Good day, everyone, and welcome to the Itron, Inc. Quarter 2 2012 Earnings Conference Call. Today's call is being recorded. For opening remarks, I would like to turn the call over to Barbara Boyle, Vice President of Investor Relations. Please go ahead.

Thank you, Marisi. And good afternoon to everyone on the call. This is Itron's Second Quarter Fiscal 2012 Earnings Call. And on the call today, we have LeRoy Nosbaum, Itron's President and Chief Executive Officer; 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 today's call. We also have prepared slides to accompany our remarks in this call, and these slides are available through the webcast and through our corporate website under the Investor Relations tab. Our earnings release and financial presentation include non-GAAP financial information that we believe enhances the overall understanding of our current and future performance. We have included reconciliations of 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 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 call and in the Risk Factors section on 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 any forward-looking statements. Now please let me introduce Steve Helmbrecht, Itron's CFO, who will start our call.

Thank you, Barbara, and good afternoon. I will begin with a summary of our Q2 results on Slide 4, starting with revenue. Second quarter revenue of $575 million was down 5% from Q2 2011 to almost entirely the foreign exchange rates. The average euro-U.S. dollar rate in Q2 was $1.28, compared with $1.44 in Q2 of last year. On Slide 5, you see the stronger dollar reduced revenue by $35 million. Adjusting for the impact of currency, total revenue was about flat compared with last year. The impact of FX on earnings was more muted. The stronger dollar negatively impacted GAAP operating income by $1 million and non-GAAP operating income by about $3 million, compared with last year. Gross margin of 34% was 270 basis points higher due to special -- reduced special warranty expense and operational improvements in both Energy and Water. Lower special warranty expense, primarily in the Energy segment, drove more than half of the margin improvement over last year. Warranty expense in the quarter benefited from a $4.3 million reduction in our warranty reserve related to the satisfaction of a customer warranty issue at a lower cost than originally estimated. Excluding that item, gross margin would have been 33.2%, up 190 basis points over last year and up 115 basis points from Q1 2012. Non-GAAP operating margin of 11.6% was up 80 basis points from last year, reflecting the improved gross margin, partially offset by higher R&D, sales and marketing expenses and the inclusion of SmartSynch in our results beginning this quarter. Consistent with improved non-GAAP operating margin, adjusted EBITDA margin of 13.9% was up 80 basis points over last year with adjusted EBITDA of $81 million. We had GAAP diluted earnings per share of $0.79 for the quarter, compared with $0.84 a year ago. Our…

Good afternoon, everyone, and thanks for joining us today. Steve, thanks for a good overview of the quarter. Let me give you some color both about the quarter we have ended and how I see the quarters ahead. Overall, Q2 shows improved execution and follow through on the initiatives from last year. Revenue is expected and nice improvements in gross margin have made for a good quarter. In electricity, we had a good quarter at BC Hydro, which helped North America to be up. The rest of the world was flat to down slightly. In gas, we were a little short of last year. I would call that normal period-to-period fluctuation. In Water, we were up nicely everywhere, but the U.K., which was down slightly. In North America, our Water business was up. But remember our Water business is not water meters in North America, but water automation in systems. From Itron's perspective, the automation systems business is holding up nicely in the U.S. and our water team is doing a great job. As we head into second half, I think our forecast and thus guidance is solid. We will have a drop-off in OpenWay revenue in North America. Gas will be flat to up, water will continue to grow. In total, we expect about $1 billion of revenue in the second half versus $1.2 billion in the first half. That is how we get to revenue for the full year of $2.1 billion to $2.2 billion. So in my view, we are executing well on the revenue plan we had in place as we came into the year. Let's turn to gross margins. 34% in the quarter, 270 basis points higher than last year, margins up in Energy and in Water. We are showing nice improvement in OpenWay from…

Before we go to questions, I would like to remind the callers that there is long queue. [Operator Instructions] So we really would appreciate you respecting that so we can get more people in on the queue.

[Operator Instructions] Our first question comes from Sanjay Shrestha with Lazard Capital Markets.

