Itron Inc (ITRI) 2007 Q2 法說會逐字稿

Good day, ladies and gentlemen. Welcome to this Itron, Inc. Second Quarter 2007 Earnings Conference Call. As a reminder, today's call is being recorded.

And now for opening remarks and introductions, I'd like to turn the conference over to Ms. Deloris Duquette. Please go ahead.

Good afternoon, everyone, and thank you for joining us today.

On today's call, we have LeRoy Nosbaum, our chairman and CEO, and Steve Helmbrecht, our chief financial officer.

The earnings release that we issued today includes the results for Actaris, which we acquired on April 18th. The release also includes an updated outlook for revenue, earnings and adjusted EBITDA for 2007.

Today's call will also include other discussions that may be forward looking in nature. The business outlook and other forward-looking information we are providing is based on what we know today and is subject to a number of risks and uncertainties. I would like to encourage you to read the forward-looking disclosures in our press release, which alerts you to a number of factors that can cause a difference between our expectations and our actual results. You should also refer to our 2006 Form 10 K for a more complete disclosure of specific risks and uncertainties related to our 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 enhance your overall understanding of our current and future performance. Schedules reconciling GAAP to non-GAAP financial information are included with our press release and are also available on Itron's external web site.

Steve's going to start the call today with a discussion of financial highlights for the quarter, and after that LeRoy will offer some additional thoughts and comments. We will hold a question-and-answer period after these remarks.

Now I'd like to turn the call over to Steve Helmbrecht, Itron's CFO, for the financial highlights discussion.

Thank you, Deloris, and good afternoon, everyone.

In addition to a review of our financials, I will provide an update on key initiatives as well as our business outlook for the remainder of the year.

First I want to talk about the acquisition of Actaris Metering Systems, which we closed on April 18th, and how we are reporting financial results for the combined company. As part of the integration process, we reorganized into two primary business segments -- Itron North America, which is principally the company as it existed before the Actaris acquisition and includes electricity metering, meter data collection, and software, and Actaris, which is the company we acquired and includes electric, gas and water meters and systems. Corporate unallocated expenses consist of expenses that are not directly related to either of the segments and are reported separately as an operating expense.

Moving now to financial results, total revenues were $402 million for the quarter. Actaris revenues were $250 million for the period April 18th to June 30th. Itron North America revenues were $152 million for the quarter, down about $12 million from the second quarter of 2006 due primarily to the completion of the Progress Energy project, which contributed over $30 million in revenues in the second quarter of 2006. Itron North America revenues for the first six months were about $20 million lower than 2006, also due to completion of Progress, which contributed over $63 million in revenues in the first six months of 2006. As previously discussed, we have returned to a more traditional quarterly revenue pattern this year.

Total company gross margin during the quarter was 31%. Itron North America gross margin was 42% in the second quarter, similar to the same period in 2006. Business combination accounting rules require that we value Actaris inventory at sales price less any cost to complete and a reasonable amount for selling efforts. This resulted in increased cost of sales for the quarter of $16 million and a negative effect on total company gross margin of approximately 4 percent points. Actaris gross margin without the purchase accounting adjustment was 31 percent, which is more consistent with historic margins, and there was no remaining revalued inventory on the balance sheet at June 30th.

Operating expenses during the quarter were $148 million and include approximately $36 million of expenses for in process research and development at Actaris. Business combination accounting rules require that we expense the fair value of the in process research and development for next generation or new technology. Actaris operating expenses without the one time in process R&D expense were $57 million, or 23 percent of revenue, which is more typical. Itron North America operating expenses for the quarter of $47 million were $2 million higher than the comparable 2006 period, fundamentally because of increased expenses related to our OpenWay AMI development.

Non-GAAP operating margin, which excludes expenses related to the inventory accounting adjustment and in process R&D was 13 percent for both the quarter and year to date periods. This is an improvement over first quarter non-GAAP operating margin of 11%, but somewhat lower than the 15% and 16% posted in the second quarter and first six months of 2006. The decrease in non-GAAP operating margin is primarily due to our increased R&D spending as well as higher G&A expenses.

Non-GAAP net income which excludes expenses related to the inventory accounting adjustment and in process R&D as well as amortization of intangibles and debt fees was $27.7 million, or $.89 per share, in the second quarter, compared with $15 million, or $.57 in the second quarter of 2006. Non-GAAP net income for the first six months of 2007 was $39.7 million, or $1.34 per share, compared with $28 million, or $1.07 per share in 2006.

I would like to point out several items that favorably impacted the non-GAAP net income during the quarter. non-GAAP net income for the quarter included realized gains on foreign exchange transactions related to the Actaris acquisition of approximately $2 million, as well as unrealized foreign currency exchange gains of approximately $3 million, for a total impact of $.12 per share. And our non-GAAP effective tax rate for the quarter was 31%.

Total company new order bookings were $413 million for the quarter, which is slightly more than a 1 to 1 book to bill ratio. Second quarter bookings include a previously announced contract with MidAmerican for mobile AMR of approximately $100 million. Itron North America had a book-to-bill ratio in the quarter of about 1.3 to 1, while Actaris book to bill for the time we owned them was about .9 to 1, primarily due to the timing of the close.

Total backlog was $656 million at June 30th, compared to $376 million at March 31st. This was driven to a large degree by $262 million of acquired backlog from Actaris. Our 12 month backlog was $491 million at June 30th, compared to $225 million at March 31st.

