Itron Inc (ITRI) 2002 Q4 法說會逐字稿

Good afternoon, and welcome, ladies and gentlemen, to the Itron fourth quarter and year end 2002 earnings conference call. At this time, I'd like to inform you that this conference is being recorded, and that all participants are in a listen-only mode. At the request of the company, we will open the conference up for questions and answers after the presentation. I will now turn the conference over to Ms. Mima Scarpelli. Please go ahead, ma'am.

Thank you. Good afternoon. Thank you for joining us. Itron's management team participating in the call today, in addition to myself, include our Chairman and CEO LeRoy Nosbaum, our CFO Dave Remington and Rob Neilson our President and Chief Operating Officer. Dave will start the call with financial details for the fourth quarter and full year 2002. Rob will spend a few minutes talking about our acquisitions over the last 12 months, the three we completed in 2002 as well as the recent acquisition of Silicon Energy. LeRoy will have some additional remarks about 2002 as well as our expectations for 2003. We expect our comments will take about 30 minutes and we will have a 30-minute Q&A session at the end of the call.

Please note that our press release includes information about Itron's future expectations in the business outlook section. In addition, we will be providing further details on our expectations during the call and likely in the Q&A session, as well. Expectations about future financial and operating ruts are forward-looking statements. The forward-looking information we are providing is subject to a number of risks and uncertainties such as the timing of customer orders, our ability to achieve projected financial targets for acquisition, the inability to predict the outcome of the appeals and negotiation efforts associated with litigation, and the number of other factors which are described in greater detail in our 10-K for the year ended December 31st, 2001 and in our form 10-Qs for 2002 which are on file with the SEC.

This forward-looking information is being provided based on our expectations based on today, February 5th, 2003. As a reminder, Itron does not undertake any obligation to update or revise any forward-looking statements although we may do so from time to time. I would like to turn the call over to our chief operating officer, Dave Remington.

Thank you. Good afternoon, everyone. As our press release indicates, we delivered record-setting financial performance in 2002 for revenues, gross margin, earnings per share, cash flow, and a number of other key operating metrics. By the numbers 2002 was certainly a great year as it was in many other ways, so now let's go through the details of our financial results. Revenue for the quarter were 77.3 million, a new record, and we're 20 percent higher than fourth quarter revenues last year. Backing out 2002 acquisition revenues of 4.5 million, comparable fourth quarter growth was still quite strong at 13 percent. On a sequential quarter basis, revenues grew by 4.2 million for the prior quarter. Approximately half of which was related to fourth quarter acquisition.

For the full year, revenues were 26 percent higher than 2001. And at 284.8 million, a new record. Excluding revenues of 11.2 million, year-over-year revenue growth was still very good at 21 percent. Domestic revenue growth for 2002 was much higher, 35 percent and was driven by strong demand by amr systems and all of our domestic segments, electric, natural gas, and water and public power, which grew individually from 29 to 41 percent year over year.

For the last two years, Itron had a very steady 35 percent market share in terms of amr meter module shift in the U.S. and Canada. We shipped 3.7 million amr meter modules in 2002, 27.6 percent more than we shipped last year. And because of this, we expect our market share to increase to around 40 percent. Shipments through our indirect sales channel, which includes meter manufacturers and distributors grew from 32 million to 47 million, representing about 17 percent of revenues. Somewhat offsetting good domestic performance, international revenues of 13.6 million were roughly half of what they were in 2001. Of total revenues, 68 percent came from hardware and ancillary software sales with the remainder in services and software sales. This figure was 64 percent in 2001, so 2002 was somewhat higher.

Strategically, we are not targeting any particular desired mix of hardware services and software. Although, we do want the mix to shift to software and services. Instead, we are pursuing our strategy of providing products and services that optimize the delivery and use of energy and water. Out of that pursuit, will come a requisite mix of products and services, which we believe over time will increasingly result in a decline in hardware revenue as a percentage of total revenue. In 2003, we expect largely due to recent acquisitions, the percentage of hardware and ancillary software to come down by two to three percent, with the silicon acquisition, decline will be more.

Looking at our customer concentration in revenue, it was about the same year to year. In 2002, the top 10 customers accounted for 45 percent of revenues compared to a different top 10 customers that comprised 42 percent of revenues in 2001. We booked 61 million in new orders in the fourth quarter, and as expected, that was down from the record 87 million in the prior quarter, but up nicely from the first and second quarter bookings of 38 million and 45 million. For the year, bookings were 231 million, about 5 percent less than 2001's244 million. However, we'd like to point out that 2001 bookings included 53 million from one customer and by comparison, the largest single customer booking in 2002 was much less 29 million.

Back log at year end was 197 million, compared to 208 million in 2001, and it came down slightly from the prior quarter's 200 million, which we expected given unusually high bookings in Q3. Our 12-month backlog, or that which will be shipped in the following 12 months was 100 million at year end compared to 115 million at the end of 2001. In backlog at year end, we had 179 customers represented as compared to 163 customers at the end of 2001. That is, the number of total customers in backlog increased meaningfully about 10 percent for greater diversification.

As a reminder, backlog is not a complete measure of our business and pertains only to manufactured products and associated software and services, such as installation services. Software only sales tend to be book and ship business, so that at the end of an accounting period, little to no software backlog exists for software-only orders. Also not included in backlog are booked contracts for maintenance, joint pool use and other services, which we estimate will result in about 45 million in revenue in 2003. As we looked to the pattern of backlog and bookings in 2003, we expect a similar pattern. We look for backlog to decrease in the first half of the year and bookings typically are lower and increase in the last two quarters when new order bookings are typically stronger.

