Itron Inc (ITRI) 2004 Q3 法說會逐字稿

Hello, everyone. Thank you for holding, and welcome to the Itron Incorporated Q3 Earnings Conference Call. Today’s call is being recorded. At the end of the call there will be a replay of today’s conference available by going to the Company’s web site at www.itron.com.

At this time, for initial comments I would like to turn things over to the Vice President of Investor Relations, Ms. Mima Scarpelli. Please go ahead, ma’am.

Thank you. Good afternoon, everyone. Thanks for joining us. With me here in Spokane today is LeRoy Nosbaum, our Chairman and CEO, Dave Remington, our CFO, Rob Nielson, our President and Chief Operating Officer, and Steve Helmbrecht, who is currently our Vice President of International but who, as we announced previously, will take over CFO responsibilities at the end of the year.

Before we begin today’s call, I appreciate your patience as we review our Safe Harbor Statement and program disclosure. Our earnings release today includes predictions and estimates about our future results. In addition, on the call today we will be providing additional detail and information that is forward-looking. The forward-looking information we are providing is based on our best judgments and expectations as to what the future holds, and is subject to a number of risks and uncertainties. In particular, I would point out that the timing of large customer orders has in the past resulted in differences between expected and actual results. There are numerous other factors that can cause our actual results to differ from our expectations, and you should review our 10-K for the year ended December 31st, 2003, and our Form 10-Qs for the quarters ended March 31st and June 30th in 2004 for a more complete disclosure of risk factors. Itron does not undertake any obligation to update or revise forward-looking statements, although we may do so from time to time.

Our earnings release today also includes pro forma information, and we will be talking about pro forma net income and EPS in the call. We believe our pro forma results provide useful information in terms of enhancing the overall understanding of our current and our future business performance. A schedule reconciling our GAAP to pro forma net income and EPS is included as an attachment to our press release, and is available on our web site.

I’m going to start the call today with a review of financial highlights for the quarter. After that, LeRoy will offer some additional details about our new electricity metering operation, and we’ll share some high level perspectives with you on actions taken this year to position the Company for improved profitability and growth. At the end of those comments, we will take questions.

Let’s now turn to a review of financial highlights for the third quarter. We did issue a fairly detailed press release today on third quarter financial results, and as such, I will not walk through each and every line item but will instead offer some additional perspective and comment on financial results where needed.

Overall, we are very happy with our results this quarter. While revenue came in a bit under what we had projected the overall profitability of the business was better. And as a result, we did do better for the quarter in terms of net income, EPS, and cash flow than we had forecast back in July.

Third quarter revenues of $122.5m are a new record high for us, and were driven by our new electricity metering segment. Electricity metering revenues were 54.2m or 44 percent of our total Company revenues during the quarter. I do want to point out that included in those revenues is some manufacturing support services that we provided during the quarter to a former affiliate of Schlumberger’s. We are phasing out of providing those services by the end of the year, so they will not be an ongoing source of revenues for us. Those revenues were roughly $4.2m in the quarter.

Clearly worth noting, however, is that the gross margin on those revenues was only about 4 percent, so there will be a very minimal impact on future net income from phasing out of those services. We did have some continued pushouts of large AMR orders in the third quarter. As a result, our meter data collection revenues which are largely AMR related were down in the quarter. However, I would point out that we did sign a large order in the first week of October, a $15m order with Xcel Energy which will contribute to increased revenues for this segment in the fourth quarter.

In our press release today we have given backlog figures for our traditional businesses, meter data collection and software, and for our new business, electricity metering. However, we are giving them separately as the nature of the order patterns in each is a bit different. For AMR software we get contracts or purchase orders that represent firm orders to be delivered over specified timeframe. Some of those extend beyond one year, which is why we report both a total and a 12-month backlog figure for those businesses.

Order flow in our meter business is a bit different. We have numerous situations where we reach agreements with utilities for their expected meter purchases, and in many cases those are for periods of several years. However, we do not treat those as backlog as they are not firm commitments at the date of those agreements. Instead, we track purchase orders received against those agreements, which typically represent expected shipments over the next quarter, and sometimes a bit beyond that.

In total, when you add together AMR, software, and meters, we have a little more than $100m in booked business at the end of September for delivery over the next six to 12 month timeframe. And as I mentioned earlier, shortly thereafter added 15m to that with the nice large order from Xcel Energy.

Pro forma EPS were 32 cents for the quarter which is a penny better than the third quarter last year, but which is a very strong increase over the 9 cents and 10 cents in pro forma EPS from our first two quarters this year. As noted in the release our third quarter GAAP and pro forma EPS were approximately 6 cents lower in the quarter due to the purchase accounting adjustments that affected finished goods inventory we acquired from SEM.

I want to point out a small change to our pro forma earnings calculation starting this quarter. We modified the pro forma calculation to exclude from earnings amortization of debt placement fees. As the amount of fees capitalized in connection with the SEM acquisition is significant, roughly $14m, and we believe our results without that amortization are a more meaningful measure of our business performance. Our GAAP to pro forma reconciliation lists all the reconciling items, and you can see that amortization of those debt placement fees was approximately 2 cents of our third quarter pro forma EPS. Our historical pro forma amounts have also been recalculated, although there was minimal change as the amount of debt placed into the amortization in prior periods was fairly small.

Our total Company gross margin for the quarter was 40 percent. There were a few factors in the quarter that caused that to be lower than it otherwise would have been. First, as I mentioned earlier we had 4.2m in revenue at roughly 4 percent gross margin during the quarter for the contract manufacturing services that are ending. Those are winding down and will be much less of a factor in the fourth quarter, and will be gone by the end of the year.

