Itron's CEO Discusses Q1 2012 Results - Earnings Call Transcript

| About: Itron, Inc. (ITRI)

Itron (NASDAQ:ITRI)

Q1 2012 Earnings Call

April 25, 2012 5:00 pm ET

Executives

Barbara J. Doyle - Former Vice President of Investor Relations

LeRoy D. Nosbaum - Chief Executive Officer, President and Director

Philip C. Mezey - President of Energy and Chief Operating Officer of Energy

Steven M. Helmbrecht - Chief Financial Officer, Principal Accounting Officer and Senior Vice President

Analysts

Benjamin J. Kallo - Robert W. Baird & Co. Incorporated, Research Division

John Quealy - Canaccord Genuity, Research Division

Zach Larkin - Stephens Inc., Research Division

Jesse Pichel - Jefferies & Company, Inc., Research Division

Craig E. Irwin - Wedbush Securities Inc., Research Division

Patrick Jobin - Crédit Suisse AG, Research Division

Amir Rozwadowski - Barclays Capital, Research Division

Operator

Good day, everyone, and welcome to the Itron Inc. Q1 2012 Earnings Conference Call. Today's call is being recorded. For opening remarks and introductions, I would like to turn the call over to Barbara Doyle. Please go ahead.

Barbara J. Doyle

Thank you, Robert, and welcome, everyone, to our earnings conference call. On the call today, we have here LeRoy Nosbaum, Itron President and Chief Executive Officer; Philip Mezey, Itron President and Chief Operating Officer for our Energy segment; and Steve Helmbrecht, Senior Vice President and Chief Financial Officer.

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

Our earnings release and financial presentation include non-GAAP financial information that we believe enhances the overall understanding of our current and future performance. We have included reconciliations of the differences between GAAP and non-GAAP financial measures in our earnings release and financial presentation.

I'd also like to cover our Safe Harbor statement. We will be making statements during this call that are forward-looking. These statements are based on our 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 reports and filings with the Securities and Exchange Commission. We do not undertake any duty to update forward-looking statements.

You will notice in our press release and investor presentation our new segment reporting. Our reporting segments have changed from North America and International to Global Energy and Water segments. This reflects how we are running the business after completing our corporate reorganization. We also believe the new reporting will provide investors with more insight into our business as we are now providing revenue, gross profit and operating income measurements for our Energy and Water businesses.

To provide some context for this change, you can reference the profile of our Energy and Water segments for 2011 on Slide 4 on the investor presentation. This slide depicts our full year 2011 results and the new segment view, including revenue for Electricity, Gas and Water and gross and operating margins for Energy and Water segments.

We have also provided on our investor website a preliminary unaudited schedule recast -- that recaps 2011 by quarter into the new segment disclosure that we hope will further assist you.

Now let me please introduce LeRoy Nosbaum, Itron's President and CEO.

LeRoy D. Nosbaum

Good afternoon, everyone. Thanks for joining today's call. I'll begin with some thoughts regarding Q1 results. Philip will add some comments on smart grid opportunities around the world. Steve will cover financial results in more detail, and then I'll return with some closing comments before we open up to questions.

So let's begin with some thoughts about the first quarter, some explanation of results and what we are working to achieve at Itron. Revenue for the quarter was $572 million. On a constant currency basis, revenues were up about 4% from Q1 of last year, including up about 5% in Water, 5% in Electricity and 1% in Gas. Given the economy around the world, I am pleased with the revenue in Q1.

Gross margin for Energy is a bit complicated, but if you adjust for onetime warranty insurance claim recovery we received in Q1 of '11, Energy gross margin was up by 90 basis points. In Water, gross margin was up 30 basis points. Total gross margin was 32%. While I'm pleased with 32% for now, we still have a lot of work to do in reducing the cost of parts and materials and increasing the efficiency of our factories.

We are working on better parts and material purchasing and expect continued improvement throughout the year. We are continuing with our factory rationalization effort, which will help as the year progresses. We are working the necessary adjustments, driven by slowing of OpenWay activity in North America, including cost reductions which are planned and budgeted for later this year.

Our Q1 -- For Q1, our warranty expenses were at a more reasonable level than they have been in past quarters. We have some potential to see gross margin improve further, but we're also working to mitigate potential downward pressure in the second half of the year. With one quarter on the books, we are on track so far.

Now let me turn to operating expenses, R&D, sales and marketing and G&A. All of them are too high if we were to allow them to remain at these levels indefinitely. So let me give you some color on what we're doing and why.

Let's start with R&D. R&D expenses were up in 2010, in 2011 and they will be up again in 2012, which is consistent with the plan we gave you last quarter, and as a result of the transition from simple metering to complex metering in nearly every corner of the world: automatic meter reading, prepayment metering, metering on the portal, smart metering, smart grid, software that is scalable to tens of millions of points, systems with multiple communications forms and millions of endpoints. This is true in electricity, in gas and in water metering technology. In short, we are seeing a transformation of technology around the world, and Itron is developing products and systems to meet that transformation.

Developing technologies that help solve customers' complex challenges is what Itron does best. Have we been as efficient and effective as we should have been? Not always. Are we later on some projects that we would like to be? Yes. And so are we spending more money than we would like? Yes. But are we spending more money than we should? Absolutely not. We are spending the required amount of research and development dollars needed to grow and preserve our future, and I will not turn that down this year.

