Itron Inc (ITRI) 2013 Q1 法說會逐字稿

Good day, everyone, and welcome to the Itron Incorporated Q1 2013 earnings conference call. Today's call is being recorded. For opening remarks, I would like to turn the conference over to Barbara Doyle. Please go ahead, ma'am.

Thank you, Cecilia, and good morning to everyone. Welcome to Itron's first quarter fiscal 2013 conference call. On the call today will be Philip Mezey, Itron President and Chief Executive Officer; Steve Helmbrecht, Itron Executive Vice President and Chief Financial Officer; and John Holleran, Itron Executive Vice President and Chief Operating Officer. After our prepared remarks conclude, Philip, Steve and John will take some questions using the process that the operator described.

We issued a press release earlier today announcing our results. The press release includes replay information for today's call. We have prepared slides to accompany our remarks in this call 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 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. These statements are based on current expectations and assumptions that are subject to risks and uncertainties. Actual results could differ materially from these expectations because of factors discussed in today's earnings release and the comments made during this conference call, and in the risk 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 I'll turn the call over to Philip Mezey.

Good morning, everyone, and thank you for joining today's call. I will begin the call with some comments on Q1 and current market dynamics and provide an update on key opportunities. Steve and John will cover the business results in more detail, then I will conclude the call with some remarks on the balance of [2014] before taking questions. Q1 was a tough start to the year. There is no doubt about it.

As we discussed on our Q4 call, we expected a slow start. Revenues in the quarter were at the low end of our expectations. We did see volumes pick up in March but not enough to cover a shortfall in January and February. But I would not call the softness across the board. We had some orders in the quarter delayed and we did see weakness in certain geographies. On the other hand, we also had some projects that ramped up and accelerated. So a combination of factors impacted our results, on which John and Steve will elaborate.

What are we seeing in terms of market dynamics? First, I'd say our level of core business remains solid. When you normalize for the top five OpenWay projects in 2012, our Electricity revenues performed well. Our Water segment revenues increased modestly in Q1 and we continue to anticipate growth in Water for the full year. The good activity in core Electricity and our Water business was offset by lower gas revenues in the quarter.

We attribute the softness in the quarter primarily to project-specific issues, but I won't dismiss the effect of economic weakness in certain regions. Revenues held up fairly well in North America. In certain European countries, utilities are moving cautiously under current economic conditions. And we are seeing a slowdown in Latin America residential business overall. On the other hand, Iberdrola issued a tender last week for 1 million meters and projects at ERDF, GrDF, ESB in Ireland and several others are poised to move forward this year. The global economy presents some headwind this year but the challenges we are facing in 2013 are largely timing-related.

Itron's innovation is thriving. Our quality continues to improve and new projects around the world are advancing. While the pace may not be what we want, our customers are telling us that they are committed to smart technologies and many are moving forward. Adding intelligence to the grid and driving operational savings are critical to their future and to managing the world's resources, and here are some examples. In March, I attended the 1 million meter and gas module celebration at Detroit Edison. I am pleased to report that our customer is very satisfied. They have achieved 135% of their business case on the meters installed. As a result, they are considering accelerating the deployment of the remaining 2.2 million meters and gas modules over the next five years. We look forward to continuing this successful partnership in Detroit.

Our 5,000-meter pilot at China Light & Power is also moving forward successfully. We have achieved better than 98% read rates on the meters in an extremely complex environment. Hong Kong is a dense vertical city, with the majority of its population and residential meters in high-rise apartments. Communications have to occur horizontally and vertically, presenting unique challenges that we effectively navigated for this project. Given the success of the testing, the project has advanced to the customer engagement phase. CLP has reported that consumer interest for the new meters has been strong in the initial weeks of their campaign.

I'm also encouraged that Iberdrola issued their tender for 1 million AMI meter. Itron's PRIME meter has qualified and we will bid on the tender. In an auction tender process, we expect the pricing will be very competitive. Iberdrola is a great Itron meter data collection customer and we are delighted to further extend our relationship with them. We expect Iberdrola will announce the award this quarter and the meters to be installed over the next 12 months. At ERDF, we continue to anticipate that the next tender for up to 5 million to 7 million Linky meters will be made by mid-year with awards in December.

And in Japan, for TEPCO, we presented recently with our partners Panasonic and Cisco. We expect notification on the selection of systems integrator for head-end and communications within the next quarter. Tendering from metering is expected in Q4 of this year. TEPCO has indicated their intention is to install the initial tranche of 5 million smart meters starting in 2014.

We remain focused on these and many other opportunities to help our customers modernize their grid and distribution systems. These opportunities require investment in product development, sales and marketing, which is reflected in our financials and our forecasts. We will continue these investments as I remain confident about our industry's growth and Itron's ability to lead the transformation to smarter grids and smarter cities. Now I'll turn the call over to Steve to cover the financials.

