Itron Inc (ITRI) 2009 Q2 法說會逐字稿

Good day, everyone, and welcome to the Itron, Inc. second quarter 2009 earnings conference call. Today's call is being recorded. For opening remarks, I would like to turn the call over to Ms. Deloris Duquette. Please go ahead, Maam.

Good afternoon, everyone, and thank you for joining us today On the call today, we have Malcolm Unsworth, our President and CEO, Steve Helmbrect, our Chief Financial Officer, and Philip Mezey, our COO for North America. Today, Steve is going to start the call with takeaways for the quarter and the year so far. Malcolm is going to discuss his initiatives for the year and what we think the rest of the year will look like. After that, we'll take your questions and Philip will participate in the Q&A session. Our earnings release include nonGAAP financial information that we believe enhances your overall understanding of our current and future performance. We also have a supplemental slide deck, which is intended to augment our prepared remarks, as well as provide a reconciliation of differences between GAAP and non-GAAP financial measures that we will talk about today.

You can find this supplemental information on our corporate website under the Investor Relations tab. We will be making statements during this call that are forward-looking. These statements are based on current expectations and assumptions that are subject to risks and uncertainties. Actual results could differ materially because of factors discussed in today's earnings release in the comments made during this conference call and in the risk factors section of our Form 10-K, Form 10-Q, and other reports and filings with the Securities and Exchange Commission. We do not undertake any duty to update any forward-looking statements. And with that, I would like to turn the call over to Steve Helmbrecht, Itron's CFO.

Thank you, Deloris. As we discussed last quarter, our financial results in 2009 continue to be a tough comparison against 2008. Given the volatility we are experiencing in foreign exchange rates, the economic slowdown, uncertainty with utility capital spending, and because we had such strong financial results in 2008. So with that background, I will talk about the quarter and the year so far. Total quarterly revenues of $414 million were $100 million, or 19% lower than the second quarter of last year. Of the $100 million decrease, over half of it, or about $52 million, was due to the stronger dollar against the currencies in which we do business.

International revenue was down $61 million this quarter compared to last year. Absent the negative effect of FX movements, international revenue decreased 3% from 2008, primarily due to lower revenue in our electric segment related to the completion of an AMI contract last year, and the economic slowdown in some regions. North America had $39 million lower revenue from the second quarter last year, or a 21% decline. The decrease in North America was due to the completion of AMR contracts in 2008 and a slowdown in spending due to the economy and customers delayed purchases related to uncertainty about the stimulus bill. We believe that some of our customers in the US are not purchasing meters or communications systems while they study the opportunity to obtain matching funds.

Six-month revenues were $802 million, which reflects a $190 million decrease, a 19% decline, from revenue last year caused by many of the same factors we experienced during the quarter. Gross margin for the quarter of 32.2% was 210 basis points lower than last year. Both business segments experienced a decline in margins.

Our international business had a margin decline of 130 basis points due to a mix shift. International shifted a lower percentage of AMI and prepayment meters during the current quarter and had a higher percentage of service revenue with lower margins. North American margins declined 360 basis points, also due to a mix shift.

During the current quarter, our North America business shipped 50% fewer automated meters than in the second quarter of last year and 18% fewer AMR modules. The decreased volumes combined with the effect of shipping our first generation AMI meters caused a decline in margins. We expect North America to stay at lower margins until our shipments of automated meters and modules increases as a percentage of total shipments and until we begin shipping our cost reduced open way AMI meter. Gross margin for the first six months of 2009 of 32.7% was 140 basis points lower than last year.

International gross margin declined 110 basis points because of a mix shift and completion of a system implementation in 2008. North America margin declined 200 basis points for the first six months of 2009 because we shipped 47% fewer automated meters and 10% fewer AMR modules and the effect of AMI.

Operating expenses for the quarter were almost $19 million lower than last year. $7 million of the decrease was due to lower expenses related to our amortization of intangibles and the remainder was due primarily to the stronger dollar. Year to date operating expenses have declined over $33 million. Approximately $15 million of the decline was due to lower amortization and the remainder was due primarily to the stronger dollar.

Our non-GAAP operating margin was 8.7% for the quarter and 8.5% for the year, both of which are substantially lower than the 13.2% and 12.7% margins last year. The decline in operating margins is due to the lower revenue and decline in gross margins. Net interest expense is lower for the quarter by more than $8 million and more than $19 million lower for the first six months this year due to the substantial repayment of debt and lower average interest rates.

Our non-GAAP effective tax rate was 6% for the quarter and 19% for the first six months. This lower rate is driven primarily by the expectation of lower income from our higher tax jurisdictions, primarily the US. For the full year, we expect our non-GAAP effective tax rate to be similar to our year to date percentage. Non-GAAP diluted EPS was $0.49 for the quarter compared with $1.02 in the second quarter of 2008. Keep in mind that the second quarter of 2008 was the highest non-GAAP EPS in the history of the company. Again, the lower revenue and gross margins significantly effected our earnings.

Now, I would like to turn to our capital structure. As a reminder, in April, we completed an amendment to our senior debt agreement. The amended agreement provides for more flexibility in our covenants with a maximum debt to EBITDA ratio of 4.75% times through September, stepping down to 4.5 times in Q4 and 4.25 times in Q1 2010. In addition to one-time fees the amendment increased our interest rate from 1.75% over LIBOR to 3.5% over LIBOR. In May, we completed an equity offering of $3.2 million shares, which resulted in net proceeds of about $160 million. We issued equity with the intention of redeeming our $109 million in senior subordinated notes, our highest rate in near-term debt -- $104 million to about $102 million on May 15, so we saved about $2 million in redemption costs by waiting until after that date. The redemption was completed on July 17.

