Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message| ()  

Executives

Steven Helmbrecht -

Ranny Dwiggins - Vice President of Investor Relations

Malcolm Unsworth - Chief Executive Officer, President and Director

Analysts

Michael Horwitz - Robert W. Baird & Co. Incorporated

Stephen Sanders - Stephens Inc.

Stuart Bush - RBC Capital Markets Corporation

Benjamin Schuman - Pacific Crest Securities, Inc.

Craig Irwin - Wedbush Securities Inc.

Jason Feldman - UBS Investment Bank

Carter Shoop - Deutsche Bank AG

Sanjay Shrestha - Lazard Capital Markets LLC

Vishal Shah - Barclays Capital

Paul Coster - JP Morgan Chase & Co

Elaine Kwei - Piper Jaffray

Dale Pfau - Cantor Fitzgerald & Co.

Andrew Weisel - Macquarie Research

Steven Milunovich - BofA Merrill Lynch

John Quealy - Canaccord Genuity

Itron (ITRI) Q3 2010 Earnings Call October 27, 2010 5:00 PM ET

Operator

Good day, everyone, and welcome to the Itron, Inc. Q3 2010 Earnings Conference Call. [Operator Instructions] For opening remarks, I'd like to turn the call over to Mr. Ranny Dwiggins. Please go ahead, sir.

Ranny Dwiggins

Good afternoon, everyone, and thank you for joining us. On the call today, we have Malcolm Unsworth, our President and CEO; and Steve Helmbrecht, our Chief Financial Officer. Steve will begin the call by giving us a financial overview of the quarter, and then Malcolm will provide a business update. After that, we'll take your questions.

Our earnings release includes non-GAAP financial information that we believe enhances your overall understanding of our current and future performance. We also have a supplemental slide deck that is intended to augment our prepared remarks, as well as provide a reconciliation of differences between GAAP and non-GAAP financial measures. You can find this supplemental information on our corporate website under the Investor Relations tab.

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, Form 10-Q and other filings and reports with the Securities and Exchange Commission. We do not undertake any duty to update any forward-looking statement.

And with that, I will turn the call over to Steve Helmbrecht, Itron's CFO.

Steven Helmbrecht

Thank you, Ranny, and good afternoon. Itron had a very strong quarter, building on our balanced portfolio of electric, water and gas solutions with record results.

Here they are: Quarterly revenue growth of 41% to a record $576 million; nine-month revenue growth of 36% to a record $1.6 billion; quarterly adjusted EBITDA growth of 115% to a record $89 million; nine-month adjusted EBITDA growth of 82% to a record $239 million; record quarterly and nine-month non-GAAP diluted earnings per share of $1.36 and $3.06.

In our last earnings call, we talked about full year revenue growth in the mid-20% range. We've done better than that. We came into 2010 with concerns about the economy, project ramp rates and supply chain risk that influenced our outlook. Over the course of the year, our focus on manufacturing, quality and delivery has helped mitigate those risks and drive growth.

I will start with Itron North America, where quarterly revenue grew 130% to a record $315 million. OpenWay continues to drive Itron North America revenue growth. We shipped $1.3 million OpenWay units during the quarter, with OpenWay revenue contributing about 50% of total Itron North America revenue. Our Gas and Water businesses in Itron North America are also very healthy, with about 70% revenue growth over the third quarter of 2009, evidence of a balanced portfolio.

Itron International revenue was down about 4% to $261 million. The revenue decline was due primarily to a strengthening U.S. dollar compared to last year. On a constant dollar basis, revenue grew about 1% on higher meter volumes. Next, our gross margin for the quarter was 32%, comparable to 31.7% in 2009. We are pleased with the improvement in Itron North America gross margin, a result of manufacturing efficiency due to higher volumes, as well as cost-reduction efforts. Thus, I'm happy to report, Itron North America gross margin for the quarter was 35.5%, up 450 basis points from 2009.

On the other hand, there was a decrease in International gross margin. Due to a number of factors, including increased warranty expense, costs related to factory moving and consolidation and increased raw material and component costs. Itron International gross margin was 27.8% for the quarter, down 430 basis points from 2009. In particular, a special warranty charge of about $4.2 million impacted Itron International gross margin by about 160 basis points, and it impacted overall gross margin by about 70 basis points. The warranty charges relate to the final settlement during the quarter of the remaining arbitration in Sweden. I discussed this matter in the last earnings call, and we are pleased this has been settled.

Now let's look at operating expenses for the quarter, excluding amortization of intangibles. On 41% revenue growth, operating expenses grew only 11% to $106 million due mostly to increased compensation expense resulting from the reinstatement of bonus and profit sharing plans. Operating expenses as a percentage of revenue, excluding amortization of intangibles were 18.4% in the quarter compared to 23.4% in 2009. We are seeing improved operating margins as a result of our focus on driving higher revenue, while managing lower growth in sales, marketing, development and G&A expenses.

As I mentioned, adjusted EBITDA increased 115% to a record $89 million. Adjusted EBITDA margin for the quarter was 15.5% compared with 10.1% in 2009. Cash flow from operations for the quarter increased 154% to $50 million. Capital expenditures were about $18 million, resulting in free cash flow of about $32 million.

Our non-GAAP effective tax rate was 33% for the quarter and 23% for the first nine months. The increase over the course of the year reflects continued improvement in profitability in high tax jurisdictions, primarily the U.S. For the full year, we expect our non-GAAP effective tax rate to be in the mid-20s, excluding any additional discreet items or the potential extension of R&D credit legislation.