As we have seen increases this quarter in sales and marketing, we have purposefully added important staff to grow our opportunities around the world. In Asia-Pacific, we added a new Regional Vice President for Energy and some support staff. We have also added to our Water sales team in China, with the addition of a new general manager and sales director, as well as supporting staff. We see an excellent market opportunity for water and heat metering in China. I believe these are reasonable additions, given the potential for growth in Asia-Pacific.

In Latin America, we added a new regional Vice President and a new sales manager for Energy. Given the potential in Latin America, again, I think an important addition.

And lastly, on G&A. We are spending money for the future on 2 vital corporate initiatives: In IT, we have budgeted expense this year for a new ERP system. As we began planning for that deployment, it became evident that the finance and accounting organizations should be realigned on a global basis to take full advantage of the benefits that the ERP system could bring. Accordingly, we incurred professional services to help us reorganize and reposition finance and accounting to the best advantage.

Implementing a common global ERP system, if you also organize your team and processes on a global basis, has well-proven returns, and it is time we did this.

Similarly, since I returned to Itron, I've been struck by the fact that while our intentions were good, we were too slow to react and too long when completing projects. Earlier this year, I came to the conclusion that we needed to take substantive action to build a more effective and efficient culture. As a result, we are implementing training to build a commitment-based, high-performance atmosphere. That process started in late Q1, with 220 of Itron's leaders, and the program will continue throughout the rest of 2012. I firmly believe that we will achieve a high return on this spending.

Let me make one additional point before I hand the call to Philip. Itron worldwide revenues continue to grow with contribution from a broad base of customers around the world in all of our product lines as our Q1 revenues show. We are making progress on gross margins, slow but progress. We are making needed investments to ensure our seat at the table for smart metering opportunities outside of North America. Our technology is strong, our expertise is unmatched, but we need to move faster and we need to expand our reach globally.

With this combination, I draw the conclusion that Itron's earnings potential will increase and will be as strong as it has ever been. Philip?

Philip C. Mezey

Thanks, LeRoy. Good afternoon. And now for a quick trip around the world to update you on the activity in several of our major market opportunities. Let's start in Europe.

While large European mandates continue to drive the overall European markets forward, the dissonance of economic news has created skepticism about the practical timing of large-scale rollout in a number of the large markets of Europe. In addition to economic concerns, each of the major market opportunities requires specific meters and communications, frequently using a specific standard or a set of requirements that have not been fully finalized.

We focused our research and development resources and product certification timing to position us in these critical markets with qualified product at what we feel is the appropriate time to take significant market share. We are positioned to take our share of each of the major market opportunities that I will discuss.

In Europe, these opportunities continue to move forward as we saw in Spain with the Iberdrola Award of the initial 1 million meters, in which Itron did not have a qualified product. While it was unfortunate that Itron did not have its prime meters certified in time for the initial tender, we fully intend to compete for the additional quantities as early as next year.

In France, an increasingly likely change of government could lead to some delay of the rollout of the first 7 million ERDF meters, not because of a policy difference but due to an administration change.

The purchasing consortium in the Netherlands, Neptahir [ph], will tender this year for the initial Netherlands deployment scheduled to take place in 2013.

In the U.K., while a few small pilot quantities have been awarded, we are in close contact with each of the 6 big retailers who want an open competitive procurement process that actively includes Itron.

On the gas front, GrDF continues on with its planning for the deployment of 11 million gas meters in France in the 2013 to 2018 timeframe. While the technical communications architecture is still somewhat unclear, Itron is well positioned for a portion of the meter business.

The Italian regulator has somewhat extended the timeframe for full deployment of commercial and industrial gas metering in which we have been actively participating, but has reaffirmed their support for full residential rollout throughout Italy to commence in 2013 or possibly '14.

Now moving on to Asia for a moment and the Tokyo Electric Power Company opportunity for a total of up to 32 million meters. 2 technical documents referred to by TEPCO as request for comments were issued to potential bidders in March, one for smart meters and one for communications technology suitable for the Tokyo service territory. We expect there to be a wide range of responses, likely to include technology offerings using RF mesh, power line carrier and cellular.

Itron has responded to both meter and the communications RFC as required by TEPCO. This process is still early on, but Itron is very actively engaged. TEPCO has indicated that the RFP for the initial deployment of meters should be out in the third quarter of this year.

In North America, we remain very actively engaged in several competitive selections for limited rollout as well as our continued work on early field trials and scope expansions. Work with Cisco is progressing well, both in North America and around the world. With the pending acquisition of SmartSynch, adding cellular communications to the Itron portfolio will further differentiate Itron.

In Latin America, there has not been a material market change. We have been focused on continuing our work for product certification. With the addition of our new head of Latin America, we will have an update for you next quarter.

Let me leave you with 2 final points. Outside of the U.S., the tendering process is very different than North America in that the tendering process generally leads to partial awards to multiple vendors and procuring tenders. Itron will compete vigorously for each of these tenders as Itron-certified product is brought to market.

Globally, we sell 30 million meters a year, and we pursue a broad range of large and small smart metering opportunities in order to provide more predictable and consistent results in Energy, as witnessed by our revenue performance in Q1.

Especially in the early stages of many of these projects, one tender is unlikely to have a material effect on our business. In fact, our 2012 forecast did not contain substantial volumes for European electric smart metering projects.

In closing, we are committed to improving our electric and gas market share through active investment in sales, marketing and R&D. Steve will now provide you with the financial update.