Our cash flow from operations for the first six months of 2007 was $63 million, compared with $52 million in the first half of 2006. The increase in operating cash flow resulted primarily from the addition of Actaris.

Our capital expenditures for the first six months were approximately $18 million.

Adjusted EBITDA was $69 million for the quarter and $92 million for the first half, compared with $29 million for the second quarter of 2006 and $58 million for the first half of 2006. Adjusted EBITDA includes operating results for Actaris from April 18th to June 30th, and excludes the expenses related to the inventory accounting adjustment and in process R&D, which was $16 million and $36 million, respectively.

We ended the quarter with about $105 million of cash, which is substantially less than the $622 million at the end of March, as we used most of our cash to help fund the acquisition of Actaris.

Total debt at the end of the quarter was $1.6 billion, comprised of $1.15 billion in multicurrency bank debt, $345 million in convertible notes, and $125 million in senior subordinated notes. In July, we made our first pre payment on the bank debt -- approximately $10 million on the approximately $100 million traunche of debt that is denominated in pounds sterling.

Now I will talk about some key integration activities, as well as out outlook for the rest of the year. We focused on structuring and integrating the Actaris acquisition to drive efficiencies including structuring the acquisition to efficiently repatriate cash, minimize our effective tax rate, and reduce cash taxes, integrating Actaris' financial systems with our new ERP system, and conducting worldwide training for Sarbanes-Oxley and the implementation of stronger internal controls over financial reporting.

We are implementing an interest rate hedging strategy to increase our fixed-rate debt in order to minimize the impact of potential rate increases. We are implementing foreign exchange hedging strategies to reduce the financial impact of potential movements in the Euro and pound sterling relative to the dollar.

With those activities in mind, I will talk about our outlook for the remainder of 2007.

For the full year 2007, we expect revenues to be between $1.42 billion and $1.44 billion, an increase of $10 to $20 million over first quarter guidance. Non-GAAP diluted EPS, which excludes expenses related to the inventory accounting adjustment and in process R&D, as well as amortization of intangibles and debt fees, is expected to be between $2.75 and $3.00, which is higher than the $2.60 to $2.90 we indicated on our first quarter call. An adjusted EBITDA, which includes the benefit of adding back in process R&D and the inventory adjustment is expected to be in excess of $230 million. For the third quarter, we expect revenues to be between $425 and $445 million.

There are several items worth pointing out when thinking about our expectations for the year. Our expectations for Actaris are based on an average foreign exchange rate of 1.35 per Euro. We expect our effective tax rate for the second half of the year to be approximately 31%. Additionally, in the third quarter we are evaluating and expect to record a tax benefit related to a recently enacted tax rate decrease in Germany which is not included in expectations for non-GAAP diluted EPS. We expect our outstanding shares for the year will be approximately 31 million.

In closing the acquisition of Actaris has produced immediate benefits, both strategically and financially, and we are very excited about our future as we focus on generating growth in earnings and cash flow. I look forward to reporting to you our combined financial results and the progress on our financial initiatives over the rest of the year.

And I will now turn over the call to LeRoy for additional comments.

Thank you, Steve, and good afternoon, everyone.

Obviously, we've had a busy second quarter. Between acquiring Actaris and all that goes with more than doubling the size of the business and the current level of AMI activity in the U.S., we've been very engaged on a number of fronts. And generally, I'm quite pleased with our results.

With the acquisition of Actaris, we've changed our reporting segments and we will also change the format of our prepared comments. Those of you that have read our earnings release have noticed that we've collapsed historical Itron segments down to one -- Itron North America. And we've lumped the electric, gas and water business of Actaris into one Actaris segment.

For Itron North America, it simply did not make sense to report meters separately from meter data collection as the majority of the meters we now ship have some from of AMR or AMI embedded in them. Software, while still very important to the overall value proposition to our customers and to Itron, is now less than 5% of the total of Itron, so we will remove it from segment reporting as well.

Many of you were no doubt looking for electric, gas and water segments for Actaris. Up until this earnings release, we've talked about these three operating groups within Actaris, and we will continue to provide color around these three groups when it's appropriate.

In putting together our current structure with Philip Mezey as chief operating officer in charge of Itron North America and Malcolm Unsworth as chief operating officer in charge of Actaris, it became clear that we would run the company in two segments, and I would hold Philip and Malcolm responsible for the results and performance of those broad segments.

Additionally, divulging detailed operational data on electric, gas and water for Actaris gives competitive information to the general market that could put us at a disadvantage in some situations. Accordingly, we will report only two segments -- Itron North America, or INA, and Actaris going forward.

Our earnings release commentary will message around these two groups, along with some general comments on the overall company. On future calls, you can expect some of the prepared remarks to come from Philip Mezey, our COO for Itron North America, and from Malcolm Unsworth, our COO for Actaris. Today, you're stuck with me.

So let's begin with some of the comments on our Actaris segment. We closed the acquisition on April 18th. Steve's walked through financial details, financing details and some of the accounting integration work which has all gone very well. Since April 18th, Actaris has contributed $250 million in revenue, with 40% coming from shipments to electric utilities, with particularly good results from prepay metering systems, 31% from gas, 29% from water -- good results on all fronts.

Sales during the quarter were in line with expectations for Actaris and, as we've previously mentioned, consist primarily of meter sales with some AMR and prepayment systems, which are increasing. At this point, we would expect good results to continue through the second half.

Again, please take care when you look at the published segment data for Actaris as purchase accounting affects several items which we call out in our earnings release.