Our debt to EBITDA ratio was 4.3% times at June 30, in compliance with our debt covenant of 4.75% times. After the redemption, we have total debt of $885 million. Had we redeemed the debt before June 30, our debt to EBITDA ratio would have been 3.8 times at June 30. We have focused on strengthening our balance sheet, as evidenced by $765 million in total debt repayments since the Actaris acquisition in 2007, inclusive of the subnote redemption. We now do not have any debt maturing until 2014, although we do have a call and put option on our $224 million in convertible debt in mid 2011. Our amended debt agreement calls for 25-basis point increase in the interest rate to 3.75% when our debt to EBITDA ratio exceeds four times. The blended interest rate on our debt is now 5.97%, inclusive of this 25-basis point increase. We will continue to monitor our covenants and our business and will balance needs for cash with higher prepayments going forward.

Cash flow from operations was $25 million for the quarter and $67 million for the six months ended June 30, which is about $39 million and $53 million lower than the quarter and six-month periods of 2008. Our capital expenditures for the first six months were about $28 million, which is similar to last year. Over a third of this amount has gone towards AMI-related expansion of our manufacturing line in the US. Free cash flow for the first six months was $40 million compared to $92 million in the first six months of 2008. We ended the quarter with $274 million in cash. Keep in mind this is before the retirement of our subordinated notes.

We had good AR collections in the quarter and customer credit quality continues to be healthy, although we did have a reserve in our international business during the quarter against a receivable for about $1.8 million. Adjusted EBITDA for the first six months of the year of $90 million is significantly below the $151 million we generated in the first half of last year due to the lower revenue and margins.

In summary, we continue to face challenges in 2009 that are negatively effecting both revenue and earnings. We did have another strong quarter in terms of bookings. New order bookings for the quarter were $427 million. Although this is slightly lower than the $432 million we booked in the second quarter of 2008. Our book to bill ratio was slightly over 1% to 1% compared to 0.9% to 1% in the second quarter of last year.

I would also like to point out that this is the first quarter in over a year that our bookings have been above 1% to 1% for our legacy business in North America. Our 12-month backlog increased from $471 million to $646 million during the quarter, due primarily to an increase in scheduled shipments of our open way AMI solution in the next 12 months. With a total backlog of nearly $1.6 billion, we believe we are well positioned for the long-term. With that, I will turn the call over to Malcolm.

Thank you, Steve, and good afternoon, everyone. I'm going to make a few comments about the quarter and then spend most of the time updating you on my focus areas that I laid out on the last call. The second quarter was another challenging one. Although currencies were not as volatile during the second quarter as they were in the previous two quarters, the dollar is still stronger compared to last year and continues to have a negative impact on the financial results of our international segment. As we discussed last time, we are not seeing the same impact of the recession in our international business as we are in the US. Business in Western Europe continues to be relatively stable, while in eastern and central Europe, we are experiencing some slowdown, primarily caused by currency devaluation.

Our North America business continues to see the impacts of the economic slowdown. And this is compounded by delayed shipments because of expected stimulus dollars. North America revenues continues to be at a lower than expected levels, as we are experiencing a faster than anticipated cannibalization of AMR systems, without an offsetting benefit yet from AMI systems. So with that, let me move on to updating you on progress against my three initiatives. As you recall, my first area of focus for 2009 is AMI strategy, deployments and execution.

Starting with deployments, let me say that our AMI project deployments are progressing as we expected. During the quarter, we shipped open way meters to Centerpoint, San Diego, and with the completion of our automated AMI line in South Carolina, Southern California Edison. Our contract with SCE called for the meters to be built on a fully automated assembly line. You may have noticed the pressure release about the executive visit and launch we had in June. And I am pleased to say that as of the end of June, we have shipped more than 100,000 open way meters so we are well on our way. We are executing on our AMI contracts and will continue to focus on these deployments throughout the year. Regarding AMI strategy, we recently had some very productive road map meetings covering electric, gas, water, and software, and I am very excited about our direction.

Itron has always had a very strong AMR position and we have also established ourselves as an AMI leader in electric, gas and water. We have a unique position with our large install base of AMR solutions and we will focus on some of those opportunities going forward. I am really excited about some of the projects that we are pursuing and look forward to updating you on the status of these projects on future calls. As you can see from today's press release on Glendale, we have secured another contract for a smart metering and smart grid solution that includes electric, water, and software. We believe this system is the first of it's kind, as it is for an electric and water customer.

Moving on to my second area of focus, which is international. As we have discussed, our international business at this point consists mostly of meter sales that are primarily driven by growth, replacement, and a few AMR, AMI, and prepayment contracts. But international is an area of very strong future growth for Itron. We track our bid activity on a monthly basis and as of the end of June, we are bidding on more than 80 AMR and AMI electric, gas, and water opportunities across seven regions for more than 25 million end points of automation. We estimate worth more than $2 billion. Which shows that there are worldwide opportunities, although we still continue to believe that Europe will be the first region to deploy AMI on a large scale.

Just to give you an idea of what's going on in Europe. In France, we are on schedule with our ERDF Phase I AMI smart metering project. In the UK, smart metering mandates are progressing. The government recently solicited comments on how smart metering should be deployed. We are submitting our response next month. There are two ongoing smart metering pilots in the UK of 100,000 units from EDF energy and British Gas. And we are bidding on both of them. In Spain, the government has published its law on smart metering deployment for electricity and the target is to be fully deployed by 2017. And just to remind everyone, Spain has more than $25 million electricity meters. These are just three examples of what is happening in Europe, as countries continue to finalize their approach to smart metering. There are also significant growth opportunities in China, and it's been announced that more than 50 million smart meters are projected to be deployed in China in the next three years. In May, we participated in both the USA, China Clean Energy Summit and exhibited at the China metering conference in Beijing. We are working on positioning ourselves well in China.

