deals or number of customers youare talking to, is it equal to 1x, 2x, 0.5x.

Chris Stanfield

That is not really the way we do it and so, I have a hard time of applyingthat model to it.  We seat down and wework with our sales teams.  We understandthe opportunities that are out there.  Wego through the process that I described to you, but we do not really do it inthe fashion that you have described so I am not really able to answer thatquestion.

Chris Borat - Analyst

Well, let me look at it this way.  Igot the impression from your discussion that it seems like you are extremelybusy in terms of bid activity.  Is itfair to say then, you are busier overall, if you look at sort of what is onyour plate, quite a bit busier than you were at this point last year?

Beatrice Yormark

Yes, absolutely!  I think we have farmore identified opportunities at this point this year than we had at this pointlast year.

Chris Stanfield

So, thank you ladies and gentlemen for joining our call.  As I said, we think 2007 was a greatyear.  We had lots of challenges in 2008but we are confident.  We feel reallyconfident about meeting those challenges and having a great 2008.  Thank you very much for joining our calltoday.  We will talk with you again atthe end of our first quarter.

Operator

Thank you ladies and gentlemen, this concludes today’s conference.  Thank you for participating, you may nowdisconnect.

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