Turning to our gross margin, it came in at a record, as well, 47.6 percent for the quarter, up sequentially from 47 percent last quarter and up a substantial 2.5 points from the gross margin of 45.1 percent in the fourth quarter last year. For the full year, the margin was 46.4, up three full points over 2001. In both cases for the year and a quarter, the improvements reflect higher manufacturing, improved processes, lower component costs and supply chain management efficiencies. Turning to operating expenses, we would first like to point out that for the quarter and the year, they include three unusual items. They are an international restructuring charge in Q4, a non-cash and process R&D write-off and adjustment in the first two quarters and the Benghiat (ph) litigation, details are in our press release and they total 17.7 million compared to a benefit of 1.2 million in 2001.

Also of note included in operating expenses is a fourth item, intangible asset amortization. We had increased asset amortization expense in 2002 as a result of the three acquisitions we completed in 2002. Excluding the unusual items just mentioned and intangible asset amortization, pro-forma operating expenses for Q4 were 26.5 million, 6.5 million higher than the fourth quarter of last year and 2.2 million higher than in the previous quarter of Q3. Similarly, pro-forma operating expenses for the year increased 22.3 million to 94 million. Perhaps more importantly as a percentage of revenue, pro-forma operating expenses for Q4 and the year were 34 and 33 percent respectively, which are three and one percent higher than the year before. These increases in dollars, as well as percentages, are mostly due to our acquisitions.

On a somewhat separate and different comparative note, we had legal expenses during the last quarter related to the Benghiat (ph) litigation proceeding the equivalent to one cent earnings per share, and that's in addition to the accrual of 7.4 million. Pro-forma operating income grew to 13.4 percent of revenues up almost two full points over 2001. Turning to interest and other net for the fourth quarter and a year, the figures were income figures as opposed to net expenses in 2001. The two main reasons being a conversion of our subordinated debt, just a bit over $50 million during April and May of 2002 to common stock and a one-time gain from the sale of our Raleigh facility in the second quarter of last year.

Turning to net income and earnings per share, pro-forma net income which excludes four items, IP (ph) R&D, intangible amortization, restructuring charges and credits and the Benghiat (ph) was 6.5 million, up slightly from last quarter, but significantly up from 4.9 million in Q4 last year. As a percentage of revenues, pro-forma net income was 8.4 percent, up from 7.5 percent in the fourth quarter of last year. For the full year, pro-form Ma net income was 24 million, a very, very good increase of 10.4 million over 2001. The pro-forma net income margin for the year was also 8.4 percent, up from 6 percent last year. Also, a very, very good increase.

EPS numbers reflect good growth, too. Pro-forma earnings per share were 30 cents for the fourth quarter, up from 26 cents last year and full-year pro-forma EPS was $1.12 for 2002, slightly higher than the range of $1.06 to $1.10 we estimated last quarter and 47 percent higher than the 76 cents pro-forma EPS for 2001. Turning to our balance sheet and cash flows, our operating cash flow during the quarter was very strong. 16.4 million, bringing total cash flow from operations for the year to a record 49.2 million. 52 percent more than we generated in 2001. Cash investments were 32.6 million at year end, which is down approximately 10 million from a year ago. However, during Q4, we used 21.2 million in cash for two acquisitions and for the year, we used 43 million approximately in cash for acquisitions and 12.6 million to repurchase common stock, a total of almost 56 million.

Accounts receivable DSOs improved to 62 from the prior year end amount of 69. And inventory turns were better at 5.4 for the quarter, compared to 4.5 for the prior quarter and 5.1 in the fourth quarter a year ago. Pro-forma EBITDA, which factors out the same items as we do for pro-forma net income, was 48.8 million for 2002, a substantial increase over 35.2 million for 2001. In summary, our record financial performance this year is the result of upward momentum across many fronts. That activity, of course, lays the groundwork for the further execution of our strategy, further growth, and yet more financial records. I will now turn the call over to Rob Neilson, our president and COO.

Thank you, Dave, and good afternoon, everyone. I had a very busy week the last few weeks in Raleigh and Alameda. But I'm excited to be here with you today as we bring new synergies together to achieve our vision. As mentioned, I will focus my comments today on what we are trying to achieve with the acquisitions we have completed over the last two year, and are in the process of completing currently. Let me first start with the statement of Itron's vision, which is to optimize the delivery and use of energy and water. We do that by leveraging our core competencies of providing products and services for advance meter read and our rich history of marketing and selling to electric, gas, and water utilities worldwide. We are accomplishing our vision through two ways, internal development of new products and services and through acquisitions and strategic partnerships.

Following is a recap of the acquisitions we completed last year. During 2002, we completed three acquisitions, which expanded Itron's capabilities to include software tools and services that enable energy delivery providers to more optimally design new transmission and distribution infrastructure and to analyze and rebuild existing TND (ph) infrastructure. Automated work force management software for streamlining and automating many of the processes associated with utility field service work orders, and forecasting software and services to help our customers avoid unnecessary infrastructure buildouts, predicted retail demand to defer capital spending when it isn't needed and accelerate capital expansion when it is. On a combined basis, they produced just under $12 million in revenues for the portion of the year they were a part of Itron. And as we all know, they were dilutive in 2002. In 2003, we look for those three pieces of our business to grow and begin to contribute positively to our bottom line. More importantly, these acquisitions bring synergy and progress to Itron's vision and our core business.

