Itron Inc (ITRI) 2009 Q3 法說會逐字稿

Good day, everyone, and welcome to the Itron, Inc. third 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, ma'am.

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 Marni Pilcher, our Director of Investor Relations. Today, Steve is going to start the call with an overview of the quarter and year so far, and Malcolm is going to discuss the stimulus announcement yesterday, his initiatives for the year and give you feel for what we feel like the rest of the year and 2010 will look like, after that we will take your questions Our earnings release includes non-GAAP financial information that we believe enhances your overall understanding of our current and future performance. We also have supplemental slide deck which is intended to augment our prepared remarks as well 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 risk 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 factor section of our section Form 10-K, 10-Q and other reports and filings with the Securities & 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, Itron's CFO.

Thank you, Deloris. Our financial results for the third quarter were impacted by many of the same factors we saw in the first half of the year. Volatility in foreign exchange rates, the economic slowdown, the credit crunch in various countries, and delayed orders in the US due to uncertainties surrounding the stimulus bill. It was a tough quarter, but we also saw encouraging indicators during the quarter, particularly a firming up of our AMI delivery schedules and increase in our 12-month backlog, that gives us confidence going in to the fourth quarter and in 2010.

Before I go in to more detail on our financial results, I want to call out a couple of items in the quarter that had an impact on our earnings both positive and negative to bring to your attention. We redeemed our remaining $109 million in senior subordinated notes during the quarter at a price of approximately $1.02. We incurred a $2.5 million loss in extinguishment. This has about a $0.06 negative affect on our non-GAAP EPS. We conducted a workforce reduction during the quarter wherein we reduced headcount by about 3% and incurred severance and other charges as part of the reduction in force. The total Company expense related to this initiative was about $2.2 million, which negatively impacted non-GAAP EPS by about $0.05. And in the area of domestic and foreign income taxes, our low effective tax rate was due to higher income and lower tax jurisdictions coupled with an increase in foreign tax credits which positively impacted our non-GAAP EPS by about $0.14. In total these one-time items basically offset each other, but I did want to point them out as I think it helps to clarify results for the quarter. In addition, we incurred foreign exchange losses of $4.4 million in the quarter, due to the appreciation of the euro, and appreciation of the dollar and about a dozen countries in which we transacted business. The losses were caused by material purchases and associated product sales in different currencies.

So with that, I will talk about our operating results. Third quarterly revenues of $408 million were 16% lower than the third quarter of last year. Of the decrease, about 1/3 or about $25 million was due to the stronger dollar against the currency in which we do business. International revenue was $271 million, down 12% or $38 million compared to last year, about 2/3rds of the decrease was related to the stronger dollar. He remainder of the decrease in international revenue was due to a softening of the markets in some regions, primarily Eastern Europe, South Africa, and South America. North America revenue was $137 million, down 22%, or $39 million compared to last year. The majority of the decrease was due to the completion of two large AMR contracts in 2008. The remainder was due to a slowdown in spending caused by the economy and customers delayed purchases related to uncertainty about the stimulus bill.

Nine month revenues were $1.2 billion, which reflects an 18% decline from revenue last year, and was due to the same factors that affected the quarter. Gross margin for the quarter of 31.7% was nearly 2 percentage points lower than last year. North American margins caused most of the decline due to fewer automated meters and modules being shipped in the current quarter, than the same quarter last year. Also, North American margins were negatively impacted by higher cost on our first generation AMI meters. Gross margin for the first nine months of 32.4% was about 1.5 percentage points lower than last year. While international gross margin contributed to some of the decline, the majority of the margin deterioration was in our North America business. The year-to-date gross margin decline is caused by the same factors affecting the quarter, primarily lower volumes. We shipped 31% fewer meters and models in the past nine months compared with last year, and as well the effect on margins from our first generation open-way meters.

Operating expenses for the quarter were $17 million lower than last year, $5 million of the decrease was due to lower expenses related to our amortization of intangibles, about $4 million was due to the stronger dollar, and the remainder was due mostly to cost containment efforts. Year-to-date operating expenses have declined over $50 million. Approximately $20 million of the decline was due to lower amortization, nearly $24 million was due to stronger dollar, and the remainder was due mostly to cost containment efforts. Our non-GAAP operating margin was approximately 8.5% for the quarter and the year, which was much lower than 11.5% and 12.3% margins last year. The decline in operating margins is due to the lower revenue and gross margin contraction. Net interest expense is slightly lower for the quarter, and more than $18 million lower for the first nine months of this year, due to debt repayments. We have reduced our debt by approximately $360 million over the past 12 months and more than $820 million since purchasing Actaris in April 2007. Our non-GAAP tax rate was 4.5%, this lower tax rate is driven primarily by lower income by our higher tax jurisdictions primarily the US and an increase in foreign tax credits. Non-GAAP diluted EPS was $0.45 compared with $0.81 in the third quarter of 2008. Our fully diluted shares this quarter are more than 3.6 million higher than they were in the third quarter of 2008.

