ITRI

ITRON, INC. - 10-Q Filing Summary

Business Context and Reporting Period

This Quarterly Report on Form 10-Q covers the period ended September 30, 2007. The reporting period is significantly impacted by 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. The acquisition expanded Itron's operations into Europe and other international markets, adding electricity, gas, and water meter manufacturing capabilities. The company now operates two primary segments: Itron North America and Actaris.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Revenues increased 164% for the quarter and 103% for the nine-month period compared to 2006, driven primarily by the inclusion of Actaris revenues ($280.8 million for the quarter; $530.5 million for the nine months).
• Profitability Decline: Despite revenue growth, the company reported a net loss of $20.1 million for the nine months ended September 30, 2007, compared to a net income of $26.5 million in the prior year. This was due to significant non-recurring costs associated with the acquisition.
• Margin Compression: Gross margin decreased from 42% in the prior year to 34% for the nine months ended September 30, 2007. This was partially due to a $16.0 million inventory step-up adjustment required by business combination accounting rules and Actaris's lower-margin product mix compared to Itron North America.
• Debt Increase: Total debt increased substantially to fund the Actaris acquisition, including a new $1.2 billion credit facility and the assumption of Actaris debt. Interest expense for the nine months increased to $63.3 million from $12.4 million in the prior year.
• Acquisition Costs: The company recorded $35.8 million in In-Process Research and Development (IPR&D) expenses related to the Actaris acquisition.

Guidance, Outlook, and Risks

• Convertible Notes: As of September 30, 2007, the company's stock price exceeded the conversion threshold for its $345 million convertible senior subordinated notes. Consequently, the notes are now convertible at the option of the holder, and the principal amount has been reclassified to current liabilities. The company expensed $6.6 million of remaining prepaid debt fees associated with these notes.
• Liquidity: Working capital turned negative to $(62.5) million due to the reclassification of convertible notes and cash used for the acquisition. However, management believes existing sources of liquidity, including a $63.6 million available revolver, are sufficient for the next year.
• Foreign Exchange: International revenues now represent 66% of total revenues (up from 8% in 2006), increasing exposure to foreign currency fluctuations. The company utilizes derivative instruments to hedge these risks.
• Backlog: Total backlog stood at $668 million at September 30, 2007, with a 12-month backlog of $494 million.
• Risks: Key risks include integration challenges with Actaris, foreign currency volatility, interest rate fluctuations on variable-rate debt, and the potential conversion of the senior subordinated notes.

Investor Verification Checklist

• Convertible Note Conversion: Verify the likelihood of conversion of the $345 million convertible notes and the company's ability to fund the cash settlement of the principal amount if converted.
• Actaris Integration: Assess the progress of integrating Actaris operations and the realization of anticipated synergies to offset the lower gross margins.
• Debt Covenants: Confirm continued compliance with the financial covenants of the new $1.2 billion credit facility, particularly leverage ratios.
• Inventory Valuation: Review the impact of the $16.0 million inventory step-up adjustment on future gross margins as the acquired inventory is sold.
• Foreign Exchange Exposure: Monitor the effectiveness of hedging strategies given the significant shift to international revenue generation.