Itron Inc (ITRI) 2011 Q2 法說會逐字稿

EventID. (Operator Instructions)

Good day ladies and gentlemen and welcome to the Itron, Inc. Q2 2011 earnings conference call. Today's call is being recorded. At this time, for opening remarks, I would like to turn the call over to Ranny Dwiggins. Please go ahead, Sir.

Thank you Keith. Good afternoon, everyone, and thank you for joining us. On the call today we have Malcolm Unsworth, our President and Chief Executive Officer, and Steve Helmbrecht, our Chief Financial Officer. We issued a press release earlier today announcing our results. The press release includes replay information about today's call. We have prepared slides to accompany our remarks on this call, and the slides are available through the webcast and through our corporate website under the investor relations tab.

Turn to slide 2 to see today's agenda. After I complete the introduction, Malcolm will provide a business update. Next Steve will review the financial results for the quarter and our updated guidance, and then Malcolm will close our prepared remarks, and 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 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 expectations 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 10K, 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.

With that I will turn the call over to Malcolm Unsworth, Itron's President and Chief Executive Officer.

Thank you Ranny and good afternoon everyone. Itron's growth in the last 7 quarters has been driven largely by smart grid projects in North America. While North America smart grid projects will continue to be very important to us. We expect that over the next 18 months other parts of the world will begin to contribute more significantly to our growth. This is the reason for our recent organizational announcement alignment into distinct energy and water businesses. In conjunction with this new alignment, we have launched a global cost reduction initiative to in improve profitability.

Let's turn to slide 4 as I review the topics that I will cover today. First I will provide a brief overview of our quarterly results. Next t I will provide a business update. And lastly, I will give you an update on our cost improvement initiatives.

Now, a look at the numbers. Consolidated revenues increased to $612 million up $48 million from Q1 and up $45 million from Q2 of last year. Top line was good, but was aided by favorable currency exchange rates. I was disappointed by our profitability this quarter, which was impacted by higher than expected project and warranty costs. In addition, operating expenses were above plan, because we continue to invest in new product development for energy and water, and in our relationship with Cisco. We are also building our global smart grid sales and marketing organization. Non-GAAP earnings per share for the quarter was $1.20, including discrete tax benefits of $0.19. And Steve will provide more detail on our results at the conclusion of my remarks.

Now the highlights for the quarter. We had very strong gas business in North America. It was up 7.5% over Q2 of 2010. Growth in international, up $24 million or almost 9% year-over-year on a constant currency basis. On a regular basis, Asia -- on a regional basis Asia was a key driver for the increased international revenue. We had record revenues from both international gas and water, with gas up 11% and water up 16% over the same period last year.

The smart gas project in Italy, with ETEL Gas, is progressing extremely well, with the first phase of conventional C&I meters being converted to smart. This project will be followed by an upgrade of Italy's 16 million residential meters over the next few years. And we believe we are well positioned to win a significant share of this business. And we are deploying smart water meters in France, the UK, India, and Australia.

International electricity was relatively flat compared to last year, but we had significant strength in prepayment meter sales in emerging markets. One of our most exciting prepayment opportunities, is with the Indonesian Utility, PLN. We began shipping prepayment meters to PLN in 2009, and in Q2 we shipped 230,000 meters, bringing the total so far to 1.3 million. The PLN has approximately 43 million customers in their service territory, and they expect to convert most of them to prepayment meters over the next 5 to 7 years. We booked $483 million this quarter. Resulting in a book-to-bill ratio of below 1 to 1.

With several large contracts nearing completion next year, growing our North America energy revenue in 2012 is a challenge. Let's talk about how we're addressing this situation.

First, there are significant smart grid projects out there, and as I mentioned in the last call, we are pursuing opportunities representing approximately 40 million electric meters. Our alliance with Cisco gives our offering a strong differentiator, as was proven by our win at DC Hydro. We made progress during the quarter on Cisco product development and marketing activities. We went live with 2 test facilities. We are preparing to deploy the Cisco field router at DC Hydro, and we are engaged in 2 large utilities on early field trials.

Second, as the industry moves from stimulus funded, or regulatory mandated projects, we are returning to a more traditional utility driven decision process. Incremental and smart ready deployments are growing. Itron has an install base of over 37 million electric AMR modules, at accounts not currently engaged in full-scale smart meter deployments. Our new OpenWay SEN electric meter is a smart ready solution, designed to operate seamlessly in our customers existing Itron systems.

While providing a future migration pack to a smart grid network when, and if, needed. We have several customers beginning to work with this technology today. In addition, we recently introduced our Centron 2 electric meter, which allows other communication vendors to put their technology in our meter. Utilities who have selected other communications solutions will be able to purchase Itron electric meters. We have several of these arrangements under development, and we plan to begin shipping these products next year.

