Itron Inc (ITRI) 2005 Q3 法說會逐字稿

Good day everyone and welcome to the Itron Incorporated Q3 Earnings Conference Call. Today's call is being recorded. For opening remarks, I would like to turn the call over to Mima Scarpelli. Please go ahead.

Mima Scarpelli. Good morning everyone and thank you for joining us. With me on the call today is LeRoy Nosbaum, Itron's Chairman and CEO; Rob Neilson, our COO; and Steve Helmbrecht, our CFO.

As you can see in our earnings release this morning, we have included an outlook for revenue and earnings in 2005 and 2006 and in today's call we will also include, or get into discussions, that are forward-looking in nature. The forward-looking information we are providing is based on what we know as of today and is subject to a number of risks and uncertainties.

I would like to point out to all of you that you should read the forward-looking disclosure in our press release and you should also refer to our 2004 Form 10-K and our 2005 Form 10-Qs for a more complete disclosure of specific risks and uncertainties related to Itron's business.

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 that we believe will enhance your overall understanding of our current, and future, performance. Scheduled reconciling GAAP to non-GAAP financial information are included with our press release and are also available on Itron's external website.

Steve is going to start the call today with a brief discussion of financial highlights for the quarter and the first 9-months of 2005. After that, LeRoy will offer some additional comments. And as always, at the end of our prepared comments, we will be happy to answer any questions that you have.

So let me now turn the call over to Steve Helmbrecht, Itron's CFO for the financial highlights discussion.

Good morning everyone. We had another outstanding quarter in terms of financial results and I am delighted to have the opportunity this morning to provide you with some additional insight and commentary on our 3rd quarter and year to date results.

We came into 2005 talking about a substantial pipeline of orders we were working very hard to close and a Company-wide focus on operational improvement. Our results for the first three quarters of 2005 clearly demonstrate that we have made significant progress on both fronts. We've had three quarters in a row of revenue growth, and more importantly, three quarters in a row of nice growth in earnings and the operating margins.

Third quarter new-order bookings of 212 million were again, a new record. Hardware bookings were strong as a result of the progress energy order and a large order for gas AMR. But also because of order momentum on a number of fronts, including some meter orders from customers who have not traditionally ordered meters from us before and some orders from utilities affected by the hurricanes as they begin their reconstruction efforts. Software orders were also very strong during the quarter and the 9 million in software orders during the quarter was also a new record.

Total Company book to bill ratio is 1.6 to 1 for the quarter, compared to 0.9 to 1 in the 3rd quarter of last year. Year to date, our book to bill ratio is now 1.4 to 1, compared with 1 to 1 year to date last year. Having the kind of success we've experienced for the quarter and the year in terms of new order bookings often leads people to ask the question, "Has the pipeline of orders dried up?". We can tell you no, it has not. There is still a very active pipeline of orders, both large and small, that we are working hard to win and to close. But, as we said last quarter, we do not expect bookings to be as large in Q4 as they were in Q3, as the Progress order in Q3 was unusually large. And, we do not expect to see other new orders of that size in the near term horizon.

Strong new order bookings have resulted in a very nice progression of revenues throughout the year, from 116 million in the 1st quarter to 135 million last quarter to 141 million this quarter. Third quarter revenues of 141 million during the quarter reflect an increase of 15% over 3rd quarter revenues last year. Our earnings release does a comprehensive job of covering 3rd quarter and year to date comparisons for revenue growth by each of our segments. So I won’t go through those details here, but will point out that for both the quarter and year to date periods, revenues increased in each segment in 2005 compared with 2004.

On a combined basis, we shipped almost 2 million Itron AMR end points during the quarter. That compares to approximately 1.2 million in the same quarter last year. Those shipments represent a combination of AMR modules we make for gas and water meters as well as for mechanical electricity meters, AMR embedded in our solid state electricity meters, and AMR boards we make and ship to other manufacturers of solid state electricity meters. We saw increases in all three categories during the quarter. Year to date, total Itron AMR shipments for all those products were just under 5 million, compared with approximately 4.2 million in 2004, reflecting a year to date increase in AMR unit shipments of 19%.

Overall gross margin was 43% during the quarter, compared with 42% in the previous quarter, and 44% in the 1st quarter of this year. As we have frequently mentioned, gross margins will fluctuate a point or two from period to period, typically as a result of changes in product mix. Again, there is quite a bit of detail in the release for both total company and segment gross margins for the quarter and year to date this year, compared with those same periods last year. So I will not go through that detail in the call.

We had an exceptional quarter in terms of operating income and margin. Pro forma operating income for the quarter, which excludes intangible assets amortization expenses of $9.7 million, was $23.9 million, which reflects the pro forma operating margin for the quarter of 16.9%. Actions we have taken to streamline the company and operate more efficiently, combined with higher volumes this year, have resulted in trends and operating margin throughout the year that we are quite proud of. Pro forma operating margin has grown from 13.7% in the 1st quarter to 14.8% last quarter to 16.9% this quarter.

