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Executives

Ken Oshman - Chairman & Chief Executive Officer

Chris Stanfield - Executive Vice President & CFO

Analysts

Carter Shoop - Deutsche Bank

Bud Leedom - Global Hunter Securities

Michael Carboy - Signal Hill

Joe Maxa - Dougherty & Company

William Gibson - Nollenberger Capital Partners

Mark Gross - GGS Capital

Michael Carboy - Signal Hill Investments

Echelon Corporation (ELON) Q2 2008 Earnings Call July 30, 2008 2:00 PM ET

Operator

Welcome to Echelon Corporation second quarter 2008 results conference call. (Operator Instructions) At this time for opening remarks, I would like to turn things over to Mr. Chris Stanfield, CFO.

Chris Stanfield

During this presentation representatives of Echelon may make statements relating to our business outlook, future, financial and operating results, accounting matters and overall future prospects. These forward-looking statements are based on certain assumptions and are subject to a number of risks and uncertainties.

We encourage you to read the risk described in today’s press releases as well as in our SEC reports including our 2007 report on Form 10-K and subsequent reports on Form 10-Q for more complete disclosure of the risks and uncertainties related to our business. The financial information presented in this call reflects estimates based upon information that’s available to us at this time. Actual results could differ materially. Echelon undertakes no obligation to update or revise these forward-looking statements.

All references to non-GAAP amounts, excludes stock base compensation. Revenues for the quarter ended June 30, 2008 were $32.2 million compared to revenues of $26.7 million for the same period in 2007. Revenues for the quarter were composed of $16.6 million from our Network Energy Services or NES product line, $14 million from our LonWorks Infrastructure product line and $1.6 million from the Enel project.

Revenues for the quarter ended June 30, 2007, were composed of $13.5 million from the LonWorks infrastructure product line, $9.4 million from the NES product line and $3.8 million from the Enel project. Revenues for the six months period ending June 30, 2008 were $67.8 million compared to revenues of $66 million for the same period in 2007.

As we have previously reported approximately $14.4 million of the revenue in the first half of 2007, was related to NES products that were accepted by our customers in 2006 for which Echelon could not book revenue as we had an obligation to deliver additional software. On an apples-to-apples basis the comparison will be $67.8 million for the first six months of this year compared to $51.6 million in the prior year.

Non-GAAP gross margin for the quarter and six month period ending June 30, 2008 was 41.9% and 38.7% respectively. The GAAP net loss for the quarter ending June 30, 2008 was $7.1 million or $0.17 per share. This compares to a net loss of $5.3 million or $0.13 per share for the same period in 2007. The non-GAAP net loss for the second quarter was $3.2 million or $0.08 per share compared to a non-GAAP net loss of $3.7 million or $0.09 per share for the same period in 2007.

The GAAP net loss for the six month period ending June 30, 2008 was $13.9 million or $0.34 per share compared to a net loss of $10.9 million or $0.28 per share. The non-GAAP net loss for the six-month period ending June 30, 2008 was $6.8 million or $0.17 per share compared to a non-GAAP net loss of $7.9 million or $0.20 per share for the same period in 2007.

For ease of reference we have prepared a complete non-GAAP statement of operations for the three and six-month periods ended June30, 2008. This additional information can be found by going to the non-GAAP financial information link in the Investor Relation section of website at www.echelon.com.

As you may recall for accounting purposes only, Echelon is the deemed owner of its San Jose headquarters facilities. Near the end of the second quarter we negotiated an extension of the leases for these buildings, in order to lock in favorable rental rates through March of 2020. As a result of these extensions the June 30, 2008 balance sheet reflects adjustments to both; total lease financing obligation as well as to the net book value of the billing assets. Each of which was increased by the amount equivalent to the net adjustment in the present value of the new lease payments.

Under the new lease terms actual cash payments we make to our landlord during the second half of 2008 will be reduced by approximately $324,000. During 2009 our cash savings will grow to approximately $715,000. As we explained during our last call, a portion of the company’s cost attributable to these leases is reflected in the income statement as interest expense while the remainder is classified as an operating expense.

For 2008 the extension of these leases will decrease our net loss by approximately $360,000. This will be reflected in our full year operating result as an $800,000 reduction in operating expenses, partially offset by $440,000 increase in interest expense.

Turning to guidance, we expect revenue for Q3, 2008 will be approximately $29 million. This is composed of $14 million of LWI product line revenue, $10 million of NES product line revenue and $5 million Enel Project revenue. As was reported in this mornings release, we are reducing our full year revenue guidance by $29 million from $178 million to $149 million plus or minus $5 million.