Steven M. Helmbrecht

Thank you, Philip, and good afternoon. I will start with Slides 5, 6 and 7. First quarter revenue of $572 million was up 1% from Q1 2011. As you can see on Slide 6, revenue was up 4% adjusting for currency impacts. Our global factory footprint helps mitigate the bottom line impact of currency fluctuations on our operating results.

In Q1, the stronger dollar reduced revenue by $12.5 million, impacting GAAP operating income by less than $100,000, with no impact on GAAP earnings per share. The stronger dollar impacted non-GAAP operating income by less than $600,000 and non-GAAP earnings per share by less than $0.01.

Continuing with the summary on Slide 5, gross margin of 32% is 80 basis points lower than last year. As LeRoy mentioned, last year's margin included $8.6 million of benefit due to the recovery of a warranty claim, which added 150 basis points to the Q1 '11 gross margin. Excluding that onetime benefit a year ago, total gross margin improved 70 basis points, primarily due to lower quarterly warranty expenses. The warranty claim recovery was in the Energy segment.

Non-GAAP operating margin of 9.5% -- was 9.5%, down 220 basis points from the prior year. The decrease in margin reflects the increased operating expenses LeRoy discussed. Consistent with operating income, adjusted EBITDA for the quarter was $67 million, down 16% from a year ago. We had GAAP diluted earnings per share of $0.63 for the quarter compared with $0.66 a year ago. Our non-GAAP earnings per share, which exclude the impact of restructuring charges, acquisition-related expenses, amortization of intangible assets and debt fees, were $0.91 per share compared with $0.99 a year ago. Slide 7 shows the year-over-year bridge for non-GAAP EPS.

Revenue by business line is shown on Slide 8. Adjusting for currency, we had year-over-year growth in all 3 product lines. Electric revenues increased 5% at constant currency, driven by BC Hydro shipments in Q1, which we expect will continue at a strong pace in Q2 before tailing off in the second half of the year. We also had growth in Europe and strong prepayment meter business in Asia-Pacific.

Gas revenues were up 1% year-over-year at constant currency, with the growth driven by 100G gas urged shipments in North America, including some large customer shipments to ATCO Gas, CenterPoint and Xcel Energy.

Water segment revenues increased 5% year-over-year at constant currency, driven primarily by strong business in Latin America and Europe. In addition, our Water bookings in Q1 were strong, which should drive healthy Q2 revenues.

Slide 9 shows our non-GAAP operating income by segment along with the unallocated corporate costs. Energy and Water segment operating income decreased with higher operating expenses in the quarter offsetting the revenue and gross margin improvements. Unallocated corporate costs were also up compared to Q1 '11, driven by $2 million for the corporate initiatives LeRoy discussed.

On Slide 10, we provide a summary of the Energy segment results. The decline in gross margin reflects the warranty claim recovery in Q1. The non-GAAP operating margin in energy was 11%, down from 13% in Q1 '11.

The Water segment results shown on Slide 11. Gross margin increased by 30 basis points, driven by increased volumes and mix of product. The non-GAAP operating margin was 14%, down from 16% in Q1 '11.

Slide 12 summarizes all of our key non-GAAP metrics. The impacts to operating income we have discussed also impacted EBITDA. Q1 non-GAAP net income was down 12% year-over-year, with significant savings in interest expense offsetting some of the operating impacts. Q1 free cash flow of $42 million increased from $25 million in Q1 '11, driven primarily by improvements in working capital and lower cash bonus payments made in the first quarter compared to last year.

I will move on to bookings and backlog using the next 3 slides. Our total backlog as of March 31 was $1.2 billion, and 12-month backlog was $760 million. You can see on Slide 14 that the OpenWay backlog, shown in yellow on the graph, is being worked down as we ship and successfully implement the systems for several very large contracts signed in North America over the last few years.

Our non-OpenWay backlog, shown in red on the graph, increased sequentially in Q1 by approximately 4% from Q4 '11. This is the second sequential increase in non-OpenWay backlog.

Now let's look at our trended quarterly bookings on Slide 15. The bookings tend to be lumpy. The total book-to-bill ratio in the quarter was 0.85:1. Importantly, our non-OpenWay book-to-bill ratios in both Energy and Water were at 1.1:1.

Now turning to Slide 16. In Q1, we paid down an additional $14 million in debt and in the quarter with $439 million of total debt. We expanded the revolver by $160 million at the beginning of April in preparation for the SmartSynch transaction. We expect the SmartSynch acquisition will close in early May, and we intend to finance the acquisition with a combination of cash on hand and available capacity on our revolver.

Regarding the share repurchase program, as of today's date, we have repurchased 1.1 million shares at an average price of $36.20, for a total of $40 million. That represents a repurchase of 2.7% of our outstanding shares. We have not repurchased any shares since our last earnings call in January given the planned use of cash for the SmartSynch acquisition. That leaves available buyback authorization of $60 million. We have created substantial balance sheet flexibility to fund growth in our business as well as repurchase shares when it make sense. And now, as LeRoy has discussed, we are increasingly turning our focus to operations. As we implement our operational transformation with our new segment reporting, our global ERP implementation and our cultural transformation, we anticipate these investments will drive similar long-term benefits. With that, I will turn it back to LeRoy.

LeRoy D. Nosbaum

Philip and Steve, thank you both. Let me start my closing comments with a few words about SmartSynch. As planned, we look to close this acquisition in the next week or so. To the degree allowed, we have been working with SmartSynch people on integration and customer opportunities. We are delighted with the people of SmartSynch. We will be acquiring a very valuable people resource.

