Itron Inc (ITRI) 2011 Q1 法說會逐字稿

Good day everyone, and welcome to the Itron Q1 2011 earnings conference call. Today's call is being recorded. For opening remarks, I would like to turn the call over to Ranny Dwiggins.

Good afternoon, everyone. Thank you for joining us today. On the call we have Malcolm Unsworth, our President and CEO; and Steve Helmbrecht, our Chief Financial Officer.

We issued a press release earlier, announcing our results. The press release includes replay information about today's call. We have slides to accompany our remarks today. These slides are available through the webcast and through our corporate website under the Investor Relations tab. Please turn to slide 2 while I review today's agenda. After I complete the introduction, Malcolm will provide a business update, and next we will review the financial results for quarter, and then Malcolm will close our prepared remarks. After that we'll take your questions.

Our earnings release and financial presentation include non-GAAP financial information that we believe enhances your overall understanding of our current and future performance. We have included reconciliations of differences between GAAP and non-GAAP financial measures in our earnings release and financial presentation.

Now please turn to slide 3 regarding our Safe Harbor Statement. 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 from these expectation, 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 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 will turn the call over to Malcolm Unsworth, Itron's President and CEO.

Thank you, Ranny, and good afternoon, everyone. Itron's first quarter results provide continuing validation of the strategic direction we're setting for the Company. Those of you who follow us on a regular basis know that we are managing Itron to capitalize on the extraordinary energy and water management opportunities unfolding before us.

As you move forward in the global marketplace, there are three watch words at the forefront of our minds. Balance, which refers to our extensive product portfolio, and solutions for electricity, gas, and water. Execution, which is how we manage every aspect of our Company. And innovation, our ability to develop new solutions to meet the evolving needs of our customers.

As you'll see in our discussion today, each of these continues to be reflected in Itron's first quarter performance. Our first quarter success underlines our unique position. Itron is the global leader in technology solutions for electric, gas, and water utilities at a time when the utility industry has begun the most significant technology upgrade cycle in its history.

The conversion to smart meters has progressed the fastest in North America, but it's spreading quickly to other parts of the world. Our North American leadership positions us well to extend our success globally. And we have the opportunity to expand our relationships with our customers to provide additional products and services. In short, we see the opportunity for dramatic growth and intend to aggressively pursue it.

On slide 4 in our presentation, you'll see the areas I'm going to cover this afternoon. First, our improved profitability and other financial highlights for the quarter. Second, our recently announced $268 million BC Hydro booking, a validation of our alliance with Cisco, and a number of other contracts awards. And third, our reorganization to support growth.

Now, please turn to slide 5. We're off to a great start for the year. Revenue is up 13% over the first quarter of last year, with very nice contributions from both North America, which was up over 14%, and international, which was up approximately 12%. We also saw growth in all three business segments; electricity, gas, and water. And as I've said many times, our balanced product portfolio is one of our main strengths.

The drivers for higher revenue in North America were higher sales from our OpenWay Smart Electricity Meter and Gas Solutions and increases in professional services, as well as continued improvement from our gas business with higher revenues from our ChoiceConnect Advanced Gas Communication modules and gas meters. The higher international revenue was driven by developing markets in electricity, in particular, Indonesia and South Africa. For gas, it was Italy, Azerbaijan, and Latin America. And our international water business has record quarterly revenues of $106 million, a 15% improvement over Q1 of last year, driven specifically by growth in Asia, the UK, and France.

The economic conditions are improving and our European factories are busy. In fact, three of our water and heat factories were at record production levels in Q1. We also had very strong bookings of $681 million, representing a book-to-bill ratio of 1.2 to 1, giving us a record backlog at the end of the first quarter of $1.75 billion.

We were particularly excited to pick up a number of key new customers that demonstrate how well our strategy is working. In particular, Aqua Latina in southern Italy, that serves over 75 municipalities, bought our newly released composite water meter. Further afield, India, where water losses can reach up to 50%, continues to be a powerful market. We are continuing deployment with Mumbai. We signed a contract for 250,000 water meters over the next 18 months with Delhi, the national capital and city of over 13 million people.

Itron's advanced water solution will be part of the transformation of old, dilapidated water distribution systems into modern networks, capable of delivering water to customers 24 hours a day. And we added new customers in central and western Australia, where our advanced water solutions are helping them save this precious resource.

In electricity, we began shipping our new OpenWay SEM solution to ConEd. This is very important because it gives customers the ability to easily migrate from AMR to AMI. OpenWay SEM is an option for utilities to get some important benefits from AMI functionality now, while they continue to evaluate full implementation of smart grid networks. OpenWay SEM targets our install base of approximately 37 million Itron electricity AMR meters in North America, giving us a significant competitive advantage at this important market.