Now I would like to turn to our capital structure, as I already mentioned, during the quarter we retired our senior subordinated notes, which was the highest interest rate and nearest-term debt we had. Our total debt is now $842 million, and we do not have any scheduled debt to mature until 2014. At the end of the quarter, our debt to EBITDA ratio was 4.1 times well within our debt covenant of 4.75 times. We will continue to monitor our covenants, and our business and we will balance needs for cash with higher prepayments going forward. With the amended debt agreement we have a maximum covenant of 4.5 times debt to EBITDA by year end.

Cash flow from operations was $87 million for the nine months, which is much lower than the $156 million in the first nine months of 2008. Our capital expenditures for the first nine months were about $38 million which is similar to last year. Free cash for the first nine months was $49 million, compared to $115 million in the first of 2008. We ended the quarter with a $125 million in cash and still have some flexibility for debt repayments with the higher cash balance. Bookings for the quarter of $400 million reflected a book-to-bill ratio of about one to one, bookings in the current period were much lower than 2008 Q3 bookings of $894 million. However, last year during the third quarter we booked our AMI contract for Southern California Edison which was $470 million. Our 12-month backlog increased from $646 million to $749 million during the quarter, due primarily to the inclusion of scheduled shipments of our OpenWay AMI solution in the third quarter of 2010. With total backlog of $1.6 billion, we believe we are well positioned for the long-term.

And with that, I will turn the call over to Malcolm.

Thank you, Steve. And good afternoon, everyone. Rather than starting with the review of the quarter, I thought I would start by talking about the stimulus awards that were announced yesterday since I'm sure you are all interested in any information that we can share. Obviously the announcements of the awards are beneficial to Itron for several reasons. The most obvious benefit is is that several of our current AMI customers will receive awards which will most likely increase shipments to them in 2010 above what they previously expected, as well it should be beneficial because of other customers in the pipeline. We can't discuss these opportunities by name either because the utilities have not be public about their chosen vendor or because the utility is still finalizing their vendor choice. And one last benefit of the award announcement is that there are -- that there is finally clarification, which should help stabilize the market and enable customers to return to more normal ordering patents even if they were not so success in obtaining grants. So with that, let's talk about the quarter. As you can see from our quarterly results. The third quarter was about what we expected. Currency are beginning to stabilize somewhat. However, the dollar is still stronger than it was last year, and continues to have a negative impact on the financial results of our international segment.

Our North America business continues to see the impact of the economic slowdown and delayed shipments caused by expected stimulus dollars, both in our water and electric business. However, as I said in the release, the good news is that we are finally beginning substantial shipments and installation against our AMI contracts. We have now shipped over 400,000 AMI units, and we expect the fourth quarter to have any more shipments, as San Diego, Center Point and Southern California Edison continue to ramp. I thought I would briefly touch on progress against our three initiatives, which are AMI, international growth, and cost reductions. And then spend sometime talking about (inaudible) in the industry and finish by giving you some color about our expectations for 2010.

As you recall, my primary focus for 2009 is AMI. We are on track with our customer's projects, and are prepared to deliver OpenWay units in the fourth quarter and in 2010 that support our customer's deemployment schedules although with yesterday's announcements, several of these schedules should change for the better. We believe that 2010 will be a very nice revenue growth for North America with our contracted AMI deployments as well as potential new awards. My second area of focus is international growth, and there were a number of activities during the quarter on that front.

In early September the European Union Energy package officially became law and was a very positive move towards the development of this market internationally. Just to remind everyone, the EU directive stipulates that members state implement intelligent metering systems that assist in the active participation of gas and electricity supply markets. The directive sets a time line of 80% coverage by 2020, and every European household equipped with smart meters by the year 2022. We believe this is just the beginning as Europe and other countries around the world solidify their smart grid plans, and those plans begin with smart meters. We held a strategic review of our solutions roadmap international this quarter and I am even more confident that we are well positioned to take full advantage of the opportunities as they unfold on a country-by-country, and utility-by-utility basis. They will not be one holistic solution globally to address the smart grid. Different countries and different utilities will adopt specific solutions to address their individual circumstances and challenges, and that is why we continue to invest in a variety of solutions and products globally, and why we continued to enhance our partnership with global leaders in this space because we want to be well positioned for all of the opportunities that are on the horizon.

