Itron Inc (ITRI) 2011 Q3 法說會逐字稿

Good day, everyone. And welcome to the Itron Incorporated Q3 2011 earnings conference call. Today's call is being recorded. For opening remarks, I would like to turn the call over to Barbara Doyle. Please go ahead, ma'am.

Thank you Jenny and good morning to everyone. Thank you for joining us so early. We had several announcements to coordinate today including with employees around the world, so we're doing our call early today. We really do appreciate you joining us. On the call today we have LeRoy Nosbaum, our President and Chief Executive Officer, and Steve Helmbrecht, our Senior Vice President and 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 in this call. And we also have a copy of our prepared remarks on our Web page as well. So, the slides and the prepared remarks are available through the webcast link and to our corporate Web site under the investor relations tab. If you turn to slide 2, you'll see today's agenda. Today's agenda.

Before I turn the call over to LeRoy, please let me provide our Safe Harbor statement. Please note that our earnings release and financial presentation include non-GAAP financial information that we believe enhances the 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 our financial presentation.

Now if you turn to slide 3, you'll see 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, and 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 our forward-looking statements. Now, let me please introduce LeRoy Nosbaum, Itron's President and Chief Executive Officer.

Thank you, Barbara. Good morning, everyone. Good to be back with all of you, kind of interesting for me this morning. Thank you for dialing in to the Itron call.

From talking with customers and employees, I'm beginning to understand what is happening in the business and in the field. From talking with many of you in the last several weeks, I think I have a fair idea of the things that are top of mind for investors. I'm listening carefully to our shareholders and the analysts that follow Itron, and I fully realize that our communication with the investor community has been less than ideal. I'm committed to restoring Itron's credibility with investors and communicating a very clear vision of where Itron is heading. For the most part, I'm going to let Steve talk about the quarter's results, I will say that while I'm not pleased with all of the one time items, particularly warranty expense, we did have a good operating quarter.

I'd like to focus on the following areas in today's call. First, I'd like to share a few of my observations from my first 60 days. Second, bookings trends. I'll also comment on our smart electricity metering business in North America, which has been a significant driver of our bookings. Third, my views on 2012. Fourth, some comments on the restructuring project we announced today. And last, our share repurchase plan. I'll then hand the call over to Steve to cover third quarter results and guidance, and then I'll come back and wrap up with some remarks about long range market opportunities and my vision for Itron, and then of course, we'll take questions.

So, let's begin, starting with my first 60 days. The challenges we are facing as a company as well as an industry are becoming apparent. I also see opportunities, opportunities for Itron, for our customers and for our investors. Some investors have lost faith in the industry after all the hype that grew in the last 2 to 3 years about smart grid, and energy investment. With so much focused on the hype in the industry, I believe Itron's well diversified global water, gas and electric business has been overlooked and under valued. The deployment of smart grid, smart water and smart graph systems is critical for managing energy and water in this century.

A big shift is happening, and Itron will continue to lead such important industry transitions. Large deployments, in short periods of time will make any industry lumpy. Especially early in the cycle and they have in this one. You can see on slide 5, Itron's stable, underlying core business growth, as well as the impact of selling smart meters has had on the Company's business. The point I'd like to make here is we do more than just smart electricity meters. And that the other part of our business is growing nicely.

Now let's turn to bookings. There's a lot of written and asked about bookings. While these are perfectly legitimate questions, we also want to make sure you're focused on the right things. Picking one piece of our business to build a thesis around, North American OpenWay, is at best an incomplete picture. We also think it's important to look at booking and backlog trends, as well as any single quarter data point. Slide 6 shows 2 years of quarterly bookings. Q2 of fiscal 2010, and in Q1 of 2011 we were driven by OpenWay smart meter contracts we won in North America. These are large spikes. Large contracts that added healthy spikes on top of what I would consider our core electric gas and water business levels.

Studies estimate that of the 150 million electricity meters in the US, approximately 40% are committed to smart metering with the material amount yet to install. Some of that commitment has moved to the left by stimulus funding, but there is certainly more smart meter business available in North America. We do not however, believe this market will continue to see the pace, and size of contract awards we have seen so far. We believe this business will get back to more traditional roll out rates justified on strong business cases, as we are in fact, more accustom to. So, our Itron North America bookings will likely return to a more rational rate of bookings for meters, automation and smart solutions.

Utilities in North America will continue to buy smart meters, but they will also continue to buy AMR, as well a new and updated gas and water meters with their smart solutions. We just expect a bit slower pace than we saw in 2010 and we will adjust our business and our forecasts accordingly. But North America represents only about half of our business as you can see in slide 7.

Another important thing you'll see on slide 6 is the red bars. Representing quarterly bookings in our international segment. Our international bookings have been fairly stable over the last 2 years, in the $250 million to $325 million range each quarter. Some of this has to do with the different approach to purchasing meter solutions in Europe. It is more common in Europe to do roll outs with multiple vendors using purchase orders on frame contracts rather than a single large contract commitment. This yields a little less lumpiness in sales. At Itron we don't book frame contracts as some of our competitors do. So, you won't see these purchase orders in our backlog number even though there's a high probability of the future business. Using this method does not over inflate our true backlog.

