Itron Inc (ITRI) 2013 Q2 法說會逐字稿

Good day, everyone, and welcome to the Itron Inc., Q2 2013 earnings conference call. Today's call is being recorded. For opening remarks, I would now like to turn the call over to Barbara Doyle.

Thank you, Rebecca, and good afternoon to everyone on the call. Welcome to Itron's second quarter fiscal 2013 earnings call. We issued a press release earlier today announcing our results. The press release includes replay information about today's call.

We have prepared slides to accompany our remarks in this call and these slides are available through the webcast and through the corporate website under the Investor Relations tab. On the call today, we have 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.

Here's the agenda for today's call. Phillip will begin with a summary of our operating results and a review of the business environment. Steve Helmbrecht will cover Q2 financial metrics in more detail, and he will provide our updated guidance for fiscal 2013. Phillip will close the prepared remarks portion of the call with summary comments. Then Philip, Steve, and John Holleran will take some questions using the process the operator described. We do ask your courtesy to limit your questions to one or two to allow time for everyone in the queue, so thank you in advance for that.

Now, please let remind you of our non-GAAP financial presentation and our Safe Harbor statement. 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've included reconciliations of differences between GAAP and non-GAAP financial measures in our earnings release and financial presentation.

We will be making statements during this call 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 our comments made during this 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 these forward-looking statements.

Now please turn to page 4 in the presentation, and I will turn the call over to Philip Mezey.

Thank you, Barbara. Good afternoon to everyone. Our call today will focus on our second quarter results, the industry dynamics and trends that we are seeing at this point, and our outlook for the remainder of 2013.

Business increased from Q1 but I attribute that more to our improved execution than a major change in the business climate. As we expected, our second quarter earnings picked up from a disappointing first quarter, and in fact, we saw improvements in nearly every financial metric. We made good progress, but our results in the quarter, frankly, are still far below from acceptable. Improving our profitability remains our near-term focus. We are forecasting a return to revenue growth with improved earnings and cash flow in the second half of the year, as Steve will discuss in our guidance.

A graph showing the year-over-year change in revenues by segment is shown on slide 4 of the presentation. In comparison with last year, total revenues declined by 17% in second quarter, primarily due to the impact of the planned ramp-down of top five OpenWay contracts in North America. The Electric business, excluding the top five OpenWay projects, increased driven by growth in North America and EMEA. Gas revenues declined on lower meter volumes in EMEA and decreased module shipments in North America. Water revenues were down slightly.

Bookings were a bright spot in the quarter. Bookings grew by 15% compared with last year, with the highest level of bookings in six quarters. Backlog increased 3% sequentially from Q1.

Now, I'll turn to our segment performance for Q2 starting with Water on page 5. Water financial performance was relatively flat year-over-year, but that masks some positive developments in this segment. Revenues were about even to last year but with a higher proportion of lower-margin professional services. This impacted margin slightly.

Gross margins declined by 10 basis points year-over-year, and non-GAAP operating margin was down by 30 basis points. However, services margin improved in the second quarter and we expect additional improvements in Q3 and Q4.

We also won some key water automation deals in the quarter. Total water bookings in the quarter were $150 million, reflecting a 1.1 to 1 book-to-bill ratio. Water bookings in the quarter were up 28% year-over-year. The bookings help support our view that Water will continue to be a growth business for Itron.

We signed contracts for two new projects in India to improve water infrastructure and distribution. The projects include smart watering systems with 210,000 meters in New Delhi and 100,000 meters in Goa. Aguas de Valencia in Spain also announced it will deploy Itron's water AMI solution to modernize its infrastructure, including 100,000 water meters and communication modules and a fixed network infrastructure and software. We also signed a water AMI contract with the City of Olympia here in Washington state.

I am also very pleased to announce that one of the biggest water tenders in Europe has been awarded to Itron by a Irish Water. Itron will deploy 625,000 of the 1 million smart residential meters being installed, with deployment targeted to begin in Q3 of 2013, with completion scheduled in 2016. This is a significant project in Ireland which has no residential water metering in place today. We will record annual bookings on this project as purchase orders are received over the contract life. This is another example of where we have more visibility to future revenue than well be reflected in backlog.