On the integration front, a number of activities have started. In Europe, we've begun to integrate Itron's international sales force into the existing Actaris team. Since Itron's international group in Europe was largely selling software, this initial move is highly complementary. It has been a great learning opportunity for both sides, and has already resulted in some joint proposals and information sharing. Nicely, I can report today that we've just signed a $1 million plus contract for software with Nuon, a large Netherlands-based utility.

We have begun formal technology sharing discussions and strategy sessions to begin to develop future product roadmaps for electric, gas and water involving systems and software. These discussions have been at the engineering and project management level in Europe and in the U.S. Our manufacturing groups have begun working together around common purchasing and other manufacturing synergies.

From a marketing perspective, we've continued to operate and likely will in the future as Actaris outside of North America. Actaris is a well-known and well-respected brand, and customers identify with it. We are presenting a common front at tradeshows and linking the two well-known brand names together to ensure consistency. Feedback from customers has been very positive.

All and all, good progress that will produce good results.

Now, let's turn to some of the external factors that are going on in Actaris' markets, and we'll focus on Europe. Several initiatives are going on that are worth noting. The European Electricity Directive, which was originally drafted in 2003, became effective July 1 of this year, after a number of revisions. While it states that all customers should have the ability to choose their electricity supplier, the support systems for that to occur are not yet in place. What this directive effectively does is to drive the need for countries that are in the European Union to increase the frequency of meter reading and potentially move toward AMR and AMI.

This legislation has already caused some countries to move forward with smart metering initiatives. Sweden began a program several years ago, and they are in the process of deploying smart metering on all of their 5 million meters. The Netherlands has stated that starting in 2008, they will begin to replace all 9 million electric and gas meters over a six-year period and are in the process of evaluating different technologies. In the United Kingdom, an energy white paper was issued in June that basically encouraged the electric utilities in the U.K. to begin deploying smart meters on new houses starting in 2008. France's largest utility, Electricity de France, is also developing a strategy that has -- and has released an RFP in June of this year. Plans are beginning for deployment of smart metering in 2010. Those are some of the areas that we're watching and customers we're working with, positioning Itron and Actaris to be able to take advantage of opportunities that are developing.

While it is natural to focus on electricity and water and gas, overall AMR activity continues to increase as utilities try to improve customer service and provide more and better information to their customers. I know that many of you have been watching press releases on AMR activity in Europe and have noted that Actaris is never mentioned. It has been their policy to not do PR on this kind of activity for, as a privately held company, they felt no need. We will move away from that general stance, however we will only announce orders where our customers have given us clearance and where the order is significant.

In Q2, Actaris shipped about 500,000 points of AMR and systems across electric, gas and water typical, and indicating of early stage AMR markets. In subsequent calls, we'll discuss other areas of the Actaris world.

Now, let's move on the Itron North America operations. Obviously, one of the highlights of the quarter was our order for close to 2 million electric and gas modules -- electric meters and gas modules -- from MidAmerican Pacific Corp for a mobile AMR system, almost $100 million in bookings for the quarter.

This order did two things. First, it validated our thinking that AMR and, in particular, mobile AMR, is alive and well. Second, it validated our statement that AMI will likely delay some AMR decisions.

We actually had hopes for this order last year, however as part of updating one of their utility commissions, MidAmerican was asked to consider an AMI deployment instead of AMR. They did an evaluation of mobile AMR compared to AMI, and the commission could readily see that the cost reductions and operational efficiencies were what this utility really needed, not additional costs and capabilities of AMI. Good decision for our utility customer, for the consumer, and for the commission.

As we talk about AMI in North America, keep MidAmerica in mind. We still believe that not all utilities will turn to AMI. There are still those utilities that will be focused on reducing costs and improving operational efficiencies, who lack the forcing functions for AMI -- limited supply in the form of generation, transmission or distribution capacity. And don't forget, AMR is alive and going strong with water and gas utilities in North America.

Before we talk about specific AMI opportunities, let me remind you that we will only publicly discuss those customers that have been public about their plans.

Let's start in California, and here I'll begin with the two news items that appeared last night on Southern California Edison. The first item was a press release by SCE stating that they had filed a positive business case with the California Public Utility Commission for moving forward with 5.3 million points of AMI. In that release, they talked about three vendors that have been chosen for the rollout -- IBM as system integrator, eMeter for the meter data management system, and Corix to do the deployment of meters once meter and communication vendors are chosen.

There was a lot of confusion about that release as no meter or communication vendor was specified. Later in the day, Edison has reported and Bloomberg confirmed that two meter vendors were under consideration and in test -- Itron and Landis + Gyr. They also confirmed that two communication vendors were in test -- Itron and Cellnet, a sister company of Landis + Gyr. These tests are scheduled to go through the remainder of the year, and final vendor selections are likely to be in December. To that end, we at Itron have shipped and installed a number of meters at Southern California Edison. When completed, 2500 meters with Itron communication will be under test.

Moving on to PG&E, Pacific Gas and Electric is in the process of evaluating more recently developed technology for electric AMI, a reconsideration of their original technology choice. Responses to their RFP are due back in mid August from vendors. Itron will be one of those responding.

At San Diego Gas and Electric, they have chosen Itron for their meter data management software solution. They are now in the process of evaluating responses from vendors to their request for proposal on hardware, which they received about two weeks ago. That evaluation with proceed and we'll hopefully know within coming weeks or months which way they are going.

