Itron, Inc.
Q3 2008 Earnings Call Transcript

Published: 12 Nov 2008

[Operator:]

Please standby we’re about to begin. Good day everyone and welcome to the Itron, Inc. third quarter 2008 earnings conference call. Today’s call is being recorded. For opening remarks I’d like to turn the call over to Deloris Duquette. Please go ahead.

[Deloris Duquette:]

Good afternoon everyone and thank you for joining us today. On the call today, we have LeRoy Nosbaum, our Chairman and CEO, Malcolm Unsworth, our President and COO, Steve Helmbrecht, our Chief Financial Officer, Marcel Regnier, Chief Operating Officer for Actaris and Philip Mezey, Chief Operating Officer for Itron North America. The earnings release that we issued today includes an outlook for revenue, earnings and adjusted EBITDA for 2008. We will also talk about other issues on today’s call that could be forward-looking in nature. The outlook and other forward-looking information we are providing is based on what we know today and is subject to a number of risks and uncertainties. I encourage you to read the forward-looking disclosure in our press release, which alerts you to a number of factors that can cause a difference between our expectations and our actual results. You should also refer to our 2007 Form 10K and other related SEC filings for more complete disclosures on specific risks and uncertainties related to our business. We do not assume any obligation to update or revise forward-looking statements although we may do so from time to time. Our earnings release includes non-GAAP financial information that we believe enhance your overall understanding of our current and future performance. Schedules reconciling GAAP to non-GAAP financial information are included with our press release and are also available on Itron’s external website. As we have done in previous quarters supplemental information is posted on our website under the investors section that includes some of the pertinent points that each officer will discuss today. Steve will start the call with a discussion about our financial results then Malcolm will give an operational update, after which Marcel and Philip will each give high-level overviews of what they are hearing from our customers. LeRoy will finish our prepared comments with a bit about guidance and then open it up for questions. Now, I’d like to turn a call over to Steve Helmbrecht, Itron’s CFO.

[Steve Helmbrecht:]

Thank you, Deloris. Malcolm will discuss our operating performance, so I will focus on our financial results for the quarter. I will talk about foreign exchange rates and the impact of the recent appreciation of the US dollar on our financial results and debt balances. I will spend some time on our balance sheet and our focus on generating cash flow and reducing debt and interest expense and will finish with our outlook for the remainder of the year. Keep in mind when I talk about year-to-date results for 2008 compared to 2007 that we completed the acquisition of Actaris Metering Systems on April 18th, 2007. Our third quarter revenue was $485 million, 12% higher than 2007 third quarter revenue of $434 million and above our guidance range of $465 million to $480 million. Favorable foreign exchange rates contributed over half of the year-on-year growth in quarterly revenues. Itron North America third quarter revenue was $160 million and Actaris third quarter revenue was $325 million, both better than expected. Malcolm will talk about operational drivers in more detail. Corporate unallocated expenses in the quarter were $11 million, about $2.5 million higher than the third quarter of 2007, primarily due to increased compensation and Actaris related integration expenses including Sarbanes-Oxley implementation. Sarbanes-Oxley for Actaris has been a major focus for us this year and we expect to be substantially complete with the project by the end of the year. Non-GAAP operating margin was 11.5% for the quarter, which is lower than the 12.7% margin for the third quarter of 2007 driven by higher operating expenses as a percentage of revenue. Our non-GAAP tax rate for the quarter was 28%, slightly higher than our expectations. The rate can change depending on tax credits and the mix of revenue by country, some with higher rates, and others with lower. Non-GAAP net income for the quarter was $29.9 million with non-GAAP EPS of $0.81 per share. Non-GAAP net income for the first nine months was $92.7 million or $2.65 per share. We had adjusted EBITDA for the quarter of $69 million, which equates to an EBITDA margin of 14.2%. For the nine-month period our adjusted EBITDA was in excess of $220 million. As a reminder to our debt investors we add back stock compensation expense when calculating EBITDA for debt ratios. Stock compensation expense for the first nine months was about $12.5 million. Our cash flow from operations for the quarter was about $36 million. CapEx was $13 million, less than 3% of revenue, which resulted in free cash flow for the quarter of about $23 million. For the first nine months, we’ve generated $115 million in free cash flow, which is nearly double our free cash flow for the first nine months of 2007. Turning to liquidity, our cash balance was $147 million as of September 30th. We have a conservative investment policy. Cash equivalents in the US are held primarily in AAA rated money market funds and banks. And overseas, cash equivalents are held primarily in AA and A rated banks. We have about $65 million in unused capacity on our $115 million revolver line. The rest is currently being used to back letters of credit. Our accounts receivables remain healthy. We sell primarily to large utilities and our bad debt provision remains very low. With the recent performance in the financial markets pension underfunding has become a concern. As a reminder, we do not have to fund benefit plans in the US. Actaris participates in several government sponsored pension plans primarily in Europe. Our current year contribution is expected to remain in the $500,000 range. At September 30th we had about $1.2 billion in total debt at a blended interest rate of 5%. Our debt consists of about $750 million in senior secured bank debt at a blended rate of 5.7% and about $455 million in subordinated debt at a blended rate of 3.8%. We’re comfortable with the maturity structure of our debt with first maturities in 2011. During the quarter we made about $25 million of scheduled payments and optional prepayments under senior secured debt and we repurchased about $10 million of our senior subordinated notes for a total of about $35 million in debt payments. In the year-and-a-half since we closed the Actaris acquisition, we have repaid a total of about $460 million in debt, nearly 30% of the outstanding balance of the debt on the date we closed. Our debt to EBITDA ratio declined from 4.2 times at June 30th to 3.9 times at September 30th and our interest coverage ratio was 3.6 times. As we move into 2009 we will see tightening in our debt covenants as per our credit agreement and are therefore pleased that we are already meeting the required 2009 levels as of September 30th with continued plans to delever. In addition to delevering, our strategy has been to lower the cost of our debt and reduce interest rate risk by fixing these low rates. There’s been a lot of focus in the market on the impact of the jump in LIBOR rates. Fortunately, that hasn’t been an issue for us. Last year we entered into an interest rate swap to fix the interest rate on all our Euro-denominated bank debt and in June we fixed the rate on $200 million of our US dollar bank debt. At September 30th with the swaps we have 85% fixed rate debt and 15% floating rate debt. Earlier this month with the recent decline in LIBOR, we extended the swap on the $200 million in U.S. dollar debt through the middle of 2010 to further reduce the interest rate on our fixed-rate debt. From a currency perspective 69% of our debt is US dollar debt and 31% is Euro debt. Our strategy in borrowing in Euros was to partially hedge Actaris’ Euro denominated operating income and we are currently hedging about a third. Looking ahead to the fourth quarter, we expect to use free cash flow to repay about $30 million to $40 million in debt. Also, we could use a portion of our $147 million in cash to further repay debt if we believe it is beneficial. With a balance of EUR255 million at September 30th, we estimate our Euro debt will decline by about EUR40 million in the fourth quarter, assuming an exchange rate of $1.30 as of December 31st. And while we are on the subject of currency rates, the appreciating Euro has benefited us in the first three quarters of 2008 in the form of higher Actaris revenue, about 50% of which is denominated in Euros. The higher Euro-dollar exchange rate affected Actaris’ cost of sales and operating expenses as well, which had an offsetting impact on operating income and EBITDA. We have updated our Q4 model to reflect the recent depreciation of the dollar from $1.50 to $1.30 per Euro. We estimate this will decrease our fourth quarter revenue by about $30 million and fourth quarter EPS by about $0.07 to $0.08 per share from our previous guidance. With those activities in mind I will talk about our outlook for the rest of the year. For the full year 2008 we expect revenues to be between $1.91 billion and $1.93 billion, a decrease of $20 million on the upper end of the guidance we provided in our last call. Non-GAAP diluted EPS, which excludes expenses related to amortization of intangibles and debt fees, is expected to be between $3.35 and $3.45, a decrease of $0.05 on the upper end of the guidance we provided in our last call and adjusted EBITDA is expected to be in excess of $280 million. I will now turn the call over to Malcolm Unsworth.