On the innovation front, we introduced Itron's new [Equi-Scan] solution in the second quarter. This heat cost allocation system provides an accurate and secure way to monitor and collect consumption data for multi-family housing units. The addressable market opportunity for Itron's targeted segment is $200 million in 2016 which presents an attractive growth opportunity in our Water segment. We have already received large orders for the solution and we like the potential in this new space.

Last but certainly not least, Itron was honored at our water factory in Macon, France, with a prestigious Industrial Excellence Award by INSEAD, a leading business school in France. This recognition is one of the best factories in France demonstrates Itron commitment to innovative manufacturing. We are extremely proud to have our quality program in our Macon facility recognized by INSEAD.

Turning to Energy segment on slide 6, in the gas business, Q2 revenues of $136 million were down 16% year-over-year with the EMEA and North America driving most of the decline. Western Europe was a little soft but relatively in line with last year's levels.

In Southern Europe, high margin C&I revenues were down in Italy, following suspended orders of Itron's product last quarter. We've introduced a new lower-cost, electronic volume converter and modem to meet the Italian specifications. This platform is the basis of our next generation of smart integrated industrial meters which will allow us to participate the next tender in Italy where Itron has strong leadership and proven products.

The bigger impact in EMEA was on several large projects in Azerbaijan, Turkmenistan, Turkey, and North Africa. The volume of meters shipped for these large smart meter projects is down compared with last year's pace. For example, Azeri Gas is one of Itron's largest smart gas meter contracts in EMEA. The deployment of smart payment meters by Azeri Gas outside of the capital city of Baku has been pushed to 2014. The project in the capital region, the most populous area in Azerbaijan, has been very successful and we expect the continuation of the deployment in the remaining regions to proceed in 2014.

A transition to smart gas metering is occurring across EMEA, in the European Union, Central Europe, and Africa, and we are excited about these opportunities. But it is rolling out slowly and meter replacements are occurring at lower levels in the interim.

In a positive sign of future business in Europe, GrDF is moving forward with its smart gas meter project, covering 11 million meters in France. This is a substantial project which is expected to proceed in two phases spanning multiple years, beginning in 2015 and extending through 2020. GrDF has issued an RFP for the first phase of the project covering 5 million meters. Itron intends to qualify a meter and bid on the RFP which GrDF has stated they plan to award in early 2014. This project is obviously in early stages, but it is another example of smart metering moving forward in Europe.

North America also contributed somewhat to the gas decline in the quarter. We are shipping a record number of gas meters, but fewer communication modules and a higher percentage of meters with third-party modules. We are actively competing for a number of gas automation projects in North America which will drive volumes in 2014 and 2015.

In the near-term, the priorities for gas utilities have shifted a bit to pipelines and safety. To support this trend, Itron has released new gas products centered on the areas of safety, accuracy, and revenue assurance, including remote shut-off, telemetry, sensing, and cathodic protection for pipelines. We remain optimistic about the outlook for gas worldwide, notwithstanding the short-term volume fluctuations. There are large gas projects on the horizon, and we believe our enhanced solutions provide strong differentiation for Itron. And our new organization dedicated to gas will provide even more focus on the segment.

Now, let's review the Electricity business. Electricity revenues of $214 million were down from last year driven by the large OpenWay projects that are nearing completion. We continue to see underlying strength in our core Electricity business. Excluding the revenue from these OpenWay contracts, North America revenues increased significantly year-over-year by 31%.

We're starting to generate meaningful revenues from contracts we signed in 2012, including Duke Energy, consumers, Los Angeles Department of Water and Power, and National Grid. We also had a strong second quarter in EMEA with Electricity revenues up 27% in constant currency, driven primarily by our project in South Africa, as well as increased shipments of C&I meters and load management to EDF and France.

On the innovation front, we are increasing our delivery of new meters and technologies for the Electricity business. We are leaders in the cellular meter space. Itron has deployed a half million cellular meters in total in North America, the largest quantity by any supplier. We have an additional 2 million meters contracted with utilities throughout North America, and we see strong potential for cellular technology deployments globally.