Also impacting margin in the quarter was the required purchase accounting write-up of the finished goods inventory we acquired from SEM. And that cost caused the sales in the quarter to be approximately $2.3m higher than it otherwise would have been. Adjusting for both of those items would result in a more normalized gross margin in the third quarter of approximately 43 percent compared to the 40 percent we reported.

We generated a little more than 20m in cash flow from operations during the third quarter, and that is up significantly from the 7m in operating cash flow we generated in the first six months of the year. Our strong third quarter cash flow driven by our improved earnings performance in the quarter, much of which is related to our electricity metering operations, and also by good collections of accounts receivable.

Our accounts receivable balances had been unusually high at the end of December and at the end of June due to the timing of shipments during the quarter. Shipments were much more linear in the third quarter which enabled us to generate cash as accounts receivable balances came down.

Our days sales outstanding or DSOs were 59 in the third quarter, compared to 58 in the previous quarter, 81 in the first quarter, and 69 in the fourth quarter of last year. So nice trend in DSOs over the last four quarters.

Inventory grew during the quarter by about 5m, and that was largely a buildup of gas AMR product. With the large order that we did get from Xcel Energy in early October we expect to begin working down our AMR gas inventories in the fourth quarter. Inventory turns in the quarter were 4.2 and that’s down from 5.1 in the previous quarter. Total property, plant, and equipment additions during the quarter were roughly 3m, resulting in free cash flow of about 17m for the third quarter.

Total debt at the end of September was approximately 303m, resulting in a debt to total capital of 62 percent. As we have previously indicated, the substantial use of free cash flow will be to repay debt. As noted in the release, we made a $10m optional repayment of our bank debt during the third quarter, and another $10m optional repayment in mid-October.

YTD cash flow from operations was 27.5m which equates to about $1.25 on a per share basis, and that amount is a little more than double our YTD pro forma earnings of 52 cents on a per share basis.

EBITDA in the quarter was 17.9m, and YTD EBITDA was 29.7m, and you’ll note that also included in the press release today is an EBITDA reconciliation schedule.

As we pointed out in the press release, we do expect to make some significant changes to the allocation of the 256m book purchase price for the SEM acquisition. We have recently received a more detailed and comprehensive valuation analysis that is based on new information that was not available to us prior to the July 1st closing.

The new analysis indicates that there will be some fairly significant adjustments to the initial purchase price including that we expect to allocate a much higher amount to intangible assets, and that will result in a lesser amount being allocated to goodwill. The higher allocation to intangible assets will result in higher intangible amortization expenses in future periods. We also expect to record some amount of in process R&D associated with the acquisition which we are required to expense. In our current estimate is that the IPRND will be somewhere between 5m and 10m.

The increase in intangible amortization expense and the allocation to in process R&D will impact our GAAP earnings and earnings per share but will not impact pro forma earnings or pro forma earnings per share. It will take us a few more weeks to complete our review of the new analysis, and we will plan on issuing an 8-K sometime in the fourth quarter with updated information on the allocation of the purchase price. And as noted in the release we expect that that reallocation will result in negative GAAP earnings and EPS in the fourth quarter, but again, will not impact fourth quarter pro forma earnings or EPS.

My last comment on financials has to do with an update on the status of our S4 filing. Last May we completed a private placement of 125m in senior subordinated notes. In early September we filed an S4 registration statement to exchange those notes for registered notes. We have received SEC comments in connection with that filing, and we are in the process of responding to those comments.

Based on the comments, we anticipate we will have some minor revisions, not restatements but minor revisions to several of our previous SEC filings. And the only change in substance we anticipate having to make at this point is a potential reclassification of prior period warranty from cost of service to cost of sales.

And that concludes our comments today on financial results. I will now turn the call over to LeRoy Nosbaum, Itron’s Chairman and CEO.

Thank you, Mima. And good afternoon, everyone. Thank you for joining us today. It was nice to finally get the electric metering acquisition closed, and it’s even nicer to be able to begin reporting meaningful results [as they] [ph] exist from the combination of Itron and Schlumberger’s electricity metering. Sales and profitability of the metering portion were better than we had anticipated coming into the quarter, and were, as Mima said, a big factor in the nice financial results Itron as a whole produced in Q3.

Given that, let me begin today with some comments on how the integration of our electricity metering operation is going, as well as give you a brief update on the electricity meter business. Following that, I’ve got some general comments I want to make regarding our longer term outlook, and I’d like to close the call today with some observations about Itron’s annual users conference held a couple of weeks ago.

The integration of our metering operations has moved along very well and even slightly ahead of our expectations. As we’ve reported before, most of the back office function such as HR, accounting, and marketing are either complete or well along their way. Product development groups are integrating well. We find that our process for product life cycles are similar, and we are beginning to leverage common platform design and philosophy across numerous products, and we’ve a number of pro-development projects that are already in place.

While our two manufacturing operations run fairly independently of each other, we are sharing knowledge across boundaries in areas such as quality and reliability, process automation tools, and have several initiatives underway aimed at reducing the product costs and improving product quality. Specifically, on the cost front we have already identified a number of common parts and material where we can achieve better pricing through combined purchasing.

In our last earnings call, I said the sales organization for traditional Itron and metering would be essentially left alone until the end of this year, and until recently they have been. In the last several weeks we’ve announced how our sales force will be deployed in ’05 and a leadership team that will manage those efforts.

Beginning at the first of the year we will divide the North American sales force into two parts, that mirror the operations group structure we spoke of last time. We will have a software sales force selling software products, so that the sales manager that reports to [Philip Musie] [ph], the head of our Software Operations Group. And we will have a hardware sales force, selling AMR in meters, reporting to a management structure to [Malcolm Undsworth] [ph], the head of our Hardware Operations Group.