On a revenue basis, our international segment accounted for more than half of our company revenues in the third quarter as you can see on slide 7. Q3 international revenues grew 14% at a constant currency rate. International revenues grew in each business line, electric, water, and gas. What's driving the growth? Smart meter projects are beginning as the meter automation trend is taking hold outside of North America. The adoption of smart meters in Europe will have a significant impact on our business in 2013 and 2014 and beyond. As well we see nice growth in our gas and water meter business throughout the world. Thanks especially to a significant increase in smart metering solutions and contracts we have won.

One of the questions I have been frequently asked is how the economic environment and the sovereign debt concerns in Europe will impact utilities investments. I'm not an economists and I don't have a crystal ball, but what we can do is talk to customers and prospects and what we're hearing is encouraging. Projects in Europe are well funded. Rarely subsidized by the government and are moving forward. A large number of our customers in Europe are in excellent financial condition. For now, our outlook in Europe has not been impacted by what we are all reading in the newspaper and listening to in the news. We continue however, to keep a close eye on developments there.

It's clear that our industry is advancing rapidly and Itron has to move quickly with the industry. We have more competitors. Some of them are changing the game, and some are simply disruptive. Clearly Itron did well coming out of the gate with our wins of CenterPoint Energy, SCE, San Diego Gas and Electric, and DTE. Over the last 5 years, we've won 5 out of 21 of the largest electric smart grid contracts bid in North America. What is also important, actually more important than just winning the deal, is that the deployments of Itron's OpenWay are going well and each of these customers and performing to our customer's expectations.

Since the early wins we've been successful at others. The most recent, the BC Hydro in British Columbia in the first quarter of this year. We are now installing or have installed this smart grid solution at 12 different utilities in North America. Some are just pilots. But pilots grow into deployments.

That said, from the beginning and even most recently, some competitors have sold at prices that we are not willing to meet. Itron is a profitable company, but our customers count on being here for the long run. We do not think prices quoted by competitors on some of these projects will enable them to sustain over the long-term. We will be competitive on every deal, but if a competitor is willing to lose money in order to get fast entry into the market, frankly, Itron will not likely win that order.

Another deal stride as we did, our network did not line up with the service territory as well as some competitor's networks. There will always be situations where Itron's network does not match up well. This is just the reality. Partnerships like that which we have recently announced with Tantalus begin to address this issue. There were some deals where we just lost the order. Maybe we were out hustled. In any case, we clearly need to reinvigorate our North American sales organization to its historic level of success. I can assure you that this process is well underway and was before I got here. And includes our own efforts, as well as those of our partners.

We have more partnerships now then ever before, and we are partnering with true technology leaders, more than 40 of these partners attended our recent Itron's user's group meeting in Phoenix, along with over 700 of our valued customers. I am confident that some of our partnerships, like that with Cisco, will change the playing field in our industry. Overall, I'm comfortable with the direction in which we are moving in smart metering.

Now I'll move onto our outlook for 2012. For this, please turn to slide 8. As we look ahead to 2012, we are early in the forecasting process. My expectation for 2012 is that revenues will be flat to down 5% compared to 2011 levels. Directionally I see water revenue for the year up, gas revenue for the year up. And electric revenue for the year down reflecting the difficult comparison to robust revenues from OpenWay this year. While our non-GAAP EPS could come in flat to down a couple of percentage points with 2011, the potential for upside is meaningful, which is certainly how we will be incenting management.

We are taking a lot of positive actions in the Company that will materially affect earnings per share. The question we are assessing now is how much will show up in 2012 versus 2013. These actions include, a global procurement initiative, benefits from the restructuring project we announced today, reduced interest expense resulting from debt repayments, and a lower share count from our newly authorized buyback plan. As well, we certainly anticipate lower warranty costs next year. Obviously, things can change. But these are my expectations at this point. We will have a tighter view when we provide our fiscal 2012 guidance in our Q4 earnings release.

As many of you have been discussing, we have a large piece of OpenWay revenue that needs to be replaced as we move from 2011 to 2012. In total, that's about $300 million. Some of this revenue will be filled by BC Hydro and other OpenWay orders that were not actively shipping throughout 2011. Some of it will be made up with shipments of water and gas product in the US, and some of it will be made up with growth outside North America continuing our current trends for international growth. The point here is we will not ship as much as OpenWay in North America next year as we did this year. While this is a business challenge, it's not an unexpected one and our competitors face the same challenge. It reflects the return to more typical deployments and project sizes after some years of very large contracts. While that creates a dip in our revenues in North America, it does not create a hole for which there is no backfill as some has suggested. Strength of Itron is our broad geographic profile and our broad product portfolio, which a number of our competitors do not have.

So, now I'll make a brief comment on the restructuring project we announced today. I won't repeat the details the press release, but I will say this is a substantial effort for the Company. We have projects in which more than 1/3 of our manufacturing facilities will be closed or scaled back over the next 18 months while increasing our overall capacity. This activity is ongoing worldwide. We expect the consolidation of facilities and the elimination of redundancies will result in simplified operations, better capacity utilization and of course, cost savings.

In total this restructuring plan will yield about $30 million in annual cost savings to Itron with approximately $15 million of the savings seen in the second half of 2012. Ramping up to approximately $30 million by the end of 2013. While it is easy to say this restructuring puts Itron in better shape going forward, it is also negatively affecting more than 750 of our employees. We appreciate the contribution of these employees and we will treat them with respect.

