Itron Inc (ITRI) 2012 Q4 法說會逐字稿

Good day, everyone, and welcome to the Itron Q4 and year end 2012 earnings conference call. Just a reminder, today's call is being recorded.

For opening remarks, I would like to turn the call over to Barbara Doyle. Please, go ahead.

Thank you, Justin.

Good afternoon to everyone on the call, and welcome to Itron's fourth quarter fiscal 2012 earnings call. On the call today, we have Philip Mezey, Itron President and Chief Executive Officer, Steve Helmbrecht, Itron Senior Vice President and Chief Financial Officer, and John Holleran, Itron Executive Vice President and Chief Operating Officer.

Steve will begin our call to cover the financial results and to discuss our financial guidance for 2013. Philip will then provide some additional color for 2013 and provide an update on key market opportunities as well as his priorities as CEO. After our prepared remarks, Philip, Steve, and Jon will take some questions.

We issued a press release earlier today announcing our results and 2013 guidance. The press release includes replay information about today's call. We have prepared slides to accompany our remarks, and these slides are available through the webcast and through our corporate website under the Investor Relations tab.

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 financial presentation.

I would also like to cover our Safe Harbor Statement. We will be making statements during this call that are forward-looking. The 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 call and the comments made during this conference call and in the Risk Factors section of our Form 10-K and other reports and filings with the Securities and Exchange Commission. We do not undertake any duty to update any forward-looking statements.

Now, please let me turn the call over to Steve Helmbrecht.

Thank you, Barbara, and good afternoon. Today, I will cover our Q4 financial results and discuss our financial guidance for 2013 before turning the call over to Philip.

First, I'll comment on our results as compared with the guidance we provided on the last earnings call. Full-year revenue results exceeded our guidance range and non-GAAP earnings per share were within our guidance range. Q4 revenues of $523 million were higher than we forecasted, with stronger book and ship revenues in both the Energy and Water segments.

Q4 non-GAAP earnings per share of $0.58 came in at the low end of our expectations. Lower gross margin, higher selling expenses associated with the increased revenue, and additional reserves offset some of the revenue upside in Q4.

Now, I will review the year-over-year results. Slide 4 shows a revenue bridge for Q4 compared with the prior year. Lower revenue from the top five North American OpenWay projects drove the decline, as four of these projects are now substantially complete. Currency fluctuations were minimal for the quarter. The positive news is that revenues grew by $41 million excluding these top five smart grid projects.

Other metrics for the quarter are on slide 5. Bookings in the quarter of $467 million were down from $515 million in 2011, but increased approximately 2% sequentially from Q3 2012. Gross margin of 31.2% was up more than 120 basis points year-over-year. Drivers of improved gross margin include lower warranty expense, lower manufacturing costs from efficiencies related to our restructuring, and savings from our global procurement program. These actions more than offset the impact of lower volumes and higher professional services in the quarter.

Non-GAAP operating margin of 5.8% was down 4 percentage points year-over-year, driven by higher R&D and sales and marketing expenses. We continue to invest in product development and our sales force, as we position ourselves to capture new pilots and opportunities around the world. Adjusted EBITDA margin of 8.4% was down 3.8 percentage points year-over-year on adjusted EBITDA of $44 million, reflecting lower operating income.

GAAP diluted earnings per share were $0.40 for the quarter, compared with the loss of $1.35 in 2011. The Q4 2011 loss was primarily driven by restructuring charges of $65 million and a $44 million impairment to goodwill. Non-GAAP earnings per share, which exclude the impact of the goodwill impairment, restructuring charges, acquisition-related expenses, and amortization of intangible assets and debt fees, was $0.58 per share for the quarter, compared with $1.19 in 2011. Slide 6 summarizes the year-over-year bridge for non-GAAP EPS.

Gross profit dollars were down due to the decrease in revenue. However, our gross profit performance as a percent of revenue improved, with gross margin up by 120 basis points year-over=year. Higher non-GAAP operating expenses had a negative impact year-over-year. Total non-GAAP operating expenses for the quarter increased 4%, driven by R&D and sales and marketing, with lower G&A. Decreased other costs, a lower tax rate, and a reduction in the number of shares from our stock repurchase activity resulted in $0.08 a share benefit compared to 2011.

We repurchased 158,000 shares in Q4 for $6.7 million. From inception of the program in October 2011 through today, we have repurchased more than 2 million shares, at an average price of $37.96, for a total of $77 million of the $100 million authorized by the Board. That represents a reduction of nearly 5% of our outstanding shares.