We have a gas meter factory in Chung King and electricity sales office in Beijing, and we are soon to open a water meter factory in Suzhou just outside of Shanghai. We are also focused on Australia, as they move to smart metering and AMI. We have a strong competitive advantage with our meter data management software solution that should serve us well in Australia's AMI development.

So let me close with my third area of focus, which is cost reductions. We have made progress during the last three months and we are continuing to sharpen our focus. 2009 is a tough year because of exchange rates, deployments that were pushed to the back half of the year, which will, of course, delay revenue, the negative impact from delays caused by the stimulus bill, and the challenges from the economy. We have targeted specific projects that we are delaying in specific expenses that we are reducing and foregoing. Cost reduction plans continue and we should see some benefit in the second half of the year from these efforts. We are focusing on the long-term and will not jeopardize our current AMI deployments of future long-term growth because of a short-term revenue issue.

So, now let me turn to the second half and briefly touch upon some of our thoughts for the rest of the year. We will continue to be impacted by the same issues for the balance of 2009. The US and world economy, the effects of the drop in housing starts, exchange rate volatility and decision delays caused by the stimulus bill. We talked last quarter about North American revenue being down and international business being flat in local currency. We continue to see our core business being negatively impacted for all of the reasons that I've mentioned. Similar, assuming similar FX rates, we expect the third quarter to look similar to the first and second quarters with an uptick in the fourth quarter driven by current AMI schedules. August 6th is the due date for applications to be submitted to the Department of Energy for stimulus funds. If some of our customers are successful in obtaining funds for their projects, there could be some good news, but it would likely be too late to meaningfully impact 2009.

We will continue to work with and support customers in their efforts to obtain funding. So as I said last time, we will continue to spend 2009 focusing on my three priorities. AMI deployments and strategy, international growth and cost reductions. We are very excited about our AMI progress in international positioning and we will continue to be focused on execution. With the strong backlog of $1.6 billion and particularly the increase in 12-month backlog to $646 million, we are very excited about 2010 and beyond. And with that, I would like to open it up for questions.

(Operator Instructions). Your first question will come from Stuart Bush with RBC Capital Markets.

Yes, hi, guys.

Hi, Stuart.

Wanted to know, you guys some examples of the projects internationally that you're bidding on. Could you give us more color on the few of the US utilities that you're bidding into?

Well, we can't mention them by name, Stuart, obviously, unless they have come forward. We would say that they are all around the country in all fairness. I don't know that there's any particular region that's more than others.

Yes, we have regions in the USA where our sales people are located and there's many of them that would involve with.

All right. Your bookings were strong in the quarter, and it seems that although, I know that you guys have highlighted that the North American business has not improved, but it seemed to have stabilized and the currency volatility has produced since the last quarter. What would you need to see before you give more exact forward guidance?

I think that we would need to see utilities beginning to behave as they used to behave, that they had set budgets that they would spend against them. I think we would have to see more clarification on the stimulus bill. Once those funds actually start slowing and customers begin projects, I think that that would probably be a signal where we would feel a bit better. Those kinds of things that haven't necessarily stabilized yet.

All right. One last question, do you intend to offer an internet protocol base solution on your OpenWay system soon? And do you think that that's necessary to do to meet the pending standards coming out of the DOE?

I'm going to let Philip answer that.

Stuart, we have announced that we will issue a product that supports IP throughout the network and down to the end point. And we are doing that, as you pointed out, partially to ensure that, if the outcome of the niched initiative requires that, that it's available as well as to meet market conditions in which it is a stated requirement.

Do you have a time line on when that will be ready?

It's a 2010 deliverable. It is a field upgradable deliverable based upon the existing system.

Excellent. Thank you.

And your next question will come from Jason Feldman with UBS.

Good morning, or good evening, I guess. There are a large number of small private players in the space. Seems like new ones popping out all the time. Are there any product or technology gaps that you are thinking of filling through acquisitions or potential growth areas that you're not involved in now?

We've developed, especially on the electric side, we've developed our open way solutions to have a complete end to end solution, which obviously covers the meter, the communication, and the home area network and also our meter data management system. So with regards to our smart grid solutions, I think we've got a complete offering today. As we move forward with regards to other areas, especially potentially overseas, there's always opportunities to look at what we could do. But one of the things that we do do, and I must admit, we partner with many, many providers, as much as we provide a complete solution, we don't provide a total solution. So we've got many, many partners that we work with. So I'm not certain if that completely answers your question.

No, I think it does. Can you also give us a little bit more color perhaps on some of the cost reduction action, specifically what types of areas you're targeting. With the specific kind of, dollar amounts that you think you can improve on the cost side in any particular timeframe?

One of the things we always look at, we're always looking at cost reductions. No matter what. If you take a look at the product side of life, we redesign products continuously. We're always trying to get the latest designs installed into manufacturing. We're spending capital on automation to do cost reductions. We obviously try and negotiate different rates, if commodity prices go down and look at all of those long-term projects. And then at the same time, we've got -- we start looking at some of the areas of where in the company do we have lower margin projects or programs that we need to do something about? So when you start looking at all of that, those are the areas that we're looking at and it's not necessarily one specific thing that's going to make all the difference. So we look at a broad range of areas for cost reduction.

And Jason, we have not quantified that or quantified a target for it.

Okay. Thanks. And then the last one, regarding the stimulus spending, I mean obviously we've heard about delays from just about everyone in the space. But it also does seem that there's some applications for the stimulus funding from utilities that have already decided to go forward with their AMI projects that are now basically looking for someone to perhaps pay for part of it. From what you've seen, do you have a sense of how much of this funding is really going to go to pre-existing projects compared to new non-previously announced projects? How much of this is really going to be incremental?