New order bookings in the quarter were $528 million for a book-to-bill ratio of 0.92:1. Total backlog was $1.7 billion at September 30 compared with $1.6 billion a year ago. Our 12-month backlog remained healthy at $958 million.

Our debt balance continues to decline as well. At September 30, we had $671 million in non-GAAP total debt at a blended interest rate of 5.05%. During the quarter, we made $33 million in debt payments, about equal to our free cash flow, and our cash balance at September 30 was $148 million. In the first nine months, we have made a total of $107 million in debt payments. Our debt to total capitalization ratio at September 30 was 33%, and our debt to EBITDA covenant ratio was 2.2x compared with a maximum covenant of 3.75x.

I want to highlight on the balance sheet, the current portion of debt, which increased from $11 million at December 31 to $226 million at September 30. This change relates to the classification of our outstanding convertible subordinated notes issued in 2006. The notes have put calling conversion features starting in July 2011. As these features now fall within a one year window, the notes are classified as current rather than long term. In Q2, we expanded our revolving line of credit from $115 million to $240 million. At September 30, there were no borrowings outstanding and about $47 million was utilized by outstanding letters of credit, leaving substantial liquidity.

In closing, we are pleased with how the businesses are executing, and I look forward to providing a full year report in our next earnings call. I will now turn the call over to Malcolm.

Malcolm Unsworth

Thank you, Steve, and good afternoon, everyone. Itron's quarter of record growth and financial performance is a direct result of successful innovation in our balanced portfolio of electric, gas and water solutions. We are a technology company. Our ability to deliver innovative products and services that meet our customers' needs give us confidence in our competitive positioning.

I'll start with a few comments about innovation. In North America, we released our OpenWay solution in 2008, and after a year of testing, began ramping of shipments in Q4 of 2009. Today, we have cumulatively shipped approximately 4.5 million OpenWay meters in gas endpoints. Installation of smart meters in North America continues at a very rapid pace. By every measure, accuracy, read performance, customer satisfaction and on-time delivery, these are successful projects. On the day of its release, demand for our smart gas distribution solution has been excellent. It is the most advanced residential gas solution in the world.

Specifically, this quarter's results included order of 1.2 million smart gas modules and the associated system to CenterPoint Energy in their gas service territory in Houston. I'd like to emphasize that this gas order is in addition to our previously announced contract to OpenWay.

Early this year, we also announced a new gas meter with an integrated, safety shut-off valve, the first in North America. So with our new gas smart network, new gas endpoints and our new gas meter, we have brought the Smart Grid to the gas industry. I had a recent story from one of our gas customers in the U.S. that is a great example of the benefits of this new offering. Its utility had a gas explosion at a home within their service territory. Fortunately, our customer had recently installed our new gas endpoints. This allowed them to capture 40 days of hourly gas consumption data at each residence, information critical to determining the cause of the accident. This example demonstrates the value our new smart gas distribution systems are providing utilities, regulators and insurance companies. And for the first time, they have the information needed to help them solve complex investigations and save millions of dollars. Itron's innovation also extends to water utilities, where water losses are a huge issue in both conservation and non-revenue water.

Our new smart water distribution system and the new leak detection solution redefine the Smart Grid for water. And we have the best selling meter data management software in the world. In fact, this Enterprise system just won the Teradata 2010 Innovation Award, its top award to a partner across all verticals globally. Teradata, the strategic partner, is the world leading enterprise data warehousing provider. And our groundbreaking alliance with Cisco announced earlier, is another example of our commitment to lead the industry. I'll give you an update on that in a few minutes. So the point is innovations like these have led to record revenue, margin expansion and improved cash flow.

Moving up to bookings, I was very pleased with Q3 bookings. They're a reflection of the tremendous opportunity for new business provided by our balanced portfolio of electric, gas and water solutions. Over the past 12 to 18 months, we have good opportunities to win large electric contract awards in North America. The first wave of electric contracts was driven by a regulation in California and Texas. The second wave was stimulus-driven, which is mostly played out. So what happens after that? We're seeing momentum in the marketplace from utilities growing acceptance of a broader operational business case for the Smart Grid. There is business to be won. And not only does Itron have great solutions, but we've made an organizational change to strengthen our focus and support broader, Smart Grid electric opportunities.

In Water and Gas, we continue to win with strong bookings. During the quarter, North American bookings included 1.9 million Smart Gas endpoints. As mentioned previously, this includes our CenterPoint gas contract. We also had a significant win with Cleveland Water, which shows our newest smart water distribution solutions. And we've also seen very good demand for gas meters, with a 62% increase year-over-year, year-to-date. And as a reminder, we acquired the U.S. Gas Meter business as part of our acquisition of Actaris in 2007. This increase in demand is clearly one of the best examples of revenue synergies we're seeing from this acquisition.

Now the opportunities outside of North America will take a little longer to play out. And in the third quarter, we saw continued momentum in many parts of the world towards the adoption of Smart technologies, providing ongoing growth opportunities. During the quarter, we announced a new water project in the U.K. with Severn Trent. And today, we announced three contracts for smart electric payment meters in Indonesia. In total, the contract includes 800,000 meters. This smart payment technology will help people self-manage their energy bill and protect utilities' revenue, a significant issue in many parts of the world.