Thank you, Philip, and good morning. Today, I will cover our consolidated financial results and capital activity, then turn the call over to John for a discussion of our segment business performance. I'll begin with slide 4 which summarizes a revenue bridge for the quarter as compared with the prior year. Lower revenue from the top five OpenWay smart grid projects drove the decline, as four of these projects were substantially completed in the third quarter of 2012. OpenWay revenues in the first quarter were $12 million compared with over $130 million in Q1 '12.

The roll-off of these projects drove the majority of the year-over-year impact in revenue, gross margin and operating profit in Q1. We still have about $263 million in backlog for these top five contracts, which we expect will be recognized over the next few years as Detroit Edison continues its rollout. Currency fluctuations and a stronger US dollar reduced revenue by $5 million. Excluding these items, we saw growth in our Electric and Water businesses and a decrease in our Gas business.

Slide 5 summarizes the year-over-year bridge for non-GAAP EPS. Gross profit dollars were down, primarily due to the decrease in North American OpenWay contract revenues. Non-GAAP operating expenses declined 3% compared with last year, with decreases in sales and marketing and G&A, reflecting our focus on reducing expenses in these areas. Decreased other costs and a lower tax rate resulted in benefits of $0.12 a share compared with last year. The tax benefit in Q1 was driven primarily by the recognition of 2012 R&D tax credits of about $4 million due to the US federal legislation passed at the beginning of this year.

Slide 6 provides a summary of the key financial metrics for the first quarter. Revenue in the quarter declined 22% over the first quarter of 2012. Gross margin was 31.3%, down 70 basis points over last year. Benefits from efficiencies and lower warranty expenses were offset by the impact of lower volumes. Non-GAAP operating margin of 3.3% was down 6 percentage points year over year, driven by the lower revenues in gross profit. Adjusted EBITDA margin of 6% was down 5.8 percentage points year over year, on adjusted EBITDA of $27 million, reflecting the lower gross profit and operating income.

GAAP diluted earnings per share was $0.06 for the quarter, compared with $0.63 in the first quarter of 2012. Non-GAAP earnings per share, which exclude the impact of restructuring charges, acquisition-related expenses, and amortization of intangible assets and debt fees, were $0.31 for the quarter compared with $0.91 in 2012. The decrease in our GAAP and non-GAAP earnings was driven by the lower gross profit from decreased revenue, partially offset by the tax benefit from the recognition of the R&D credit for 2012. Free cash flow for the quarter was negative $14 million compared with a positive $42 million in the first quarter of 2012. Obviously, this is a significant decline, which is driven by the lower net income coupled with increases in working capital.

Our results in Q4 and a slow start to this year resulted in lower cash flow from accounts receivable as well as higher inventory levels, both raw materials and finished goods. In addition, operating cash flow was negatively impacted by a reduced accounts payable balance. The increase in inventory levels from year-end relates to future order activity in the year. Looking ahead to Q2, and the remainder of the year, along with improved earnings, I am focused on reducing our working capital balance and closely watching our level of capital expenditures to improve cash flow.

Now turning to capital. In March, our Board authorized a new one-year share repurchase plan for up to $50 million. Our initial pace in March was slow as we got up to speed with the new program. Our level of activity has increased in April, and as of yesterday, we have repurchased about 57,000 shares at an average price of about $44 for a total of $2.5 million. This builds on the repurchase of more than 2 million shares for a total of $77 million under our prior plan which expired in February. We finished the quarter with about $400 million in debt. In the near term, my focus is on improving our working capital metrics to increase free cash flow.

In closing, we had a slow start to the year, which had a negative impact on our earnings and cash flow. Our balance sheet is strong, and gives us a lot of flexibility. We remain optimistic about opportunities for new business to drive revenue growth and are taking measures to improve our cost structure and margin profile. With that, I will turn it over to John.

Thanks, Steve, and good morning. I'm going to review the results for each of our business lines. I'll close with some comments about continuing priorities for the balance of the year and then I'll turn the call back to Philip. Start with Water on slide 7. Revenue was up 1% year over year and one of the main drivers was an increase in professional services. However, gross margins dropped 36% to 33% because the margins on those same professional services related to our Cleveland project were lower than projected due to some unexpectedly high installation costs. We're pursuing several alternatives so that we can fix this problem as soon as possible. Non-GAAP operating expenses were flat year over year, but the non-GAAP operating margin was down 250 basis points due to the lower gross profit.

Regionally, North America Water posted a pretty good quarter, with revenue up 17% year over year. However, gross margins fell as a result of the professional services component that I just mentioned a moment ago. EMEA and Asia-Pacific revenues were basically flat year over year, and gross margins in each of these regions were down slightly due to product mix. Latin America revenue and gross margins were down year over year, a result of some orders in Brazil that we expected in January but didn't receive and start to ship until late March. We expect to catch up on these revenues in the second quarter and see an improvement in their gross margins.