Now, moving to slide 7, I will review revenue by business line in more detail. Water segment revenues increased 12% year-over-year in constant currency. Our water business grew across all regions as we bring new and innovative products to market, such as solid-state heat meters and products that help our customers minimize water losses.

Gas revenues in Q4 were flat year-over-year in constant currency. Revenues were up in North America, driven by increased shipments of gas metering products, which more than offset the impact of lower shipments of communication modules and services due to project timing and schedules. Our customers' trend to smart metering and gas continued, with higher smart metering shipments and lower shipments of basic gas meters and services across the other regions.

The completion of our large OpenWay projects continue to impact our electricity year-over-year revenue comparisons. Non-top-five OpenWay electric revenues were up 11% year-over-year, with growth in products and services in North America and EMEA. Our Cellular Solutions Group that we acquired in May 2012 contributed approximately $10 million in revenue in Q4.

Water segment results are shown on slide 8. Gross margin declined by 170 basis points. Benefits from favorable product mix and operational efficiencies were offset in the quarter by lower margin on professional services and incremental charges for the relocation of a small facility in France due to rezoning. Non-GAAP operating margin in Water was roughly flat compared to Q4 2011, with lower G&A expenses partially offsetting the gross-margin impact.

Slide 9 summarizes our key financial metrics for the Energy segment. Energy gross margin increased by 190 basis points year-over-year, driven predominantly by reduced special-warranty expenses and efficiency improvement in our factories. The operations team has done an excellent job managing costs in North America, given the large shift in production volumes that occurred in 2012. Our manufacturing team continues to implement quality initiatives and manage fluctuating volumes very effectively.

Non-GAAP operating margin in Energy was 6.7%, down nearly 570 basis points compared with Q4 2011, driven primarily by higher sales expenses and increased G&A expenses related to certain assessments in the quarter for bad debt and legal contingencies.

Slide 10 summarizes key non-GAAP metrics at a consolidated level. Non-GAAP operating and net income both declined 53% year-over-year, reflecting the impact of the top-five OpenWay projects and higher operating expenses. Q4 free cash flow of $52 million was down from $84 million in Q4 2011, due primarily to lower EBITDA. For the full year, we generated $155 million of free cash flow, compared to $192 million in 2011.

Now, I will move on to bookings and backlog using the next three slides, starting with slide 11. Total backlog at year end was $1 billion, and 12-month backlog was $568 million. Let's look at the main components of our backlog.

The change in backlog compared to December 2011 was driven by the top-five OpenWay projects, as you can see on slide 12. These projects have been highly successful, with more than 12-million units deployed, generating read rates above 99%, and driving more than $1.5 billion in revenue since Q4 of 2009. Four of these five contracts are substantially complete, and Detroit Edison, which is now approaching its one-millionth smart meter, will continue its deployment into 2014 and beyond. Excluding these five-large contracts, our backlog at year end was $760 million, up approximately 2% from December 2011.

Trended quarterly bookings are shown on slide 13. Total bookings in Q4 grew sequentially by about 2%. Our largest booking in the quarter was for $33 million in the Energy segment for the NiSource contract. Total book-to-bill ratio in Q4 was 0.9 to 1. We had sequential upticks in our bookings in Q3 and Q4 of 2012, as our win rate on pilots and contract awards has increased throughout the year.

Now, I'll turn to slide 14 to discuss debt. Our total debt declined to $418 million, during the year in which we drew on our credit facility to fund the SmartSynch acquisition and also repurchase stock. Interest expense in Q4 was $2.5 million. Assuming no major change in our debt structure or the LIBOR rate, we expect this quarterly interest expense to be a reasonable estimate for 2013.

Now, I will cover our guidance for 2013, turning to slide 15. We anticipate full year 2013 revenues to be in the range of $2 billion to $2.1 billion and a non-GAAP diluted EPS range of $3 to $3.25. This guidance includes the following assumptions -- gross margin of approximately 33.5%, a non-GAAP effective tax rate of approximately 25%, and a euro-to-US-dollar exchange rate of $1.34 on average for the year, average shares outstanding of approximately 40 million.

I want to comment on a few key drivers underlying our guidance. Our full-year guidance reflects growth across all businesses and regions, except for Electricity in North America. Electricity revenues in North America will decline year-over-year given the nearly $200 million decline in 12-month backlog.