In general, I would say that the business opportunities are potentially better than we had thought, both at existing customers and at prospective customers.

Now let me turn back to Itron with a few closing notes. First, an update on the CEO search. As many of you may have been thinking, we have started a CEO search. The process is now well along, with the search firm in place, a comprehensive specification developed and a committee of the board in place.

We are actively looking at candidates. The board and I are pleased with the people we are exploring. We will see how it goes as the board and I actually begin interviewing candidates later this spring.

Just a few words on our announced restructuring process. We continue to make good progress on the necessary manufacturing changes. Originally, we indicated a reduction of approximately 800 people. We are about halfway through at this point. We're adding some people back in other locations, so the net effect is about 350 people down today. At year end, we should be about 90% through with the people adjustments.

The sale of a number of minor businesses are soon to close. Planning for reducing the size and scope of several facilities is on track. Unions and work councils are fully informed. On our initiative to reduce purchasing costs, good work goes on and will continue to have positive impact.

In the quarter, we had a number of good things happen on the sales front. One I'd like to highlight is a $33 million order from Southern California Gas for curve meters, a great win for our gas team in North America and a great example of significant business in our traditional meter markets. It is exactly the point I make when I talk about revenue opportunity continuing to grow here in North America, in Europe and around the world in traditional electric gas and water meters. As well in smart metering, the potential Philip described, with SmartSynch and with software and other products Itron sells. 2012 is a transition year, but it is a year that will lead to real opportunities in '13 and beyond. A '12 in which Itron is spending real R&D dollars positioning for the future growth. A '12 in which we move on rationalization, systems and people to be better positioned around the world and into the future. I came back on August 31, 2011. I said we could be a better company. We are. I said we had some things to improve. We are making real progress. I said we had great potential in Europe, in Latin America and in Asia-Pacific. It is developing. I am pleased with the progress. Yes, we have more to do. Yes, we have to show you some wins in smart metering. They will come. Our earnings potential is growing. For some of you, we have yet to prove that. We will.

With that, let's open up to questions.

Question-and-Answer Session

Operator

[Operator Instructions] We will take our next question from Ben Kallo of Robert W. Baird.

Benjamin J. Kallo - Robert W. Baird & Co. Incorporated, Research Division

So my first question was on guidance. Could you just give us your policy on guidance? I know there was no mention of guidance within the press release or anything. And then could you comment on your book-to-bill ratio and how we should view that going forward? Now that it seems that more of your business is going to be a returns business, should we see that approaching one as we go forward? And I'll jump back in queue.

Barbara J. Doyle

Ben, this is Barbara. I'll start with the guidance question and then turn it over to LeRoy on the book-to-bill. Our practice has been to provide full year guidance on our Q4 earnings call. So we provided our full year guidance for 2012 on our earnings call in January. We do not update our guidance each quarter. We do update our guidance mid-year. So on our second quarter conference call, we'll provide an updated guidance figure for the full year at that time. So that's our practice, we'll continue to stick with that. And now LeRoy will address the book-to-bill...

Benjamin J. Kallo - Robert W. Baird & Co. Incorporated, Research Division

If I could just add one more to that for LeRoy, too. In guidance, I think one of the areas that you had the difference between the low end of guidance and the EPS and the high end of the guidance was your margin. And your margin this quarter was better than I expected and looked like the street expected. So could you tell us -- update us how that fits into your overall guidance, LeRoy?

LeRoy D. Nosbaum

Sure. Ben, book-to-bill first. And admittedly, book-to-bill for us, I think it's a little bit confusing, because we have in the last number of years had these huge quarters with mega-bookings, due largely to OpenWay in North America. And so for the remainder of this year, I think you're going to see -- if you take OpenWay out, you're going to see more of a 1:1 or a little bit over 1:1 as we move throughout Qs 2 through 4. That said, forewarned, as we move into the '13 and then on into '14, we are going to see some seriously large orders coming out of Europe and potentially elsewhere. As we get back into '14, I think we'll see some serious orders again potentially in the U.S. And that will, again, disrupt sort of this book-to-bill number, because you're going to have quarters where the bookings could be very large compared to what you ship, and so the book-to-bill is going to look astronomical, and then in the very next quarter, it could very well go back to a negative number, depending on how orders are flowing and so forth. So you have to have a little bit more color than just the number around book-to-bill. So we'll try to keep giving that to you, both in chart form and in our prepared comments as we go forward. But I would look for non-OpenWay book-to-bill to be slightly in excess of 1:1, best we can tell at this point in the year. On the subject of margin, as I called it adjusted 32% gross margin, we've got a lot of efforts throughout the organization to improve margin, but we also have some stuff pushing back on us. To be honest, we are seeing, with the exception of copper where we've nicely bought ahead, parts and materials increases all over the world, quite frankly. We're shoving that down to some extent by improving our purchasing operation with a more global approach, and yet as we move into the second half of this year and particularly where volumes are going to be down relative to the OpenWay shipments, you got lower volumes in some areas that are going to push back against purchasing improvement as we look to globalization. What do I think about margin for the rest of the year? I think we're in line. I don't see any particular reason why we ought to stray too far from the number we printed in Q1. We'll see how it goes.

Operator

And we will take our next question from John Quealy of Canaccord Genuity.