LeRoy, 2 quick questions. First, I apologize if I missed this, but did you give an update how do you sort of see opportunities unfolding in Japan with TEPCO, and where are they in terms of selecting the vendor and things like that?

Yes, Sanjay. Japan has come through, I think, a very useful and worthwhile process in that they have been working on specifications and talking with various vendors for the last several months. That has pushed the actual date for them to come to market with a bid out until looks like April of next year and probably not actual shipments until early in '14. We think we are positioned well. We have played a heavy role in reworking of specifications, which feature International standards now, which gives the guys outside the -- outside of Japan a real opportunity to participate.

Got it. One quick follow-up if I may then. So given this recent, sort of what was an unfortunate event in India, a lot of talk about a need for a smart grid because of the grid failure, a lot of people out of power, can you remind us your presence in that market, and what kind of an incremental opportunities that could turn into for you guys and for the entire smart metering industry, if you would?

Yes, Sanjay, first, let me start, if you will, by just saying a tough tragedy for those people. We feel deeply concerned as we, too, have people that live and work in India, working for Itron, 60 in total. About 30 of them are actually affected by the current blackouts. Currently, we do about $15 million of revenue in India, about half of it is water, half of it is energy. The water stuff is outside the area affected and it is a smart water project around Mumbai. The energy stuff is largely gas. We actually have not been doing business with power grid on a usual basis. However, in most recent weeks, interestingly enough we have been talking with them about a smart grid project in the southern part of their territory utilizing smart electric meters, as we all know them. I suspect that project will get highlighted in the future as being one of the things that could have helped them avoid the level of blackouts and the length of blackouts that they are currently experiencing. I mean put most simply, this is a matter of too many people using too much electricity, and it's difficult to control. So I look in a perverted sort of way at -- this could be good for the smart meter, smart grid community as India assesses how better to deal with their electricity problems.

Our next question comes from Zach Larkin with Stephens.

First question, LeRoy, you talked about mix in the quarter, and I wonder if there's anything specific you could highlight on kind of on mix shift. Wondering how much of the improvement in mix was due to AMR ready meters, which seem to be catching on around the world?

Well, Zach, most of the goodness of mix was clearly OpenWay in the U.S. and 2 things: one just volume of it, mostly to BC Hydro, as you would imagine; the other one is we have in recent times done a lot of good work on redesigning the OpenWay product to take cost out of it. When I mentioned a design for cost program, that was it. So the margins in general were better in that project so a lot of good work going on there in the quarter. Other than that, I don't know that there was anything particularly unusual remix.

And then just a quick follow-up. I wonder if you could give a little bit more color on the management project you've been working on, is there anything specific you've noted kind of culturally or changes that you could talk about?

Well, I could use one word to describe it. Wow! I have been incredibly impressed far more than my expectations at how much the new processes were working, how much the change in culture relative to commitment based management and speeding up decision time, it's been tremendous across the 220 people that we're putting through. And even more important, it's spreading to the rest of the company so we're delighted and I would describe it, wow, what an effect.

We'll take our next question from John Quealy from Cannacord Genuity.

So 2 questions. First, LeRoy, CEO search. Can you update us where we're at, what timing should be expected, you're quickly coming up to your year anniversary. And then secondly, Steve, I'm going to give you that same question I give you every quarter. So you gave us a look at '13, can you walk us through cash flow expectations? I assume what you meant with your comments for '12 is we're looking over $140 million of free cash, can you extrapolate trends anyway for '13?

Yes, John, I'll start. I knew somebody would ask, so we didn't put it in the prepared remarks. Thank you for reminding me that I've been at this for almost a year now. First of all, I'm having fun, most days. The search is ongoing and we continue to talk to interesting candidates, we have probably talked to 15 or so at this point, we continue to look at candidates, putting some in the go-back bucket and some banking further interest in Itron. My current expectation is within my commitment, which was to be here till the end of '13, we will have a new CEO designated and a good transition handed off, so I'm comfortable with where we're headed at this moment.