Our new guidance of $149 million is composed of $80 million of NES product line revenue, $57 million of LWI product line and $12 million of Enel Project revenue. The primary change from our prior guidance is a $30 million reduction in our expected full year NES revenues. As it relates to our Q3 NES revenue guidance all of the $10 million we are forecasting is currently in backlog. Approximately 16% of our Q4 NES revenue forecast of $32.9 million has also already been booked.

The remaining 84% is composed of identified accounts that we believe can and will book and ship in time to be recognized as revenue this year. NES revenue for 2007 was $70.6 million, but as I mentioned earlier approximately $14.4 million of this amount related to revenue differed from 2006. On an apples-to-apples basis Echelon’s current full year guidance of $80 million represents a healthy increase of 42% over the $56.2 million of NES revenue actually accepted by customers in 2007.

Our non-GAAP gross margin guidance is 44% for Q3 2008 and 40% for the full year 2008. Our operating expense guidance is $17.3 million for Q3 2008 and $69 million for the full-year 2008. Net interest income in other is forecast to be $30,000 for Q3 2008 and $700,000 for full-year 2008. Income tax expense is expected to be $100,000 for Q3 2008 and $600,000 for the full-year of 2008. We expect stock-based compensation expense to be $3.8 million for Q3 2008 and $14 million for full-year 2008.

For Q3 2008 we expect the non-GAAP loss per share of $0.11 and a GAAP loss per share of $0.21 based on the weighted average of 40,750,000 shares. For full-year 2008, we expect a non-GAAP loss per share of $0.23, plus or minus $0.04 and a GAAP loss per share of $0.57, plus or minus $0.04 based on a weighted average of 41 million shares.

I will now turn the call over to Ken.

Ken Oshman

Well, it’s common on a quarterly call to talk about the quarter just completed. I’m pretty sure that all of you are more interested in focusing on our outlook going forward, so that’s what I planned to focus on in my remarks and then we’ll open the call for questions, but I think I should say briefly that our results for the second quarter were very good exceeding our earnings expectations.

As you read in our press release and as Chris has just explained in depth, we have reduced our guidance for revenue this year, primarily our guidance for NES revenue. This also means that we will no longer meet our objective of full-year profitability. I would like to explain why we’ve reduced our guidance from what we see.

The answer for better or worse is actually quite simple, decisions are taking longer than we were promised or than we had expected and some projects are ramping more slowly than we have planned. The obvious bad news is that this means things that we had hoped would be revenue this year will not be.

We based our previous guidance on the best information we had at the time and until recently it appeared that the guidance was still approximately correct, but with the passage of time that is no longer the case. Even, if the contracts we expected were to be awarded this year, we believe that there won’t be enough time in the year to shift sufficient meters to meet our original targets; that’s the bad news and it’s very disappointing to us to report it to you.

The good news is that these projects have not gone away. We have not lost them someone else. The awards have been delayed, but we still see them as projects out there for us to win and we continue to believe that momentum is on our side.

In Europe, so far this year we’ve announced wins in covering nearly 700,000 additional homes. While all of these projects will begin shipment this year, many of these projects are long-term and go towards building a healthy backlog for 2009 and beyond.

Here in the United States, we’ve already shipped over 65,000 meters to Duke Energy, and our project continues to go well. Cutting through the height and perception in the market, we believe that if you look at actual numbers of advanced meters shipped, installed and running in the United States, the NES system at Duke is the largest true AMI system with reliable two-way communications, integrated disconnect, power quality and other advanced metering functionality in North America today. We welcome any of our competitors to share the size of their working AMI installations to show otherwise.

We have also begun a second project, initially a small pilot with another North America utility. This year we’ve also signed new partners to open new markets with new NES partner HCL Info Systems in India and Power Meter Techniques in South Africa. While it will take time for both of these partnerships to bear fruit, both India and South Africa are markets with major imbalances between supply and demand and other critical energy problems that make them attractive markets for the NES system.

So, while this year clearly is not progressing the way we had believed it would in January I remain convinced that the markets we serve are enormous and that Echelon is building a leading position in them. Profitability remains of utmost importance to me and I believe that we’re well positioned for profitable 2009. With that I’d like to open the call up to questions.

Question-and-Answer-Session

Operator

(Operator Instructions) We’ll go first to Carter Shoop with Deutsche Bank.

Carter Shoop - Deutsche Bank

I wanted to talk first about the push outs. Was this more one or two large utilities pushing out a deployment or were there actually several different smaller projects that got pushed out and if you can comment on where you saw that by geography that would also be helpful?

Ken Oshman

By geography I would say most of the push outs have been outside the United States that we saw, so that’s first of all an answer to your question and secondly, I don’t exactly know how to answer the first part. It is certainly push outs or whatever we want to call it. It’s not so much a push out as it just is they didn’t get finished with the decision processes and lets call that a handful of decisions, a few not one or two or not 12.