Now let's move to Energy on slide 8. I'll cover the segment information first and then I'll discuss both Gas and Electricity separately. Energy revenues were $313 million in the first quarter of 2013 compared with $438 million in the first quarter of 2012, reflecting the run-out of our top five OpenWay projects. Excluding the revenue from our top five OpenWay projects, our segment revenues year over year were down just 2%. Gross margins were essentially flat. Non-GAAP operating expense was up about $600,000 from the prior year, but that includes almost $4 million of incremental operating expense from the SmartSynch acquisition. However, Energy non-GAAP operating margin fell from 10.8% to 2.5%, which reflects the impacts of lower shipments during the quarter.

Now turning to Gas. We got off to a disappointing start in the first quarter. Year over year, revenues were down about $16 million, or 10%. About $3 million of the drop was from -- was related to the sale of our stations business in the Netherlands last year. Regionally, Gas revenues were down in North America, EMEA and Latin America. Asia-Pacific was up year over year.

In North America, we started slow in January and February, but picked up in March, just not enough to catch up with the early softness, and North America continues to be strong in April. EMEA is a bigger issue as we saw several utilities substantially reduce their spending and our customer in Italy suspended its purchases of commercial and industrial meters indefinitely. As we see utility stretching and drawing down inventories, I think we're seeing the impacts of the slowing economies in some of the EMEA countries and some uncertainty on the timing of the larger meter rollouts.

Turning to Electricity, overall Electricity revenues were $176 million compared with $284 million in the first quarter of 2012. Regionally, we exclude the revenues from our top five OpenWay contracts for the comparable periods. North America revenues were up 26% quarter over quarter, showing good strength in our underlying business. EMEA first -- excuse me, EMEA first quarter revenue was also up slightly, but we are seeing some market softness as the utilities have started working off inventories. However, there is at least one encouraging sign that utilities are getting closer to switching to smart meters. Several utilities have been increasing the number of meters sent out for repair.

Based on prior experience, when we see utilities increasing the number of meters sent out for repair, it's a sign that they're getting pretty close to moving to a new generation of meters. Asia-Pacific was a good story. Although revenues in Asia-Pacific are perhaps small in relative terms, they are growing and their revenues were up year over year. A big challenge in Asia-Pacific is our business in Indonesia which continues to be price pressured by Chinese manufacturers. Latin America revenue was down as utilities delayed decisions to move to smart grid and smart metering. Most of the revenue pressure is in Brazil where the government has decided not to push utilities into making grid improvements despite the fact that they're getting ready to host both the World Cup and the Olympics in the next few years, and utilities continue to experience significant technical and non-technical revenue losses.

As a side note, I recently attended our African Users' Conference in Cape Town, South Africa. We had a terrific customer turnout with representatives from almost 100 different customers in attendance. As you know, we finalized the contract with City Power in Johannesburg to install a new meter data management system and deliver more than 250,000 smart meters starting in late second quarter. This is going to be our showcase project in Africa, and when we get our deployment underway and begin to demonstrate the benefits of the business case, I am absolutely convinced that there's going to be a lot of new projects coming to market. The excitement and the enthusiasm among our customers is just amazing and I think Africa will be a great opportunity for us over the next few years.

Moving to bookings and backlog on slides 9 through 11, bookings in the quarter were $447 million for a 1-to-1 book-to-bill ratio. Total backlog at the end of the quarter was $1 billion, and 12-month backlog was $565 million. We believe the diversity of our bookings across our businesses and geographies underscores our strengths. Among others, our Q1 bookings included a gas contract with National Grid for $30 million, a water contract with Las Vegas Valley Water for $20 million; in Asia-Pacific, we booked a contract to supply electric prepayment meters in Indonesia for $12 million; and in France, we booked a $12 million contract for ERDF for electric meters; and a $7 million contract for gas meters and devices with GrDF. And while the bookings include some of our early pilots and some partial project revenues, our bookings don't include revenues we believe we're going to be able to book at Consumers, Duquesne, FirstEnergy, National Grid, LADWP, Energy, City Power, FortisBC, and China Power and Light.

As Steve and Philip already mentioned, we had a slow start in the first quarter. Some of the issues were simply timing and we'll catch up in the second quarter and throughout the rest of the year. However, we can't ignore some of the themes that are emerging. First, growth will be slow across several of our businesses. Some countries in Europe will continue to slow their spending and adopt austerity plans and utilities won't be exempt. Second, we expect to see continued pricing pressure. Third, we are going to take actions to mitigate the impacts of the slowing growth and pricing pressure to help preserve and improve our margins.