We also have several new electric meters qualified which position us well for upcoming smart grid projects. There new meter in Japan has been GeMiC-certified, and over the past two quarters several new products have been certified in Brazil.

We also have SMETS-compliant smart electric and gas meters available in the UK, positioning us well for this market. Tenders for the initial phase of pilots are expected this year for 2014 and 2015 deployments. Itron is aggressively competing for these tenders, continuing our strong presence with utilities in the UK.

Electricity bookings in the quarter were strong at 1.2 to 1 book-to-bill ratio. On the top of the list, is Duquesne Light, the Pennsylvania PUC approved Duquesne's smart metering project to replace 625,000 meters spanning its service territory. With the regulatory approval, we booked a significant contract with Duquesne in the quarter for communications, software, services, and meters.

We also signed a five-year contract with British Gas to provide a full suite of hosted managed services for 1.25 million electricity prepayment customers in the UK. We book one year at a time into backlog for this contract, so again, this is an example of revenue visibility over and above our backlog.

I'll wrap up Electricity with an update on Iberdrola and ERDF Linky projects. Iberdrola's award for its tender of 1 million smart meters is now expected to be in September, as they finalize deployments of their current inventory. New electricity tariff legislation was recently passed in Spain with speculation that it may slow investment in new projects. In speaking with the customer, they do not anticipate it to impact the meter deployment. Funding is in place and increased operational efficiency gained by the meters helps reduce their costs.

The Linky project at ERDF appears to be on track with installation expected to begin in early 2015. In positive news, ERDF issued the RFI for 3 million meters this week which is the first step to the tender. We are prepared to immediately begin work when the tender is issued.

Now, I'll turn the call over to Steve Helmbrecht to cover our financials in more detail and to provide our financial guidance for the remainder of the year.

Thank you, Philip, and good afternoon. I will begin with slide 7 which summarizes the financial results for the quarter, compared with the second quarter of 2012.

Revenue declined 17% over the prior year. Excluding the top five OpenWay contracts, total revenues in the second quarter increased by approximately 1%, compared with last year.

Consolidated gross margin was 33.1%, down 90 basis points over last year. The decrease in margin was driven primarily by the impact of lower volumes. In addition, the gross margin in the second quarter of last year included a benefit from the reversal of a warranty accrual. Excluding that benefit, last year's gross margin was 33.3% which is comparable to this year.

Non-GAAP operating margin was 6.7%, down from 11.6%. Operating margin is being negatively impacted by the lower revenues and gross profit. We have taken actions to reduce our cost of sales to maintain gross margin, despite lower revenues. We are also taking actions to reduce our operating expenses.

In total, Q2 non-GAAP operating expenses decreased 2% year-over-year with decreases in sales, marketing, and product development. General and administrative expenses increased over the prior year, due primarily to increased legal reserves.

Adjusted EBITDA was $44.7 million this quarter, with adjusted EBITDA margin up 9.3%, down from 13.9% a year ago. GAAP diluted earnings per share were $0.31 for the quarter, compared with $0.79 in 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 $0.58 for the quarter compared with $1.16 in 2012.

The decrease in our GAAP and non-GAAP earnings was driven by the lower gross profit from decreased revenue, partially offset by benefits from lower operating expenses, lower tax expense, and reduced share count resulting from our share repurchase program. We have a non-GAAP EPS bridge in the presentation on slide 8.

Free cash flow for the quarter was $4.2 million, compared with $26.9 million in the second quarter of 2012. This decline was driven by lower net income, coupled with an increase in working capital. We saw lower cash collections from accounts receivable, due mostly to longer payment terms that are standard outside the US. But the primary working capital driver in the quarter was increased raw materials and finished goods inventory, related to future order activity in the second half of this year.

Looking ahead to the remainder of the year, along with improved earnings, we are taking steps to reduce our capital working balance and reduce capital expenditures. We expect free cash flow in the second half of the year will be about 4% to 5% of second-half revenues.