Carter Shoop - Deutsche Bank

I just wanted to ensure if you were planning on one large utility ramping somewhere in the U.S. or Europe at the end of this year, but that commentary is helpful.

Ken Oshman

We always hope a large utility will ramp at some point, but that wasn’t part of our plan.

Carter Shoop - Deutsche Bank

In regards to the second utility that you’re working on a pilot for in the US, how would you characterize the size of that utility? Would that be a large IOU, say over 1 million endpoint or would it be more of a smaller regional operator?

Ken Oshman

At this point we really would rather not comment on this trial, so.

Carter Shoop - Deutsche Bank

Okay and then as a last question, it’s just a clarification on some of the comments you had earlier. Chris, the comments you made about the percentage of the 4Q implied revenue and implied second half that you booked in NES? I didn’t actually catch all of the commentary there, could you possibly repeat that for me?

Chris Stanfield

Sure, no problem. What I said was, as it relates to our Q3 NES revenue guidance all of the $10 million we are forecasting as currently in backlog. Approximately 16% of our Q4 NES revenue forecast, $32.9 million as already being booked. The remaining 84% is composed of identified accounts that we believe can and will book and ship in time to be recognize as revenue this year.

Ken Oshman

And again Carter, I would add to that; that is not one utility; that is a handful of things we expect to book and ship in the fourth quarter.

Carter Shoop - Deutsche Bank

And just a little bit more color around that type of visibility; is that typical having two quarters out, that limited visibility or that small percentage of the overall implied revenue booked or is that a little bit maybe more aggressive than how you usually provide guidance.

Chris Stanfield

Carter I’m not sure there really is a typical, because this business I don’t think really existed before we started shipping products and so we’ve obviously been in a position in which we’ve had backlogs just stretched out further, but what I would caution you about that is that as we came into 2007 with a tremendous backlog and a good portion of that sled into 2008 and so I think this is more based upon the actual information that our sales people have, with respect to real utilities and the project that they want to complete in what their schedules are.

Ken Oshman

I would also add just to try and help explain what goes on in booking and in shipments. I would add that we don’t talk about backlog as being a contract that has been awarded or project that is underway; in general we don’t talk about backlog there. What we talk about are hard specific orders for shipment with specific ship dates and so on. Much of the backlog that we expect to create for Q4 is additional orders from existing customers that are planning to take the next sort of step in their ongoing project. I hope that’s helpful.

Operator

We’ll go next to Bud Leedom with Global Hunter Securities.

Bud Leedom - Global Hunter Securities

Clearly I appreciate the opportunity out there. It is large and eventually we’ll see a lot of this come to fruition, but I guess I’m just trying to drill in a little bit more towards the backlog and how you essentially determine that. I mean so we have 100% of the third quarter backlog that’s already accounted for, yet 16% in Q4. So that’s a pretty large number that’s still out there.

I guess given the fact that you said some of these utilities didn’t finished their decision process and that’s why some of the spill out and really you sort of characterized that as promised I guess in terms of what they will book and ship. I guess I am just trying to figure out in terms of your forecasting on a go forward basis, how do we sort of look beyond the Black Box and get our arms around some of the opportunities that are quite specific or we’re still waiting for decisions to be made.

I guess I’m just trying to learn a little bit more about how you actually forecast your backlog and how that plays out in each quarter.

Chris Stanfield

Sure, well let me help with part of that and then Ken can add onto this. When it comes to Q3, Q3 was no different than any other period. We started this with some years that were actually awaiting acceptance, where they’d already been delivered to our customer. In some instances, the meters were still on the boat and they were on the way to that customer and in other cases there were shipments that were planned and so I would expect to see something on the order of what we saw for this period. As it relates to a subsequent period…

Ken Oshman

Chris you said Q3, did you mean Q2? When you’re talking about the backlog that is booked on a boat, that’s the form out there?

Chris Stanfield

Yes. A portion of the $10 million that was already at the customer side, we made an acceptance. A portion of the $10 million was on a boat and a portion was scheduled for shipment and was scheduled to arrive in time for the acceptance to still take place this period.

As Ken said, with respect to our ongoing business what happens is the customers give us releases. Now they have various documents that they use, but we’ll just call it releases for this purpose and what we do is, we then go ahead and schedule shipments based upon that, but for inventory planning purposes and business planning purposes, we are in close contact with our customers understanding what those future releases are going to look like and that’s the basis for the projections that we’ve provided.

Ken Oshman

Bud, let me just say that some people might talk about our backlog as the size of the contracts, the total size of the contracts that we or our partners have been awarded and that are expected to be installed. For example, I have seen people talk about a US utility placing an order for 1.5 million meters and that being a $250 million or $350 million order while in fact we understand and I’m sure you understand, that is not an order; that is generally a contract framework under which orders will be released generally, because the schedules will be set and projects will come and go and regulatory things could change and so on and so forth.