First of all, the, the four projects that we have booked have not depended on, have not depended on stimulus money. But of course a couple of them are going to be applying for stimulus money. And the only thing that that will do to those is probably speed it up.

Okay. So there could even be a benefit. So even if a fair amount of this money goes to projects that would go ahead with or without the stimulus funding, do you think it could impact the eventual speed with which those projects progress?

With our current contracts, yes. With future contracts, we don't know.

Okay.

Without current contracts, yes.

Thank you very much.

You're welcome.

Your next question will come from Carter Shoop with Deutsche Bank.

Good afternoon. Wanted to start off with a clarification. When you talked about 3Q looking like 1Q and 2Q, is that in regards to earnings per share or revenue, or what were you referring to there?

Revenue.

Okay.

Just in general, we don't see anything out there that would make it be dramatically different in thy of those areas, except for potentially some of the cost reduction efforts. And even that, we wouldn't use the word dramatically different.

And FX. Talk about FX as well, assumption about the same FX rate.

When you say the same FX rate, are you talking about what you saw in 2Q? Because rates have already increased some in the third quarter.

Yes.

By the calculations, it looks like FX will be about a 300 basis point sequential benefit in 3Q. Are you assuming those types of rates? Are you assuming the rates that you experienced in the second quarter?

More the rates we experienced in the second quarter.

Ok, Great. And regards to the tax rate. Based on my calculations, it looks like they lowered tax rate was about a $0.12 benefit versus street expectations. Why do we see such a significant decline in tax rate? It looks like operating income in the North America division is about $2 million below 1Q, but we're seeing about a $4 million tax benefit this quarter.

As I mentioned in my remarks, it's really, as we look at high tax jurisdiction, primarily the US and looking out over the year, that plays a big part in determination of what we think the effective rate is going to be in a given year. As we look out over the course of the year, we think that 19% or 20% is more indicative of the rate we'll have for the whole year.

And not disclosing any information about customers, can you talk a little bit about your expected AMI ramp? You mentioned you shifted about 100,000 by the end of June. Can you give us a little color on where you'll be by the end of September and end of December?

Yes. We don't quantify that anymore, because we just get ourselves in trouble with our customers in all fairness. Almost all of our customers have filed rates and deployment schedules and I would just point to those filings.

The only other comment I would add, as I mentioned in the backlog, it's growing primarily due to the AMI shipment schedule should give some indication of what we're seeing now in the 12-month horizon. How that's changed over the last quarter.

Carter, we just picked up Q1 of course and 2010 for our 12-month backlog.

Sure. All right, great. Thank you.

Sure.

From Lazard, we'll hear from Sanjay Shrestha.

Great, good afternoon, guys. Just a couple of quick questions. First, on that, you notice, sort of the margin -- Q2, which obviously was a bit below for you guys and you guys explained that it was the utilization-related issue. Do we need to potentially worry about the fact that maybe there's a lot of price competition in the market as well and that's forcing you guys to cut pricing as well, or is it strictly just utilization issue and as demand comes back, those margins would simply go back up?

You really have to look at this both domestically and international. If you look at AMI pricing, I don't think so. I think that's holding its own regarding both current and obviously current and future projects as well. Regarding regular metering business if you start looking at the volumes that have been produced today, obviously there's going to be competition, especially without AMR and AMI solutions. Overseas, a little bit, a little bit. Not really too much. We've got some price pressure in South America. Western Europe and the rest of Europe, not really. Nothing more unusual than we've had before.

And Sanjay, this quarter it was also some mix in there. I don't know that we were very clear on the earnings release, but if you looked at the last year for international, we were shipping a higher percentage of AMR and AMI meters as a percent of total. We have a higher mix of residential sort of kilowatt hour meters, so that brings down your margins in general. And then for North America, you're absolutely right. It's utilization and then that AMI meter shipments.

Got it, great. So a few more questions, if I may, guys.

All right.

So there certainly seems like some big network companies are also getting into the smart grid area. It is a big area of focus, seems like, for a lot of players right now. We're getting the buzz. And you guys clearly are by far the leader in the smart metering area. Now, when bigger networking companies start to get into this market and get even more aggressive, how do you see this industry unfolding? Is that a net benefit for you because you don't need to spend as much money on product R&D and just take the benefit of selling, electronics meter with a much higher price tag versus electromechanical meter and see that incremental jump? Or how should we think about that evolution of this industry, given how things are pretty rapidly changing here?

Sanjay, it's Philip. I mean, as we've commented publicly. We see this as a positive development for us. We have a very positive collaborative relationship with these large network providers. Our system is designed in such a way that we feel that we're adding the most value with the end point and collection system up to the neighborhood level. And that the large network companies who are providing ubiquitous high speed communication over the whole distribution territory are really adding value to our smart grid play and are increasing the speed and reliability of the total solutions. So we very much welcome those players into the space and I think it strengthens our offering. And it doesn't really affect our R&D that much in as much as we have to certify our products with multiple back haul solutions and already have done so. And so we would expect to work with a wide range of partners.

Got it. One last question, two-part though, guys. I know you guys don't want to talk about the specific utilities that have gone into sort of looking for the stimulus money, if you would, but is there a way you guys can give us a sense as to how much maybe in that near-term pushing out to the right impact that you guys had with some of the large scale AMI opportunity? And two, given that, how should we think about 2010? I mean '09 is what it is. We all know that, but how big of a growth can we potentially see in 2010? Can you guys talk about that a bit more?