That hardware sales management structure will include a team focused on gas only utilities, a team focused on water utilities, a team focused on electric plus electric and gas combination utilities, cooperatives, and public power districts, and a team focused on Canada. That structure will be in place and operational as we start 2005. Our international efforts they will stay as they are now, where we are beginning to see good traction.

Let me now switch the electric meter market where there are three areas I’d like to address. The nature of the sales cycle market growth rate in the U.S., and how we stack up against competition.

The purchase cycle for electricity meters are fairly different from our traditional AMR business. While most AMR sales are project driven, purchases of electricity meters are more routine in nature. We feel that these will typically go out for bid to supply meters over one year or several years in timeframe. Bids have been awarded to the vendors with some indication from the utility as to expected purchases over a certain period of time. In many cases, however, there are no scheduled shipments when a bid is awarded. Instead, the affiliate will issue purchase orders or releases through the meter vendor that may require shipment of the product.

Historically, there have been two reasons for the routine purchase of electric meters. New construction and the replacement of old meters. Over time, those two factors have caused nice steady growth at around 2 to 3 percent per year. In the last few years, market growth rates have been a bit higher, closer to 4 to 6 percent in our estimate, primarily as the utility has developed interest in AMR and that interest has increased. When utilities implement AMR they tend to change-out and replace meters at a faster rate.

All of that results in a meter business for Itron that is in general more steady, more predictable, and not subject to the same degree of large swings from quarter to quarter, as we have historically had with our AMR business. In other words, a higher level of base business on top of which we still have some lumpiness due to AMR orders.

Let me now turn to a few comments on competition in the electric meter market. We are, today, the leading manufacturer in the U.S. of solid state residential electricity meters. We have shipped more than 11m of these meters, whereas we estimate all of our competitors combined have shipped something less than 500,000 in total.

As expected, we’re starting to see competition beginning to ramp in the solid state residential electricity meter market, with product introductions over the last couple of years from [inaudible] , and this year from General Electric. Purchases in the meter market like many hardware products are largely driven by price and market acceptance.

With regard to pricing we have several advantages at Itron. We have been making this product since 1998 which gives us a serious cost lead over other manufacturers that are just now getting into the market. We have a robust technology platform, having already done several technology turns. And with AMR and electricity metering operations now combined under one roof, that being Itron, we have additional opportunities for sales, integration, and operating efficiencies. We are well able to deal with competition from a cost perspective.

On the market acceptance front, we’ve sold over 11m units and the other guys are in trial in pilots. Between Itron and our metering group we have the best customer relations in the industry. After that, our meter data management software and other software products and in the end Itron has a competitive market advantage for many years to come.

A few comments now about longer term outlook for Itron. As we indicated in our press release today, we ought to be further through the fourth quarter in our planning process for ’05 before we provide specifics about our outlook for 2005. In the meantime, however, I can share with you some general observations and thoughts about the utility marketplace and Itron’s performance that may help you draw your own conclusions or at least provide some useful context regarding next year.

In the last half of 2003 and so far this year the overall utility capital spending environment has been challenging for us as well as for most other vendors in the utility space, including AMR vendors. While we have seen a nice steady increase in AMR orders from smaller utilities and we’ve seen small follow on orders from some of our existing larger customers, what we haven’t seen are many large orders for AMR with either existing or new customers with the exception of the $15m order Mima talked about at Xcel Energy.

The fundamental issue has been the restraint of capital spending on the part of large electric and electric and gas utilities. The heart of Itron’s client base. Clean-up the balance sheet has been the watch word of many of the large investor owned utilities throughout the last part of ’03 and on into ’04. They’ve had good success which should lead to a better ’05. Projects have remained in the planning, budgeting, and budget approval process during the last half of this year where our continuing high levels of activity in the request for proposal, economic modeling, and contract negotiation areas, that activity should turn into orders throughout ’05.

As you’ve all seen, the meter business has been a great acquisition for Itron. That business will be strong as well throughout ’05. We are seeing customers where the combination of Itron and electric metering is opening up new opportunities for selling product. In total, I like our revenue prospects for next year.

In the face of what has been a challenging market, we’ve been very active throughout 2004 positioning the Company for improved profitability. We’ve made good strides in driving costs out of a number of areas, within the Company. Reorganization of the two operating groups, hardware, and software, has enabled us to reduce managerial headcount and has provided us with other opportunities for product and cost synergies, some of which are already beginning to show-up.

In software, we’ve looked very hard at markets where we did not expect to see near-term market activity, and made headcount and other spending adjustments. Reorganization of our sales force will also result in further synergies. We’ve also rolled out a number of new products that will begin to drive organic growth, including a new handheld computer for meter reading and the field work force management. A mobile collector with GPS capabilities. New versions of fixed network AMR technology.

The utilities want more data, faster than they seem to, Itron will fix network capability with anyone. They’re looking for cost advantage in urban and high customer density residential environments, Itron has the lowest cost fixed network products. If our water customers are looking for the benefit of the fixed network ARM system with the applications software to really make a difference, Itron has it.

Our competitors like to say that Itron is only a mobile AMR company, that’s because they can’t say, as we do at Itron, that we sell millions of points of mobile AMR each year which we can turn into a fixed network system when and where the utility desires.

We have introduced serious new products for meter data management, not only of Itron collected meter reads, but also where our competitors have won business in more rural applications of AMR. As well, we’ve introduced software applications for leaks and tamper analysis, and distribution asset optimization. And some very nice forecasting products in an area where Itron’s tools now forecast over 70 percent of the electricity used in the United States. Overall, a very nice new product suite to help guide revenue in ’05.

Had you been at our Annual Users Conference two weeks ago in Florida, where we had over 630 customer attendees from 11 different countries you would have seen those products along with others. It was a great opportunity for our customers to collaborate with each other and share knowledge about how they’re using Itron’s technology to solve many of the issues they face.