During the quarter we issued a press release regarding IDIS, which is the initiative taken by Itron and other companies to promote interoperability in smart metering. We strongly believe that interoperability will create a more favorable environment towards smart metering development in Europe and other regions. International is participating in several smart metering projects and demonstrating its capabilities in various smart metering technologies, such as power line carrier, GPRS, and radio frequency, in electricity, gas, and water projects. My third area of focus is cost reductions, we made progress during the quarter as you can see from our reduced operating expenses. Our reductions in force affected about 3% of our workforce worldwide. Steve talks about the impact that the severance and other charges had on our financial results for the quarter, but we believe that will translate into more efficiencies going forward. Keep in mind, though, as we said on the last call, we believe we are in a short-term situation regarding our revenue challenges, and will not make decisions to cut our expenses and infrastructure so deeply that it would negatively impact our future potential in this market. We believe that the future is very promising, given all of the momentum in the space.

Now I would like to turn to some of the momentum that we're seeing in the market. The third quarter traditionally includes a number of industry conferences, and I would like to briefly touch on a few of them. During the quarter we attended both grid week and the smart cities conference which was hosted by IBM. Both of the conferences showcased the smart meter and smart grid space as well as the importance of sharing information in order to build a smarter planet. In late September, Itron held its 27th annual user's conference, where we had more than 800 attendees. The conference was very useful as we continue to gather feedback on our solutions and fine tune our offerings to address the challenges our customers are facing. We also attended two global conferences this quarter. Metering Europe, which -- which is held in Barcelona, Spain, and World Gas Conference and Exhibition which is held in Buenos Aries in Argentina. These conferences were attended by thousands of customers from many countries and for the first time we attended a unified Itron. All of these conferences have a common theme in that they were focused on climate change and how utilities around the globe will address these very serious issues.

Smart metering and smart grid are at the center of addressing these issues and this is precisely the space that Itron has been involved with for the past few years in the US, and that we now have the ability to participate on a global basis. The conference is reiterated my conviction that there will not be one holistic solution globally to address the smart grid. And my conviction are our broad portfolio of products and solutions is the right strategy to take advantage of the worldwide opportunities. I was particularly proud of the fact that two of our AMI customers, Center Point and San Diego, spoke at a number of these conferences about their OpenWay smart metering deployments. This is really an exciting time to be in our industry.

Before I close, here are my thoughts about the remainder of the year and 2010. We mentioned on the last quarter call that Q3 would look similar to the first half of the year, and it did. We believe that this is the low point of our results. We said last time that we expected increased revenue in Q4 due to installation of our AMI products, and we still expect such an increase. However, Steve said earlier, that our international business is showing some signs of softening. Although the international business continues to be fairly predictable we are seeing some impact in some countries, delaying purchases of projects, because of the financial and economic condition that we expect will continue for the remainder of this year, and potentially in to next year. For 2010, we would expect that North America sales will grow significantly over 2009, driven by the rollouts of our booked AMI projects, offset somewhat by continued declines in our legacy AMR, and metering business. Margins will continue to be challenged until we lower our AMI product costs through initiatives that will rollout later in 2010.

Let me close by repeating just one number from Steve's overview, $749 million. That's the amount of 12-month backlog we had at September 30, which is $300 million higher than we had at this time one year ago, $749 million in 12-month backlog, that's why I am very excited. Next year is going to be a really incredible year of opportunities for this industry and for us. I can't wait to update you on our progress going forward and with that, I would like to open it up for questions.

Operator, we are ready for questions.

Thank you, ma'am. (Operator instructions) . And we'll take our first question from Steve Sanders with Stephens,

Good evening, everyone.

Hi, Steve.

I'm going to ask a two-part first question, and a one-part second question, if I may.

You may.

If you can clarify how aggressive the DOE will be on the pace of spending the stimulus money and kind of related to that, Malcolm to your point about the enhanced pipeline, because several utilities got money, but they have not selected vendors yet. How long do you think it takes before they need to make a decision to stay on this DOE spending space?

We probably think between -- anywhere from one to three years, somewhere in the middle, I guess, Steve.

Okay. So the utilities who got significant grants and have not picked vendors, would you expect them to make a decision in a matter of months, or could it take quite a bit longer than that. What is your thinking on that?

I would say months. A lot of the work has already been done, so I would say months.

And I think regarding the margins, in prior quarters you talked about gross margins in North America getting back up in to that high 30s or better range, during 2010, I just wanted to see if you could either put a finer point on that, or maybe talk a little bit more about your comment regarding the cost-outs during 2010? Just give us a little bit more information on the gross margin picture in North America.