But the question is more about future bookings. In that regard, here are some things to keep in mind. I attended the European Metering and Billing Conference in Vienna in September. Many utilities presented and demonstrated that they are continuing to move forward with their plans to meet the 20/20/20 European mandate. And during the quarter, we announced the Smart Grid pilot with GrDF, the main gas utility in France, with 11 million residential customers. We won a full vendor selected to participate in their smart meter pilot. We also announced the smart metering partnership with Hager, that strengthens our market position in Germany.

And the Brazilian government issued a draft measure for the adoption of smart meters, a continued sign of government support for smart metering. These are our growth drivers in different regions of the world, encompassing all of these three markets, electric, gas and water, and it highlights one of our key competitive advantages. We are strong in all three areas, with presence around the world. And let's also remember the growth opportunity for new electric, gas and water infrastructure. In some countries, electrification is still being established, water being measured for the first time, and new natural gas resources are being found and extracted.

Finally, I have some thoughts to share with you about the movement to open standards and interoperability. Some see this as a negative for metering companies. But that's not the way I see it. Itron supports this movement, and I believe this will be positive for us and for the industry. The issue is about accelerating the market, lowering the overall implementation and integration costs for utilities in order to enhance business cases by opening up the market for widespread adoption and consumer benefit. No one company can claim to supply the network for the Smart Grid, rather the Smart Grid is a network of networks. We're excited and very excited to be working with Cisco, the world's leading network company, to develop the first truly scalable, open standards-based Smart Grid architecture based on IPv6. And since we announced our alliance, our collective teams have made significant progress. We've confirmed our OpenWay 3.0 platform is forward-migrateable to a full implementation of IPv6. In fact, we provided live demonstrations of OpenWay on IPv6, supporting distribution automation devices at our Itron Users Conference last week in Orlando, and as we previously committed, we'd do in Q4. We're already working together, on customer meetings, joint sales proposals and engineering reviews to ensure we meet customer needs. We couldn't be more pleased with the synergies this alliance is bringing.

In summary, with our innovative capability, global footprint and broad portfolio of electric, gas and water end-to-end solutions, Itron is very well-positioned to compete for the growth opportunities ahead of us.

Operator, we're ready for questions.

Question-and-Answer Session

Operator

[Operator Instructions] We'll go first to Vishal Shah with Barclays Capital.

Vishal Shah - Barclays Capital

I have a question on the margin outlook for the International business. I believe you said that the warranty charges are behind us now. So can you talk about how we should think about the margins in that segment going forward? And also, did I hear you correctly, you say that the OpenWay revenue lift in the 50% of your North American revenue, and that imply that your ASPs in some of the AMI contracts are better than the others, like CenterPoint is probably better than the others?

Steven Helmbrecht

This is Steve. So let me cover those. First of all in international margins, as I mentioned, it's down about 400 basis points, and more than half or probably closer to 2/3 of that in the quarter was really due to, as I mentioned, a number of specific items, the warranty being the largest. We are seeing some increased material and component costs and are continuing to work on managing that, our purchasing areas. We've seeing some pressure there on the pricing. We continue to focus on manufacturing efficiencies to offset that to the extent possible. And so, as I said, the primary driver for that over the course of the quarter was those other items I mentioned. I did say that the OpenWay was about 50% in total, and so non-OpenWay was about the other half as well. And then I missed the last part in the ASP.

Operator

We'll go next to Dale Pfau with Cantor Fitzgerald.

Dale Pfau - Cantor Fitzgerald & Co.

As we look forward, in the past, you've been asking us to focus on your 12-month backlog, and for the first time in several quarters, we've actually seen a slight dip. Can you talked about trends you're seeing out there and how we are to expect seasonality over the next few quarters?

Malcolm Unsworth

It was a slight dip in backlog, but we still have a very, very robust backlog of $1.7 billion. Considering our bookings were $528 million and our revenue was $576 million, the backlog did go down slightly, but not anything that we're worrying about. And that gives us an opportunity as we move forward to look at all the relationships we have, to grow that business with the relationships that we now have with Cisco. And so we're looking forward to increasing that, as I say, over the next period of time, especially with these relationships.

Dale Pfau - Cantor Fitzgerald & Co.

And should we expect any seasonality in your bookings over the next couple of quarters?

Malcolm Unsworth

Usually, at the end of the year, it is one of those situations where sometimes in the fourth quarter, utilities do seem to spend, either-use-it-or-lose-it theory. So occasionally, we do have year end orders to make sure they spend their money. So it is a little seasonal sometimes.

Dale Pfau - Cantor Fitzgerald & Co.

Any comments on how you think this year will play out?

Malcolm Unsworth

We're just starting now in the fourth quarter, so it's still too early to tell.

Operator

We'll go next to Stuart Bush with RBC Capital Markets.

Stuart Bush - RBC Capital Markets Corporation

I was hoping you could give some more color on specific opportunities in Europe and internationally that you're focused on here for the first half of 2011? I mean, I know you mentioned you've got a great platform and a lot of opportunities. I mean, is there something that investors should be looking at for PRIME opportunities for next year?

Malcolm Unsworth

Stuart, we did spend, as I said in my prepared remarks, I did spend some time at the European Metering Conference in Vienna. And we're working primarily with many of the large utilities based on their mandate of 20/20/20. In particular, I mentioned, in my prepared remarks that we've got GrDF pilot, we have an ERDF pilot. We're working with Ebadrola [ph], and now we've announced this partnership that we have with Hager in Germany. So we really cover many of the areas. And of course, we provide a lot of products into the U.K., where we have our Smart Payment solutions, and we're working on that as well. So we try to cover, we've got a significant, broad portfolio where recover all of the countries both in Europe and the rest of the world. So when it comes to Europe, we're very well-covered, and other parts of the world like I told you, the situations in Brazil and South America, so we don't rule out any of that. We're looking and working with all of the utilities throughout the globe.