Now turning to capital, in March our Board authorized a new one-year share repurchase plan for up to $50 million. As of today, we have repurchased about 538,000 shares under this plan at an average price of $42 per share, for a total of $23 million. We ended the quarter with $410 million in debt, up about $11 million from last quarter. Our interest expense in the second half of the year will increase by about $1 million, due primarily to a forward interest rate swap for $200 million at a fixed LIBOR rate of 1% which takes effect in the third quarter.

I will move on to bookings and backlog using the next three slides. Turning to slide 9, we have $515 million in bookings during the quarter, representing a book-to-bill ratio of about 1.1 to 1. Bookings increased year-over-year in both Energy and Water. Our largest booking was $94 million, related to Duquesne Light's smart metering project. Bookings for CenterPoint Gas, EDF France, and New Delhi combined totalled nearly $50 million.

Turning to slide 10, total backlog at June 30 was about $1.1 billion with 12-month backlog at $558 million. Our base business backlog shown in the red bars on slide 11 has grown over the last 12 months. In addition, our total backlog increased from Q1. The yellow bars represent the backlog related to the large OpenWay deployments. These projects are substantially complete, with the exception of Detroit Edison, which has installed over 1 million OpenWay units and will continue its deployment over the next couple years.

Now let's move to guidance, turning to slide 12. We expect full year 2013 revenues in the range of $1.95 billion to $2 billion and non-GAAP diluted EPS in the range of $2.25 to $2.55. We expect annual gross margin of approximately 32%. Average shares outstanding of 39.7 million and a Euro-US dollar exchange rate of about $1.31 for the remainder of the year. We expect our annual non-GAAP tax rate to be 18% which implies a second half tax rate of 20%, exclusive of discrete items.

You can see on slide 18, our summary results for the first half of the year. Let me talk for a moment about what our guidance says about our outlook for the second half.

At the beginning of the year, we said that revenues would be a mirror image of 2012 with the second half being higher than the first half. With the first half revenues of $930 million, our full year guidance implies second half revenues of $1.02 billion to $1.07 billion which is growth of about 10% to 15% over the first half. We are growing, but not by as much as we originally estimated and that is primarily coming from gas. Revenues in gas will be lower than originally expected, due to a slower pace of business in EMEA and product mix in North America.

Moving now to margin, we have gross margin of 32.2% in the first half, and we expect that to stay flat in the second half. This is a lower gross margin than our original guidance, due to the shift in forecasted product mix particularly in gas and the impact of lower volumes on absorption.

In terms of non-GAAP operating expenses, we originally expected increased research and development expenses to be partially offset by reduced SG&A for the year. Our updated guidance reflects further cost reduction efforts we have taken. We now expect to reduce our non-GAAP OpEx overall. Our updated guidance reflects total non-GAAP operating expenses in the second half of the year to be consistent with the first half run rate, with R&D increasing slightly over the first half, sales and marketing being somewhat flat, and G&A decreasing.

In closing, we saw some revenue growth in our core business in the quarter which translated to improved earnings performance. We expect additional improvement in the second half of the year as our revenues increase and our expense reduction efforts continue to take effect. With that, I'll turn it back to Phillip.

Thank you, Steve. I'll close with some brief comments and then we'll open the call up to take questions.

I'm encouraged by our progress in Q2. We continue to drive innovation, encourage collaboration, and set the highest standards of quality. At the same time, we are increasing efficiencies in our operations and reducing our product costs. Our bookings are growing and our backlog has ticked up. We are resetting guidance to reflect the lower level of business in the first half of the year, as well as the impact of lower volumes and product mix on our gross margin for the full year.

We are forecasting a return to modest revenue growth in the second half of the year. We are also controlling costs and increasing the flexibility in our business operations. But our efforts are not complete. We are focused on higher growth and further improvements in our profitability. We must continue to optimize our cost structure, and we will take necessary steps to better balance our global operations.

Looking ahead, our goal is to consistently achieve mid-30% gross margins and mid-teens EBITDA margins within the next few years. In addition to our focus on costs, we're actively pursuing more profitable growth by addressing new opportunities with product investments that will drive revenues in 2014 and beyond.

Thanks for joining us today and, operator, let's go ahead and open up the line for questions.

(Operator Instructions)

Sanjay Shrestha from Lazard Capital Markets.