Now, let me switch and spend a few minutes on the acquisition of Silicon Energy, which we announced two weeks ago and are in the process of completing. This acquisition is our latest step and the most significant move we have made so far in terms of filling out our vision. Full optimization requires tools that deliver information about energy and water usage and tools that manage usage. Meter data and interval data need to be consolidated into a data base that feeds all other systems that make use of the data to operate other parts of the energy and water marketplace. This is not just a meter data base. It must include utility infrastructure information, such as, assets, load, temperature, and numerous other items. This data then needs to feed not only other systems and groups with in the unit, but other market participants, as well.

Generators, public utility commissions, end users and others. As we have called on utilities over the last year, it is clear that the number one value proposition a utility is looking for is technology and services that help them reduce their operational costs and reduce risks. Silicon Energy brings to Itron the opportunity to create this critical, integrated offering that will uniquely position us to help utilities optimize management and to optimize operations throughout the utility making them more efficient and cost effective while reducing their risks. Some of that integrated offering will be available on day one. And some will be developed and become available over the next few months and years through future development, partnerships and integration.

Over the past month, we've been working on the creation of a new Itron product group called energy management solutions. This group will include Silicon Energy, (inaudible) our forecasting group in San Diego, and restructured and downsized software operations in Raleigh. Product integration strategy work has already begin in the Itron teams are excited. In addition to great technology with the acquisition of Silicon Energy, we move into a new market, that of selling to end user customers. A few examples of end user customers that Itron has now added to its portfolio include general electric, Ford Motor Company, Safeway, along with universities and government entities. We will now bring energy and water usage benefits to these end user customers saving them money on their utility bills while improving their operational efficiencies. Let me close with some key thoughts about each of our four acquisitions. All of these companies are best in class businesses and solid investments on their own.

However, even greater value and opportunities will result as we start to realize synergies from combining these acquisitions together with Itron's data collection hardware and software technologies, our industry partnerships, sales channels, and customer relationships. With our acquisitions, we are trying to build a series of products and solutions that fit together and over time will lead to a more integrated operation for our customers and their customers. With these acquisitions, we now have solutions in the utility and end user spaces to cover energy on water budget dollars wherever they are available. Each of the acquisitions we have announced so far is strategically aligned with our vision, our core business, and our culture of innovation and customer focus. Each of them is a known quantity as we have had experience with all of them in the past. They all bring to Itron some of the best minds, subject matter expertise and management talent in the industry.

Over the last year, we have been building a vision to optimize the delivery and use of energy and water. With the addition of Silicon Energy, we bring our vision to life for our customers. A value proposition that extends from the supplier of energy and water all the way through the end customer. And now I'd like to turn the call over to LeRoy for some additional comments.

Thanks, Rob, and thank you all for taking the time to be with us today. As you have heard from Dave and from Rob, 2002 is an incredible year for Itron. As a result of our financial performance and our acquisitions, we're a very different company today than we were just a year ago. We are bigger with new customers and new markets. We are stronger with new capabilities that give us fresh opportunities with our existing customers and markets. We have done a lot, though the industry we serve has been markedly affected by the general malaise of the U.S. economy. Many issues have helped accelerate a shift to a new efficiency-based paradigm and cast the spotlight on the pressing needs that Itron is able to fill, lowering cost, increasing efficiency, reducing risks, making people more productive. Let me begin today by talking about 2003 and Itron's perspectives.

As we said in our press release, we're looking for revenues in a range centered around $335 million, a 17 percent increase from '02. A 17 percent increase, even as we factor in some continued weakness in the overall economy and the tough capital constraints and tight budgets that many of our energy and water customers face. Put some detail on '03 and our electric business unit, we're looking for growth of 20 percent. Not the 37 percent we saw from '01 to '02, but growing and only one big order away from very exciting growth. In our water business unit, we look for growth of 17 percent coming -- seven percent rather coming off the year of 29 percent growth from '01 to '02. Together, a realistic rate over two years. We look for our gas business unit to be essentially flat '02 to '03 after growth last year of 42 percent. At its current level, we're very happy with this business.

In international, we look for 12 percent growth in '03. As we have said in our press release, we look for $15 million in revenue from Silicon Energy for the part of the year we owned them. Net, we're projecting an Itron revenue increase of 17 percent from '02 to '03 following '01 to '02 growth of 72 percent. We believe this more modest projection is in order given the state of the economy and the conservative capital spending on the part of utilities. From an overall amr perspective, including Itron and all others, we look at the '03 market as being more in the normal range of 10 to 15 percent growth following years of 30 percent and 25 percent growth in '01 and '02 respectively. If you look at those years, you see National Grid, an Itron project and Pennsylvania Power & Light, a DCSI (ph) project, causing out of the ordinary growth rates. We believe 10 to 15 percent is good growth in '03 for the overall amr mark, and Itron should hold our share in the 35 percent range.

In the other part of our business, non-amr sales, we look to increase from $50 million in '02 to $65 million in '03, a nice 15 percent increase on a normalized basis adjusting for partial year ownerships. Given the softness in the '02 software and service markets 15 percent growth in '03 is something we feel very good about. We are projecting earnings for '03 of $1.20 to $1.25 on a pro-forma basis coming off $1.12 for '02. Inside that number is an acknowledgement that the great gains in hardware margins along with operating efficiencies, we've been able to affect over the last several years are behind us. We will continue to improve, but on a more moderate basis in '03.