[Malcolm Unsworth:]

Thank you, Steve, and good afternoon everyone. Let me begin with a discussion of the North American and Actaris results for the quarter and then make a few comments regarding the Itron user conference we had in Dallas this past week. Marcel and Philip will give you some color around the business climate for Q4 and next year. In North America third quarter revenue of $160 million was 12% over Q3 of last year. For the first nine months revenue of $475 million was 11% over last year. Great growth year-on-year, coming both from increased meter and module shipments and some business that showed up in Q3, we’re forecasting Q4. While we had forecast as much as 5% of our 2008 revenue to be AMI, projects have moved enough to the right to push that revenue largely into 2009. That said, we have signed four major contracts for Itron’s OpenWay totaling approximately $1.4 billion. Modest shipments begin in Q4, with a real ramp-up projected from one of our customers in Q1 and the other customers following as we move into Q2 and the second half of next year. We just met with all of those customers at our user conference, so we have a high level of confidence about their rollout schedules. Given the good revenue picture for the first three quarters of 2008, what will the fourth quarter look like? Q4 revenue will have two flavors – normal business and year-end spending. We feel fairly confident about normal spending levels for water and gas AMR. Electric AMR, as it has all year, is suffering from the effects of AMI decisions. We believe electric utilities will continue to purchase electric meters as they generally do, so the swing factor really is year-end spending. Some of our customers have said there will be none while others have been more optimistic. Accordingly our guidance for Q4 reflects a muted optimism. Let me now move into a few of the details on Q3 for Itron North America. We shipped 1.2 million electric meters during the quarter, 9% more than we shipped in the third quarter of last year. Over 60% of these meters had Itron AMR embedded in them compared to 35% in the third quarter of last year and we shipped 1.2 million gas and water modules, during the quarter – 11% more than we shipped in the third quarter of last year. Gross margins of 39%, was 2% points lower than last year. This is largely a product mix issue. This year, we shipped more electric residential meters, and less C&I meters than last year, and commercial and industrial meters have better margins than residential. Operating expenses were similar to the third quarter of last year although we have increased R&D and marketing expenses that were offset with lower G&A and amortization of intangible expense. Non-GAAP operating margin was a very healthy 15.9% for the quarter, which was below the 16.7% last year due to the lower gross margin. Bookings for the quarter were $583 million reflecting a book-to-bill ratio of 3.6 to 1. With the approval of SCE contracts by the California Public Utility Commission, we were able to book $470 million in the quarter. Our other AMI contracts will be similarly entered into backlog as various accounting and other milestones are reached. Now let’s move on to Actaris’ financial results. Revenue was $325 million for the quarter, which is about $33 million or 11.5% higher than last year. Over half of this revenue increase was caused by the stronger Euro in the current quarter compared to last year, but in addition we saw stronger sales in Asia, South America and the Middle East. Gross margins of about 31% in the quarter were higher than last year primarily due to improvements in operating efficiency due to higher volumes, better material costs, and product mix. Operating expenses of $83 million was $17 million higher than last year. About $6 million of the increase was due to the change in foreign currency and the remaining expenses were higher because of more investment in marketing, sales, and R&D, high amortization of intangible expenses due to the re-evaluation of the asset lives, and increased costs associated with the implementation of Sarbanes-Oxley. Total meter shipments for the third quarter were 5.1 million versus 4.6 million in the third quarter of last year, which is an 11% increase. Actaris non-GAAP operating income was $41 million for the quarter compared to non-GAAP operating income of $40 million in the third quarter of 2007. Bookings for the quarter were $311 million or about one-to-one book-to-bill ratio – all in all a very good quarter for both businesses. Let me close with a few words about Itron’s Users’ Conference. This was our 26th annual Users’ Conference and was our largest ever. We had over 770 utility attendees representing more than 300 worldwide utilities. Over the course of two days our users were able to attend over 150 sessions learning from actual employees and learning from each other. The energy and enthusiasm was really exciting. The interest in AMR and AMI systems was higher than ever as was the interest in using software solutions to add value to the systems that customers are thinking of implementing. We also had some Actaris meters and systems on display in the Knowledge Center and customers were exposed to some of the progress that has already been made with Itron North America and Actaris teams working together. We started the session with a panel discussion from several industry experts representing electric, gas, and water interests, as well as public utility commission viewpoints and although all panelists acknowledged we’re facing tough economic times, there was also agreement that technology, which helps consumers, use their energy and water more wisely is an investment worth making. Technology that enables consumers to control usage, and costs, during these tough times is valuable and technology that helps utilities optimize the delivery of energy, and water, and lowers cost, is also valuable. I came away from talking and meeting with many of the 770 conference attendees knowing that our technology and company direction is right. Knowing that even in tough economic times utilities are going to spend money on projects that help reduce costs for them and their customers. I came away feeling great about Itron’s prospects. I look forward to talking to you in the future and with that I would like to turn it over to LeRoy.