We have introduced our first -- really, second version now of our open-way meter. We expect that we will probably introduce our second version sometime later in 2010. And obviously once the volume starts to grow, we're going to leverage on those overhead expenses and we'll get better absorptions.

And Steve, we're obviously not giving a time frame for being back to what we were, say, in 2008, but certainly that's the goal we'll look for, whether you can achieve that in 2010, as Malcolm said, later in the year, that's probably unrealistic next year, but as you ramp, that gets better.

Okay. Thank you.

Okay. Steve.

And we'll take our next question from John Quealy with Canaccord Adams.

Hi, good afternoon.

Hi, John.

Hi. With regard to the margins in international about anywhere from 5% down local currency in the quarter it looks like, but yet margins did quite well. I realize mix is in there, how do you think about that moving forward, given that commodities, the easy compares go away on the cost side of it, and then have a follow-up.

So obviously on the cost side of it, one of the things we're obviously trying to do is renegotiate commodity prices. We have seen some of those impacts, but we have probably seen it is going to be flat between years, to be quite honest with you, John.

And then a follow-up, two parts, one international and one domestic. Do you see a convergence of the traditional AMR buyer in to the AMI buyer? Can you comment about that movement? Do they want to see millions of smart meter end points deployed in two to three years before they look for perhaps a less premium priced product with decent functionality to move forward?

Are you saying international or are you saying domestic? Sorry.

Both, actually.

So in the US, I think the majority of what you are going to see is -- on the electric side now, is we're going to see a continuous trend towards AMI. There's no question about that. On international, I think it's going to be a couple of years yet, before you really start to see that trend going to AMI. I think even though we have got the European union directive, it's probably obvious that that is going to be in a couple of years that we'll do that, so about 2012.

And I'm sorry, just the last one on domestic, if you look year-on-year in the domestic metering business, volumes are down on the production side anywhere from 40 to 50% depending on how you are counting them. What do you think about that level of degradation moving in to 2010 on the legacy product line very clearly OpenWay seems to be sopping up that and more, but what are your thoughts about that level of degradation that you have seen moving forward?

Let's see on the metering side, on the electric metering side, we're probably seeing 10 to 20% degradation over the next couple of years.

And one of the things, John, just to frame it, in 2008, we did have those contracts that we were shipping against, so you get a decline from that, but don't overlook the part that the economy has driven in the degradation in year to date shipments, and the effect of stimulus that has sort of been delaying purchases. So, yes, we would not expect as much of a degradation next year obviously.

Thanks, I appreciate it.

Thanks, John.

We'll take our next question from Sanjay Shrestha with Lazard.

Great. Good afternoon, guys. Malcolm, you said some of this large deal-related stuff probably will end up taking anywhere between one to three years before they become a real contract and you get to recognize revenues off of it?

No, that's the funding.

Sure. So with that sort of a backdrop, so when we think about 2010, certainly the 12-month backlog trend looks pretty good, by is it one of those situations that AMI benefits but not until the second half, and slowdown on the AMR side, we're probably looking at 2010 being a better year but probably skewed more towards the second half of the year? Is that the right way to think about it?

We have got the schedules that we got from our customers.

Okay.

And they start moving up -- right at the beginning, really, of 2010 with a pretty steady ramp all the way from Q1 all the way to Q4.

Okay. Okay. That's great. And one last question, then, guys, in terms of sort of the selection criteria, and the Phase 1 being sort of oversubscribed here, it is fair for us to think about the fact that 2011, and 2012 even without the up tick, you are looking at a pretty substantial opportunity, just strictly true by the North America and sort of smart meter rollout?

Yes, I would say some of these public filings, and you have seen the deployment plan, so you can see the level of activity that we have in North America for the next couple of years, and we do believe probably by 2012, some of it in 2011, we're going to start seeing some ramp up in Europe. Those will be 2012 and then we'll start kicking in.

That's great guys. Thank you.

We'll next our next question from Stuart Bush with RBC Capital Markets.

Hi, guys. If we look at the existing AMI contracts that you have with Center Point in Detroit, they were originally on three to four to five-year shipment schedules, with the new DOE funding, should we expect that to be shortened to two to three years, when we think about volumes that would impact upside in 2010?

Yes, Stuart, Center Point in particular have actually said publicly that they would go from the five-year deployment period to three years.

And so would we think of it sort of as a normal ramp up in those three-year period now instead of the five-year?