John Quealy - Canaccord Genuity, Research Division

A couple of questions, just let's go back to the margin, if we could for a moment. If BC Hydro, sort of the volumes wind down mid-year, and you're talking about 32% plus or minus, we shouldn't expect a big downturn in Q3 Energy margins just based on absorption in Oconee? Or what's the relative impact of that?

LeRoy D. Nosbaum

Right, John. Let me say that as we move toward the time when our OpenWay volumes and Oconee go down, a number of things will be transitioning for Itron. First of all, in Oconee itself, we have a number of plans under way to take costs out of that factory, and so absorption will go in the wrong direction, we are doing some things to accommodate that, and so the impact is less than you might imagine. The other thing that happens interestingly enough for North America is actually our gross margins on everything else are higher than OpenWay at this point. So we actually see a raw improvement from a mix perspective as we move into that period of time, which will begin to occur in Qs 3 and 4. So our budgeting process, as we went into this year, took all of that into consideration. So we are not looking for, let us say, a cliff relative to margin. We're fighting it. It's not -- we can't just let it go unattended, but we're spending an awful lot of effort in the manufacturing group and elsewhere to prevent a serious decline because of the drop-off in OpenWay.

John Quealy - Canaccord Genuity, Research Division

In terms of the operating cash flow, this is a very, very strong quarter, even given the OpenWay volumes. Steve, what should we expect in terms of patterns moving throughout the year on that cash flow?

Steven M. Helmbrecht

John, yes, we did. We had a good quarter, had free cash flow per share of over $1, pleased with that and the working capital metrics. You see we've built up a little bit of inventory in Q1. That was in anticipation of future orders for the year, so we'll see a little movement. But I think we see a relatively steady pattern throughout the year in cash flow overall, nothing major. Interest burden is quite low now, and our cash taxes continue to be low as well as CapEx. You might have seen that's pretty low in the quarter as well. So I'd say a fairly stable pattern for the year overall.

John Quealy - Canaccord Genuity, Research Division

Okay. And my final 2 questions. On the gas side, can you give us a relative timeline about ATCO, Xcel, and, clearly, CenterPoint must be getting late. But how far away are we from these contracts winding down? Or when should we look for that?

Steven M. Helmbrecht

John, they're substantially shipping throughout the remainder of this year. And however, we fully expect to be competing for additional business to fill in there, so I don't see any overall real change in trend for that North American gas endpoint business.

John Quealy - Canaccord Genuity, Research Division

Okay. And then lastly, LeRoy, back to you, you mentioned this commitment-based program for some of the leaders. Can you just talk to us about what that means? Is this a change in compensation for some of these people and trying to increase competitiveness? Or can you just fill in the details a little bit of what you're trying to accomplish with this?

LeRoy D. Nosbaum

Yes, John, a little bit brief on that because it's longer than we can take on materially in the call. But let us just say that as we looked at the company overall, it was clear to us that, on a team basis and on an individual performance basis, while we were doing a lot of stuff, we were not doing it very effectively or efficiently, and we were spending huge amount of time doing it. So we did some fundamental soul-searching about how could we get better? How could we be better from a team perspective? How could we be better as we work, particularly in the new global organization across teams, across continents from people to people who are not used to working with each other very well? We happen to be quite well aware, because the leader of the organization lives in Spokane, of a group that specializes in essentially retraining corporations on how to work together in a very commitment-based high-performance program developed originally with very high-performance athletes, then on to the military having worked with virtually every unit of the Armed Forces. And in the last 10 years' time, specializing with companies, all of whose names you would quite well recognize around the world. And so we have committed 220 of Itron's leaders to a program that is quite rigorous, and it started early in Q1, and it continues virtually every week throughout the year of 2012. And I am delighted to report we are already seeing serious results in terms of people accomplishing things in less time with less effort than they have been able to before.

John Quealy - Canaccord Genuity, Research Division

And would you think this would be additive to some of the restructuring realignment savings? Or is this part of getting that initial number done?

LeRoy D. Nosbaum

Well, I will not commit to what this will add in terms of cost savings. It is not part of the original realignment. And so as we come out of this year, I expect to see a very high level of performance that should, in fact, reduce our overall cost to get things done.

Operator

We will take our next question from Zach Larkin of Stephens.

Zach Larkin - Stephens Inc., Research Division

First up, I wondered, LeRoy, you've talked in the past about how when you came in, you saw some places where you thought Itron maybe wasn't as well positioned as they should be. And you've mentioned kind of broadly the improvements or how you've worked to position Itron better. I wonder if you could give a little bit more specific commentary on where you feel that the most improvement has been made in Itron's global positioning and maybe give us a little bit more color on where you're focused in the near term with the increased OpEx to really get Itron positioned exactly where you like them to be.

LeRoy D. Nosbaum

Fair enough. Most improvement is the one I'm processing, because I think we've seen significant improvement in a couple of places. If I think about North America, we have done a lot of work restructuring our smart grid organization with a new leader. I think that's had wonderful success so far. Unfortunately, most of it can't be announced yet, and we'll come to announcement before too much longer. So I'm very pleased with smart grid sales. And as well how that whole team is now working with the rest of the organization. I would also say that when I came back, I was very concerned that we were not in a good position in Latin America, particularly in Energy. Philip and his team have worked hard bringing on new people there and been patient enough to get the right people to fill the positions that we had open and that we were searching for. So I'm coming far more pleased with the activity in Latin America and how we are positioning there. I would say that as well, when we came back, we all were looking at a big objective for Asia-Pacific and potential growth there, both in Water and in Energy. We have added people in those 2 regions, which are already proving to be just serious players and producing real results. And so those 3 things I would talk to, to start out with. And from an OpEx perspective, clearly, some of our increase in the first quarter on a sequential basis and year-over-year basis has been people adds in Latin America, people adds as I talked to in Asia-Pacific. And so we look for good results out of that. I would also say that as we look to Europe, clearly, our research and development organization and dollars have been very highly focused, both in hardware and, in some respects, software in Europe. And to the questions we have repeatedly gotten about why have we not been approved for some of the initial pilots, we have spent a lot of time, energy, money, resource, people in Europe on getting from where we were to closer to where we should be. So I point to that, particularly on research and development line, since I've been back. And very pleased with progress on all those fronts.