The customers actually paid to attend this conference, and very actively participated in the planning and execution. They had over 120 different sessions including 57 different customer presentations. Every Itron product was on display to show our users how to get further value out of their systems by applying software applications, to help make further use of data gathered by their data collection and management solutions from Itron. Our keynote speaker was [Ray Gogle] [ph], the CIO of Xcel Energy, talking about their utility innovations project of which Itron is a major part. What a big hit to the conference was a regulatory panel featuring [Nora Brownell] [ph], her first, along with Public Utility Commissioners from Washington, Indiana, New Jersey, and Michigan, as well as Itron’s own Board member, [Sherry Nelson] [ph], the past Chair of the Washington State Public Utility Commission, and current member of the Electric Reliability Council. No one in the industry can bring together a users conference of that depth and size.

As most of you know, we’ve been excited about the possibilities for our electricity metering business and its potential to transform the financial profile of the Company. Our third quarter results demonstrate that despite what has been a challenging utility spending environment. Itron can produce solid revenues and earnings, and cash flow as we have shown in the third quarter.

Even though the timing of large AMR orders is still tough to gauge we’re pleased that we have been able to transition the Company for improved profitability. We remain confident that along with the foundation of AMR and now the electric meters that our knowledge based software tools provide value propositions to our utility customers to carry them into ’05 and beyond providing the operational efficiencies they require.

With that, we will open it up for questions.

[Caller instructions.] [ph]

We’ll go first to Steve Sanders, Stephens Inc.

Good afternoon.

Hi, Steve.

On the meter data collection side I think you said revenues were down about 18 percent, and that was a combination of lower AMR shipments and also handheld. I wanted to see if you could split that out? I think you gave it to us on an annual basis last call.

You know, Steve, we don’t track it internally that way anymore, and so I don’t have it in front of me. My rough guesstimate is that handheld sales on a YTD basis are down by about $10m. I don’t know in particular how much that was in Q3.

Okay. And along, in the handheld business you talked about some new products, potentially some replacement cycles, do you think that business will pick-up in’05?

Yes, Steve, LeRoy here. I think the business begins to pick-up in ’05, both here and in the U.S. and a bit around the world. And I think as we look at ’06 and ’07 we’re probably pretty much in the heart of the replacement cycle.

Okay. And then, the meter orders in hand number, and I think it was 37m through 1Q ’05, can you help us interpret that a bit? Maybe give us some, you know, historical levels for that, or what typically, you know, that would represent for the next couple of quarters of shipments? Just something to kind of give us a good metric there?

Yeah, Steve, we don’t have any historical numbers to share with you that would be necessarily meaningful. But it’s not uncommon at many utilities for them to issue purchase orders on a monthly basis. So even though that 37m is for, you know, shipments, some of which are for the quarter, and some of which actually go into the first quarter, the base visibility in that business is actually much greater than just the amount of purchase orders in hand.

So it doesn’t equate to the bookings figure that we talk about in our core business. It’s a lower number relative to the revenue that the meter business produces as compared to what we report in bookings, as compared to our revenue in the non-meter side of the business.

Okay. I guess I’m still a little confused about sort of the rationale for providing. It maybe on a go forward basis we’ll get a better understanding of how that number moves around.

On the cash flow side, I think you were expecting about $45m of EBITDA for the second half. You’re at 17m or 18m in the quarter, could you update us on that?

We’re expecting around 20m of EBITDA for Q4, and about 20m of cash flow from operations for Q4, as well. So that for both cash flow from operations and EBITDA we figure it would be about 40m for the second half.

Okay. Okay. And then, a final question on the segment results, I’m having a little trouble interpreting the operating profit or actually operating losses on the software side. You know, first quarter was 4.2m, second quarter was 1.7, it looked like there was potentially a trend there. Now, we jump up to 3.8, and can you sort of help me understand that number a little better, and then maybe make a general commentary on the earnings drag from the software acquisition, and what we should expect there going forward?

Yeah. The historical numbers that you have for the first and second quarter of this year and for ’03 for hardware and software have changed slightly. In July we talked about some further refinements that we had made to the segregation of our internal operating groups, the hardware and software. And the biggest change there is that in the previous reporting that we did last quarter we had all of handheld systems, both hardware and software, in the hardware segment. We’re now reporting those separately. And so software is separately in the software segment, and hardware related to handheld systems is in the hardware segment.

And there is a fair amount of sustaining engineering that goes with that handheld software efforts, which is why the profitability looks a little worse in the current quarter than it did to the previous two quarters. But in fact, you’ll not on a YTD basis the profitability, you know, the loss is about 16m, so the profitability for our software business has been improving, and we will get those previous quarter numbers out to you guys as soon as we finish that analysis.

Okay. And maybe a general question along those lines for LeRoy. You’ve talked in the past few quarters about being in the investment mode on the software business, and are we still in the investment mode there and will we continue to be in the foreseeable future?

Yes, Steve, I think it’s fair to say that as I look at prospects for software sales the rest of this year and on into ’05, I mean I think the whole software industry and Itron is no different, is doing a conservative mode. We don’t see a lot of breaking news of momentum in terms of software spending. That having been said, we are still in the investment mode, and we will be there for awhile, but we are looking very hard not only at the areas of business where we’re focused but also where we’re spending money to try and close off the investment mode as soon as we can. You know, we’re investing and we will continue into next year.

You know, one of the things that we have done, which I think is going to prove to be very beneficial, is to break the hardware, or to break the sales force into two pieces, hardware and software. And in so doing, we’re looking for a focus in the software area that we have been somewhat disappointed with as we’ve come through ’04 this far. So I’m hoping that will drive some sales for us, and we like the way that’s beginning to look.