As we look to the future, gains in software sales with their inherently larger margins along with steady growth and amr hardware will continue to push our earnings numbers higher. We're particularly encouraged by prospects for 2004 as we believe '02 and '03 are years where utilities are regaining their health and getting back to the basics of running the utility. As well, we believe Itron's value proposition is approaching the sweet spot in terms of what the energy and water industry will be focused on in '03, '04, and the years beyond. So the question comes, how do we know that? Obviously, we call on our customers every day not only selling a product but talking about future direction. Others do, as well.

And what I would like to do now is give you a few passages out of the meta. A group's recent update report on energy industry I.T. trends for 2003 and 2004. In the generation area, meta projects renewed focus on enterprise management resulting in an increase of 4 to 6 percent and total IP (ph) spending as energy companies invest in optimization and enterprise-esque technologies. One of silicon energy's value propositions. Meta thinks that transmission will also see an increase in I.T. spending in '03, growing from 4 percent to 8 percent as energy companies invest in metering, work and asset management, business analytics and other information intensive energy technologies.

Again, another Itron acquisition come out to play, Mindsoft, which we call transmission and distribution solutions. As well, we can inject Silicon Energy's value proposition and that of our energy information systems group. Meta projects that I.T. spending in the distribution area will grow from 10 percent to 12 percent of total I.T. spending. There's distribution drives toward optimization with investments in work and asset management, mobile commuting, business analytics, and here again, silicon energy and tds, but as well an exciting opportunity for our recent e-mobile data acquisition. Meta believes that during '03 and '04, operating efficiency will be driven by regulatory mandates, a need to improve business performance and a need to improve asset performance. Encouraging I.T. investments and asset management, reliability-centered maintenance and crew scheduling as well as enhanced forecasting and planning capabilities.

Once again, Itron to the rescue with value propositions from both our traditional businesses and our new acquisitions including RER (ph), the forecasting group. Throughout the meta report, you hear two major themes. Operational efficiency and increased analytics. Itron came into 2002 with an offering that began to provide these major themes to our customers. With the acquisitions we made in the silicon energy acquisition we plan to close shortly, we are adding additional strategic assets that give our customers opportunities for even greater operational efficiency, increased analytics, risk reduction, and the knowledge to shape their future.

Some have questioned the 71 million plus purchase price for silicon energy. Based upon $19 million to $20 million for revenues for '03, a nickel's delusion in '03 and a forecast of accretion not occurring until '04. Itron's view of silicon energy was not an '03 view. It was a view highly consistent with the comments I just shared from the meta group with whom we have talked about the silicon energy acquisition. It was a few consistent with their similar comments from another highly respected industry consultant team. It was a view with the knowledge that three of the country's more significant utilities had said to us, you are going where we are going. When we showed them the vision of Itron with silicon energy, and our view of what the energy and water marketplace of the future should look like.

We don't think 71 million was too much to pay for this great company, great management team, great people, and a very exciting future when combined with Itron. Let me close with some thoughts about direction. In a perfect world, our stock price would reflect our exceptional performance and prospects. We all know we don't live in a perfect world. I can tell you across this company every day, employees continue to work very hard. They work very hard to bring the value of this company to where it belongs. We do that by generating increasingly good bottom line performance, having shown 12 quarters in a row, meeting or exceeding our own expectations as well as those of our analysts. We also do that by growing the company non-organically by acquisition and through partnerships.

Our goal is to grow the company not with the utility industry of yesterday or even today in mind, but we look at the energy and water marketplace of tomorrow, including its end users and build an Itron that can capture value propositions that resonate with that industry, both tomorrow and for years to come. We have made software and service oriented acquisitions in the last year. Four of them, acquisitions that build for the future consistent with the energy and water marketplace of the future. Some of these acquisitions will begin to bring a brighter future immediately. Others will take time. Time for markets to develop, time for the economy to turn around, and time to technically combine a variety of new value propositions that, together, these acquisitions bring to Itron and to our customers. Thank you for your attention today. Thank you for your continuing support. Back to Mima.

Great. LeRoy, Dave and Rob, thank you very much. We're going to start the question and answer session of the call. I would just like to ask that given the number of participants on the call, for those of you who do have more than one question, if you could limit your initial questions to one or two, and then jump back into the queue, we would greatly appreciate that to make sure everyone has a chance to ask questions. Tom?

q-and-a

Thank you. The question and answer session whether begin at this time. If you are using a speaker phone, please pick up the handset before pressing any numbers. Should you have a question, press star one on your push button telephone. If you wish to withdraw your question, press star two. Your question will be taken in the order that it is received. Standby for your first question. Your first question comes from Bill of Davidson Investment Advisers (ph). State your question.

Given that you limited me to one or two. I will start with gross margin. Last quarter, I believe you folks had said that gross margin would most likely be below the third quarter level. In fact, it appears that gross margin increased in Q4 versus Q3. What was behind the better than expected performance?

Bill, this is Mima, when we gave that guidance, we were looking for international revenues to be a bigger portion of revenues during the quarter, which they were. However, we didn't have quite as low of growth margin on those revenues as we expected. As well, we continued to see a great stride in the factory, in terms of material costs, efficiencies and had slightly higher margins there than we had planned.

If I may, just one other. The general and administrative account was $9 million, or line item $9 million in Q4, versus 6.2 million in Q3. Would you walk us through where that jump-up in costs came, please?