Today's market requires that we share resources, including manufacturing and product development, across countries and product lines. The combined effect of our new organizational structure and our restructuring actions will enhance Itron's market leading position as it evolves around the world. It will provide even greater opportunities for our employees. Other action we are taking is instituting share repurchase plan. The Board has authorized the repurchase of up to $100 million of Itron's stock during the next 12 months. This is the right move, as our current share price does not represent the significant value of Itron. With that, let me turn the call over to our CFO, Steve Helmbrecht.

Thank you, LeRoy and good morning. In addition to our financial results, I will also discuss our recent debt refinancing and our financial outlook. Let's start with Q3.

In a number of ways, we had some good things happen this quarter. We had the second highest revenue quarter in Itron's history. Strong earnings per share generated from core operations, significant reductions in debt and interest expense, and strong free cash flow. However, there were substantial charges that negatively impacted margins and earnings in the quarter, which I will also address in my remarks. The items included, warranty charges of $0.33 per share, net of reductions and bonus compensation resulting from the increased expense. One time charges related to our change in capital structure and hedging of $0.05 per share, and a $540 million goodwill impairment charge that impacted GAAP earnings per share by $13.27.

I would like to take a few minutes up front to cover the warranty charges and the charge related to our hedging since they resulted in a large financial impact in the quarter. In the past 6 quarters we incurred $4 million to $5 million in warranty costs on average. We incurred total warranty charges of $25 million in Q3. For several issues involving suppliers provided components, as well as Itron's own equipment. We will not detail each item, but the single biggest item, representing half of the total charges in North America, concerns a batch of diodes used in certain water applications. Our decision in several cases was to proactively do a full replacement of equipment in the field where these situations were found. That results in larger costs, but we feel strongly it is the right thing for customers and in the best long-term interest of our company. In addition to the warranty, we incurred charges in the quarter related to the close out of a Euro interest rate swamp as part of the debt refinancing. That transaction resulted in a one time charge totaling $0.05 a share.

Now, let's move onto a summary of our Q3 results as shown on slide 9. Please note, we added a column to this slide that isolates the impact of the charges in the quarter for the warranty and the interest rate swamp. Going down the list of our key financial metrics, revenue in the quarter was $616 million, up 7% over Q3 of '10 or 2% on a constant currency basis. Total bookings fell 16.5%, primarily driven by North America and the trends LeRoy described. Gross margin was 28.6% and our non-GAAP operating margin was 9.8%. Excluding the warranty expense, gross margin would have been 32.8%, and our non-GAAP operating margin would have been 13.2%. Adjusted EBITDA was $73.7 million and non-GAAP earnings per share was $0.92.

On the next slide, slide 10, we provided an EPS bridge to further assist in the assessment of our Q3 earnings. You can see that adjusting for the $0.33 impact of the warranty charges net of the compensation reductions and the $0.05 impact from the interest rate swamp, our non-GAAP EPS would have been $1.30. We are not suggesting that one ignore these items, but we do want to point out the strong earnings generation from our core operations in the quarter.

Now let's cover GAAP operating results on slide 11. The main impact on GAAP operating result was a goodwill impairment charge of $540 million we recorded in the quarter. The sharp decline in Itron's stock price and market capitalization during the quarter led to an assessment and resulting impairment charged. This is an estimated charge that is subject to adjustment in our fourth quarter as we complete our testing. The goodwill impairment impacted the balance in our international segments which is why you see the large operating loss in international in the quarter. In total, it resulted in a GAAP net less of $517 million, or $12.70 per share in quarter, compared with GAAP net income of $27.6 million, or $0.68 per share a year ago. I want to be clear that the primary driver for the impairment charge was the sharp decline in our market capitalization and the corresponding impact on our testing and our assessment, not because of a changing forward outlook for our international business.

Now let's turn to slide 12. I've already covered the drivers of our earnings performance for the quarter. What I want to highlight here is our cash flow. We had a good cash flow in the quarter with cash flow from operations of $66 million and free cash flow of $49 million, both up substantially from last year.

Moving to slide 13, unit volumes were up slightly overall showing the trend we have seeing all year with international volumes up 7%, slightly offsetting 8% lower North America volumes.

Now we'll turn to revenues on slide 14. European revenue grew nicely over the prior year driven by increased gas and water smart metering projects, and revenues in other parts of the world grew 30%. Smart metering projects continue to account for a large part of US and Canadian revenue, but lower volumes did decrease revenue from Q3 2010. The story here continues to be that our fiscal 2011 revenues are growing year-over-year reflecting our broad portfolio of products that we sell around the world.

Now let's look at revenue and gross margin results by region. Starting with our international results, which accounted for more than half of our total Itron revenues in the quarter. Slide 15 shows healthy year-on-year revenue growth of 14% on a constant currency basis. We had growth across all 3 business lines driven by smart metering projects. Gross margin in international is 28.4% during the quarter, versus 27.7% a year ago driven by increased volumes. As shown on the next slide, Itron international operating expenses grew year-on-year, about half due to fluctuating currency rates. The remaining increase of $6 million was due to investments in product development, increased selling expenses and G&A costs.

