10-Q 1 itri10q93012.htm 10-Q ITRI 10Q 9.30.12
 
 
 
 
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
 
 
FORM 10-Q
 
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2012

OR
 
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from             to             
Commission file number 000-22418
ITRON, INC.
(Exact name of registrant as specified in its charter)
 
Washington
 
91-1011792
(State of Incorporation)
 
(I.R.S. Employer Identification Number)
2111 N Molter Road, Liberty Lake, Washington 99019
(509) 924-9900
(Address and telephone number of registrant’s principal executive offices)
 
 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
 
 
Large accelerated filer
x
Accelerated filer
¨
 
 
Non-accelerated filer
o  (Do not check if a smaller reporting company)
Smaller reporting company
¨
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x
As of October 31, 2012 there were outstanding 39,206,165 shares of the registrant’s common stock, no par value, which is the only class of common stock of the registrant.
 



Itron, Inc.
Table of Contents
 



PART I: FINANCIAL INFORMATION
Item 1: Financial Statements (Unaudited)
ITRON, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2012
 
2011
 
2012
 
2011
 
(in thousands, except per share data)
Revenues
$
504,063

 
$
615,555

 
$
1,654,843

 
$
1,791,647

Cost of revenues
332,266

 
438,559

 
1,103,196

 
1,237,722

Gross profit
171,797

 
176,996

 
551,647

 
553,925

 
 
 
 
 
 
 
 
Operating expenses
 
 
 
 
 
 
 
Sales and marketing
44,913

 
44,870

 
145,616

 
138,019

Product development
43,299

 
38,377

 
134,295

 
119,147

General and administrative
30,743

 
33,492

 
100,763

 
104,627

Amortization of intangible assets
11,929

 
16,013

 
35,867

 
47,807

Restructuring expense
(5,054
)
 
1,096

 
3,455

 
3,003

Goodwill impairment

 
540,400

 

 
540,400

Total operating expenses
125,830

 
674,248

 
419,996

 
953,003

 
 
 
 
 
 
 
 
Operating income (loss)
45,967

 
(497,252
)
 
131,651

 
(399,078
)
Other income (expense)
 
 
 
 
 
 
 
Interest income
297

 
155

 
667

 
631

Interest expense
(2,551
)
 
(10,796
)
 
(7,594
)
 
(34,330
)
Other income (expense), net
(1,269
)
 
(1,402
)
 
(4,224
)
 
(4,342
)
Total other income (expense)
(3,523
)
 
(12,043
)
 
(11,151
)
 
(38,041
)
 
 
 
 
 
 
 
 
Income (loss) before income taxes
42,444

 
(509,295
)
 
120,500

 
(437,119
)
Income tax provision
(6,547
)
 
(6,042
)
 
(26,740
)
 
(15,529
)
Net income (loss)
35,897

 
(515,337
)
 
93,760

 
(452,648
)
Net income attributable to noncontrolling interests
550

 
1,745

 
1,445

 
2,878

Net income (loss) attributable to Itron, Inc.
$
35,347

 
$
(517,082
)
 
$
92,315

 
$
(455,526
)
 
 
 
 
 
 
 
 
Earnings per common share - Basic
$
0.90

 
$
(12.70
)
 
$
2.32

 
$
(11.21
)
Earnings per common share - Diluted
$
0.89

 
$
(12.70
)
 
$
2.31

 
$
(11.21
)
 
 
 
 
 
 
 
 
Weighted average common shares outstanding - Basic
39,472

 
40,725

 
39,756

 
40,648

Weighted average common shares outstanding - Diluted
39,791

 
40,725

 
40,042

 
40,648

The accompanying notes are an integral part of these condensed consolidated financial statements.


1


ITRON, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(UNAUDITED)

 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2012
 
2011
 
2012
 
2011
 
(in thousands)
Net income (loss)
$
35,897

 
$
(515,337
)
 
$
93,760

 
$
(452,648
)
Other comprehensive income (loss), net of tax:
 
 
 
 
 
 
 
Foreign currency translation adjustments
24,596

 
(80,625
)
 
806

 
43,432

Unrealized gains (losses) on hedging instruments:
 
 
 
 
 
 
 
Net unrealized gain (loss) on derivative instruments, designated as cash flow hedges
(828
)
 
2,086

 
(1,677
)
 
1,922

Net unrealized gain (loss) on nonderivative hedging instruments

 
408

 

 
(8,854
)
Net hedging loss (gain) reclassified into net income

 
(176
)
 

 
2,598

Pension plan benefit liability adjustment
(5
)
 
22

 
40

 
(506
)
Total other comprehensive income (loss), net of tax
23,763

 
(78,285
)
 
(831
)
 
38,592

Total comprehensive income (loss), net of tax
59,660

 
(593,622
)
 
92,929

 
(414,056
)
Comprehensive income (loss) attributable to noncontrolling interest, net of tax:
 
 
 
 
 
 
 
Net income attributable to noncontrolling interest
550

 
1,745

 
1,445

 
2,878

Foreign currency translation adjustments
69

 
(442
)
 
109

 
71

Amounts attributable to noncontrolling interest
619

 
1,303

 
1,554

 
2,949

Comprehensive income (loss) attributable to Itron, Inc.
$
59,041

 
$
(594,925
)
 
$
91,375

 
$
(417,005
)
The accompanying notes are an integral part of these consolidated financial statements.