John, this is Steve. In terms of free cash flow, as I mentioned, we expect the second half of the year, we tend to see that type of second half seasonality, customers pay, we drawdown inventory for year end spending and so forth and being more heavily weighted. Just bigger picture, and we've averaged about a 7.5% to 8.5% free cash flow yield for the last couple of years and the drivers for that have been no major change really in our working capital metrics. We built some inventory up as we ramp up projects and that can come down a little bit, and so we don't see any major with that. Our CapEx remains fairly low and I don't see that changing in a material way next year, as well as our interest profile remains obviously quite low. And there may be a little change in the cash taxes, but again, not meaningful. So I would say, our ability to generate strong cash flow into '13 should continue.

We'll take our next question from Ben Kallo with Robert W. Baird. Benjamin J. Kallo - Robert W. Baird & Co. Incorporated, Research Division: First, LeRoy, you mentioned Duke in your prepared remarks. Can you talk more about the opportunity there, and what exactly you're doing, if that can expand overtime. And then, Steve, on the cost front, how much more can you do on the gross margin front, and can you just talk about maybe in the percentage of what -- how far you've gotten so far?

Yes, on Duke, I'm going to be guarded in my comments here because it's early days. We have been shipping some stuff to Duke on and off for a while now. We were fortunate enough in the quarter to receive a $40-plus million contract with them for deployment in Ohio, in the Carolinas. That will rollout on a schedule that Duke will give us. As for opportunities beyond that, I'm not just going to speculate on that at this moment, it's incumbent upon us to do a good job. I know we can because we have done a great job at our 5 major contracts and we're doing good work at others as well. So that's all I can say on that one at this point.

Ben, on the cost front, and margin front, as LeRoy talked quite a bit about the work being done in procurement savings and very much focusing on a manufacturing footprint, we're starting to see those benefits. LeRoy talked about 34% second half of the year as we look ahead. We continue to see focus on maintaining that or continuing to focus on improving the gross margin from that level. One of the big wildcards has been special warranty, so it remains that in the future. But again we're pleased with the progress we've made on the quality front as well but that's something that certainly weighs in on the number.

Our next question comes from Amir Rozwadowski with Barclays.

Just tailing off on that gross margin question, certainly, we've seen pretty big improvements from you folks last quarter, this quarter and with respect to your guidance. What are the sort of elements that can help drive further appreciation on the gross margin side? And if we -- if I may, the second part of the question, really, if we look at those opportunities sort of internationally, I suspect that they're going to be competitive, where should we think about sort of the different elements from a pricing standpoint versus an innovation standpoint along those lines?

That's a good series of questions. Let me just say that the -- the elements on gross margin are clear. Steve mentioned one, stay away from the special warranty. We've done an awful lot of work across the company on quality, that work continues and it will continue indefinitely, forever. It's just important and we put some people in charge of that, but I think they're doing a bang-up job. The other -- another one that's been really important is we adopted global procurement across energy and across water and then across both of them. That activity has started a while ago, but it begins to -- it takes time to ramp that up and it begins to show itself, small at first and then become meaningful and I think we're into the phase where meaningful is starting to show up. Certainly, so far this year, over $10 million in energy, meaningful; coming along in water, similar pace. We're pleased with that. There's a long way to go there and that includes just buying on a global basis, but also where do you buy? Where do you set up your procurement mechanism? And we've got along way to go so I think as we move through the rest of this year and on into '13 since I've called '13 flat, important for us will be to focus, focus, focus on cost and gross margin is in that area, and I think we can do some good work there. Also, our factory rationalization is helping our gross margin where we're putting more volume through on a fewer number of factories with more automation and the right kind of automation. That is always going to yield good process and I will tell you, I am very comfortable with what we're doing in…

We'll take our next question from Colin Rusch with ThinkEquity.

Noah Kaye for Colin. Can you give us a little bit of an update on how the distribution automation program development is going. You've announced a meaningful collaborations obviously in the last 6 months. I wanted to hear an update.