The restructuring work we've done over the last 18 months to manage our factory capacity and reduce costs has already helped to mitigate some of these impacts. However, we still face challenges in lowering our fixed cost fast enough to meet the fluctuating volumes. In some countries like the US, we are able to meet the challenges with a flexible workforce of both permanent and temporary employees. However, in many countries, managing our manufacturing capacity with a flexible workforce will take more time to implement as we have to deal with stricter labor laws and negotiate with unions and works councils.

We're also sharpening our focus on purchasing. While lower volumes in 2013 may impact our purchasing leverage in some spending categories, we are kicking off new purchasing initiatives in spending categories like telecommunications, travel, and logistics. Better systems are giving us better data which enable us to better leverage our purchasing power. And we have a terrific new group of operations managers that are driving improvements throughout our system, lowering cost, improving efficiencies, and increasing the variable capacity of our factories through lean manufacturing.

Even though we've made significant improvements and worked hard to rationalize our product and manufacturing footprint, there certainly is still more that we can do. For starters, we've made some internal changes in the way we manage our business. The Water business has benefited from a strong business line focus. It has shaped its go-to-market strategy region by region, prioritized its product marketing and development needs, and focused its plans for future investment.

With that in mind, I recently separated the management of the Gas and Electric businesses, with the idea that each of those units would also develop its own go-to-market strategy, prioritize its own marketing and product development requirements, and prioritize its own strategic investments. At the same time though, I've centralized our R&D Group to maximize the use of global platforms, eliminate redundancy, reduce waste, and improve our time to market. We also centralized our global operations team. They are intensely focused on quality, lean manufacturing, process improvement and industrial excellence. We'll continue to have a regional sales and marketing focus in each of the business lines as we have to balance the need for local solutions with the efficiencies and effectiveness of global platforms.

I am a believer in operational excellence in all that we do, not only in manufacturing but in sales and marketing, research and development, and in the staff organizations that support the businesses. I'm a believer in quality and using the power of all the employees in our Company to improve and simplify processes and drive out waste and redundancy. And I'm a believer in Itron's future. While there are many things we can and will do to improve our operational and financial performance in the short term, the one thing we won't do is jeopardize our future by taking short-term actions that materially impact our ability to meet our customers' needs in the future.

And so in summary, on the operations side, we've seen steady growth in our Water business, which we expect to continue. In Electricity, we're still going to have some tough comparables through the third quarter as our top five OpenWay projects in North America continued to wind down, but the underlying business is good with the exception of some ongoing challenges in Latin America. And while the early going in gas was a bit of a disappointment, I like what we're seeing in March and April which suggests a pretty good recovery from what we saw in the first quarter. And finally, as always, we'll be working on the cost side of our business and making the tough decisions which balance short-term actions to lower costs with the longer-term objectives of growing our business and serving our customers. Philip, back to you.

Thanks, John. I want to comment on the balance of the year. While we'll update our guidance on our Q2 call, consistent with our policy, I will provide some color on what we anticipate for the remainder of 2013 and where we are focused. We said last quarter that we see 2013 as a transition year ahead of an expected increase in global smart meter projects. We said that we expected our financial results would be slower in the first half of the year, strengthening in the second half. We continue to forecast that revenues and volumes will increase through the year. We will also continue our focus on costs and expenses. As such, we are confident that margins and earnings will improve from the Q1 level.

Business in Q1 was, as expected, slow. We saw some orders moving to the right and ongoing economic headwinds. We also saw some positives. Our non-OpenWay electricity revenues grew 10%. We reduced our operating expenses year over year. We had some forward motion in Europe with the Iberdrola AMI meter tender. We are already working on a list of actions to help mitigate the impact of the slow start in Q1 on the full-year's results. We are going to preserve critical projects and review actions we can take to improve profitability in the near term. We will factor these items into our guidance update on the Q2 call.

As I said earlier in my remarks, the challenges we are facing in 2013 are largely issues of timing. I remain confident about Itron's long-term growth prospects. Our core business is stable, our backlog is sound, and the list of customers who have selected Itron provides good visibility for additional business that is not yet in our backlog. My confidence also comes from long-standing satisfied Itron customers that are achieving and often exceeding their business case for their projects with Itron. My confidence comes from Itron's technical innovation and strong partnerships. We deliver new products and innovation to our customers with high performance and high reliability. This gives Itron the strongest customer reference base in the industry. With that, let's open up the call to the question-and-answer session.

(Operator Instructions)

Sean Hannan of Needham & Company.

So a question on the water side. You had a pretty sizable decrease in the margins due to mix in the quarter. So from a hardware perspective, that was obviously down a little bit. Trying to get a sense of how you see mix changing in '13; it sounds there's a little more optimism as you're moving into second and third quarter. So just any perspective there would be helpful. Thanks.