Stuart Bush - RBC Capital Markets Corporation

Can I follow up with that? Real quick, should we expect your international OpEx to go up as a result of increased sales and marketing efforts around the world?

Steven Helmbrecht

This is Steve. We talked before, Stuart, in the area, where we've seen -- we have a strong distribution network already in international and are comfortable with the structure we have in place. There can be a little bit of variable compensation growth. But the main area and point has been in R&D. We have talked about increasing that modestly in order to help focus on the opportunities around the world, which require us to be able to be local and to work with the specific requirements in each of the industries. And on the G&A line, no, we don't see a lot of movement there as well.

Malcolm Unsworth

Just to add some or color, Stuart. We do have 60 locations, where we have salespeople throughout the world. And in those sales locations, we're trying to strengthen the position, where we can provide the services that utilities need on how to move towards Smart Grid. So will there be increases in our sales and marketing expenses? Marginally, yes.

Operator

We'll go next to Ben Schuman with Pacific Crest Securities.

Benjamin Schuman - Pacific Crest Securities, Inc.

Can you talk about the split between Q3 and Q4 for the bookings and delivery for the Indonesia contract? And then maybe just talk in relative terms about the ASP of that prepayment solution versus something like an OpenWay in the U.S.?

Malcolm Unsworth

Just to give you an example, I believe about half of the booking was included in the bookings for -- so all of it was included in the bookings for Indonesia. With regard to selling prices and ASP, no, we don't do that. We don't say that. It's confidential, of course. But there's significant opportunity in that region of the world for prepayment and smart solutions, Ben.

Benjamin Schuman - Pacific Crest Securities, Inc.

Can you give us a rough dollar amount for the CenterPoint gas bookings?

Malcolm Unsworth

No, we've got 1.2 million points that we have associated in our CenterPoint gas booking. What's important about that is that is the new solution that we have for our Choice Connect, two-way Smart Grid solution for gas. And they've elected to do that so that they can also incorporate that with one holistic system for their non-electric territory, or should I say, gas-only territory.

Operator

We'll go next to Sanjay Shrestha with Lazard Capital Markets.

Sanjay Shrestha - Lazard Capital Markets LLC

Two questions. First, on some of the European pilot program that you guys are working on, GrDF and all those guys. Where do they move from pilot to full-scale installation?

Malcolm Unsworth

That is a very important question, Sanjay, and obviously, that's something that we monitor very closely. The mandate call for having the complete installations done, as we said, by 2020. These pilots, they start this year. We've done very well with ERDF, and providing that one to the electric side. But those projects have been traditionally known that they would start around about 2012. So not much change from that, that's been made public to us today. We're working with GrDF to do the same kind of thing.

Sanjay Shrestha - Lazard Capital Markets LLC

You guys have done a great job this year. Next year is probably going to play out pretty well driven by the OpenWay traction strength, existing backlog. One general concern that is there, and I'm asking you to come and take a look at the crystal ball here a little bit is about potential slowdown in North America for 2012, especially on the electric side. But based your comment about broad operational business case, Cisco relationship, are we looking at a situation here where, even electric business does well in '12 and you will do well with Itron North America, as you continue to do well with the Gas and Water Meter side of the business and international complements the growth and '12 results are a pretty smooth year versus any major decline?

Malcolm Unsworth

Sanjay, I also, don't have a crystal ball. But what I can tell you is that the relationship that we have with Cisco, as I said in my prepared remarks, we're visiting customers. There are certain customers in North America that have to have these installed by 2012. We're working with a handful of these clients, working with Cisco, making joint calls, and I'm trying to meet their customer requirement dates so that we can enjoy some of the opportunities as we move forward like we've done with the full five large contracts that we have today. So we're obviously spending time with Cisco, and trying to change the way and do things slightly differently because, let's face it, this alliance agreement that we have with Cisco is going to reduce the total cost of their business case to push for more and quicker deployments.

Operator

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

John Quealy - Canaccord Genuity

First, can you talk a little bit about Cisco? I know, Malcolm, you mentioned that some of your utility customers, you've been out there jointly visiting them and potentially pitching them. But can you comment for North America, or at least, in the Electric side? Has every single open RFP or major potentially AMI, have they met with Cisco with you folks together at the utility? Or can you give us a little background there?

Malcolm Unsworth

John, we signed the official agreement on September 1, and we've had a significant number of meetings with them. In particular, I haven't seen Phillip Mezey for a while, because he's been talking to Cisco probably too much. But it shows you that we've got this significant relationship with Cisco. And going together with all the RFPs with Cisco is something that we endeavor to do, absolutely.

John Quealy - Canaccord Genuity

As a follow up, again, going back to this booking question, if you would, there seems to be three deals of note this quarter, Cleveland, CenterPoint Gas and Indonesia. If they're all in the booking number this quarter, is it safe to say that collectively, they're in the neighborhood of maybe 15% or 20% of the total bookings represent those three jobs? And if you can't comment on the number, can you talk about Q2, and were there any like-size deals in Q2's bookings?

Malcolm Unsworth

Do you want take that Ranny?