Moving on to Texas, our OpenWay project with CenterPoint Energy is doing well, and CenterPoint is at a place where they are ready to move beyond phase one. The next phase for CenterPoint will be the deployment -- or development and submittal of an AMI rollout plan to the commission, which we would expect to see released in the next several weeks. This will start an open comment period lasting 150 days, after which appropriate action will take place.

Lastly, let me mention Detroit Edison -- three million plus points of electric and gas AMI. RFP responses are in from vendors. Detroit is evaluating and working the business case.

In general, activity continues to be high from an RFP perspective on AMI. We are seeing a second wave of inquiries from customers and geographies outside of those that we've talked about in these specific examples and on previous conference calls. Also encouraging is that most of these requests include requirements such as integrated disconnect/reconnect switch in the meter, the ability to talk to in home devices including displays, appliances and thermostats, ability to download firmware and other changes and updates over the network, ability to net meter for distributor generation or homeowner-provided energy like solar panels, and flexible backhaul capability, all of which validates our AMI strategy at Itron and our AMI product, OpenWay.

A note of caution on all of this positive news -- these activities move slow. They are large, and they require commission approval. None of them have moved along on their original schedules.

Earlier in the year, we thought we might see energy legislation at the federal level. That pot is boiling as we speak. Favorable tax treatment, initiatives around smart metering and smart grid all of these are up in the air at Congress right now. With final results frankly too close to call, we'll see how it goes as we watch what's going on in Congress. In the end, while anything at the federal level would help quicken the pace, the pace is already fairly quick for AMI.

Lastly, let me comment on our guidance. Revenue and earnings up a bit, with EBITDA about the same. For those of you that have had a chance to study the numbers, you will note that some of the goodness is from currency gains; some of the goodness in our guidance comes from preferable tax treatment. It's nice to have both of those. Going forward, they will always be a factor.

So what happened to the earnings on approximately $10 to $20 million in additional revenue? Part of it goes to the bottom line, so that's good. But if we look at all of it, we have increased expenses for the last half of the year, primarily in R&D and other areas in support of OpenWay. This increase accommodates accelerated schedules on AMI and AMI-trial deployments. Now is not the time to short expenditures in this area. Frankly, it's nice to be able to say that the numbers of customers and potential customers interested in Itron's OpenWay are resulting in additional workload that requires more resource.

As I look back at the quarter, three takeaways come to mind. The first takeaway -- the integration of Actaris goes well and their performance continues to be good, a testament to the Actaris people and as well, their future has a lot of bright promise when we think about AMR and the potential for AMI.

The second takeway -- Itron received the second-largest order in the history of the company for mobile AMR, nearly $100 million, from MidAmerican Pacific Corp., a great order.

And lastly, AMI and the opportunities for OpenWay, really quite exciting and expanding.

And with that, let's open up for questions.

Thank you. [OPERATOR INSTRUCTIONS]

With Canaccord Adams, we have John Quealy.

Hey, good afternoon.

Congratulations on the close of the deal here.

Thank you, John.

Thank you, John.

A couple housekeeping things, if we could. You gave a production by meters you said electricity. Could you either break that out by geography or technology, just to give us an idea of what was the mix here? I think you did 1,200 solid state in the U.S. last quarter, so if you could give us an idea there?

Yeah, John, the figures for North America were similar. We did about 1,200 total meters in electric meters in North America as well, so that was fairly consistent. The delta there would be Actaris electric meters.

Okay, the in process R&D charge, is that mostly overlapping solid state or AMI? What exactly is in the charge out?

Oh, John, it's a whole flavor of things. It's electric, water and gas; next generational meter development. It is some system development around AMR and a little bit of AMI, but not a great deal. And then as well, some development around prepay meters in electric and gas.

Okay. And just two more housekeepings -- one, Actaris on a constant currency basis looked down quarter-on-quarter, June to March. Is that just because you lost 18 days in April, or what's the flow with that business overseas?

There is some -- this is Steve -- there is some seasonality there, but we did lose the 17 days of results for the second quarter as they occurred prior to the close of the transaction.

Yeah. We don't see it as an indication of anything going forward.

Okay. And the last housekeeping, on the commodities side, how exposed to you are prices in raw materials, especially for the gas and the water meters?

Yeah, John, I mean, if we look at commodities, let me address a comment to that sort of -- I start at North America and then I'll go to Actaris, where it's a bit bigger because of copper.

In North America, we've seen increases in copper. Correspondingly, we've seen decreases in prices for electronic components. So net-net, it sort of balances at this point going forward.

One of the things we are doing on the copper front is we're having discussions between Actaris and Itron North America to see if we can lever vendors a little bit more, so let me now go to Actaris. Actaris clearly has seen in the electric meter side, some increases in copper for terminals and stuff like that. Again, it's pretty well balanced off with decreases in both electronic components and in the ability to cost reduce product.

The real commodity hit for us in Actaris is fundamentally raw copper that goes into water meters, and there, fortuitously, last year they were able to get some price increases that are continuing to stick. That balances some of the price increase on the copper side.

As well, we've been very careful with some spot buys to take advantages of dip in the copper market to sort of do a really good job of planning when we buy copper and to offset increases.

So net-net, no negative effects. We have across the board seen some increases in some kinds of steel. We're pressuring our vendors so that that's been a de minimus issue, and we're seeing an awful lot of freight activity, where people are adding fuel surcharges these days. Again, operational efficiencies have made up for that as well.

So so far, weathering the commodity storm really quite well.