Moving to gross margin, we saw improvement in 2012 over 2011, despite decreased revenue, due to lower special-warranty charges, manufacturing efficiency efforts to offset lower volumes, and the favorable impact of our restructuring activities. Our full-year 2013 guidance reflects continued improvement in gross margin for those same reasons.

In operating expenses, we expect research and development to increase year-over-year by $10 million to $15 million. 50% of this increase comes from the full-year impact of R&D spending in Itron Cellular Solutions. The other 50% comes from increased R&D spending to expand our product portfolio to meet a wide range of functional and technical requirements around the world.

Sales and marketing grew the past couple of years, as we expanded and retooled our sales force globally. However, in 2013, we expect some decreases in both sales and marketing and general and administrative expenses, which will partially offset the higher R&D.

Our estimated annual effective tax rate is 25%, which factors in the recently signed tax legislation that reinstated the US R&D credit for both 2012 and 2013. We expect to recognize a discrete tax benefit of approximately $4 million in Q1 for the 2012 R&D credit. This will reduce the Q1 effective tax rate to approximately 12% to 15%, with a planned 27% rate for the remainder of the year, for an overall blended effective tax rate for the year of 25%.

Our revenue and non-GAAP EPS guidance reflects an average euro-to-US-dollar rate of $1.34.

In terms of the shape of the year, we expect revenues to be back-half loaded, which will put pressure on earnings for the first half of the year. In addition, we believe Q1 will be the low point for the year. In Q1, we anticipate revenues will be 10% to 15% lower than Q4 2012, due to expected timing of projects impacting margins and earnings in the quarter.

Our guidance assumptions are subject to change as the year progresses; and as a reminder, we will update this 2013 guidance as part of our Q2 earnings release call later in the year.

With that, I will turn it over to Philip.

Thank you, Steve, and good afternoon to everyone on the call. I will use my time today to expand on 2013 and share with you what my priorities will be as CEO of Itron.

After my first 45 days in the new role, I can tell you that I have never been more proud to be a part of Itron. While we are facing some headwinds in 2013, I want to underscore that Itron is a strong and successful company, with substantial opportunities for growth and increased shareholder value.

Let me begin with my view of 2013. This year, we will be focused on building our core business and preparing for new large projects that are developing around the world. Specifically, this means growing our revenues around the world, with the exception of Electricity revenues in North America, further improving our gross margin, and a targeted increase in R&D spending for an expanding international market.

Given the goals of increasing our backlog and growing market share, we must continue to build out our product and systems to pursue the most promising opportunities across the global gas, water, and electric markets. We are strengthening our electric-metering platforms for critical markets, including France, Spain, Japan, Hong Kong, the UK, Brazil, and Australia. We are pursuing solid-state metering in gas and water, gas telemetry, and water-loss management and will launch a heat-cost allocation solution in Europe in 2013 to open a new market for Itron.

In the US, we are also investing in a unified platform for Consumers Energy, Duke, and the Los Angeles Department of Water and Power that allows for integrated cellular, mesh, and RF systems. As we anticipated when we acquired SmartSynch last May, customer interest in cellular is increasing. Our recent announcement with Qualcomm keeps us at the forefront of cellular technology here in the US. It also broadens our portfolio for international bids, such as Tokyo Electric Power Company.

We will also continue to invest in our Itron-Cisco platform in 2013, both in terms of technologies and geography. We are very happy with the success of our smart-grid projects with Cisco, and we have additional very encouraging projects developing around the globe.

I am mindful that the level of R&D expense this year is higher than many of you may have modeled. Our increased product investments are targeted to specific requirements in markets with mandates and funding. In 2012 and 2013, we have significantly shifted our R&D focus from legacy products to forward-looking investments and from US to rest-of-world opportunities, and that is where the bulk of our R&D is allocated.

With that, let me provide an update on key developing projects we are tracking. In Energy, we were delighted to see our field trial at National Grid expand to a full pilot and to be selected by NiSource for their northern Indiana gas and electric project. We are also tracking forthcoming regulatory approvals where we have been selected at Duquesne Light and FirstEnergy. We also have expansion opportunities at Con Edison of New York and CenterPoint, in addition to several other large electric and gas projects in North America.

There are more projects coming up for bid internationally than are pending in North America. In France, the ERDF Linky mass rollout tender for 5 million to 7 million meters is anticipated by mid year, with awards in December. We are fully engaged on this tender.

There is also a second project at ERDF this year. They are expecting to concurrently tender a small 4,800-meter pilot to test interoperability for their second-generation meter, referred to as G3. We have indicated to ERDF that we do not plan to bid for this pilot. While we have G3 power-line carrier capability, supporting the pilot requires us to redirect the skilled PLC resources that we think are better utilized at this time to deliver on the G1 mass rollout. Itron will bid for subsequent G3 mass rollout tenders.

