Itron Inc (ITRI) 2011 Q4 法說會逐字稿

Please stand by, as we're about to begin. Thanks very much for standing by, everyone, and welcome to the Itron Incorporated Q4 and year end 2011 earnings conference call. Today's call is being recorded. At this time for opening remarks and directions, I'd like to turn things over to Ms. Barbara Doyle, Vice President of Investor Relations. Please go ahead, ma'am.

Thank you, Abe, and good afternoon to everyone 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 on the call. Also joining us are Marcel Regnier, President and Chief Financial Officer of Itron's water business, and John Holleran, Senior Vice President and Corporate Secretary. We issued a press release earlier announcing our results. The press release includes replay information about today's call. We also 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.

Before I turn the call over to LeRoy, please let me cover our Safe Harbor statements. Please note that our earnings release and financial information includes non-GAAP information which we believe enhances the overall understanding of current and future performance. We've included all the reconciliations of differences between GAAP and non-GAAP in our financial measures, and in our earnings release and financial presentations. Regarding our Safe Harbor, please know that we will be making statements during the call that are forward-looking. These statements are based on our current expectations and assumptions, and they 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 factors section on 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, please let me introduce LeRoy Nosbaum, Itron's President and Chief Executive Officer.

Thank you, Barbara. Good afternoon everyone, thanks for joining the call. We've got a lot to talk about today, most importantly the acquisition of SmartSynch, which I think really strengthens our solutions portfolio, and go to market strategy. But before I go there, let me begin with some highlights of our business results, including an update our restructuring project. Steve will cover the quarter's results in more detail, and provide our financial guidance for 2012. I will close the call with my observations about '12, and what I've learned in my first 6 months back at Itron. And we'll open up for questions. So let's begin. Overall, Q4 was a solid end to fiscal 2011, and I'm pleased with our results. It was a good end to a tough year in our industry, and let's be honest, a rather tumultuous year for Itron.

We ended the year with $2.4 billion of revenue, the top end of our guidance, and non-GAAP EPS of $4.29, above our guidance range of $4 to $4.20. On a full year basis, our global revenues grew by 8%. You can see on slide four that we had 13% revenue growth in water, 8% revenue growth in gas, and 13% growth in non-OpenWay electric business. As we forecast, our North America OpenWay sales declined slightly by 2%. But as the graph nicely shows, the 2% loss was more than offset by growth in what we would call our base business, represent by different shades of blue on the graph. The graph is key to understanding Itron. While we have exciting opportunities beyond our traditional business, OpenWay being one, our strong, steady, and profitable base business is significant, and I believe too often overlooked and under-valued. I'd also point out that our FY '11 revenue and non-GAAP EPS represented record high results for Itron.

Equally important, we are nicely moving forward with our operational plans, including the pace of our restructuring project. As we announced in October, several of our manufacturing facilities will be closed or scaled back. The goal is simple; more volume in fewer manufacturing facilities, which in turn eliminates redundancies, streamlines and allows automation of remaining operations, and reduces costs. We are on track with all of our plans. Actions taken to date include, successful negotiations with work councils at effective locations, which will allow reductions in workforce. We are negotiating with sale of several smaller businesses, which we hope to close in Q2. We have closed two facilities, one in Canada, one in Portugal, with a reduction in headcount of 140 people. As well, our downsizing plans are being finalized in several other locations. Given our solid Q4 results, and progress on our operational initiatives, I feel confident that our focus is appropriate, and that we are moving forward aggressively in the right direction.

Let's turn now to some customer contract wins we have announced that are clear examples of how Itron is capturing market potential around the world. In December, we announced an important win in Ecuador, where Itron provided 4,300 commercial and industrial OpenWay electric meters, two-way wireless communication, and meter data management for the utility. We are executing well, and are in a strong position for the next opportunity of 1 million electric meters planned for award in 2012. In November, we announced the roll out of our advanced water metering solution, with the Water Corporation of Western Australia, who is installing 13,500 Itron meters, our network infrastructure, and software. Itron's solution is part of its project to manage the city's resources more effectively, and provide greater control over water delivery. In October, we had a significant win for 400,000 residential water meters that we will supply to Hong Kong water supplies department. We also announced the significant follow-on contract for 400,000 gas smart pre-payment meters with Azeri Gas in Azerbaijan. This is the second phase of the project in the Republic, following our initial project for 250,000 meters.

All of these wins highlight the strength of Itron's presence around the world. They also underscore what I said last quarter. Yes, North America business has slowed somewhat, but the rest of the world is growing. Our global customer base and strong manufacturing are, indeed, sales and services presence, around the world bode well for Itron. Itron's strength is bringing our global expertise on a local basis. And forgive me if a brag just a little. In the most current water meter industry report published by IMS research, IMS estimates that Itron has the top unit share for total worldwide water meter shipments, total worldwide water communication modules, and total worldwide residential water meters. So all in all, I believe it is appropriate to say Itron is the world leader in water metering. And at DistribuTech in San Antonio in January, Itron was recognized with a prestigious Frost and Sullivan product quality leadership award for our smart grid platform. We were selected due to the performance of Itron's solution benchmark against our competitors. Using multiple criteria, including product performance, product reliability, product design, product usability, and perceived value.