Third, we continue to focus on innovation to fuel new revenue. Customers such as Atlantic Gas Light are replacing legacy AMR gas modules with our new smart module, because of the new capabilities, the new business resource that it delivers. This highlights our opportunity to offer new solutions to our install base of over 36 million gas AMR modules. In addition, our gas meter business continues to grow and we keep adding new customers. This quarter we began shipments of gas meters for the first time to Piedmont Natural Gas [and SCANA].

Moving now to international energy. We see good progress on the smart grid initiatives in Europe. One of the most visible is ERDF. Last week ERDF moved another step closer towards the deployment of their 35 million smart meter projects, when they received approval from the French regulatory authority for the initial 7 million meters. The initial deployment now awaits final approval by the energy minister. As one of the large -- as one of the world's largest and most influential electric utilities, this step represents a strong signal to European and world markets.

On the heels of our successful gas project, with Azeri Gas in Azerbaijan, we have won new smart gas payment business in Russia, in Kazakhstan, and in Turkmenistan. Software remains a strategic component of our energy offering. And in April, we announced that the Itron MDM Software became an SAP qualified business solution, and now SAP is selling our software.

Let's talk about our global water business. Due to our success in Mumbai, India, we signed a new contract in New Delhi. This market has a tremendous potential, and we are well-positioned having just built a small, but scalable factory in India, and a comprehensive Itron distribution channel in this country.

We also won smart water contracts in Australia and Canada. We announced a new international partnership with Krohn, a German company recognized as the market leader in static flow measurement for industrial applications. And we are now selling this technology into the water industry. And our recently introduced smart water module now represents over 30% of our water revenue in North America.

Now a comment about our cost improvement initiatives. We are performing a comprehensive review of our cost structure. We have a significant opportunity to achieve substantial savings in our global purchasing activities. We are also completing a feasibility study of our manufacturing footprint to determine how to consolidate our manufacturing operations, and to reduce costs and improve efficiency.

We are not to the point where I can provide a specific figure, however the number will be substantial. And I am firmly committed to lowering our operating costs and driving efficiencies throughout the organization. I will provide you more specific information during our Q3 earnings call.

Now I'll hand the call over to Steve, who will give you the details of the quarter, as well as cover our updated guidance.

Thank you Malcolm and good afternoon. Please turn to slide 5. Revenue in the quarter was $612 million, the second-best revenue quarter in our history. Revenue grew $45 million over Q2 of 2010, with FX accounting for about $36 million of that growth. We had year-on-year improvement in gross margin to 31.2% from 30.7%, however higher revenue did not translate into the level of operating margins we would like to see, due to higher operating expenses as well as certain project and warranty expenses.

Non-GAAP operating margin fell to 10.8% from 11.8%. Adjusted EBITDA was $80 million, slightly down from last year. We had non-GAAP EPS of $1.20 per share compared with $0.94 a year ago. Non-GAAP EPS included about $0.19 of discrete tax benefits.

In addition, we had restructuring charges of $1.9 million or $0.04 per share, which were excluded from Non-GAAP results. These initial charges relate primarily to severance for positions that were eliminated during the quarter. As Malcolm discussed, we will provide more specific information in our third-quarter earnings call. Total company bookings were $483 million, for a book-to-bill ration of 0.79 to 1.

Turning to slide 6, I mentioned that our Non-GAAP net income was impacted positively from discrete tax benefits of about $8 million, or $0.19 per share. These benefits relate primarily to 2 areas. One is a favorable resolution of tax litigation in Hungary during the quarter. The second relates to the finalization of tax accounting, which enabled us to realize certain tax loss carry forwards, in the UK. Our EBITDA margin was 13.1% in the quarter, compared with 14.3% a year ago, and 14.2 % in Q1.

What drove the decline in EBITDA margin? I will call it 3 areas. First, we saw some margin pressure in our international water business due to higher materials costs. Second, we incurred higher sales and marketing, and research development expenses. And third, we had unexpected project and warranty expenses in the quarter. Cash flow from operations was $51 million for the quarter, about even with a year ago. Cash flow was impacted by a buildup in inventory balances in Itron International, in anticipation of future shipments and for supply-chain continuity. We had capital expenditures of about $17.5 million dollars related to investments in information technology and manufacturing efficiency.

On slide 7, GAAP operating income for the quarter was consistent with last year, but you can see a shift here, from Itron North America to Itron International, in terms of relative contribution.

Moving to slide 8, unit volumes were up slightly, with Itron International up 3%, and Itron North America volumes consistent with last year. We had an increase in communication modules and advanced meters offset by decreases in basic and smart meters.

Slide 9 shows smart metering projects continue to account for a large part of US and Canadian revenue, down from Q2 2010, but we did see increases in gas smart module revenue. European revenue growth, shown in red, was driven a lot by FX, about $28 million, but also by the increases in gas and water advanced meter projects. Revenue in emerging markets grew 31% year-on-year, from projects in India, Indonesia, and Africa.