I'm going to talk a little bit about the stimulus package and how that's going to be rolled out. Then I'm going to let Philip talk about the opportunities that could have for 2010. But when you think about the process that's been developed right now, I think August the 6th is when all of these applications have to be filed. And you think about how much this $3.5 billion, I believe, that's going to be utilized. There were three tranches originally, tranche 1, 2 and 3. The second at the back half of the year. If you take a look at how many of these applications are being presented, this is a significant number. But how long that takes to sift through all of those to determine how long it how one is each judged. It's going to have to go obviously to the commissions if they decide to go forward and they have not put proposals forward today. It is a lengthy process that they go through. So with the contracts that we have as I've said before, I think those are opportunities potentially for acceleration. But after that, I'm not certain exactly how long it's going to take, but it's not going to happen overnight. So Philip, do you want to add some color to that?

Well, I think that the question was, is there a way to quantify the retardant effect. And then there was a question about 2010 benefit. The retardant effect is, is expressed in particularly -- let's just take a look at the mid tier of the market -- markets that would be traditional buyers of our products that through the stimulus process and now applying for the most Advanced Technology available, which causes near-term declines in some of our basic business lines, while those applications are being considered.

So it's fairly widespread, but in small increments that effect. And I would just say that we have made public comments about an expected decline in our legacy business, as the market transitions from AMR to AMI. That decline has been more rapid as we've comment order prior calls, as a result of economic pressure. And now we are saying that that decline is even a bit sharper as a result of this stimulus retard. So I think you can probably model that against last year to get some sort of an idea about the magnitude.

In terms of the benefits for next year, of course we see this very strong backlog in AMI rolling out. We have some nice visibility in what we would think of as the legacy business in our 12-month backlog as well. And our, at this point, are very conservative about modeling the stimulus projects because there is, there is so much uncertainty. But certainly a very, very high volume of application activity.

Okay, that's great. Very helpful. Thanks, guys.

Next question will come from Paul Kosta with JPMorgan.

Hi, Paul.

Thanks. Hi, good morning, good afternoon, in fact. Just following through on a few of those questions, Philip, do you have a sense of what the addressable market is in North America for electric AMI meters? We're hearing numbers in $80 to $90 million range. Does that, does that work for you?

$80 million to 90 million? In the addressable market? $80 million to $90 million points?

In North America, yes. We have seen a prior survey from you till point that was in that range. We don't know that we would disagree with that number.

Right. And thus far, you've had about $12 million allocated to you in these projects and that's probably right about 30% of the market. Do you think that's a good, good assessment?

Yes, we've got $14 million. Now, remember, some of those include gas, so it kind of depends on how you're defining the market. Yes, we think we probably have 30%, 35% of the real awards that are out there excluding pilot.

Right. And is there any reason why the next sort of tranche of AMI adapters should move quickly, or can they take their time? What are the pros and cons of, say, waiting a year or two?

Well, if you take a look at the ones that we have, they have defined deployment plans. Stimulus will probably could accelerate those. On the new ones, traditionally they will go anywhere from three, five years deployments. So, whether that stimulus money would help accelerate that five-year deployment, whichever it is, which these large contracts, that could help. That could help. What they would bring it down to, Paul, I really don't know today.

Okay, and when we look at the actual configurations that are being deployed at the moment, it seems to get more difficult the more you learn here, that. Sometimes the communications vendor is capturing the smarts for communicating with the home area network, for instance, and on many occasions it's the actual meter itself. Is it correct to think that there are different configurations for different utilities and therefore the selling price of, let's say, an open way meter will change according to the specs for that particular utility. Or is it a uniform type of product deployment for you across the nation?

I'm going to take this, then I'm going to let Philip take it. One of the advantages that we have is that we can, A, we manufacture in the United States in one factory and we can do all of those communications and metering solutions ourselves. So we, I do believe we have a cost advantage compared with everybody else. And when you look at the combined selling price of one of those communication meters, sorry, communication boards or companies and the meters, their selling price is definitely combined,. We believe is higher than ours when you do the two together. So on a competitive basis, I think we are -- we have the edge on that particular solution. Philip, did you want to comment on that?

Well, Paul, I think you're absolutely right, that we are comparing apples and oranges at times, that when we talk about these market share numbers. Because when we give you a number, it is for general -- almost entirely for integrated meter and communications offering. However, we also do provide our communications separately from our meter in selected cases and our meter separate and vice versa as we supply the meter under others communications. But the large numbers that we have quoted generally for these contracts are on the assumption that we are providing both elements. There are companies out there providing only a single element. And to your question of configurations, the integrated home area network and disconnect switch, as you mentioned, and so we don't have that many configurations.

Okay. Thank you.

Thanks, Paul.

From Pacific Crest Securities, we'll hear from Ben Schuman.

Hi, guys, thanks for taking my call.

Sure.

Can you guys talk about the relative effect on the North American gross margin between capital, or capacity utilization and AMI? Was capacity utilization a much larger driver of the weaker gross margin?

You know what? It's about half and half.

Okay. And just to put some context around the gross margin impact to the Actaris business, can you guys tell us how much revenue that Sweden AMI project contributed last year, maybe how many end points?

I don't know that we have quantified it in terms of dollars, but again, with the margin decline, that was about half the services business, about half when lieu at the margin decline.

Okay, great. And going back to the stimulus, with the grants coming in three tranches, it looks like, lasting through June, are you guys concerned that some of the uncertainty can maybe push into mid 2010?

What we're hearing is that most of that will probably be released with the first tranche.

Okay.

And then there's no guarantee there will be any money left for the other two.

That's what, yes, that's what we've heard, is the whole amount of the stimulus money will be used up in the first tranche.

Okay. And then one last one, are you guys active in other vendors AMI deals, just as a meter supplier? I know I've seen some compatibility arrangements announced, but I haven't seen any big deals with you guys as the meter supplier on other vendors, AMI networks.

We are currently participating in small volumes and completing R&D work that we hope will provide the meter and larger, in larger volumes. That is our intent. But so far to date, no, we have not participated as a large meter supplier in these deals.