GAAP earnings were $6 million or $0.23 per diluted share in the quarter. Pro forma earnings were to exclude intangible asset and debt fee amortization were $12.6 million during the quarter or $o.49 per share. The best quarterly earnings performance in the Company’s history, breaking the record we set just last quarter.

EBITDA was $26.3 million during the quarter, $69.1 million for the first nine months of 2005, and $88.5 million for the last 12 months.

Cash flow from operations was $13 million for the quarter, which is very similar to last quarter’s number.

Accounts receivable increased by $9 million during the quarter driven by higher revenues, particularly in September.

Day sales outstanding, or DSOs, were 55 in the quarter compared to 59 in the 3rd quarter of last year and 49 in the previous quarter.

Inventories increased by 4.3 million during the quarter as we continue to build inventory to meet the ramp up required for the Progress Energy Installation. Inventory turns were 5.1 during the quarter compared to 4.2 in the 3rd quarter of last year and 5.3 in the previous quarter.

Capital expenditures were $5 million during the quarter, up somewhat from what we have been running on a quarterly basis this year as we invested in some capital to increase manufacturing capacity for residential solid state meters in our South Carolina factory. Year to date, operating cash flow is $49.6 million and net capital expenditures were $7.6 million, resulting in free cash flow for the first nine months of 2005 of $42 million. That compares to $17.5 million in the first nine months of 2004.

We repaid an additional $14 million on our term bank debt during the quarter, resulting in a remaining balance at the end of September of $28 million, which means that in the fifteen months since the electricity metering acquisition we have repaid $157 million of the $185 million in term bank debt used to partially finance the acquisition. Our total debt balance was $155.6 million at September 30th. Our total debt as a percent of our total capitalization was 34% as of September 30th.

Now, let me say a few words about our earnings guidance for the rest of this year. In the earnings release, we updated our guidance for this year and also provided a preliminary outlook for 2006. You will note that for the full year 2005 we tightened our previously projected range of revenues and slightly increased our projected range per earnings. For the full year 2005, we now expect revenues in the range of $535 to $540 million, which equates to 4th quarter revenues between $142 million and $147 million. We are now looking for a pro forma EPS to be in the range of $1.70 to $1.75, which equates to a range of $0.45 to $0.50 for the 4th quarter.

There are two main factors that will tend to drive us toward one end of the range versus the other. One of the biggest factors that will influence our financial results in the 4th quarter is the installation of meters at Progress Energy. We are managing the installation and providing significant services on this project. Revenue recognition for Progress Energy is based on route acceptance after equipment has been installed, not on hardware shipment. Route acceptance can be affected by the installation rate and by factors such as not being able to get access to a customer’s home, which sometimes causes multiple site visits to the home before product can be installed. Installation rates and route acceptance can be affected by things such as weather. So, the low end of our projected range provides some cushion for factors that are not necessarily within our control and that may affect the speed of route acceptance. The high end of the range assumes that installation and route acceptance proceed at the currently scheduled pace.

Another factor that can influence 4th quarter and year end results is the amount of year end budget money that utilities have to spend. We usually do not have a good feel for what that looks like until later in the 4th quarter. The low end of our projected range assumes minimal year end money, with the high end assuming somewhat higher year end budget spending. In either case, we are delighted with the projected range of outcomes for us in 2005, both of which reflect very nice revenue and earnings growth 4th quarter of 2005 over 2004 and for the full year 2005 over 2004.

We are also very pleased with how 2006 is shaping up. The excellent new order bookings so far this year will enable us to head into 2006 with a strong backlog and better visibility than we have had for several years. As noted in the release, our preliminary outlook for 2006 is for revenue growth of approximately 10% and pro forma earnings growth of almost twice that.

That concludes my remarks today on our financial results and I would now like to turn the call over to LeRoy Nosbaum, Itron’s Chairman and CEO, for some additional comments.

Good morning, everyone, and thanks to all of you for accommodating the time change on the call. For some of us it’s a tad bit early today.

Financial results reflect that ’05 has been a very good year for Itron. It’s been a good year for most of our customers as well, who are buying more meter data collection products, more electric meters, with and without AMR, more software than ever in the history of the company.

Earlier this week, Rob, Steve, and I had the pleasure of meeting face to face with many of those Itron customers at our annual Users Conference in Dallas. I’d like to share some highlights and perspectives from this year’s conference.

We had a total of 736 attendees. That’s an increase of almost 20% over last year. Of those attending, 91 who were from outside the U.S. representing utilities from eleven countries from around the world. In total, we had 327 different utility companies attending. We had over 140 sessions, including 54 different customer presentations. In addition to the utilities, we had independent system operators, federal and state regulators, energy and water industry consultants, end users, and federal agencies.