We talked about it generally on the call with regard to all operating expenses, increases quarter to quarter are substantially due to the two acquisitions that we closed October 1st, at the beginning of the quarter, the very first day of the quarter and both on a dollar and percentage basis. Most of the increases are due to acquisitions. They're either directly due in that in the department that comprised of acquisitions picked up those costs where they didn't exist before and also indirectly in that there's a lot of support parts in this organization that have extra activities because of those acquisitions.

Bill, I would add as Dave mentioned, we did have higher expenses during the quarter associated with the Benghiat (ph) litigation.

A penny that I mentioned approximately.

Great. Thank you both.

Your next question comes from Paul Coster from J.P. Morgan. Please state your question.

Yeah, quick one on cash flow outlook for '03, please. Dave, I wonder if you could just the debt you're taking on with respect to the Silicon acquisition. Can you just give us a sense of what's going to happen on the cash flow side? What the balance sheet will look like at the end of the year?

Well, we expect cash flow to continue to be strong going forward basis, and we expect cash flow to be higher than it was in 2002. With regard to the capital structure part of that question, we believe that the $50 million of acquisition debt aim advertised over three years is well within the capabilities of normal ratios our cash flow generation. If you look back to December of 31 of '01, we have 64 million of debt, including 53 million of subordinated death debt. We converted that as we noted. We had a large book that we paid without the new 50 million of debt, we have about 5 million of project debt. So that projects us to 55 million. So on a year-to-year basis, we're actually down 9 million in total debt. But we think we have some modest capability for increasing debt beyond where we are now, but we do not have plans to do that presently.

: Is the stock buyback program completed?

We have -- Paul, it's LeRoy. We have authorization from our board to purchase one million shares back should we feel the need. We currently do not have a program in force after redoing that. We watched the stock price where we can see a precipitous fall, and we thought a buyback program would help either reverse that or at least slow it. We put one in place, but we don't have one today.

You can do that?

Without any additional approval.

Last question. Capacity constraints, are there many on the manufacturing side of things?

No. We've got about another 15 to 20 percent uptick that we can do in our existing factory without any particular nasty ads of capital, as well about a third of our product line, we could take outside if we wanted to, so we are not in any way capacity constrained.

Great. Thanks. Congratulations on the quarter and the year.

Thanks, Paul.

Your next question comes from Steve Sanders of Stephens Inc.

Hi. Good afternoon. A couple of questions on Silicon Energy, I guess, we'll call this one question, but it's kind of a series. I wanted to see if you could comment a little bit on the quarterly build throughout the year on the 15 million you're expecting. Maybe give us a little detail on license sales versus service and maintenance, whether your initial focus will be more on the utility side and then just kind of a general comment on the Silicon Energy pipe line today.

Sure, Steve. This is Mima, let me start. If you look at the quarterly flow of silicon energy revenues, we expect a similar pattern to what Itron has traditionally seen where revenues are slower in the first quarter and pick up in the last half of the year. In terms of how much of software license versus service, it's close to 50/50. About 50 percent of the revenue is software license and about 50 percent service. What else did you ask, Steve?

Whether your initial focus was going to be more on the utility customer rather than the C&I (ph) customer, which is somewhat of a new market for you guys.

Steve, this is Rob. Actually, there's going to be equal focus on both segments. There's a sales force and complete support team at Silicon energy that has been in business with the C&I (ph) market space, and they're armed and ready and charging ahead. We expect them to do about 40 percent of the revenues or so, and maybe 35 to 40 percent. The utility market space is also fully functional and running and we'll be combining the sales forces together with our business units and that should give them even more bandwidth and windage to get out there in the market.

Okay, and then in the quarter, could you just break out the line soft and revenues?

We're not -- I don't think we have that. Although, it's probably safe to say that they're probably about half and half of the 4 million that we listed in the press release of being acquisition revenue.

Okay, thank you.

Your next question comes from Jarett Carson of RBC Capital Markets. Please state your question.

Good afternoon. Two quick ones. On gross margin, once again, I know the first caller talked about tick-up this quarter versus down. You talked about maybe not seeing continued strong quarter over quarter improvement. Can we expect a level slightly higher or certainly higher than 45 percent for 2003? Do you feel that's achievable?

Yes, we do. In particular with the acquisition of silicon Energy, which is higher embedded margins with the nature of their business. The comment that I believe we made with regard to margins pertained to bringing out entire margins on the manufacturing side hasn't increased manufacturing on the manufacturing side. That doesn't mean that overall margins will be relative as to being better going forward, and we believe that given the increasing software and services nature of our business that we talked about, that increased margins going forward are in order.

Okay. Second question, on the international front, we talked a little bit about some major (ph) projects that might kick off, Latin America, Caribbean that may come to fruition in 2003 or even in Asia. Any additional update on that?

Yeah, Jarett, it's LeRoy. Pretty similar update as to last time. As we look out there, we look to Asia Pacific to begin coming alive in terms of amr potential as we look out into '03. We, in fact, have just had a bunch of people from headquarters out there assessing possibilities and we think, you know, as we look over '03 and '04, there's some exciting possibilities out there. The Caribbean, we're hoping actually for some orders as we look into '03 and we'll see where that goes throughout the year. As we've said before, one of the problems with particularly the Caribbean is depending on what the government is doing at any given moment, things can get pushed forward or delayed, and so we still think there's some good opportunities there.

Thank you.

Sure.

Your next question comes from Steven Colbert of JMP Securities.

Thank you. First of all, I think you said that the acquisitions that you made in 2002 were dilutive in '02. Could you put a number on that that delusion for last year?

We haven't put out a number on that, Steve. We're not going to.