As I come back to Itron, it is clear that there is a lot going on in the industry. We are leading on many fronts, and there is a lot of potential for Itron. One of the things that is crystal clear is that the landscape in this market is not homogenous. Our customers and potential customers are demanding a number of technology options for smart grid and smart meters. One of the opportunities on my radar screen has been the need to tailor complete solutions, and align with customer considerations, in using existing cellular networks for residential smart metering and other smart grid applications. Accordingly, we are very pleased to have announced today that we have reached an agreement to acquire SmartSynch. Here, you might go to slide 5. SmartSynch is the leading company deploying smart grid networks utilizing cellular technology.

The rationale for this acquisition is simple; providing an integrated cellular option makes sense. This acquisition gives Itron the flexibility to offer a variety of choices that meet specific customer needs. With SmartSynch, we can support multiple customer scenarios, anything from hybrid situations, where RF Mesh plus cellular offer the most could have effect solutions to opt in rate-based scenarios in places like Pennsylvania. Itron has been partnering with SmartSynch for over a decade on just such opportunities. There have been many significant advances in cellular communication, including data transmission capability, coverage, and improved backward compatibility. The cellular pricing model has also become far more attractive. With these advances in cellular communications, and the expertise in technology developed by SmartSynch, we believe the opportunities are expanding for cellular network utility solutions in smart grid applications such as electric, gas, and water metering, and distribution automation applications, as well.

Utilities like Consumers Energy and Texas New Mexico Power have made significant commitments to SmartSynch's cellular smart grid. Other utilities are utilizing combination networks of OpenWay and SmartSynch, including West Penn Power, San Diego Gas and Electric, and Southern California Edison. In 2012, we look for sales of SmartSynch post-close to be in the range of $50 million. This is just the beginning of the opportunity, as we see both revenue and margin synergies in the combination of our two companies. With Itron's financial and marketing strengths, sales will grow in North America, and potentially around the world. We will not quantify sales beyond 2012 today. We also plan to combine our skills in manufacturing and embedding devices in meters, along with the ability to sell Itron meters under SmartSynch networks to produce overall better margins and additional meter sales going forward.

Technology does not stand still in this industry. We have been watching the opportunity for cellular technology in the smart metering, smart grid arena for some time. There will be utilities that for geographic, regulatory, or other reasons find cellular technology very attractive. Before you ask, this is not a change in Itron's position regarding Mesh Networks or OpenWay. It is an acknowledgment that cellular technology has significant promise, in the acquisition of SmartSynch puts Itron at the forefront of this very exciting opportunity, while positioning Itron with one of most complete portfolios of smart grid communications solutions in the industry. We welcome Steven Johnson, from the smart grid team to Itron. Steven will continue to lead SmartSynch, and will report to Russ Vanos, who leads Itron's smart metering and smart grid efforts. SmartSynch will continue to be headquartered in Jackson, Mississippi and will adopt the name Itron upon close. We would expect the transaction to close in the second quarter of this year. Now let me turn the call over to our CFO, Steve Helmbrecht.

Thank you, LeRoy, and good afternoon. Let's start with slide 6. We had a very good quarter, with record revenue of $642 million, up 3% from Q4 of '10, driven by strong core operating results in both segments, North America and international. Gross margin was 29.8%, consistent with a year ago. Margin improvement from a more favorable product mix was offset by higher material costs, and warranty expense in North America. Adjusted EBITDA for the quarter was $79 million, up 7% from a year ago. We had a GAAP diluted loss of $1.35 per share for the quarter, compared with GAAP net income for $0.65 a year ago. The main drivers for the GAAP loss were restructuring charges, and a goodwill impairment charge. Restructuring charges of $65 million related to our re-organization and cost reduction efforts. This amount was higher than our original projection, due to higher than expected severance costs at our UK locations, and additional non-cash charges for asset impairments in two of our factories.

With these adjustments, we now expect total restructuring charges to be about $85 million, compared to our original estimate of $65 million to $75 million. We had a non-cash goodwill impairment charge of $44 million in the quarter, related to the finalization of our goodwill assessment testing. Our non-GAAP earnings per share, which exclude the impact of restructuring and goodwill charges, as well as amortization of intangible assets and debt fees, were $1.19 per share, compared with $0.95 a year ago, an increase of 25%. On slide 7, you can see that unit volumes were up about 1% over the prior year, driven by advanced meter sales. By geography, units sold increased 3% in our international segment, and decreased by 1% in North America. In terms of technology trends, we continue to see a shift from basic meters towards advanced and smart meters. You see on slide 8, that Q4 revenues increased by 3% in total, with increases in both North American and international segments. Q4 international revenues grew 6% in constant currency, driven by growth in electric and gas solutions. North America revenues increased 3%, driven primarily by OpenWay projects.