[LeRoy Nosbaum:]

Thank you, Malcolm. Before I make my closing comments I’d like to ask both Marcel, who runs our Actaris business, and Philip, who runs our North American business, to talk about the business climate and outlook for Q4 in 2009 in each of their respective areas. I want you to hear from those closest to our customers what is happening on the front lines. Let’s start with Marcel, on activities outside of North America.

[Marcel Regnier:]

Thank you, LeRoy, and good afternoon to all. I wanted to give you a brief overview of what we are seeing at this point in the Actaris business, which is predominantly Europe but also throughout much of the rest of the world. Actaris sells a number of products and systems, but our primary business is the sale of electric, gas, water, and heat meters and I think it is important here to point out that meters are a critical part of the utility capital spending. They are – they’re cash registers. We have history with Actaris that stretches back 150 years and in fact, we just celebrated our 150th anniversary of a gas meter factory in the Netherlands last month. So, in our history we have seen a number of economy corrections, but the benefit of the Actaris business is the fact that we sell all types of meters – electric, gas, water, and heat and the fact that we are very geographically diverse. Yes, we are concentrated in Europe, but different countries within Europe experience different economic conditions despite all being part of the European Union. For example, we are seeing some effect of the lower housing starts in Spain, but not so much in any other country. In late September, we attended a conference called "Metering Europe" in Amsterdam. We organized demos for selected customers and had almost 100 people from 19 countries and 38 different companies attend, all of which showed great interest in AMR and AMI systems. I think this is a greater indication that interest in Advance Metering System has not decreased. At this point we do not see any major shift one way or another regarding our business within each country. In fact, we were recently notified that we will be awarded a contract in Abu Dhabi, for an AMI project and we have been awarded a new water metering contract in the United Kingdom. In speaking with customers across the world we have not seen signs of any noticeable slowdown, nor have we seen a decrease to date in terms of activity and our pilot with EDF AMI Project, which ultimately would be the largest ever with 35 million points, is still on schedule to begin deploying late in 2009 into 2010. So, we strongly believe we will continue to see the single digit growth that we have experienced over these past years. In fact, sometimes conditions like these can actually drive other business we may have not been expecting. For example, we may see increased interest in prepayment system, because utilities could try to help their customers stay within their budget with this type of solutions. For the future, we still expect many AMR and AMI projects will be awarded and that we will be successful with a number of them, which will drive the traditional Actaris meter business to much more of a system business. There are no fundamental changes in the long-term expectations and customer direction that would make us question the forward momentum. So, from a business standpoint, we think we are well-positioned and we will continue to talk with our customers to ensure that we are in touch with any changing needs that they may have. And with that, I will turn it over to Philip, to talk about North America.

[Philip Mezey:]

Thank you, Marcel, and good afternoon everyone. Given the state of the US economy and the current financial situation we are getting asked many questions about our business. Specifically, how utilities are affected and how they behave in times like these. Because North America really has two different kinds of business, regular meter, and module shipments and then project based business, I wanted to briefly talk about what we are seeing so far and our thoughts for each. In talking to our customers two things have become fairly clear. First, capital budgets remain largely intact with projects continuing. Second, operations and maintenance budgets are getting tighter. The implication to Itron is also fairly clear. Our large AMI projects are on track and other AMR projects are continuing to move ahead with one exception that we are aware of where we have seen a push out. Meter business in North America, may see some slowdown as utilities work off inventory, but that can only go on for so long. Remember, we sell to utilities who are fairly sheltered from the ups and downs of the economy and currently most of them are in good financial shape. Our AMI customers have affirmed their commitment to proceed. San Diego Gas & Electric plans to initiate their broader deployment in February 2009 and to be complete by mid-2011. Southern California Edison plans to begin their full deployment in Q2 of next year and are in the process of determining their final deployment schedule. DTE will be deploying small quantities in Q2 with a planned larger deployment in Q4 upon approval. CenterPoint is having promising discussions with their commission regarding full deployment and we expect the project will commence at some point in 2009. We have planned shipments in 2009 of about 1.4 million AMI points. In support of these projects, I would just like to reiterate that our OpenWay system is performing great. First, our project with Manitoba Hydro has in excess of 99.5% regrade on a daily basis, as well as our 10,000 point project with CenterPoint continues to perform and was completely unaffected by Hurricane Ike. We and our customers are extremely pleased with OpenWay’s capabilities and performance. In conclusion, we do not see today’s environment to be much different than it normally is. As a reminder our customers, similar to Actaris’ customers, tend to be very conservative, well-funded, and well-capitalized. They do not tend to move in tandem with the consumer product industry. You do not generally see steep upward curves in their buying patterns when things are booming and you usually do not see steep downward curves when the economy goes through corrections. Fairly stable spending patterns in general. We understand everyone’s concern and certainly do not have all the answers, but in general, and in speaking with our customers, we feel that we are well-positioned to weather changes in the economy and are pleased to be selling to these financially stable, conservative, and loyal businesses and with that I will turn it back over to LeRoy.

[LeRoy Nosbaum:]

