Itron Inc (ITRI) 2005 Q2 法說會逐字稿

Good day everyone, and welcome, ladies to the Itron Incorporated second quarter earnings conference call. A reminder that today’s program is being recorded. For opening remarks, I would like to turn the call over to Mima Scarpelli. Please go ahead.

Thank you. Hello, everyone, and welcome to Itron’s financial results call for the second quarter of 2005. With me here in Spokane today is LeRoy Nosbaum, our Chairman and CEO; Rob Neilson, our President and Chief Operating Officer; and Steve Helmbrecht, our CFO.

Before we begin today's call, I appreciate your patience as we review our Safe Harbor and pro forma disclosures. Our earnings release today includes predictions and estimates about future results and on the call today we will be providing additional details and information that is considered forward-looking. The information we are providing is based on what we know as of today, and is subject to a number of risks and uncertainties as described in the forward-looking disclosure in our press release.

You should review that disclosure, as well as our 2004 Form 10-K and our 2005 Form 10-Q for a more complete disclosure of risks. 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 also includes non-GAAP financial measures, pro forma results and EBITDA and we will be discussing both in today's call. We believe these non-GAAP measures provide useful information in terms of enhancing your overall understanding of our current and our future financial performance.

Schedules reconciling GAAP to non-GAAP financial information are included with our press release, and are also available on Itron's web site. Steve is going to start the call today with a brief discussion of financial highlights for this quarter and for the first six months of 2005. After that, LeRoy will offer some additional comments and at the end of our prepared comments, LeRoy, Steve, Rob and I will be happy to answer any questions that you have. I would now like to turn the call over to Steve Helmbrecht, Itron's CFO.

Thank you, Mima. Good afternoon, everyone. We are very pleased with our financial results for the second quarter. We set new quarterly records in revenue, earnings and new order bookings. Revenues were $135 million during the quarter, an increase of 70% over the second quarter of last year, most of which is attributable to the electricity metering acquisition completed July 1st of last year.

Second quarter revenues were 16% higher than first quarter revenues. Strong new order bookings for both AMR and meters during the quarter resulted in quarter-over-quarter revenue growth of 25% in meter data collection and 12% in electricity metering.

During the quarter, we shipped more than 1.5 million AMR units, defined as standalone AMR modules as well as meters with our embedded AMR, a 35% increase over shipments in the first quarter. Average selling prices for standalone AMR modules declined in the quarter compared with the same quarter last year, as a result of competitive pricing pressures driven by the license of certain electric AMR technology to a competitor, Hunt Technologies, pursuant to a licensing and sale agreement.

The agreement, which expires later this year, was part of the consent decree entered into with the Federal Trade Commission in connection with the electricity metering acquisition. Also, average selling prices declined partially as a result of larger contracts, which generally result in more favorable pricing on a per unit basis.

Overall gross margin was 42% during the quarter, compared with 44% in the first quarter and 42% in the fourth quarter of last year. Compared to the first quarter, metered data collection margins improved two points from 42% to 44%, primarily because of a shift to a higher mix of gas modules and fewer electric modules.

Electricity metering margins declined from 45% to 41%, with over half of the decline due to a pilot for a smart metering system in Ontario which included certain pass-through sales of third party equipment, with the rest being normal gross margin fluctuation due to the mix of meters shipped.

Software margins declined from 45% in the first quarter to 38% in the second quarter, primarily due to lower revenues.

We had a record quarter in terms of new order bookings, with $177 million in orders placed during the quarter. Our book to bill ratio for electricity meters and software was close to 1:1 during the quarter. Our book to bill ratio for metered data collection was 1.9:1, resulting in an overall book to bill ratio for the quarter of 1.4:1.

Total backlog grew by $53 million during the quarter to $243 million, the highest level in our Company’s history. The portion of backlog deliverable over the next 12 months was $151 million at quarter end, up nicely from $116 million at the end of last quarter.

In early July we announced an order with Progress Energy for 2.7 electricity meters with embedded AMR worth approximately $120 million. In the third quarter, as a result of that order, we are well on the way to breaking the record for new order bookings we just set in the second quarter. I would point out that while we expect new order bookings to be higher in the third quarter compared to the second quarter, which will result in increased new order bookings for three quarters in a row, we do not expect an increase in bookings in the fourth quarter over the third quarter. It is not always possible to produce sequential increases in bookings from one quarter to the next due to the timing of large contracts and there are a more limited number of situations such as Progress Energy in which the upfront scope is for the whole service territory. The unit quantities are high and the installation timeframes relatively short.