Next, you see that Itron North America revenue declined 4%. OpenWay represented about 40% of total I&A revenue. We shipped approximately 900,000 OpenWay units during the quarter, a decline of about 25% from Q2 2010, due to the wind down of the San Diego project, and lower shipments to Southern California Edison. In terms of margin, increased OpenWay project costs were offset by increased revenue from higher margin gas shipments.

Slide 11 shows Itron North America operating expenses grew in absolute amounts and as a percentage of revenue. This growth was due primarily to continued R&D spending and an increased level of marketing activity. Both investments-- both relate to investments in smart grid, which we expect to maintain at this level for the foreseeable future.

Moving now to international, slide 12 shows nice year-on-year growth of 9%, exclusive of the impact of FX. As Malcolm mentioned, we had record quarterly revenue for gas and water, driven by advanced metering projects, which drove a relative shift in revenues from electricity. Gross margin in International was 29% during the quarter versus 27.5% a year ago.

It is an improvement, but last year we had significant warranty expense. We expected to have better margin performance this quarter but did not. We are seeing margin pressure in our water business due to higher materials costs, we had additional warranty costs, and we have lower margins in certain service businesses, and are taking steps to correct that.

As shown on that next slide, Itron International operating expenses grew primarily to FX rates, about 82% of the total increase. The rest was due primarily to increased selling expenses.

Moving now to bookings in backlog on slide 14, we had total bookings of $483 million for a book-to-bill ration of 0.79 to 1. Itron International had $335 million in total bookings for a book-to-bill ratio of 1.03 to 1, and both gas and water had book-to-bill ratio in excess of 1 to 1. Itron North America had $148 million in bookings, for a book-to-bill ratio of 0.51 to 1.

The low bookings caused total backlog to decline sequentially as shown on the next slide. From $1.7 billion in Q1 to $1.6 billion in Q2, down about $125 million. Although 12 month backlog grew sequentially from $989 million to $1.05 billion.

Moving to slide 16, our debt balance remains stable, as planned. We made scheduled repayments of $3 million. We increased our cash level to $168 million at June 30, up from $133 million at March 31. Our total debt balance at June 30, was $576 million and our debt to EBITDA ratio was 1.7 times.

Our debt includes $224 million in convertible notes. The holders have the option to put the notes back to us on August 1, on which date we will pay them back. We are in the midst of the put notification period. At the end of this week the put notification period expires, and we will know specifically the dollar amount to be repaid. We have sufficient cash on hand and access to our revolver, to retire the notes that are put back to us. Further, with our improved credit profile and stronger conditions in the credit markets, we are moving forward in the refinancing of our bank debt and are engaged in the syndication of a new senior credit facility.

The amount will be in the range of $800 million, comprised of a bank term loan and an expanded revolver to replace our current institutional term loan and reduce our cost of debt. Both facilities will have a 5-year maturity, which will extend the maturity profile of our debt to 2016. The new credit facilities will be executed in the bank market, rather than the institutional term loan market, due to strong interest from relationship banks and favorable market conditions.

We are pleased that there is strong interest by banks to participate in our refinancing, which will reduce the margin on our term debt, while allowing for additional capacity and increased flexibility. We expect this refinancing will close by the end of August.

For your models, we expect approximately $3 million in unamortized financing costs for the existing credit agreement, will be written off during the third quarter. This is a non-cash charge. And we will book a cash charge of approximately $3 million to close out the remaining interest rate swap on our Euro denominated term debt which will be retired.

I close with an update on our 2011 outlook on slide 17. This updates the 2011 guidance we provided in February. We expect revenue for the year to be between $2.3 billion and $2.4 billion, and non-GAAP diluted EPS to be between $4.20 and $4.60 per share. This outlook is based on an updated Euro to US dollar rate of $1.40, and average shares of $41.2 million. Our non-GAAP effective tax rate for the full year is estimated to be between 22% to 25%. Given the low rate for the first half of the year, the non-GAAP effective rate -- tax rate for Q3 and Q4, is estimated to be in the 27% to 28% range.

A few points about our outlook. It is dependent on project schedules which can be subject to adjustments. It excludes any charges and benefits related to our restructuring efforts. We will provide additional details on this in our next earnings call. And it does not include any potential impacts from our refinancing efforts, as I discussed.

In closing, we saw encouraging results in terms of revenue from emerging markets, our international gas and water activities, and continued execution on smart and advanced metering projects. In addition to our capital structure, we are focused on profitability and improvement. And with that, I will turn it over to Malcolm.