On slide 17, you see that Itron North America revenue declined 6%. OpenWay represented about 47% of total INA revenue. We shipped approximately 1.1 million OpenWay units during the quarter, including our first shipments to BC Hydro, which represented a decline in OpenWay units of about 15% from Q3 2010. In terms of margin, the increased warranty costs negatively impact the INA gross margin by about 6 points. On the next slide you'll see that non-GAAP operating expenses in INA were about flat year-over-year.

Moving to slide 19, you see our bookings and backlog show the same trends we have been discussing all year. With steady growth in core bookings offsetting some of the impact of the lower OpenWay bookings in North America compared to last year. Given these trends, total backlog declined from $1.6 billion at June 30 to $1.4 billion at September 30. And 12-month backlog declined about $150 million.

Now let me take a moment to update you on our debt financing initiatives. On slide 20 you can see that we continue to reduce our debt level. We are very pleased with the structure and more favorable terms of our new credit facility and that we were able to complete the refinancing prior to the debt market's contracting. During the quarter, we repaid all of our convertible notes outstanding and we refinanced our debt, which now consists of a US dollar term loan and a revolver. Our total debt balance at September 30 was $496 million. We've already repaid an additional $40 million of debt in Q4. With our debt to EBITDA ratio now following below 1.5 times, the interest rate will be reduced to LIBOR plus 125 basis points in Q4. Therefore, models for 2012 should take into account a $450 million dealt balance with an all in interest rate of under 2% at current LIBOR rates. This reflects a substantial reduction in interest expense compared to 2011 and prior years.

I'll close with an update on our 2011 outlook on slide 21. This updates the 2011 guidance we provided in July. We expect revenue for the year to be between $2.3 billion and $2.4 billion, which reaffirms our prior revenue guidance. Given our strong revenue results in Q3, we hope to end the year towards the upper end of that range. By business line, which is how we will be reporting next year, our 2011 revenue breaks out globally to approximately 52% electric, 26% gas, and 22% water. We expect non-GAAP diluted EPS for the year to be between $4 and $4.20 per share. Our non-GAAP EPS range largely reflects the impact of the $0.33 per share net warranty charges in Q3. This outlook is based on the Euro to US dollar rate to $1.40, average shares of 41.2 million, and an non-GAAP effective tax rate for the year estimated to be 22% to 24%.

A few points about our outlook, it is dependent on project and production schedules which can be subject to adjustments. It also excludes any charges related to our restructuring project that was announced today. As detailed in our press release, we expect to record pre-tax restructuring charges totaling $65 million to $75 million over the next 15 to 18 months. Approximately $45 million of charges will be reported in the fourth quarter of 2011, approximately $15 million will be recorded in 2012, and the reminder in 2013. Approximately 70% of the charges are severance and 30% are facilities costs. The severance charges will be cash payments. We expect that the restructuring project will yield a run rate of approximately $30 million of savings on an annualized basis. We expect to see $15 million of savings in the second half of 2012, reaching the run rate of about $30 million by the end of 2013. With that, I will turn it over to LeRoy.

Steve, thanks a lot. Let me leave you with a few words on our long range market opportunity. On that subject, I'll begin with some thoughts on Itron's vision.

Our vision has been and continues to be Itron will be the leading technology supplier of electric, gas and water measurements in automation solutions in the global market. We come to this vision as we believe, that in many areas of the world, the installed base of meters will continue to grow for electric and even more so for gas and water meters. Many of those meters will be automated to provide efficiency in meter reading, as well as smart meter and smart grid information and capability. The potential market in these areas, metering and controls, automation for meters and the distribution grid, and software solutions, is substantial around the world. We all know about the opportunity for electric smart metering and smart grid in North America. New orders are not likely to occur with the magnitude or pace they have in the last 4 years. There are many independent reports telling us so. That said, the orders and opportunity have not stopped. There are many utilities that will be facing upgrades, replacements and enhancements to their systems and there will be more wins for Itron in North America.

The market for gas metering and water metering, along with automation, still continues to grow in North America. We're very pleased with our progress and opportunities in gas, as our offerings have continued to gain favor in the market. For example, large gas contracts with Atlanta Gas Light, ATCO Gas, CenterPoint, and NiSource have accelerated our gas business by 20% from the original 2011 plan. We've also launched our CNI gas meter, the DATTUS, and continue to ship large volumes of our 100G Datalogging product, which is the basis for the building out of smart gas meter networks.

Outside of North America, the near term market opportunity looks even more robust. Many of you have recently been to metering Europe or have read the reports. Smart metering is alive and well in Europe. These initiatives are clearly moving forward in many regions. For example, ERDF has recently indicated their intention to move forward. Itron is well positioned there, as we've been a major part of the initial trials. On September 28, French government announced the roll out of smart meters to 35 million homes across France. 7 million meters will be deployed from 2013 to 2014. With the remaining 28 million to be installed between 2015 to 2018.

We are also actively engaged with GRDF and their project to replace 11 million gas meters, with 2 way communicating smart meters. We have been short listed for collection and meter data management software. Meter deployment will begin in 2014 after extensive piloting in 2012 and 2013. At Azeri Gas, a project we've mentioned before, we have completed deliveries of Phase I of the Azerbaijan smart payment project and planning for Phase II. Success on the project has already led to a sizable project in Turkmenistan.