Thank you Philip, and Marcel as well. As I have the last couple of conference calls I’m going to review what I think are some of the more important takeaways for this quarter then I’ll talk a bit about 2009. We had a good Q3 especially given the current environment – good revenue, good earnings. As Malcolm pointed out we continued to increase R&D expenses in Q3. Look for that in Q4 and most of next year as well as we continue to focus on cost reduction projects, taking costs out of the products we make every day, and product innovation projects, keeping us ahead of our competition and in-sync with what our customers need. As we head into next year we look for good cost control everywhere, but prudent while growing necessary expenditures in R&D. For Q4, I like the term Malcolm used – "metered optimism". There are a lot of good things happening, but we also have some headwinds in Q4 and heading into 2009 – largely currency, but also some the general mood. We will continue to chase business and we will continue to get awards. Utilities are doing business. We are seeing two contracts move out of Q4, only two in the entire world. These are micro events, not macro trends. The real swing factors for Q4 are year-end spending in the US and currency changes between local currencies that Actaris does business in and the US dollar. We will get some year-end spending in the US, the question is how much? The relative strength between the Euro and the dollar remains to be seen. Because of the stronger dollar we have taken down the top end of guidance for both revenue and earnings putting revenue at $1.91 billion to $1.93 billion and non-GAAP EPS at $3.35 to $3.45 and even EBITDA at greater than $280 million. Last quarter, we were using $1.50 to model the dollar to Euro exchange rate. This quarter we’re using $1.30. So, you can see we’re largely making up our operational goodness that was lost in currency changes. Turning to 2009, you just heard from Marcel and Philip. Let me remind all of us we sell to utilities. Generally, they are financially strong with good balance sheets. In our view, they will continue with long-term capital projects. When they deploy capital most earn a rate of return on it. Projects and products that reduce cost and have great paybacks are always good for utilities and are encouraged by regulators. Consumers are crying out for ways to control their costs and reduce their costs. That means more data and information. That means AMI and the four contracts we’ve already announced. That means there will be more contracts coming to market during 2009. No doubt, 2009 is going to be a somewhat different year. We have already told you that the year will be backend loaded, but we have just met with over 700 customers, including the utilities that have given us contracts for $1.4 billion worth of OpenWay. I simply did not get the impression that business has dried up or that projects are moving out of 2009. We do have real tough comps in Actaris with the dollar continuing to strengthen against the Euro and other currencies. Even though Actaris will grow in local currencies in the mid single-digit range, in US dollars they will have a down year in 2009, because of the strengthening dollar. For North America, where we look for growth in the mid-teens, the picture is much different. For the whole of Itron that means relatively flat revenue growth in 2009 over 2008. As to EPS, a better picture presents itself. We should see cost reductions in a number of areas. Costs of the financial integration of Actaris will generally be behind us. We look for some modest improvement in gross margins, all of which results in expected non-GAAP EPS growth from ‘08 to ‘09 of low to mid-teens. Given the shift in economic climate that we’re going through I will be very satisfied with that kind of a year. Let me close with two more points. First, a word about our debt about which there seems to be some concern and there should be in times like these. As of September 30, we were already within debt covenants required for 2009. Since acquiring Actaris 18 months ago, we have paid down $460 million in debt. Given how we see the business between now and the end of next year, debt covenants are fairly low down on my worry list. That doesn’t mean that we don’t worry about debt covenants, we model them continuously and we watch where we’re going to be, but we’re in good shape financially as we enter 2009. The second point also involves Actaris and the strategy of acquiring the company from which we have gained so much – revenue, earnings, cash flow, global diversity of economics, counterbalance and growth rates, product diversity, and opportunities far beyond those in the United States. 2009 will be an interesting year. Revenue is actually growing, but the material currency swing mutes reality. EPS does grow and nicely in this environment. The future potential for these two companies as one, Itron and Actaris, is simply tremendous. AMI will begin to take hold in the U.S., where we are planning to ship – as Malcolm said – 1.4 million units and the seeds we have planted in the US will continue to grow not only in the US, but in Europe and elsewhere. Thank you for joining us today and with that let us open up for questions.

[Operator:]

(Operator instructions) Our first question will come from Steven Sanders, with Stephens, Inc.

[Steve Sanders:]

Good afternoon.

[LeRoy Nosbaum:]

Hey, Steve.

[Steve Sanders:]

A couple of questions. First, on – I think you said in your prepared remarks that a modest amount of AMI moved from ‘08 into ‘09. Is that correct and can you provide a little more detail there?

[LeRoy Nosbaum:]

Steve, LeRoy here. Yes, Philip said a modest amount – or Malcolm did – one had moved. As we’ve come through the whole of 2008, we’ve continuously seen a little to the right shift in AMI plans. I mean, the good news at this point is that those plans have largely firmed up to a great degree. We are now talking about pretty firm schedules for the four customers we’ve announced. And so, the point to be made is in Q4 of this year, 2008, we had originally, as we set plans counted on a lot of AMI revenue, which has gone right and frankly we’ve been able to make up for it with other shipments of meters, of AMR, of software, both in the US and to some extent, in Actaris as well.

[Deloris Duquette:]

And Steve, just to add to that we didn’t ever have a material amount. It was something around 5% in the year, but a large portion of that was moved out and we’ve had to make up it up with other shipments.

[Steve Sanders:]

Okay and then you’ve got 1.4 million AMI units assumed for 2009. We can do the math, but what does that say about the growth rate in the non-AMI business in North America? Does that imply, flat – could you give us some additional detail there?

[Deloris Duquette:]

We don’t have it directly quantified, but we have warned all along that there would be some cannibalization of the electric AMR business. So, if you thought about – 5% to 10% cannibalization just off the top, then you’re probably close at this point.

[Steve Sanders:]

Okay and ‘09 is obviously second half loaded given the AMI ramp. Can you put a little finer point on that?

[LeRoy Nosbaum:]

Steve, at this point I would just underscore what you just said and say hang on and wait for our next conference call when we’ll give you some detail.

[Steve Sanders:]

Okay and then on the Actaris side, I think over the past couple of years we’ve seen the local currency gross there more in 6% to 8% and I guess you’re talking now low single digits to maybe in your comments you said mid single digits. Anything there beyond just being a bit more cautious, given the macro? Do you have projects there that may slip or do you have a tough comp somewhere? Can you just talk a little bit more about that?

[LeRoy Nosbaum:]

You bet. Steve, in general mid single digits is still the number. The tough comp is currency and we’re modeling currently at $1.30, dollar to Euro. Who knows what that’s going to be? Is it going to stay there? Is it going to go down further? Who knows? So, yes, we’re being a little bit cautious there. We’ll firm that up as we head into the next call and two things happen then. We’re in the closing part of our budgeting process, so we’ll have some different looks at exactly what moves from one location to another. I mean one of the things to understand here is we not only deal with the Euro to dollar, but we deal with the Reis to the Euro. We deal with the Rupee to the Euro, we deal with the Reis to the US dollar – so, all of that sort of movement of currency is being fairly closely modeled as we look into real details of our ‘09 forecast.

[Steve Sanders:]

Okay, and then two final questions. What do you expect to book for AMI in the fourth quarter? And then could you provide some additional color on the AMI pipeline and also the AMR pipeline on the gas and water side?