Sean, this is John. I think the margin challenges we had on the Water side were not so much due to the hardware side of the business more to the professional services side. That's where we saw the challenge in the gross margins. And in terms of the confidence level and in seeing things pick up the rest of the year, we're seeing things pick up in March. We had some orders, particularly in Brazil, that slid from January to very late March, and we've really seen the shipment level pick up pretty well down there. So I'm feeling pretty good about water.

Okay. In terms of your quarterly bookings, those were down about 8% year over year, 4% on the quarter. Is there any more perspective you can provide around that? It sounds like that also, from your standpoint has some expectations to start ticking up a little bit as we proceed into -- a little further into the June quarter.

Yes, Sean, I agree with the observation about the bookings. We've really looked at that closely. We feel the bookings are strong. They vary just on timing issues on large contracts. As we've said many times, a significant part of our base business does not appear in that bookings numbers, and we have contracts that are coming online in the second half of this year, some of which do not appear in our bookings and backlog yet that give us confidence about the second half of the year. So we actually -- I think that the bookings performance in Q1 did not indicate some broader economic slowdown and which is why we're maintaining our confidence level in the second half of the year.

Okay, and then last question for the moment, it sounds like although you're not updating your guidance, and I understand the policy there. It seems that incrementally, the news, the communications, what you're observing in some of the general markets, particularly those abroad, that there may be a little bit of reduced expectations for what we could see in the back half of the year. Do you -- would you agree with that viewpoint? Is there perhaps a perspective that we should say there's a little bit more caution around how that second half materializes for you? Thanks.

Great, thanks. So what I'd like everybody in the call to notice is that we are really making a concerted effort to provide much broader color about geographies and our individual markets with these more detailed comments from John. So I want to make sure that we place context around some of the specific comments that John has made. Overall, with our geographic diversity and business line diversity, while there are certainly some challenges in specific markets, we have an excellent mix of business to mitigate some of the factors. But Sean, you're absolutely right, that the reason that we are pointing out some difficulties is we are really examining those tough markets, looking how we can offset them in other places and taking the time prior to this guidance update to understand what we can do to offset some of the economic pressure that we've commented on.

Sanjay Shrestha, Lazard Capital Markets.

I'm sorry, Sanjay. I just wanted to make a comment. So Sanjay, I'm sorry. I just wanted to make a comment that please -- remind everyone just if you can just hold your questions to, really, just two at the most. We do have a long queue and we want to get everybody in there.

Got it, okay. Good morning, guys. So first question right -- I'm trying to understand where you guys are coming from based on this [full-year thing]? What was the surprise element versus how you guys are looking at the world at the end of 2012 versus at the end of Q1 here? There's obviously going to be a lot of puts and takes, but I can tell you guys are pretty vocal that Q1 was going to be soft, there was going to be a rebound in the second half on the last call. Did anything change here at the end of Q1 that makes you feel increasingly more cautious? Like I think it was from maybe try and [pick-up]?

Sanjay, there were -- yes. We were surprised by the slowness of January and February. As we've commented, March has picked up and we do see -- John has made some comments and I'll pass to him in a moment about continued pick-up in April. There were a couple of project related delays that were unexpected, and these economic factors that we cited. So you're absolutely right, that we had planned and talked to you about an expected softness in the first half of the year, but we just had not expected quite as slow a start in the first two months. John, anything to add there?

Yes, the only thing I'd add is I think our customers at the end of the year, they have budgets, they accelerated some purchases. And then I think they went into a bit of a wait-and-see conservative mode on purchases, and that just slowed things down, a little bit more than we expected. But we are seeing things pick up in a number of our regions, not all of them but in quite a few of them. So that's why we continue to think the back half of the year will be better than what we've seen so far.

Okay, great. One more follow-up for me, guys. So there was talk a about -- one of your competitors potentially looking at UK opportunity moving forward and that's something that you guys haven't talked about in some time. Can you share any insight into what are you seeing in that market? Because obviously, you've highlighted Iberdrola, ERDF, TEPCO, and obviously, you've got a bunch of things here in the US that you've won in the last 12 months. But is that opportunity to get something real by moving forward sooner? Are you guys participating in that with [a solution]?

Yes, Sanjay, great question. We haven't talked about that, of course. The opportunity in the UK, 45 million combined electric and gas meters potentially up for replacement with -- in a market in which Itron has traditionally been very strong. There have been competitive announcements for initial pilots and rollouts and Itron has not been visible in some of those earliest announcements.

However, we do have products certified for the UK. We have demonstrated a dual-fuel solution that is an electricity and gas meter coordinating through a hub, and are working very closely with a number of the six retailers as will as taking a look at the central market solution. The story in the UK is an evolving one, with the standards just in the process of being finalized. And we are very, very actively focused on qualifying products and on selling to each level of the market and participating in the regulatory and standards process there. It's a very important market to us.