In water, several major utilities are already investing in Itron automation including the [Olea] and Suez in France, and Yorkshire Water and Severn Trent in the UK. All of those projects are firmly moving forward. In Latin America, following on an OpenWay selection in Ecuador, we have a launched our proven North American smart grid solution at Metering Latin America this week. Our strategy is to actively pursue the developing 68 million meter opportunity in Brazil, as we extend our position across Latin America. We will pursue these markets with local partners, as well as leveraging our global relationships like the one with Cisco.

In Asia-Pacific, building on our very successful PLM pre-payment electric project in Indonesia, we see growing opportunities in Hong Kong, Malaysia, Taiwan, the Philippines and South Korea in addition to the massive opportunities in China, India and Japan. Water in Asia-Pacific is a key focus for Itron. With one of the most promising opportunities being heat metering in China, where the central government has published regulations towards efficiency in widespread thermal energy distribution systems. We serve this market out of Suzhou where we have a manufacturing facility. And let us not forget software where Itron is the most, foremost leader in meter data management software and forecasting.

Itron has an unprecedented view of the world's energy and water data through these offerings. We see opportunities to capitalize on this and invest in smart grid analytics that make the vast quantities of the smart metering and smart grid data being collected actionable and more valuable. These strategies are the key to building a stronger and more sustainable market for our products and solutions.

These are clear examples of the objective, profitable growth around the world. We do that by expanding our presence geographically, particularly in Latin America and Asia-Pacific. We do that by providing leading automation solutions and services tailored to local needs. We do that by exploring new opportunities in adjacent product markets where we are not currently present. We do that by bringing our global expertise on a local basis. There is no need to waiver from our vision. There is a need to move forward aggressively, execute flawlessly and take advantage of the opportunities that vision presents. We'll now open up will call to questions.

(Operator Instructions) And we will hear first from Paul Coster with JPMorgan.

Yes. Thanks, good morning. Thanks for taking my question. LeRoy, looking out to 2012, in the context of the guidance you've already outlined, do you have a sense of whether the international business will be growing faster or slower than -- or the decline will be greater or less than the domestic business? And then in respect to that international business, building out from kind of break fix preventative maintenance projects and these frame-type deals, can you give us some sense of the visibility in aggregate that you have so far, and how that might evolve?

Paul, good morning. Happy to answer that. First of all, in our best estimate at this point, international's going to grow faster than domestic. There's just many more opportunities. There's far more going on in Latin America and Asia-Pacific. Europe is going to maintain a steady pace, so I think as we look to '12, we are certainly looking for growth internationally as opposed to growth in what I'll call the US or North America. Although, BC Hydro is going to be a nice growth prospect for us in North America.

As I think about international visibility, one of the things that has traditionally been nice about international prospects is we know them. We know them well. We're not quite so affected by the great magnitude order, but rather we have lots of orders from a lot of really well-known customers, so I think the visibility internationally is really quite good. I'll give you an add -- as we move into '13, we're going to begin to see some of the big smart metering projects come into play. And while we will know them well, they will certainly cause international revenue to begin to look a little bit more lumpy than it has in the past, so just a heads-up on that one.

And we will go next to Sanjay Shrestha with Lazard Capital Markets.

Good morning, guys. LeRoy, good to have you back on the call. Two quick questions -- first, LeRoy, when you talk about that comfort surrounding flat to down revenue with 12-month backlog less than $1 billion right now, so there's inherently about $1.2 billion to $1.5 billion kind of a book and a burn business, can you sort of help us get into that a bit more as to where did that come from? What is the trend like on that? What is that related to? Give us some more visibility on that so we can get comfortable with either the low or the high end of that range from a book and a burn business for you guys. And I have a quick follow-up.

Yes. Let me direct most of this answer to North America, which I think is the real question. We're going to have a fall-off in North America round numbers, as I said, $300 million in OpenWay bookings. We'll fill some of that back with BC Hydro. We'll fill some of it back with some smaller OpenWay stuff that we're shipping as well. And so that begins to fill up a reasonable size of that hole.

Our gas business is growing in North America, and that's going to fill up some of that. And we know that business well. It's automation projects and just raw selling of gas meters, to be honest about it; the team is doing a great job of that. As well, we're doing very good on water projects, automation projects around the United States.

Sanjay, I would say that we are not filling that back up with unknown prospects at this point, so we're not looking at holes in 2012 that we have yet to fill to be able to be flat to down a tiny bit next year in North America. For Paul, I answered the North American piece of it, essentially.

Sure. So, one quick follow-up then. That warranty charge in the quarter, which obviously impacted EPS by north of $0.20, are we basically done with that or is there more to come? That was a pretty big number. What are those?

Yes. Sanjay, I'd love to say we're done with it, unfortunately in this particular quarter we got stuck with a diode problem that caused over half of that issue. And should we have caught it before we put that diode in a bunch of products? Maybe. I have actually, on the warranty side, got my nose into this stuff pretty severely. I do that for 2 reasons. One, as you suggest, the numbers are big. Two, it kills me to send bad product out to our customers, and I think we need to make a better effort culturally to get the DNA of Itron wrapped around quality more than it is today. I don't expect, going forward in the next quarter or quarters next year, that we're going to have that kind of warranty. Now that's an expectation, it's not a promise.