Thank you, Steve. We recognize the challenge we face in North America in 2012. However, with our regional diversification, balanced portfolio of electric, gas, water, and heat end-to-end solutions, alignment of global resources and proven track record of innovation, we believe Itron is very well positioned to succeed. Operator we are now ready for questions.

(Operator Instructions)

Steve Sanders, with Stephens Inc.

Maybe first Malcolm, regarding Itron North America in 2012 versus 2011. I know you don't want to talk about specific customers and projects, but can you give us a sense, in aggregate, of what the large project counts look like in 2012 versus 2011? We have San Diego rolling off, you have BC Hydro coming on, can you give us a little additional detail there?

Sure, Stephen. As I said my prepared remarks, we're pursuing about 40 million points of smart grid solutions in North America. There is about 20 million, that is split probably 50/50; 20 million are active right now, and there is about 20 million that's developing, and we are closely watching all of these. But at the same time let me also stress that, as I said in the other areas, that's not the only thing that we have to offer.

We have got the smart ready solution, where we have 37 million electric installed AMR meters and modules that we are approaching with our new solutions, and also the new features that we have got with a 36 million gas modules that we have installed. And now at the same time we have got a balanced portfolio across the whole world. So, it' s not just the only thing we are addressing, but obviously as I said my prepared remarks, it is an issue.

Okay, and then two quick follow-ups. First, can you just provide a little more color and the dollar amount on the warranty issue. And second, are there other suppliers at PLN at this point?

Steve, I will cover the first. We had some component related issues on the supply-side that we had to replace and take care of that occurred during the quarter, and it was an impact on the warranty that was not expected. So, we have worked through that issue, are working through that issue, and taking care of that overall. I just wanted to call that out because we did have some warranty in the quarter and it did have an impact on the results.

And I'll answer the question on Indonesia. As you know Steve, we do have a fairly strong factory and presence in Indonesia, and that gives us the confidence that we will win significant market share. We do of two competitors. Those two competitors are Chinese manufacturers, and we feel very well positioned to win a lot more of that business going forward.

And as I said there is 43 million points that we have installed at PLN that are going to be converted over the next 5 years to 7 years. So we compete head-to-head with these two companies and it is split three ways, and we have got a significant market share.

Okay. Thank you.

(Operator Instructions)

Steve Milunovich, with Bank of America.

Thank you very much. Just a follow-up on that, could you give us a little more granularity on the four big electric contracts in the US. I think you said, San Diego Gas and Electric, is that done? And you said SoCal was down sequentially, or maybe it was down year-over-year? Is that a temporary or is that just beginning to roll off? And what about Detroit and the remainder?

We've got contracts for taking us through and I believe it's through 2012 and into 2013 with the four contracts that we have. We know that one is coming to an end which is San Diego, but BC Hydro is also kicking in, and of course we've got others in the pipeline as well.

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

Hi, good afternoon guys. If I can just sandwich my, I guess two, in here.

First of all, North America when you look at book-to-bill, excluding BC Hydro last quarter in the bookings, it looks like booking are $148 million this quarter, last quarter X BC Hydro was $111 million. So that book-and-ship business, can you talk about what you think are the relative strengths or lack thereof in North America? And do you think it's a good level moving forward? And I just have a follow-up.

Let me answer that first of all, and not just talk about North America, John. Right? I know you want me to cover that, but it also -- we have a balanced business. Yes, if you take a look and you take out some of these large contracts, we've got a steady business of singles, doubles, and triples which we've had for the last years. And if you look at the $150 million that we have, $148 million booked this quarter, that's a good indication about our steady business that we've got in North America.

But remember, we've also introduced these two new products that we've got, called smart ready, that takes advantage of our 37 million electric AMR meters in there. And also these new 36 million gas modules that we see a significant opportunity for that.

So as much as we say that's the book-and-ship business, we're also creating new opportunities with our install base, and we're seeing that actively, people are looking at that today, both in energy and also in water. So okay? And then internationally, as you know, we've got a significant book-to-bill business there. And the revenue in the bookings that we had in international, happens to be the second-largest bookings that we've had since we own that towers in the first quarter of 2007.

And just a quick follow-up. So in terms of Q3 it sounds like it's going to be noisy with these charges on at least closing down the put.

And number two it sounds like were going to get more detail on restructuring. You know we talked about a lot of macro issues I think at the analyst day in terms of trends going 2015. Is Q3 the period where we're going to have a lot more detail, you think, about all these initiatives and your thoughts moving forward? Or how should we think about getting more details here?

Yes, John, this is Steve, And we will have, we will provide more in, and I want to clarify on the financing side, on the put itself. That's not the cause of any charges or the write-off of fees. It's the opportunity to significant lower our interest rates going forward in the current market, given our improved credit rating. And that will just produce a right-off of the remaining unamortized balance in the debt fees.