Itron's goal is to increasingly bring to our customers actionable knowledge that will help them enable innovation today and tomorrow. This User’s Conference gives our customers a forum for sharing specific examples of how knowledge is enabling innovation at their companies. And there were some great examples across all of our markets.

For customers thinking about meter data collection systems, there is the city of Akron, Ohio Water, where they went from routinely estimating range to AMR with a 99.5% read rate. For customers laying awake at night thinking about managing large amounts of energy and water meter reading information, I had a chance to talk about meter reading with the Southern Company, where they are about to implement, or where they are implementing Itron Enterprise Addition Meter Data Management System that integrates more pro data collection systems to residential and commercial industrial billing systems. For those customers adding to or rebuilding distribution systems in lines, Snohomish County Public Utility district shared how they’re using Itron’s design tools to manage a 200% increase in substation designs, with no incremental design resources and reducing costs in the process.

While many of you know that Itron has a forecasting analysis and consulting group, you may not realize that Itron's forecasting solutions are used to forecast over 80% of the electricity consumed in the United States. Speaking of forecasting, AEP was at the conference sharing how they used Itron forecasting tools to forecast financial performance at month end close as well as load forecasting.

There were numerous examples of customers talking about the advantages they’re experiencing, having installed solid state meters. Or those with Entergy, talking about their expected long term cost reduction and revenue gains from solid state meters, equating to over $4 per meter per year. Cucamonga Valley Water District was at our conference. They’re using Itron’s Six Network Water System, FN 2.5, new technology from Itron, at 1.5, 1.4 gigahertz rather to read meters every 4 hours and with Advanced Leak Detection software pinpointing leaks not only in their distribution system, but in customer houses as well.

From panel discussions, to large and small group presentations, to workshops, to dinner conversations, to a panel of public utility commissioners from New Jersey, Michigan, Mississippi and the Federal Regulatory Energy Commission, there’s an incredible amount of collaboration and knowledge. Sharing that takes place at our User’s Conference. No one else in the industry can, or does, bring together a User’s Group of this depth and size. I came away from this year’s conference with two take-aways.

First, Itron is on the right track from a product perspective. Utilities are looking for data driven solutions for the operational problems. Together, our hardware and software solutions are providing just that. Second, there’s a lot of activity in the planning stage for next year, mobile AMR, software applications, an increasing move to solid state meters, fixed networks, AMI. Over 700 people sent by their companies to our conference with an eye toward the future, which leads me to guidance for ’06.

In our earnings release, we introduced a preliminary outlook. Let me add a few comments on our perspective as we look into next year. We’ve had a good year so far in terms of new order bookings, and as a result, it looks like we head into next year with over 35% of our expected sales already booked. It’s better visibility for the next 12 months than Itron’s had in many years.

We are not, however, the only vendor in the market place. There’s more competition out there than ever before. They’re aggressive and some of them do have good products. We see an economy that is somewhat in a period of transition. Increases in natural gas and electricity prices can create uncertainty for some of our customers. However, as I met with commissioners attending the conference, I certainly was relieved to hear them acknowledge that rising fuel costs must be passed through quickly to avoid, among other things, putting the squeeze on utilities capital spending.

From what we know now and are hearing today, it appears that many of our customers will continue to pursue investments, spending in AMR, metering, software products that help them work smarter and more efficiently. That leads us to a preliminary 10% top line growth rate for next year that we’ve announced today. We expect that earnings growth next year will outpace revenue growth. Volumes are up, costs are being controlled at every level, with strong operating teams in place focused on customers and earnings. We continue to invest in systems and process improvement to run our operations more efficiently. And our strong cash flow this year has enabled us to pay debt down. Thus, we believe, potential for furthering operating leverage in ’06 remains good.

Many of you might ask, given the backlog and the large order from Progress we are not even more bullish about ’06 from a revenue perspective. The answer is quite simple. To hit a 10% growth number in ’06, on the top line, the actual meter, [HERT], and software deals that need to be closed, this feels substantial. At this point, we’re not going to get out beyond our headlights. We’re very comfortable with the guidance we’re giving today.

With that, I thank you all for participating. Operator we will now open up to questions.

[OPERATOR INSTRUCTIONS] We'll take our first question from Steve Sanders with Stephens, Inc.

I want to see if you could provide a little more color on the RFP activity and the competition by segment. Obviously you had a lot of sizable gas orders and electric orders. But just wanted to get a little more color there.