Zach Larkin - Stephens Inc., Research Division

Okay. And also maybe just a follow-up on the restructuring. I think last quarter, you made the comment that as you get more into 2015 and when a lot of these projects start to roll up, you're kind of curious about if you've got adequate capacity to meet these current demands. Now that you're a little further down through the restructuring process and have looked at some of the manufacturing rationalization, have you changed your outlook on that? Or what are you thinking about kind of your future capacity and potential needs in a couple of years?

LeRoy D. Nosbaum

One of the things we have done is to either put in place a plan to reduce the size of some of our existing factories in Europe, or, in fact, we have actually closed one. But a corollary to that is we've been adding some people in other locations and looking at resource requirements in terms of automation and in terms of skill capacity and factory capacity. So while I would say to you today, if the faucet turned on hard tomorrow, we're not ready. By the time the faucet turns on hard, which will begin in '13, '14 and, for sure, at full force [ph] in '15, I'm comfortable with the planning we've done in the capacity we will be at. I have spent in the latest quarter a lot of time with our manufacturing people. I'm very pleased, both on a raw manufacturing talent and as well some adds we have done in the quality arena under the manufacturing umbrella. So good forward progress there.

Operator

We will go next to Jesse Pichel of Jefferies.

Jesse Pichel - Jefferies & Company, Inc., Research Division

What's your current level of manufacturing utilization? And what are you targeting there through a restructuring?

LeRoy D. Nosbaum

When we talked about that last quarter, I said we target something in the neighborhood of 80% utilization. I mean, that target doesn't change relatively speaking across time. And the overall utilization is almost not a useful number because it changes so much from place to place to place. I mean, currently, Jesse, in North -- or in South Carolina in the U.S., we have very high utilization. That utilization will drop off markedly by the fourth quarter as OpenWay stuff turns down, and it's, in fact, one of the things we're currently addressing. We know what the utilization is going to be. It's a grand question of what are you going to do about it? And so we'll take some corrective action there. If you look across factories in Europe, generally speaking, since we have closed one serious factory, our utilization rates, I would say, at current capacity are pretty close to that 80% level. We will see capacity increase through the next, let's say, 2.5 to 3 years. And as capacity increases, we certainly are forecasting utilization to increase right along with it. We're in a position last year where utilization in South Carolina was way beyond what its normal design capacity would be, and in fact, in that run, we actually were somewhat wasting money because we were having to pay too much overtime and running too many people too hard. If we look at Asia-Pacific, I would say that our utilization rate, again, is probably about 80% in our large factory in Indonesia, both Water and Electricity. We are in similar situation in Tianjin with gas meters where we manufacture in China. In Suzhou, which is a new water factory in China, our utilization rate is very low because we are just, in fact, opening that factory. We will formally open it later in the month of May. Turning to South America, I would say, in Water and Gas, we're probably someplace between 50% and 80% utilization. In electric, we're way below that. That is corrective action that we have said we needed to take. And as I referred to in a previous question, we are taking with both General Manager for Energy plus Sales Manager for Energy and some other staff as well. So we are recreating a more positive situation in Latin America relative to energy.

Jesse Pichel - Jefferies & Company, Inc., Research Division

That's great color. And if I could follow up, looking at the higher level of OpEx that you had in the quarter, I'm a little unclear. Was that fathomed into your plan and guidance? And how should we think about the absolute level of OpEx as we progress through the year? I understand R&D will be up, but in terms of total OpEx.

LeRoy D. Nosbaum

Right. Let me just say for the quarter that a good bit of what I mentioned as being high was in the budget as we came into the year. And so we had budgeted an increased level of our R&D, but we had also budgeted by and large an increased level in sales and marketing. But to be fair, we overran it a little bit in Q1. On the G&A line, quite frankly, I caused almost $5 million worth of overrun in G&A. And it was 2 fundamental projects that I referred to in my prepared remarks. One was the cultural project to transform us into a higher-performance group and...

Barbara J. Doyle

$2 million.

LeRoy D. Nosbaum

$2 million -- rather, not $5 million. $2 million. And the other one was the reconfiguration of our finance and accounting group to be ready to take on the goodness that a new ERP system takes globally. And so I caused those 2, those were not in the budget. We will have some ongoing expenditures from both the cultural project and the finance and accounting project throughout the year. However, we will -- they will be less than they were in the first quarter, and we will manage our budget, as we originally cast it, to make up for the additional first quarter expense than we have had. So net-net, while we are a bit over in Q1 in a number of areas, G&A, a little bit in sales and marketing; we will manage that out as we transfer throughout the rest of the year and get back to on budget by the rest of the year.

Operator

We will take our next question from Craig Irwin of Wedbush.