Great. And my last question, qualitative, LeRoy, so you talked about utilities being more deliberate as they explored AMI. Can you comment on what part you think they're being deliberate about? We talked before about hardware risk and data management of software risk, and what about actually sort of implementing these schemes of real-time pricing. So as you look at those three buckets of where the delay, if it -- or deliberateness, however you want to characterize it -- where do you see that it's been most actively lately?

And the second part of this question is: How are your competitors reacting, especially on price, to these continued AMI discussions?

John, if you take a look at customers across the board, you see them looking at a couple of things. One, virtually every serious AMI customer is looking at the ability of head end software and integrated systems to deal with the volumes of data they're going to have to deal with.

So, you know, in customers where we're competing for meter data management, we've done an awful lot of volume-based testing, i.e., how many meters in a given period of time can be read and how much data can be pushed through the system? We've done very well in that regard, but it is an area of concern by utilities because if you think about interactive pricing schemes and controlling real loads with 4 or 5 million customers, you're going to have to push an awful lot of data in a really short period of time.

And it's not just through the system that an Itron would present, both hardware and software, but as well it's through the whole utility data processing customer information system. And so that's why you see big integrators like IBM, Accenture, Cap and SAP involved those things. So utilities are spending a lot of time there, and they need to spend a lot of time there. So that's one of them.

Second one is communication testing across what I'll call the data acquisition network. So we're all putting meters down in place and if you're putting 4 or 5 million meters down in place, can you get data from those metering locations in a variety of topographies -- you know, mountains, hills, dense population, rural areas? And so see a lot of that sort of technology evaluation going on.

And then the third one, clearly -- and PG&E's a good example of this -- where they have gone back out, one of the reasons was because they wanted to look at home area networks. And so we see the great majority of utilities sort of focusing in on ZigBee technology there, which is our preferred technology. But I wouldn't be terribly surprised to see some other technologies being considered in that as well.

So those are the three areas we're seeing people look at. Beyond that, we're seeing an awful lot of customers visiting factories to check up on a question. I wouldn't be surprised somebody will ask, do you have the capability to produce enough units? Clearly, at Itron we do. And so that's a big subject.

Price levels, you know, pricing is interesting, to go to the second question you had. As we're looking at big AMR requests for proposal, clearly we're looking at hundreds of millions of dollars of opportunities here, so -- but we, as I'm sure our competitors are doing, are looking at prices. So far, I'm happy with margins generally. We have big deal pricing pressure, as we always have.

Certainly part of these RFPs are very large integration opportunities. We're not participating in that but, as well, a large piece of these opportunities is installation. And we saw Southern California Edison say that they were awarding the installation of meters to Carix, but in a lot of proposals we're bidding that. There's not going to be great margins on those installations and because those jobs are so big, they are meaningful.

Net-net, we've had prices in a range that we would expect and we're going to be pleased with going into next year. But as we've said, on some of these pilot and early deploys, we will be pressed on margins because we simply haven't gotten all of the factory based integration and automation work done. As we go through '07 and on into '08, we will be in far better shape.

Great. Thank you.

And moving on, our next question comes from Lazard Capital Markets, Sanjay Shrestha.

Good afternoon, guys.

First of all congratulations here on a good quarter.

LeRoy, you mentioned in your opening remarks about some of the, you know, utilities that have talked about the AMI initiative. And you said you were just going to talk about them and not about the ones who haven't publicly discussed it. But if you were to at least qualitatively talk about the opportunity domestically for the AMI, both announced versus unannounced, would unannounced also make almost 50% of that overall opportunity, or how should we think about that? How big could this be versus those that have already been announced?

Well, you know, one of the things about the announced is you've got California and you've got two very large utilities, and at San Diego, you have one that is certainly a large utility. And at CenterPoint, a pretty fairly large utility.

So, I mean, does it approach 50%? I'm not scared away by that comment, Sanjay, but I think you do have to recognize that at PG&E and Southern California Edison, you've got two of the biggest.

But if you think about some of the opportunities on the Eastern side of the country and you think about other things that I believe will come to the forefront because they have the same forcing functions-- you know, issues with generation, transmission, and distribution, yeah -- the level of inquiry and potential out there I think is about equal to the size that we're already seeing.

Got it. Got it. That's great.

And kind of talking about the CenterPoint, I missed a part of it. LeRoy, you mentioned that they are now ready to move beyond phase one. So but, you know -- and again, I recognize that, you know, things could take longer than anticipated in large-scale projects like this -- but is it a potential, you know, full award approach opportunity before the year is over, or do you feel comfortable saying it's the first half of '08? How should we think about that?

Yeah, I mean, it could and it could slip out.

I mean, one of the things that I think is the great unknown -- which is why I did mention it, but I didn't say a lot about it -- is, you know, we're probably not very far from CenterPoint going to the commission and saying we'd like to move forward with full rollout. That starts the clock ticking on a 150-day comment period. Everybody and their brother can make comments and, you know, some of those comments will be meaningful and they may cause either the commission or CenterPoint to have to take into consideration something that hasn't been well thought through already.

So, you know, late this year, early next, that certainly is the timeframe. I think more important is the fact that CenterPoint is ready to begin that process. And so here you see, not different in California, another utility that's saying we're moving forward.

Yeah. Got it. Got it. Now, LeRoy, you mentioned that -- again, you guys did mention in your prepared remarks that you are purposely spending more money on R&D related to, you know, OpenWay and, you know, if it wasn't for that, I think, you know, operating EPS numbers probably could have been higher in the second half of the year, despite the raise here.