Spain's IBERDROLA tender for 1.5 million PRIME PLC meters is expected in the March timeframe. Itron's meter will be certified for this tender. We are also working on smart-meter opportunities that should come to market this year, and for which we believe we are well positioned, in Ireland, Hong Kong, Australia, Indonesia, Brazil, and Ecuador. And, we are working on multiple gas opportunities across Europe, India, and Asia.

The other major opportunity is for 27-million meters at TEPCO. This opportunity is still in a multi-stage process, and Itron remains deeply engaged. The system integrator and participant selection is expected in the first half of this year. Delivery of the initial pilot volumes is planned for early 2014. The expectations are for 5 million meters to be deployed in the first three years of the project, starting in 2014.

In the Water segment, Marcel Regnier and his team are soundly executing our water strategy, driving growth in existing and new markets for Itron. There are significant opportunities for water and thermal solutions across all geographies. We are competing for 2013 deals in the US, France, Ireland, India, and the Middle East. In addition, we have been awarded some key water contracts in the US, which we expect to announce shortly.

Before we take your questions, let me close with a few words about my priorities as Itron's CEO. I spent the first weeks in my new role working with my team to establish clear imperatives that will become the foundation for Itron's success. These imperatives are -- commitment to quality, collaboration for innovation, investing for profitable growth.

We are committed to improving the quality of all of the products and services that Itron delivers to our customers and continuously increasing the quality of all aspects of our business. In 2012, we strengthened our internal and vendor-quality programs to drive consistent, sustained progress and clearly measure improvement. We have already seen an impact in 2012 from improved quality, an impact that directly benefits our margin. Quality was critical to me as the head of our Energy segment, and it remains a top priority to me as CEO.

My focus on collaboration encompasses our internal Itron team and extends to our world-class technology partners. Collaboration speeds up the innovation cycle, and that is the core value of this effort. We are building collaborative teams, focused on global platforms, that will enable us to pursue more opportunities with greater efficiency. Our expanding work with Cisco and new relationships with Panasonic, Qualcomm, and Deutsche Telekom are crucial in a world in which digital-connected devices run on open standards. We are leaders in this industry transformation, and I believe that this type of collaboration drives innovation at a rate faster than any company can do alone.

My comments today should make clear my focus on investing for profitable growth. We are investing to speed innovation, to increase our share of demand, and to expand our markets. Some of this investment is in-house R&D. In the case of cellular technology, the acquisition of SmartSynch made the most sense. We will also continue to invest in the partnerships that I just mentioned.

My focus is squarely on profitable growth. While we are making targeted incremental R&D investments in 2013, I am firmly committed to ensuring that our operating expenses, over time, will decrease as a percentage of revenue.

We will also continue the solid work we have begun on global efficiency and improving gross margin. This is of such high importance to me that one of my first moves after being appointed CEO was to ask John Holleran to take on the position of Global Chief Operating Officer. John will work to lead further actions to drive better performance and lower costs for Itron's operations around the world. And to help drive our growth strategy, I have appointed Russ Vanos to a new role at Itron to lead Strategy and Business Development. Russ, an Itron veteran, an industry expert, will build a clear road map for all of our growth initiatives moving forward.

Let me close by saying that Itron is the leader in our markets today, by share of demand as well as innovation. As the industry continues to move to smart technologies, we see tremendous opportunity for Itron. It is our time to widen Itron's lead by aggressively pursuing new global business opportunities where we can bring new innovative solutions to market.

As tenders for new projects around the world move forward in 2013, coupled with further efficiencies we are driving in operations and costs, we anticipate a return to top-line growth and accelerated earnings generation by Q4 of this year and in 2014. I look forward to talking with you about our progress in our future calls.

With that, let's open up the call for your questions.

(Operator Instructions)

Zach Larkin, Stephens.

First off, Steve, I wondered maybe could you give us a little bit more color on the sales and marketing and the G&A line? I thought the color on the product development was really great, but is there a run rate we should think about, plus or minus, from a quarterly perspective on the sales and marketing and G&A, as we contemplate how to think about those two cost line items through the year?

Yes, Zach, this is Steve. In terms of the level of spending in those areas, we view that to be fairly consistent throughout the year. Sales can fluctuate a little bit with revenue, but generally, is pretty consistent. And, there is a bit of a down trend over time as some of those cost efficiencies are in. So, we're looking at down 2% percent on a year-over-year basis overall; and again, offsetting some, but not all of that, that increase in the R&D expense on a year-over-year basis.