In Germany, we launched a new compact, ultrasonic heat meter, which is gaining traction with customers. This is a key innovative breakthrough for the heat industry. And in Mexico, we're starting to penetrate the gas market, selling a 25,000 gas meter prepayment system.

We are pleased with the rebound in profitability. With the launch of OpenWay behind us and a year of product experience under our belt, we're seeing significant margin improvements in OpenWay and professional services. It shows that our continuing emphasis on enhanced execution in our operations is working well. Steve is going to provide more details later.

As we have previously announced, we have undergone a top to bottom company-wide initiative to improve profitability. We'll be reporting on our progress regularly.

Please now turn to slide 6. Our win at BC Hydro is validation that our advanced OpenWay solution is working extremely well. With over 6 million endpoints in the ground, we now have the number one position in North America with over 35% market share according to IDC. The competitive impact of our innovation and our strategic alliance with Cisco, which began only eight months ago, is undisputable. We feel the benefits of buying an integrated solution from Itron, meters, communications, services, and software has real appeal to prospective customers.

We are providing BC Hydro with an end-to-end solution, including OpenWay meters and RF Mesh Network consisting of OpenWay communication modules and network concentrators, a data collection engine and our meter data management software. This solution would include the Cisco IPv6 stack, which we will license from them. When completed in approximately two years, this will be one of the most advanced smart [width] solutions in the world.

BC Hydro will use our OpenWay Network to support a number of additional applications beyond traditional metering and demand response, including five examples. A system to help lower delivery cost, a network to optimize voltage delivery, a theft detection solution to pinpoint energy diversion, tiered rates to promote conservation, and intelligent solutions to communicate to over 500,000 in-home devices.

I'm also delighted to tell you that last week, Itron's customers, Southern California Edison, Detroit Edison Energy, and San Diego Gas and Electric swept the Excellence Awards at The Metering America Conference in Dallas. They took home awards in all three categories; innovation, business case excellence, and customer service excellence. Likewise our Smart solutions for water and gas continue to gain traction, because of the advanced functionality and innovation we provide.

In our last call I talked about our new North American Smart gas endpoint, the 100G, and some of the contracts we've recently won. This product is doing really well. Customers are buying the new Smart two-way communication module as they replace earlier one-way versions, and we're also seeing the same interest for water. As you can see, with our OpenWay SEM solution and with our 100 series for water and gas, we're executing on our strategy to provide utilities a clear migration path from AMR to AMI; and this approach is producing results.

Now turn to slide 5. Now before I turn the call over to Steve, I'm going to make a few comments about the reorganization we announced in March. We have reorganized the business into two global organizations, energy and water. Energy, encompassing electric and gas, is led by Philip Mezey; and water, by Marseilles Reyniere. And we made this change to meet our customers' global needs, drive growth and profitability, as many of our customers today have a global presence and are looking for global solutions, like National Grid, Iberdrola, Veolia, British Gas, and others. We can serve them better and more profitably by maximizing global technology platforms.

With a global focus, we can be smarter, faster, and more efficient. We are dedicated to building solutions for a sustainable future. Now I will hand the call over to Steve who will give you the details of the quarter and the year.

Good afternoon, everyone. This is Steve. I've asked Ranny to step in today to take you through the financial materials in order to save my voice for the Q&A. We'll be starting with slide 8 and with that I'll turn it over to Ranny.

Thank you, Steve. As Steve said, please turn to slide 8. Overall we are very happy with our results for the first quarter, with both Itron North America and Itron International operations contributing to overall revenue growth. Revenue grew 13.3% over Q1 2010 to $564 million, with FX contributing about 1% of that growth. And bookings were $681 million, inclusive of our $268 million booking for OpenWay at BC Hydro for a book-to-bill ratio of 1.2 to 1. We saw year-on-year improvement in gross margin to 32.7% from 31.6% last year and improvement in non-GAAP operating margin to 11.7% from 9.9%. We had GAAP EPS of $0.66 per share compared with $0.62 a year ago, and we had non-GAAP EPS of $0.99 per share compared with $0.96 a year ago. However our non-GAAP EPS of $0.98 in Q1 last year included $0.26 of discrete tax benefits with minimal benefits this year, indicating much stronger operating performance, as also evidenced by EBITDA with growth of 24% to $80 million, driven primarily by the improved gross margin in Itron North America.

Turning to slide 9, our EBITDA margin was 14.2% in the quarter compared to 12.9% a year ago. Cash flow from operations for the quarter was $36 million, good performance considering we had scheduled payouts on incentive compensation plans of about $40 million, as well as a plan buildup of certain inventory which impacted our trade working capital. And we had capital expenditures of about $11 million.