Pro forma operating income which excludes intangible asset amortization expenses, restructurings and in process research and development for the quarter was $20 million. Pro forma operating margin for the quarter was 14.8%. That compares with 13.6% pro forma operating margin in the first quarter and 14.5% pro forma operating margin in the fourth quarter of last year. Our efforts to drive out costs including a number of focused initiatives to improve operational efficiency are starting to produce very nice results.

Pro forma earnings were $10.4 million during the quarter, or $0.42 per share, which is the best quarterly earnings performance in the Company’s history. EBITDA was $23.9 million during the quarter. For the first six months of 2005, EBITDA was $42.8 million. For the last 12 months, EBITDA was over $80 million, demonstrating strong earnings performance in the first full year subsequent to the close of the acquisition of our metering business.

We had another good quarter in terms of cash flow, although not as strong as the first quarter due to interest payments as well as to increases in accounts receivable and inventory. In May, we paid approximately $4.8 million in semi-annual interest on our $125 million senior subordinated notes. Accounts receivable increased approximately $12 million, commensurate percentage-wise with the increase in revenues. Although accounts receivable increased, our cash collections have been strong and our days sales outstanding during the quarter dropped to 49, the lowest level in recent history.

Inventories increased by about $4 million during the quarter, as we built inventory in anticipation of the order from Progress Energy, and due to a planned factory shut-down in our meter plant for the first two weeks of July, a long-standing tradition that we are continuing.

In total, we generated over $12.8 million in cash from operations during the quarter. Capital expenditures in the quarter were $3.6 million, however capital expenditures in the quarter net of the sale of our building in Canada, were $900,000 resulting in free cash flow during the quarter of $11.9 million. Year to date, cash flow from operations was $36.8 million compared with $7.2 million in the first six months of last year.

In May, we received approximately $60 million in net proceeds from the issuance of 1.725 million shares of common stock. With the common stock proceeds and funds available from operating cash flow, we made $87.3 million in term bank debt repayments during the quarter. Our term bank debt balance was $42.3 million at June 30th which means that in the 12 months since the electricity metering acquisition, we have repaid $142.7 million of the $185 million in term bank debt used to partially finance the acquisition. Our total debt balance was $170.1 million at June 30th. Our total debt as a percentage of our total capitalization has decreased from 65% as of July 1st last year to 38% as of June 30th this year, and we made an additional $4 million optional repayment on our term bank debt this week, bringing our balance to $38.3 million. In one year, our post-acquisition focus on generating cash flow and reducing debt has strengthened our balance sheet considerably.

Let me close with some comments on our financial guidance. As noted in the release, we have increased guidance for revenue and for earnings per share for full year 2005. In the second half of the year, there are a couple of items worth pointing out when thinking about how to model our results.

First is the recent $120 million order from Progress Energy. While we will begin implementation shortly, the project does not ramp up to full implementation until some time in the fourth quarter.

In addition, as we have in the past on certain large deals where we are not only shipping hardware but are also responsible for installation, revenue recognition on the Progress Energy contract is based on installation and route acceptance, not at the time of hardware shipment. We expect to see some higher revenues in the third quarter in electricity metering from the Progress order, but we expect to see the bulk of the increase in the fourth quarter.

The second thing I would point out to you is that we expect an increase in our outstanding share count from the second quarter to the third quarter. Part of that is driven by the 1.725 million shares issued in mid-May, not being outstanding for a full quarter. The other factor driving a higher share count is the recent increase in our stock price, which has generated an increased amount of employee stock option exercises, as well as a higher dilutive effect from stock options that remain outstanding.

With this in mind, we expect the calculation of diluted earnings per share for the third quarter to be based on approximately 26 million shares, a slightly higher share count for the fourth quarter. We are increasing our guidance for full year 2005 revenues by about 5%, to a range of $535-545 million and we are increasing our guidance for full year 2005 pro forma diluted earnings per share by about 10% to a range of $1.65-1.70.

In summary, we are pleased with our financial performance this quarter and will continue to focus on improving earnings and cash flow through strong sales and delivery execution coupled with operational efficiency. We like how the rest of 2005 is shaping up and I look forward to sharing our financial results with you over the next two quarters.

I will now turn the call over to LeRoy Nosbaum.