And then we had us swap in place. But we are doing this to lower our overall cost of debt going forward with almost immediate benefits starting in the quarter itself. We're just not prepared, since we have not finalized, to provide that, but we will provide that. And then back to the activities that are more important to talk about operationally, yes, we will provide much more detailed information, including specifics, in the quarter.

Thank you guys.

Sanjay Shrestha, with Lazard capital

Great, thank you. Good afternoon guys. My questions is also kind of a follow-up on December, which falls [all true]. Malcolm, I hope I'm not putting words in your mouth, but you sound a bit more cautious about sort of the outlook for 2012, than maybe I've sort of heard it in the past. But when we add everything up, and given sort of portfolio approach that you guys have, and a tremendous amount of book-and-ship business.

Is there anything that you see here that, maybe, regulatory dynamics or push-out on some of the large projects, that kind of maybe makes you sound like the North American dynamics might be a 2013 opportunity with the Cisco relationship. And maybe not as big on large project size in 2012. Can you talk about that a little bit? Maybe give us more granularity there?

Yes, I will, I will. First of all, the regulatory dynamics that I talked about earlier. If you think about North America, the stimulus package certainly did generate a lot of interest in our A&I business, for everybody. Regulatory dynamics in California, et cetera and also in Texas, drove a lot -- now we have other places like Pennsylvania, that's still pushing forward.

As you move overseas, one thing that I did talk about was Europe. This is a great opportunity for the regulated, that is approved, the ERDF solution, that the president and CEO of ERDF just got approved with the, its on the table, with energy minister. I'm pretty thrilled with that, that's going on right now. So that gives you an idea of the regulatory dynamics that we have.

Okay. Great, Thank you.

Paul Coster, with JPMorgan.

Yes. Thank you. Can you just clarify whether or not the guidance that you've issued for the year assumes that cost saves start to kick in this year. And can you just talk us a little bit through the process of getting the details out and why, given the fact that you first announced this in May now, that it's taking such a long time to get the information out to investors?

I will take that one Paul. First of all, we do believe, as I said in my prepared remarks, it's going to be substantial. And the cost savings will probably not hit really, until next year in 2012. And beyond.

But we want to be very -- we want to make sure we give the right message, because we've got, as I've said, we're really looking at the purchasing savings, we're looking at consolidating a lot of our purchasing activity, we're also looking at rationalization of facilities. So we want to make sure we get that absolutely correct.

And then of course we're doing a lot of shared services that we said before, which will have an impact of where were going in the future. It will have an impact on 2012, and our results in 2012. Yes.

Paul, this is Ranny. I would just add that it's on schedule. Meaning that the length of time it's taking is what we had planned. It' s a big project and that's why it's taking the time, its a comprehensive review.

Thank you.

Patrick Jobin, with Credit Suisse.

Could you provide maybe an update on the pricing environment? It might be helpful if you could break that out either by meter type and then maybe by geography.

Sure. Obviously one of the things we don't talk about on the call for competitive reasons, is pricing. But we've seen no real degradation of pricing across the whole of our industry, across the globe. Fixed pricing is obviously on the contracts that we currently have.

Obviously these big contracts that you have, are fixed prices and they are competitive, the same as everything else. But we're not seeing significant changes in pricing across the globe to be honest with you.

Just as a follow-up can you maybe provide little more color on BC Hydro and Cisco? How should we see that progressing throughout the year, and have meter installs started with the Cisco project today? I was just slightly confused by the comments. I just wanted some clarity there.

Sorry, if I confused the listeners, then I apologize about that. With BC Hydro we're planning to start this quarter. And we've started with our shipments of OpenWay hardware 3.0 solution, that's going in as we speak. And at the same time with our relationship with Cisco, as I said in my prepared remarks, we have now got the field router that we're preparing to install this quarter. And so there will be revenue with BC Hydro this year in the second half.

Thank you.

Carter Shoup, with KeyBanc.

Good afternoon. This just a quick follow-up on the BC Hydro contract. At what point do you think you will be at a full volume deployment at BC Hydro? Will it be sometime, in kind of mid Q4?

We have contractual obligations that we work to, and when did you say Paul? I'm sorry? Q4?

Q4.

I do believe so. That will be the case. Yes.

Okay. And then a follow-up question, can you talk about the mixed implications to margins in the second half of 2011 and 2012 in North America, as you start to see the electricity business decline on a year-over-year basis and the gas and the water business really increase? Historically we have seen better margins in the AMR business than the AMI business. Do you think that will play out in the second half of 2011 and 2012?

We don't give specific guidance on margins for individual products, but we know, as we said before, we have a very good gas and water business both in North America and outside North America, where our margins are better than our electric business. Yes, we do reflect that in our numbers. Steve?

In addition, Carter this is Steve. Related to 2011 and the guidance. Yes, some improvement in margin. Part of that is just the recurrence issue on some warranty or other costs, but mixed does play some role in that as well.