Yes Steve. Let me start. RFP activity remains very strong as it has throughout the year. We’re continuing to see lots of requests, not only for information, but for proposal. A few very large and then the real volume is sort of in the middle of the large to small region. If we look at across the board, RFP activity remains high in all segments. I mean competition for us has not changed in terms of segment competition. We still are, we think, very strong in the gas market and so we're competing well there. We have seen a lot of competition in the water market as we’re seeing some very aggressive competitors out there trying to make their niche both with fixed network and then certainly, we've seen some competition in the mobile area from a couple of our competitors. In the fixed—or in the electric area, I think it's fair to say that we're doing a nice level of business in mobile AMR and we’re duking it out wherever there's fixed network opportunity. The next sort of growth opportunity that I'm sure somebody is going to ask me about is Ontario, which is coming up pretty quick, and all of the major combatants will be up there working hard to get that order, or whatever number of orders comes out of it.

Okay. And looking forward, how should we think about book and ship trends in your business? Can you provide some additional detail there, either meters versus A&R overall, just a little direction there?

Yes Steve, this is Mima. I think we will continue to see a fair amount of book and ship in the water side of our business which historically has gone through a distribution channel and that's the pattern that we see there. Although I would add in terms of some color on RFPs that there are some larger municipal orders out there and those would not necessarily fall in that book and ship category but there is still a fair amount of business on the water side business that is book and ship. I think when you look at the meter business, again, there's a significant portion of our meter business that is most definitely a book and ship kind of business where orders come in and we deliver and ship against those during the quarter. So, overall I wouldn't expect much of a change on that side of the business.

Okay. And a final question on the handheld business. I may be incorrect here but I thought it was a little soft in '04. It sounds like it's picking up in '05. Can you give us an idea of what that represents of the meter data collection segment or at a minimum just talk about what you see there over the next year or so.

Sure. If you look at our handheld business from a normal domestic upgrade kind of cycle, we’ll see anywhere from $20 to $30 million a year in terms of hardware and software sales as utilities fairly routinely upgrade those systems. We’re actually seeing a little bit higher number in our handheld systems this year and that's really driven by a couple of large orders on the international side. We are in the process of doing an upgrade for a utility in Japan. This is the third generation handheld upgrade there. We're also doing a large handheld system, I believe, in Ireland.

That's correct.

Okay. And—and I'm sorry, one more question. Just on the Progress side. What is the rough size of a route? Is it 50 thousand end points? 10 thousand? Just help me understand that a little bit better.

No. It's significantly smaller than that Steve.

Yes. Typically Steve you're going to see routes between 315 to 400 depending on the density of the particular area they're in.

Okay. Thank you very much.

Next we'll hear from Sanjay Shrestha with First Albany.

A couple of quick questions here. Looks like the margins on your meter data collection business obviously up sequentially but does it have a lot to do with the ongoing strong pricing that you guys have on the gas side of the business? Or can you elaborate on a little bit more?

Sanjay, clearly mix always affects margins and we've sold a lot of gas products where we routinely have had higher margins and continue to look forward to that, both today and ongoing.

Yes. The other thing that helped handheld—or that helped meter data collection margins in the quarter was handhelds systems revenue.

Got it. Kind of like the upgrades cycle that's gradually starting to kick in and that's helping you guys out?

Yes.

Got it. Okay. So, then staying with that side of the business, then is it fair to say that for you on the stand alone AMR business, obviously you are not tracking any big—big large sized projects like you've been able to win this share. But there should be a fair amount of business coming from the gas side and in your '06 guidance that you guys have been talking about for 10% growth, you're not talking about potentially winning a big to large sized fixed network electric AMR project. Am I reading that right?

Yes. I think that's probably a pretty good read. I don't think we’ve factored in any major activities, for example, from something like Ontario.

Got it. Got it. And also, right along those lines. When we think about, obviously, it seems like Japan's taking up a bit here, you guys are talking about expanding internationally and now, are we—we're not [breaking] in any major traction from the international market again to kind of do that 10% type of a top line growth in 2006 and that's probably more of an '07 average. Is that correct?

Sanjay, you're absolutely correct. As we look towards '06, we're looking for just a normal steady growth rate in international. We're not looking for any spare set function and I would also say that you're conclusion about '07 is where our head's at this point and time.

Okay. Got it. One last question. In your prepared remark you talked about feeling comfortable with the commissioners saying, "Hey, there's going to be a lot of flexibility about passing on the increasing price of fuel in the rate base", and with the rising, or at least the outlook for the rising interest rate, I guess. Do you see that having a major implication for the—what has been a good CapEx outlook for the utility industry in '06 and '07 time frame? Can you talk maybe, I don't know—maybe in some more detail about that?

Well I am happy to actually. I forcefully engaged the commissioners that were at our conference because I do think we have to watch somewhat that the utilities can get into a cash squeeze where they're buying it at $12 or $13 or $14 for gas and they're selling it for significantly less unless they're allowed to quickly pass through those kinds of cost increases. The impression I got universally; No detractors, was no-- we've seen this problem before. We understand it. We will give these guys relief very quickly and likely we will handle the low end of the economic ladder by providing some special packages to those that can't afford the higher utility rates. All of that was really, really good. I am some afraid that if we get interest rates moving up rapidly and we get cash crunches at utilities that they're going to get more mindful about their capital budgets. We haven't seen it yet. I was encouraged that we had utilities attended by 730 odd people for a conference. But I do think that's something that we all aught to watch because it does make a difference. You guys heard us all through late '03 and '04 say, capital budgets are down so we're suffering from it. But now we look for a good '06 as we've said. But I think that is one of the things that we all aught to be watching.