Thank you, Steve, and thank you all for joining the call today. I said last quarter that 2005 was shaping up to be a good year and that it had the potential to be a great year. We are now halfway through ’05 and by almost any measure used to evaluate our performance, you are likely to conclude that Itron is on track for a great year.

Robust proposal activity in the overall metering and AMR markets has now worked its way into firm capital spending commitments by a number of our utility customers. Accordingly, we are setting records for new order bookings, as Steve has mentioned.

Including the early July order from Progress Energy, year-to-date so far, so roughly six months time, we have signed contracts to automate nearly 6 million meters in electric, gas and water. Those orders range in size from small to quite large. Some are first time AMR installations, such as Piedmont Gas and Equitable Gas; some are continued expansions of large, utility-wide commitments such as Dominion. And some, like Progress Energy, are not only doing AMR but are doing a complete replacement of every mechanical meter in their territory with our more advanced, highly accurate, electronic technology.

In addition to those hardware orders, we have had some success in software bookings as well; orders for a variety of knowledge applications, including enterprise energy management applications with Clemson University and American Water. An order for our mobile workforce software from Intermountain Gas, and numerous upgrades with existing customers of our commercial and industrial meter data management software. Orders for hardware and software that give our customers an immediate way to reduce costs, boost productivity and improve service to their customers. Orders that total well over $400 million of new business to Itron since the first of the year.

Those orders have given us strong near-term visibility and a solid base for continued growth heading into 2006. It has now been one year since we have completed the electricity metering acquisition. Since then our revenues have nearly doubled, our earnings and cash flow have more than doubled and our customer relationships have grown stronger as we are now able to provide a much broader value proposition to our customers.

The electricity metering acquisition is now well integrated, and is producing synergies far beyond what we had initially expected when we first set out to make that business part of Itron. It has also been about one year since we restructured the Company into two distinct operating groups: hardware and software. The reorganization has proven itself to be a smarter, more efficient way for us to manage and run the Company as we have grown in size and complexity.

Today we have two separate but synergistic teams, hardware and software that are well-managed, highly motivated and intensely focused on the right things. At the helm of those two groups are two of the most talented and effective leaders in the business. Malcolm Unsworth heads up our hardware group. Malcolm joined us with the electricity metering business. He challenges his team everyday to take out costs and build in value. Philip Mezey heads up our software group, where they are providing innovative and sophisticated software products and services, changing data into value for our utility customers.

Many of you will have noted, we are announcing today that Rob Neilson, our President and Chief Operating Officer will be retiring effective at the end of this year, along with his wife, Randi Neilson who is our Vice President of Marketing. During Rob’s 23 years and Randi’s 15 years with the Company, they have made many substantial contributions and have played key roles in Itron’s success. As Itron’s President and Chief Operating Officer, Rob has been instrumental in creating a vision and a strategy for bringing about the successful company Itron is today. With Rob’s help, the course is well charted and we are well on our way with a very talented and well-run organization in place.

Much of Itron’s branding and marketing position have come about under the leadership of Randi Neilson, who has also been instrumental in helping to create today’s Itron. Our customer, industry and governmental relationships have all flourished under Randi’s watchful stewardship. With her help, Itron has become Knowledge to Shape our Future for many of our customers.

While departures are never easy, these two come at a good time for Itron. Relative to Rob’s departure we have developed tremendous depth and strength in the two individuals leading our operations groups, as well as in the rest of Itron’s management team. Accordingly, we will not backfill Rob’s position. We are rich in senior management talent and we are well-positioned for an orderly transition.

Relative to Randi’s departure, we have several potential internal candidates and a variety of external candidates that are worthy of consideration.

As we head into the last half of 2005, I really am looking forward to a great year and I like the prospects for ’06. We have had strong order activity so far this year and there are still a number of active RFPs in the works in various sizes and stages – good news for the rest of this year and on into next. As a worldwide leader in AMR, a leading provider in the U.S. of solid state electric meters, and a leading provider of complementary software for both, I very much like our positioning and I am quite confident that we will continue to win a large share of the business awarded. We would now like to open up the call to questions.

Thank you. (Operator instructions) We will go first to Amy Mann with JP Morgan.

Hi there, this is Amy Mann for Paul Coster.

Hi, Amy.

Hi, could we talk about the software gross margins this quarter? What was happening there? Is that a trend that we expect to continue going into the back half of the year?