Moving to slide 10, unit volumes grew about 7% overall, with Itron International up 6% and Itron North America up 8%. And revenue grew faster than unit growth due primarily to a mix shift towards products with higher average selling prices. Most of the growth is coming from shipments of Advanced meters, SmartMeters and communication modules with our basic meter shipments down slightly. We've shipped nearly 1.1 million OpenWay units during the quarter, demonstrating continued progress with our large projects. Shipments of OpenWay units declined over the record levels of Q4 2010 due to several reasons, including the near completion of the San Diego project coupled with deployment schedules on other projects that trended back to normal levels.

On slide 11, you see Q1 revenue by region. Growth in US and Canada continues to be driven by SmartMetering projects. European revenue growth, shown in red, was driven by gas and water Advance Metering projects. Emerging markets, in blue, grew 37% year-on-year and came from a variety of customers and projects, including Azerbaijan, Indonesia and India. We like these markets and will continue to focus on growth opportunities.

Now please turn to slide 12. Itron North America revenue grew 15% to $277 million. OpenWay represented about 48% of total INA revenue. INA gross margin increased 184 basis points, due primarily to improved OpenWay margins. The driver was improved operational efficiency in our electricity factory.

Slide 13 shows Itron North America operating expenses grew in absolute amounts but lower than our rate of revenue growth. This growth was due primarily to continued investment in R&D with focus on new product development and an increased level of marketing expenses during the quarter driven by increased resources directed towards the pursuit of Smart grid opportunities.

On slide 14, Itron International revenue grew 11% from Q1 2010 on a constant currency basis. Revenue growth came from gas and water Advanced Metering projects. We are definitely seeing a shift towards Smart and Advanced Meters outside the US.

I'm going to focus for a moment on I&L gross margin. It was 31.2% in the quarter, a 40 basis point improvement over Q1 2010 and a significant improvement over Q4 2010. We had a warranty charge in Brazil, which negatively impacted margin, but we also benefited by the recovery of a warranty claim. So what's happening with long-term, I&L gross margin trends, and what are the drivers? We have to look at each business line over the long term and separately, gas, water and electricity, because there are different trends and drivers.

In gas, margins are good and have improved long term. Manufacturing efficiencies have been a significant driver, but we are continuing to monitor raw material costs, primarily steel, in light of the Japanese situation. Additionally, we have seen some benefits from increasing volumes of Smart payment products.

In water, margins are holding fairly steady. We are seeing margin pressure in water associated with higher material costs but higher volumes in Q1 have resulted in better manufacturing efficiencies, which has helped mitigate the increases.

Electricity is where we have seen the most margin pressure, driven by several factors; decreased volumes in certain high margin product lines, increased competitive and pricing pressure, increased warranty charges, including those in Sweden last year and in Brazil this quarter, and manufacturing efficiency issues. But we see this as transitional as we begin to optimize and migrate our manufacturing capabilities from legacy products towards high volume Smart Metering, particular in Europe. Improving our profitability, particularly gross margin, is a key objective of our transformational and organizational efforts, which we will talk about more next month at our Investor Day.

Slide 15 shows Itron International operating expenses grew due to several factors. We had increased compensation costs, and we also had growth in R&D spending, similarly focused on innovation and new products.

Moving now to slide 16, we reduced debt and improved our capital ratios during the quarter. We repaid $53 million in debt in the quarter. Our total debt balance at March 31 was $576 million. Our debt-to-EBITDA ratio improved to 1.7 times at March 31 from 1.9 times at December 31, driven by the debt payments and improved EBITDA. We had $133 million in cash at March 31. And in January, we expanded our revolver credit agreement by $75 million for a total of $350 million in revolver capacity. And we were upgraded by Moody's during the quarter to a Ba2 rating. With our debt at a much lower level and stronger conditions in the credit markets, we are looking at ways to lower the cost of the outstanding debt while building sufficient capacity to support growth, topics Steve will cover next month at our Investor Day meeting.

On slide 17, Itron International had $302 million in total bookings for a book-to-bill ratio of 1.05 to 1 with very healthy bookings in both water and gas. INA had $379 million in total bookings driven by the BC Hydro booking of $268 million for a book-to-bill ratio of 1.37 to 1. The remaining $111 million in INA bookings is consistent with the range of our normal quarterly activity. Our RFQ activity is high, and to use a baseball analogy, in Q1, INA had a lot of singles -- no doubles or triples -- and a grand slam, which leads to our last slide, backlog. With record total backlog of $1.7 billion and 12-month backlog of $989 million.

In closing, we are happy with our financial performance for the quarter. And with that I will turn it back over to Malcolm.

Thank you, Ranny. In summary, with our global footprint, balanced portfolio of electric, gas and water end-to-end solutions, continuing emphasis on organization-wide execution, and proven track record of innovation, Itron is very well positioned to compete for the growth opportunities ahead of us. Operator, we're ready for questions.