Okay. Thank you.

We’ll move to Paul Coster with JP Morgan.

Yes, LeRoy, most of my questions have actually been answered. But a quick one on the secular trend here. How can you reassure, if you are in a position to reassure, investors that we’re not just sort of hitting some kind of plateau in terms of penetration here? And the follow-up question really is there anything in the political process, regulations, et cetera, that we should be thinking about as catalysts, positive or negative? Thank you.

Yeah, let me – as you talk about penetration, Paul, I’m assuming you’re talking about AMR penetration?

I’m talking about the use of any form of automated metering across, sort of inclusive, across all three of the utility clients?

Yeah. Let me make a couple of general comments, and then one specific. First of all, if we look at AMR in general, I mean there are numerous surveys that are reasonably recent that just say the grand majority of utilities expected to pull an AMR, and a very high majority of those expect to deploy AMR in 100 percent of their territories.

I have just myself spent time with a number of utility people, and you know, there is no lack of interest in AMR. There is a lack of spending of capital right now which I think we come out of as we move toward ’05, because utility balance sheets are getting better. If you look in general at their financial performance they are getting better, and we think that all bodes well for the future. In a specific way, I mean clearly AMR and the water world is continuing to grow, and grow nicely. And we’re happy with that, and we take that as a good sign for the smaller customer base.

But Paul, I can certainly point internally here to lots of activity in terms of AMR proposals, lots of activity where we are helping large utilities run financial models. Those financial models are still great. And the question always comes with if the financial models are so great, why aren’t they buying? Because there are alternative places to be spending capital or, as I’ve repeatedly said, in some cases they’re just not going to spend any capital for awhile.

So I’m pleased with the prospects going forward. I think we will see an up tick in ’05. Now, having said all of that, there’s an awful lot of AMR activity outside the U.S. which is just beginning to come to light. And I think that looks very exciting as we get all the way through ’05 on into ’06, and beyond.

Any update on the political processes here, and what that means for your end market?

Yeah, an interesting question given the day. We had high hopes earlier this year for an energy bill in ’04, which certainly got off the deck because of the elections. And quite frankly, derailed because of all the parts that was being added into it. I actually asked a lot of questions of the commissioners we had at our recent users group. We have lobbyists that are working not only in D.C. but elsewhere, the political landscape. I don’t think we’re going to see a meaningful energy bill probably not in the first half, no matter who gets elected.

But I think we could see an energy bill in ’05, and I think a real test will be whether or not it’s loaded down as the last one was, and whether we can get something out of it. Certainly, we’ll see more emphasis from a Democratic Administration on energy conservation, time of use, which is helpful for us. We’ll probably see a bit more emphasis on exploration in a Republican Administration, which is, in general, not all that great for us, but still even in the existing, you know, bills that never went anywhere there was an awful lot of emphasis on things that would help us. So I think that one is a crap shoot by anybody’s guess, and we’ll see where it goes.

Thank you, LeRoy.

Sanjay Shrestha, First Albany.

Good evening, guys. Just a couple of quick questions here. The first one on the margin front for the electric metering side of the business. I mean pretty impressive the 39 percent, it would have been higher by 4 percent. Should we be using that number to sort of model out what should be the margin profile within that business? You know, especially given some of the new players that are coming in the market, and given some of the initiatives that you’re undertaking, could that number actually be higher than that, going into 2005 and beyond?

Yeah, you know, Sanjay, I can tell you that for Q4 we’re modeling a gross margin that’s a little bit lower than the 43 percent, but clearly the mix of meters during the quarter and the percentage that are AMR enabled versus not will impact that. We do expect to see some pricing pressure as some of the new solid state meter entrance produced product in larger volumes. But as you also notice, we have a lot going on on the cost front to certainly look for some savings, as well.

Okay, so then it would be fair to say 39, 40 percent kind of a margin in that side of the business, going into 2005 is not a stretch?

I would say anything in the low 40’s percent range is a possibility.

Okay. Okay, kind of stating, again, with the gross margin number here on the meter data collection side, down to about the, you know, 42 percent here, you know, given obviously it’s difficult to predict large sized AMR orders, you know, on a quarter to quarter basis. But I mean what should we be expecting out of that side of the business going into 2005? Is that the trend or the number we should be looking at, or do you think there’s going to be some meaningful improvements?

I think on the meter data collection side we’ll see much greater swings than we saw on the electric meter side. And, again, it’s highly mix dependent. In the third quarter we had a large component of electric product and water product that goes through in direct channels.

Okay.

It might have produced a little on the low side. You know, the nice order from Excel Energy has a fairly nice GAAP component that will help margins in the fourth quarter. 2005, it’ll be somewhat dependent on mix, electric, gas, water. It’ll be somewhat dependent on domestic versus international. And also, from quarter to quarter it can be impacted to the extent we have a large installation contract that we’re handling for someone.

Okay. But kind of taking a look at that more from an annual perspective, I mean is it something we should be expecting on the low 40’s side, mid 40’s side, or the high 40’s side? Just a ballpark numbers? Can you guys do that?

Yes.

We’re just staring at each other, wondering who was going to go next! You can go for the low 40’s to the high 40’s from quarter to quarter, on the non-meter side of the business. Strictly according to mix, the things that Mima mentioned, the installation contracts are not et cetera, which tend to be a lower margin or have lots of handheld which can be higher margin, et cetera. So.

Yeah, Sanjay, it’s LeRoy, let me color those comments which I completely agree with, by saying I think we need to be careful in ’05. I mentioned we got, you know, competition is going to come alive in the metering place, and we’ve taken that into account, as we’ve talked about margins. But there’s lots of competition in the AMR side of our business.

Yes.