Ranny Dwiggins

John, this is Ranny. We haven't really given numbers on exactly what the bookings are by contract or in groups. So we really don't talk about that. Going back to Q2, you know we had a really big booking that we just closed in Q2 for Detroit Edison. And I think, you're talking about things other than that one. And right off the top of my head, I can't recall what those were.

Operator

We'll go next to Patrick Gilman [ph] with Credit Suisse.

Unidentified Analyst

I was hoping you could provide a little more color on international growth. You said on a constant currency basis, you saw 1% growth. Could you maybe provide a little more color on the geographies and product mix that are seeing the strength and then recent trends?

Malcolm Unsworth

We have a very balanced portfolio of electric, gas and water. So it's not specific just to say, one particular area with regard to what bookings we have. But we've got -- we have seen very good opportunities with our Gas business with regard to prepayment as we talked about. That's one of the countries where, in Azerbaijan, Azerigas, where we're deploying smart gas products. We've got opportunities, as I said, worldwide with Indonesia, with PLN, and that was an electric deal. And then of course, we provided water solutions to India. We talked about earlier, and this new opportunity that we booked with regard to the water smart project or the water project with Severn Trent. So it's a bit of a blend all over. And so there's not one particular section that's really moving. And the balance that we have, as we said, is about 40% for electric, 30% for gas and 30% for water. So water's sort of moving up a little bit to be honest with you. We booked more business with the water in the little while, and we're seeing that as a trend.

Unidentified Analyst

Just as a follow-up or somewhat separate question, your strong cash flow would suggest, you have quite a few options. Is there maybe deleverage or maybe a smaller technology-specific acquisition? Can you maybe help us think through what your target leverage ratio is? Or what your plans are with your cash flow?

Malcolm Unsworth

Let me let Steve take up for leverage and then I'll talk a little about possible choices we have.

Steven Helmbrecht

Patrick, we've paid a significant amount of debt. In the near term, we're going to continue to focus on that with this number [ph]. We are comfortable below 2x at the EBITDA covenant over time. I also want to maintain some additional liquidity for the reasons I talked about, and at the same time, make sure that we are providing investment organically where needed for R&D kind of growth opportunities we've talked about. So we see the best use of cash in the near term as continue to be used to pay down our debt.

Malcolm Unsworth

And when it comes to potential acquisitions, obviously, we can't probably talk about that. But we'll always look at the possibilities. I mean, we do that, we look globally at the possibilities. It's not just in North America or in Europe, it's across the globe. So we're always looking at the possibilities for that, Patrick.

Operator

We'll go next to Carter Shoop with Deutsche Bank.

Carter Shoop - Deutsche Bank AG

First off, congratulations, six consecutive quarters of a positive book-to-bill in the North American region is pretty impressive, excluding the OpenWay business. Looks like the overall booking's up 40% year-to-date, excluding OpenWay, is a pretty noticeable trend here. And I wanted to get your sense on if this trend is something that we can continue to see going into 2011? Is there any reason to think that the bookings momentum outside of OpenWay will slow?

Malcolm Unsworth

Carter, it's obviously, one thing that we're always looking at. As the economy picking up, our housing starts increasing, already adjusted, their inventories have gone down. It could be a blend of all three, specially in North America. We have got some very good innovative products that we've put together. When we talk about the gas solutions, the two-way AMI gas or smart gas distribution solutions, which I talked in my prepared remarks, when we talk about the new booking that we've got in Cleveland, it's a bit of a game-changer when it comes to areas that were traditionally, our AMR customers. And now that we've got this two-way communication and smart technologies for both water and for gas, it's given us a bit of an edge when it comes to being competitive, when you've got lots of features at a decent price. And of course, the OpenWay situation, everybody's aware of that with the Smart Grid and Cisco. So we're working very closely with these customers to look at opportunities. So we do cover all of the water, gas, electric customers over the -- and we're looking at 2011. Hopefully, we'll continue with the trend.

Carter Shoop - Deutsche Bank AG

In regards to gross margins in the International business, can you disclose what the impact was from restructuring in the quarter and what type of impact do you expect from restructuring in 2011?

Steven Helmbrecht

This is Steve, Carter. As I mentioned, of the total reduction at a high level, about 2/3 of that was related to the warranty. But there were some additional restructuring. And we are in the process of moving a couple locations in consolidation of a factory, which is a good thing, to drive more efficiency go forward. As we look into 2011 in the bigger picture, we're very comfortable for footprint, multi-local, we're happy with what we have, and we don't see the need to be expanding in terms of CapEx and building out facilities over time, nor even focusing as well on rationalization in any large way. We will look for smaller opportunities to continue to take costs and then improve efficiency.

Malcolm Unsworth

And just to expand on that, we did do some, as we said, consolidations in South America. But at the same time, we've opened up the markets for water in India and also, in China. So we've added some of those capabilities. So as much as one's come down for consolidation, other areas are increasing.

Operator

We'll go next to Elaine Kwei with Jefferies.

Elaine Kwei - Piper Jaffray

Outside of the existing OpenWay deployments, could you talk a little about which segments of the market in North America are showing particular strength? Is it spending coming back faster at the larger IEUs [incumbent electric utilities] or smaller to midsized utilities? And then on the product side, is that primarily from the smart gas and water or MDM [Meter Data Management] and other products? And then finally, I think, you had mentioned in your prepared remarks, stronger gas meter demand, and we're just wondering if there's something specific driving that?