Well, we're certainly doing a lot of work with Cisco and a bunch of other partners relative to smart grid. And the smart grid subject for me is always one of magnitude. In its totality, smart grid is an extraordinary opportunity around the world. When you get down to the specifics, it gets a little harder and the numbers get smaller quickly, so we work routinely with about 50 to 100 different partners in the general area of smart grid. It tends to be what I call customer-specific where we're partnering to do some specific thing. To be honest, Colin, it's hard for me to give you any degree of specificity beyond that.

Sure, sure. Maybe go back to procurement savings. Just wondered if it would be possible to get a little bit more detail on that, where do you see are some of the core components where you can do a little bit better?

That one is reasonably easy. If you look at the things we do all over the place, we put some kind of silver content on top of -- on down on a circuit board. We buy circuit boards in half a dozen different locations. We buy electronic components, used to, in a half a dozen different locations. We buy batteries in about 5 different places. And so when you start looking at those things you say, "Okay, how much purchasing power can we wield if we go to the various vendors?" And we say, "Okay, how would you like a contract that's 4x as big as the 1 you've been getting from us and maybe even with some extra time considerations?" The other thing that we begin to look at very, very carefully is we're not continuously requalifying vendors on a part that a different part of Itron is already qualified or knows a lot about. And from time to time, we also disqualify people because we haven't been getting good parts in one corner of the globe and we're getting them in the other. The other one, we have taken some serious action on is it helps you if you're buying particularly electronic components out of a purchasing group that is located someplace in Asia Pacific and so we've been moving along in that direction as well in order to do well. Now, we have 1 great big purchase of copper that's out of water, we. Have managed that historically very well and we manage it today very well, looking ahead and buying ahead and trying to give our best eye on where the copper market is going as we look at water meter and the copper content in water meters.

We'll take our next question with Ben Schuman with Pacific Crest Securities.

Can you just give us a quick update in terms of the PRIME meter development and what you're hearing in France in terms of the political situation as it relates to ERDF?

Sure. Let's start with PRIME, which is Iberdrola. Our view of Iberdrola is it's going to move forward on essentially the schedule it has had. It's got $1 million or 1 million point contract that's working off. Our view is that gets worked off shortly after the first of the year, they go back out. We have been in almost constant communication with Iberdrola showing them a product. We will be in test at the front end of October with them. We are well enough -- and well enough conversing with them to know that we will come out of that with an approved product that should be able to participate on their next tender when that occurs. Our guess, the front end of 2013. Now that said, I would be remiss if I didn't add that we recently had signed off on our meter data management system there, which is working well, are collecting data from other people's meters, unfortunately, not ours but we'll soon fix that. In France, with ERDF, the government change there is an unfortunate circumstance in terms of timing, but not one in terms of how they view smart meters and the Linky project in general. We come through a change of government that means we're going to have a new Energy Minister, that means we're going to have some shuffling down of people change. So our view of that and it has been fairly public -- publicly stated by ERDF is that they will come back out early into '13 with a tender process, and that will move to shipments in the 2014 time frame. So I don't know that there's been any -- well, I will say it differently. There has not been any change of heart relative to smart meters. There has been a change of timing. And there's a great actualization over there that a smart meter project across France adds a huge number of jobs. When I asked the question how many, I was told something in the range of 10,000. That's good for the new administration.

Okay, great. And then when Toshiba was rolled out -- or when Landis+Gyr was rolled out into Toshiba, did you see any kind of competitive disruption or opportunity? And can we expect anything similar with Elster changing ownership?

I think there's a fundamental change between the 2. Landis+Gyr, we saw no competitive difference, we see no competitive difference at all. We did see some nervousness on the part of -- particularly senior people at LNG. I think that's all died away now, and that's to we expected. At Elster, yes, there's going to be some nervousness as they have a new set of bosses but, by and large, they went from 1 financial guy to another financial guy but, no, change so far.

Your next question comes from Ahmar Zaman with Piper Jaffray.

This is Shawn for Ahmar. I was wondering if we could -- you could give us just a little more detail on what you are sort of saying and targeting for your OpEx improvement. You've given us some detail but just wondering if you guys can give us a sense of what might be a goal in terms of a run rate and how you might get there.