Yes, but you do—you guys have sort of taken all these factors into consideration when you were talking about the guidance at this point and time though I have to imagine, right?

Absolutely.

Okay. Got it. That does it for me guys. Thanks a lot.

Paul Coster with JP Morgan has our next question.

A couple of quick questions, and the first one is the installation services that you're offering at Progressive. Are these—is it an unusual contract? Is it a sort of one off? And then can you just give us some insight into how it's priced. Is it time and materials, cost plus or fixed cost contract, please?

No it's not unusual in that we routinely offer to do installation services for our customers. We can be unusual is we will go through some periods where we don't have a lot of those installation services we're providing and other times, for example this year, where we've had a number of utilities that have hired us to do the install. Piedmont Natural Gas, there's another gas customer where we're doing the install and obviously Progress. What makes Progress unusual is the size and the speed with which we are providing those installation services. It's not separately priced. What we have done is—or the contract with Progress is essentially a per unit price and that covers the hardware, the software and the installation services.

Are they own employees or is it—are you subcontracting?

We subcontract that out.

And what risks are there associated with it, if any?

Paul, ask that question again.

What risks are associated with it from a pricing perspective? I am just recalling a situation where we had some budget over runs in the past and there was a—

Yes. There risks on this one, to be specific, are almost nonexistent. This is quite routine work in terms of what we have to do and where we're doing it and a situation that—well, we subcontract the real labor, we are managing the project with our own people, which we always like to do. To arc them back to earlier times that was, in fact, at ConEd New York where we were fighting some fairly difficult issues with the union there and some coordination problems between ConEd, the union and ourselves which we, frankly, intractable and so we had some trouble, but the risk here is virtually none.

Excellent. Okay. My last question LeRoy is, utilities obviously planning capital expenditures some way out into the future, but how sensitive are they to the economy? Can they change their plans quickly and if so, in your experience, how quickly do they do so?

That's a reasonable question Paul. If we look at what utilities has done in the past, they don't-they don't react in either direction sharply or quickly. There's just a lot of momentum that those large organizations have. That being said, when they start getting into a cash crunch they will just stop programs and so we are mindful of that. The good news is, is we're currently constructed and if you look at—at the Itron of old versus the Itron of today, utilities buy meters every day no matter what their capital structure is and so we have a fairly substantial portion of our business now that is not very subject to the ups and downs of the economy, the ups and downs of the utility capital budget because they will buy meters.

Now the AMR business, that's another story and certainly the software business, that's another story. And so those—those differ. We will not routinely see a company like a Progress or any of the other ones where we're in the middle of a project, shut a project down. Those monies are clearly baked in, they're baked in for the rate base typically, so those keep going forward. But what we do see, or at least historically we have, is that new projects get delayed and that's—that will cause us a problem. As we look to '06 today, we are not alarmed, but as I said to Sanjay's comment, I think we all have to be aware that we have an interesting time ahead.

Paul, the only thing I would add to what LeRoy said is if you look at the kinds of historical examples where we've seen a real sharp change in spending, it's typically been driven by something pretty extreme like a weather event such as the hurricane that went through Dominion's territory a number of years ago. Obviously, as I talked with a number of you during the quarter, we did not have that negative impact from the hurricanes so far this year.

Okay. Got it. And so the new Itron is more resilient to the downside of the economy than the old Itron, in part because you've now got the integrated meter business, which is—that goes on regardless of everything.

Quite correct.

Got it. Thanks.

[OPERATOR INSTRUCTIONS] Next we'll hear from Jarett Carson with RBC.

I wanted to ask a question on your shipping solid state meters, I think you mentioned Entergy as a customer there, where there is no embedded AMR. Is there a positive or a differentiated opportunity if you want to come back over time, so I know you have the retrofit on existing electromechanical, but to an extent where you're shipping solid state meters that someone wants and someone has installed those in their territory and then one, two or five years down the road, they decide that they want to go to AMR. Do you have a better opportunity relative to other solutions such as PLC to come back from a price point perspective to integrate that versus—retrofit that versus retrofitting an electromechanical? Can you talk a little bit about that dynamic?

Yes Jarett, a good question, thank you. One of the things that the folks at [Schlumberger] were very mindful of was to construct a solid state meter that not only had superior metrology characteristics but could adapt quickly and easily to what they termed 'personality modules'. So it allows them to—whether it's AMR or it might be some advanced metering function in the future, it allows them to simply slip in a personality module to an existing meter and to change its characteristics from bread and butter kilowatt hours to time of use to AMR to AMI to whatever we might look upon in the future as something the customer wants. A real advantage for us, because not everyone who is currently introduced to solid state meters has used that same sort of personality module configuration.