Malcolm Unsworth

When I talked about the prepared remarks for the stimulus money, that also related to the water side. Basically, that's what helped them from the water side. So what's growing the Water business? As I said to Carter, it's really the new innovative products that we've developed. You get better business cases and gives them the ability to do the traditional things that AMR used to do, but with now some significant different capabilities like, as I say, these safety issues that we've got. So that is helping the utility put a better business case together. And maybe they're looking at these opportunities going forward, and it's sort of a blend of a number of things, the economy, the fact we've got better products. And it's never just one thing. So that may have answered your question, Elaine.

Elaine Kwei - Piper Jaffray

Just as a follow up, I was wondering if you could share any thoughts you might have in terms of pursuing more recurring services or software type of revenue, and what the potential opportunities might there be in, for example, network management, demand response in the prepay systems, especially in the context of the Cisco partnership, does that open up any avenues there?

Malcolm Unsworth

With regard to prepaid services, obviously, one of the areas we got strength on is managing that in South Africa and also in the U.K. We will not be doing that yet for the time being in Indonesia. But that's always a possibility. We always look at these recurring services. When it comes to demand response, as we've said many time, there's a couple of large players in this business and they're doing quite well. They're going quite well. But we also offered a product that helps the utility do that function for themselves. But the Cisco relationship, that could help, there's no question. They've got some services that they could provide, and we could use their services and push that going forward. So there's always that possibility, Elaine.

Operator

We'll go next to Steve Sanders with Stephens Inc.

Stephen Sanders - Stephens Inc.

I just wanted to come back to the project in Indonesia and see if you could talk a little bit more about how competitive it was, how the margins on that project would compare to the international corporate average, and whether there are significant incremental opportunities in that area or with that customer.

Malcolm Unsworth

You know that I won't cover pricing, I think, in line of that. But we live, eat and breathe everyday with competitive pricing. These are not just awards that you get without being competitive. And so we do this all the time. We have a factory in Indonesia. It has about 1,000 people, and we have local content. Does that make a difference? It could. And so these are the kinds of things that we offer. A very large portfolio of local content, because we're a global company and we operate locally. That's the advantage that we have. Could we ship this product out of the U.S. or out of the U.K.? Probably not. We manufacture that product for the Indonesian market. So I just want to make that clear. And of course, I won't talk about pricing there.

Steven Helmbrecht

But Steve, you also asked about the potential of our growth over time. Obviously, Indonesia is a populous growing company with growing GDP. And clearly, our strategy, with all our customers, is to execute, deliver well on projects and hope that, that leads to winning additional business over time on America.

Malcolm Unsworth

I think the number, Steve, is 240 million people in Indonesia. 800,000 points is not a large percentage. So there, opportunities continue because they have what the Brits refer to as some non-technical losses, so this helps the utility with that.

Stephen Sanders - Stephens Inc.

The question really wasn't on pricing. It was more around just kind of a general idea that this is a product that arguably, has more technology content than a base meter, and so shouldn't it be a positive incremental contributor to your margin? So whether you want to go down that road or not, I understand. And then my next question was just, as you came away from the European Meter Show, what are you thinking about in terms of the most significant obstacles to seeing some meaningful vendor selections in the back half of '11 and some sizable rollouts starting in '12?

Malcolm Unsworth

Vendor selections, well, if you take a look at the market shares that we have with electric, gas and mostly, electric and gas in Europe, I came away from that feeling quite confident that we have a very good opportunity in all of the markets in Europe. We've got, as we said before, market share is something we look at all the time. And having been selected in certain markets or certain customers, they've made the selections in two or three locations our customers today. And so long as those longest those solutions work, you're pretty much going to get selective going forward. But that doesn't guarantee it. But we've got very close relationships and close ties with all of the major players in Europe for gas, electric and water products, and we've been progressing. We're going over to AMI solutions and they like it.

Steven Helmbrecht

And Steve, this is Steve. Just to add to your prior question, certainly, we see that and consider our prepayment meter to be our smart meter. And as such, relative to traditional consumption watt-hour meter has a lot more capability and functionality and that certainly factors in terms of pricing and the value proposition to the customer.

Operator

We'll go next to Michael Horwitz with R.W. Baird.

Michael Horwitz - Robert W. Baird & Co. Incorporated

With the CenterPoint bookings in the quarter, you said 1.2 million units for gas? Is that correct?

Malcolm Unsworth

Yes, that's correct.

Michael Horwitz - Robert W. Baird & Co. Incorporated

So is it fair to say, if I look at Smart gas meter prices, and I make my assumptions around price, I know you're not going to comment, but it's pretty well-documented that, that is better than half of your North American bookings this quarter?

Malcolm Unsworth

We really haven't commented on the specific dollar amount of the CenterPoint booking.

Michael Horwitz - Robert W. Baird & Co. Incorporated

It's a very large contract, I guess, is my point.

Malcolm Unsworth

We're very pleased with it, yes. It's a great complement.

Michael Horwitz - Robert W. Baird & Co. Incorporated

I would normally not bring this up, but any issues we should see around the law suit that CenterPoint and Oncor and Texas-New Mexico Power have in their hands now as of the 21st from TransData? Does that affect any of your technology offerings at CenterPoint?

Malcolm Unsworth

I'm not as familiar as I should be. But no, we really can't comment on any particular legal issues that are going on with our clients.

Michael Horwitz - Robert W. Baird & Co. Incorporated

The only reason why I asked is because it seems to fairly specific about technology and it was just filed. One other quick question. On Cisco, are you implying that you're going to see utilities right now that may have already awarded their contracts to other vendors and so they may need to get things done by the end of 2012 and perhaps things aren't going well with their other vendors. So you're going in and offering a different solution with Cisco in hand? Or are you talking about other business?