[Deloris Duquette:]

I’ll take the question on what we expect to book from AMI. We still have not booked San Diego because the gating item on that contract, which is worth about $250 million, is contract approval. We would expect that to come before the end of the year which implies Q4, but that’s certainly something that we’re watching with the California Commission.

[Philip Mezey:]

And Steve, it is Philip. On the AMI pipeline, we are still working off the list that we’ve mentioned in previous calls on the order of 20 active deals that are in the pipeline and I would reiterate that we’ve said that we do not expect any major announcements in the fourth quarter. Activity is still very, very, brisk with an emphasis generally though on pilots as you’ve seen state legislation and various regulatory activities that are kind of stimulating pilot level activity. So, only a handful of those deals we think are full-fledged deployments where we would expect to see large quantities toward the end of ‘09, beginning of ‘10. On the AMR side while there is proposal activity out there as we’ve said, the general emphasis on AMI – and I would not limit that to just the electric space – there are now a number of fixed network opportunities in the gas and water space that loosely qualify as AMI. We see a shift in focus to more advanced systems, and so, on the AMR side we’re largely expanding existing installations where utilities are automating new territory. So, contract extensions as well as a small amount of new business that we’re pursuing.

[LeRoy Nosbaum:]

Steve, it is LeRoy. Let me make one point of clarification. As Philip talked about real quantities, at the end of ‘09 and on into ‘10 that is not when orders would necessarily show up. We will potentially see some nice orders in the industry as we move into 2009 here. So, we’re not – as some people have tried to portray – looking at a dearth of AMI business through the front end of 2009. We think the marketplace is actually going to see some more new contract awards that are material in the front-end of 2009.

[Steve Sanders:]

Okay. Thanks very much.

[Operator:]

We’ll move now to Ben Kallo with the Stanford Group.

[Ben Kallo:]

Hi, good afternoon. I have two questions. First, as far as the budget flush goes in Q4 how much of that is built into your guidance; maybe get a little more detail on that? You touched on that LeRoy, a little bit.

[LeRoy Nosbaum:]

Well, Ben, I’m not going to give you a tight number, but let me say in an ordinary Q4 we have expectations for a pretty fair amount of what I’ll call "use it or lose it money". As we head into this Q4 we will see some of that and the issue is will we see as much as we usually do in terms of what’s built into our guidance. We certainly don’t have as much built in as we normally would and if you think of upside and downside it circles around that issue. If we got a little bit more, then we have some upside in Q4. If we get a little bit less, then we’re going to have to pedal harder to make up for it.

[Ben Kallo:]

Okay and then how are you approaching – in the past couple of calls you’ve been asked about acquisitions quite a bit. Are you in a "hoarding your cash mode" or are looking out there for the value that this type of market has created?

[LeRoy Nosbaum:]

Yes, that’s a great question. If you look at us today, we are hoarding cash to a degree because we think it’s the right thing to do in the kind of climate we’re in. That having been said we have our tentacles up perhaps more than we did in the front-end of this year because I think there is some potential as we move into ‘09 for some interesting values to come apparent. I don’t have anything that we’re working at this moment, but we’re probably a little wiser than we used to be.

[Ben Kallo:]

Okay. Can you say if you’re looking domestically or internationally focused on those?

[LeRoy Nosbaum:]

No.

[Ben Kallo:]

Okay. Thank you.

[Operator:]

Our next question will come from Stuart Bush with RBC Capital Markets.

[Stuart Bush:]

Hi, guys. Good afternoon.

[Deloris Duquette:]

Hey, Stuart.

[Stuart Bush:]

So, you mentioned that you expect some margin improvement going into next year, but what the North American base business down and Actaris somewhat flat I guess net or down sequentially my understanding was the AMI business would start off being lower margin. Where is exactly that margin improvement going to come from?

[LeRoy Nosbaum:]

Philip, I’m going to give you sort of three views of this. First of all, the Actaris business is not going to be down sequentially. It’s going to be up sequentially in local currencies. It will be down sequentially in US dollars because of the big swing in dollar to Euro and dollar to frankly other currencies. One of the things that Malcolm was instilling when he was running the Actaris Business Unit for us was pounding on gross margins and improving gross margins wherever that could happen. We do that in fundamentally two ways. We do that through engineering, which takes out costs of products we make every day and we do that through increased automation in places where that is the right thing to do. Recall that on the last conference call I think we let you guys know that we had actually moved the manufacturing manager, Walter Oettl, from our Oconee facility in South Carolina over to be part of the Electric Meter Group in Actaris. One of the great strengths of Walter is taking costs out of factory operations. The next point I’d make is that as we go through the year while AMI will start out with relatively lower margins compared to what our usual and typical would be, that AMI shipment throughout the year is going to get increasingly better because we are taking costs out of that product and we are taking costs out of what is inherently a higher average selling price product so that has goodness associated with it. And as well as we move more AMI product through the factory we get better factory loading, so we have better overhead absorptions which also plays into the gross margin calculation. So, we got lots of goodness coming in some places. I’m not looking for multiple points of margin expansion, but I think we could get a point or maybe a little bit more than that as we look across the world and that would be very nice.

[Stuart Bush:]

Okay, fantastic. I read it as quite reassuring that at your user conference and what you see on the ground that utility is not looking to pull back on CapEx spending in this environment. We have seen in the past some cycles where utilities have done so. Can you comment on what is different here and how you expect that to play out this time?

[LeRoy Nosbaum:]

I’d make two points and then we have lots of people sitting around this table. If anybody else has got anything to add, please do. First of all, I’d say that in this particular cycle utilities come into this cycle by and large, not every single one, but by and large in great financial shape and so, they are in a good place where as in other cycles sometimes they’ve not been in a particularly good place. The other thing you see playing into this one is a number of the spend projects are projects that quite frankly either reduce expense enough that they’re too attractive not to do, or they are so vital for the utilities health and operation or helpful to the utility’s customer like an AMR or AMI project that Public Utility Commissions simply aren’t going to let them delay them and so, we are just not seeing projects pushed out. I will say that we will see utilities and we’re seeing some of it already look at their maintenance budgets and their expense budgets and be more prudent than they have been and so, they are being careful about where and how they’re spending money. They’re being careful about how much money they’ve got tied up and I think Philip mentioned that we’re seeing some utilities working off inventories and I think we’ll see some more of that through maybe a quarter or so here. But capital projects, we are just not seeing capital projects delayed by and large either in the US or at Actaris. As I mentioned so far we’ve seen two in the whole world. If that’s all there is, I’ll be wonderfully thrilled.