I want to move now to bookings and backlog, using the next 3 slides. Our 12-month backlog as of December 31 of '10 was $913 million, and we ended 2011 with $766 million in 12-month backlog, down about $150 million. We had full year revenues of $2.4 billion in 2011, which gives a sense of our ability to drive book-and-ship revenue. You can see on slide 10 that the OpenWay backlog is being worked off, as we ship and successfully implement the meters for several very large North American contracts signed over the last 3 years. You can also see that the base backlog is relatively stable. Now, let's look at our trended quarterly bookings on slide 11. First, you see our overall bookings pattern is lumpy, particularly in North America, driven by some of the large OpenWay projects. You can also see the steady growth in our international bookings. In fact, on a full-year basis, they grew 11% over 2010. To summarize, our OpenWay deployments have progressed very well, and the backlog associated with these projects is being worked off, as anticipated. You can see that our core business, which includes book-and-ship revenue, continues to be stable and sound.

Now, let's review our operating results, moving to slide 12. We had a GAAP operating loss of $60 million in Q4, driven $65 million of restructuring charges, and the finalized goodwill impairment charge of $44 million, which particularly impacted our international segment. Slide 13 shows an improvement in all of our key non-GAAP metrics. Non-GAAP operating income increased 6%. Non-GAAP net income increased 25%. Adjusted EBITDA increased 7%, and free cash flow increased 20%, driven by the strong revenue, and improvements in our trade working capital. Now, I'll review Q4 results by region, starting with slide 14. Revenues in North America increased 4%. Gross margin improved 60 basis points, and non-GAAP operating expenses decreased slightly, in total, and as a percent of revenue.

Our Q4 international segment results are shown on slide 15. Revenues increased 6% in constant currency. Gross margin decreased by 70 basis points, driven primarily by higher material costs, and non-GAAP operating expenses increased, driven by additional spending on international R&D. The next few slides cover full year results. Several highlights are that 2011 revenues grew 8%, or 5% in constant currency. We had revenue growth in both segments, but particularly strong revenue performance in international, as you can see on slide 17. Gross margin declined by 40 basis points, driven primarily by the special warranty charges in 2011. Non-GAAP operating margin was flat at 11%, and adjusted EBITDA was up 2%. Non-GAAP EPS of $4.29 increased 10% year-over-year due to revenue growth, reduced interest expense, and a lower effective tax rate, as you can see on slide 18.

Now turning to slide 19. We have significantly strengthened our balance sheet, leverage, and financial flexibility in 2011. We paid down our debt by $178 million in 2011, ending the year with $453 million of total debt, at much more favorable interest rates of under 2%, due to our debt refinancing, and so far this year, we have repaid an additional $10 million in debt. We will finance the SmartSynch acquisition with a combination of cash on hand, and available capacity on our revolver. We also commenced our share repurchase program in Q4. As of today, we have repurchased 1.1 million shares at an average price of $36.20, for a total of $40 million. That represents a repurchase of 2.7% of our outstanding shares, and leaves available buyback authorization of $60 million. Our balance sheet provides substantial flexibility to fund growth in our business, as well as to repurchase shares when it makes sense.

Now, let's talk about guidance, which includes the impact of the SmartSynch acquisition. We expect revenue to be $2.1 billion to $2.3 billion, with non-GAAP diluted earnings per share between $3.80 to $4.20. We expect to close the SmartSynch acquisition in early Q2. Excluding amortization of acquired intangibles, purchase accounting adjustments, and acquisition related charges, we expect the acquisition will add approximately $50 million in revenues, and be under $0.10 dilutive to non-GAAP earnings per share in 2012. We expect the acquisition will be accretive beginning in 2013. Our guidance assumes a 32% gross margin, Euro to US dollar exchange rate of $1.37, average diluted shares outstanding of 40 million, and a non-GAAP effective tax rate of 27%. With that, I will turn it back it to LeRoy.

Thank you, Steve. Let me adjust a little color of my own to our guidance comments. Given where we sit today, I think it's the right guidance. Would I like to see revenue higher? Of course. I think the opportunity is there, but in this economic environment, timing of projects can be he affected by a variety of forces. So let's get SmartSynch under our belt, see how the US and Europe macro issues are shaking out, and we'll give you a mid-year update on our Q2 call this summer. So let me now turn to some final comments. We had a great year in 2011 and very nice Q4, and as you can see on slide 4, that growth was not built on OpenWay, but rather on electric, gas, and water business, a lot of it outside the US. In fact, worldwide water grew 13%, with growth in Europe of 15%, smart water meters and modules grew 22% around the world, with over 2.8 million points shipped. Let me add a few words about gross margins.

I'm not thrilled with the gross margined of the overall business, but if you back out special warranty charges, we look more like 32% margin versus the 30% shown in our numbers. Looking back 12 quarters, our percent of direct labor has been going down. Our percent of overhead has also been going down. Materials, however, have been going up, and special warranty charges have been going up. While nice price increases would fix gross margins, that's not going to happen, and in this economic climate, we are seeing price pressure. So we're working hard on reducing material costs through global purchasing initiatives. We're working hard on ensuring better quality and control over our suppliers, who have largely been the cause of special warranty. We can do better, and we will do better.