Craig E. Irwin - Wedbush Securities Inc., Research Division

You mentioned in your prepared remarks the ERP implementation. I was hoping you might be able to frame out for us the timeline for the implementation, roughly how much you're spending on it, so that we can understand the incremental contribution and the relative taper in the future.

Steven M. Helmbrecht

Craig, this is Steve. As LeRoy mentioned in his prepared remarks, we are rolling out a global ERP system, and it's really in a lot of ways from a finance perspective a culmination of the Actaris acquisition 5 years ago and moving towards One Itron. The timetable for that is a lot of intensive activity over the next couple of years. A high percentage of that will be a capital budget for the efforts to actually roll out the system and some of the things [ph]. There will be some additional operating expenses along the way, deploy the system. But as LeRoy said, we factored that into our budget, and in terms of the benefits of that, we have not quantified that externally yet, but we expect it to be quite significant because of what that will do for us in having a single platform. It will certainly be helpful to Philip and Marcel as they think about purchasing opportunities in a global supply chain and a whole range of areas, so it is one of my highest priorities.

Craig E. Irwin - Wedbush Securities Inc., Research Division

Great, great. So as that project continues, do you expect to have a similar level of third-party implementation support as what you had in the March quarter? Or is this something that will move up and down over the course of the project?

Steven M. Helmbrecht

No. We don't expect that same level, as LeRoy said, as well as looking for ensuring that we do manage to our budget. As LeRoy said, some of that was pre-work, if you'd like to call it that, and making sure the organization is structured in a way that will support that type of a rollout as well.

Craig E. Irwin - Wedbush Securities Inc., Research Division

Great. My next question was on the backlog. So with the change in reporting, consolidating Itron North America and Itron International, and I really like your Slide 14, the way you lay it out so clearly. One thing that's not on that slide is the contribution from currency. So obviously, the $12.5 million headwind to the top line in the quarter was material. Do you have an approximate number for the impact on non-OpenWay backlog in the quarter? Is this something that we can look at just roughly as flat year-over-year, maybe, if we exclude the currency impact?

Steven M. Helmbrecht

Craig, that's a good question. I just have to look at that. I don't have that right in front of me, but given that the mix of non-OpenWay backlog, again, coming from North America, where we're not exposed to that, I would see it be slightly less than that in terms of backlog, being more heavily weighted in dollars. So I would take the percentage impact on P&L where we're more heavily weighted in Europe on the revenue line and where we have more dollar denomination in our backlog as being slightly less of an impact than it had on revenue. I'll just confirm that.

Craig E. Irwin - Wedbush Securities Inc., Research Division

Great. Another item that you've had much more active discussion on in prior calls but you haven't mentioned yet is the potential M&A environment, the number of targets out there and how aggressive you are in potentially considering some of the assets that might come up. Previously, Itron has talked about expansion in global geographies that aren't yet served maybe the same way that you could serve them or into contiguous product groups. Is this something that's still a very active subject at Itron? Is this something where we should look for relative progress over the next several quarters?

LeRoy D. Nosbaum

Craig, I'd say not a day goes by at Itron where some of us don't think about M&A in one flavor or another. I mean, you'd characterize our interest appropriately. We look for geographies that would expand our footprint, although to be fair, there's not many of those left. We look for adjacencies that we think provide good growth going forward. And we are far more, at this moment in time, opportunistic than we are purposed. And by that I mean we do not have an active group today at Itron that is looking at a list of 15 or 20 M&A possibilities and deciding which ones we ought to chase and relationships we ought to build. Now do I think that's a place where we ought to go? Yes. And I would say to you that a year from now, we ought to have a list of 15 to 20 possibilities in relationships that we ought to be chasing and a good strategic story that we can lay up in the front of the board to allow them to weigh in and to judge our forward progress. We would not, for sure, share that with the external world. But I think as a process that is regularly occurring at a company like Itron, that's one that ought to be assuredly in place. The reason we don't have it today is we are, for better or for worse, sort of at an interim place here where we have a lot of change going on with reorganization, restructure, new CEO who is going to change out over the next year to 2 years. And so we're a little cautious about putting one more thing on the plate at this moment in time. I'll make one more comment. I know there's a lot of buzz in the marketplace about potential acquisitions and potential IPOs and the potential combinations of companies that are in our space. And I would say to you that we think about all of those potential things, and we judge them on their own merits, we judge them on regulatory issues that might surround any one of them, and we judge them on the ability to grow not just one time as we make the acquisition, but to grow through time after we would make an acquisition. And I'm highly more focused myself on acquisitions that not only help us to expand ourselves today, but as we look at 5 years from now has that piece of the company been able to grow materially and to move the needle on a continuous basis? Hope that helps.

Craig E. Irwin - Wedbush Securities Inc., Research Division

Yes, that's very helpful. And my last question, if I can just fit one more in. When I talk to staff from different utility commissions and executives from the utilities on the East Coast that I see on a regular basis, they're all showing a much greater level of enthusiasm for gas, gas automation. There's a lot of interest in spending for pipeline integrity programs. I think there's more than $20 billion in requests in front of the CPUC right now out in California. There seems to be an upsurge, a potential up-cycle in North America and potential spending for gas infrastructure, not just AMI, but, obviously, pipeline integrity and smart pigging, smart metering on pipelines. What do you see as the potential for Itron to participate there? How do you frame that out? And are there any other products that we should really be focused on other than your core AMI and metering products that you think really are something that are a real opportunity for Itron?