If I want to take that kind of approach and say what is the size at this moment of our backlog that one could impute not from hard orders to ship on a such and such date, by such and such ship and so on, but from all of the contracts that are ongoing and that have been awarded to us or our partners, I would tell you that over the next some period of time not all in 2009 or this year or the next year, but we probably have a backlog of on the order of a million meters, but we don’t consider that a backlog.

Bud Leedom - Global Hunter Securities

No, no that’s help Ken, thank you. I guess I was just taken with the “didn’t finish the decision process” which I guess would employ the fact that some of these are indefinite orders. I mean obviously there is a relationship there in a future order, but…

Ken Oshman

Let me give me one example of an unfinished decision, okay. Let me give you one very specific example. We have been working with the Dutch utility Nuon, a great customer of ours. We are very enthusiastic about them and they’re very enthusiastic about the NES system and they were in fact our first NES customer in the world and they intended to buy on the order of a $0.5 million meters this year and they issued a tender.

It was finally issued early this year like January or so and it was actually intended to have been issued in September of last year or something like that or maybe even May of last year, but anyway they issued a tender in January. Then they never actually got to a decision on that one -- this is an ongoing next step in their deployment project.

They never got to finish with a decision on that one and in part because in that particular case the Dutch Parliament decided to pass some new legislation that rather than sticking with the current schedule for deployment as advanced metering infrastructure in Holland, it sort of added a one year grace period.

In waiting for all of that to happen, the Dutch utility decided that its tender had become stale and therefore they canceled the tender and they promised that they are going to reissue a tender in September. Now just between all of us on this phone and the world I think we would love that, but we are not really accounting on them getting the tender issued by September and it will be a while, but we had certainly expected early this year that some number, not an enormous number but some number of meters we would have won that and some number of meters would have been shipped on it; that’s the kind of decision that I am talking about. They’re going to buy those meters, they are going to buy them soon, but they didn’t. That’s the decision that was postponed.

Having said that there are also other kinds of things, examples that we have won contracts and it’s just a question of do they want the next 50,000 meters this month or do they want to next 50,000 meters next quarter and those are also postponements, but they’re not decision postponements there are just schedule slips. I don’t know if that helps, but its complex, we’ve got lots of customers and each one is a little different.

Bud Leedom - Global Hunter Securities

Well, I appreciate that level of detail, it does help. Just one other question along these lines; in terms of Duke, obviously there has been some activity on the regulatory front where the state recently filed you have the meters implemented there and obviously there is a timeframe that that we need to wait for, but it seems that there is some progression. Is there anyway to maybe put your arms around when you see the total opportunity unfolding, within the next one to three years or is it a little further out; can you maybe help a little bit on the timing there?

Ken Oshman

I can't tell you how much I wish I could. No, I really can't. I know that to the extent that things continue to go well and to the extent that Duke receives regulatory approval for proceeding, they are very eager to move; that much I am pretty confident of. They will move about as fast as they possibly can. In our case if they happen to choose us and they get these approvals we can move very fast with them.

Bud Leedom - Global Hunter Securities

Okay great and just finally Chris, do you have a CapEx figure for the second quarter?

Chris Stanfield

No, I am sorry, I do not have that with me the. That part of the documents I haven’t brought with me.

Operator

We’ll hear next from Michael Carboy with Signal Hill.

Michael Carboy - Signal Hill

A couple of questions for you; lets sort of swing back to this what I’ll call procedural administrative postponement rather than your competitive value proposition postponements that you’re talking about. What are the issues that seem to be coming up, before the PUC's? Are these intervener issues, there’s a confusion at the PUC with regard to the direction of the direction of technology, evolution and development or the economic issues being raised either by the utilities or by rate interveners that are causing this procedural stalling.

Ken Oshman

Michael, I wouldn’t characterize what’s going on as procedural stalling at all. There was a political question in Holland that got a little confused and that was why they moved that for a year. Ultimately it was a question of who would own the metering infrastructure; would it be the distributor of electricity or would it be the retailer who would own the meters and ultimately that got resolved and it just took a while and it never changed, it had been decided and it just came up again, that kind of thing has happened, but first of all in the EU, there is no stalling; people want to move on with AMI. It’s just a question of getting your acts in order and deciding exactly what they want and so on.

Michael Carboy - Signal Hill

But what is sort of causing the uncertainty about what it is they want, the timetable they want to move on? I mean you’ve said it’s some political …

Ken Oshman

I don’t think there is any road blocks; I don’t think it’s with their road blocks. These are just big decisions, big projects and it’s just a question of organizing to do it and getting the various parts of the utility up and ready to do what each part needs to do and making a decision you really want to throw at all your existing leaders and these are just big tough decisions, but I don’t think there is any road block in the way. I mean of course there are road blocks here and there, there are going to be this or that, but I think it’s now in my opinion more or less inevitable that over the next decade, almost all the developed world will change to advanced metering infrastructure.