One of the things we're doing is to use EBITDA margin as one of our annual bonus measures, which will ensure attention on both gross margin and OpEx. 2012 and beyond is increasingly coming into focus for me. I have had deep conversations with Itron people. I spent most of January in Europe, and last week I spent two days in Washington DC at a DOE energy conference with commissioners, utility executives, and energy policy experts. I draw two conclusions. First, growth in the US will be slow for a number of years, until we can see the economy materially moving forward, housing rebounding to something over a million starts, and the consumer in better shape. Many utilities are reluctant to put large smart meter deals in front of commissioners for approval where consumers are already over-burdened. Will there be smart meter sales, yes? Will Itron be successful at many? Yes. Will the level of business rebound to the high level we saw in '10 and in '11? Not for a while. But it's not going to fall off the cliff, either.

In fact, as I look at smart meter, smart grid opportunities that will come to market this year, albeit some will be pilots, I like Itron's positioning on 2 to 4 of them. Speaking of positioning, many of you will have seen the Itron-National Grid announcement that was released a short time ago. We are, of course, delighted to participate with National Grid in this most comprehensive project to build and evaluate smart grid in Massachusetts. This project will utilize Itron's OpenWay meters, the Cisco Itron IPv6 smart grid architecture, home area network capability, and distribution automation, all over a common network infrastructure. The importance of this project is not its size, but rather what will be learned by both National Grid and Itron about optimizing the grid, and giving customers choice and control over their energy usage. Itron is delighted to have been chosen for this very important project with National Grid. So again, while the US has slowed a bit, there are important projects and opportunities that are available.

The second conclusion I draw is the action is moving to Europe, and it is real. During January, I was in the UK, France, Germany, the Netherlands, and Spain. I visited executives at British Gas and National Grid in the UK, ERDF in the Energy Ministry in France, as well as Theolia Alliander in the Netherlands, Iberdrola, and GNF, Gas Natural Fenosa, in Spain. Projects are moving forward everywhere. Money is available. Yes, there is dither on the exact schedules, but they move forward. In the UK, British Gas is buying smart electric meters now, and smart gas metering will start next year. In France, the regulator is pushing to start the tender process for the next 7 million electric meters immediately. The energy ministry is on board. ERDF is anxious to move forward. I believe they will be rolling out in 2013. In the Netherlands, at Alliander, Itron is supplying meter data management and meter data collection. Electric meter tenders at Alliander and the distribution companies are coming later this year. Installations will begin later in 2013.

Yes, Itron has to win the business, but projects are moving forward. In Spain, both Iberdrola and GNF are moving forward. While I was there, Iberdrola issued a tender for 1 million smart electric meters. This is the beginning. We have the meter data collection award. Itron now has to win the meter business. These are obviously my views from meeting with utility executives. Many of you will not believe in the forward progress until the tenders are on the street, and awarded. Fine. But I will tell you that, while I'm still focused on the US market, I am spending an increasing amount of my time and focus in Europe the reminder of this year, ensuring we are appropriately positioned, making sure our factories are ready, and supporting the fine efforts of our Itron people.

Let me leave you with a couple final points. While most of my comments today have been about the US and Europe, there are many exciting things going on in the rest of the world. One of them that is getting a lot of press in the last week is the pending opportunity in Japan. 17 million meters by 2019, with 3 million to be awarded in October of this year for delivery toward the end of 2013, and on into 2014. There are a lot of opinions of how this business is going down. Let me give you my view. First, the testing that is gone out at TEPCO so far has largely been lab testing over the last couple of years, with a minor amount of field trial. That testing has included both RF and power line communication line testing under meters provided by the 4 traditional Japanese meter manufacturers. As aside, we provide both RF and power line carrier technology in many places around the world. While the tender is for 3 million meters to be to be deployed at TEPCO, external organization like METI, The Ministry of Economics, Trade, and Industry, and others are encouraging TEPCO to use an open-bid process, inviting newcomers and international companies to the Japanese smart grid market. The Ministry of Internal Affairs and Communication, MIC, has announced that they are in the process of reallocating bands in the 900 megahertz frequency area for smart metering applications.

If it is not clear, it should be, that the game has changed in Japan since the earthquake. The traditional 4 Japanese meter manufacturers will see international competition for the TEPCO business. Itron has been doing business with TEPCO for over 20 years. Nearly every residential meter in TEPCO has been read by an Itron solution for the past 20 years. We have literally spent the last year and one-half positioning Itron for this TEPCO opportunity, and the nationwide smart grid opportunities in Japan. Just like everyone else, we're awaiting the release of the tender specifications, and the bidding process for both local and international smart grid companies' participation. No one has won anything. When we have real results to report, we will.

Turning now to business that has actually been placed. In 2011, Itron sold over $100 million of metering out of our factory in Indonesia. Most of it was smart pre-pay metering, and a lot of that went to Indonesia. There is a very large opportunity in Asia-Pacific, there's also much to be encouraged about in Latin America. We will talk more about these areas next time. And finally, customers around the globe will increasingly be drawn to a vendor with financial staying power that is leading with technology. Itron's technology portfolio, strong balance sheet, scale, and history with customers is more of an advantage today then ever before. It is our responsibility to capitalize on this opportunity, by staying at the forefront in our own technology solutions, and running our Company in the most effective and efficient way possible. That is what we are doing. Now, we'll open up the call for some questions.