So, and I think we need to be some careful. We’re all hungry. We haven’t seen a good ’04, and we’re all going to be fighting for orders out there. And at the end of the day, frankly, our biggest competitor in the AMR land is still, you know, the economics of the installation. And so, I’d be careful, as I thought about margins, expecting margins to continue to increase throughout the ’05 period, and if I was modeling I’d be some cautious.

Okay. Got it. Got it. Great. And just a couple of quick questions here. Can you also remind us how much you guys are actually going to be paying in cash taxes this year?

Are you there?

Yes, I am. I didn’t hear anything.

There’s a loud hum actually when you’re on, Sanjay, and let me say it again. In Q3 of the approximate $1m provision for taxes there’s roughly $100,000 that is current taxes payable, that is what we expect to pay in cash taxes. We do not expect to become a substantial cash taxpayer until mid-2006. So we’re still benefiting from historic NOLs, both those that we had before acquisitions and those that we acquired as a result of acquisitions.

Okay. And what is that total number, again, since [inaudible] on the call? But what is that total number, again, can you remind us of that?

Of the NOLs, or?

Of the NOLs?

The deferred tax balances on the balance sheet, if you hold for a second, on the NOLs. Why don’t we go on with some other – it’s a little over $30m.

Okay. Okay. That’s great. That’s great. And one last question, but maybe this is to you, LeRoy. It kind of sounds like from the comments here electric metering side of the business, you know, is certainly doing pretty well, but overall growth in that is a replacement of the [housing] [ph] stats, and things of that nature, maybe some growth of the AMR side. It seems like software should do marginally better going into ’05, you know, with the potential for some traction on the fixed network, AMR side, and maybe a hardware solution should do a little bit better. Maybe you were entering into an upgrade cycle on the handheld side.

You know, when we kind of consolidate all of those, you know, data points, it looks to me like, you know, that the core Itron side of the business should be modestly up. And you should see some nice, you know, at least high single digit kind of a growth out of the electric metering side of the business going into 2005. Is that the right way of thinking about it?

Yeah, I’m good with where you went there.

Okay. Perfect. That’s great. Thanks a lot, guys.

Jarett Carson with RBC.

Yes, a couple – one point back on the electric meters. Maybe toward Steve’s question earlier. Is there a way to think about how you came into the third quarter? You gave us this number, almost 37m that kind of looks out for two quarters, and then you printed 54 for the third quarter, do you have a comparable number on kind of how you came into the back half of the year?

You know, Jarett, I’m sorry we don’t. Obviously, we’ll put those together and get that information out at some point, but we don’t today, all we have is the number we gave you today.

Okay. The inventory write-up that you had in the third quarter is that pretty much, is that inventory is worked through?

For the most part. There’s very, very minor amount left that will roll through in Q4, but it’s very small.

Okay. A little bit, I want to get down to the G&A number, the G&A line, last quarter 8.6, and then the prior quarters, the first quarter of 6.6. And then, you know, we added all the new businesses, and we went from 8.6 to 9.2. Can you talk about kind of sequentially, I mean that’s – we had one or two little things in the second quarter that made that higher because that seems to be a fairly modest increase for the size of the business that you added? Or are we feeling some effects of cost-cutting in the base company?

We certainly aren’t seeing a whole lot yet in terms of any of the cost-cutting or other kinds of initiatives. I mean, you know, on a quarter to quarter basis, G&A will bounce around a little bit depending on what’s happening in terms of outside audit fees, or those kinds of things. We did in the first couple of quarters this year have a couple of write-offs of some software tools, and that inflated G&A by a little bit. So I think the run rate you’re looking at in the third quarter is actually a fairly good kind of number on a going forward basis.

Okay. And final question, I know LeRoy, you’ve talked about and I believe GE just maybe had a press release in the last, recent weeks, talking about their new solid state product. But also, mentioning, you know, that it contained the Itron, or so can you talk a little bit maybe about the dynamics of clearly competition potentially picking up, going forward, on the electric side, yet the ability to participate at some level? And I think also, in particular, if I recall there was a legacy licensee that was with Schlumberger’s that was quite a bit lower perhaps relative to what the current licensees are?

Yeah, let me see if I can make sense of all of that, because it does get confusing. Let me start with the end of your question, the legacy license which was at very low royalty rate. And actually has gone on for a number of years. And that is essentially gone as we bought the Schlumberger’s Electricity Metering Group we bought that license arrangement. So it just goes away. So that’s one of them.

There are a couple of other licensing arrangements around, and we’ve talked about the hot licensing arrangement which was a product of our FTC clearance, and there’s a second one which is the GE license arrangement which you just talked about, which is on a very, very nice terms. And fundamentally it gives GE the ability to put Itron AMR technology, electric AMR technology, into their solid state meter products which they have announced and began talking about.

That’s, you know, while it doesn’t make our meter guys happy that’s a great arrangement for us, so it is under good financial arrangements which cannot be disclosed so I’ll save you asking. And but we’re very happy with that as opposed to sort of the minimalist license we had with Schlumberger. So there’s two. There’s [Hunt] [ph], and there is General Electric.

In addition, we continue to sell products through investors which is certainly sort of a second tier meter supplier at this point. We’re hoping to be substantial, but they certainly aren’t yet. They [inaudible] Itron technology, and we are getting a nice royalty fee for that. We actually make part of that product for them. And so that leaves essentially [inaudible] . And, you know, we sell lots of this through them. And we, and some minor pieces of technology in the [Alser] [ph] product, but we don’t have licensing arrangements with them, as we do with General Electric.