Amy, the biggest thing affecting software gross margin this quarter was slightly lower revenues for the quarter, particularly high margin revenues. We also had a little bit of a reclass from product development up to cost of sales that impacted margins by just a bit, so I think that if we assume that revenues are going to stay at least at this level or slightly better than that, we should see a bump back up in margins to 40-45% again next quarter.

For the software business?

Yes.

Okay. LeRoy, could you talk a little bit about any changes you are seeing in the competitive landscape over the last quarter?

Well sure, over the last quarter we have seen a lot of interesting business go down and a lot of it has been large orders. Amy, the large orders produced the obvious effect of people sharpening their pencil a bit, everybody else, us as well. Clearly we all fought hard for PG&E, we all certainly fought hard for Progress, we were successful there. We have seen some other orders as well.

The general level of competition, I think, has steepened. We are seeing more aggressive pricing. Some of that is driven, however, by the fact that the orders have gotten seriously large. I will say that as we look at that whole situation we are very happy with our ability both in our AMR products and in our electric meter product to continue to make cost reductions. We like certainly the volumes that some of these new orders are going to build for us, we will get some advantage to that.

So while the competitive nature has certainly increased, we are very comfortable with being able to support the kind of margins we have.

Okay, great. Thank you, good quarter.

Thanks.

Thanks.

Moving on, the next question comes from John Quealy with Adams, Harkness.

Hi, good afternoon. Good quarter, folks.

Thanks, John.

Thanks.

Looking at the bookings number, you posted a good performance from your first release in June, now this final number of 177. I take from the book to bill with the AMR so high that it was mostly AMR weighted in that interim period for the month of June, basically.

Can you talk a little bit about what went on, that 30-day period? Were there any big orders in there that tipped the scales for that big booking number? And if you could break it down, at least qualitatively, electric, gas and water that would be great.

John, it was predominantly orders on the metered and the collection side of the business, and in the month of June there are no large orders that come to mind. I think they were a good example of continued follow on bookings with existing customers, existing AMR installations as well as a number of small ones. Quite honestly, we don’t have the breakdown in front of us between electric, gas and water. I suspect that it is a mixture of all three.

Okay, and in terms of LeRoy mentioned a couple of big industry contracts out there this past quarter. Since those have come to pass, have you seen any different change in the tone or the acceleration of RFP activity? Has it picked up at all? Has it flattened out since some of those big, large contracts have now come to pass?

it has neither picked up nor flattened out. It was at a pretty high level, John, and it stayed that way. We have seen all through the year so far high levels of RFPs that continue, which quite frankly I think bodes well for the rest of this year and on into next. So no, certainly a lot of flash around PG&E and Progress because they were so big, but lots of activity.

LeRoy, picking up on the software piece of business, how would that track into your expectations in terms of getting into customers for hardware orders and vice versa?

Actually a great question, John. We, on one hand, are some disappointed that the software business has not been a little firmer than it has. On the other hand, the software business is still helping us in lots of locations to bring in that hardware business. So we are pleased with the effect of software on hardware. We have seen a lot of interest in a number of our software products but we have not closed some orders that we had hoped we would by now.

I have spent some time with our software chief yesterday on that subject and I think we have some good prospects for the rest of the year, but software is still tough to close. I think it is going to remain that way the rest of the year.

My final two questions. First on some new industry news that we are hearing on broadband over power line and it looks like you guys are teamed up with several different partners there. Can you comment a little bit about what you are seeing in that level of activity, and Itron’s involvement on some of those smaller pilot scale projects?

Well we are participating with a couple of different partners in BPL projects at a number of utilities, both using BPL as just backhaul and as well as connecting meters to BPL. Certainly there is a lot of interest on the part of utilities in BPL for most of them, although not quite all, because it provides an alternative revenue stream for them as they think about competing with other broadband suppliers, whether that is cable or wireless broadband.

For some of them, they just look at it as a way to move the utility data around. So there is lots of interest, there is lots of activity. We are working with a number of utilities, we have some active pilots going on. We are working with most of the broadband over power line suppliers. We look at broadband over power line as being just another way for us to get reads out of meters. So we don’t look at it as a competing technology, but rather as a technology we work with and we are actively doing that, John.

And then lastly on the financial side, in terms of the free cash flow outlook for the full year, are we still looking at roughly $50-60 million in full year free cash flow?