Malcolm Unsworth

Michael, it's a great question. It really is. We do the same as all the rest of our competitors. We have the opportunity, because we've got a very large portfolio of solutions that they use today. While they're deploying some of other competitors' products, they have to go and read meters. We have a significant, broad portfolio of handheld devices using our reading solutions. They have to use those. So we have the reasons to go and see them anyway. And while over there, yes, it's the perfect opportunity to revisit some of those clients that already have been awarded.

Operator

We'll go next to Paul Coster with JPMorgan.

Paul Coster - JP Morgan Chase & Co

Malcolm, in your prepared remarks, you stressed this is a technology company and so as a metering company, and I'm just curious in the context of acquisition and looking out several years from now, whether you're looking at the sort of application layer that will sort of hinge off the deployment of meters, whether it's building management, home-area management systems, energy management systems, direct load control, grid management, which I think people believe may have high margins attached to it. Do you think it's going to be part of Itron's strategy long term?

Malcolm Unsworth

Obviously, Paul, I don't comment about specific opportunities. But yes, you bring up a good point. We're always looking at opportunities to grow. One thing that we will always remember is we will always be in the utility space. We will not go outside of that space. And as I said many times that if you take a look at some of the smart service steps, for example, around your wall, I don't think we can compete with companies like Honeywell. There are certain areas that, yes, we will look at, but not the obvious ones like the home area network devices and looking at companies like, if you take a look at the iPhone application and Google, we really can't compete with those companies. But yes, we do always look at other opportunities. So, yes, we do, Paul.

Paul Coster - JP Morgan Chase & Co

Electric has already yielded some endpoints and another 30 million pilots is seen through that. So that leaves another 70 million homes that could go smart, now that you've had some time talking to more utilities. Is your sense that eventually, every U.S. home will have an electric smart meter?

Malcolm Unsworth

Yes, the opportunities are there to do that, obviously, if the business case is there for each particularly utility, with all the business capabilities, that would be something that we would look at. But there's public documents that do look at the total numbers of about 65 million points. I mean, you could take a look at it, and I'm sure you're pretty familiar, Paul with some of these added information that you can look at, that show you that there's significant number left to deploy, and it will take quite a long term -- quite a length of time to deploy all those. But as the price point comes down, as it is doing now, the business case has improved, there's opportunities to do that, yes.

Operator

We'll go next to Jason Feldman with UBS.

Jason Feldman - UBS Investment Bank

So some companies this earnings season, selling other types of products into the utility space like transformers, have kind of noted a pickup in utility activity and purchasing. Have you seen a change of sentiment more broadly among the customers, not just in their activity, but how they're kind of viewing the world? And also, do you think there's any kind of uncertainty overhang right now related to the upcoming election?

Malcolm Unsworth

When it comes to if utilities are starting to increase there buying patterns, one thing that we've done with our solutions is that we managed -- this was a company, years ago, obviously, with the large ones is we've done that without stimulus money. And stimulus money now, sort of moved away. Then it's coming back to replacements. They didn't spend much money in 2009 because of the recession. Yes, I do see that if they're starting to spend a little bit more money, it's because our inventories went below in 2009. So they will eventually have to spend money on things like transformers to replace the old ones. And will the elections make a difference? I don't have a crystal ball.

Jason Feldman - UBS Investment Bank

I understand you're not updating guidance. But when we think about fourth quarter from a revenue perspective for North America, what are the factors that we should take into account? I mean is there typically, seasonality we should be aware of, or something else? Or is kind of the third quarter run rate reasonable, given that your backlog was roughly flat?

Steven Helmbrecht

This is Steve, Jason. To that point, we talked about the backlog, and Malcolm did mention year end spending and seasonality. That's a bit too soon to talk about in terms of what utilities do. But historically, we had seen some year end spending over time. That just depends really in terms of individual circumstances. But we tend to see, as Malcolm mentioned, that there can be year end spending as well in utilities. It just depends.

Operator

We'll go next to Steven Milunovich with Bank of America Merrill Lynch.

Steven Milunovich - BofA Merrill Lynch

First of all, the OpenWay bookings in the third quarter, have you given out that number or could you?

Steven Helmbrecht

We haven't given out the number. We had a couple of pilots that we booked that were relatively small. So nothing significant compared to the overall bookings number.

Steven Milunovich - BofA Merrill Lynch

And then, Malcolm, you've obviously, talked quite a bit about the Cisco relationship. You kind of make it sound like it's potentially accelerating your business looking forward. Is that true? Are you seeing any customers who might be concerned about committing to Itron today, given that -- I don't think you're going to be integrating their technology into the communications product till next year. You did mention that I think the current communications software is forward-compatible, which, I assume, is very important to people who are going to be buying anytime near term. But I guess, I'm asking, is there any risk that it actually slows things? Or is it truly accelerating customer interest?

Malcolm Unsworth

The feedback that we've had from customers about the relationship we have with Cisco has actually been excellent. And one thing that I really want to stress, which I did say on my prepared remarks, was that our hardware 3.0 solution is completely what we call backward-compatible. So it can be downloaded over the air. So whatever solution that we're proposing, using the full interoperability with mixed standards is all backward-compatible. So it's adding a lot of flexibility to our customers. And they're liking the fact that we're working together, making joint calls and trying to align their timetables with our timetables.

Operator

We'll go next to Craig Irwin with Wedbush Securities.