Well definitely be Center Point, there's no questions. The projects that we have got defined contracts with Southern California Edison, I can't remember exactly what that is, but that's not going to change, and then San Diego has got to be finished, I believe by 2011, and 2012, so.

Okay. And then my follow-up on the Q4 outlook, you mentioned that Q3 would likely be the bottom. I know you will be helped by, you know, some of these AMI shipments, but on the legacy business are you expecting a stabilization at least in the fourth quarter as utilities -- now that the stimulus money is out due decide to spend out their budgets on that side of the business or do you expect further decline sequentially in that business?

Well, one of the things that we talked about was that once the stimulus money has now been released, it may have eased off some of the pressure of holding back. So probably it's going to be pretty flat with AMR, I would say for the next -- for the next quarter with what we have had.

Okay. Great. Thanks for giving me some good color. Bye.

And we'll go next to Michael more it with with Robert Baird.

Hi, everything, thank for taking my call. If we look at the way the money was handed out yesterday, and you have the big -- the top 15 and you have some exposure there, but then you have quite a few smaller utilities that historically you probably wouldn't have thought would be thinking about AMI, and some of them are going to deploy, so does that cause them to further -- you know, not order some of your more core products? And then on the flip side, there's quite a few end points in large utilities that didn't get any money. And does that delay their decisions around moving to an AMI solution as they watch some of their brethren in the industry do an accelerated deployment?

Let me think. One of the things that we did -- we certainly helped -- and we said this publicly -- we helped 25, 30- utilities go forward. Some of those were small ones as well. A lot of these are in this group, and as far as what they do they'll choose whatever AMI solution will go towards. Will they actually reduce or delay their opportunities for going forward? I'm not certain. I don't think they will. I think they'll -- we have talked to them, obviously our competitors have talked to them, and I think they will start to move forward. I think they will start to do something. And some of these larger utilities that didn't get any funding, you know, we'll have to wait and see on that one. I think, some of them thought they would get money and they didn't, or they didn't apply. So we'll see. It's just a mixed bag, really.

Fair enough. And one additional question separate topic, as this plays out a little bit, and we get to see how some of your competitors execute as well as you, at what point do you start to think about consolidation, and what is your strategy there? And are your hamstrung by your current balance sheet situation or how does that play out in your mind over the next year as we start to see some success?

I'm not certain what you mean by consolidation.

At what point does the value chain start to consolidate rather than have niche players across the value chain? Does there become a point where you consolidate different functionality across the overall smart grid as universe?

No, we -- we basically provide a complete solution for everybody. We have one solution, which we can provide to these utilities, and I'm not certain it's -- it's going to be lots of consolidation personally. I think with having one solution to provide to these customers, I think -- I think we're fine going forward to be honest with you, and as far as a balance sheet, I'm going to let Steve just talk about anything on the balance sheet. Steve, any issues, Steve?

I think relative to your question about that that certainly is something we have to take in to consideration is our ability to finance consolidation like that. As Malcolm says, we're comfortable with strategy right now and go it alone in organic growth. Our use of capital has been primarily internal, and we think that has been the right strategy and continue to focus on that. And we have publicly said in the past that we wouldn't rule out some tuck-in or other opportunities, and we'll certainly scan the horizon as appropriate.

Thank you.

We'll take our next question from Paul Coster with JPMorgan.

With Europe in mind, do you think there is any risk that will encounter the same problem that we have seen here in North America where the utilities basically freeze and spend their spending as they evaluate the state grants and the like to fund their AMI programs in 2012?

We may have seen a little bit of that. Utilities over in Europe, they have no choice but to replace their meters to be quite honest with you. There may be a slight delay in making decisions, but they really do have to replace those meters on a periodic basis, so I think there might be a slight air pocket, but we're not seeing that much of it, to be honest with you.

And that's because they are electromechanical?

No, they just have the requirements what we call MID that they have to change out their meters, quite strictly actually, at a particular period of time, because of degradation of performance, so they have to replace them.

Okay. Got it. And then the other question I had was regarding the competitive landscape, I think you have partly answered it, but many people are concerned that the communications vendors are going to be capturing much of the functionality of communicating within home devices, and providing, sort of information services to the consumer in particular. Is that true? What -- what is generally your perception of your positioning in that value-added segment of the -- of the smart grid?

It's -- it's a good different's a really great question. One of the things that we have done is we have tested our solution to completely have a -- an end-to-end solution that completely allowed the utility to do 15-minute interval data, monitoring, and at the same time that will go inside the home, and we have got specific home area network partners that we are working with, who can do all of these in-home devices. So as far as we're concerned, we offer -- and we're not afraid -- we offer complete end-to-end solution inside the home and of the grid, and I'm completely happy with the solution that we have. And if some of our competitors have different solutions, then, no, I'm not worried at all.