Great, thank you very much.

(Operator Instructions)

I'll take our first question from Chris [Covex] with Robert Baird.

Hi. This is actually Ben Kallo. Thank you guys very much for the call, and congratulations. Can we just go a little bit more into your guidance, how much of the guidance is weighed into the international side of the business, and then, LeRoy, if you can give us some idea about your visibility into the international business that gives you confidences in that guidance? And then on the gross margin front, how do you expect to expand gross margin as your business mix moves more toward the international side, where that typically carries lower gross margins.

Let me start with the gross margin question, and I'll let Steve take the question about how much is international and how much is not. I mean, one of the things we look at as we think about gross margins, and I referred to it in my prepared remarks, is you have to back out special warranty. And while I'm not guaranteeing that this special warranty stuff won't crop up again in '12, I would say that we lost a couple of points on gross margins to special warranty, and we are doing some things to try and get that back under control. Another point I'd make, big time, about special -- or not special warranty but about gross margin is that as we look at Europe, part of our restructuring efforts were a real attempt to put our factories in better shape as we look at 2013 and beyond. So we're closing some facilities, we're moving some production out of some facilities into both facilities with lower cost operations, and as well, just bulking up the amount of product that we put through any one facility. That allows us to put more automation in that facility, and accordingly, drive gross margins higher by driving our costs down.

So we've got a couple things going there. And then lastly, I would say that he really have a pretty substantial effort going on worldwide to combine our purchasing power across the globe, and really hit some areas where we can take some costs out by negotiating better prices with our competitors. All of that is on the plus side of gross margins. Now I'll be the first guy to say that, in these economic times, everybody's chasing orders, there's a lot of price pressure out there, and as we look particularly at some of the tenders that are going to come forward for smart grid stuff in 2012 late, and on into 2013, we're going to have to go after some business, because other people are going to do the same thing. So I think we've got a nice balance there as we head into '12. Steve, some thoughts about how '12 plays out.

Yes. Ben, just to build on LeRoy answer. He's covered the margin side of it. Let me talk if the geographic splits. We think about the North America, in the last couple of years it's been hovering at or slightly above 50%. As we look out the year, we see it more trending in the 40%, 45% probably higher end there. AMEA growing on a relative scale. Again, probably about even with that, maybe toward the lower end of that range. And up international, probably about 15%, plus or minus, and that is up 200 basis points as we continue to see growth in OPAC, Latin America, and Asia-Pac, but particularly in Asia. And then a final comment I'd make is as we report in 2012, we will be recasting our segments into global energy, made up of electricity and gas and water, we'll also be providing revenue splits by geography starting this year, Q1, North America, AMEA, Latin America, and Asia-Pac, we'll be providing that level of detail going forward, but not today.

If I can, if I may, ask one more question. I here BC hydro is going very well, as far as end points go. Could you talk about the actual network deployment, the scheduling there, if there's any deadlines that you have got to meet, I saw that the Cisco executive to their smart grid program left today. Does that impact anything with your relationship?

We've known for a little while that that Cisco executive was leaving to join another company. We were warned of that, and have had deep conversations about how that will be backfilled, so we're comfortable with that. Virtually no effect, from Itron's perspective, at all. A real dedication to smart grid and the utility industry on the part of Cisco. I would say that the deployment at BCH is going good, both in respects to meters and the network. I would also say that I think it's fair, as we move through '12, we'll give you some other updates on that, but at this point everything going well, and precisely as we had expected it to.

Great. Congrats on SmartSynch.

Thanks, Ben. Operator we'll take the next question.

All right. Thank you, moving on we'll go to Paul Coster with JPMorgan.

Thank you very much. Well, LeRoy, could you give us a little bit of help on how to shape the revenues for the year? You know, it's not clear anymore what normal seasonality is, but perhaps you can sort of give us a sense of what might happen?

Paul, a couple of things for sure. I mean, we're shipping in the front half a lot of OpenWay to BCH. That goes without saying. In the back half of the year, I think we'll see again a Q4 that's probably tilted up a little bit. I mean, if I had to give you a sense across Europe, I think it's rather flattish, quarter to quarter to quarter.

Yes, and maybe just a quick follow-up on the SmartSynch acquisition. Could you just confirm with us that, from a technology perspective, it syncs in with the Cisco platform, and is there any backlog originating from that acquisition?

I'll let Steve answer the backlog question specifically, but let me give you a couple thoughts on the technology. First of all, ever since I got back, so all the way back in the very front end of September last year, I'm looking at cellular, and I'm saying that, quite frankly, this is a technology that is coming to its forefront. Pricing of cellular has gotten cheaper. The capabilities of cellular, including the ability to move data in large volumes, clearly backward compatibility, clearly security, and its general prevalence almost everywhere these days just drives cellular to be a good option to take a look at as a utility. Now, cellular is running, IP, as is Cisco, and we look at a network and say--What a great combination to be able to provide, where it makes sense, Mesh Network, where it makes sense, cellular, and together that's a very powerful product and technology portfolio for Itron, so we don't see any incompatibility there, and, in fact, as Itron, we think we're uniquely able to bring technologies from a communications standpoint, as well as it meter data collection and meter data management together, to form a very powerful offering.