Craig Irwin - Wedbush Securities Inc.

In your prepared remarks, you mentioned CenterPoint and the 1.2 million smart gas meters that you booked in the quarter. I thought I heard you mentioned a total of 1.9 million smart gas meters booked in the quarter. Just wanted to know if you could confirm that. And if you could comment on the breadth of customers that are contributing to the additional units, and if you have any comments on the overall level of trials activity in smart gas meters right now.

Malcolm Unsworth

That is correct. We said 1.9 million gas endpoints. The acceptance I was recently speaking at the American Gas Association and when I talked about the situation with the 100G products that they use for 40 days of hourly data, and the fact that saved a particular utility potentially a significant amount of money, gave them all the information that they needed that they've long been waiting for safety reasons. And we're seeing tremendous opportunity and tremendous interest in our new gas solution or gas AMI solution. So yes, everything will shift now. Most of everything will shift on the gas side is within our AMI two-way communicating Smart Grid gas solution. So tremendous interest in that.

Craig Irwin - Wedbush Securities Inc.

And it sort of looks like on the gas side, we might be at an interesting point, maybe similar to where we were five to seven years ago on the electric side. Can you comment on whether or not you see customers coming in for broader business cases and ramping activity significantly in the North American market? Or if this is something we should consider that will move alongside the electric AMR over the next couple of years?

Malcolm Unsworth

I can absolutely say that for a fact. One thing that the utilities have always thought about and watched very carefully is safety. Safety is the number one concern that they have with gas utilities. We don't really say an awful lot about that, only when it's public, but this product allow us the ability both with this with the safety shut-off valve, with what we call product protection with gas lines to stop them from rusting or at least indicating that. There's a significant amount of interest in our solution. We'll come forward like the electric side, it could. That's what we're hoping for.

Operator

And we'll go ahead and take our next question from Colin Rusch with ThinkEquity.

Unidentified Analyst

This is actually Brandon Moara [ph] for Colin. I was just -- I have two questions. And I guess, the first one is over the next two or three years, are there any kind of opportunities that you're seeing for the distribution automation network in the electricity industry in the U.S.? Not necessarily M&A, but if there's M&A, I mean, I know you said -- you weren't going to talk too much about that, but just in general. And I guess, the second question would be with if you've seen any new kind of activity in water metering opportunities for municipalities in the U.S.?

Malcolm Unsworth

Let me just answer your question with regard to distribution automation. When it comes to understanding what's going on in the grid, that's one of the benefits that we have with our Cisco relationship. We've also got distributed generation that we are looking into, and also, electric vehicle charging stations that we're working with some of our customers on that. All of these all sides together over the next two to three years when it comes to looking at the activity level that utilities are trying to determine for their Smart Grid applications. So yes, we are working with utilities on their DA solutions. When it comes to water acceleration, we're just doing the same thing. We end up that we are always looking at solutions with water distributors. But they're looking today at fixed network. Nearly all of the opportunities that we are seeing coming from the water side now. Mobile used to be there, and we're offering backward compatibility, but nearly everything we're seeing with regard to RFQs is fixed network, and that's what we're offering.

Operator

We'll take our final question from Andrew Weisel with Macquarie.

Andrew Weisel - Macquarie Research

If you look at the shipment that you had over the past say, six quarters or so, or seven quarters, there's been a steady shift from the old electromechanical meters into the AMR and AMI. Obviously, a good mix shift. My question is when you look at your current backlog and the trend of bookings that you've had more recently, do you expect that shift to continue? How high can that proportion get? Or is it kind of going to plateau at this 50/50 or so on a volume metric basis?

Malcolm Unsworth

When you look at the global market, remember, there are certain countries that we still provide electromechanical products, whether we've got water, gas, electric. So just on the electric side, the Electromechanical business is definitely declining. There's no question. As we talked about when we got the business in Indonesia with smart payment solutions. That's 100% electronic with a smart keypad. So the whole of the industry is moving towards solid-state, smart metering solutions throughout the world, yes.

Andrew Weisel - Macquarie Research

And that's reflected in your current backlog now?

Steven Helmbrecht

Increasingly so.

Malcolm Unsworth

We still sell electromechanical products to certain parts of Europe and certain parts of Asia and certain parts of South America. So yes, it is reflected in the backlog today.

Andrew Weisel - Macquarie Research

Lastly, you mentioned in the press release some of the benefits in the North American margin from the cost-cutting activities. Can you just elaborate, maybe quantify the benefit and how much of that is sustainable?

Malcolm Unsworth

We're always looking at opportunities to reduce cost. If it's redesign, if it's purchasing higher volumes, absorption, a better absorption, we're always looking at that. And so with regard to continued cost reductions, it's something that is just in our nature. That's what we do everyday.

Operator

And that does conclude our question-and-answer session. I'd like to turn the call back over to our presenters for any additional or closing remarks.

Ranny Dwiggins

Thank you, Kevin. I appreciate it. So thanks, everyone, for joining us today. And as always, if you have any questions, please give me a call, Ranny Dwiggins, and I'll be happy to talk to you.

Malcolm Unsworth

Thank you.

Operator

There will be an audio replay of today's conference available this afternoon. You can access the audio replay by dialing 1-888-203-112 or 1-719-457-0820, with the pass code of 4037712, or you can go to the company's website at www.itron.com. Again, that does conclude today's call. We do appreciate everyone's participation.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Itron CEO Discusses Q3 2010 Results - Earnings Call Transcript
This Transcript
All Transcripts