Okay, great. Sorry, just one last one. I think I saw an article last week about that Glendale project. They were mentioning $28.5 million on that contract. Is that kind of in line with what you guys are going to get, or were there some other vendors content included in that?

There was a small amount of other vendor content, but that number is very close to our portion.

Okay, thank you.

Thank you, Ben.

Next question will come from John Quealy from Canaccord Adams.

Hi, John.

-- made mention previously of not a dramatic shift in operating expenses in the back half of the year versus the front half. If you look at Q2, for example, it's about $120 million US in operating expenses. On a run rate basis, in the back half of the year, is 10% decrease material to you folks, or can you calibrate it a little bit for us. What do you consider meaningful or not and saving on OpEx?

Well, this is Steve. As Malcolm mention, we continue to look at a number of programs, not only the OpEx line, but also in cost of sales of what we're doing above the line. But speaking to OpEx, the two key areas that we're continuing to focus on is infrastructure in terms of sales and R&D. While we're working to improve efficiency there, as Malcolm said, we have a core level of spending we need to stay on track with a number of very key deliverables. That does leave other areas that we're focused on, particularly on the G&A line and just line item spending and that's an area we're focused on. We can't get to that 10% number in that area certainly in the second half of the year, but we're focusing on everything we can to take costs out. That's how we run the business while maintaining Malcolm's key initiate he was he talked about.

We're looking at different areas, both in North America and international as far as cost reductions, John.

Okay, thanks. Then a couple more questions. With regard to the software products in the product line, it seems to be, I think you quote add 33% or 30% AMI share for real AMI jobs. It seems like software is much, much higher than that. Can you talk about in terms of the future open bid opportunities where you're packaging the EE platform and the hardware. Does it make a difference competing now, moving forward, having such a big share in software? And then also, can you talk about third party relationships that you expect going into 2010 broaden out the platform a little? John, one of the things that we're also addressing is that our IEE solution for the software meter data management system is actually universal.

We've got a lot of deals that we've secured internationally, as well as North America. So one of the terms that we've used is we use it as bundling. We call it bundling. So we've looked at those opportunities on a global basis. With regards to North America, I want Philip to talk about that one, as far as what that looks like. So Philip?

So, John, as you pointed out, the software market share is even higher than the hardware share. And I believe that the competitive advantage there is we're still in early stages in the market in which people throw around terms like service-oriented architecture and plug and play and that sort of thing. I think what we're going to see is these implementations scale up and you start getting into reading millions of international meters, that having a solution that is proven to very, very high scale with proven deployments out in the field, that the combination of our hardware and software together is going to provide a significant advantage once we move beyond this sort of specsmanship that's going on in these early selections.

And then final two questions, just to come back to the stimulus conversation, it seems like there's very high incentives for every utility to apply for stimulus funding for basically anything they can throw in, just to pass muster with the public utility commission, if you will. I know that's a fairly cynical way, but perhaps every bit of CapEx is going through the stimulus, just to pass muster. What's your thought if, number one, a lot of those jobs that may have been pushed into stimulus, quite frankly don't get funded. Do you think that business goes away or do you think they just have to check the box to make the regulators happy and then move forward? Then I had a follow-up.

John, my assumption is we are being very cautious about that business coming back. Once the market has an appetite for this very high priced and advanced functionality, if it does not come through, I'm thinking that it's going to have a retarding effect on going back to other technology. That is our thought.

And, John, just thinking about the way that the utilities decide on what projects to do. I mean all of these specific projects, whether they are an AMI project, whether they are specific requirements for generation capacity, or whatever, they are all fighting for funding. So this really is no different than what we've had before.

And then lastly, internationally, I know we've all talked about the visibility and the way utilities have been acting domestically, but if you strip out FX for international, it seemed to be in line with your previous expectations of low single-digit declines. Have you seen any normalization of spending behavior in Europe, or are you just still seeing some unconventional buying patterns over there?

No, as I said, in the presentation, Western Europe, we really haven't seen really any impact. But as far as Eastern and Central Europe, yes, it's definitely had an impact because their devaluation of their currency has made a difference. We've seen that in certain parts of Eastern Europe. So it is having an impact there definitely, no question, John. Thank you.

Next we'll hear from Scott Graham with Ladenburg Thalmann.

Hey, good afternoon. Several questions for you. The revenue, I want to maybe ask the question a different way in terms of what you're thinking for the second half. Are you -- when you said that it's going to look like the second quarter, and I'm sorry to ask this question I guess a second or third time, but when you say it's going to look like the second quarter, are you saying in dollars, year-over-year percent, which was it?

Yes, Scott, this is going to be hard for us to specifically answer cause we obviously not giving guidance. We have fairly good visibility 90 days out and we're just saying that we're seeing things in the third quarter look similar to the second quarter. We haven't gotten much more specific than that. Obviously based on AMI shipment schedules, we're seeing an uptick at this point in time in the fourth quarter. We've always talked about the year being back end loaded, which we would still characterize it as back end loaded, but we're seeing the fourth quarter be more so than we would say the third at this point in time.

That's fine. On the revenue side, could you talk about -- could you quantify for us what SCE, San Diego and Centerpoint were for the quarter?

No, but AMI shipments in total were in that $10 million to $12 million range.

Okay, and lastly, you went into a fair amount of detail on the mix issue in North America. I was wondering if you would just repeat that. You went through it pretty quickly. A lot going on there I think within the mix issue all together within AMI. Could you kind of repeat that and maybe give me a little more color on that.

I'm sorry, can you -- we're not sure what you mean.

The mix shift. When you were talking about in North America the lower gross margin, the gross margin in North America dropped, I don't know, whatever that number was.

Yes, yes.

But you were talking about a portion of that being, sounds like a fairly half of it was mix. I was wondering if you would unbundle that again.