And Paul, the second half, this is Steve. We will be seeing some acquired backlog, but what we really see, and look very forward to, is the visibility we're getting here, because of the signed large contracts that LeRoy talked about at consumers and elsewhere, and the future deployment schedule over time, not all is contained in firm backlog, as we have defined, as we define as well, so we're quite pleased with that visibility going forward.

Okay. Thanks very much.

All right. Thank you very much. Moving on we'll now take a question from Sean Hannan with Needham and Company.

Yes. Thanks if I could just follow-up on some of the SmartSynch thoughts there. Just from a very high-level perspective, can you talk, perhaps, Leroy, what SmartSynch brings to the table strategically, when you look at geographies, particularly outside the US, given the cellular approach? And then also, how quickly are you in position to effectively leverage that solution into some other markets?

Let me say that our primary focus was the US, as we looked at the acquisition of SmartSynch, with a secondary focus as to what we could do outside of the US. So you know, we valued the acquisition wholly, if you will, on its capability, and what it brought to us in North America. Having said that, in many respects, cellular capability outside the US, particularly in Europe, is, frankly, advanced, compared to what you see in, in the United States. There are many places in Europe where we believe, as does Steven Johnston, that the ability to sell SmartSynch technology in Europe is really there. And we look forward to exploring those opportunities as we move through 2012. Right now, our primary focus with SmartSynch is going to be bringing them under the Itron umbrella, and making sure we do a good job of integration. We'll then make sure that our customers, and SmartSynch's customers in the US, are getting appropriate attention, and they're not lost in the acquisition shuffle, and then we'll turn our eye to opportunities beyond the US, and I would imagine that that will begin in Europe.

That's helpful. And then a quick follow-up around the guidance. You talked a little bit, both you and Steve, about the international versus domestic breakdown. Can you elaborate, perhaps, on the product front; rank, discuss, as you look to 2012 growth in gas, electric and water?

Well, let me say that I think, in general, as you look at electric and gas and water, gas and water are going to continue to grow, and electric's the one that is going to be a tougher growth comp from '11 to '12. Part of that is OpenWay in the United States, without question, and, in fact, maybe mostly OpenWay in the United States. Having said that, things are continuing to grow around the growth. We are growing in Asia-Pacific, as we have been for the last several years, and that will continue. We're seeing good, albeit modest, growth in Europe in gas and water, and a tiny bit in electric, so I like that. But as our guidance for '12 relative to '11 says, it's essentially flat year on year, with a little down in '12. The real growth picture, for me, begins late in '12 and on into '13, and that story is largely a European story, potentially some stuff in South America, and of course, we believe Asia-Pac will continue to do what it's been doing.

That's very helpful. Thank you so much.

Sure.

And we've got a really long queue of questions, and not as much time, so we'd really appreciate it if you can hold to one question.

All right. Thank you very much. Moving on, we'll go to Steve Sanders with Stephens, Incorporated.

Hi, guys, good afternoon.

Hi, Steve.

Maybe first, Leroy, just to follow up on Europe commentary. France and Spain clearly have some pretty significant macro issues. What did you hear from the utilities there in terms of the business case drivers that gave you the incremental confidence, and then part B of my question is just, the restructuring charges went up to $85 million, is the savings still $30 million annualized at the end of '13, or do we have something incremental there? Thank you.

Steve, that one's easy. It's still $13 million on an annual run rate, and it will become full at the end of the '13, so full for '14. I met with the head of EDRF, Madame Bellon, and I asked her straight up--Is this moving forward or it isn't? And give me the issues? And her response to me was real straightforward--It's moving forward. Yes, this is France, Leroy, we always have issues, and we've got a French election coming, and that's not going to help, just because it takes people's mind away. This is going to move forward. It's going to provide 10,000 jobs when it starts rolling out. There's no way this is not going forward. Iberdrola. Same situation. Same head of Iberdrola. Similar question. Are you moving forward or not? I'm sitting there with them on the day they had released a tender for 1 million points of smart electric meters. It's moving forward.

And we just simply have to be prepared, we have to win our share of the orders, and I got no different perspective when I was in the UK at British gas, or with national grid in the UK, nor did I get a different view when I was with Alliander in the Netherlands. One of the reasons I went over to Europe was to sit down with as many utility heads as I could sit down with, and ask that very question, because as you guys have been skeptical, I have been skeptical, and I think that's a reasonable amount of skepticism, I just didn't find it in reality. Those utilities are well financed. They have a lot of money. They are willing to spend it. And so I think you have to simply believe them at their word. And by and large, for instance, in France, the cost of smart grid is not being charged to the consumer. EDRF has said--We'll take. It's our deal, we'll spend it, we are going to get cost savings. That's not universally the case in Europe. It certainly is at EDRF. So, I've got to tell you, my concern is not whether or not the orders are coming. My concern is participating, my concern, frankly, and I've been leaning all over my factory guys, is that in about 2015, I think we have not enough factory to produce what we're going to need to produce.

Okay. Thank you very much.