The fact of the matter is, if you buy millions of little parts and pieces, and the manufacturer makes a change to the formulation, whether they tell you about it or not, pretty hard to know sometimes until you've got that component out in the field in nasty conditions like humidity or sitting in water, in water pits or being baked on the side of a building if you're an electric meter -- pretty tough to know what that compound change is going to do anything to you or not. While we do an extraordinary amount of testing, and we do an awful lot of looking at our suppliers, at the end of the day you're going to get stuck once in a while. And we had too much of it. We've had way too much of it. Unfortunately, I can't tell you that everything out there is in perfect shape. What I can tell you is we've got an awful lot of focus on making sure that going forward everything's in a whole lot better shape than it has been.

And we will go next to Ben Kallo with Baird Investment Bank.

Hi, good morning. Thanks for taking my question. LeRoy, how did you get to the number of facilities that are impacted in the restructuring? Is that the right number as we look forward, or will we have to look at this again in a couple of months and see if that is the correct number of facilities to shutter?

And then also, as we look out in the European opportunity, can you tell us where your technology is? We've heard in North America there was some technology hiccups. Do you feel comfortable with your technology going forward for that European opportunity? Thank you.

Good questions, both. Thanks. First of all, the facilities around the world, one of the things all of you have noted is that we have not come back to you as quickly as maybe we had hoped with complete plans around the restructuring. Part of that has been a real grounds-up effort to look at every facility around the world, and take just a real sort of fine lens to whether or not these facilities were necessary, whether or not we could combine facilities and do a better job of it. So, I'm pretty comfortable with 13 facilities that we're impacting with this. I don't believe, Ben, going forward for the next bit of time, several years at least, that we look at any more facilities. So, I'm real comfortable with the leg work that was done around that, and the economics that were looked at, and the considerations that were taken.

That having said, this is a tough project, and the real work, frankly, starts now. We're going to be heads down on this as we go through 2012 and 2013 being very careful of people impacts. The bulk of the closures are in Europe, a little less so in the United States, and so that process has already begun.

Technology in Europe, to some extent and some of the reorganization we've done over the last several months helps us to bridge technology from the United States that we developed for OpenWay and other projects, to some of what we are doing in Europe. We have a fairly healthy product development group in Europe and other places of the world that are also working on the technology for opportunities in Europe. We have been deeply involved in the Linky project at ERDF, and deeply involved in the GrDF project as well. So, that technology is quite well along as we sit here today, so I'm comfortable with that technology progress. I'm comfortable we'll have technology to serve those markets.

I will, before you ask me, say that we were a bit behind at British Gas. We did not get to look at a piece of that business that has been awarded this year to Landis, if I remember right. We will catch up in that technology area, and we will be participating in that business as time moves on.

And moving on, we have a question from Steve Sanders with Stephens Incorporated.

Hi, good morning, everyone. Welcome back, LeRoy.

Thank you.

First, just as it relates to Europe, what do you think the impact of pending AMI roll-outs will be on the traditional replacement business in Europe? Clearly we saw some issues in '09 in North America that were amplified by the stimulus, but I just wanted to see what your thought process was on that. Then I have a follow-up.

Sure, Steve. We're going to affect normal meter purchase sets anyplace we have a big change out between plain meters and AMI stuff, so whether it's ERDF or GrDF or British Gas or potential smart meter programs in other places, that business gets [affected]. And so, as we forecast, not so much this year, but certainly as we look to '13 and beyond, we're going to have to take that into consideration, and in fact, in many ways as we think about our planning relative to the restructuring, we were thinking about these things going forward, so that we could be more efficient and better utilize our manufacturing capacity.

Okay. And then, and then the follow-up is a couple of parts. On the restructuring, you're obviously taking out facilities, but you mentioned increasing capacity. Is there a philosophical change in your outsourcing strategy here, or is this more about consolidation and automation? Could you give us an update on BC Hydro? Do we think about this as one-third this year, two-thirds the next year, just generally? Thank you.

Okay. On the restructuring, let me say that as we looked at restructuring, we thought about manufacturing from the prospect of how can we do it within our own grasp more efficiently than we are? How can we better utilize factories? We looked at factories for cost structure within those factories, and we looked at factories relative to levels of automation that might allow us to increase our capacity. I can say reasonably that we did not look at further outsourcing to subcontractors or to contract manufacturing people.

We still believe, and I believe personally fairly strongly, that we have it within our grasp generally to manufacture at a far more competitive rate under our own roof than under somebody else's roof. And I know that flies in the face of a lot of thought around being in the manufacturing business, but it pains me to share margin with a contract manufacturer when I know I can make it for the same price he can. We are manufactures of millions of things around the world. We're going to be better at it at the end of 2012, and even better than that at the end of 2013.

Now, that having been said, BC Hydro, this year about one-third of it gets shipped. Next year about two-thirds of it gets shipped. Probably a little spill over into '13, but not much.

And we will hear next from Patrick Jobin with Credit Suisse.

Hi, thanks for taking my question. Welcome back, LeRoy.

Thanks, Patrick.

So, I guess, a few months ago Itron laid out a pretty aggressive inorganic growth strategy. Is that still on the table, or is it focusing more on operations?