Sean Hannan, of Needham & Company

Malcolm, I am going to try and go at this one more time. For the four major deployments that we have here in the US, is there a way, at least, if you can give us a sense, where you stand today? Contractually you have an obligation around certain numbers of meters for each of those projects. Can you u give us a sense? Were do we stand today? Say for Detroit Energy, are we 15% or 20% complete? San Diego Gas & Electric, are we 90% complete? Is there is a way to just kind of walk through those four, and give us a general sense?

Let me let Steve take that call, Sean.

So, and this is kind of a build on the other question, as well as the rollout. I'm not going to give the specific percentages there, but in terms of overall where we are, clearly San Diego is the farthest along. We have talked about that. We are continuing on, on Southern Cal through this year and into next year. As Malcolm said, Detroit, and I mean, each has their own schedule, and that is really their decision, and we will follow through that.

But, in terms of rolling that up in macro with roll-up of BC Hydro, we think into next year. And it is reflected really in the 12 month backlog, which has increased some, actually year-on-year. So that, I think it's indicative of the continued execution on these contracts rolling out the next year.

In terms of how that rolls out overall, I think it's the latter half of 2012, where you start see the impact starting to roll-off. And that's why Malcolm talked about the need to focus on executing these new contracts now. Continuing to build that, that's something we've always focused on doing. So we roll those forward, we're very pleased with the progress of these projects, but we do start to see that in terms of the impact in the second half of next year, which is where we will be focusing on building that next set of bookings going forward.

Just a comment a little bit further. If you take a look at our balanced portfolio of products. One of the things that we've talked about, and it is not just North America, we've got all these projects that are going on in emerging countries, and we've seen a 31% increase quarter-over-quarter, on some of these emerging markets. We've also seen good gas activity across the whole globe, and across the water, in general.

It's not just about this, the backlog in North America. We've got opportunities for significant book-and-ship business in the next 12 months in our international arena. And also, as I talked earlier, with the discussion on book-and-ship in North America. So we're pretty pleased with what we have there, and the growth that we've seen internationally.

Agreed on the balance portfolio, so thanks very much for the color there. Just a quick follow-up though on those four North American projects. Can you also share with us whether any of those utilities have given you an indication whether the scope may be expanding slightly? Could you perhaps see a little bit of a tail to those projects, incrementally added, or is it too early in order, to tell?

You know one thing that we always find, and we do a lot of these projects, and I'm not just going to talk about just these four, I'm talking specifically in general, when you win some of these large contracts, what they try to do is accelerate. That's what they do to try and get the savings. There is a lot in the pipeline, and this is the kind of business case that, because you've now got no stimulus packages that is there, it's about a business case.

And when you get business cases, the utility is going to save money. That' s what we do for a living. That's what we've been doing for 10 years, and this is exactly what we're pushing forward with our new products. Whether it's water, gas, or electric. That's why we're doing this to fill the pipeline, and accelerate projects that today we don't have, in 2012 and bring those forward, because that's what utilities do.

Jason Feldman, UBS.

Regarding the cost reduction initiatives, it sounds like most of those are focused on a cost of good line. Factory rationalization for purchasing, et cetera. But you're also kind of talking in some areas, and we've seen over the last couple of quarters, upward pressure on operating expenses. Typically product development, and sales and marketing.

Are you envisioning a net savings? Or are the cost reduction initiatives going to be used primarily, to essentially fund growth initiatives as you expand internationally and ramp-up product development elsewhere?

For model purposes, our -- we've said our product development expenses across the globe are primarily for investments in energy and water solutions of course. And I see that that's going to continue. In the OpEx line, we are obviously looking at shared services across the globe, which is why we've put this organization in place the way we have. We do see this -- the change -- significant change will take place in cost-of-goods-sold.

You're absolutely correct. There's no question about that. And it will fund some of the other things that we have in there. Steve, do you want to add a comment?

I just want to add, that on a net basis, so it's not intended solely to fund the increased level, it's beyond that. It's to reduce the overall costs and improve the overall profitability, net of the investment decisions that we will continue to make in these areas.

Craig Irwin, with Wedbush Securities.

This is actually David Giesecke, Craig is stuck on a plane right now. Thanks for taking my question.

For you're customers in procurement of meters at this time, the roughly 4 million that you mentioned? Can you share some of the gating factors that they would be facing in front of their commissions? For instance, that they definitely need the business case with the positive ROIs. What else might be helping or hindering getting these by their commissions?

Let me just talk a little bit about what's going on with the commissions. First of all, in the states that we've talked about with regards to Pennsylvania, very favorable, with some of those solutions. I think they are gong to have the support of the public service commission.