Okay. A final question relative to the operating expense lines, product development, the G&A and the sales and marketing. You’ve talked about the reorg that’s currently underway, and sales and marketing, relative to these three. Is there one out of those three, do you feel comfortable with kind of on those run rate basis, one of those that, you know, there’s some more synergies that we might find over the next, start to kind of unfold over the next two to four quarters?

Yeah, Jarett, we might be a little bit guarded with what we say today. But you’re going to see some decrease in sales and marketing line. You’ll see only a modest increase in development. As I look at all of next year on the development side I do think we’re spending more money than I’d like to be. But you should see some decrease in sales and marketing, and a more modest one on the development front.

Okay. So sales and marketing on a percentage of revs type basis?

Yes.

Okay. Thank you.

[John Queeley] [ph], Adams and Harkness.

Hi, good afternoon. In terms of the Q4 guidance can you talk about if there’s any large AMR orders baked into that guidance? Like obviously, we saw the good order thus far at Xcel. But can you talk about if there’s any others that you’re expecting this quarter?

Yes. The only order that is baked in is the one we’ve already announced, and the one we’ve already been awarded, which is the $50m order with Xcel. We have taken out any other large order expectations. That’s not to say there isn’t the possibility that one could happen. But we have not included another large order in our Q4 guidance.

Okay. Great. And on the fixed network side of things clearly there are small pieces of business right now, but can you talk about whether it’s new product offerings or the competition where you see that business going for you as we get into fiscal ’05?

Yeah, John, you know, we have seen a lot of fixed network requests for information, requests for quote, modeling work going on in the last half of ’04 here. Certainly, an elevated level compared to ease in the first half of the year or certainly ’03.

There’s a lot of interest out there in fixed network application for specified pieces of the utility service territory. We have been developing for the last several years products to fit into that space, knowing quite well that the day would come when the utilities would begin to be more interested in whether it was real time pricing or other features and functions that you can do with fixed networks.

So I think as we look at ’05 we’re going to see more of that business than we have before. We’re certainly in the middle of several opportunities on that front, and you know, I would make two points, the one I already made today. We often get asked whether or not we’re even in the fixed network business. Well, we are, but our mobile business so dominates that we look like a mobile company, but the key there is that we can turn that mobile piece of business into fixed network just by adding infrastructure, and that infrastructure has gotten less expensive with our new product offerings.

The second piece I’d add is that, you know, one of the good things about fixed networks is they’re more expensive so their revenue level is higher, the nasty part about it is they take more time to come to fruition. The gestation period on a fixed network contract is very long, because they’re very complex, and there’s a lot of modeling that goes on and a lot of soft costs that are looked at. And so, you know, in some sense, some of the delays that we’ve seen are contracts for fixed networks that are just taking longer to go through the process. And then really anybody anticipated.

Okay. And LeRoy, on the international side you talked about good growth opportunities. We saw a new product down at the user conference for multi-nation on the RX side. In terms of growth do you think it’s going to come from new products or potentially new geographies as a new leader takes over that business in the January ’05 timeframe, or is it a combination?

Yeah, John, I think the reality of that is certainly both. We’re pleased with new products. We’ve begun to sell some handheld stuff in Europe where we hadn’t, or mobile, or work force automation tool where we hadn’t before. We certainly in Australia have just closed some business in the 433 area where we hadn’t before. And so we like what the new product development has done for us there.

In addition, I think we’re going to see some exciting business in the forecasting area, in Europe, and elsewhere. I mean I did raise an issue today when I said 70 percent of the electricity was consumed in the United States is forecasted using Itron forecast tools. We’re having some success around the world, as well in that very same area.

And then, lastly, I think there are some geographies where there either has been no activity, that’s in South America for Itron, certainly, Schlumberger electricity metering is done more there, but we’ve done almost no activity in South America. We like some prospects down there, so that is new geography.

And then, I think relative to the AMR scene, the entire Asia-Pacific area seems to be coming alive, and I think that would be a good, fertile opportunity as we look into the last part of ’05 and then on into ’06 and ’07.

Okay. Great. And my last question on the unscheduled debt payment thus far in October, should we look for additional payment as we close out Q4, or should we be looking for fiscal ’05 for additional debt pay-down?

We are hopeful of making another installment in Q4, but what we do have is just under a $5m first semiannual interest only payment on $125m of seniors subordinated notes due this November. But we are nonetheless hopeful of making a payment probably smaller than the two $10m payments that we have made. We will continue to make prepayments as we go into 2005 on what we believe is the substantial basis in accordance with the EBITDA and cash flow numbers that we’ve mentioned previously today.

Great. Thanks very much.

Alan Robinson with Delafield Hambrecht.

Good afternoon. LeRoy, in broad terms, can you give us some guidance? What do you think it’s going to tell you that utilities are ready to spend again? Is it going to be a pick-up in RFPs? Is it just going to be an influx of orders? You know, what can we look out for there? And secondly, is there anything that you don’t sell to utilities now? Anything that’s not in your product portfolio that may compete with the utility budget once it materializes?

The last one is an interesting question. Let me think about that in background mode while I answer the first one. You know, we’ve had an interesting back half of the year, Alan, because we have seen a very high RFP level, we’ve seen a very high level of our financial analysts going out and talking with customers, and I don’t mean just, you know, sort of mid-level people but you know, clearly executives. Some of them financial executives at utilities.

Having said that, I’m very encouraged about prospects for ’05 because we have been able to keep projects on the table. Now, we haven’t gotten all the way to order, but we have high levels of activity in the back half of this year, and you know, I think that all bodes well for next year. So I think to specifically answer your question, we have been watching, you know, sort of earnings and balance sheets for the utilities. They’re improving. We think that is a good forecast of things to come, but the truth of the matter is we need to start seeing some orders. And when we do you guys will hear about just as soon as we close those deals, but we’ve got lots of activity going.