I'm going to give you two answers to that, Patrick. First of all, I like the goals. I certainly think that $5 billion by '15 is a great goal. I certainly think that 18% EBITDA margin is something we have to work at every bloody day of our existence. Having said that, as I've come back, I have far more focused my own attention and accordingly everybody else's on 2012, on making sure that we are competitive on the smart meter and smart grid projects that we've got in front of us.

But to the grand goal laid out in transform, we are absolutely aggressive in our efforts in water. We're absolutely aggressive in our efforts in Asia-Pacific, which I just look to be a very exciting area for us. We've been adding people in Asia-Pacific at the senior-most level that will bring to us both experience and wherewithal that we've not heretofore had, so none of the transform objectives are off the table. But I have reasonably, I will admit, focused far more on 2012 and making sure that we were very buttoned up in order to have a great platform for growth.

Next question?

Yes, we will go next to Craig Irwin with Wedbush Securities.

Good morning, and thank you for taking my question. And of course, welcome back, LeRoy.

Great. Thank you.

One of the things that we've noted over the last couple of quarters, this quarter included, is that the core Itron, your legacy AMR products and some of the software and other things that you're selling into North America, appear to be selling very, very well. I think last quarter was your best quarter ever. This quarter is, again, right up with the top of your execution there over the last many years. Can you talk to us a little bit about the core markets in North America outside of the very large implementations, and update us on what you see as technology solutions for the general customer base there? And then if you could also update us -- a couple quarters ago, Malcolm shared with us a number -- 24 million is the number of units that are just generally being bid or out for proposal in North America, if you could maybe give us an update there as far as the potential units on the horizon for the next couple of years?

Sure. Let me start with sort of what we would call our core business in North America, or maybe even more precisely to say our non-OpenWay business in North America because certainly OpenWay has looked pretty core to everybody in the last couple of years. Craig, we have a great team in the gas business. We were sort of loafing along, selling gas meters for a long time. We have energized that with the right people in the right place. I couldn't be more pleased with the gas team. They are knocking the cover off the ball in many respects. We are selling gas meters to people we've never sold them to before. We've done some work in the product area. We're doing some more work in the product area that's going to bring us home some more business, so I'm real, real pleased at the growth and the prospects for our gas meter group.

On the water side, our water business is interesting because we don't have a water meter franchise, and so what we look at is a whole lot of, what I'll call project business, and that project business often is not as funded through some kind of municipal funding like municipal bond or other not-normal revenue for the municipal. So, while in some areas you're seeing the water business hurt because the municipals are just not taking in a lot of revenue these days, some of these big projects are not only key to reducing costs, but they're funded in a different way that's not affected by gross tax receipts in any given annum. And so you get a little different picture for our water business than you might for a meter company that's in the water business.

So, again, that business has grown nicely, and there are prospects. And I actually spent a lot of time with our water group since I've been back, and here, again, I think we've got a great team that's doing the right stuff, but I think the prospects are alive and well, and we'll see some more of that as we go into 2012. I mean really, the gas folks and the water folks are making up for a lower level of OpenWay sales as we move into 2012 in the United States and beyond to be fair about it.

Now, to your second question, Malcolm did talk about 24 million potential OpenWay deployments. Lee me turn that question a little bit, because I'd like to give you what I sense is a bit more concrete answer. There certainly is a lot of stuff in the top of the sales funnel that you can paint OpenWay. And is the number that big? Sure it is. But that's going to extend beyond 2012 into '13, into '14, and I think the real important thing about that big number is that OpenWay hasn't stopped for us and for our competitors. Smart grid and smart meter applications are continuing in the United States. The pace is a little slower.

I think we're going to look at 3, give or take, prospects that are going to be firm prospects next year that you'll hear of. One of them is pretty far down the line, and it's a public -- it's been publicly listed, project at Ducane where we have been selected as the vendor. That's got to go through regulatory approval. It still has to complete contract negotiation, but that one's out there. There are a couple more that could happen next year, so nice steady business, not the big mountain of business we've looked at before. But I think as we look at 2012, we've got great prospects for OpenWay. And as we go beyond, we will have more of that in '13, '14, and beyond.

And we will take our next question from Steve Milunovich with Bank of America Merrill Lynch.

Thank you, good morning. A lot of questions have been asked, but LeRoy, could you comment on -- as you come back to the Company, obviously, the restructuring thing was under progress and I'm sure you've supported that effort, but specifically, what are you looking to change and take in a different direction from what you've seen so far? And maybe incorporated into that, you could talk a bit about the culture of the Company?

A couple of things. Steve, I clearly support the restructuring, as you said. Unquestionably, I've spent a little bit of time there making sure that we follow up on that through '12, and make sure that we pay attention to the people that are involved in that.

As we look at a couple other areas I focused on, we have had not only a restructuring effort, but an effort to recast how we are going to present the Company to you guys, and so you will look at an energy and water presentation, and inside energy we'll have electric and gas. I've spent a lot of time on that organizational structure, making sure that we are firmly focused on the customer, and we have good line of sight to the customer because everything we do starts with the customer. And I wanted to make sure that the organization was not getting in the way of good line of sight to the customer. So, I've tinkered with that a bit, but the plan in general was very good going forward.

I have looked at people throughout the organization, and comforted myself that we have the right people in the right place. And generally we do. I won't say everywhere we do, but we're working on those kinds of things. I certainly have gotten involved in early days, as I mentioned earlier, in quality. We are having far too much warranty issue than we have had before, and that needs fix.