Thank you.

We'll take our next question from Jason Feldman with UBS.

Good afternoon.

Hi.

Just back to the margin topic for a minute. Certainly I understand that volumes are down substantially from last year. But relative to the first quarter or second quarter, it's not all that different, but there has been the substantial drop-off. Is it really just on -- is it really just product mix that's driving it?

Yes, Jason, obviously we had a bigger portion of our North America this year be that AMI revenue, and so it's really a mix within the quarter that's not necessarily apparent.

Okay. And in terms of the cost-saving measures, you know, you clearly have been reducing headcount, have talked about some other cost-containment measures, given the expected ramp up, and I know you said you didn't want to cut too deeply, where are you cutting and what other construction-containment measure you taken.

We have cut in G&A areas where we can. We have done some policy changes with specific things you can touch and consolidation is -- of -- oh -- I'm trying to think of the term, travel plans, all of the -- all of those sort of areas that you are not going to touch any of the skill sets that we have got from our folks. And as far as the headcount is concerned, we really do have a flexible manufacturing -- we flex our headcount where we need to, mostly if we ramp up, we get additional volumes, we'll flex it with direct labor people, but we have really tried to reduce our spending in the areas of G&A.

Okay. And last quick thing. I mean, currency looks like it will be finally turning to a tail wind next quarter, monitoring the revenue line is pretty straightforward, but based on the location of your production relative to sales, should there be some margin impact that we should be thinking about one or another that we should be thinking of right now?

Not that we can think of, no.

Thanks.

We'll take our next question from Scott Graham with Ladenburg Thalmann.

Good afternoon -- good evening, actually. Just three questions for you. The -- I'm sure I'm just overstating the obvious here, $0.45 a share, the non-GAAP number does in fact include the $0.06 from the extinguishment, right? So --

Yes.

Operating is higher than that.

Yes. It includes that $0.06.

Yes. The -- the -- kind of a -- just piggybacking off of the last question, admittedly GAAP-based but still North American operating income number was a loss on that basis, and what I'm wondering here is from a cost-reduction standpoint -- and I realize that we want to be careful with the skill sets and what have you, but are you contemplating rationalization in non-AMI areas, so if we're going to have an AMI ramp -- obviously there is going to be cannibalization of other areas. Are you contemplating anything for the facility or even call it even a production line rationalization in facilities for some conventional meters, AMR meters that will probably not be needed going forward?

That is a good question. We always look at that on a constant basis. We really don't have four factories in North America. We have an electricity metering factory in South Carolina and that is transitioning over from our traditional AMR meter products over to our AMI products. We have a facility in Minneapolis, south Minneapolis that focuses on battery technology for our gas and water products, and then we have a gas meter company in northern Kentucky, and we're seeing as we go forward that the consolidation and the things that will probably go down, we could have a reduction of hand health technology, mobile solutions, which is not really a big factory, we outsource some of that. So I think from North American standpoint, we'll continue -- we really won't see much consolidation to be honest with you, and much rationalization going forward.

Okay. On the severance, last question. How does that split between North America and international?

Of the $2.2 million?

Yes.

Most of that was North America. There was, I would say 3 or $400,000 round numbers that were international.

Great. Thanks.

You're welcome.

And we'll take our next question from Elaine Kwei with Piper Jaffray.

Hi. Thanks for taking the question. I was wondering if you could give more detail on the bookings number, whether that includes any AMI or if it is all AMR meters versus modules and then also, North America versus international?

Just for North America. We did have one AMI booking project in the second -- in the third quarter, which was Glendale.

Okay.

And the rest of it was our traditional business. With regards to -- with regards to international, it's a pretty usual mix of electricity, gas and water orders, which is pretty typical of what we have been receiving for the past couple of quarters.

Okay. Great. And in the last couple of quarters, we have heard you say that the decline in the AMR business hadn't quite been offset yet by the ramp-up in AMI, and are we seeing it get to that point in Q4 where the inflection point of AMI will offset the decline in AMR?

On the electric side, absolutely. Yes. You start to see the decline of AMR and ramp up of AMI for electricity products.

Last question, in terms of the AMI marketplace out there, are the projects with your large contracts, are they at a point, where other utilities are potentially looking to them as a reference point?

Absolutely. I mean , we have had -- or our customers have had significant amounts of attraction in talking at these conferences, as I have said. They have had visits from different part of the -- different parts of the world, and different parts of the US as well. So it's -- when you visit some of these metering conferences, both -- as I said in Europe and also in South America, these guys are worldwide customers now. We have worldwide customers visiting the locations in North America and also at our booth in some of these international locations, so it very worldwide. Very, very

Great. Thank you so much.

