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Echelon Corporation
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By howardroark
January 18, 2002

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trenchrat said:

gonna need some help here...if you have the time...how much of this is really sustainable?...and how much is a one time shot in the arm...only recurring rev growth can sustain a stock price...so looking for answers where they might be.

That's an important question without a certain answer. As you probably know, Echelon revenue growth this year was driven wholly by the Enel deal. The initial Enel deployment should be good for ~$300mm in total revenues, which will only support a three year stream. When the initial 27 million home deployment ends, there are three potential sources of recurring revenue. This first is meter replacement, since meters have finite lives and new Echelon product will likely be covered based on the operating meter replacement cycle. That stream is difficult to quantify, but it will inevitably lower than the ramp-up stage. The second and third potential sources of post-deployment Enel-related revenue depend on the uptake of value added services by customers in Italy. Since Enel plans to offer more than simply meter-base network automation to customers, there is significant (but highly uncertain) potential to sell additional Lonworks services through to the user. Those services would generate revenue both by increasing Enel's investments significantly (required to offer additional home automation) and by directly increasing the number of nodes in the home. An example of the latter requires OEM participation, and one early good sign has been Merloni's expression of interest in manufacturing Lonworks-equipped white goods as a potential value added addition to the Enel deal.

Unfortunately, there is unlikely to be visibility from value added uptake for some time, as the companies (Enel and ELON) will inevitably be focused on the core energy deployment for some time to come. Obviously, it's an important thing to watch out for, and while a complete drying out of Enel revenues are unlikely due to replacement cycles, value added uptake is critical for the stream to truly recur in proportion (or greater) to its ramp up rate. Of course, all of that ignores additional deals that might develop along the way, which is a key (the key) component of Echelon's game plan.

The service agreements that ELON has do not have a very good margin of profit built into them? If so, do you find that unusual? Is it the norm? I really do not know the answer. Did they make the agreements such in order to "win" the business in the first place?

The "services" portion of Echelon's business are being phased out and are virtually immaterial (1%). Services are primarily training and support, and Echelon is in the process of trying to farm as much out as it can. It almost has farmed out all of it. Thus, service costs, as an immaterial and fading portion of the business are less important going forward than product costs, which now make up 99% of revenue.

Also I am assuming that you mean if the service margins had been better that the gross also would have been more than a "slight upside?"

No. Like I said, service margins are basically irrelevant. I only pointed them out to note that product margins, which are the important line item, were slightly higher than overall margins, and thus the upside surprise was just a fraction better than it seemed from the raw Gross Margin line.

Does 6.2 turns a year translate into something I can get a hold of? Does this mean that inventory that is "Current" gets moved in and out of the "Warehouse" 6.2 times over the course of the year? If so......... is this a good number? If it means something else would you extrapolate for me if you get the time? If that is what it does mean, then is there a difference for "turns" within other businesses? I mean does TORO expect to turn 6.2 lawnmowers per year? I think I just need some clarification of terminology. Still I know I am beholding to you for the answers. Are chips turned faster than LONworks, or lawnmowers, or lawn chairs? I really would like a frame of reference for my peabrain.

Could you repeat the fourth question? I nodded off for a minute. Seriously, inventory turns is a straightforward metric. It tells you how many times you would turn over your entire inventory in a year, if an entire year resembled the period you are analyzing. The strict formula for a quarter is (Cost of Product Sold * 4) / Average Inventory Outstanding). Note that my 6.2 turns number was for quarter ending inventory rather than average inventory, which I sometimes prefer to use in this case for reasons that would make me nod off again if I explained further.

As to how to evaluation the number, there is no absolute benchmark, save for the relative benchmark of the company's own past experience. The best rule of thumb, and rules of thumb are themselves limited, is that a companies inventories should not grow much faster than its sales. Ballooning inventory is sometimes seen as a sign of potentially disappointing demand (ordered more than was purchased) or potential earnings management (b/c of the way inventory is run through the COGS line). The other part of inventory, besides being a potentially negative signal, is that they actually reflect a cost to company, insofar as capital is committed without generating returns (i.e. cash interested is forfeited and inventory doesn't earn interest).

I'll try to give some color to standard inventory turns, but I can only generalize. A good discount retailer (WMT, TGT) might turn inventory 6 times a year. Some models destroy this (COSTCO) and some can't keep up (Kmart). Another group that might average 6 times a year is the typical consumer non-durable brand, like Coke, Wrigley, Kellogg, etc. But you really need to understand your specific business to make a judgment. For example, it's not unusual for some semi-conductor related companies (Vishay) to turn inventories much slower (Jabil Circuit) than others. Deer & Company turns inventory around 7X a year, while Caterpillar only gets 5X. Like any metric, it's more important to understand why you are looking at it in the context of the individual company than to spend too much time benchmarking. Are you worried that management has bought more than it can sell next period? Is management consistent in its inventory management policies?

I think I will just ask what I even think I have a clue about. Hmmmmmmmmmmmmmm DSO???.......... Days Scarlet Ovulated??? Heck I just get lost with some of the Abbreviations. The concepts I will finally get a hold of. Hey I promise if I learn it from you I will pass it on to others when the time comes. Okay?

Days Sales Outstanding. This tells you how many days, on average, it takes customers to pay for their orders. Officially it's (Accounts Receivables / (Revenues/# days in period)). Bloating receivables may indicate a risk that you are selling to poor credit customers, collecting poorly, losing bargaining power in the supply chain, or, in some cases, stuffing the channel to boost revenue.

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