(Operator Instructions) We will take our first question from Steve Melonovich with Bank of America/Merrill Lynch. Please, go ahead.

Malcolm, with the BC Hydro win, there were a lot of questions about your relationship with Cisco on that and specifically what kinds of payments you have to make with them and how you share the economics. Could you elaborate at all on that?

Certainly. We have a solid relationship now with Cisco. And one thing that we obviously can't say an awful lot for the competitive reasons, -- we've signed an NDA, and talking publicly is quite difficult. One thing we're going to do, as I said in my prepared remarks, we will be paying them a license fee for the use of their IPv6 technology. And the margins on this contract are very comparable to the other OpenWay contracts that we've had.

Okay, thank you. And then on one hand it seems like the adoption of SmartMeters in the long run is inevitable, but in the short term, it seems somewhat murky in terms of the economic argument. You've seen public utility commissions, some of them pulling back; some of them moving forward. It's a real mixture out there. What's your sense right now of demand uptake and what we can expect over the next 12 or 18 months for the industry?

So this may be a little long. But there are about 175 million electricity meters in North America. About 51 million have been awarded to Itron and some of our competitors. That leaves about 124 million that are left. Out of the 124 million, there's 24 million of those that are highly active and they should sign anywhere between now and the next one or two years. That leaves 100 million. Those 100 million, about 25 million of those are, what I call, fairly active. They don't necessarily have RFQs put out, but we visit them regularly. If you take 100 less the 25, it's about 75 million that are not active.

Out of those 75 million, there are about 30 million that have Itron's AMR Solutions in there. So that's about another 45 million that are left to go. Overall, we see between now and the next two years about 24 million that will be awarded potentially, and about 25-more million that are active. That gives you a pretty good picture in North America about what's going on with the business. And obviously over in International, we've seen a significant number of RFQs coming in. Nearly all of the RFQs and tender activity is associated with AMR and AMI activity.

Next question from Steve Sanders with Stephens.

Good afternoon. Good quarter. A follow-up on BC Hydro, will they be taking the Gen3 product, and do we effectively have to wait until the government review is finished in June to begin shipping in any kind of volumes there?

Our Generation 3 is our next, obviously, our next version of our OpenWay Solution, and that is included in the contract. We've definitely got that. When it comes to when roll-out is going to start, it's basically been approved obviously by BC Hydro. It's been approved by the government. And we're moving forward and probably start deployment sometime in the second half of the year. To be completed, obviously, with the mandate in BC to be completed by the end of 2012, Steve.

Okay, okay. And then follow-up, I appreciate the color that Ranny provided on the various segments, internationally. He did mention that there are some headwinds on the electric side. Is that in your mind essentially some of the bigger utilities slowing down their replacements in front of the Smart grid ramp. Is it a significant headwind as you see it over the next year? How would you characterize that?

We can only look at headwinds based on current activity that we have with these utilities. We're actively involved in many of the utilities as I said. About 22 million points of actively involved with bits. I'm not sure certain what the definition that you'd call that is. I think that's fairly active. And then the rest of them, as I've said, there's about another 24 million that we have where we're involved.

Headwinds, what can I say? We are now back to business cases. Good business case which is what we do -- which we've done many times. And good business cases makes good business sense for the utility. Okay, Steve?

Steve, this is Ranny. I would also add that in Europe, yes, we've seen some headwinds, I would say, with the planned rollout of projects there. On the other hand, as we mentioned in our prepared remarks, business has held up pretty well in Europe. We were pretty pleased to see that, so in spite of the fact that these big rollouts are planned, business has been holding up pretty well.

We'll take our next question from Michael Horwitz with Baird.

Nice progress on the margin. Just two quick questions, when I think about your relationship with Cisco, should we think about each deal that you're able to win and then implementing Cisco IPv6 as separate when we think about your licensing payments of BC Hydro will be separate from whatever other project you win? I'm just trying to understand the math; and so, when you book $270 million into backlog from BC Hydro, but then we're going to X-out a license fee, how do we think about that for subsequent contracts?

Michael, every single contract that we have is different. We have a license fee that we'll be paying for this one. And we have the contract. We have the contract with BC Hydro. Everyone will be different after that, so there's not one answer that I can say, because it will change over time, but this is the first one that we've had where we'll be paying this license fee.

Fair enough. Quickly, clearly your balance sheet's in a much better condition. Quite a bit of talk out in the marketplace about consolidation. And given some of your comments about the competitive marketplace, are you starting to look at acquisitions again? And clearly, there are some very big competitors that seem to be in play, even some news this afternoon regarding Landis. How are you going to maybe counteract some of those forces or at least get in the game?