Great. Thank you. Good afternoon, guys.

My question actually is really more about 2014 and beyond, rather than 2013 because 2013 always was expected to be a transitional year for you guys. Can you maybe further elaborate on the point about getting to that mid-30% margin? And what actually should we be tracking here, should be watching to get the level of comfort that we will see a nice growth in your top line, as well as in your earnings profile as we go into 2014?

Sanjay, there are two parts to that, the growth part and the gross margin control. On the growth side, there are clearly elements we don't control. But I have given you updates on a number of promising signs we see as the market's developing and contracts that are coming online that are giving us better visibility in the second half and somewhat beyond.

On gross margin side, the good news is we do have controllable items. I commented in my remarks in the first quarter that we really are focused on controlling our variable cost. We still have a large number of fixed costs that we can go after. And John, maybe comment on that, if you would.

Sure. Sanjay, I think there's still a lot of opportunities we have in the business to improve our margins. We're going to continue to twist all of the dials that are available to us and keep driving towards those targets that Philip outlined.

It's not only obviously increasing our sales, that helps, but it's evaluating customer profitability and finding out where we really have the good opportunities and good growth markets. It's continuing to evaluate our manufacturing footprint, focusing on the supply chain and our purchasing leverage, continuing to push products through R&D, not only new product, but cost-reduced products. That's where we're going to be focused on and that's why we have some confidence that we'll move forward pretty well.

Okay. Can I ask one quick follow-up on that?

One of the balancing acts you guys have is, you're focused on innovation and as a function of growing the margin profile. At the same time, if some of the larger projects gets pushed to the right, that will end up hurting the revenue growth and you don't end up getting that operating leverage. Is there a level from an absolute dollar standpoint, where you feel like you can actually keep R&D expenditure contained? So that even if some of these projects were to be pushed to the right, we will still see a nice earnings growth year-over-year from 2013 to 2014?

I'm not sure there's a perfect answer to that question. I've talked in past calls about the importance of the R&D investments that we're making, for not only improving our gross margin opportunities, but also to open in new markets. So we're competing in a more diverse set of markets as a result of having qualified product.

But as you've seen us react to the business climate in the first half and as we looked ahead at the market opportunities, John and the team have done an excellent job of really prioritizing our development and pulling back appropriately in areas that are not as productive. I think that that action that we're taking, you can read into that, that we really are stabilizing our R&D and I think monitoring it very carefully. John, other comments?

I think the other advantage we have or that we're finding is, we collaborate more and more around the world in these development efforts. We're finding a cut that we can develop common platforms and get reuse out of existing technology. That's enabling us, even in markets where we might not have really terrific growth, to continue to spend and develop products.

That's all I have guys. Congratulations on the Duquesne win.

Thank you.

Ryan Connors from Janney Montgomery.

Thanks. Good afternoon. I wanted to examine the margin potential on some of these bigger European tenders that you mentioned. Philip, you obviously seem to be maybe not getting pushed as far to the right, but maybe you could just characterize the competitive dynamics there?

Obviously, some of these are trophy project. Is there a risk that the bidding there is overly competitive and we end up with a winner's curse situation on some of those?

Ryan, it's an excellent question. We commented on this in the past that a couple of these markets, I would not characterize them as all of Europe, nor all of EMEA. By the way, I would point out we have very, very attractive business across EMEA, that just in selected markets. We've talked specifically about France and Spain Electricity, where there is a very competitive environment.

The margins on those projects are somewhat lower than some of the other geographies. I would point out however the news that we highlighted in this release, in which we've got the C&I business in EDF. So there is a balance between residential, commercial, and industrial product helps us to manage the overall gross margin, even within those markets. But it is something we monitor.

My response historically to that has been, the product that we're currently delivering in France and Spain does not have a particularly high gross margin. Overall, there is margin improvement opportunity for us, even going forward in those competitive markets.

I will point out that this Irish Water win is a very attractive profile for us. There are another a number of other markets in the UK and other markets where we yet to see the kind of competitive dynamic that you mentioned here and the winner's curse. It's something we're very aware of. We address it through a mix of business.