All right. Thank you very much. Now moving on we'll go to Sanjay Shrestha with Lazard.

Good afternoon guys. Congratulation on a good quarter. That was kind of my question, LeRoy. I would call this what it is, right? It looks like 2013 and beyond is really shaping up to be a very big growth year. So how you guys, and the industry of Japan, Brazil, Europe, international markets, and even some of this 2 to 4 large opportunity in the US all hit at the same time, how are you planning in terms of sort of capacity for you and for the industry?

Well, Sanjay, that's a question I've been asking my guys a lot, and spent a lot of time on it just a couple of weeks ago. I'm very comfortable in the US. We have plenty of capacity. We have too much capacity. I'm asking questions about whether or not we can offload some of the stuff that we have to do elsewhere around the world, South America, maybe Europe, although it's harder, moving stuff back and forth across the pond, but I think there's probably some things we can do. We have taken some good steps in Europe, as we went through the consolidation, to both expand capacity in a couple of places, and put more automation in some others. So we're expanding capacity in a low cost country, Hungary. We're increasing capacity with automation, appropriately so, in France.

When we turn to Japan, I think that, quite frankly, while I think we have great promise to participate in that business, and we might, in the early days, produce something probably in the United States, we will work in corporation with a partner in Japan to bring that volume up to speed, as that marketplace rolls out. We have the potential of looking at some of the stuff we're doing elsewhere in Asia-Pac, whether that is Indonesia, or elsewhere. So I think we have to be careful to plan for it, but I think it's well within our capability. I think the other thing we have to be mindful of is that our global supply chain, including our parts suppliers and other vendors, have to be ready, and so we're talking with them as to how to make those transitions. But your question is well found. You guys in subsequent quarters are going to continue to ask me--Are you sure you can make enough? That's a nice problem to have.

Okay. That's great. Thank you so much.

All right. Great. Now moving we'll go to Patrick Jobin with Credit Suisse.

To keep the queue moving along, I promise to keep these short. I just want to do housekeeping item, actually three items. First, the specialty warranty seems to keep popping up here. What are you doing to address it, and how do you see that evolving throughout the quarter, next few quarters? Secondly, is just the FX exchange rate assumption. What are some of the moving pieces there, as far as the cost equation for how it impacts? And then lastly, the $567 million in smart meter backlog. How do you see that hitting the statements in '12 versus 13? Thanks.

You bet. So I'll give you the book end here. I'll let Steve take the FX. Let's start with the $567 million in smart meter backlog. I think about half of that is going in '12, and the rest of it trailing out in '13. And the better part of the half will be DCH. As to special warranty, I wish I could give you a hard answer when the hell that's going to quit. Unfortunately, that's one of those deals where, you made the problem, but you don't know about it for some days, weeks, or months, in some cases even years ahead. I will tell you that we've brought on some quality people, and I like the way they're attacking the problem.

We're beginning to work a little bit better with our suppliers in terms of making sure we understand what they are changing when they make changes, and we're looking across multiple Itron locations to make sure, when one location qualifies a supplier, if another location knows something about that supplier, either good or bad, that we are, en masse, gathering our information and doing a good job there. The unfortunate part about that special warranty is the fact that too much of it was caused by our vendors. Sometimes we knew that they had a made a change. Other times we did not. So we are for sure tightening down on our vendor quality control, and we are instituting some new processes and procedures. The tough part about it, frankly, is that we may have done something 6 months ago that will show up 3 months from now, and quite honestly, we don't know. We think we do a pretty good job on a day-to-day basis. Every once in a while something comes up. We need to do better. Steve, FX?

Yes. Patrick, we used a $1.37 rate. It's clear that's a bit high, today, in terms of the Euro-dollar rate. That shapes our thinking on the low end of the range in terms of revenue. In terms of how that flows through EPS, we have a lot of cost structure in Euros, so the change in the Euro rate is primarily an impact on revenue, so it could move that $50 million plus or minus, let's say, a little less on EPS. It's the other currencies. If the dollar stays fairly strong in the other currencies, that could have some impact flowing through down to P&L, plus or minus $0.05, let's say. So again, we try to take that into consideration in our ranges.

Great. So the low end of the guidance, at least on the revenue side, is partially attributable to an FX movement back to spot.

That's correct.

Thank you.

All right. Thank you very much. And now moving on, we'll go to Craig Irwin with Wedbush Securities.

Good evening gentlemen. Congratulations on the impressive quarter.

Thank you, Craig.

I know multiple people have asked questions about your restructuring and your guidance, but I just wanted to weave the two of those together. Can you maybe shed some light on how much of a benefit from restructuring is included in your gross margin and EPS guidance for the back end of '12, and whether or not the timing of these actions, and the benefits of these actions weights EPS to the back of the year, or if there's, potentially, a more positive contribution that would push performance toward the higher end of the range, if these actions are very, very successful?