Let me answer regarding Landis, first of all. Obviously the announcement that came out talked about the possibility of Landis, I think, and GE. If you start looking at the competitive landscape, I feel as though that's fine. We've been competing with GE and we've been competing with Landis for a long time. So I don't think that's going to be any issues. At the same time, if you start looking at our acquisition possibilities, obviously, we've always talked about -- talking acquisitions, we've been doing that, but obviously with a balance sheet, it's a lot more prone to -- a lot more opportunistic. We're always looking at that, but I don't publicly comment on what we're working on. We're always looking at it though.

And this is Steve. Excuse me. As Ranny mentioned, we do feel the balance sheet is, as he says, in a much stronger position today than it has been in the last four years. And it gives us an opportunity to take a fresh look and tie that into our strategic work that we're doing. And that we'll be talking about more next month at Investor Day.

We will take our next question from Ben Schuman with Pacific Crest Securities.

Hi, guys, thanks for taking my question. Just quickly on the North America AMI bookings outside of BC Hydro. Would you say that there's a healthy pipeline of those doubles and triples coming up next couple of quarters that can turn those bookings around or is that a more persistent weakness?

Ben, one of the advantages that we have is we have a balanced business. We have water, gas, electric, as I've said many, many times. And a lot of these doubles and triples don't necessarily come from our AMI solution. As we said in our Q4 prepared remarks, we've had a lot of gas opportunities that were considered to be doubles and triples. We've had a lot of water opportunities in North America. So we're not just dependent on our AMI electric solutions in North America. And of course, overseas there's lots of opportunity, as I said, with parts of India, parts of Asia. And Europe is actually looking quite good. So we don't just depend on the AMI situation in North America.

Okay, great.

This is Ranny. We don't see it as a downturn in business opportunities. Yes, the pipeline is good; and there are a number of doubles and triples out there that we're pursuing.

Okay, great. And does this OpenWay SEM meter have a price premium to the ERT, AMR meter? And are you shipping those to Con Ed as an upgrade or is that more a replacement meter?

We have been developing sometime -- we have a very, very large install base of AMR. What this product does, it is a higher selling price absolutely, because it includes a lot of the features that we have with our AMI solution -- with our OpenWay Solution. But at the same time, it's got backward compatibility, which allow us to read a lot more, not just of Con Ed, which I'll talk about in a second, but out of the whole 37 million that we've got installed, it allows them to do this upgrade and look at going towards AMI, but still using the AMR functionality. And with regards to Con Ed, we've already got a significant number of AMR electric meters and the gas meters as well, using our SEM solution. So it blends in perfectly for Con Ed.

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

Thank you for taking the question. You sound pretty pleased with the start of the year. Would you say that the quarter exceeded your expectations at the time off issuing guidance, anyway. And in answering that question, looking out through the remainder of the year, do you expect the typical seasonal pattern of an ups for 2Q, flattish 3Q than a strong fourth quarter?

Paul, this is Steve. I'm going to voice-wise attempt to answer this. As I said, as Ranny said in prepared remarks, we are happy with the quarter overall. And you mentioned seasonality, we certainly have seen some of that in the past. We didn't see a lot of seasonality in the first quarter.

And we'll be updating our guidance at the end of the second quarter for the rest of the year, Paul.

Okay. And then regarding the reorganization -- what is the status of this -- is it on completion on the anticipated benefits falling out of it? Are there restructuring costs associated with it? Are there any risks, if you can provide some color, please.

Paul, it's a bit too early to tell. What we said initially, we've called -- we've obviously transformed 2015, which we'll be covering a lot more detail at our Investor Day. But we started off by putting the re-op together with Philip and Marseilles. Obviously the idea of this is to expand on all of our opportunities that we've got in North America, because of the number of -- with the little bit more maturity that we have and the experience we've had. And we see this as going forward with some -- obviously there'll be a lot more reorganization that's going to take place rather than just the two top guys.

When it comes to restructuring, we're not there yet. We've not really looked to all the details. It's part of what we're doing now. We should have a little bit more to talk about on Investor Day, but I don't think we'll have too much more. But the idea obviously is to do some consolidation, trying to improve time to market, trying to standardize and simplify, and look at the systems that we have. So we call it a 4S solution, standardize, simplify, systems and share information globally amongst Philip and Marseilles.

It's a big project. We are well underway. We're spending a lot of time on it. We will be getting more updates on it later, but we expect significant changes.

We'll take our next question from Patrick Jobin with Credit Suisse.

Congratulations on the solid quarter. My first question, just looking at Europe and Latin America, Malcolm, you mentioned that It looks quite good for seeing some awards later this year. Was that a correct interpretation of when you expect some awards for the SmartMeter deployments internationally?