You're welcome.

And we'll go next to Jeff Osborne with Thomas Weisel Partners.

Great. Thank you, I was just wondering if you could help me understand the difference in the margins of -- within the North American segment. You talked about this mix shift, but is there a way you can put rough numbers on either a gross or operating basis to help flush out what the deviation of the core business is versus the Gen 2 AMI?

No, we really don't break that out, Jeff.

Okay. Can you talk about the Gen 3 AMI version that you mentioned from mid-to late 2010, what some of the cost improvements are that you will be implementing in that product?

One of the things that we do on a constant basis is review these designs. We have been doing this business a long time, and we always focus on reducing the cost of these products no matter what. The -- improve the quality, improve the cost -- and reduce the cost and improve the functionality. So one way to reduce is to cost is with acetic developments, so that's one of the reasons we have said it's going to be in the latter half of 2010.

Great. And I assume you can't quantify either from a basis point margin standpoint or dollar value or a bomb, any of it?

Not, we don't give that information out. Just that it will certainly improve the margins on that project.

Understanding. Thanks much.

You're welcome.

(Operator instructions). We'll go next to Carter Shoop with Deutsche Bank.

Good afternoon. First question relates to AMI revenue in the quarter, I think for the second quarter you mentioned it was 10 to $12 million. Could you comment on how much you generated from AMI revenue in third quarter?

Yes, it was close to $20 million, Carter.

Okay. Going back to gross margins, I hate to kick a dead horse here --

Well, why not.

It's okay. Go ahead.

Yes, I guess I'm going to, sorry. If you back out the severance and assume all of that was in COGS, it still looks like gross profits in North America are down about 10%, versus only about a 4% decline in sales, and after we back out that restructuring, is there anything else going on there that is worth discussing or exclusive the mix shift between AMR and AMI?

Actually a couple of things. I'm not quite sure where you get the 10% decline, what I might reiterate is that when we recast our North America business at the beginning of the year and put our gas and water metering business in there, it did bring down our gross margins for North America. So last year, Q3, they were in that 37% range, so we absolutely have has degradation since then, no doubt, but it's not 10 points.

I apologize, I was talking about the sequential change.

They were 35% last quarter. At any rate there was bathe of the cost in severance sales, but the bigger component are the AMI shipments at that low gross margin and lower production volumes.

Okay. And as AMI shipments ramp in Q4, and that mix shift continues, do you expect gross margins to improve on a sequential basis in North America?

Well, as Steve said in his comments or Malcolm said, we would expect North America margins to continue at that lower level, until we get the production level up, but improving in 2010 obviously, and then that acetic chip in place, so it will be an sequential improvement over time.

Okay. Can you comment on your outlook for the tax rate in 2010?

Yes, this is Steve. We -- we expect the tax rate next year will be higher -- driven by higher income in tax jurisdictions particularly the US, and the absence of that foreign credit catchup. We're still working on that. We would expect that to be back in the mid-to higher 20% range next year.

Great. Thank you.

Thank you Carter.

And we'll take our next question from Mark Rogers with Calyon Securities.

Thank you. I was just wondering, Steve, you mentioned that you are tending your cash internally on product development, and I know you have a pretty significant AMI IP fully enabled meter that you are rolling out in 2010. I'm not seeing a significant ramp up, though, in product development spending, so is there a way for us to track the investment that you are making in this new product offering?

Let me just comment on that. We have spent a significant amount of money over the past three years developing this solution, and what we're finding is now that -- a lot of it now is completed, we will see, obviously we're going to see sort of -- not necessarily a huge ramp up. It will not be. But we have got -- we have got some things that we have got to do IP, firmware, all of those kinds of changes that we're going to be making to the products. So I don't really see a huge amount of development, because it's already been done, as I said the [Asics] that we're developing, they are part of the expenses, but we don't see a huge increase in any of the requirements. A little bit of the ramp, but not much.

Okay. And then a question on stimulus money going to utilities. Let's just use Center Point as an example. They talked about on their call, a potential tariff-free determination based on they are not spending nearly as much as they thought they would, so the Texas PUC might come back and say it's not fair to the customers. Do you see this being a potential in delays in projects for utilities that had a rate base established for without stimulus funds? And now they have received stimulus funds, so the rate base needs to be negotiated?

I didn't really want to talk for our customers, but I don't think so. I don't think so.

Thanks.