[Stuart Bush:]

Okay and just a couple last questions. As far as you buttoning up some of these AMI contracts you’ve got in place like San Diego my understanding is you need to get a contract for a second meter supplier for some of those. Can you comment on progress there and what needs to get done to finalize and get these into backlog? And than the last question is how do you see your competitive situation as we look forward? You’ve mentioned in the past that having a strong balance sheet benefits you in approaching some of these potential customers. Have you seen on a relative basis that that status improved given this environment?

[LeRoy Nosbaum:]

I’m going to let Philip take the first part and then we’ll come back to the second.

[Philip Mezey:]

So, Stuart on the first part in relation to what it’s going to take in order to book these remaining contracts there are a series of milestones of which approval and progress through some early phases are required to actually book them. It is not related to the second meter source. While we are contractually obligated to that it does not in any way interfere with our booking or our ability to perform initial deployments. However, on that front we do have a Memorandum of Understanding with the supplier and are in active negotiations with other major suppliers in the marketplace and have made substantial progress in the past quarter and are very optimistic about our ability to secure one, if not multiple, second meter sources for these deals.

[LeRoy Nosbaum:]

On the balance sheet and how it helps us compete with various utility customers, I’ll make two points. First of all, our size in balance sheet particularly in times like these is extraordinarily attractive to utilities because they know if they’ve entered into a long-term contract with us we can withstand the strong winds of economic downturn whenever they occur. The second point I’d make and this one is both balance sheet as well as willingness with the kind of financial strength we have we can spend R&D money better than anybody and so, we compete with our competitors in both our ability to and our willingness to spend R&D expenditures when we think the market both dictates and the opportunities present themselves so we can take advantage of. And so I made the point in my prepared remarks about continuing R&D expenditures to let you guys know that we think now is the time to be spending R&D dollars and so, we’re going to continue to spend there pretty much no matter what else we have to do.

[Stuart Bush:]

Okay, great. Thanks a lot.

[Operator:]

From Canaccord Adams, John Quealy.

[John Quealy:]

Hi, good afternoon. LeRoy, coming back to the R&D spends. Can you give us a sense of sensitivity moving through ‘09? Would you even consider slowing down the rate of acceleration on that R&D line? Clearly, it doesn’t look like you’re that concerned about guidance given that you’re really spending a lot on R&D. Can you just talk about what would cause you to slow that down a little bit?

[LeRoy Nosbaum:]

John, that’s a reasonable question. If we all of a sudden saw economic conditions cause utilities to in fact stop spending capital dollars and so our revenue retarded markedly we would begin to look everywhere else but R&D, but we’d finally get to R&D. And so, we’d look at some projects in both areas sustaining engineering and new product development areas, so we’d try to pick out those that we thought were going to be best for us in the long run and produce the best result, but we can trim sales if we had to. One of the things we do, we have an awful lot of contractors not only in the US, but around the world that we use. We’d see if we could skinny those guys down and we’d take a good hard look at it if we had to. At this point in time, I don’t think we have to and so we’re not going to.

[John Quealy:]

And then quickly on the volume expectations for AMI in ‘09. If I understood $1.4 million spread across the four. Clearly, the Californian’s seem to be more visible and solid on their deployment plans. Can you talk about relative percentages if you could about CenterPoint and Detroit? I know they’re smaller projects in earlier, but especially in the case of CenterPoint has had a lot of push back and risk associated with that.

[LeRoy Nosbaum:]

What I can say about CenterPoint is that they are currently in active discussions with their Public Utility Commission. They’ve gone back with a full-scale rollout plan, so not just a partial implementation. Those discussions proceed as we’re talking right now. I’m encouraged that we’ve moved from partial to full rollout. I do know that Public Utility Commission there has been quite supportive of full-scale rollout and so there it’s a timing issue that I just can’t answer because I’m not party to those discussions and I couldn’t answer it if I was, but I’m encouraged. At Detroit, I think we know the scope of Detroit’s project in 2009 and good news therefore, in my view is that if we perform well I think that project is going to go to full-scale rollout and we’ll see that beyond 2009. Right now, clearly San Diego and Southern California Edison are pushing us to move forward on realistically, fairly aggressive schedules when you look at them.

[John Quealy:]

And my last question for Steve. Free cash flow, Steve, for the full-year, is this sort of in the 130 size and then also for ‘09 assuming sort of flat revs of 10 to 15, whatever the guidance is on the bottom line, a similar number for ‘09 or at least assumptions for that?

[Steve Helmbrecht:]

John, in terms of ‘08 we see free cash between the 135, 145 range. That will depend on fourth quarter CapEx spending for us. We’re not prepared to give specific – that was ‘08 – excuse me – for ‘08 and for ‘08 not specifically yet, but I think generally we’re not seeing anything next year in terms of CapEx. For example, that would be anything out of line with our traditional – what we’ve seen the last couple years about 3% of revenue or less and otherwise you see the similar ratio.

[Deloris Duquette:]

Yes, we would expect it to be materially different.

[John Quealy:]

Great, thanks folks.

[Operator:]

We’ll move to Sanjay Shrestha with Lazard Capital Markets.

[Sanjay Shrestha:]

Great, good afternoon, guys. Most of my questions have been answered, but a couple of quick questions. LeRoy, you talked about the balance sheet benefit for you guys as to all the things you can do. But are you also potentially seeing a scenario where utilities are saying that we really can’t be dealing with a lot of the smaller companies because it’s not just the issue about the credit crunch, but it’s the issue of the broader capital markets and we might end up entering into a relationship with those guys, but long-term viability of those companies have kind of become a bit more of a question mark given the environment we’re in and you are starting to see an incremental benefit because of that?

[LeRoy Nosbaum:]

Oh, Sanjay, it’s a reasonable question and I’d love to be able to say yes, we’ve seen that in a half a dozen places. I can’t. What I can say is that utilities peer into our balance sheet strength and our forward viability to a great degree. If they’re doing that with smaller companies they have to be asking questions that are very difficult to answer.