And then I alluded to in the very front of my prepared remarks, I don't think we've communicated to the street worth a damn, to be blunt. I think we have been too evasive. I think we have not been specific enough. I think the result of that is -- we've caused a lot of confusion, both for you folks and for our investors, and in some cases even for our own employees. I think we need to be far more crystal clear about how we move forward, what the prospects are, what the prospects aren't. I'll close by saying -- we've lost too many orders on big deals, and we will take sufficient corrective action to fix that.

And we do have several questions in the queue at this time.

We've got time for about two more questions, please.

Thank you. We'll go next to John Quealy with Canaccord Genuity.

Hi, good morning, LeRoy, and everybody else. So, again, staying with the higher level stuff -- LeRoy, you talked about the message being muddied for Wall Street. Can you talk about how you are going to rectify that for customers, especially as we look near term in the US in sort of a maintenance mode, but clearly in Europe sort of mid-decade or whatever we think it is on, if there was very big utilities with a disproportionate share? Can you talk about, one, your impressions of what you've heard from them? And then secondly, I have a quick follow-up.

Well, so far, John, to be frank, I have not visited any customers in Europe. I am going to spend the entire month of January in Europe, and high on my list, although not the only thing on my list, will be spending time with customers. I have spent a lot of time with our team in Europe to assure myself as to where we were on projects, and to the extent I shared in my prepared remarks, where we were with big mega deals that are going forward.

The interesting thing about some of the mega deals in Europe is that, whether we like it or not, they're not going to be solely awarded to one contractor, and so we'll get a piece of most of those deals. The question is -- how big a piece will we get? And to some extent, I'm going to personally intervene in some of that to make sure that we can get as big a piece as we can. My intervention is not only meeting with customers, but it is making sure we have the right stuff available, and making sure it's at the right price range.

One of the issues always in Europe is price, and I'm very much encouraged by our rationalization around factories to make sure that we can make things at the appropriate cost level, so that we can enjoy winning deals and making money.

I think that answered your question, John, I'm not sure actually.

No, that was fine. And then my follow-up -- so, for many years many of us have considered Itron more of a technology company, clearly from the early days up until the AMI cycle, if you will. Can you talk about your vision of heritage and/or change to that technology DNA to Itron? We're talking a lot about standard manufacturing consolidation on this call, but can you share your thoughts about what you think Itron is, and where you want it to go?

Oh my, there's about half a dozen questions in there. Let me see if I can answer that. First of all, we have moved, both through time and opportunity, to a place where we are selling systems that are not just Itron systems. We're selling systems that connect to all kinds of things that other people make, and in that sort of stage, on that stage, we have to work with partners of a wide variety. I know people have questioned, for instance, our partnership with Cisco. But there's a perfect example of where Itron says -- we belong in this piece of this market, and we can better lever our talents if we have a partner that can do other pieces of this market.

So, if you look at Cisco and Itron, we're still making meters. We are absolutely still in the radio business, in the communication business. We are absolutely still in the software business, but by joining with Cisco, we get a partner that is clearly a superior network management company, a superior company relative to broad deployment of networks where security, quality of service, the kind of features that are common in an IP network are important. That is not a place where we have to have an expertise. We have to have knowledge and we have to have good partners, and there will be other places like that as well.

So, I think key going forward technologically is to pick our points. We will command the metering business. We will command the communication of metering information into networks that are not always ours. We'll do some of that however, and we'll take a look at technologies beyond radio because in some places, that's what the customer is demanding. So, our technology focus around meters and communications modifies itself a little bit where we can use partners to a better advantage.

On the software side, we're in the meter data collection business, we will always be in the meter data collection business, and we'll command the highest ground in that business. If we can add analytics around meter data collection to provide more knowledge to our customers than just pure data, we are very much, I think, moving in the right direction.

Overall, I think we have to have a culture here and a mindset around innovation, and innovation is not just doing new things. Innovation is looking down the road 3 or 4 years and saying -- what are the new things that are needed? And so I don't have a -- I don't have a pension for following somebody else. I kind of like to be out front leading.

Operator, I think that will be it for today.

So, with that, I'll turn the call back over to you for any additional or closing remarks then.

Yes, let me say a couple of things about this call today, as we close. First of all, I appreciate some of you getting up early. We'll go back to our normal format. We just thought we had a lot to lay on the table, and we wanted to get it out to you. As well, we were coordinating to a great degree with some of the stuff we had to do around restructuring, particularly in Europe.

As well, I've handled almost all of the questions today, maybe I did handle all the questions. Thank you, you wanted try me out and see if I could remember what I've learned in 60 days. I'm going back to the format we had before. I will have other people sitting at this table who will comment -- Philip, Marcel, from time to time even others, and we'll do more of that. I know at our most recent analyst conference that we laid out a pretty aggressive strategy. We'll try to talk to that strategy in further conference calls as we go along, and we'll maybe pick off bits and pieces.

I'm looking forward to traveling with a bunch of you, and seeing you and reacquainting. It's kind of good to be back, actually. Thanks, you weren't too tough on me this morning. We'll see you all soon.

Thanks very much, everyone.

And 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 a pass code 6304863, or go to the Company's Web site www.itron.com. We do thank you for your participation, and have a pleasant day.