Okay, that's great. Then, I guess my follow-up. You made a comment, Philip, in your prepared remarks that if and when we do see a tender on the ERDF Linky project, the Company would get to work right away. Does that mean there would be a short-term increase in expenditure, ahead of the actual potential delivery or award on that project that would be material to the margin?

No, we would not anticipate an increase in expenditure. It's really managing internal priorities and timing.

Okay, great. Thanks for your time this afternoon.

Craig Irwin with Wedbush.

Good evening, everyone. Thank you for taking my question.

The first thing I wanted to ask about was cost reduction in the business. So, over the last several quarters, Itron has actively been restructuring and reformatting the business to reduce operating costs. What is there left that you can do, as far as reducing the overall operating base of the business, consolidating, or restructuring that could help drive the margins into the mid-30%s over the next couple years?

Craig, this is John. There's always things we can do. As business changes, as our focus changes, we're continuously looking at both of our manufacturing footprint. We are continuing to check and double-check the priorities within research and development for both product development, new product development, and product improvement.

There's still a lot of dials we can twist in improving our cost structure. That's exactly what me and our team are doing regularly. Of course, as an operating guy, the favorite whipping post is always G&A. So, I'm sure there's room there somewhere.

Excellent. The next question I wanted to ask was about the larger opportunity in North America. A while back, the team had framed out 50 million meters in North America that are on the block, at some stage of procurement, probably further out than near-term.

But can you comment as far as whether or not you're seeing the same competitive dynamic as a few years ago? Or whether the quality information of some of the competing installations -- I guess one of the largest has 45% of the endpoints -- it's not activated. Whether or not this information is impacting your discussions with customers, as you look forward to their plans over the next two years.

Craig, I've commented on this before that I do see the market changing and that we've clearly come out of a hype cycle and some regulatory mandates that have authorized large projects that have moved forward very rapidly. What we're seeing is a more disciplined approach. Our roll-outs have longer periods of time, roll-outs that are targeted to specific business problems, in which ROIs are being measured.

To your question, do we see a change in the competitive dynamics and the dynamics of award? Yes, we do. I think the balance of play amongst the competitors has changed somewhat in that period of time, as success stories have built. We think we have a very strong reference base.

One dynamic I will point out is that of the remaining meters the marketplace, many of those already have some type of automation. One thing that will change the market in North America is, one has to justify replacing possibly an AMR system with an AMI system, which is going to require a different type of business case, in order for that to move forward.

Great. Congratulations on the 2 million unit win in Pennsylvania. We're waiting for the press release.

Sean Hannan with Needham and Company.

Thanks. Good evening.

Good evening, Sean.

I want to see if I can switch focus for a moment to the Water market. Thanks for some of the color you had provided so far tonight. The Indian market, you continue to get some wins there and I just wanted to call out, there seems to be a dynamic right where the Indian market, not particularly attractive on the electric meter front. It tends to be a lot of the lower-cost preference but it has been attractive and effective on the Water front.

I guess part A of the question is, I'm looking to see if I can give some color from you folks around how sustainable you think some of that is? With some color on how dramatically you look for that region to grow for you. Then secondarily, can you provide a perspective on what could turn the tides a little bit more in your favor, to drive a similar dynamic in China? I think you face a similar challenge on the Electric front, but there should be a better opportunity on the Water front at least in getting some strong momentum there. Any color on that would be helpful as well. Thanks.

Sean, great questions. One point I'd make about the India Electric market, one of the challenge or local incumbent players and some very specific tamper requirements. It's not all a price-based issue. These initial deployment, our expectation is after getting a few hundred thousand units, the benefits will be so obvious and measurable that they'll build the sound basis for expanding the projects, not only within the cities that we've named, but clearly going into other metropolitan areas. I think developing a reference base and a strong return on investment -- demonstrated return on investment scenario, will continue to build a strong opportunity for us in those markets.

To the overall question, do we see the Indian Water market as an attractive market? Yes. Does that same dynamic play out in China? A little harder to say.