Okay. So let me just give you a broad picture of what's going on in different parts of Europe, because Europe is 27 countries. And also Latin America. If you take a look at different countries with different customers, what we're seeing is that we believe that by about 2012, we're starting to see some RFQs coming out now. RFQs in pilots, we're involved with many of those pilots. We should start seeing some rollouts that are starting in about probably in 2012, the ERDF probably started in late 2012. For Iberdrola, which is a big one obviously in Spain, they'll start in '12.

For Ital Gas, which is a big -- the 16 million gas customers in Italy. We will probably -- we've started that one already. But residential will start probably in '12, later half of '12. And then you've got Gaz de France; and they will probably start quite late in '12, and maybe even start in '13.

There's other areas in Brazil that we're finding out they're doing legislation in Brazil, that's talking about centralized metering systems. So all of this is looking very positive. They just did some new announcements in the UK, where, by law, the energy retail providers have to start deploying their SmartMetering solutions by 2014, by law. And we're starting to see some of those pilots that are going on -- that should start between now and 2012.

Great, that's very helpful. Just as a quick follow-up. You had one comment as related to the strength you're seeing in the international business for the Advanced Metering aspect, and still seeing some sluggishness in the base meter business as utilities are considering the SmartMeter adoption. Was there anything about the timing for the Advanced Meter deployments for the quarter, or could that trend continue?

Remember, we do have this balanced business. We're not dependent completely on these AMI Smart large projects. If you take a look at the RFQs and the tender activity that we have, we have got substantial tender activity going on in various parts of the world. But the AMI and AMR activity is high, but we still have this metering base that is still going on and I think the numbers running that we have in there for our quarterly standard metering projects and standard metering solutions was $20-odd million for the quarter.

Yes, the basic meter's declined slightly. And the strength we're seeing is in water and gas. That's really not regulatory driven; that's really coming from business drivers in many parts of the world, particularly outside of Europe Although we've seen some good business in Europe too on Advanced Metering. So water and gas is very strong and that's the comment we made during -- (multiple speakers)

And there's significant progress going on in Indonesia as well, like I talked about. It's not just with prepayment. And we're finding prepayment being a significant -- starting to be a lot more attractive to many of these developing countries.

We'll take our next question from John Quealy with Canaccord Genuity.

Good afternoon. Nice quarter, guys. And I'm sorry to do this to you, Steve, or maybe Ranny can take some of these balance sheet questions, but seasonally, we usually have the buildup in inventory, but it looks like you had payables come off pretty hard. When we talk about cash flow expectations moving forward -- and I also see you got a new deferred on there, can you talk about the ins and the outs in the free cash flow in the next three quarters? And then I have a follow-up.

Sure, John. And good afternoon. Q1 cash flow was impacted quite a bit by the compensation payments. And that is seasonal in the sense of Q1. The working capital built up a bit in terms of inventory in advance of shipments later in the year. And so we would expect a more normalized pattern going forward. Ranny, can you add to that as well. And I'd like to talk about CapEx.

I think I'd just reiterate what Steve said. It was an unusual situation in Q1 because of the incentive comps and to some degree the inventory. We expect that inventory to normalize out over the year and no significant changes in cash flow.

We've tended to see stronger cash flow in the second half of the year, generally speaking, over the last couple of years. Our CapEx, we would expect to be somewhere in the 3% to 3.5% of revenue range.

All right. Thanks for that. I appreciate it. And, Malcolm as a follow-up, I want to make sure I understood what you folks are saying about focusing on an improvement in gross margins. Was that worldwide or just international, and was that in reference to what we should expect in New York next month? And if that's the case of raising gross margins -- this is kind of a tweener technology and manufacturing business model, so as you focus more on gross margin, should we expect more to fall out of operating expense, or do you need some facility investment to absorb some of that?

John, we will be looking at all aspects of both North America, International, when it comes to gross margin opportunities. At the same time, I will reiterate constantly, our invest in R&D is important. We're looking at the kinds of things in G&A., what can we do there? How to we alternate some of the processes that we have, how to improve globally what we do. How do we look at facilities, whether we've got excess facilities. But we will be looking completely at the whole area of operating expenses. Hopefully, some of that will drop out in gross margin improvements.

So it is a worldwide story there, John.

We'll take our next question from Colin Rush with ThinkEquity.

Good afternoon, gentlemen. Can you talk about some of your R&D efforts on the communications side, if you're working on any enhancements to communications speed to enable specifically to distribution moderation.

We are always -- we spend $140 million in R&D a year. And if you take a look at how that's broken up into some of the various parts, I'd say -- I don't know whether it's 50%, but it's close, that the number of engineers are working on firmware and communication technology. One thing that I didn't make very clear on the BC Hydro project is that when it comes to DA and optimization of [Bopaw] and a few of the solutions that are outside of just metering, our OpenWay NIC card is obviously going to be used there. That's an area that we see as a growing opportunity for distribution automation as well.