Yes, that is the approximate range for free cash flow plus our CapEx is tracking nicely to what we had expected for the year, for the second half of the year and we are maintaining our guidance in terms of operating cash flow. Yes.

Thank you.

We will now take a question from Jarett Carson with RBC.

Yes, good afternoon. Real quick on the gross margins, particularly hardware gross margins. Is there the opportunity, let’s say over the back half of the year – I guess I am looking for revenues trending up, potentially see some improved utilization in the facility that might possibly lead to some higher hardware gross margins? Or, is the pricing competitiveness of these large deals going to nullify that? Any thoughts around that?

I think last quarter you had reported, Rob had mentioned something around 70% utilization at Waseca.

Jarett, it is Mima. I think there are a couple of things that certainly could help improve gross margin, volume through the factory being one of those. But the other thing to keep in mind when you are looking at our hardware business is, we are not only winning business for hardware as we have at Progress Energy and Piedmont, but we have also been awarded installation business at Piedmont, at Progress, at Equitable and so we have a much higher component of revenues starting in the third quarter and continuing into the fourth quarter that are installation related.

And as you know, our margins on that are pretty low, they are generally around 10% in that area. So I think that some of the goodness from volumes will be offset by some of the lower margin pressure from things like a higher proportion of revenues coming from installs. So as we look at gross margins, 42% in the quarter, depending on the mix it could be a little better. We will just see as the rest of the year rolls out.

Okay, LeRoy can you talk a little bit about PG&E and then PGN? We have seen – I am going to call it all or nothing. Either in both AMR, meters and software. Is there a middle ground with perhaps some additional, if not larger deals over the next 12-18 months where you may or may not win AMR but you might feel better about meters or software? Can you talk about that dynamic a little bit, what we have seen and what might come to fruition?

Sure, that is a good question. I think you have seen a couple of aberrations, realistically, with PG&E and PGN or Progress in that regard. We are still doing a lot of business where we are doing the meter portion and one of our erstwhile competitors is getting AMR in some form or fashion. That business is out there, it is not getting the press the two big orders have gotten. I think we are still going to see some of that kind of business go down.

We are certainly shipping modules for electric meters that are not our meters, although that is not our product. Although over time, we certainly aggressively pursue both AMR and electric modules together, as we did at Progress and we were fortunate enough to get all of that order, but I think you will still see the splitting of orders from time to time.

I maintain we have a number of ways to compete, we compete for electric meters in electric; we compete for AMR modules so the AMR portion we compete for the software. We certainly are aggressively pursuing software opportunities where other AMR vendors have been successful.

A final question on the international front, and from the three buckets -- AMR, meters and software – how you see things playing out over the next six to 12 months relative to what you are looking at today?

Jarett, this is Rob. The way it is playing out is a little bit different depending on what region of the world you are talking about. In Europe and the Middle East it is primarily handheld systems and a little bit of software in Europe, continental Europe. In the Middle East it is a combination of handheld systems and AMR. In South America, Mexico, it is a combination of meters and AMR. And in Asia, primarily Japan, we had recently launched a brand-new handheld computer for a handheld system and have real nice bookings and backlog going on for that handheld system in Japan, and of course pursuing sales of that in other parts of Asia as well.

And then finally in Australia, Australia right now is mostly focused on software sales, that has been the majority at this point in time, however handheld system upgrades, a little bit of AMR in the water space is starting to pick up as well. So it is really a mixed bag.

Great, and I didn’t know you were on, Rob. Thanks for your help over the last number of years.

You bet.

Moving on to Brent Barrow with Stephens Inc.

Good afternoon.

Hi, Brent.

The first question I have is based on current backlog and where you see that over the next 12 months, and standard versus embedded electric?

I am sorry, we didn’t understand the question?

Where do you see, over the next 12 months, with the current backlog in standard versus embedded electric meters? What is the mix, in standard meters versus embedded meters?

I think we increasingly continue to ship meters that have AMR embedded inside as opposed to meters that don’t. I mean, it stayed relatively steady from the first quarter to the second quarter, about a third of the meters that we shipped in the first quarter had our AMR technology embedded inside and as we moved into the second quarter it was a little bit higher.

I mean clearly, the large order from Progress Energy will cause that percentage of meters that are being shipped with our AMR inside to go up by quite a bit. We haven’t exactly stopped and calculated what the percentage will be, but it will certainly increase to probably close to at least 50% if not more.