Well, I think that what we said was about half of that drop was caused by lower production volumes and about half of that drop was caused by sort of shipping our first generation AMI meters, which are at the lower margin.

With the comment that we had fewer automated meters as a result of some con -- in relation to contract completions in 2008. So we had a lower volume of that type of product.

Yes. Does that make sense?

Right. That's the piece I was looking for. Okay. Thank you. (Operator Instructions).

Your next question will come from Richard Birdy with Servant and Company.

Good evening. Thank you for taking my call. Just -- most of my questions have been answered, but touching on the waterside. I know you touched on it briefly there. But domestically here, can you just discuss what type of trends you're seeing here in AMR/AMI because despite the challenging economy here, these water utilities are still acquiring companies and staying on their typical pace. And in speaking with them, they say they are still going -- they intend to install them. And I was just hoping maybe you could discuss what you're seeing in there.

Let me just give you an indication of the stimulus money that's happening with the waterside. The stimulus funding of $2 billion for drinking water, they have used the same ruling as the same format of applications that they have with the EPA. So one of the things that we see in the waterside is that these municipality will actually get funding quicker than the because it's all instructed. So, we expect to see that kind of activity a lot quicker on the waterside rather than the electric side. Philip, do you want to add anything to that?

Yes, I would say that the water business is holding up pretty well, although it's somewhat of a mix story in which we see a decline in some of our traditional channels and through our distribution mechanism to some of these smaller accounts to which we do not sell directly and is strengthening on our project business in which we're selling networks and mobile systems. So actually, we've been very, very pleased with activity on the waterside.

Okay.

And if you look at our international business, we're seeing quite a, not much change actually in our international water business which is quite substantial.

Okay. Now, with the AMI, I know that water utilities aren't as quick as the electric utilities to switch to AMI. They like the AMR, what have you. But are you seeing any sort of uptick there, even in just water utilities inquiring about the AMI technology?

Well, we did have the recent press release that we put out for Glendale, which covers our AMI solution, absolutely. We're seeing more and more activity going on with our AMI two-way communication systems.

Oh, yes, very strong shift towards large two-way network bid activity.

Okay. Okay. Everything else has pretty much been answered. Thank you very much.

Thank you.

We'll hear from Steve Sanders with Stevens, Inc.

Good afternoon, everyone.

Hi, Steve.

Just a follow-up. I know you don't want to talk real specifically about the four projects. But in the last few months, have you seen the shipment schedules change significantly in aggregate for those projects?

No, Steve, we haven't. They have been quite stable.

Okay, and as we think about maybe 2010, I think in the past you've commented that AMI margins should be comparable to historical Itron North America margins, which I think about high 30s to low 40s. So understanding that you have some issues in the core business, once you hit the kind of run rate you expect to hit in 2010, is there any reason to think those margins won't be back to those historical levels?

They will end up being back at historical levels once we get the product, or should I say commercialized like we have done in the previous products that we've had with electricity. It takes, it takes a couple of generations to get to the kind of margins that we're at and we foresee that towards the latter half of 2010.

And the only thing that I would add to that, Steve, is that also it's going to depend on the mix of services that are in there. So Malcolm's certainly talking about it from a product level, which is true. I think you have more service in there which to some extent we price at a lower margin, such as installation. That, of course, drags down your overall mayor begin, but it's good for your gross profit dollars, obviously.

Right, right. Ok. and then Malcolm, on the international side, we don't have the cannibalization issue related to AMR that we have in North America, but are you concerned that the replacement side of the meter business will be negatively impacted in 2010 and 2011 as a lot the of these countries look at starting significant AMI projects in 2012 and beyond?

You almost have to look at that country by country and obviously I don't have the time to go into it in such detail. But there's no question that if they have a -- if they have a choice of waiting a little bit until they replace their product with a new AMI meter, they probably will. However, there are regulations that require that these utilities do change out those meters and small replacement than new housing starts in certain countries. So the answer is, yes, in certain, in one respect and maybe no in another.

Okay. Thanks very much.

Thanks, Steve.

Next question will come from Jeff Osborne with Thomas Weisel and Partners.

Great, good afternoon. Just a couple of clarifications for Philip. Philip, you mentioned your software market share was higher than your meter share in advanced meters. I thought that for the first four AMI wins that you folks had won.only one of them actually had your meter data management system. Could you just expand on that comment and talk about what share you're seeing there?

Sure. So that comment is correct and it's just our ability to sell the meter data management system independently of the hardware so that we are supplying the meter data management system in a large number of competitive AMI deployments as well as non-AMI deployments. And so there are over 40 installation of the meter data management system out there and of course a very, very broad array of other Itron data collection systems, including MB 90 out there with very, very large market shares.

And, Jeff, I think that the last independent survey that was done shows us having a 50% market share in the meter data management in US.

And then also, just for Philip, if you could expand, maybe quantify the comment about the communication board coupled with the meter being a more expensive solution than open way. Is there any way you could expand upon that and give a rough estimate as to what degree of expenses you think it is?

I can just say that historically the reason that Itron purchased Schlumberger electric metering, and this is relating to Malcolm's history very closely, was the effort to combine Itron's electric AMR product and directly embed it into the solid state electric meter. We've been through this process before historically. We feel there is leverage and advantage into merging these manufacturing assembly and delivery processes in order to capture the margins of having multiple companies, including contract manufacturers involved in the ultimate delivery of the solution. So the only quantified number I have is just that the traditional margin required by contract manufacturer is typically in the 5% for 7% range. And so when you have a number of parties involved in the process, margin will be consumed. And we feel that we have optimized that very carefully.

Got you. And just a last question. Just a follow up to Stuart Bush's question. When you mention the IP field upgradable capability of the IMR units in the field, is the assumption there that you would be moving away from the C1222 standard into a full native IP meter, or are you just referring to an IP communications technology that you would still be capturing the data from the meter data management standpoint, not legacy protocol?

