ITRON, INC. quarterly report, Q2 FY2011

Itron, Inc. — Q2 2011 Form 10-Q

Reporting period: Quarter and six months ended June 30, 2011. Unaudited results; 2010 comparative figures were restated for a prior revenue-recognition error involving an extended-warranty provision. Itron supplies hardware, software, and services to energy and water utilities worldwide.

Financial performance and position

Metric	Q2 2011	Q2 2010	Six months 2011	Six months 2010
Revenue	$612.4 million	$567.3 million	$1,176.1 million	$1,065.0 million
Gross profit / margin	$191.1 million / 31.2%	$174.1 million / 30.7%	$375.2 million / 31.9%	$331.1 million / 31.1%
Operating income	$48.1 million	$50.0 million	$98.2 million	$81.6 million
Net income	$34.4 million	$25.3 million	$61.6 million	$50.6 million
Diluted EPS	$0.84	$0.61	$1.50	$1.23

• Q2 revenue rose 8% year over year and first-half revenue rose 10%. Foreign-currency translation contributed $35.8 million and $40.0 million, respectively, to those increases. International segment revenue increased 22% in Q2 and 17% in the first half; North America declined 4% in Q2 but grew 4% in the first half.
• Q2 operating income fell about 4% despite higher revenue, as operating expenses rose 15%, including increased product-development and marketing costs and $1.9 million of restructuring expense. First-half operating income increased about 20%.
• First-half operating cash flow was $87.7 million, versus $117.1 million in 2010. Investing cash use was $42.8 million, including $28.7 million of capital expenditures and a $14.6 million acquisition; financing cash use was $53.4 million. Cash decreased $1.2 million to $168.3 million.
• At June 30, total debt was $575.6 million ($234.4 million current and $341.1 million long-term), down from $610.9 million at year-end. Working capital was $211.7 million. The $315 million revolver had no borrowings outstanding and $275.0 million available after letters of credit.
• Current assets were $958.8 million and current liabilities $747.1 million. Inventory increased to $253.1 million from $208.2 million at year-end. Total assets were $2.95 billion and shareholders’ equity $1.62 billion.

Material changes and management commentary

• Itron announced a global reorganization into Energy and Water operating segments; reporting remained on the North America and International geographic segments during 2011, with Energy/Water financial reporting expected to begin in Q1 2012.
• Management was reviewing costs and manufacturing footprint, with plans expected to be formalized by October 2011. Further estimated restructuring charges had not yet been provided. Q2 recorded $1.9 million of severance-related restructuring costs.
• Total backlog was $1.622 billion and estimated twelve-month backlog $1.049 billion at quarter-end. Management cautioned that backlog is not a complete measure of future business and projects may be rescheduled or canceled.
• Q2 tax expense included a $7.8 million net discrete tax benefit; first-half discrete tax benefits were $7.3 million. The filing attributes the 2011 lower tax provision in part to international earnings mix, interest deductions, a foreign tax litigation settlement, and a prior acquisition-related tax election.

Outlook, risks, contingencies, and unusual items

• Management said existing liquidity sources should fund operations and obligations for the next 12 months and foreseeable future, while noting this is not assured. It expected 2011 tax payments to rise by $5 million to $7.5 million following the subsequent convertible-note repurchase.
• On August 1, 2011, noteholders exercised a put and Itron repurchased $184.8 million principal of convertible notes plus accrued interest using cash and revolver borrowings. The filing does not specify the split between those funding sources. The notes had been classified as current at June 30 because of 2011 put, call, and conversion options.
• Warranty balances totaled $62.8 million, including $30.0 million current. First-half International warranty expense reflected an $8.6 million recovery related to Swedish claims and a $7.7 million charge for certain Brazilian products; estimates and future claims could affect margins.
• Disclosed litigation included securities and shareholder derivative suits related to the 2010 restatement, a patent suit involving Transdata for which Itron agreed to indemnify a customer, and a patent claim by EON. Itron said it considered the claims without merit; an unfavorable outcome in the patent matters could materially affect results in the period recognized. Recorded legal liabilities were not material.
• Key risks include customer demand and project timing, product acceptance and warranty claims, competition, supplier dependence, foreign exchange and interest rates, international operations, litigation, and compliance with anti-bribery laws. The filing added specific discussion of the U.S. Foreign Corrupt Practices Act and U.K. Bribery Act.
• The 2010 comparative results were restated after revenue on one contract was deferred due to a misinterpretation of an extended-warranty obligation. Management reported disclosure controls effective at June 30, 2011 and no material quarterly change in internal control over financial reporting.

Important facts for investors to verify

• How the $184.8 million note repurchase was funded, the resulting revolver balance, and remaining liquidity after the transaction.
• Whether the manufacturing-footprint review leads to additional restructuring charges and when those estimates are disclosed.
• Conversion of backlog into revenue, particularly given project timing, cancellation rights, and Q2 North America OpenWay volume declines.
• Progress and potential financial exposure from the restatement-related suits and patent claims, including the customer indemnity.
• Sustainability of warranty estimates and the Swedish recovery, alongside the Brazilian product charge and higher inventory.
• Tax cash payments and the resolution or expiration of uncertain tax positions; the filing said the timing of related future cash flows could not be reasonably estimated.