Craig, you're going to get the $15 million that we talked about, give or take. So we're comfortable with that, and I think in some respects it's pretty flat across the year. We were already able to take 140 people out. We dropped that pretty quickly. You know we've got some great work going on to get rid of some businesses, and we think that that's not too far down the pike. So I'd say if you look quarter to quarter over the 4, I think it's reasonably flat, so I don't think that the affect on EPS is particularly weighted one direction or another. I think it is fair to say that as we consider the $15 million savings, we've spent some of it. If you haven't noticed, you'll note that our R&D expenses from '11 to '12 go up.

We're going up about $20 million, give or take, in R&D '12 over '11. The wonderful thing about what we've said to far today is that we've got lots of opportunities in Europe, in Japan, in Latin America. The bad thing about all those opportunities is, in some form or another, they all take more engineering, and so we're allowing our engineering numbers to go up a bit in various places around the world. We've got a little bit more sales and marketing expense, but a little bit in Latin America, some in Europe, as we're making sure we're positioned for opportunities in those places. A little bit in Asia-Pacific as well. So, while we're getting the $15 million, we're some giving it back in a variety of areas, but I think all good investments, as we look toward the latter stages of '12, and on into '13 and beyond.

Great. Thank you for taking my question.

Sure.

All right. Thank you very much. Moving on we'll take a question from John Quealy's line from Canaccord Genuity.

Hi. Good evening. Two questions. First, the SmartSynch acquisition with CMS, can we sketch out revenue opportunities? Is the Centron or OpenWay going to be part of CMS, do you think? We've all been primed to $100 ASP price in past, how should we think about this moving forward in timing? Secondarily on free cash, excluding the purchase, what should we think about? You had an over 1-to-1 conversion. Should we be thinking a little bit more use of cash to your points earlier?

I'll let Steve take the cash question. OpenWay-Centron at the consumers. John, we come into that deal having acquired SmartSynch with some commitments already made by SmartSynch, both to consumers, and to other meter manufacturer. We'll see what leverage we can have there. I guarantee nothing. I am hopeful that we can probably participate to some extent in that. As to the exact amount of participation, I can't tell you today. Because we have not, as yet, been able to work that aggressively, as we will after the acquisition closes. But some help there, I think more promise beyond consumers, to be fair about it, and in that realm, we have great synergies, as we put SmartSynch communication inside Itron meters, and looking very favorably there.

John. Yes, this is Steve. We had very good free cash flow year. In fact, our free cash flow for Q4 was best ever. We think about 2012, and as we think about overall, I think relatively a similar cash flow profile, and that would be slightly north of the earnings, as well, in terms of our outlook. So we talked about, as you mentioned, 1-to-1. We've had very healthy free cash flow in the last couple of years, as a reflection of our non-GAAP EPS, as well. So we see that continuing.

Thank you.

Thank you, John.

Just one other comment. Our Capex continues to be fairly modest. We don't see the acquisition changing our profile in a major way in terms of capital expenditures.

Okay. Operator due to the time, let's take one more question, all right?

All right. Great. And that question will come from Steve Milunovich's line with Banc of America, Merrill Lynch.

Great. Thank you. The backlog, obviously, has been coming down, and the long-term backlog is down quite a bit year-over-year, and you mentioned the book-and-build business, which is going to be very important. Does the backlog concern you much in looking at future revenues, or do you have some visibility on this book-and-build business that gives you confidence?

As I mentioned in prepared remarks, we do have confidences in the book-and-build business. In, for example in international, with where we have not seen a large project-based bookings, we've averaged over 1-to-1 pretty much over the course of year, and so that's a reflection, I think, of the stability and the outlook we have going forward.

I would echo that. I am not in the least concerned about the backlog coming down. I mean, we've seen this before historically, where we have several large orders in a row. They happen to be OpenWay, and they happen to be huge. We're in a bit of a trough here, relative to those large kind of smart grid orders. They will begin again toward the end of this year, on into '13, in a number of locations. Our book-and-ship capability, and our knowledge about that is really, really good. We build up from the ground up every quarter, with all of our sales guys, and all of their management teams, so I'm very confident in that.

Just one other comment. Is that our guidance does reflect that our 12-month backlog declined sequentially about 150 million, as I mentioned in my opening remarks, so we certainly took that into account as we were looking at 2012.

Okay. Operator, I'm going to make some closing remarks, and we'll turn it back to Barbara for a final comment. Everybody on the call, thanks for joining us. Delighted to have you with us today. Sorry to have to cut the questions off, which were great questions, thank you. Appreciate those. We had a great, great 2011, and a strong finish in the quarter. We're pleased with where we are in many respects, positioning both in the US. I think you began to see some things happen, both the SmartSynch acquisition, and the National Grid announcement today, that make us very happy about our prospects going forward in the US. As I said, I'm going to spend more time in Europe. I just think the opportunity there is just fantastic as we look to '13, '14, '15 and beyond. So I'm sitting here today reflecting upon my first bit of time here back at Itron. I like what I see, and I like the feel. So I would say to you, thanks for joining us, and give you a heads up that tomorrow you will see another exciting announcement out of the water side of our business in the US that I'm not at liberty to share with you yet today. Barbara.

So folks, I've got nothing else to add to that one. Thanks for joining us, and we will speak with you during the quarter.

Great. Thank you very much. Again, ladies and gentlemen that does conclude the conference for today.