What are some of the key areas that is, you know, acquiring some more attention at this point in time, you know, before we get to the full-fledged deployment for the, you know, OpenWay?

You've got great questions.

A couple of things immediately come to mind. One, you know, part of the process, as I've said I think in the last call, is that we begin to move from a period of development, which is fundamentally, you know, looking at technologies and looking at ways to create OpenWay, and we moved toward producing a product that is economically producible so that we can make decent margins.

And what that generally requires is an awful lot of integration work in terms of electronic components. So instead of having 100 components, you try to get down to something in the 20s. Instead of having a processor that costs $35, you're trying to get into a processor that costs $8.

Well, what do you do there? You bring out a bunch of people that can crush down firmware from hundreds or maybe thousands of lines of codes into less. You bring on electronic expertise that can help you move toward less-expensive board layouts. And as well, on -- from a mechanical perspective, we're building units that we're shipping. They're probably not mechanically as cheap to build as they might be, both in terms of tooling and in terms fundamentally of just mechanical design. And so we bring on some extra people in those areas so that we can get product out the door in 2008 that will have margins that we'll all be very pleased with.

Got it. One last question, then. You know, but what's now, you know, a Actaris acquisition and some movement for the smart meters in the European market as well, you know, now -- so you did mention that, even if some of these larger projects were to, let's say, move forward simultaneously, probably Europe being slightly behind schedule, capacity is not really an issue for you guys.

At what point does it end up becoming an issue -- capacity ends up becoming an issue, or the fact that capacity is not an issue, and now you have Actaris is actually even a stronger competitive advantage for you?

Yeah, I mean, the capacity in terms of North American capacity is actually from building things, not an issue relative to Actaris because we would build all of that Actaris-based stuff someplace in an Actaris facility. We certainly have plenty of them.

Capacity in North America at this point in time is absolutely not an issue. I mean, we have the capability of building from an electronic module perspective something over 6 million electronic modules for -- which we dedicate today to water and gas, but we could certainly shift some of that product to AMI modules if we had to and expand the capacity in our Waseca, Minnesota facility.

In Oconee, where we build meters, we can build 8 million meters pretty easily without any strain. We can lay down more capacity because we certainly have geographic and plant capacity to do it.

The real issue, Sanjay, is not manufacturing capacity. It is the capacity to install this stuff. These are very complex systems, and so you have to have technology people available to help with those installations, help with bringing those things up, and in fact, part of the additional R&D expense that we will have in this year is to bring some of those kinds of people on so that we can actively support installations and pilots out in the field. And that's a point I had neglected to mention earlier.

No, that's [inaudible].

On the Actaris side, we have plenty of manufacturing capacity. One of the nice things about having lots of plants in Europe is you have some choices about where you do things. We certainly have a couple facilities in the Far East where we could lay off some production.

And it's not without possibility for any of the opportunities to go outside to general [inaudible] circuit board contractors and get some stuff done as well.

Got it. That's great. Thanks a lot guys.

Thanks.

Thank you.

I will now move on to Paul Coster with J.P. Morgan.

Thank you. This is Sam Doctor on behalf of Paul.

Hi, Sam.

Hi. Nice quarter.

Thank you.

We had a couple of questions. First of all, you've spoken in the past about building up your water capability in the U.S., so what are you looking for in terms of, you know, acquisitions and what are your priorities in terms of paying down debt versus making acquisitions?

Great question, Sam.

You know, as we think about water in the U.S., we clearly are thinking about two opportunities. One, we have acquired a beginning water meter business with Actaris in the U.S. It's not large today and it's not broad based over a lot of customers. It has issues of distribution channel and also just approval of product at water companies. And while that's -- clearly you can build a distribution channel and clearly we can get the necessary approvals, you know, the speed with which anybody could do that -- even Itron -- calls to question the wisdom of following that path. But we are considering it.

As well, you know, you hint at or actually point toward, you know, is there a water meter company that we might think about acquiring in the U.S. We are not actively engaged in any kind of activity in that regard today. Have we thought about it and will we continue to think about it? Yes, we will.

If you look at the water business in the U.S., it's a very interesting business. And, you know, it's attractive for a number of reasons because we think the water business over time expands. Certainly water, AMR, it's easier to compete in the marketplace if you're actually making a water meter. So these are, you know, both things that we are thinking about today.

Clearly, as we sit here today one of our great priorities is paying down debt. So any thoughts about any major acquisition -- and certainly a water meter company would be one -- we're trying to push off into the future to where we have a better let's say situation relative to the amount of debt we're carrying.

Right. The second question is really on Europe. You spoke a little bit about the interest in AMR and AMI and obviously, you know, some countries are further down the road than others. So especially in those situations, you know, where countries are progressing fairly rapidly, how are you placed given that Itron is a late entrant or at this point perhaps, you know, just a marginal player in that space?

Well, Itron certainly is a late entrant and a marginal player in Europe. That's why we acquired Actaris. Actaris, on the other hand, is probably the largest electric meter vendor in Europe, and close to the largest in water, if not.

Right.

And also close to the largest in gas.

And if you'll look at the European AMR and AMI initiatives so far, almost without question with the exception of [Inel] in Italy, they have turned to meter vendors -- electric, water and gas for technology consortiums that produce a product that utilities are buying.

So frankly at this point in time, I feel extraordinarily well placed in Europe about AMR opportunities and AMI opportunities.