And we'll go next to Michael Horwitz with with Robert Baird.

I have always wanting to clarify something. When I think about improving margins over time for AMI, and -- and you talk about cost improvements, but I also want to understand a little better, over the long-term, I think that you and some of your competitors have said that that the AMR-type margins probably aren't available in the AMR opportunity. And my other curious question is when you do a big AMI deployment, and there's likely to be technology bumps in the road for any new technology at this scale, how does that affect margins? How does your margin get affected as you deploy? And do you share that pain with the utility?

Well, let me just tell you how long we have -- we introduced -- I could do this for both electricity and gas modules, if you take a look at when we introduced the [centron] a number of years ago, we have continually made changes to the design, and that is something that is in evolution, and you continue to make changes and reduce cost. But from a product standpoint, you are continually making these changes, and so do I see that we'll be the same margins with AMR as AMI? That's the goal, of course. I mean, we have -- we have a product that we spent a lot of money in R&D, and I expect some of those benefits to happen over the next few years, so, yes, I do see that some of those -- some of those margins will be -- will be continuing to improve. But at the same time, we have got mix of services, as well as installation as well, so overall it depends on exactly which particular product you are talking about.

Just to be clear, when you are doing a brand new technology at this kind of scale, and you are out there deploying and getting out the bugs, I would anticipate, you know, getting out those bugs and exploring your new technology and seeing what works and what doesn't work. I would anticipate that that implies lower margin at least in the beginning as you get all of those bugs out, let alone any cost things you doing in the production of your equipment.

This is Steve. What we have talked about is a lot of test and piloting over the last couple of years, and the costs associated with that have been flowing through the R&D line in the sense that we have been out testing that and been working on that, and our strategy has been to focus on quality, and focus on making sure that works before we deploy in scale out in the field, so that we don't want to see margin degradation from quality-related issues in the future. Back to original answer -- before we begin to deploy scale for the very reasons you are talking about.

Okay. That's helpful. Thank you.

We'll take our next question from Tom Whitely with Shanksman Capital.

Good afternoon, just two things. On -- you mentioned you would balance the need for cash (indiscernible) covenants. I was just wondering if is there a minimum amount of cash you would be comfortable with on the balance sheet going forward?

Yes, our cash is split between domestic and internationally, and we're comfortable with $75 million plus or minus, that can change a little bit, but in terms of our working capital requirements as a level necessary to run the business, we continue to focus on that as well.

Okay. And just, with the cash on hand, then free cash flow, do you feel comfortable over the next six to 12 months with the covenant levels as you amended them.

As I mentioned we have a 4.1 times ratio at the end of September versus a 4.75 times. That does step down. And will continue to evaluate a variety of operational and funding scenarios to maintain and fund and grow our business, and we'll look at various scenarios in order to achieve that.

Okay. Thank you.

Thank you.

And we'll take our next question from Stuart Bush with RBC Capital Markets. Mr. Bush, please go ahead, your phone line is open. If you could check your mute button.

Yes, can you hear me now?

Yes, we can Stuart.

Yes.

Sorry. A follow-up question for Steve on the tax issue. If you can just clarify what the tax credits were. I noticed that the international business did not change significantly sequentially, so was that just a different jurisdiction where you got tax credits, and how do we think about that tax rate going in to the fourth quarter? And then I missed your response to what tax rate you anticipate for 2010, if you could just repeat that.

Sure. We -- as I mentioned before, we saw significant increase in foreign tax credits in the quarter, and reflected in that low rate, that was from work we have been conducting over some period of time to look at the benefits of taking foreign tax credits versus deductions, and as we filed our return and completed that project, we identified credits to be much more beneficial for us, and have really tied that in to the integration of the international group. For the full year and remainder of this year, we would expect a 5 to 10% rate as appropriate for the whole year, and then my prior answer was to a question about 2010. We expect that rate will be higher because we see that higher income again, higher tax rates, particularly in the US We're going to see growth there, and we don't expect a similar foreign tax catchup -- or benefit in the next year, so we would expect that to be in more in the mid-to higher 20% range next year.

Okay. Great. Thanks for that.

And that does conclude today's conference -- that does conclude our question-and-answer session. I would like to turn the call back over to you Ms. Duquette for any closing remarks.

Thank you, everyone for your participation today, and as always if you have any follow-up questions, feel free to give us a call. Thank you, operator.

Thank you, ma'am. There will be an audio replay available this afternoon. You can access the replay by dialing 1-888-203--1112 or 1-719-457-0802 with the pass code of 5642738 or you can go to the company's website, www.Itron.com. That does conclude today's call. Thank you for your participation.