And—but does that give you from an integrated perspective on the Arms side, say the point that somebody wants to come back, an easier or maybe a lower cost retrofit solution versus--?

Absolutely. Because many of them can't be retrofitted. It simply has to be taken out and thrown away.

Okay. Second question, this is more qualitative and I think maybe 190 degrees opposite to some of the earlier comments, but can you talk qualitatively—are you talking to more public utility commission people and around the country and the reason why being, clearly electricity rates are going through the roof, they are going to continue as coal prices move forward for at least the next twelve months or more and the opportunity that AMR can be, in some small way, a cost savings that--I know sometimes you're going to have to work it out between what the utility keeps on return on investment, but a way to perhaps slow down a small bit of that increase and creating some demand pull through the public utility commissions. Can you talk about that as far as protecting consumers a little bit? And if those conversations are starting to happen?

Those conversations are in full flow. We are spending huge amounts of times with commissioners in virtually every state and officials at the federal level on that subject. And it's interesting because we also got some help here as we talked last conference call from the Energy Bill. There is an awful lot of commission activity, both because they were doing it anyway, looking at time of use rate, looking at alternative rate structures, demand response programs, plus the Energy Bill forces them to do it anyway in a more processed way. So we are engaged with commissioners and we do that in a learning mode. We are not trying to sell them on the benefits of what Itron has but trying to sell them—not sell them really, but point out that time of use rates, automatic meter reading, AMI kinds of initiatives are good because they allow, not only some relief for the low end customer that can't afford electricity and natural gas prices, but they also allow some conservation efforts and they're just good public policy in various places. So yes, we are spending a huge amount of time--I think Rob's got a comment in the same area.

Yes Jarett. In the second half of your question, you were talking about does that create pull? In some cases it does, although utility commissions don't tend to go to their utilities and require them or request them to automate. What they do instead though is the more they're educated, which is why we have poured an awful lot of energy into this area, is that when a utility brings a project before them, an automation project before them, and they're already educated, they tend to move the acceptance process along much quicker.

Okay. So, relative to we—we kind of started off the first part of this call talking about concerns about all the different things going with the economy and utilities. Is there a theoretical possibility that '06,'07—just industry order rates actually pick up from the fact that people are starting to use this to hold down some of the rising costs in overall electricity prices?

Yes. Jarett good perspective and I think that is likely to happen but realize the normal inertia of the utility industry. So I'd look for that more '07 as some inkling of it and some sort of piloting or at least public pronouncements in '06, but I don't think you'll see much of an impact there until the '07 time frame.

Jarett, Rob again. I just want to tack on to that one too that I think you've seen some of that momentum in 2005, at least as it relates to Itron's momentum.

Okay. Thank you.

Thank you very much. Next we'll hear from Bill Dezellem with Tieton Capital Management.

Thank you. We have a group of question. First of all, relative to your 2006 guidance of roughly 10% revenue growth, would you share with us how you would see the rates of growth as splitting out between the meter data collection segment and the electric meters. And then secondarily, I think it was roughly a year ago that you had several prospects that delayed making decisions and to help us understand the pace at which utilities move and just the issues that they're dealing with, we're curious, have all of those delays been resolved at this point?

It's all timing. In terms of providing more detail on the guidance for '06 at this point by segment, we're not ready to do that today. We are, as LeRoy said, very comfortable with our top down guidance but we're just in the process of formulating all of our bottoms ups plans and—and I think clearly you can make some assumptions based off of the one large gorilla order Progress Energy is to the fact that our meter revenues should show some pretty nice growth next year but other than that we're just not prepared to give any segment detail for '06 at this point. We clearly will do so next quarter.

To your second question Bill, I think with maybe no exception that's coming to mind right now, yes some of those projects turned back on and are part of the good year we've had in '05.

And then finally, Japan has been referenced just a couple of different times in passing in this call. Would you provide some color in terms of the history and what it is you are actually seeing in Japan and what opportunities may be there and unfolding over the next one to three years please?

Sure. This is Steve Helmbrecht. I was formerly responsible for the international group and so I've spent quite a bit of time in Japan. We've been in—providing products to the Japanese market now for over a decade and as we previously mentioned, we're on our third generation now of handheld systems. We provide products to the Japanese industry both on the electric side and at water for meter reading. Today the Japanese market is almost all read with handheld systems with no AMR. The market is going through deregulation on the electric side. It's fairly concentrated in that there are only ten utilities in Japan, electric utilities covering the whole market. But with deregulation, there are new entrants. We think that makes it very attractive for us in a variety of ways, AMR systems as well as software to help deal with that deregulation. And we are very focused there on adapting our AMR technologies to meet the needs of the Japanese market. We also have very strong relationships we've established over the years and feel that Itron is well branded now given our track record in delivering multiple generations of handheld systems that are still in use today.