Craig Irwin with Wedbush.

In your prepared comments, you talked a little bit about some of the utilities that are seeing elevated maintenance cost, shopping for a migration strategy and looking for how they want to implement AMI technology. Can you maybe give us a little bit of color? Are you seeing these utilities indicating that they're leaning towards very large wide-scale rollout of new technology? Or are they leaning more in the direction of what Connecticut Power & Light was proposing to its Commission where they were basically saying that they would put up the towers and then fill in with AMI units ratably. And as a part of this question, do have any legacy customers that might be considering a migration strategy that are actually taking the AMI units already given their backwards compatibility to the older AMR networks that they have installed?

Sure, Craig. Let me take that question in a couple of pieces because the comment that John had made had to do specifically with meter repairs; it was made in the context of the gas market in Europe. And in Europe, where there are market mandates, those mandates are for total replacement. And what we're talking about is a phenomenon that we saw in the US somewhat in 2009 in which prior to very large rollouts, customers are really delaying purchases of new meters, old-style meters because they're getting ready for a complete meter change-out. So that was a comment made in a specific context. And we do not see incremental deployment strategies really being planned in Europe and as much as there is a mandate for total replacement there.

We did comment though on phenomenon that we absolutely are seeing in North America, and it -- which is more targeted rollout plans. Yes, we do have customers that are taking our so-called bridge meter. That is a meter that reads in an AMR, existing AMR environment, which we have 45 million installed, electric endpoints with AMR solutions. And those customers are starting to take the bridging technology that prepares them for smart meter environment. We are -- and those our customers in the Northeast that are starting to take those products as well as customers taking more selective rollout approaches with our Itron Cellular solutions in which they're able to very specifically target customers and build incremental rollouts. So we see that phenomenon more strongly in North America. It could emerge in some other parts of the world, but in Europe, we do see complete rollout plans.

Great and then my second question is, you've shared with us, as in the past on many occasions, that both replacement and wide-scale implementations and smaller implementations are a large part of your business, but new housing construction is also a driver. Can you maybe give us a little bit of color as far as the lag between neighborhoods initiating construction and when they would need the meters? And how much of this business you actually saw contributed to your overall mix in the prior housing construction cycle?

So, the technical question of what the lag is, is very little and as much as electric meters are placed in new construction at the time, of construction, and so that demand occurs simultaneously. New housing starts affect us. It's difficult to isolate it exactly -- I'd go back to our comments though that our core business, which is made up of things like equipment that is at the end of its useful life being repaired as well as new housing starts and expansion of both AMR and AMI programs, that, that business has remained very solid. And that we saw growth in our North American Electric business outside of these very large projects, both of which indicate that we are seeing signs of the recovering economy in North America.

John Quealy of Canaccord.

So my two questions first. Japan, can you talk about how you're sensitizing yourself to the likelihood of winning or not winning any of that business? Clearly, I would say consensus is Japanese conglomerates win most of it and perhaps their in-house suppliers win most of it. So can you comment on sensitizing the model to that? And then secondly, Steve, on the buyback, I'm sorry, did you say 2.5 million deployed since April but $50 million in total? Thanks, guys.

Okay, I'll start on Japan. John, I mean, we absolutely share the concern that the historical buying pattern in Japan is internally focused. I think I commented on the last call that I had been over in Japan and received very senior-level assurances that they were going to try to break that cycle and welcome foreign technology, experienced companies and really take a broader look. We've tried to mitigate the internal buying pattern, as you know, by partnering with Panasonic to have a very strong partner present in the Japanese market. We are -- you can't balance your risk in terms of your technology plans. We are going full-bore ahead at building the best technical solution that we can for the Japanese market and doing everything we can in order to win that communications business.

On the metering side, we expect that there will be tender similar to the style that we see in Europe, in which portions of the metering bid will be available to us, even in the case that an internal -- internally-developed communications solution wins out there. So we remain focused and engaged, but we also, on the other hand, have not built in assumptions into our performance plan that we have won that business. And I would point out that the opportunity is not just at TEPCO; there are [seven] other utilities and it is our intent to continue to compete for all of the business in Japan. With that, I'll pass it to Steve.

Hi, John. The authorization of the stock purchase plan was in March, and it's a one-year plan. Total authorization is $50 million and per my remarks, we've repurchased about 2.5 million or so. So, just with some rounding, we'd say that we have about $47 million in remaining authorization through next March under the current authorized plan.

Vishal Shah of Deutsche Bank.