Okay, thanks. And then, maybe just one more. Philip, you mentioned Brazil and some of these other areas of the world as being new opportunities. Could you talk through how different some of the technology architectures are versus some of the other global markets that you focus on?

Sure. Great question. Brazil, there are not only different meter technical requirements in those markets, but also, in many cases, communication differences. Brazil, it would be a mixture of an RF-mesh market with some cellular communications, most likely. Some of the other markets -- our China Light and Power project is a power-line carrier pilot. So, there are -- and each of these communication technologies must be certified for the local market as well as variations in the type of meter that is used in the local markets.

All right. Thank you very much.

John Quealy, Canaccord Genuity.

A couple questions here. First, I'm sorry if I missed it -- the sequential drop off in margins in the water business, I understand there is some relocation or some things going on, but it was quite marked -- marketed, could you talk about what was driving that quarter to quarter in water?

Yes, John, this is Steve. It was primary one-time items that related, as mentioned, to a couple of activities, in terms of the core direct margin, we're comfortable with actually how we did over the course of the quarter. But, there were a couple items that came through, as I mentioned, that impacted the results for the quarter itself, but we don't see as reflective of water's margin capabilities going into '13.

Okay. Thank you. Steve, while I have you, free cash flow of $155 million last year -- can you sensitize '13 for us about what we should be thinking about, given that some of the OpenWay stuff has been fully baked, excluding DTE at this point?

Yes, John. Our 2012 free cash flow yield was about 7%; and as we look into '13, we see that in the 6% range, plus or minus. And drivers for that, a couple things -- we see our cash tax expense increasing a bit in '13 versus '12, as we continue to use up loss in other credit carryforwards quite well as we continue to be profitable.

We think CapEx, it tends -- it will stay at about 3% of revenue, but we think year over year could increase a bit as we invest in some additional equipment. That will help drive some of the cost savings Philip talked about. And, the rest would come from some of the change in the EBITDA, and there is some other movement. But, I think a 6% number is appropriate, I think, at this point.

We're pleased with some of the working capital improvements in the fourth quarter, reduction in inventory and all, so we will be closely focused on driving and maximizing cash flow, given next year's outlook -- this year's outlook.

Thanks. Philip, two quick ones for you. First of all, can you expand a little bit on the international markets? I know you did a great job, but Turkey, I think, has been coming online, especially with some US governmental help about trying to really deploy smart grid generation meter-type technology, so if you could speak to that as a potential for us?

And then, lastly, I think this is the first time I have ever seen smart cities mentioned in an Itron press release, and I wanted to talk about -- is that foreshadowing for acquisitions, Philip? Or, am I reading too much into that? Thank you.

Great. John, thank you. Two great questions.

International opportunities, specifically Turkey, of course, with the great announcement of AKSA gas this year -- last year, which will be rolling out this year and for the next several years. Then, you commented on some US-supported projects for conversion of the electric grid, which is a situation we're following closely. Turkey is a very promising market, across electricity, gas, and water, actually, for us. The market development there is the privatization of a number of the cities in Turkey that will create some great smart metering opportunities for us. So, we are following that very closely.

The reference to smart cities, absolutely, you will be hearing more from us about that. At DistribuTECH, we did talk about that. We see tremendous opportunities in the convergence of electricity, gas, and water data with other sources on the smart grid. Part of the activity that you see working with Cisco and Qualcomm, who are talking about the Internet of Everything, is getting involved in larger networks that allow us to integrate information to generate new insights. And that, again, creates opportunities for us in further connected points in those extended grids and analytic and data collection opportunities for us as well.

Anything else, John?

No, that's good. Thank you very much.

Sanjay Shrestha, Lazard Capital Markets.

A couple of questions. First, I just wanted to talk about the guidance for '13, here, a bit more. When you previously talked about '13 versus '12, it was plus or minus 5%, and I understand R&D does impact that EPS number a bit more. So, just wanted to understand -- is there some conservatism there with this number here, or was there anything that maybe changed a bit, that got pushed to the right? And, one final point of clarification on that -- what are you expecting SmartSynch to contribute to the top line in 2013? Thank you.

Sanjay, I will start -- this is Steve, and Philip will add as well.