Michael Carboy - Signal Hill

I agree with you on what stepping-stone four, five and six looks like; it’s stepping-stones two and three that are the problem in the outlook and what I’m trying to get at is; what are the real motivational drivers that are behind the actions on the part of other foreign utilities or domestic utilities that are driving these, because there has to be sort of a common thread. I can’t accept the fact that it’s a lot of random stock?

Ken Oshman

No, I don’t think it is random, if I implied that I apologies. I think it is very simply energy conservation and management and control. At the end of the day that’s what it’s all about and in all of Europe that’s clear, in places like India and South Africa that’s clear, in places like the United States today. I think very few U.S. utilities spent a whole lot of time trying to make a business case work. They do try and make it work at some level, but it’s not a narrow business case which pays back itself in four years. So, it’s not business case drivers, there is plenty of business case rational. I think the real driver is energy conservation control.

Michael Carboy - Signal Hill

Certainly the issues of accelerating energy costs are painful in Europe as they are here in the US; are these issues that are before the utilities and the regulatory bodies, questions about do we scale up the projects, do we move faster or is it a question of how do we finance them in the existing capital markets environment, vis-à-vis concerns about our recessionary environment, do we need to move as quickly; can you maybe give a little bit of color or shading on that dynamic?

Ken Oshman

I’m not a utility executive, but I have not heard any financing pressures from utility executives. That is not a problem that we have ever heard. We’ve never heard any decision slipped or what have you financing, so no, I don’t think that’s an issue.

Chris Stanfield

Michael, this is Chris. Let me make just one comment here. I think obviously, there are lots of technical factors, but sometimes it’s a little simpler than that. These projects tend to be installed in geographic areas and so someone starts off and they do it in city A and maybe they reach some milestone and then they do city B and it moves from that.

So what happens is while the total project might be some large number of meters, what happens is we get releases on sort of a phase basis. Sometimes those come more quickly, then we had expected, that happened last year with the first phase of our opportunity in Russia, sometimes it comes less quickly, but I think a lot of it has just to do with the rate at which these projects will allow.

Ken Oshman

I would also say Michael, I like your analogy stepping stones. In terms of that analogy, I would say we’re on the first couple of stepping stones right now and the form of that is a number of smaller, but not enormous number of smaller deals, $0.5 million meters here, 1 million meters there, a 100,000 here, 80,000 there and its not universal, it’s not uniform and it’s sort of spread out all over the world everywhere from Charlotte to Copenhagen. So, there are a lot little things happening.

When we get to steps four and five, the market size is going to be $100 million a year, which we’re not there and I’m not trying to be there. In fact, we are little happy it’s not quite there yet because while we’re growing very rapidly and capable of growing very rapidly we’re not there.

Michael Carboy - Signal Hill

With regard to the small pilot in the US, what’s driving that pilot program? Is this a business case issue or is this more a state RPS initiative? What’s the dynamic there, can you elaborate?

Ken Oshman

I think pretty much everywhere. If you look at California, you look at Charlotte, you look at anywhere in the United States, these are mostly just being driven by -- PUC is actually saying to utilities often “we want you to go do something about shaving peek demand. We don’t want moving energy conservation, managing and controlling it” and the utilities are attacking that in a number of ways, of course one of the ways we know is demand management like internet provides, happily one of our good customers and it also is by smart metering infrastructure which has I think a great future into all of that.

So, I mean the economics can’t be egregious. I mean, if smart metering infrastructure were costing what EDF is paying per meter for its initial trail -- this is the French utility is paying on the order of $1000 a meter for it’s initial trail. If the economics were anything like that then absolutely that would stop everything in it’s tracks, but economics are closing enough to positive breakeven in virtually every case and if someone really wants to sharpen their pencil, we think they almost always will put this -- a really intelligent AMI system will pay for itself, so long as it’s not an enormous burden on the rate payers and it provides benefits to the rate payers and it does, then there are not big problems anywhere.

Michael Carboy - Signal Hill

Chris, a couple of questions for you; could you elaborate a little bit on the foreign exchange impact on gross margins here for the quarter and last quarter you had cited input costs inflation, yet we see some positive margin trends going forward. Would you help us reconcile that, because I’m not seeing decreasing costs in the cost of goods sold arena?

Chris Stanfield

I would be happy to do that. I think the things that I spoke about in our last call are generally happening. I know the improvement we saw this quarter is all timing base, its overhead absorption variances if you remember your cost accounting, and it’s just a timing variance between Q2, Q3 and Q4 and in our outlook we’ve assumed that that all gets back to where we expected it would be by the end of the year.