Perfect, thanks a lot, guys.

Our next question is from Craig Irwin with Wedbush Securities.

Congratulations on the strong quarter and thank you for taking my question. So Malcolm, I was hoping you might be able to comment a little about what you've learned from the implementation of the 6 million AMI units out in the field already, and whether or not we should expect some quantitative studies from these utilities over the course of the next several quarters that would really help the business case of the tens of millions of units out there that still have to go in front of the commissions.

What have we learned from our OpenWay installations? We have learned a lot. What does that really mean? I've got to put something around that. One of the things that's important -- and this may be too much detail for you -- but what's important is to make sure -- there's two things that you have to do. Or a number of things. But one of them is to make sure your billing accuracy is good. A frequent read, a read that's based on the contract that you're deploying, which means that you've got to have a high level of meter reading as well as communication technology performance.

What we've learned is how to deploy networks, how to put the right number of -- concentrated in the right locations, whether you do that first or you do that second, understanding what your -- how your whole system and your network is behaving. Because this is dynamic. It goes on constantly. It is not something that you're just looking at once a month. It's happening realtime, all the time. And information going through to an in-home device is so critical. As sensor point energy is now done, you have to provide this information on a frequent basis every 15 minutes.

So we've learned a substantial amount from that 6 million installed in those three. And that was reflected obviously with the awards that these guys had. And all that ties into a meter data management system which we also have with regards to software. We've learned a substantial amount that we're going to pass on to other areas in the rest of the world. Hopefully, that will help you as far as the information that you needed.

My next question is about the margins in Itron North America. Obviously, with the general recovery and base utility spending benefiting the core Itron America revenue trends there, historically, you've had very high margins in that business. High 30s, low 40s. Is it fair to expect the recovery there to continue to be a modest gross margin headwind? Or are the margin improvements we're seeing in that business more driven by efficiencies on the manufacturing side of the AMI business and some of the other product mix benefits that you see?

One thing that's important to understand is that you can't stop technology. Technology is continuing to grow. Functionality continues to grow all the time. What happens is you don't stand still. We have new designs that come out that improve the functionality. We develop new basic technology, but at the same time, we have to learn how to make high volumes of these.

And what we've learned over the last period of time in North America in particular is automation is everything. If you don't automate, you don't get the right quality levels, you don't get the right reliability levels. You have to do that so that you're getting -- it's not something that you can outsource. We don't believe that you outsource everything. We believe that you have control of what you do. That all boils down to labor improvements, material changes, when it comes to design changes. So we're always looking at how do you redesign your product, improved performance, reduced cost, and it's something that we're used to. We've been doing it for the past 25 years.

We'll take our next question from Andrew Weisel with Macquarie, Please, go ahead.

Thanks a lot. Most of my questions have been answered. I just have one I want to touch on. The BC Hydro is obviously a very short lead time given that you've announced the contract and are planning to ship them pretty much as soon as possible, it seems. Should we take that as a unique circumstance given their mandate or is that a trend that you're seeing, a shorter lead time versus the same 9 to 12 months that we've historically gone with as a rule of thumb?

One thing that's important to understand, is that they have a deadline to meet for the year 2012. The sooner they start, the better. We're very well prepared with our OpenWay Solutions. We can accommodate that. So compressed lead time, what I've found over the past few years in this business is that once utilities start to put and see the benefits of these, they will accelerate.

So at the very beginning, public service commissions and the utilities, they like to put a decent length of time to do these deployments. But as they find the benefits are improving, and they get them, they usually accelerate. And Itron, both internationally, where we've installed a significant number of automation projects to accelerate the markets for Europe, we've invested [upseas] in CapEx to increase and reduce the lead time in all of our opportunities. So we can capitalize and maximize on everything we do, because we see that this is something that the utilities will want to do. Once they start to deploy, they'll start to accelerate. And Itron is there to be able to do all of that for them

So just to be a little more specific in Europe, how long of a lead time would you expect in general from when a deal is announced to when the meters start shipping.

Of course, it depends on whether it's electricity or gas or water. And it depends on the design. And it depends on the forecast that you get and how long you get, but from start to finish, you can very easily start to deploy in a matter of two to three months.

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

Congratulations on a great quarter. Two quick questions. First off, Malcolm, with the BC Hydro being the first project, you and Cisco's going to be working together, and the 14 -- you know NDAs that you guys have out there. What can you tell us at this point in time as to how quickly that can start to pick up and all this concern about slowing down at this [full] big electric project and potential slowdown for '12; it's becoming an inconsequential type of scenario for you guys.