Okay. Second of all, in terms of the non-utility customers of Silicon Energy, is it your hope to sell them a system tied into the mv-90 system that you're selling right now, or a different type of network at all?

No, actually, it sold the system solutions and there are numerous solutions for the end users, end user customers. First off, some of them do have mv-90s where we sell a solution together with the new mv-90 or an existing mv-90, that new solution coming from silicon energy coming on top of and using the mv-90 data and we use solutions that are stand-alone software products and services delivered to the end user customers, as well where a mv-90 may not be involved.

I see. Thank you.

Let me do an adder on that one. This is LeRoy again. One of the things that really we find attractive about the new value proposition at silicon energy is the capability to not only sell silicon products into that user community, but as well begin to sell some additional products that Itron traditionally has made and only sold to utilities, whether that be software or in some cases (inaudible) We're looking at that new distribution channel, if you will, that silicon brings to us as being very exciting. We'll have a better idea in a few quarters as to how exciting. We're encouraged about that whole new marketplace for us.

Is there a revenue approximation that you can give us a range on what that might be?

Are you talking about 2003?

2003 or 2004?

Not yet, Steve. A good question to ask. Keep asking it. When we're comfortable, we will try to bandwidth that for you.

Thanks.

Your next question comes from Steve Sanders. Please state your question.

I wanted to follow up on the kind of large amr order pipe line. These things are tough to predict especially in the last quarter, but I wanted to get a general comment from you on orders on the large side.

Sure, Steve. It's LeRoy. There's a handful of prospects that are being pursued. Some of them only by us and some of them by us and other competitors that we see across the '03 timeframe. Some of those will actually close. Some of them will probably melt and some of them will get pushed into probably '04, but we think there's a couple of opportunities at least throughout the year. You know, it's difficult to say timing on these, and we are reasonably, I think, being some conservative about '03 given where we sit with the economy and given the utilities still squeezing down on capital budgets, but there's some good prospects there for the rest of this year.

Dave, the tax rate looked a little higher in the quarter than I was expecting and has been recently. Is there any comment there?

It is because the overall tax rates will be a little bit higher due to international pre-tax income coming in differently than it was originally planned for at the beginning of the year in the budgeting process for adjustment quarter.

Is this a good fourth quarter rate going forward?

No. No. We think that a good rate for 2003 and going forward is a little bit lower than we ended up for the entire year, actually. Down around 37.5 percent.

Okay. Thank you.

Your next question comes once again from Jarett Carson.

Okay, thank you. Just a quick question, trying to -- you had a press release out before the -- almost before the close in regard to the hand-held meters and the litigation. Does that mean you're basically -- you would be freed up to sell hand-held systems without the threat of looming royalties between now and when that patent runs out in the middle of 2005?

Jarett, this is LeRoy. Yes, you're absolutely correct. We began immediately upon the nasty verdict, which we still disagree with and may take other action about, but we began an immediate work around so that we could guarantee a continuous flow of products to our customers and obviously guarantee a continuous flow of revenues and profit from that. So we will be able to ship those products toward the end of this month first of March, and very pleased about some seriously good work on the part of our engineers.

Okay. One other quick question on the financial side, Dave or LeRoy. Product development has been declining for the last couple of quarters and seems, in my mind, a little counter-intuitive in that you have taken on additional products. Where do you expect that maybe to kind of flatten out for '03?

Are you talking about dollars?

Just the overall dollars, yes. Kind of gone from 10 million down to 8.9 fourth quarter.

Jarett, I would say on a quarter-to-quarter basis, you know, a jumping around of about a million dollars or so is not unusual because we do use a fair amount of contract labor for our product development projects, so sometimes projects are starting up, sometimes they're finishing off, and sometimes there's an overlap, but in general, we would anticipate that R&D is going to stay right around the 13 percent level or maybe slightly less than that, you know, level that we've been running for the past year.

Thank you. One final point or question, and I think an important point being the new amr deployments (ph) or pilots, if you will, that you have started, and I believe for the year ended up 300 versus 200 last year. Can you give us a little color on -- is there one of these particular three segments that is showing more strength and why?

Yeah. I think we're seeing obviously quite a bit of strength in the water and public power segment. Where Dave talked about in his script that we have seen a nice increase this year in the amount of business that is coming through our direct channel, commuter manufacturers and distributors, so I would say there's probably a fair number of that customer increase that is coming from the water and public power channel.

Thank you.

Your next question comes from Patrick Boykin of Lauder Research.

Good afternoon. I was wondering if you could convert the pro-forma EPS guidance to GAAP guidance. LeRoy, I was wondering if you could compare, in contract perhaps, the silicon deal to the Line soft deal with expect to valuation, implementation hurdles and you know, the revenue shortfalls that you had with line soft.

Patrick, we don't have GAAP guidance as of yet for 2003. We're still finishing some valuations of some of the silicon energy technology that we're acquiring and what kind of amortization life it has, so as soon as that is available, we'll share it with everyone.

Okay.

Patrick, that was an interesting question. Compare silicon energy with line soft. Rob's got some thoughts on it. Let him start.

Hi, Patrick, you had about three questions embedded in there. One had to do with confidence. One had to do with price and how that was created and I will defer that one to LeRoy and Dave. The second one had to do with confidence and revenues and how that's going to look, and the third question had to do with integration incentively. First, on the two that I'll address are the revenue confidence and then the second will be the integration. On the revenue confidence, there's three things that contribute to us being confident in the revenue guidance that Mima has given.