In the other states, it's just the business as usual. Do they put it on the rate-based? Do they give it to the shareholder? Do they put it on their own balance sheet? It's just one of those back to normalcy business with utility industry. And that's exactly what we're used to.

So I think there is a lot of positive movement that has taken place with public service commissions, now that you've got a lot more of these benefits that are taking place in Texas and California. You're saying that there are benefits to these rollouts of smart solutions. In particular, you see some of the things that are going on in Texas.

And BC Hydro now, there is 500,000, in what we call in-home devices, that is going to drive that. So yes, you are seeing favorable acknowledgement of these solutions with the Public Service Commissions.

Ben Schuman, with Pacific Crest Securities.

We've seen some pretty granular schedules for AMI deployments, published by the regulators in France and England, with some real volume's kicking in around 2013, 2014. When do you guys expect things to clear up in terms of market share and average selling prices, assuming that those timelines stay firm. And then to a follow-up on that, for France, do you expect to see large awards for the duration of the deployments, or framework agreements with orders each year? How can we think about that?

Ben, it is very different than what's going on over in the US. So, let me just put that straight, as I've said many times. I will address each particular country.

The regulator in France has approved, the solution, and it's going through to the energy minister. Their rollout is to start, and they have now got the RFQ in place that they put out, and there's three of us there. There are two of our competitors, and us. So on the pilots, there are just the three. We're doing very well. It is working extremely well. So I see France absolutely moving forward.

In the UK, 2014 in the UK, it still looks like it's on plan. I don't see any major issues. There are a number of, there are six ERA utilities there, and they're all moving forward. Albeit a little slower, but by 2014, with the installations, that's what they plan on doing.

And looking at other areas, we do see, that will be done as a, I think, as a book-and-ship business. Because you've got a full interoperability, for example with France, or with ERDF. I don't believe we will make a full booking, unless you get scheduled deliveries.

Like we've just done with PLN, in Indonesia. Because of interoperability, we've got a good market share there, and they release their quantities every few months. I think the same thing will happen in France and in the UK.

So the model, our model, of this large backlog that we have, and I've said this many, many, times, may change moving forward, of more of a book-and-ship business. Especially in the European countries with interoperability with book-and-ship business.

Okay, great. And did you guys ship any meters to courts for BC Hydro in Q2?

I don't think we did. I think we started that in July.

Thank you.

Chris Kovacs, with Robert Baird.

Can you guys maybe speak to the activity that you're seeing in Latin America, or South America. And then maybe address any types of differences you're seeing in the characteristics of deployments? For example, how in Europe your typically bringing in multiple vendors versus the kind of lone vendor mentality in the US. Timelines, that type of thing?

Yes, absolutely. First of all, South America is a big place, but the majority of it is in Brazil. Their is 195 million people in Brazil, and they are looking at mandating smart metering. What they do is slightly different. Because they have got a very high degree of non-technical losses that is there, especially on the electric side, and what they're looking at is what we call centralized metering solutions. Where you put 12 meters on a pole, which are, can be, prepayment or interruptible through a, in a home device.

We're very well positioned there. We've got a good strong market share, and we are working very closely with the regulators and also the place where they do all of the approvals of there, the solutions. So it's moving forward quite well.

Ryan Connors, Janney Montgomery Scott.

You talked a couple of questions ago about the issue of regulatory commissions kind of embracing smart grids increasingly. But also in your prepared remarks you talked about a shift in decision-making post-stimulus, to a more, I think the word you used was incremental type decision-making process. There is a little bit of a disconnect there.

My question is, is it your belief that maybe the macroeconomic situation, and in particular unemployment, et cetera, may be making PUC's somewhat less willing to approve the very large contracts, because they are more sensitive to rate shock in this environment than they were a few years ago. I would just be interested to get your take on that.

Yes. It is hard to always predict what Public Service Commissions are actually going to do. What I'm really trying to say, is that it's going back to, there's no more stimulus money that's going to be available or a limited amount, so you go back to the business case solutions that you put forward to the Public Service Commissions. And they have looked favorably at these locations, I will just say like Texas. So they'll use those as a reference, I believe, and look into that and seen how they're doing.

And we've seen that, as I say, in Texas, with Barry Smitherman now moving over to the transport section. But will it be rate shock because they've got to put a higher number in there? That's one of the reasons we developed our smart ready solution, because it's not as big as an impact to the utility and to the rate payer, when you pay a less amount for your AMR ready solution. And then, when you want to move it to AMI, what you do is that you install that infrastructure there, and that adds a bit more cost to the whole of the solution that this utility, that a utility would have.

So, a lot easier business case to get the approval on with solutions that are smart ready. And then you layer over the top of a network in place there, and that puts XR install base, as I said of 37 million electric meters. So we're in good position there.

Interesting. Thanks for your time.

Colin Rusch, ThinkEquity LLC.

Hi. This is Noah K., calling in for Colin. Also plane issues.