In terms of SmartSynch overall, let me start with that -- our guidance, certainly includes the contribution of SmartSynch, and we're -- which we now have folded into Itron Cellular Solutions, or ICS. So, we look into '13, we do see improved revenue in '13 as we start to roll out certain projects; but as I mentioned in my earlier remarks, we also have included in our guidance increased R&D spending related to the next-generation products. We talked about that in the last earnings call as well -- the move to 3G, but that is included.

In terms of growth in that piece of our business in ICS, which is now a part of Electricity, we really see that significantly changing in 2014, rather than '13, overall, so not contributing meaningfully to the earnings number in '13 overall. In terms of the shape of guidance overall, Philip mentioned as well, it's really the R&D investment. It is from a heightened level. We have looked closely at that and have really buttoned down the priorities and the projects that are in place. As I mentioned, we see that up about $10 million to $15 million, but again, offset by reductions and savings elsewhere, not completely offsetting.

The real story is on the revenue line, and it's that sequential decline in the 12-month backlog, which is predominantly due to the large OpenWay contracts rolling off. And, the real issue in terms of the timing and the back-half shape is the timing of the tenders and when those are really going to come into place, and we see that in the second half of the year. But in terms of the timing of that, that's always -- there is some uncertainty associated with that. And I think that is certainly partially reflected in our guidance overall.

Okay, that's fair --

Sanjay, I think as we built this plan from the bottom up, we had provided -- LeRoy had provided an initial view, and as we have refined the business plan from bottom up, I think we have gotten a much clearer view of '13, which has led us to that top-line guidance.

Okay, fair enough. One quick follow-up, guys, if I may -- and I understand it's really not '13 earnings for you, it's really more about '14 and beyond. That leads me to my next question, which is -- Philip, you talked about IBERDROLA Spain, a lot of the European opportunities, TEPCO, and clearly, R&D investment -- SG&A number probably directionally coming down. So, how do we think about your margin, going forward, as more of this international business starts to hit your P&L and that '14 margin expansion, revenue expansion, earnings trajectory, and beyond that -- how do we think about that from a big-picture?

Yes, great question, as -- so of course, we are projecting a nice improvement '12 to '13. And we have commented before that projects like IBERDROLA and ERDF, which are highly competitive tenders, are challenges to us. But, there are very attractive margin opportunities in other parts of the business.

Steve mentioned the fact that 11 out of 12, that is across 4 geographies and 3 business lines, we have growth across gas and water in these geographies at more attractive margin profiles, and some of these large electric deals still are very promising. And, our goal in investing in these systems, of course, is to maintain or improve the gross margin that we can achieve, as opposed to just being relegated to being a meter provider. So, we have a very strong drive on the systems side.

Okay. That's all I had. Thank you so much, guys.

Paul Coster, JPMorgan.

I do appreciate that sales and marketing will be trebled back slightly next year, but it's quite elevated as a percentage of revenue relative to where we were in '11 and even parts of 2012. Sales and marketing expense has gone up for a couple of years now, despite the fact that revenue has come down. Most of us think of it as a somewhat variable expense. Can you tell us what's going on there? And, it sounds like you are investing -- and maybe it's something to do with this international reach that's forcing out?

It absolutely is, Paul, thank you. We have spoken about the fact that we are investing more in Latin America and Asia Pacific in order to expand our markets there. Our traditional strength, of course, has been in North America, and Europe, the Middle East, and Africa. We do see these expanding opportunities in these other markets, so we have strengthened our sales and marketing presence in those markets. We have also discussed that, as we move beyond the meter to these more complex system sales, that there is a somewhat different profile to the sales team that we are putting out in the field, and there are some costs to adding to our capabilities in that regard, even in the European market.

Got it, okay.

As you think about the strategy for the Company, and one of the things which was clear from DistribuTECH is the application layer on top of the smart grid is actually growing, particularly customer-engagement software. Is that something you are interested in? Can you talk about the long-term strategy? Are we locked into, primarily, a hardware business here? Or, do you see yourself moving up the value chain?

Paul, we absolutely see ourselves moving up the value chain. We have the largest market share of the meter data management market on a global basis. And, the reason that we focused on that layer of the system is because we feel that if we can collect, store, and then start to analyze that information, it allows us to deliver more value to our customers. So, we are collecting and storing a massive amount of information across electricity and gas and water for our customers, which we think positions us very well for the developing applications, and even ultimately, a recurring-service market in order to deliver analytics to our customers.

Any sense of the timeline there?

It's developing -- we have announced several products on the analytics side, and I would expect that at latter half of '13 into '14, that we are going to see more there. And, the announcement of Ross Vanos to focus on this growth strategy really is around firming up our position in those markets.