We do have a water meter manufacturing facility in China. We do have some business there, by the way, very attractive heat business in China, where we've seen a really nice growth opportunity. Not the same kind of problem in India, where we've seen, I think we have a release out in which we talked about 300 million liters of water being wasted in Mumbai. There's already infrastructure that is wasting tremendous amount to water, so there's just a very pressing need in India. We'll see there first, a very encouraging market, we continue to explore the Chinese market.

Thanks very much.

Vishal Shah with Deutsche Bank.

This is Susie Min on behalf of Vishal Shah. Thanks for taking my question. In your prepared remarks, you talked about the ability to improve your Water margins in the context of your services. I was wondering if you could talk about what improvements you expect to see, with respect to service versus your product mix?

In North America, the bigger issue we had last quarter was with one of our customers. We have worked very, very closely with that customer and had jointly developed some solutions to the issues we were encountering which better meets both of our respective interests. That's where we feel some confidence that we'll see the margins increased on the Water side, from the services.

Okay.

That's the biggest driver of all.

Okay, perfect. Can you talk a little bit about your analytics side? I think it was about 10% of total revenue. I just wanted to understand how that fits into your overall strategy, not just 2013, but as you think about it over the next couple of years.

We do have analytics products in the market. Last time, we did talk about the fact that San Diego Water is using a water analytics product which we released that we're very excited about. We have a number of products released in the electric and gas space as well.

To the reference of 10% of revenues, that reference is overall to our overall software and services business, and it's not specific just to the analytics space. We see tremendous potential in that space, in analytics, and a real opportunity for growth. We're have the largest market share in the meter data management space. Once you collect all that information, the value that we can deliver to the customer has still not been fully exploited.

So, we see a real opportunity for us to continue to increase there. I want to point out that, again, the value's across electricity, gas, and water, great opportunity for us.

Okay, great. Thank you.

John Quealy with Canaccord Genuity.

Good evening, folks. First question, Philip, we'd talked about this in previous calls, but R&D spending, once this design cycle ends in Europe, and it feels like it's getting close when the utilities are locking down their metrology designs, in their comms designs. I wouldn't imagine that you need to spend this level of R&D on the Electric portfolio.

I realized Gas and Water have different physical specifications, that you'll probably always have to spend R&D on that. If you could talk to us, is that a fair thesis that this is a design cycle for digital equipment that we don't need to do again in the next three to five years, once Europe locks down? Then, I have a follow-up.

John, I don't think of Europe as being in that primary driver behind the R&D expenditure. To your thesis, I see how you get there. And all of us wish that R&D would hurry up and finish. John Holleran has pounded the table about that frequently.

But the competitive dynamics in the electric space are such that there's so many players that are really interested in the space, that the innovation cycle is actually quite rapid. I would expect that as we have basic metrology products qualified in these markets, yes, I think the focus shifts away somewhere there. The investment, generally on the electric space, is going to move up the value chain to more sophisticated communications and smart grid related products, to analytics and other capabilities. What I do agree with though is that as a percentage of revenues, we would expect that R&D investment would begin to decline over time.

Okay, thanks. A bigger picture question, you've been a CEO now for six months plus. Can you talk a little bit more strategically about what you're thinking about Itron, clearly a leader in metering and metrology and advance communications?

What else are you thinking about? When can the Street and investors hear what you're thinking about, and the Board's been thinking about, strategically about what Itron can be, again, in a couple years? Thanks.

John, thanks. I think there are tremendous opportunities.

We've already touched on a couple of those ideas, which are once that data is collected, how do we add value to the organization, to our customers in different ways? We've discussed analytics. We've talked about services that we provide to our customers. We are very actively looking at value, as we say, beyond the meter.

Given the outstanding relationships we have at our customers, there are opportunities for us to increase our recurring revenue streams. We really are looking at expanding on the kinds of business. As an example, one of the announcement with British Gas, on winning the contract to maintain their prepayment electricity systems over a five-year period. We certainly want to look at expanding that type of work.

There's actually been quite a lot of strategy work that's gone on. We've built a group inside the Company to focus on strategy and business development that's looking at what we develop, what we partner, what we invest in, what we acquire. And are developing a pretty strong game plan that we will begin to talk about over the next six months.

Thanks, John.

Jeff Osborne with Stifel.