First, they had some new products and particularly one called Dao (ph) that came out last year, and that new product is getting a lot of attention and interest by utilities. And so we're seeing that as being something that actually provides some uptick potential for where they're at. The second thing is that on the C&I (ph) end user market space that we have been talking about a bit more today, we see increased traction going on there, increased interest and increased results from the kind of savings that our customers in that area are getting, and these are large dollar savings as a percent of their overall costs in the energy sector.

And then the third is that as silicon energy increases its customer base, we see a lot of activity on follow-on orders. They provide an unbundled solution set, and each of the components of the utility and C&I (ph) customer might buy leads them to interest in other components that can be put together with the original component that they put in, so follow-on orders is the third area that gives us confidence.

Rob, before you move on, I would add to that that, clearly, one of the differences between silicon energy and line soft is silicon energy has a fair amount of booked backlog that they will bring to us at the time the acquisition closes. Very similar kinds of percentages to what we have here at Itron. When we did acquire line soft a year ago, we did not have much of booked business and much in terms of that kind of visibility.

On the integration question, that activity is much further along at that stage than we were with line soft. You know, we've been actually working with them and talking about partnering relationships and structuring with silicon energy for the better part of the year, and over the last three months or so, we spent quite a bit of time putting together a co-selling agreement with them to begin working in Europe and in North America together, so I would say that from a sales and marketing value proposition perspective, we're quite far along. From an organization standpoint, a lot of planning has taken place and you know, we'll be ready to move very, very quickly once the transaction closes on all fronts.

Patrick, let me add one comment to what both Rob and Mima said and then we will talk a little bit about valuation. If you reflect back to line soft's, the acquisition of line soft, I think it's fair to say that as we close that deal, we were on almost a ledge relative to utility buying in the I.T. area, and it precipitously dropped off. It wasn't just Itron that felt the brunt of that in terms of line soft I.T. and software sales. It was virtually everyone selling software to the utility industry, and did we miss the mark we had hoped for? My goodness, yes. We missed the mark.

I look at the time we're in now and the acquisition of silicon and the confidence that Rob expressed and Mima expressed that we certainly don't believe that we're about to hit another table edge and fall off of it in terms of I.T. spending and software sales. We feel pretty confident going forward, but I mean, if you are trying to get me to say that we blew it on line soft relative to expectations to revenue, we blew it on line soft relative to revenue expectations. They just weren't where we thought they ought to be and frankly, I was the guy that went out in the field and talked to both salesmen and customers, so I will take the heat for it, which my buddy, Mr. Remington, reminds me altogether too often, and I will now turn it over to him.

Sorry. With regard to price and valuation, we approached both situations, in fact, all four situations substantially the same or exactly the same. We look at a number of metrics. They're fairly standardized. We look at multiples and look at profitables, comparable public companies, how they're being treated in the marketplace and comparable to the Itron faction, and most importantly, we look at the net value present value projected after cash tax flows using the range of discount rates that are all higher than our estimated weight of average cost of capital. We think that is most important.

It is in a way an (inaudible) sort of calculation and it's designed to add to shareholder value. The processes that we went through in both cases were substantially similar. There, of course, was negotiation on price as well as other things, the price that we ended up with as well as the price asked for at the beginning. The due diligence was robust in both cases. In the case of silicon, the CFO said that the folks that we had hired were driving them crazy, but they for sure, if they were in the position that we were in a deal would hire, we knew both of them before and worked with them on some basis, so there was a degree of similarity, so I would say the two from a process and evaluation and M&A standpoint were substantially similar.

Dave, did you guys consider stock as part of the transaction here like you have in the past?

You know. We did consider stock, and stock would have been more than option. It's a $25 share than from where it is now. So we looked at that fact, and two, we looked at the capital structure and knew there was only 5 million of debt that we had a non-optimum capital structure from the weighted average cost of capital standpoint and the cost of capital debt and cost of equity. On a book accounting basis, structuring the deal had far less than of a dilutive impact as compared to having issued stock. In fact, the difference between having done an all-stock deal and somewhat higher stock price on $18 or $19, I believe it was doing the calculation versus where we are now, would have been 12 cents difference in EPS in 2003. All stock deals to the way the deal is structured right now.

Okay. Last question, I promise. So you're really looking at '04 for silicon to be accretive. Do you have a revenue target in '04 for that operation?

We are looking to are them to be accretive in '04. But no, it's just the start of February and '03, so we will share '04 targets for you as we get further through the year.

We don't have an internal target. Yes, we do have expectations, much discussed with silicon but not for external consumption at this time.

Thank you.

Your next question comes from Steve McNeil (ph) of SSRM (ph). Please state your question.

Good afternoon. Just had a question on win rates. Do you guys talk about that at all and perhaps how it's tracked over the year versus prior years?

Well, Steve, that's an interesting metric to look at. I mean, our win rates, quite frankly, are generally really high. They're really high because our market shares are high. They're really high because oftentimes, the bit of business we do is not shall we say bid against anybody else, so we are the sole supplier.

Let me just drill down a little bit. In a competitive situation, what would your win rate be?

In a competitive situation, my estimate for win rate is some place between 30 and 40 percent.

Okay. How is that --would that sort of be an '02 figure?

An '01 figure. It's an '02 figure, and I expect it will be an '03 figure.

I'm just wondering if you can help us understand with in the three different segments, electric, gas, and they wonder why the growth rate is expected to decelerate in '03 relative to '02 for all three segments?