Michael Carboy - Signal Hill

Right and foreign exchange impacts in the quarter?

Chris Stanfield

It was none. I’m sure there was one, but it wasn’t meaningful

Michael Carboy - Signal Hill

Not meaningful. Okay and what amount of expenses were booked in the quarter that were related to the restatement. Was there any trailing stuff floating around from that?

Chris Stanfield

I don’t have that number, I am sorry. I am just guessing now, but I would say it’s $300,000 to $400,000.

Michael Carboy - Signal Hill

Okay, if you look in the back half of the year, do you think you’ll spend more on the sales and marketing side or more on the product development R&D side in terms of growth rate?

Chris Stanfield

I don’t get into break-in expenses down by category, its hard enough to get the total right.

Operator

We will here now from Joe Maxa with Dougherty & Company

Joe Maxa - Dougherty & Company

Just a little bit on the longer term deals you’ve signed. Well the deals have been signed, the contracts have been signed, deliveries I suppose can change here and there, but in general would you expect those to be pretty linear as far as if you have a three year deal for $40 million or how should we be thinking about that?

Ken Oshman

Joe I wish I could answer that definitively. Almost anything is going to start at one level and go up, so the rate, it’s going to start at some initial rate and then the rate will increase overtime until you get to some point where it sort of peaks and then starts to come right back down and that can be over an extended period of time. It can be one year, three years, two years; that’s almost a necessity, beyond that I can’t tell you much else.

Certainly what we would like and what our ops guys would like is if every order were shippable 10% every month and they would just love that and it’s just not quite that way; that’s one of the things. We have lots of capacity, but we can’t move our capacity instantaneously, no one can and so we would like to able to just run things at a flat rate but we’ll never be there.

Joe Maxa - Dougherty & Company

So they are going to give you a batch; like you can give us 10,000 meters or 50,000 meters by this date and then we’ll reevaluate and ...

Ken Oshman

Right, they going to say over the next three months “we’d like X meters a week” and then at some point they’re going to say, “in this three months period we’d like Y meters of week” and it could be 5,000 this week, 8,000 next week, 4,000 the next week 12,000…

Joe Maxa - Dougherty & Company

Do you currently have in your backlog for this year a number for the two contracts with Eltel that are supposed to start shipping in Q4?

Ken Oshman

We don’t divide our revenues by contract publicly, but we certainly expect those contracts to begin shipping at this year, as we said.

Joe Maxa - Dougherty & Company

Okay. Chris a question for you on the interest expense, on your lease obligations there’s a lot of numbers and I may have missed it, but the number you guided for Q3 is that a good number to think about for the next really several quarters.

Chris Stanfield

The net interested number is a good number. With regard to this accounting as you know what happens is, because we’ve gone through this renewal, we start working our way down the compound interest calculation again and that’s why that interest number went out and as you appreciate just given the timeframe between now and say 2020 you can sort of project on your own, how that will amortize. It will obviously be less next quarter and less in every succeeding quarter. Does that help?

Ken Oshman

I mean that's a number that Chris will be able to give us pretty well in guidance, in each quarter and for our annual guidance. Now that we have the extension, it’s a calculation that they’ve done and it will change every quarter slightly and costs will go down, interest will go down and we will give you that every quarter and with our annual guidance.

Joe Maxa - Dougherty & Company

Chris, do you have the geographic split up by revenue for the quarter?

Chris Stanfield

No, I don’t have it yet.

Joe Maxa - Dougherty & Company

Okay, and then I’ll ask a quick question on LonWorks. Your guidance suggest a 9%, 10% sequential growth in Q4, $15.3 million level. Now are you seeing something there that would give you that confidence, it’s been around $14 million the last several quarters?

Chris Stanfield

Yes. I mean once again that’s based upon our forecasting process and what we see as we see some customers that have new application areas, we are once again projecting a rate that they are going to grow at, that is you and I have discussed previously this is absolutely a turns business and so I find out about what happened after it happen, but yes we believe that there are customers who are growing and we expect the business to grow in Q4.

Ken Oshman

I mean to be a little more explicit, I think we believe that there are one or two or three customers in Q4 that are going to start volume production of things they’ve been working on for two years, three years and so I think that’s part of the forecast in Q4.

Joe Maxa - Dougherty & Company

So then that should be a good kind of a base number going forward, is that…

Ken Oshman

God, I hope so.

Operator

We’ll hear now from Bill William Gibson, with Nollenberger Capital.

William Gibson - Nollenberger Capital Partners

Is there anything beyond this year in terms of their existing Italian upgrade or would that be depended on a new bidden in the new market?