Good evening. A couple quick questions for my part here. On the Pennsylvania wins, are those going to be using your own OpenWay communication platform, or are those going to be partnered with Cisco?

Jeff, I have trouble accepting a distinction between our own OpenWay and Cisco. I want to point out that the Cisco offering is a small embedded piece of firmware, providing IP communications that resides within our meter hardware and service delivery. I don't see the distinction there.

Okay. But it's a IPv6 network? It's not the proprietary legacy standard?

That is correct.

Great. Then, you mentioned that the 50 million meters that the prior caller asked about, in terms of the automation embedded today. It seems to be, at lease from our part, that some of the spending in North America is moving more towards distribution automation, whether it's a transformer substation.

Many of the things that you mentioned in response to John Quealy's question were more internally, inside the utility organization. But what are your thoughts about leveraging the network that we just spoke of, the IP network, to branch out beyond the meter, more in the low-voltage distribution portion?

Our customers are actively pursuing that. I'd point to National Grid very specifically, a project that was driven by a comprehensive look at the integration of distribution automation, along with some metering, as a customer that's done very strong work there, as a number of our other customers. The network that we're providing is absolutely a high value in a distribution automation environment. There's very active work that we're doing.

I mentioned, by the way, on the gas side, sensing products that we're coming out with on the water space as well. So, we're very interested in the other grid applications and see opportunity there. That being said, the volumes are substantially different from what we see in the metering space.

Great. Last quick one. Last call, you mention manufacturing rationalization. I think John spoke about that. It was alluded to today.

If my memory's right, I think you're close to high 20s, 30s manufacturing plants around the world. With some of the standardization in particular on the Electric side, what are your thoughts about doing a more substantial overhaul of your footprint?

We're continuing to look at that. I think when you say we've got 25 to 30, that probably includes relatively small assembly factories that we have, where we ship in kits and they're assembled. And in many instances, that's because customers require that we have a local presence.

So, necessarily we're going to have some factories that, in ideal settings, you may not have and you can consolidate. But the practical realities are that we're going have some smaller locations in a lot of different countries in order to support the business that we get.

Thank you.

Thanks, Jeff.

(Operator Instructions)

Patrick Jobin from Credit Suisse.

Thanks for taking the question. Just as you look at growing the analytic services, and potentially some distribution automation applications, and trying to move up the value chain. Are you looking at that as an internal push to get those products growing or is that more M&A?

Both. Patrick, when I made that comment about our strategy work, it was very specifically about developing, partnering, investing, and acquiring. It's really in developing a whole innovation framework that embraces all of those things.

We've built a standards-based network with the intent of providing on ramps for partners. We see opportunities of accelerating development of partners. In some specific cases, we would consider investment or acquisition. But we have developed quite a lot of that technology internally as well.

Okay. Then just lastly, on the 2014 growth outlook, following up of the first question. Is it possible at this stage to look at the awards that you envision being out there, and saying low-single digit or high-single digit, or really a break out here in growth of 2014 at this stage or is it to early?

The second half, we view as a good run rate for the business. We see some encouraging signs but are not providing 2014 guidance at this point.

Okay. Thank you.

Thank you, Patrick. Operator, any more questions?

Not at this time.

Okay. Thank you all for your questions.

I want to acknowledge that we have now lowered guidance once again. This has been a very difficult process for us and something we clearly do not relish doing. We think we have now got a prudent view of the marketplace. Our visibility in the second half has improved.

We are taking, as John has mentioned, very clear steps at reducing cost and really critically evaluating our markets. Steve is driving cash flow and capital expenditure efforts, reducing G&A expenses. But we are very, very focused on growth as well. I think there's some great announcements that we've talked about today, as well a strong indications on the booking side, and some updates in terms of the marketplace I think of opportunities.

We are absolutely committed to providing you with a clear view of our business and welcome our further discussions with you. Thanks for your time today.

Ladies and gentlemen, there will be an audio replay of today's conference available this afternoon. You can access the audio replay by dialing 1-888-203-1112 or 1-719-457-0820 with a passcode of 531-0793. Or go to the Company's website at www.itron.com. Thank you for your participation.