This is Susie Min on behalf of Vishal Shah. Thanks for taking the question. So you have mentioned that Q1 seems to have been weaker than you expected and was wondering as it relates to your guidance, how are you thinking about the revenue growth trajectory? Is Q2 trending in line with your expectations? Or how should we think about it over the next few quarters?

So Susie, the color that we've provided is that is it really -- well, January and February was a slow start with a pick-up in March. And I'll pass it to John on his thoughts on what we're seeing in April. We have some pressure clearly, which we really have characterized the first half as tough. And there are a couple of project delays which we're working to resolve. From a margin perspective, John has talked about a number of actions that we're going to take in the short term. So we feel that Q1 is the low point and we see signs of the business really improving in the second quarter and the second -- onward into the second half. John?

So I think you covered that well. I don't have much to add.

Great. And then my second question was related to margins. You had mentioned that some of the European tenders seem very competitive. How can we think about some of the other levers? I know you mentioned some good progress on the cost front. Can you talk more about that and then the dynamics between the margins on the Energy business versus the Water?

Yes, I think we're going to continue to see some pressure on the electric margins, Particularly on these larger projects. they are big; there is a lot of competitors playing in that. We had, however -- in North America, margins were pretty good on the OpenWay meters. So it remains to be seen how that plays out. We've got to get those tenders issued first and foremost. I think in terms of the Gas business and what we see there, I think that's been a good business for us historically. We have, as we've mentioned a bit of a slow start and some issues in the first quarter, but gas rocks, and I think we're going to do just fine with that business going forward.

Susie, I'll just make one comment. We've had pricing pressure and planned pricing pressure all along and our business volume is extremely critical for giving us gross margin benefits. So as these projects ramp-up, we have more volume, we have continuous price reduction programs, as John has mentioned, with a very strong operations team that progressively works on reducing total manufacturing costs. And so to your question about the levers that we pull are build-ups in volumes, the proper sizing of our capacity and continued cost improvement plans. Even in our highly competitive deals, it really help us over time to improve margins on those large deals.

Ben Schuman at Pacific Crest Securities.

My first question is around professional services drag on the water margins. When can we expect that to subside maybe just in terms of that contract being completed? How does that look from an incremental operating margin standpoint?

I think the contract is going to extend for awhile. And we're doing a couple of things, talking with the customer to try and fix some of the challenges we've run into, some of which were unexpected. But I am reasonably confident we'll get those margins fixed here in the second quarter and see a return to what I would consider to be a much healthier margin on those services.

Okay, great. And then in terms of the incremental weakness since the Q4 report, you guys reported in the middle of February. Can you help me understand just how January and February could have turned out to be such a dud with the mid-February report? Were you expecting maybe a stronger snapback? Or just help me reconcile what is going on there.

Ben, that's an absolutely fair question. In the middle of February, we don't have the ability -- we don't have results reported for our February month. And with a can-do team, we've got a lot of very motivated people who saw a slow January and said, it's a one-month phenomenon. We're going to get it back in February and so by the time you get to mid-February, you've got a lot of people pedaling as hard as they can. You don't have your February results and so it's a little bit difficult to see that you've got another slow month in there. The good news is that by March, they really had made a substantial pick-up in terms of the momentums and volumes. So it's just a timing issue, but you're absolutely right about when we spoke to you.

Paul Coster of JPMorgan.

So I understand that you were working fiendishly hard on bringing down your cost structure. At the same time, you seem to be running into international projects which have maybe lower pricing and I imagine some pressure on gross margins. Can you talk to us about the longer-term gross margin outlook for the Company and what can materially shift it up a gear?

So Paul, volume, again, is the huge magic in the manufacturing business. So as we see these large projects come online, we have better absorption of our cost, better purchasing leverage, which allow us -- and also give us the time in order to continue our cost reduction plans on the manufacturing side. The longer-term plan, as you know, is to move beyond just being a bidder in meter [options] to providing measurement communication software and services solutions that give us better differentiation and margin opportunity to concentrate on markets with higher average selling prices and profit opportunities. As to what the long-term prospects are in the gross margin side, we have strong plans under place to continue the growth in gross margin that we saw in 2012 and have projected in 2013. There are certainly opportunities for us to continue along in that improvement plan through 2014 and '15.

Okay, maybe just revisit the UK question for a second. I think I understood from your question that you're not part of the -- one of the consortia that's bidding on the infrastructure side. You're really trying qualify your products for any of the winning teams; is that a correct statement?

It's not. It's -- as you point out, it is a two-tiered business in which the current incumbent players do have independent plans in advance of a complete market solution to make procurements and to begin to deploy units out in the field with the intent that there is also a central market offering. And we are present and competing at both levels of the procurement process in the UK.

Ryan Connors of Janney Montgomery Scott.