Thank you.

Next we'll hear from John Quealy with Adams, Harkness.

A couple of questions here. If we go back to the AMR results for the quarter, clearly gas helped the margin in what I'm assuming is some of the equitable in the Piedmont business coming through and hitting, in reference I think to Sanjay's earlier question, can we see the gas business continue to stay strong as we exit '05 and get into '06 or is some of your expectations for '06 growth continued good growth in gas once those legacy contracts are wrapped up?

You absolutely can expect the nice growth in gas AMR to continue into '06. If you look at the Piedmont order, it's a three year order. If you look at some of the other contracts we signed this year, Public Service Electric and Gas in New Jersey, [Vectron], Equitable, we really have had a lot of nice gas orders that we booked this year that carry well into next year.

Okay. Great. And if I could just drill down a little bit on Progress when we're talking about the high and the low range of whether it's Q4 or getting into the early part of '06. How much—is it weather dependent and how much is it actually trying to get in people's homes? It looks like Progress has been spared the worst of the storms thus far versus its Florida Power and Light sibling down there, but can you comment on the logistical issues that you watch closely for that?

Yes John, I would say it's really not so much weather impacted, although clearly we always watch weather, we'll be very happy when hurricane season is over in the Southeast. It really is more of a factor of getting route acceptance. I don't remember the specific criteria for a route to be accepted, but it's fairly high. So even though a route might be comprised of only 400 or 500 homes, if you have 20 homes that it takes you three or four visits before you can actually get the technology installed, that can delay things. So I think we've tried to be somewhat conservative in terms of assuming that we will have some of those situations where it takes us a number of times to go back.

Okay. And last couple of question here, you updated guidance. Can you talk about free cash flow '05 and '06, either quantitatively or qualitatively?

Sure. Our free cash flow so far during the year was right around 42 million and so for this year; our free cash flow guidance remains unchanged at somewhere between 50 on the low side to 60--is a very nice range. Now that excludes the purchase of the building that we talked about, but overall our free cash flow looks very good. We did have a buildup in receivables at the end of the quarter, but collections so far in October have been very, very strong. So we do expect a nice cash flow quarter in '05, or excuse me in Q4. And then heading into '06, some of the issues that have actually kept cash flow lower this year will be behind us. We are using a lot of cash in Q3 and Q4 this year to build inventories for Progress. We will no longer be in a situation of having to ramp up that installation as we head into '06 and so we'll start to see the cash benefit of that.

Okay. And my final two questions. The Oconee expansion, when do you folks think that that will be online and ready to go?

John we have been expanding Oconee through the backend of Q3 and then on into Q4. We will finish the first phase of that fairly shortly actually. We are in a second phase planning stage and we'll be doing some additional expansion as we move into the 1st quarter of '06 and we would expect to see that be at—ready as we get to the end of Q1. We're being very careful here to balance the need for increased production largely because of our good fortune at Progress and with the reality that we don't have another gorilla order like that so far for the back half of next year. So, some of it finished this quarter, some of it Q1.

And then LeRoy, my final question for you, in terms of—if we talk about the macro outlook for the industry, several points have been brought up on the call for utility spending. As you look into '06 and beyond, what's the biggest driver or concern for you? Is it utility CapEx? Is it the pass through? Is it how people shape their plans in the face of AMI and the Energy Bill? What are you looking at closely right now?

I think from an external perspective CapEx spending effected by high energy prices is one. I think the effect of the Energy Bill will largely be an '07 thing and I think it's all positive to be honest about it. There's actually some talk in Washington these days to go back in and take another look at a supplement to the Energy Bill or a new one that might price—might apply some economic incentives moving forward with time of use and AMI. We'll see if that even gets any traction. That having been said, I think utilities clearly are beyond now the stage where they're thinking about AMR in terms of is it effective. They're certainly moving forward hard so I like that.

AMI is interesting in that, you guys have all heard me say this repeatedly, so I'll say it one more time just so that I don't pass up the opportunity, AMI's got more voice than its got legs. Its got voice in California, its got voice in Ontario, but it doesn’t have legs beyond that. We're going to see a continued progression of AMI stuff up and down the coast in California. Southern California Edison is engaging all of the various vendors on what they what to think about in terms of meter of the future. San Diego is engaging vendors on AMR that has an AMI lean to it, not quite as extensive as PG&E did. And PG&E is still trying to come to grips with actually awarding contracts and getting them signed and where they're going to go. So we'll see where that plays out. Ontario is reported to be concluding this week, or this quarter, with an actual award to somebody. They did finally hire a consultant to bring that thing to term. That consultant was actually at our users conference. I had the good fortune to spend numbers of hours with that person. They have a lot of work to do in Q4 but I think that will push some activities forward. You'll see a lot of activity in the municipal area around automatic meter reading. Nothing like AMI but just reading meters every month and I think that activity looks good for '06 and '07. So, I like—I like the view out there as we're going forward because I think the momentum on AMR is there. It's certainly strong mobility. It's certainly strong from a fixed network perspective and I do think that the magnitude of the two AMI areas in Ontario and California are such that they'll affect the market positively. So, I've been as optimistic lately as I've been in my ten years here at Itron.