LeRoy D. Nosbaum

Well, I'd absolutely concur with your premise. There is huge focus on gas infrastructure, unfortunately, largely driven by the grand explosion that occurred in California. It simply highlighted what all of the utility executives already knew existed, a deteriorating infrastructure. And so in a perverted way, that is good for all of us in the U.S. But having said that, we certainly have seen an increase in interest in AMI for gas. We certainly have seen an increase in interest to be able to provide gas meters with shut-off valves. And you'll remember, late last year, we announced some cooperative work to do just that. We certainly have seen an increase in activity around the country in interest in new meters and AMI on a gas basis. We are not today positioned to do stuff beyond modules that go on gas meters and gas meters themselves in North America, although we look at a number of different activities that could carry us into -- maybe not adjacencies, but expanding our product offerings. Beyond that, today, Craig, I wouldn't commit, but we certainly agree with your premise. Time has gotten exciting in gas world.

Operator

And we will take our next question from Patrick Jobin of Crédit Suisse.

Patrick Jobin - Crédit Suisse AG, Research Division

First, back to Ben's first question on guidance, and thanks for the color there and some of the other answers. Just trying to summarize some of the moving pieces. LeRoy, you pointed out $2 million in additional costs that weren't budgeted. I guess excluding those specific items, is core OpEx trending above expectations that were formed in February?

LeRoy D. Nosbaum

No, I would say that by and large, in the first quarter, it was a little bit above expectations. But as we look across the rest of the year, I wouldn't characterize it as trending above expectations. And I would add that we are putting in place some efforts to get it back to where it should be or below that so that when year-end comes, we are, on an overall basis, on or below budget.

Patrick Jobin - Crédit Suisse AG, Research Division

Great. And then just the last question, I guess, LeRoy, you mentioned that there were some corrective actions you could do in South Carolina to help, I guess, alleviate some of the pressures from OpenWay projects starting to compete. I guess is that part of a restructuring plan? Or would you be shifting some lines and repurposing? What are some of the options you have there?

LeRoy D. Nosbaum

Let me say it's not part of the restructuring plan that we announced last year to be clear. And frankly, thank you for asking that question because I don't know that we've been real clear there. So it's not part of the original restructuring plan. I mean, it will contain restructuring. I mean, it is going to be a material adjustment. So, yes, people will be involved. Yes, we'll look at how we're running the line. I mean, I would say to you today that we run a very automated and, in some respects, long production line. We're looking at that line to see if it needs to be retooled and to be, in some sense, repurposed. We are looking at things we make around the country and we make around the world and considering is there some others manufacturing process we can put into that factory? And all of those things are sort of, as we would say, in the mix of consideration.

Operator

And we will take our final question from Amir Rozwadowski from Barclays.

Amir Rozwadowski - Barclays Capital, Research Division

LeRoy, I was wondering if we could just touch base again on sort of the gross margins thought process here. Obviously, we saw an improvement in terms of warranty costs. You did highlight some of the puts and takes when it comes to potential input cost fluctuation. But it does sound like you still have some of the restructuring efforts ahead of you. How should we think about the possibilities for gross margin expansion from this level? Is there potential? Do you expect to trade off some level of gross margin so you can be a bit more flexible in pricing? Any color there would be helpful.

LeRoy D. Nosbaum

Well, certainly, over the long term, we look for the costs of some of our products to go down. We look at margins in terms of EBITDA margins to improve. As we look at the rest of the year, we certainly have some headwinds we're fighting. We just talked about one of the biggest one, which is what's going on in South Carolina. Now to be fair, we have not yet fully realized all of the benefit of the rationalization plan we talked about last year. We said in this year, 2012, we would get about $15 million of benefit from what I'll call factory rationalization. We also said that we are looking for some additional savings in globalized procurement. We have gotten some of that by the end of the year. We will get more. So as we think about gross margins for '12, we have a number of things that could help those margins get better. But I am being, admittedly, cautious, because we also have some pressure in the other direction. I'm going to assume we're still connected. So I think as we look long term, we are driving the company, we are driving performance on the basis of improving the cost -- our cost to produce product, our cost in terms of OpEx, and so I would certainly expect as we move forward that, that picture gets better. I am not willing today to say that we're going to be materially better than 32% gross margin the rest of the year or that our EBITDA percentage gets materially better. I am willing to say to you that we have everybody in the management structure of this company bonus-ed to make that happen.

Barbara J. Doyle

All right. LeRoy, would you like to make any closing comments? And we'll end the call.

LeRoy D. Nosbaum

Let me just make one closing comment. A little bit unusual. I don't normally make this kind of a closing comment, but I would like just to publicly to you guys who see the effect of it make a very big thank you to all the people that worked on the restructure of the company here. I mean, we have turned the finance and accounting organization and many people who feed into it upside down to recast the company from 2 business units, North America and the Rest of the World or International, as we called it, into Energy, comprising Gas and Electricity and into Water worldwide. Herculean effort, and they've done a great job. We will be, certainly, as the year progresses, looking for ways we can help you in terms of how we report and the things we call out to you and try as always to be crisp on calls and give you the information you need to build your models and to do the work you do. So thanks for joining us today, and we look forward to the next conference call where, as Barbara has referred, we will give you a mid-course guidance update on that call. Thanks very much. That will end it.

Barbara J. Doyle

Thanks, operator. We're all done now.

Operator

This does conclude today's conference call. 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 the passcode of 1314113 or go to the company's website, www.itron.com. Once again, we thank you for your participation, and have a wonderful day.

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!