Chris Stanfield

This is Chris. There will be a NEL revenue we believe next year. We’ve signed a multiyear agreement with them as you know in which we’re supporting them and in fact if you noticed we slightly increased our guidance for this year, for the NEL project. Once again, net revenue is not easy of forecast and we work with NEL to try to understand what their requirements will be and it is obvious those requirements this year have been a little bit greater than I thought they were going to be, when we prepared our initial guidance.

William Gibson – Nollenberger Capital Partners

On the international front, I hadn’t heard that step before on the meters in France, that there on the initial trial I think with three manufacturers paying $1000 a meter; are you precluded from getting in there just for political reasons being an American company?

Ken Oshman

I don’t think that would be politically correct to say yes to, that question, because we certainly expect to have business in France. My understanding of the process and we’re trying to be part of the process, we just didn’t win it. EDF is spending this enormous amount of money and it’s for 100,000 meters from three different companies for a trial. This is all really just a trial and most of the money is because they are telling the meter manufacturers the kind and exact specs of a meter they want. They want someone to develop a new power line technology to a spec that they are providing and mainly that money is being spend for system, infrastructure, software, a bunch of systems and stuff that they want.

I don’t think that the meters per se are $1000 a meter. The meters per se are probably under $100 meter, certainly 100 Euros a meter, but the project, the way they’ve structured it is very costly to get this first 300,000 deployed and I think it’s over the next two or three years, really three years, it’s something like that and at the end of all of that they will now have a spec for meters and there is no guarantee that any of the guys they got meter orders at this point will get another meter order down the road nor that they’ll actually deploy this system as defined at this point, so it’s a very complex thing.

Having said that it would be better if we were French and I think we’ve had a better chance at getting this order, but they actually gave I believe 100,000 of the meters to Isramco, which is the Slovenian company owned by an Egyptian company, so that was a long way from France, so it would be inappropriate to say you had to be French.

William Gibson - Nollenberger Capital Partners

Okay and speaking of pilots, you’ve got this second trail in the US; is that only you or are they putting your heads up with other suppliers?

Ken Oshman

I think it’s just us Bill.

William Gibson - Nollenberger Capital Partners

Okay, I guess from my perspective, I’d love to see an open trail where the results would be available for everyone?

Ken Oshman

So would I. I think our system works so well and provides such full functionality that I mean I don’t think anyone is yet in our league, that’s my feeling and I feel very confident about that. We are routinely providing highly reliable, highly capable, daily 15 minute interval data and information everywhere that are stuff is installed in, in the United States, in Europe and Asia, Russia, so I would love to be able to see a head-to-head competition.

William Gibson - Nollenberger Capital Partners

Good and just one last question; can you kind of share with us in rough numbers that number of potential new utilities that are in the funnel out there?

Ken Oshman

I don’t know, the funnel is pretty big, maybe there are 50 in the funnel, I don’t know, it’s like that kind of a number. I don’t focus on 50 of them by a long shot or even 100 of them on a routine basis until they get closer to getting into the bottom part of that funnel. There are lots of utilities doing request for information and early qualification, potential bidders and those sorts of things, but those are things that are little further out there and I’m worried about Q4 and Q3 and next year and so we are mostly focused on a subset of that funnel.

Operator

We will go next to Mark Gross with GGS Capital.

Mark Gross - GGS Capital

My main question was partially answered, but let me ask it anyway; besides EDF also Ibedrolla -- I’m sure I'm mingling the pronunciation, started implementing PLC Metering Solutions and I was going to ask why you felt NES was passed over in those cases. You’ve already made some comments regarding EDF.

Ken Oshman

So Ibedrolla has had a program -- they have a guy running this project that has for a long time said he wants one total infrastructure with multiple suppliers and so that’s what he’s going out trying to do. He’s got multiple people trying to make power line ICs, he’s got multiple companies supposedly making meters to a spec that he’s created, he’s got multiple companies making data concentrators; it is a work in progress.

I think it remains to be seen how successful it will wind up, but at this point they’re really not buying anything; they’re sort of asking people to develop products and see what happens with them, so I hope that’s helpful. That is not our business; we are not in the business of going out and designing special meters to the special specs. We think it’s a tough problem to solve well and we’ve solved it well and we solved it well by making an infrastructure which is complete and works very well and it has opened IP interfaces, opened interfaces into the homes, opened interfaces into the head end. At the end of the day, this is all a result of utilities saying, they want multiple meter suppliers and so this is a desire to have an ability to have multiple meter suppliers.