I had a question with regard to the tax line, actually. The R&D tax credit, obviously, had a reasonably material impact on the profitability of the quarter. So just in terms of modeling that tax line going forward, any color you can give us about whether that reverts to a more normal historical pattern or whether there are more positive realizations there on the R&D credit?

Ryan, this is Steve. It reverts back [through] the year closer to 24%, 25% rate over the course of the year. It can always be subject to some discrete items going forward, legislative changes and all so I'm always going to qualify that but on a general basis, as we look at mix and so forth across the [world], it blends to about that level.

Okay, great. Thank you. And then other question had to do with the water market and specifically the type of products that -- of communications that water utilities are purchasing. Can you give us any color on whether you're seeing a shift towards AMI fixed networks away from the traditional drive-by solutions? Whether or not you're seeing that and if so, how you are faring competitively in that next generation? Thank you.

So Ryan, the -- of course, I've got to give you a geographic answer there. In North America, we are absolutely seeing a shift towards more focus on networks. We've done extremely well competitively with announcements in San Diego and Las Vegas, which have been the two large metropolitan announcements here in the last several quarters, and have an extremely competitive product that is both a drive-by and fixed network solution which is what our customers are frequently looking for because they start out in one mode and migrate to the next. But the trend is clearly towards -- and that, by the way, that same endpoint is a two-way advanced endpoint with embedded security and full AMI capability. So -- but we see a strong trend in the North American market in that direction.

In global markets, we're not quite that far along. We haven't seen a strong emphasis on network water solutions. We're really moving from an environment in which -- in large parts of the world, water meters are read semi-annually or annually to getting to a handheld, and then eventually to a -- and in many of these markets now are moving to drive-by solutions. And so there -- somewhat we've seen this development in the North American market in the past decade or two, and we would consider the rest of the world going through that process again at this point, and again, have qualified solutions to compete in those markets as well.

Patrick Jobin of Credit Suisse.

Just wanted to follow-up on some of the pricing pressures you're facing with the multi-vendor contracts. So Philip, what are you doing to position Itron to move up the value chain? Maybe more software? In that same topic, and I promise it's one question but where are you focusing R&D and are there any acquisitions out there that are on the table? Thanks.

Patrick, nice construct of a single question. (laughter)

We were advised only one.

No, no, no problem at all. It's a good -- great question. So on the tenders that we've commented on, by the time that the tender like Iberdrola is structured, the -- our opportunity to compete within the tender, once it has been structured, is essentially a meter option. It's to compete on quality and customer responsiveness, which -- and by the way, in some cases, the fact that the product is manufactured in the European Union. So the -- I mean, those are really the levers that you've got to pull because feature differentiation is not encouraged in a bid, in a fully specified bid like that. So there are a couple of specific markets -- we've talked about this before. The French market and the Spanish market that have been structured in this way, we don't necessarily see that model being used in many other markets, but there will always be a blend of those.

As to the -- where are we placing our investments, of course, we have to have qualified meters and we've talked about before there are challenges in having that basic measurement device qualify in each one of the jurisdictions. But our investments are absolutely in differentiating on communications and collection systems, software analysis and essentially manage -- helping to manage our customers' risk in implementing new solutions. We see real opportunities there. As to M&A opportunities, yes, there are absolutely growth opportunities for us on getting more value out of the data, out of extending the number of endpoints that are on the communications network into these other adjacent areas, and there are things that we are actively examining.

At this time, we have no further questions in the queue. I'd like to turn the conference back over to Philip Mezey for any additional or closing remarks.

Well, I thank you for the interest. Look, Q1 was a tough quarter and as we've said, there were some disappointments for us in terms of the slow start in the quarter. We are heartened by the pick-up we saw at the end of the quarter. We are -- have gone through a bottoms-up forecasting process. John is working on a list and Steve on a list of activities. We are absolutely focused on improving cash flow and managing working capital, as Steve has talked about. And we'll have an update for you here in Q2.

That said, we did anticipate a slow first half of the year. We have strong confidence in the second half of the year because of signed contracts already underway, qualified products that are coming to market to give us a strong grounding for an improvement. We think of the first quarter as a low point in the year. However, we also see great developments that indicate a build-up in smart metering for 2014 and beyond. Again, I [cite] Iberdrola and other things -- there are other tenders that are coming to market here.

So I want to absolutely acknowledge that are things that we've got to do here in the short term in order to improve our financial metrics and we are working on that very, very diligently. But we are not going to react to a short-term disruption that we think is going to work itself out here. That being said, we are aware of economic pressure and really factoring that into our thinking and we'll provide an update. So thank you for the questions and the interest and look forward to further discussions with you.

All right. Thanks, everyone. We'll end the call now.

This does conclude today's conference. 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 179-457-0820; enter the passcode of 406-6711, or go to the Company's website, www.itron.com. Again, thank you for your participation.