Yes, it's LeRoy. I'll start, if Steve wants to add some additional color he can. First of all, we're going to be real cautious about that. I know I've got the pressure and I know I've got the focus. We will see some reduction in the level of R&D spending. We will see continued reduction in the level of G&A spending. Sales and marketing is going to be harder because as I said we're going to be very cautious about doing too much in sales and marketing because there's just too much tender activity either ongoing or about to be ongoing in our view. Having said that, while we've got some numbers targeted, I have no intention of telling you what those numbers are at this point. What I will say is that we're comfortable with the guidance we have given you, top, bottom and margin and you can sort of back in if you run the math to what you think the overall OpEx number is going to be.

Very good. And if we -- if you could just give us an update on your initiatives in Brazil, progress there and what you're hoping to accomplish there in the next 6 to 12 months as we -- as you talk about sort of a 2014 roll-out period.

You've got -- Brazil is exciting. It's a huge opportunity and one of the things we've recently done is we changed up sales management down there, but I think more importantly, we put a new general manager in charge of energy down there who comes out of that industry, he is steeped in it. And I'll just say it because if you work hard you can find out, he used to work for Silver Spring. And so we have what we think hired a very good guy who is well aware of the competition, he is well aware of the market and he knows personally the chief set many of the utilities. So we have a very good sense of positioning relative to Brazil. We have also been able to participate in some of the recent trials down there. We have been selling commercial/industrial meters into some of the trials and so we the like that. Our view is this is a 2014 event, if you will, I don't think we're going to see tenders before that time period, and our job at this point is just to be ready.

We'll take our next question from Jesse Pichel with Jefferies.

This is Scott Reynolds for Jesse. A question on the FX and the change in FX. So your taking FX rate down by about 10% in the back half of the year. On a constant currency basis, what else was stronger that offset that decline for you to be able to maintain guidance? And also, can you remind us what change in FX and how that affects the bottom line?

Sure. So as I mentioned in some of my initial remarks, Scott, we, in the case of the euro, that's our largest exposure to -- that's the largest nondollar exposure, but keep in mind that over half our revenues are dollar-denominated and not impacted by FX overall and in the case of the euro, we are not an exporter into the Euro zone from the U.S. so we are not affected competitively by changes in FX rates primarily, but we're we are affected is in the translation of that revenue back to dollars. The reason why it doesn't flow through very significantly into the EPS line is that we also have a large part of our cost structure there. That's where we manufacture the products, so it acts as a natural hedge overall. And if you think about the last 6 months, unlike a few years ago where all currencies were kind of moving in lockstep with the euro, it's been the euro that has been moving down based on pressure whereas a lot of the other currencies have held up fairly well against the dollar including the Canadian dollar. So we have large increase in Canadian dollar exposure given the work that we've been doing up there, as you know. So the impact bottom line on earnings per share resulting from the stronger dollar is more muted as compared to what it does to the revenue line and that is certainly -- that certainly shaped the modeling we did internally and we know that -- have actually talked about that before and that's really been proven out. So we are seeing. We were originally at $1.37, we are at $1.23 up in the second half of the year and that accounts really for the bulk of the reduction on the top of the end of the guidance range down because of FX, which is at least 75% of that number.

Scott, does that answer your question?

Yes.

All right. Thanks very much. Before we close, LeRoy, would you have some final comments for the call?

Yes. First of all, thanks for the questions, appreciate it. Thanks for joining us today. Let me close by saying we've got a lot of emphasis here on cost to build product and cost to run the company, and so we're working that one really tight, we had a lot of questions around it today. We are seriously working costs because we know that the top line on the company is not going to grow appreciably in the second half and it's not going to grow appreciably in '13, so our job at this point is to get every order we can, but to make sure we're doing it as efficiently and effectively as we move through time running the company. We are doing just that, and spending time and time on it. We look forward to speaking with all of you again next quarter. Thanks very much.

Thanks, everyone.

There will be an audio replay of today's conference available this afternoon. You can assess the audio replay by dialing 1 (888) 203-1112 or 1 (719) 457-0820, with a passcode of 5714755 or go to the company's website, www.itron.com. That concludes today's conference. Thank you for your participation.