Sanjay, as I mentioned earlier, we know that there are, as I said, 22 million more to deploy. Do I think that those are going to move very quickly? They're in negotiations -- not negotiations, but they're in discussions today and I'm looking at all of these deployments. We've talked to 14 of our customers with regards to what we've done with Cisco -- is it DistribuTECH?

Yes.

And they're very happy with what they're looking at for the relationship between us and Cisco. It's moving forward. And we have Laura Ipsen, who is going to be talking at Investor Day, where you can get a pretty good understanding in New York from her about what they're looking at with their Smart Grid Solutions. And it would be a good opportunity to listen right from the horse's mouth.

I apologize. I hopped on the call a bit late. What would you guys be able to share with us as to better functionality and therefore better ASP and here is the potential impact to margin and maybe gross profit dollars are probably net neutral, even though there is some sort of licensing arrangement between you guys and Cisco. Will we get some sort of granularity like that on the analysts day?

Maybe not to the extent, because for competitive reasons, obviously we can't share all this information. Obviously, there's value associated with the two of us getting together. There's definite value. As I said, we spend $140 million in R&D. We put that back into the product. We some margin on that; it helps us get some business. Reduce costs. It's something that -- we are used to doing this. You may get something out of the Investor Day. But we won't be specific for competitive reasons, obviously not.

Sanjay, I would just add that we definitely think that Cisco is bringing value to the table, not diminishing at all the value we bring. And with the combination of the two, customers will be willing to pay more.

We'll take our next question from Elaine Quay with Jefferies. Please, go ahead.

Hi, everyone. Thanks so much for taking the question. On the international gross margin, I was wondering how much of the recovery was purely from backing out some of the one time things that were a drag in previous quarters. And going forward, could we potentially see this trend higher than the historical highs with the continued mix shift to some of the more advanced products.

Elaine, this is Ranny. If you're comparing Q1 to Q1, international gross margins and if you ignore these unusual items, the special warranty, the recoveries and that sort of thing, margins are pretty flat quarter to quarter. So what we were trying to comment on was some of the long term trends. Water margins are very, very good. Gas margins look really good. We've had struggles with electricity. And we're in a transition phrase. So the point we were trying to make is as we move forward to SmartMetering in Europe, we think we can address some of those electric issues.

This is Steve. As we move next year to reporting energy and water, a part of that process as well will be more discussion about margins on that basis rather than international versus INA.

I guess the last comment on, Elaine, is that one of the comments in the prepared remarks, says we are very focused in this transformation that Malcolm's been taking about on our whole manufacturing strategy and how to improve our gross margins. This is a big part of the work that's going on now.

And just one more. Do you have any updates on the large AMI pilots that you do have currently underway in Europe, and France, and Spain and perhaps elsewhere? I was just curious if we passed any milestones there and if there's any more clarity on timelines for deployments?

I answered some of those earlier. So you can probably get that from the transcript. Just to repeat the ERDF, which is the big one, we've completed the pilot. That is done. It was completed in December of 2010. And they're going to be looking at that over the next year or so. The rest of them, they're ongoing. We've got pilots Iberdrola -- not pilots, but Ital Gas will actually be deploying that, and then GRDF is also working on deploying a pilot a little later. We're already starting it, but a little bit later this year. Great. Thanks so much. And Steve, we hope you feel better soon.

Thank you.

We will take our next question from Steven Charest with Divine Capital Markets.

Good quarter there. My question has been somewhat answered, but to bring up the question in terms of how it was phrased, maybe last year. There was a lot of talk about enhancing margins via an improved chip set in the meter and now we've got Cisco's product baked in. The gains that we've seen in this last quarter here, could you characterize, without giving away the secret recipe, what the fraction is between how much of the gain came from enhanced manufacturing processes, which was alluded to before, versus simply a cheaper components or a lower number of components in the meter. How much between the meter and how much between the processes? Could you give us some flavor on that?

Most of the margins today have been improvements on the process. That's important. We've put a lot of automation into our electricity factory in the US. So we've gained a lot of efficiency and process improvement for that. But what we'll find later is the latest new ASIC that we have that we'll be doing later this year in 2011.

I would just add to that, Malcolm, in our manufacturing plant in Oconee, our electricity, we're very automated there and we have improved our automation there and we have a higher level of automation now, and so that's driving some lower overhead costs as a result on a per unit basis.

Absolutely.

That's useful,.

At this time there are no further questions. Mr. Unsworth, I will turn the conference back over to you for any closing comments.

Thank you, everybody, for listening to our prepared remarks and our earnings. And I look forward to -- Ranny, any other comments? I look forward to you being on the call the next time for our Q2 earnings call, and thanks very much for showing your interest in Itron.

If you have any other questions, this is Ranny, feel free to give me a call. And I'd be happy to talk to you. Thanks again.

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 555-0136 or go to Company's website at www.itron.com. This concludes today's conference call.