Sure. A couple of things. If you peel back to any one of those segments, what you'll see is particularly in the gas area and the electric area, one big order can cause growth rates to just zoom north. If you look at national grid, as I mentioned, that caused growth rates for us and growth rates in the marketplace in general because they were such a big piece. At times, approaching 15 percent of our revenue.

And if you don't have one of those mega orders every year, you see a prep sip to us drop in growth rates, so from a --whether it's an Itron or a total market, we will be affected by that in '03 and on electric side, gas you see similar kinds of things occurring, and the water area, it's a little bit different because water tends to have more smaller orders and lots thereof. As we look into '03, we do a very bottom's up forecast. We had an incredible '02 in water area, and so now the numbers -- number's that much larger. To sustain that larger number, it gets more difficult.

Yeah, but we did also have a very large order on the water side, as well. A pretty large contract with the city of Houston that we're wrapping up, so, again, when we look at our 7 percent growth expectation for '03, while there are large orders out there, we haven't factored those in.

Lastly on the backlog, itself, has the composition of the backlog changed? I mean, you said, all right, well the water business has smaller orders and the number of customers in the backlog has increased, you know, low double digits year over year. Does that, therefore, mean that we can say, hey, there's more water business in the backlog versus what there was previously? Are the pieces of the pie differently now than they were last year, say?

The pieces of the pie if you look at last year versus this year and how it breaks out on a business unit basis, you will see a shift around, but nothing that I would call substantial. If you think about the water and public power business, there's a lot of business there that doesn't ever show up in backlog because it is shift through meter manufacturers, distributors and so we typically will get an order and ship against that order during the quarter, so it shows up in bookings, but not necessarily backlog.

Okay. Thank you very much.

Ladies and gentlemen, if there are any further questions, please press star one at this time. Once again, your question comes from Bill Bedevlon (ph).

Thank you. I have a couple of bookkeeping questions and one other. Line soft revenues that flowed through European l in 2002 were what? Second question, the warranty and other obligations category on the balance sheet went from 16.8 million in the third quarter to 21.2 million in the fourth quarter. Trying to get my arms around what caused that sequential increase. And then the third question, relative to silicon energy, they are a new or young company. What makes -- what gives them a sustainable, competitive position, and why is the feat that they recently accomplished, why is it not replicateable with enough money?

Let me take your acquisition revenue question. As we said in the press release, we had a total of 11.2 million in revenue from acquisitions during the year, about 9 million of that was line soft. So the balance of that coming from ...

Thank you.

I will pick up, Bill this is Rob. I will pick up with the question having to do with silicon energy competitive advantage and sustainability. The primary competitiveness is technology. They are implemented in a very advanced way, and you know, sort of grew up during the primary loans. (inaudible) And they are a fairly young company, but that results from having new technology that's really been put together well. Second thing is that the scalability of their product and the centering on this advanced data base technology that they have built is real exciting also, and it already builds and uses interfaces to numerous other company systems. I mentioned that they interfaced to the mb-90 already in about 20 utility cases but they also interfaced to other technologies, as well, and they have an open architecture, open architecture structure.

Bill, it's LeRoy. Let me do a tag on to that answer. Two things of note. Silicon has spent a huge amount of time and money interfacing to a variety of control systems throughout North America, whether it's a square deed, cutler (ph), hammer, and while anybody could do that with enough time and money, they've got it and they got it now, which makes their systems highly implementable at various commercial, industrial customers and useful for utilities, as well. Sort of last specific question you asked, it is possible to do what they've done given enough money?

Yeah, actually, the money for me would be less of a concern. Although, certainly one because you'd spend a serious amount of it. And it would be my guess today north of 40 or $50 million, but the time it would take to put that together would leave you in the dust of silicon, for one, and I suspect between now and then, some other people as well, so time and money would have been a serious burden where we would try to do that on our own.

With regard to the increase that you asked about, almost 4 million of the increase was long-term deferred tax liabilities as a result of the line soft and RER acquisitions. They are the result of values assigned to identify intangible assets under purchase accounting that will be aim advertised in future periods for book purposes, but not deductible for tax purposes. We also had a shift with regard to a couple of situations with regard to the long term versus the current portion of warranties extended, and part of the reason has to do with a water 18-year operations and maintenance contract where we added to our warranty for battery replacement that will occur roughly in years 12, 13, and 14 of that contract that we have had for three years now.

Your next question comes from Steven Colbert.

Thank you. I just wanted to ask also. It sounds like the nature of the amr market in 2003 might be one of smaller co-ops in the market, more than the IOUs (ph) perhaps. I am just wondering if there's a difference, generally, in the gross margins dealing with those types of customers as opposed to the large utilities.

Steve, I wouldn't have drawn the conclusion you did, that there would be more co-op. I think we will see some small customers, but you know, if you stack up 50 of them, you overwhelm them with one big order from an IOU. Is the margin significantly different? Well, if the order from an IOU is very large as it was from subway someone like grid or even Duke, clearly, those orders are large enough to drive margins down. It's just volume issues there. If you look at the smaller market, however, you have to realize that that goes through a distribution channel, so there's another person in the food chain, if you will, so the margin differential there tends to be di minimus.

I see. Thank you.

If there are no further questions, I will turn the conference back to Miss Scarpelli.

Thank you, everyone, for joining us today. We appreciate your time and attention today, and look forward to future conversations. Thanks.

Ladies and gentlemen, if you wish to access the replay for this call, you may do so by dialing 1-800-428-6051 or 973-709-2089, with an ID number of 281105. This concludes our conference for today. Thank you all for participating and have a nice day.