Thank you very much.

Sean Hannan, Needham & Company.

Actually, both questions I have are really cost-focused here. I wanted to see if I could bring up -- first, looking at the gross margins, I think year over year that change is pretty well understood, and you have partly addressed some of the one-time scenarios, and touching on the dynamics that we saw in water for the pressures going from the September to December quarter.

But, can we step back a little bit? Just give us a little bit better perspective on how we declined sequentially on better revenues? And then, how we have comfort on what drives your margin expectations in '13, particularly how dominated that might be by the anticipated mix, et cetera?

Sean, this is Steve. We -- as I mentioned in the prepared remarks, we did, over the course of the year, see margin improvement over lower revenue. And, that really came from seeing the results of the efforts that are underway to reduce procurement costs, to reflect the restructuring activities we announced a couple years ago, and there is also the benefit of improved quality in the form of lower warranty expense. Those are some of the key drivers, but there are additional efforts underway in terms of cost reduction.

I think at a high level, I'll say that in terms of ASPs and resolving that type of pressure, but we really are making good progress on the cost side. And that's, as Philip mentioned, going to continue to be the main focus for John Holleran and his team. We went into the year, into 2012, with an expectation of 32%. That was a big improvement over the prior year. And over the course of the year, we saw better margins, over time, such that for the year is 32.8%. Yes, there was some impact in the fourth quarter, and there are [top-end] situations where we have some warranty or other charges, and that's reflected as well.

So, as we think into 2013, and we did the bottoms up and look at the mix of products and the continued improvements in cost, that is reflected in the 33.5% margin expectation for the year that's underlying the guidance. And, we really don't see the fourth quarter as reflective of a new run rate. We see that as really reflective of some activity and some assessments in the fourth quarter.

Okay, that's helpful.

Then, a follow-up to that -- getting now into the OpEx, and sorry if we're beating a dead horse here. I understand, and I think we all do -- understand the need to spend here, particularly as you're getting prepared for Europe and some of the other geographies.

The question's, obviously, always around spending wisely, and just wanted to see if we could discuss a little bit more about how perhaps that step up in R&D, as well as in considering where the elevated sales and marketing levels are -- how that should be thought of as perhaps being sustained, really going forward years, or is -- how much this is more specific to '13 and early '14, due to a lot of that positioning for those ramps and other opportunities?

Sean, thanks. I am, as I said, absolutely committed to reducing the level of OpEx in relation to revenue over time, and I do see this as, and referred to it as, an elevated level of spending in '13 in order to qualify for this range of markets. The goal is to contain -- absolutely contain that level of R&D spending as revenues do increase. And as we talked about, these slight offsetting reductions in sales and marketing and G&A, John Holleran's focus is to continue the trend on those reductions for us to continue to drive for greater efficiency. So, I do not see a long-term trend here. I think this really is a stand-out investment year on the R&D side.

Okay. Thank you.

Vishal Shah, Deutsche Bank.

Hi, this is Susie Min calling for Vishal Shah.

Wondering if you could dig a little bit deeper as it relates to -- I know Steve, you mentioned that going forward, you're working on improving your gross margin. Given that 2013 is kind of a transition year and the second half of this year will be backloaded, how should we think about gross margin in light of that as well as the fact that you're working on cost reduction and lower warranty expenses, et cetera -- so, I guess, would it be evenly -- will you see the improvement through the second half of the year? Will it be evenly disbursed? And, how [big] could gross margin be?

This is Steve. We see some commensurate with the shape of revenue over the course of the year that, while the gross margin for the year will be 33.5%, will be improved in the second half with higher volumes and with a fuller reflection of some of the other cost-savings initiatives, reflecting a more of an average of 33.5% over the course of the year.

Okay. Then, as it relates to the actual mix between energy and water, can you give any additional color on your expectations for the year?

The relative ratio of water will go up on a relative basis. Within energy, you might see a little mix increase as well in terms of gas, and that, again, is a reflection of the decline in the North America electricity. So, on a relative basis, as Philip mentioned, the water business grew nicely in 2012, and as Philip mentioned, we see growth in that area. On a relative percentage, it would be a bit more weighting on both water, relative to the Energy segment, and within energy, a bit of a shift into gas, but not material there. I'd view it more in terms of a little bit of a mix increase in water.

Okay. Great, thank you.

Amir Rozwadowski, Barclays.