Great. Thank you.

Next we will hear from Chris Summers with Greenlight Capital.

I wanted to get a better understanding for handheld revenues in the quarter. I guess if I look at 1.2 million modules shift at an average selling price of called $40 a module, that gets me to 48 million of revenue and there's an incremental additional 22 million of revenue in the quarter. How much of that is handhelds and what's the margin on the handhelds? And then what makes up the difference?

We don't disclose that detail separately in terms of margins by various product lines and I think our handheld revenues in the quarter were somewhere between 8 to 10 million. But there's installation revenues in there as I mentioned earlier, we're doing a lot of installation work right now for our gas AMR contracts and the—we obviously haven't disclosed per unit pricing for some of those contracts, so—handhelds were not significant, but maybe somewhere around 8 to 10.

Got it. What would that have been in the 2nd quarter? The handheld revenue?

I'm sorry, I just don't know. We just don't typically track it. But as I said earlier on an annual basis, domestic upgrades are generally between 20 and 30 million a year.

20 and 30 million per year. Okay and then the 500 thousand AMR gas meters, is that PSE&G or is that a new --?

No it's a new customer and we don't have permission yet to publicly talk about that contract by name. But we hope to shortly.

Okay. Great. Thanks a lot guys.

Next we'll move to Patrick [Gorkin] with [DeHause] Securities.

LeRoy, with respect to Ontario, is it your sense that with respect to AMI there, that there will be sort of one winner takes all or do you think there will be a combination of technologies and vendors?

Patrick, for certain we don't know. I think that one, there is likely to be a lot of teaming to whomsoever is successful. Whether it's a combination of partners or it's one partnership. So far what they've talked about is—it is broad enough to draw partners together and certainly if you look at the pilots that are up there, there's almost a dozen of them, we participate in about half of them. There's partnering going on in every kind of form and way. So I think the opportunity for teaming is there. And we'll see if more than one company is given that order. Certainly the magnitude of it is such that my own counsel would be it would be wise to break that up a bit. But we'll see.

Sure. Along those same lines, where do you stand as far as agreements with competing fixed network solution providers integrating that in to the Centron Meter?

Yes. We have agreements in place to put Esco's product, their DCS1, their power line carrier stuff in our meters. We have agreements in place with CellNet and we have agreements in place with [Hontweum] that their stuff—we certainly work with SmartSync. I am running down my Rolodex here. And in general, there's not much that goes on. We’ve been asked if we would consider putting [Elstra's] stuff -- Elstra's fixed network stuff in our—in our meter and philosophically we don’t have a problem with that but we certainly don't have an agreement to do it either.

Okay, how about CellNet's meshed network product? Are—are you on board with that?

We have a long history of embedding CellNet product into our meter and whether it's their meshed network stuff or other stuff, we would be delighted to get their meter business.

Okay. And then Hexagram's gotten a little traction. Are you working with them at all?

No we do not.

Okay. Very good. Thank you.

Next from Beekman Capital we'll hear from Brandi Shaw.

I was wondering if you can talk a little bit at all about the run up in copper and maybe how that and some of these other commodity materials are going to have an impact on the business or not?

Yes. The reality of it is, is that kind of material stuff is minimal to no effect on us whatsoever. We don't use a lot of copper anymore. Were we making electromechanical meters, we might have a different view on that, if you look at the buildup of what we do, integrated circuits is our largest cost and so we're mindful of that. And we have had a very long run of good pricing on ICs. It's made even better with the doubling of our volumes as we added our meter group. We'd certainly watch plastics. We buy a lot of plastic and again, there's a place where we’ve had a fairly long history now of good plastic prices and we have actually managed to get some nice cost reductions as we've doubled our volumes on plastics. But copper, your basic raw materials, we just have not had any impact at all.

Great. Thank you.

And Ms. Scarpelli, that appears—it appears there are no further questions at this time. I will turn the conference back over to you for any additional or closing remarks.

Great everyone. Thank you again very much for joining us and as always, either LeRoy, Steve or I would be happy to answer any questions that you have. Thank you very much.

And that does conclude today's conference. As a reminder, there will be an audio replay of today's conference available this afternoon. You can access the audio replay by dialing 888-203-1112 or 719-457-0820 with the pass code of 5349308 or you can go to the Company's website, and that is www.itron.com and we thank you very much for joining us on today's call.