You know, if you – we’re going to go to the second question now, what don’t we sell the utilities? Well, I mean we have confined our activities to what I’ll call the operational side of the utility. We don’t do billing systems, we don’t do CIS systems, that’s not a no, not never, but we certainly aren’t doing that today. We don’t sell what I’ll call, you know, sort of dumb hardware. We don’t sell poles. We don’t sell transformers. We don’t sell wire or cable. You know, so none of that kind of stuff.

But if you look at the operational aspects of an electric, gas, or water utility we’re beginning to sell them in affect, a lots of things that they do operationally, from collecting data where we’re just doing electric meters now, you know, we don’t have water meters or gas meters in the Itron portfolio. But then we take data from all three of those electric, water, and gas. And we move it around their systems on our variety of AMR systems that go, you know, from simple RF in a mobile system all the way to products that are now satellite based for gas systems. We take that data that we collect, and we turn it, you know, every which way in order to present it to the utility billing system, in order to present it to their CIS system, in order to add it to their status system data, and look at transformer loading, and predict where they need to be doing maintenance. The whole gamut.

And then, as I mentioend a couple of times, we do forecasting both at the utility level, at the ISO level, and at the you know, the big predictors of energy flows level. And so, there’s not too much we don’t touch. We really don’t.

And, by the way, the important part of that is that both sides of the equation pull each other. As we generate more useful software tools they require more data, which requires more AMR, and data out of electric meters. As we provide more data, and the electric meters are off the end of an AMR spigot, that requires more software to act on that data in a timely manner. And so, you know, we do sort of have, you know, this self-generating thing going on between the hardware side of the business and the software side of the business.

All right. Thanks. And one last question, in terms of scale of integration, do you have any opportunities to backward vertically integrate your operations at the [Akoni] [ph] Plant for solid state uses?

Well, certainly, we get some goodness that flows out of being in both of the AMR business and the meter business, and we look for some of that integration to begin taking hold through ’05. There’s the natural things that come from one development group, one product marketing group that, as well, I think we get a little bit better at how we integrate AMR in our electric meter product compared, let us say, to other people. We did talk about, you know, just buying parts at a better cost, or the same, you know, real healthy stuff there. So I think there is some gain.

I know we will find some goodness in the area, we’ll be able to integrate silicon parts of both sides of the equation, meters, and AMR, and to do some interesting things there that should produce not only performance advantage but cost advantage, as well.

Okay. Thank you.

And we’ll go to Eric Prouty with Adams and Harkness.

Hi, guys. I’m on the road, so hopefully you can hear me.

We hear you good, no problem.

Great. Just heard you mention Hunt in passing, could just give a little update with where that relationship stands? Have you seen them – are they at the point where a product can, or they have product that can be shipped into the market? If not, you know, what would you estimate their timetable to be on that? And if you’re actually seeing them in the market yet as a competitor?

Yeah. Eric, let me say that, first, and very important, we have complied with the full letter of the Federal Trade Commission edict as to how we have licensed Hunt, handed off information, given them training. So we’re clean as a whistle there, so that’s good news because otherwise the FTC can come down on you rather nastily.

But part and parcel of that, we were required to provide for an interim period which I cannot disclose, product directly out of Itron to Hunt for their resale to prospective customers. We are doing that, but we have shipped them some stuff, and we will continue to do that for a limited period of time, or better said, a period of time that has a limit to it.

And so we are beginning to see them in the market, particularly at smaller customers. They are working with other meter manufacturers, and they have approached many of our customers. In so doing, and we’re out their competing with them. And we talk about, you know, what Itron brings to the table, not only a massive AMR machine but all of the software, all the ability to stand behind our product both from a warranty perspective and a development perspective, spending, as you guys all know, huge numbers of dollars on R&D every quarter.

And so they have product they can ship, that product has been made by Itron, that ability will come to an end. They’ll have to develop their own product. And frankly, I can’t tell you where they are in that process exactly because I don’t know. They have talked to other meter manufacturers, and we have seen them at a customer, and so far, the oh, the affect has been minimal to light.

Great. Good update. And then just one final question. In the past, the past couple of years, we’ve had some impact from ice storms, the blackout, et cetera. Any impact from the recent storms down in the Southeast? Is that impacted any of the larger purchasing decisions from any of your customers? Persons that are future potential ones?

Yeah, good question. Clearly, all the storms in the middle South and the Southeast have I mean literally millions of dollars out of their, you know, capital budgets for the utilities. That’s the bad news. There is some good news in there, however, a couple of pieces. One, all utilities have storm budgets, and so as bad as it looks from the outset I mean some of that was money that was put away for a nasty day, and so it’s not as bad as it could have been. Now, we’ll see what happens going forward on that front, whether the utilities make, start stashing money at a higher level than normal. Which could have a negative impact.

Another good impact is clearly we’re probably going to see a little bit of a windfall on the meter side of the business because electric meters in those storms get covered up or damaged, they’ll get replaced, so a little good news there. You know, had we had some affect on orders that we were chasing, absolutely? Have there been any of the major orders that we’ve been talking about, fortunately no. But I do think as you look at, you know, part of the southern company clearly all the utilities in Florida we are going to see them enter ’05 with a little bit of a slower spending level on new capital, except the poles and wires which they’re putting up like mad, and probably slower spending on software, as well.

Great. Thanks, guys.

And I show no further questions at this time. I do want to give everyone a final chance. If you have a question, please press star, one now.

And it appears there are no further questions. Do any of our speakers have any concluding comments?

All right. Just to say thank you, everyone, for joining us. I know you’re all anxious to get off and check what’s happening with the Election, so we appreciate your patience with the call. It went a little bit longer than normal today. Thank you very much.

And that will conclude today’s conference, and we do thank everyone for their time.