I know we've touched on this sort of investment year thesis for a bit now, but if I may, just one more question along those lines. It does seem as though you are tracking a number of opportunities on a global basis, and I just want to understand -- have you received specific specifications from these opportunities, whereby you are now investing in order to ensure that your product portfolio is well positioned to capitalize on these opportunities? Or, is this -- should we view this as some potential holes if your product portfolio that you're anticipating wins down the line, or potential standards down the line, in order for you to meet those standards?

Amir, thanks. Yes, I commented on that we really are pursuing identified projects with specified requirements in markets that have mandates or identified funding. So, there is very little speculative investment here, in terms of build it and they will come. These are focused -- very focused opportunities with known requirements.

If I may -- I know it's probably looking a little bit further out than the crystal ball allows at this point, but you did comment that you expect accelerated revenue and earnings growth starting, probably, in the tail end of this year. Should we expect 2014 to be a bit more of a healthy growth environment from an overall installation perspective?

Yes. That affirmative answer is based upon pilots that we have already won, and are in the process of deploying, that have ramping schedules that begin to add up in the second half of the year, as well as the declared deployment intentions of our customers on a number of large tenders and other project opportunities. So, yes, we expect 2014 to be a healthy year for growth.

And then, if I may, just one last question. Can you comment on the pricing environment for some of these new projects that you see out there? Is it increasingly competitive, or do you see it in line with historical trends? Any commentary along those lines would be very helpful.

First, I'd like to point out the strength of the gas and the water businesses, and the strength of the gross margins in those markets. We have done a really nice job of maintaining selling prices and strong gross margins across the gas and the water businesses, and we see that continuing. There are some specific electric opportunities that have very competitive bidding, but those are only a segment of the electric market. There are some very large projects in which we have the opportunity to provide meters, communications, and services that give us a healthier margin profile, as well as I would point out, significant opportunity in the small and medium end of the market in which, traditionally, margins remain healthier. So, it is a diverse market. There are some very competitive markets, but we are, actually, doing quite well at maintaining selling price and overall gross margin.

Great. Thank you so much for the incremental color.

Chris Kovacs, Robert Baird.

Seems like you have had a good amount of strength recently, or a little momentum, I guess, on the gas side with a few multi-100,000 meter endpoint wins. What would you characterize as the biggest reason for this recent success? Is it new products you are introducing? Is it a new sales strategy? Have the competitive dynamics changed at all?

Thanks. The competitive dynamics have changed, and I think these comments may refer a little bit more to North America -- a couple of very large announcements there, in which we have seen an opportunity in the market and are pouncing on it to increase our market share. And, it is based upon our very strong market position with our gas endpoints that we are using our sales force to bring along the meters, as well, in a very aggressive fashion. US-based market share has improved very nicely, which you see in those announcements.

Okay. And then, not to harp on this too much, but on the R&D side, it sounds like you have a few pretty large projects coming up for tenders on the international front, maybe in the first half of the year. Should we think about R&D maybe being higher in the first half as you qualify for some of these opportunities and those projects start to maybe roll out, in terms of being awarded in the second half of the year, that kind of slows a little bit?

Yes, would that it were so. No. I think the prudent thing to do is to think of it being relatively flat. It is frustratingly difficult to complete projects in a six-month period and/or to control headcount, to dial headcount up and down, and in that way these are complex systems. So, the prudent thing to do would be to model it as flat.

Okay. Thanks, guys.

That does conclude the question-and-answer session. I will now turn the conference back over to you for any additional or closing remarks.

Thank you. I'd just like to make final comment here, which is -- our revenue in 2013, this is our best view. It is what it is, and we are excited about the tender opportunities. We don't control the timing. We will provide you updates as we make progress on these. We do, clearly, believe there is a substantial opportunity.

To the question of -- are we being conservative? I really think that we are being prudent. Coming out of an interesting revenue year in 2012 and a decline in backlog, we really have studied this very closely and are giving you our best guidance. The gross margin really is a huge focus area. Again, where John Holleran will be targeted -- where there is additional room for improvement you see from '12 to '13, we will control the OpEx and investment line very carefully and report back to you to as we are qualifying products and making progress against these tenders. And, I think that will give much clearer visibility into 2014.

We are energized and excited about the year, and it's great to be on the call. I look forward to providing more updates to you on subsequent calls. Thank you.

Thanks very much, everyone. Thank you, Justin, we will end the call now.

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 of 4441088. Or, go to the Company's website at www.itron.com.

Again, that does conclude today's conference. We do thank you for your participation today.