[Sanjay Shrestha:]

Fair enough, another follow-up on that then. LeRoy, you guys have sort of seen the utility industry evolve and some of the projects that have approved financing in place, I mean, obviously. If this environment continues to deteriorate and we sort of go into a deeper type of recession environment I guess, rather than maybe a shallow one, is there still a risk to some of those that have already got funded, given that utility balance sheet is in the best shape it has ever been and these are projects that are funded by putting into rate case. Could we see that for some of the already approved AMI-type opportunities?

[LeRoy Nosbaum:]

I’m going to give you two views of that.

[Sanjay Shrestha:]

Okay.

[LeRoy Nosbaum:]

One view is it depends on where the project is. If it’s a trial, I think you could see trials being essentially completed, but sort of slowed down and I’m not going to say winded down, wound down. If you’ve got a project where the capital is approved and the public utility commission has approved it is really hard to turn those off. Could I foresee an economic circumstance where that would happen? Well, as one well-placed utility executive said to me not many weeks ago, "If that happens none of us are going to be worried about that project, trust me".

[Sanjay Shrestha:]

Probably true, probably true. One last question then. So, when you guys are talking about this preliminary outlook for ‘09 and I understand we still have Q4 left here – when we talk about sort of flattish type of a revenue in the low to mid-teens type of an earnings growth does that take into consideration ongoing de-leveraging and benefit from reduction of interest income or its just more of an operational benefit?

[LeRoy Nosbaum:]

No, it takes some of that into consideration. Yes, I won’t say that we have wrenched out every little bit of goodness and potential downside. We’re still in the backend of that budgeting process, but, no, clearly it took into consideration some of that.

[Sanjay Shrestha:]

Okay, terrific. Thanks a lot guys.

[Operator:]

Next we’ll hear from Carter Shoop with Deutsche Bank.

[Carter Shoop:]

Good afternoon. I wanted to touch on a couple topics here. First, on the push outs that you mentioned, you mentioned there is only two of them – I was hoping you could kind of comment on how many that’s out of? Is that two push outs out of 100 major projects you’re looking at or is that two out of 20 major projects you’re looking at?

[LeRoy Nosbaum:]

Well, let me think about that. It’s far more than 20 and it’s probably a bit less than 100. It’s immaterial enough that I’m not worried.

[Carter Shoop:]

And then when did we see those push outs – those that we saw over the past week-and-a-half, are these push outs that we saw over the past two months?

[LeRoy Nosbaum:]

Two months.

[Carter Shoop:]

Two months, okay. That’s helpful and then you mentioned earlier that debt covenants aren’t necessarily on the top of your list of concerns. I was hoping you could maybe comment, LeRoy, on what is on the top of the list there?

[LeRoy Nosbaum:]

Quite frankly, lately what’s on the top of my list is watching our stock bounce up and down like a yo-yo, mostly in the down direction for no good damn reason. That’s the first one and the reason that’s concerning is because it just concerns everybody involved. It concerns your employees. It concerns your customers. It concerns you guys. It concerns the rest of our investors. So, that one frankly has been top of mind. As I look out into 2009, I’m clearly worried that utilities are in a dour mood and so we’re doing exactly what you guys are doing. We’re going to utilities and we’re asking them, where are you? What are you going to do? Are you going to delay projects? Where’s your capital budget? So, top of my mind has been what are utilities doing, which is why had I had both Marcel and Philip talk to you about how they’re feeling – and frankly, I’m feeling pretty good about that, but if – along are things I have to worry about because I get Mr. Helmbrecht to worry about debt covenant – that one’s a little higher up on my list. And then thirdly, I worry every damn day that we’re going to get the next big AMI contract and so I’ve got my foot right on the backside of Mr. Mezey to make sure that that happens.

[Carter Shoop:]

That’s helpful and last question here. Could you maybe discuss expectations for electric, gas, and water, non-AMI meters in 2009 – maybe in a very high level – kind of discuss the trends in automation that you’re seeing in those three categories across the world and then which segment you’d expect to be most impacted by the macro economic slowdown?

[LeRoy Nosbaum:]

That’s a useful question. I think as I look at meter business in general around the world and the potential for automation and electric, water, and gas, clearly as we referred earlier in some prepared remarks the electric meter business in the United States is moving from AMR to AMI. Not all of it, but we are seeing some cannibalization there. So, automation in the electric space is largely turning to AMI and so we’re seeing a downtrend there. We’re seeing an awful lot of automation around the world quite frankly electrically in prepayment meters and Marcel mentioned – as we look into economic conditions that are slowing down, a lot of utilities are looking closer at prepayment meters as a way to give their customer, the consumer, a better manager of their electricity bill, and a better way to budget what they’re doing. In the U.S., we are continuing to see growth in water AMR and that one you have to watch carefully, although I’m not dour on it. You have to be a little mindful that there will be some municipalities out there that are going to suffer some because their tax receipts are going to be lower than they had been earlier and so we’re watching that right now – that is not affecting us as much as it might be some others. Gas automation in the US still going great. We look for good 2009. In the rest of the world we are seeing increasing levels and increasing interest in water and gas AMR. So, I’m as ever excited about that. And the interesting part about the rest of the world is it doesn’t take too many contracts to make a big increase in that because it’s been only a modest amount of activity so far. So, as Marcel said we are looking for our business to become more systems oriented and less just bread-and-butter meter oriented than the rest of the world here as we move into ‘09, ‘10, ‘11 and so forth.

[Carter Shoop:]

And just commenting on the impact to maybe the non-automated meters from a macro economic slowdown, would you expect the electric meters to be a little bit more resilient than gas and water?

[Malcolm Unsworth:]

It’s Malcolm. If you take a look at the North America and the rest of the world a lot of the meters that are required are mandated that you have to change them out. Change outs are by law and you have to replace them. So, or you have to order them to make sure they’re still within the limits of their performance. So, housing starts – they have a little bit of an impact, but if the housing starts are down they replace more meters. So, they will always be replacing meters because it is their cash register. So, is it having an impact? I’m not certain we’re seeing that effect really – as Marcel said, a little bit in Spain because of housing starts, but not a huge impact, no.

[Carter Shoop:]

That’s helpful. Thank you.

[Operator:]

Next we’ll here from Paul Coster with JP Morgan.

[Paul Coster:]

Thank you. A couple of quick questions. First on Actaris side, I believe the shipments were up about 11% year-on-year, but the revenues were on a local currency basis only up in the single digits implying that the ASP came down. Can you just give us some color around what the causes would have been?