Yes, Great question. So frequently, IP and C1222 are assumed to be competing standards. And in fact IP is a transport protocol and C 1222 is a full application protocol. So, we would use IP for communication purposes. All of the data would be packaged and therefore understood, open and available by the C 1222 protocol to any other applications that wish to consume it.

Do you ever see the need three to five years down the road to move to a native IP meter and away from that protocol, given you would need more just kind of layer 4 through 7 technology at the edge to analyze all of that and that could present some security risks?

It's a detailed follow-up. The distinction that you're drawing about it being non-native, I don't except. I don't , if you are implying that there is significant additional overhead associated with what we are proposing, I don't believe that to be the

Okay. We can fill it out some other time. Thank you.

Sure.

Next we'll hear--

Operator, we're past an hour, is there any other questions in the queue, or--

You have two questions left in the queue.

We'll take those two, please.

All right. First one will come from Jesse Mitchell with Piper Jaffray.

Hi. This is Elaine for Piper Jaffray Thanks so much for taking the question. Could we get a little more color on the international regions and segments that experienced stronger or weaker shipments in the quarter? It looks like (inaudible) meters were down sequentially, but revenue is up. And you said you didn't see any significant pricing pressure. So, I'm just trying to understand. Is there a meter mix shift or services that might have contributed to the higher sequential revenue?

As Deloris said earlier, as we said in the script, we have a mix change. The actual volume of the specific meters, if you take a look at the volume that we have for electricity meters, for example, is fairly similar to what we've had in the previous quarter. Gas is about equal and water is maybe slightly down a little bit,. But overall, there's no significant change. It was just a mix issue on revenue, but the volumes are holding out.

All right, and then just , does the new open way production only from the new facility for SCE in the near term or will the facility also begin supplying meters for the San Diego, Centerpoint and DTE

We have the open way meter go into all three of these projects and even now Glendale. I'm sorry. Am I--

The production on the new line.

No, no, no. The new line, the reason that I mentioned that with Southern California Edison was that they would only accept their products on the new line. All of the other, all of the other customers have actually already previously accepted that. So, not an issue.

Yes, all of them--

All of them are going to be produced on that line.

Okay, great. Thank you.

Thank you.

Your final question will come from Mark Rogers with Gagnon Securities.

Thank you. First question is, why is product development as a percentage of revenue trending down when you are supposed to be developing open way to the IP addressable version? Phillip if you can answer that, that would be great.

I guess.

Why is product development as a percentage of revenue trending down when you are supposed to be developing open way version 2 and if Phil could answer, that would be great.

Just to specify, we don't think it is trending down as a percentage of revenue. So I would like to know what comparison are you using?

On a sequential actually.

From quarter to quarter?

Yes

This is Steve. It was sequentially down a bit from Q1. There are some factors, FX, for example, but really it's not down when compared to last year as a percent of revenue overall. That said, while we said we're not going to be disinvesting in R&D, we are looking at efficiencies at the same time and we're fairly comfortable with this level of spending going forward. So we expect going forward as revenue increases, that will increase at a rate higher than our R&D. One of the main strategies we have, we've had in the past with Centron is to invest in a platform that is scalable. We don't need customize a product for every individual order customer and we're building that same type of platform for the open way meter as well.

Okay.

And you might want to talk a little bit about the development of what we're talking about for IP.

Oh, yes

To answer your question.

Mark, two comments. The first is that R&D quarter to quarter, while primarily head count driven is also fluctuates in that we are involved in capital development projects. I mean there are a variety of things that are going on in which we're involved with third parties and cost reductions in particular focusing on application specific integrated circuit development. So it's a little tough to look at one quarter to the next and assuming that that's all head count related change. And to your point on IP development, it's actually a very tight core group that's working on it. It is, as you've heard, a firmware development project. Small teams do the best work there. And so there is absolutely a protected team focusing entirely on that and it's considered a high visibility, very predictable project.

Okay, and you said this was going to be ready in 2010. The DOE, we've seen in some recent press releases, that the DOE is saying that stimulus funding won't be handed out until several security measures have been tested. How does your development of a product in 2010 affect your customers who are going to be receiving this product, receive stimulus funding because they won't, the DOE won't have the product to test for security?

The underlying assumption you have made is that the release of IP in some way is related to the security of the system, and that is not the case.

I mean could you elaborate further.

Sure. We have put out press releases and public presentations on our security architecture. We provide application security, not transport security. It is possible, if you wish to turn on transport security as well, but we have fully vetted and tested our application level security. And it's compliant with all of the standards that have been proposed on the DOE nest process.

Okay, and I know you wouldn't give guidance on how many open way meters you plan on shipping at the end of September and December, but how many open way meters were shipped at the end of March?

Well, we've got that information in the earnings release. We have 100,000 year to date, and we reported it for the quarter. So it would be the delta.

Okay. I'm looking at the earnings release. I don't seem to see it.

It's on the bottom of the segment information. I'm sorry. I don't have the number right in front of me.

Okay. I'll go ahead. Final question, the Glendale project. Is that for the time being, and when I say time being, maybe two, three quarters out, the typical size of projects going forward?

No, not necessarily.

Okay. Thank you.

And there are no further questions. At this time, I would like to turn the conference back over to the speakers for additional or closing remarks.

Okay. We thank you for joining us today. If you have any follow-up questions, feel free to give us a call.

Thank you, guys.

Ladies and gentlemen, there will be an audio replay of today's conference available this afternoon. You can access the audio replay by dialing 1-888-203-1112, or 1-719-457-0820 with the pass code of 9496493. Or go to the company's website at www.Itron.com. Thank you for your participation.