Wanted to follow-up on your discussion about South America. There and other developing economies, I think, that clearly step-to-turn is a major driver for sales. Can you talk a little bit about product development in this area, and some of the functionalities you expect to compete on going forward?

Certainly. The thing I talked about earlier about theft. Was, the definition of, the nice word for theft is non-technical losses. (laughter) That's the driver. Especially, they have up to 40% of theft in certain parts of South America. So regulatory decisions, or legislation decisions, are being made down there and they're not there yet today.

When it comes to product development, we have a global footprint of R&D, especially on the electric side. We put the solutions in various parts of the world and we're taking advantage of our R&D expertise in the US, and also in South Africa, and also in Latin America.

So because we now have this global footprint with R&D, managed by our new CTO, that's going to help coordinate all of this, we have this ability to develop products much faster for time-to-market. So we'll take full advantage of what's going on down there. And as I say, theft is the nice -- non-technical losses is the nice word for theft.

Yes, exactly. Can you give us more color on that trend in meter sales coupled with third-party communication's modules? Can you tell us about how that, how that trend you expect to, going forward?

Well, we developed a solution on a product called the Centron, about 10 years ago. We have always been proud of the fact that we've, we can have other communication technology providers onto that device. That was a one-way solution that we developed, those years ago, and that was the driver. And is still the driver for our AMR solution, that we still produce a lot of those Centrons with radio products on to do AMR.

What this new Centron 2 does, is it takes the new OpenWave design solution with reference to, call it the C1219 solution, and what we do is we put on there a disconnect switch. So we allow the utility to use other peoples' network, or one of our competitors who doesn't have a meter, use ours and it gives them the ability to put their communication technology on our meter. And then that gives the ability to communicate to two-ways, and also with their communication module into the home.

But it does have a disconnect switch, and that's what gives it be opportunity to participate in lot of those other solutions that we have.

And Ladies and Gentlemen, due to time constraints, our final question is from John Quealy, with Canaccord Genuity.

Hi, thanks guys for the follow-up. Steve, just going to the balance sheet, inventories are up 20% year-on-year. I realize there might be some commodity inflation in that, but can you give us a little bit of walk on the cash flow? Just give us a range if you could, about what you think the new bank debt terms could save from a cash perspective? And then also, if you just touch on what we should expect on the balance sheet moving forward, for working capital?

The inventory has grown John, and that was, as I mentioned, increase in raw materials and some work in progress, but a lot of it is for actually development of finished goods for future delivery. And then I also mentioned supply-chain continuity.

One in particular, related to a critical component, that, where there were post earthquake shortages, and we wanted to make sure that we had the right amount in place to help secure deliveries in Indonesia and the prepayment meters.

We expect that to, that ratio to improve and therefore to, in addition to the AR side, as projects reach milestones and so forth. And receive payments against that, those are the two key areas where we're going to see some cash released out of working capital, that has grown to a more elevated level than what we typically see. And want to see. And so we would expect the second half from a cash flow perspective, to be improved on that basis.

To your point about the debt, we had an expiration of, irrespective of this change, we had a $200 million swap, a fixed rate swap, on our US dollar debt, which expired at the end of June 30, at no cost. Our average rate on our debt as of March 31, was about 5%, and with the expiration of the swap alone, that's dropped down to about 4.2% total average rate. With this refinancing that will go lower than that number. Not specific yet in terms of the amount, but our current credit agreement is at LIBOR plus 350, on our current remaining bank debt, and market is lower than that. And we have about $350 million in that bank debt today.

So the variable is on the convert, to 2.5% coupon, And it will depend on how much is put back to us this week, but any outstanding puts at a very low rate at 2.5%.

So to summarize, with the expiration of swap alone our rates dropped from about 5% down to 4.2%. With the completion of refinancing we expect that to drop again because of the improved rate environment. And then the, kind of the variable is the amount of the put that's converted back to us, and we'll have to see, we'll know that at the end of the week.

And then, just, in terms of the cash flow when we go through the restructuring in Q3, free cash on the back-half will be impacted by what you pay-out, whether it's severance or whatever? Is that right?

Yes, that is right. And the timing of those payouts, charges, generally predate the cash outflows as those are taken out. That will depend, again, specifically on that. But we will provide, in addition to the charge information, give a sense of the rollout of that, the implications on the cash flow going forward.

Expect some impact on free cash flow second half of the year, yes, this year. But not in the full amount of the charges themselves. Some of that will push into 2012 from a cash perspective.

Okay, Operator this is Ranny. I would like to thank everyone for joining us today, and if anyone has any further questions they can certainly give me a call, but let's go ahead and close out the call today, please.

Thank you. 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 6754032. Or go to the Company's website, www.Itron.com. This concludes today's presentation. We appreciate your participation.