[Marcel Regnier:]

Marcel speaking. Thanks for this great question. Actually, what we have seen – think about the large diversity of electric, water and gas meters. They are not all the same price point. So, this is definitely a mix issue. We have seen more increase in Asia and Latin America and the average price is not the same than in Europe. It’s a mixed thing.

[Deloris Duquette:]

As well, Paul, there were a little bit more prepaid meters in last year’s quantities versus this year so the volume is up a bit, but the average price per meter because of mix is down.

[Paul Coster:]

Do you think that will change going into ‘09 or we’ll be likely to see this as a constant now?

[Deloris Duquette:]

We think that it will continue to be a mixture of prepaid C&I and residential and so we don’t think it’s a trend. We think it’s a mix issue in any given quarter.

[Paul Coster:]

Okay. Got it and then my main question really is for LeRoy. Michigan and Southern California, two locations where you have had most success are also locations most impacted by the economic downturn. Have those utilities shared with you any data regarding the peak flow utilization? I guess the negative piece here is being fixed by tighter wallets on the part of the consumer without the need to implement demand response technology.

[LeRoy Nosbaum:]

Paul, I would say that we have seen in a couple of places around the country general slowdown in the sale of electricity. Interestingly enough, that started almost at the front end of 2008 when gasoline prices soared and what we saw – we saw it in Florida. We saw it some in Southern California. We saw it in some other places that people were obviously making trade-offs between spending electricity money so it was air conditioning by and large and driving their vehicles. Whether or not the more recent turndown in gasoline prices will affect that in the other direction or the economy will hold it steady I don’t know. Even with those conditions that we’ve seen frankly all year long we don’t see any turnaround in the mood for AMI and demand reduction because the needle peaks on any given day for an electric utility are so costly if they can get customers off of that the amount of money that they and the consumer can save is absolutely worth it unquestionably.

[Paul Coster:]

I guess the follow-up there is simply do you know the number of days that we encountered the peak load issue in California this year?

[LeRoy Nosbaum:]

Specifically, I do not have that, although I’m guessing that’s probably in some public filing on a continuous basis, all the delayed data I’m sure.

[Paul Coster:]

Okay. Thanks very much.

[Operator:]

(Operator instructions) We’ll move now to Andy Young with Thomas Weisel.

[Andy Young:]

Hi, good afternoon. I have a couple questions. You mentioned that utility capital projects are pretty steady right now. Can you give us some color on how you generally finance a large capital project like AMI Project? And also with ROI capitalization project the impact of higher financing costs.

[Deloris Duquette:]

Andy, it is Deloris. Every utility is going to be a little bit different. Some of our customers just fund those projects out of their normal capital budgets which come from operations. We don’t know of any utility that is specifically going out and seeking individual funding for this. Keep in mind that the utilities that we’re selling to are large enough that although these are large projects to us they’re not necessarily huge in terms of a utility’s capital budget. And as far as the ROI on any given individual utility most of those are public in their filings and they’re going to depend on their individual assumptions that they rolled into their business case.

[Andy Young:]

Thank you. Next question is regarding your interest rate swaps. What’s your view on the counter party under the current capital markets involvement?

[Steve Helmbrecht:]

This is Steve Helmbrecht. Our interest rate swaps are with primarily with AAA rated bank and as such we believe is very low counter party risk regarding those particular. We have a small number of those contracts in places as I’ve already mentioned and those are with very highly rated banks.

[Andy Young:]

Okay, great and one final question. It’s obvious that at the current exchange rate the Euro is going to be a pretty significant headwind next year. So, besides assuming $1.30 for US dollar Euro exchange rate how should we approach the sensitivity of your 2009 sales in EPS in relation to currency fluctuations?

[Deloris Duquette:]

At this point, Andy, we are finalizing that model. I think if you looked that up on a very high level that for every point change in that Euro rate you’re going to have between one penny and two pennies at the bottom line you’re probably close.

[Andy Young:]

Okay, great. Thank you.

[Deloris Duquette:]

You’re welcome. Operator, I’m just doing a status check. We’re about 10 minutes over. I’m just wondering how many other questions are in the queue?

[Operator:]

We do have one question left in the queue.

[Deloris Duquette:]

Okay.

[Operator:]

From Mark Rogers with Gagnon Securities.

[Mark Rogers:]

Hi, thank you, guys for taking the question.

[Deloris Duquette:]

Sure.

[Mark Rogers:]

If I was to look in the information given today and I tried to find out where – let’s say, for example, the Detroit contract was, I mean, where could I look for that? And where does that show up in the numbers?

[Deloris Duquette:]

It’s really not in any of our numbers per se right now because we have not booked that contract. Certainly rolling through revenue will be the revenue for that first 10,000 units that we’re shipping out, but it’s not material enough. If you look in our – when you looked at the press release that we put out we gave the dollar amount for that contract, but it’s not embedded in any of our financial metrics at this point.

[Mark Rogers:]

Okay, and then quickly, if I could just have a follow-up? The 12-month backlog to revenue ratio – and maybe this is just something I’m doing – but, it’s been continually trending down since Q1 and I wonder if you could just talk a little bit more about that?

[Deloris Duquette:]

Yes that ratio – I don’t know that we track it as a ratio – but, certainly we have individual components on it, given any contract that we may have signed. For example, if you’re comparing 12-month backlog this year against last year, you’ll notice its a little lower this year. Two things, we had a large contract that was in 12-month backlog last year that we had signed in April, Mid-American and Pacific Core that was still in there and remember that in 12-month backlog we only have a minimal amount of that SoCalEd. Despite the fact we’ve booked the whole thing, a lot of that revenue comes through in Q4 of next year – that’s not reflected in 12-month backlog currently. As well we have not booked San Diego Gas & Electric contract yet, so it’s not in 12-month backlog.

[Mark Rogers:]

Okay, great. Thank you.

[Deloris Duquette:]

You’re welcome.

[Operator:]

And there are no other questions at this time, Ms. Duquette. I’ll turn the conference back to you.

[Deloris Duquette:]

Great, thank you everyone for joining us today and the great questions in as well. If you have any follow-on questions, please feel free to call me.

[Operator:]

Thank you. There will be an audio replay of today’s conference available this afternoon. You can access the audio replay by dialing 888-203-1112 or 719-457-0820 with the pass code of 3124368, or go to the company’s website at www.itron.com. That does conclude our conference. We do thank you for joining us.