Okay. I also want to check on gross margins, looking at for meters, is an assumption of low to high 40’s – or excuse me, low to mid-40’s for meters fair?

Yes, I think as Steve talked about last quarter, whether you are looking at meter data collection or meters, we are very comfortable with a range of low 40% to mid 40% for our hardware business. It really will bounce around by a point or two in any given quarter, depending on the mix and meter data collection of gas versus electric versus water; and to some degree, meters that depending on whether or not they are meters with AMR or not. So that is a good range.

Okay. And obviously you guys have had impressive bookings. You have talked about the pipeline and you also made a comment that obviously the pipeline is limited, to an extent, to the number of situations out there, but you are still feeling pretty positive about it overall?

We actually are very positive. I mean, if we continue to get the gorilla orders that everybody fascinates about – we do as well – but we are getting lots of solid orders that neither hit the press releases nor the radar screen, and they continue to come in. We are having very nice bookings as Mima and Steve talked about, but we like the prospects going out the rest of the year as well. It is a nice flurry of activity which I think is indicative of utilities have capital to spend and the business case for AMR and solid state electric meters proving itself well so utilities are jumping on the bandwagon there. Yes, just feel real good heading into the second half here.

Great, you talked a little about the competitive landscape for large deals with very aggressive pricing out there. You just mentioned some of the small deals. How is the competitive landscape for smaller deals playing out?

It depends. I mean, we are seeing a lot of competitive pressure in the water world, for water AMR, all over the place. That is higher than it has probably ever been before in terms of pressure. In electric and gas, when the deals are small, the pressure is less but often times a whole bunch of that business goes through resale organizations, so another head in the trough there. But in general, competition for large orders is what has affected margins a bit.

Okay. And then a quick question on capacity. I think you have stated in the past that you have been shipping about 4 million meters a year, and that AMR module capacity is about 6 million. Is that correct?

Right.

Okay. For a ramp up, is it primarily people or facilities and equipment?

A bit of both. Actually, a good question and I am glad you asked it. I mean, as we look at capacity in both of our factories, we are fortunate that last year we began an increase in the factory space in Waseca where we build modules and earlier this year in both factories we authorized some capital expenditures to increase capacity.

So while orders have gone up nicely and backlog is building, we have also ramped up capacity a little bit both in Oconee, South Carolina where we build electric meters and in Waseca where we are building modules. So we are generating more capacity than the 6 million numbers we talked about before. Very nice.

Great. There were some expectations following the meter business acquisition for purchasing consolidation in the combined company. Can you give us an update on that?

Brent, I don’t have specific numbers but I can tell you that we have continued to be able to leverage our suppliers putting together requirements from both facilities and we have had some substantial savings in the millions of dollars there which has been very, very helpful.

Great, thank you very much.

You bet.

We now go to Sanjay Shrestha with First Albany.

Good afternoon, guys.

Hi, Sanjay.

Hi. First of all, congratulations on a great quarter. A couple of quick questions here. First one, you guys talked about the low 40’s to the mid 40’s kind of gross margin number that is in the comfort zone for your hardware business. What assumption goes into that when we talk about that number? Does that take into consideration unknown pricing pressure that you guys have talked about? Does that take into consideration enhancement of the utilization, which is going to help your margin? Can you talk about that a little bit more? What is in that expectation?

Sure. It takes into consideration all of those things. It takes into consideration contracts that are clearly booked so far; our expectation on contracts we expect to book in the future in terms of average selling prices. We have modeled in what we expect factory production volumes to be; and as I said earlier, we have also modeled in what we believe will be the impact of doing a fair amount of installation activity starting in the third and fourth quarter as well.

And it is fair to say that we look at product mix. I mean, clearly we are selling more of our own electric meters with embedded AMR than we are standalone electric modules, and so that affects not only the dynamic in the Waseca factory but it also affects the dynamic in South Carolina as well.

Got it. And also, one more thing. Staying with that, once you guys, the Hunt relationship that ends this year and the impact that you have from the mix of the meters shipped, especially related to Ontario and the electric metering side, once that is behind you, should the expectation on our part be that the margins are going to likely trend towards the mid-40’s rather than the low 40’s for the hydro side of your business?

Well certainly as we’ve tripped through the end of the year we have a different relationship, not an ending of it, with Hunt.

Correct.