One way, you can have multiple meter suppliers is to put very little functionality into meter and put a lot of functionality somewhere else or try and put a lot of functionality and bolt that onto a dumb meter, that is the sort of old traditional U.S. AMR automated meter reading idea. You use commodity meters and somebody’s single source communication. That is what as I understand it, if I understand the Silver Spring announcement yesterday or the day before, that is what PG&E has once again done; is they are bolting on a radio technology to existing dumb meters. So, that’s a legitimate approach, it’s not the approach we think is the right approach and we think an integrated system that provides all of the functionality is just less expensive and more functional.

I do believe in the long run, utilities will want less expensive, more functional systems. I hope that explains what we are doing. We got our hands full of keeping up with the requirements that utilities have for features and functions that we can add to our existing infrastructure very readily and very easily.

Mark Gross - GGS Capital

Okay, thanks and just a couple of very minor questions, book-keeping question. Did that in fall end up being 600,000 or 700,000 meters, for Echelon?

Ken Oshman

I’m sorry, what did it end up in?

Mark Gross - GGS Capital

That Vattenfall, I saw some places were it was reported as 600,000 meters associated with NES and other places 700. So I was just trying to figure out which…?

Ken Oshman

Let me explain, that’s a very good question. I’m glad you asked it, because it explains exactly what I talk about, when I say the overall contract versus actually what gets done. The overall contract for Vattenfall was a potential for 700,000 meters and that was what was awarded to Telvent with options to go all the way to 700,000 meters.

Along the way, Vattenfall found out they only had 600,000 that they needed, they lost a 100,000 customers. They really didn’t lose them, I think they just didn’t know exactly how many customers they had and so when all was said and done they finished with 600,000. They recently announced they finished the project, they are very happy with it, its working well, it’s all installed, it’s a show piece of modern metering infrastructure and we’re very proud of it, so were they, but anyway it wound up with 600,000.

Mark Gross - GGS Capital

Okay and another minor question, I noticed there is some investment banking presentations during the second quarter that were not webcast, so I was just wondering why they weren’t webcast?

Ken Oshman

I don’t know, is there an important reason to the webcast, Chris.

Chris Stanfield

Yes, I think it’s just a cost issue in the sense that we put the presentation themselves up on the web before we give them and the way that those things typically works is you race through that presentation. I think the last one that Ken did, he was given like 10 minutes to get through it, but what we do is we actually put the presentation upon the web, but the companies, typically we have to pay for that.

Ken Oshman

Actually I am glad we didn’t webcast it, because some of my friend say it wasn’t my best presentation and so I’m not proud of the presentation, but I am proud of the information in the presentation which is on our website.

Operator

We’ll here from Roger Stone with Stone Enterprises. Mr. Stone if you are still online, your line is open. Hearing no response we will go back to Michael Carboy.

Ken Oshman

Okay operator, I think we’ve been at this for about an hour, so if it’s okay I think we ought to take this question and maybe one more and then end the call.

Operator

Sure, no problem and please go ahead Mr. Carboy.

Michael Carboy - Signal Hill Investments

Thank you for the follow up. Ken or Chris could you elaborate; it looks like NES was kind of running at a break even basis this quarter and would we look at the differences in the sort of run rate break even cost for NES compared to a year ago as being the benefit of some of the migration on to generation two or am I overstating things?

Chris Stanfield

Michael, did we have product lines? I honestly do not know the profitability of NES if your thinking of it like that we don’t have an NES division and so I think as you appreciate for instance in an engineering area, we have engineers who are one moment are working on an NES problem and other moment helping an LWI application and so al that I can sort of surmise are the direct costs in manufacturing of the products and that everything else is just allocation.

Ken Oshman

I would say Michael that at a gross profit level, I mean from month-to-month we see what our costs are of manufacturing a product and we know what our sales prices are and I can just tell you that - I mean I hate to tell you because it’s not an easy answer, but the answer is that the gross margins are pretty much all over the map and we have all old contracts that we are shipping, old products to and we have early pricing that was trying to get us started and then we have later pricing at different points, so it’s all over the map.

In general, our costs will go down when we can do this thing that are up skies would like in that’s making 10,000 meters for this guy every month and 20,000 for that one every month and when the volumes go up, that will drive down the costs in our factories, there is no question about that.

At the same time, we still are seeing the one that is very strong which continues to gain strength against the dollar, so that doesn’t help our costs and the materials that go into these meters, the cost of those materials are not going down they are going up, the copper, the plastics and so on. So, while our new designs are probably the simplest, most straightforward and most reliable way of driving down costs, as we do that, as get these new designs, we got the headwinds of one, costs and commodity prices that are hitting us. Right now what we’d really like is to be shipping a few million meters a year.

Operator

And gentlemen, there are no further questions. I’ll turn the conference back to you.

Ken Oshman

Thank you very much operator and thank you all for joining our call today. We appreciate your interest and your support. Thank you.

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Source: Echelon Corporation Q2 2008 Earnings Call Transcript
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