I'll say it again -- and thanks for asking the question because that gives me a chance to reiterate you know, one of the things Actaris has never done is do press releases about AMR or AMI that they have sold. And so we continually get, you know, the sort or question well, they've never sold any AMR. Well, you know, in the last quarter they sold, you know, nearly a half a million points of AMR and system to utilities around Europe in electric, water and gas. So they are not an insubstantial player in this market. They have been a very quiet player.

Okay. Now was that product an Itron product or was it something that was previously contracted before the transaction?

It was in fact an Actaris product, some of which -- most of which, frankly, was their own internal development. And some of it was in partnership with other communication technology vendors.

Right. Great. Thank you.

Thanks.

Thanks.

And let's move on, taking a question now from Stephen Sanders -- I'm sorry, Steve Sanders with Stephens.

Good afternoon.

Steve.

Hi, Steve.

Congratulations on a good quarter and the deal, and I'd like to make a plea for an extra 15 minutes before the conference call.

LeRoy, you've talked quite a bit about the data management communication challenges, all the activity that's going with OpenWay, but specifically on the AMI side, how do you feel about the roadmap for the vendors to meet the demands of these big customers?

Well, you know, Steve, I indirectly touched on that a teeny bit. We're putting on more people because the customers are moving quicker than we actually thought they would. And when you get into these projects, they are so encompassing and so complex that they are requiring a level of technical support that is really quite substantial.

I'm feeling really comfortable, by the way, as Itron because I can afford to put on the resource and I've got a lot of resource. How some of my smaller competitors are doing that, I can't even imagine because there is an awful lot of activity out there. And I am somewhat predicting that once some of these pilots are completed successfully and utilities commit, that their public utility commissions are going to start lighting little fires of hurry up underneath them and say let's get going and let's get this done faster and get these things implemented and not stretch them out as long as you're stretching them out.

So, you know, I think some of the requirements of our customers are both exciting because they're there, and they are some troublesome because schedules are getting compacted towards [inaudible] resource. Not all bad.

Okay. Okay, and then you made some comments earlier about, you know, particular segments of the country where you've got the supply-demand imbalances that really provide the catalyst for AMI. Can you sort of drill down a little bit more on that and talk about AMI suitability in terms of the meter population or the geography of the country, something like that? And then if you could maybe do something similar for Europe?

Well, if you ring the utilities around the United States, so the whole of the East Coast, Southeast, Texas, all of the West Coast, and the population centers in the Upper Midwest, you got it. Those people all need what AMI can provide.

I've got some difficulties in the Upper Midwest because at the same time, utilities have issues with regard to supply because of capacity constraints. They also have big time issues because, quite frankly, the economy in those areas is not what it might be. And so you've got some problems there.

But if you look at the Northeast, the East Coast, the Southeast and the whole of the West Coast, those are the areas of the country that have forcing functions for AMI, and frankly that's where you see interest, some of which we've talked about and some of which we simply have not.

If you go over to Europe and you think about our requirements, there the driver's a little bit different with some exception, and that exception happens to be southern Spain. In southern Spain, they have exactly the same supply requirements -- it's driven by real hot weather and a lot of population growth because, not different than the U.S., people are moving to southern Spain because the weather's nice. It's pretty straightforward.

But the other big forcing function -- very different from the United States -- is energy conservation, concern for the environment, and a keen interest in reducing consumption of electric, gas and water. Some of that's driven by pricing -- natural gas prices certainly and other pricing issues around electricity. Some of it's driven by running out of water, and clearly a number of the places where there's pockets of population in Europe are running out of water not different than the U.S.

So you see strong activity in Scandinavia, where it started sooner with the demand for time of use pricing and automatic meter reading, the Netherlands following closely behind, as we talked about. You see France very, very hot right now as EDF is in the very beginnings of proposal period. And the one that's lagging but I think they'll pick up is Germany, as we look at Europe as a whole. And I don't even talk about Italy, which is largely done.

The U.K.'s a bit different in that there are more utilities in the U.K. There's, you know, more than just one or two. But there again, as I mentioned, we have -- the Energy Ministry in the U.K. is showing a white paper that said get with it and do it -- begin at least in an '08 timeframe.

So, you know, I think that you'll see an awful lot of activity out of Scandinavia, the Netherlands. You're going to see an increasing amount of chatter around what EDF is doing. It is so large, 35 odd million meters, there will be some consortiums of vendors involved in that. It will not go all to one vendor, and we feel very good in our positioning around that as we say today.

Okay, and then on Southern California Edison, is it your sense that they would like to split the meters and the communication, or run two systems in different territories? I kind of heard some differing views on that.

Yeah, I mean, what they have stated, you know, pretty loudly and publicly is that they're looking for two meter vendors and a common communications system. So they have, you know, asked meter guys like us -- I'm sure they've said the same thing to the other people under [inaudible] Landis + Gyr, that they want to see communication technology inside at least two meter vendors. So we're working with other meter vendors to produce that. And they have also said pretty publicly that they're only looking at one communication vendor.

Now having said that, the testing that they're doing is looking at geographical components, five different ones, and they are looking at geographic components because they realize that communication issues and different kinds of typography are meaningful. You know, is it dead flat with lots and lots of houses? Is it mountainous? Is it rolling hills? Is it along an ocean where you have effectively a border that is noncommunicating? And so they're testing all those areas, so I don't know that it would be either impractical or out of the question for them to think about more than one communication vendor when they're done. But that has not been their direction to this point in time.

