ITRI

ITRON, INC. 10-Q Summary: Period Ended June 30, 2007

Business Context and Reporting Period

This Quarterly Report on Form 10-Q covers the three and six months ended June 30, 2007. The reporting period is defined by the completion of the acquisition of Actaris Metering Systems SA (Actaris) on April 18, 2007, for approximately $1.1 billion plus the assumption of $626.9 million in debt. This transaction fundamentally altered the company's geographic footprint, expanding operations primarily outside North America, and restructured operating segments into "Itron North America" and "Actaris."

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Revenues increased 145% for the quarter and 72% for the six-month period compared to 2006, driven almost entirely by the inclusion of Actaris revenues ($249.7 million for the quarter). Excluding Actaris, Itron North America revenues declined 7% and 6% respectively.
• Profitability Decline: The company reported a net loss for both periods, contrasting with net income in the prior year. This was primarily due to a $35.6 million charge for in-process research and development (IPR&D) related to the Actaris acquisition and increased amortization of intangible assets.
• Margin Compression: Consolidated gross margin decreased from 42% to 31% (quarterly) and 43% to 34% (six-month). This was caused by the lower margin profile of Actaris products and a $16.0 million step-up in inventory value required by acquisition accounting rules.
• Balance Sheet Expansion: Total assets increased from $988.5 million to $2.99 billion. Goodwill increased by $1.13 billion, and long-term debt increased by approximately $1.14 billion to finance the acquisition.

Guidance, Outlook, and Risks

• Outlook: Management expects operating expenses for Actaris to eventually be lower as a percentage of revenue compared to Itron North America due to a more meter-centric product mix, though this will be offset by higher amortization expenses. The company anticipates continued expansion through internal development and acquisitions.
• Market Risks:
  • Foreign Currency: Post-acquisition, 63% of revenues are now international. A 10% fluctuation in the U.S. dollar could impact operating results by approximately $5 million.
  • Interest Rates: The company holds significant variable-rate debt ($1.2 billion credit facility). A 1% increase in interest rates could reduce earnings before taxes by approximately $5.3 million in the second half of 2007.
• Contingencies: The company adopted FIN 48 (Accounting for Uncertainty in Income Taxes) on January 1, 2007. Unrecognized tax benefits increased to $35.9 million, largely due to the Actaris acquisition. Legal contingencies are currently not considered material.

Investor Verification Checklist

• Acquisition Integration: Verify the timeline for realizing synergies and the actual cost to complete the $16 million in IPR&D projects identified during the Actaris acquisition.
• Debt Covenants: Confirm continued compliance with the new $1.2 billion credit facility covenants, specifically regarding leverage ratios and excess cash flow provisions.
• Margin Recovery: Monitor gross margin trends to determine if the step-up in inventory costs and lower Actaris margins are temporary or indicative of a new long-term baseline.
• Currency Hedging: Assess future strategies for managing the increased exposure to the Euro and Pound Sterling, given the shift to 63% international revenue.
• Tax Liability: Review the impact of the $29.3 million in unrecognized tax benefits acquired from Actaris on future effective tax rates.