And so we would think that a modest at best differential there. Depending on volumes, you might not even notice it. The Ontario thing was a one-time thing that caused a blip in the night, but it could be that we have some more of that, depending on what goes on in Ontario. That is a case where we had some third-party stuff that went pretty inexpensively out of our shop.

Got it. And also, one other thing with the integration of the electric metering business completed, obviously you guys have done a great job on the cost reduction front and integration. Is there more leverage that you can take out of that above and beyond what you have been able to see up to this point?

Well certainly as volumes go up we are going to add some additional efficiencies in the factory. We chase costs everyday in both factories and we have a master at it who is leading the hardware group, that being Unsworth –

[Inaudible]

Yes, I certainly hope we have some efficiencies. I mean, one of the reasons why we did what we did in terms of hardware group and putting all of that together was to continue to chase efficiencies and we think we have some that can continue to show up.

Okay, that is great. Now LeRoy, obviously the backlog number and the new bookings number and the traction that you guys are having suggests that we are going to have a fantastic 2006, no question about that. Clearly you have a good visibility there. But when you look at this market longer term and ongoing chatter about the two-way communication, the power line carrier technology, are you guys also looking at gaining traction on the fixed network 2.0? Can you go into some more detail – not necessarily from a numbers perspective, but at least qualitatively – and paint a picture for both the AMR and the electric metering side of the business, not just for ’06 but over the course of the next several years?

Well I think certainly as you portray, we’ve set ourselves up to have a nice ’06. Certainly as we sit here today we are in much better shape than we were last year at this time, so you have to, given the backlog, what ’06 looks like. I also think that you have to like the trend for good, good sales of AMR and electric meters as we look into ’06 and ’07, because quite frankly utilities are looking at each other and looking at utilities that have deployed electronic meters and they are looking at utilities that have deployed AMR and they are saying, hey there is something to this. There is a lot of good in this.

So as I look out to ’06 and to ’07 I think the U.S. market looks very, very good. I also think we are going to see a continuing level of activity internationally, which quite frankly I am every bit, if not more, excited about some of the stuff Rob mentioned, some of the activities that we have got going on that we are not quite ready to talk about.

Okay. So when we look at the market right now, is it fair to say that maybe we have landed some of the bigger ticket items, but there are plenty of smaller opportunities that are more likely going to come? And there is more opportunity for enough players in the market that should give us a good growth in ’05 and ’06 and maybe into ’07?

Sanjay, I would say there is not only a lot of small opportunities, I think there are a lot of large opportunities left as well. There are some very big utilities out there that have not yet moved that are getting closer every day, so yes, I like the next three years in this market quite a lot.

Okay, that is great. Once again, congratulations on a great quarter, guys.

Thank you.

Thank you.

(Operator instructions) We do have a follow up from John Quealy with Adams, Harkness.

Hi, a quick follow up. During the last few weeks we have started to see some M&A activity pick up, particularly on the private equity side. Can you folks comment on how you think that will change the pricing dynamics, if at all, with some of these new financial buyers? Just your impressions of some of the activity here?

John, I don’t know that that is going to cause any particular change. I mean, the dynamic in the market is not going to move much. The financial buyers we have seen are reasonably run companies that don’t come into markets and just trash price levels, so we think we are going to see pretty much what we have. We are all duking it out. Certainly the landscape is changing, there is a lot of interest which I think just underpins the good market we are in and the steady growth that we are seeing, but we are not seeing any particular – we have seen no acquisitions that would lead us to believe that the market is going to get crazy or that we are going to see –

And LeRoy, a quick follow up. In terms of your appetite for acquisitions and using that cash moving into ’06, can you comment on what your priorities are for that cash in the next couple of quarters?

Well the priorities for the cash for the remainder of this year is continuing to pay off debt, which we are doing one hell of a job on. As we look beyond that certainly we are going to begin to amass some cash if conditions remain the same, and we consider acquisitions. We have been putting together a strategy as we look beyond ’05 as to where we might expand next. It is clearly going to be in the electric, water and gas world. It is clearly going to be in businesses we know well. So we look both domestically and internationally for opportunities in that regard. We think there are enough of them out there to keep our interest and to provide some opportunity for us going forward.

Great, thank you.

There are no more questions at this time. I will turn the conference back over to our speakers.

Great, thank you everyone for joining us today. We appreciate you listening in and as always, any of us are available for questions. Thanks very much.

Once again everyone, this will conclude Itron Incorporated second quarter earnings conference call. Thank you all for dialing in today.