Okay, thanks. And then just a final question for Steve. Can you just provide us an update on CAPEX, working capital trends, you know, over the next few quarters, and cash taxes?

Sure. For the year, we expect our CAPEX to be somewhere around $40 to $45 million. That's combined, and that's inclusive of Actaris from the 18th on through the year.

And cash taxes we forecast a range of around $18 to $20 million for the year on a combined basis as well. The CAPEX is about 3% of revenue in total as a trend. And in terms of working capital, we forecast that somewhere in the 13%, 14% revenue is the way we look at that, and that's trade working capital -- ARs, AP.

By the way, we did focus a lot in the quarter on collections of ARs in the North America business and made good progress there as well. So we don't see any sort of unusual trends there and we certainly don't see AMI affecting a lot in the way of working capital in terms of having to prepurchase a lot of inventory or parts, either.

Okay. Thank you very much.

Our next question is from Patrick Forkin with Tejas Securities.

Hey, good afternoon and congratulations on a great quarter.

Thanks, Pat.

Pat.

LeRoy, your comments on CenterPoint about them moving past phase one. Does that mean that we've got most of the product technology risk behind us? Said another way, I know they have piloted OpenWay there and I'm assuming it works or otherwise they wouldn't be moving forward.

Well, that's certainly a good assumption. I won't say that we've got all of the technology issues surrounding integrating with a multitude of vendors, both integrator and we do not have the meter data management system there. So those cause issues. A big issue at CenterPoint is working with broadband over power line, and the things that cause that to arise.

But I think it is safe to say that at this point, CenterPoint thinks that the, you know, their technology choices are solid enough to move forward. And they have seen good progress as we have all worked together to produce, you know, a product for them that is doing what they need it to be doing.

So I'm feeling pretty good about that at this point.

Okay, great.

And then on PG&E, they filed their AMI assessment report recently and it looks like they have solidified their decision to go with solid-state meters. So on this new RFP, I assume you guys are in a position to propose not only on the AMI system but also on solid-state meters?

That is correct. And clearly, we were pleased to see that change of heart there around solid-state meters. And we were glad for that.

Okay, great.

Did the meter [inaudible] management piece come back up, or is that still with the original vendor?

With the original vendor.

Okay. Very good. Thank you.

Thanks.

And next with Greenlight Capital, Chris Sommers.

Hey, guys. A question on Itron North America. I guess for the first six months, you guys did about $300 million and that's about a little over 10% below the run rate of the guidance for $680 to $700 million. Just to segregate between North America and Actaris, is North America still on track to achieve somewhere near $680 to $700, or has some of that been pushed out to '08?

Well, Chris, I mean, we haven't given guidance that's been broken down by Itron North America and Actaris but what we did state publicly is that we expected a stronger second half related to Itron North America than the first half. So it's not surprising to us that we have those kind of results right now.

Got it.

And that is historically very typical as opposed to last year, which was really turned upside down by Progress, Chris. So, you know, it's typical to start out slow in the first quarter and steadily increase through the four quarters out to the end.

Got it. Thanks, guys.

There's one question remaining. [OPERATOR INSTRUCTIONS.]

And next Umesh Mahajan with Merrill Lynch.

Hi. Can you hear me?

Yes.

Yes.

Hi. Just a follow up on the PG&E question, and one of the things that has been revealed through this entire episode with PG&E was, you know, the utility actually changed their mind two years into awarding of the contract. How -- LeRoy, how is the discussion with the utilities going on now, for example, with SoCal Edison or with San Diego, where, from a vendor point of view, you are protected from an event of that nature.

Oh, you know, I'll give you two perspectives on that, Umesh.

First perspective is, you know, PG&E suffered what pioneers suffer. You know, you don't know what's over the hill until you get there. And so to be some kind of forgiving of them, when they came out with that RFP, we were just beginning to talk about AMI and a whole lot of the -- let's say the thinking around technology's directions, what you would want to achieve with this kind of technology, really wasn't very fleshed out.

So today, if you think about Edison or you think about CenterPoint or San Diego and now PG&E, you know, there's been a lot of real good minds thinking about what they're trying to accomplish and what the technology has to be capable of to be able to do that.

So I think those kinds of philosophical and sort of, you know, feature function benefit questions are really tightly answered. One answer to your question.

The other answer, however, is to say that, you know, initial contracts for AMI are going to have all kinds of off ramps for utilities and they're going to have them for a whole lot of reasons and, you know, there's not a damn thing you do with it. As a, you know, an investor in Itron or a potential investor in Itron, I couldn't look anybody in the face and say well, we've turned a $300 million contract down today because the utility wanted an off ramp. I don't think anybody would be real happy with me.

So I think we're going to see off ramps. I don't think that we stand the risk that PG&E/Esco stood being a pioneer in letting an AMI contract because I think at this point so much discussion has taken place, so much technology has been investigated, we're all pretty firm on what you've got to do out there to be successful.

But, I mean, I can't say that you're not going to have off roads in these contracts, because you just are. Utilities' got a public utility commission they've got to deal with, and they've got the reality of that -- that they'll just protect themselves from.

[inaudible] Congratulations on a great quarter.

Thank you so much.

And we have no further questions in our queue at this time.

Ms. Duquette, I'll turn the conference back over to you for additional and closing remarks. Thank you.

Okay. Okay, great. Thank you all for joining us today and, as always, if you have any follow-up questions, please feel free to give us a call.

That does conclude today's conference call. Thank you for your participation and have a --