2




ITRON, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands)
 
September 30, 2012
 
December 31, 2011
 
(unaudited)
 
 
ASSETS
 
 
 
Current assets
 
 
 
Cash and cash equivalents
$
91,474

 
$
133,086

Accounts receivable, net
363,111

 
371,641

Inventories
201,775

 
195,837

Deferred tax assets current, net
58,866

 
58,172

Other current assets
102,195

 
81,618

Total current assets
817,421

 
840,354

 
 
 
 
Property, plant, and equipment, net
251,703

 
262,670

Deferred tax assets noncurrent, net
13,268

 
22,144

Other long-term assets
29,875

 
62,704

Intangible assets, net
247,636

 
239,500

Goodwill
687,432

 
636,910

Total assets
$
2,047,335

 
$
2,064,282

 
 
 
 
LIABILITIES AND EQUITY
 
 
 
Current liabilities
 
 
 
Accounts payable
$
219,945

 
$
246,775

Other current liabilities
62,250

 
53,734

Wages and benefits payable
82,405

 
93,730

Taxes payable
8,754

 
11,526

Current portion of debt
16,875

 
15,000

Current portion of warranty
32,834

 
52,588

Unearned revenue
41,255

 
37,369

Total current liabilities
464,318

 
510,722

 
 
 
 
Long-term debt
404,375

 
437,502

Long-term warranty
22,853

 
26,948

Pension plan benefit liability
63,041

 
62,449

Deferred tax liabilities noncurrent, net
21,307

 
31,699

Other long-term obligations
81,199

 
73,417

Total liabilities
1,057,093

 
1,142,737

 
 
 
 
Commitments and contingencies

 

 
 
 
 
Equity
 
 
 
Preferred stock

 

Common stock
1,294,990

 
1,319,222

Accumulated other comprehensive loss, net
(38,100
)
 
(37,160
)
Accumulated deficit
(282,822
)
 
(375,137
)
Total Itron, Inc. shareholders' equity
974,068

 
906,925

Noncontrolling interests
16,174

 
14,620

Total equity
990,242

 
921,545

Total liabilities and equity
$
2,047,335

 
$
2,064,282

The accompanying notes are an integral part of these condensed consolidated financial statements.

3


ITRON, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
 
 
Nine Months Ended
September 30,
 
2012
 
2011
 
(in thousands)
Operating activities
 
 
 
Net income (loss)
$
93,760

 
$
(452,648
)
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
 
 
 
Depreciation and amortization
81,856

 
96,919

Stock-based compensation
14,319

 
12,401

Amortization of prepaid debt fees
1,176

 
5,365

Amortization of convertible debt discount

 
5,336

Deferred taxes, net
1,505

 
(1,410
)
Goodwill impairment

 
540,400

Restructuring expense, non-cash
(4,841
)
 

Other adjustments, net
(119
)
 
(917
)
Changes in operating assets and liabilities, net of acquisition:
 
 
 
Accounts receivable
46,493

 
(21,940
)
Inventories
(4,619
)
 
(32,750
)
Other current assets
(21,525
)
 
(8,672
)
Other long-term assets
1,624

 
(17,499
)
Accounts payables, other current liabilities, and taxes payable
(39,368
)
 
12,347

Wages and benefits payable
(16,869
)
 
(28,018
)
Unearned revenue
9,201

 
22,862

Warranty
(23,610
)
 
28,028

Other operating, net
(1,980
)
 
(6,003
)
Net cash provided by operating activities
137,003

 
153,801

 
 
 
 
Investing activities
 
 
 
Acquisitions of property, plant, and equipment
(34,278
)
 
(45,799
)
Business acquisitions, net of cash and cash equivalents acquired
(79,874
)
 
(14,635
)
Other investing, net
4,005

 
634

Net cash used in investing activities
(110,147
)
 
(59,800
)
 
 
 
 
Financing activities
 
 
 
Proceeds from borrowings
70,000


670,000

Payments on debt
(101,252
)
 
(804,304
)
Issuance of common stock
3,778

 
3,512

Repurchase of common stock
(40,700
)
 

Other financing, net
(342
)
 
(5,319
)
Net cash used in financing activities
(68,516
)
 
(136,111
)
 
 
 
 
Effect of foreign exchange rate changes on cash and cash equivalents
48

 
2,147

Decrease in cash and cash equivalents
(41,612
)
 
(39,963
)
Cash and cash equivalents at beginning of period
133,086

 
169,477

Cash and cash equivalents at end of period
$
91,474

 
$
129,514

 
 
 
 
Non-cash transactions:
 
 
 
Property, plant, and equipment purchased but not yet paid, net
$
(1,533
)
 
$
(3,130
)
Fair value of contingent and deferred consideration payable for business acquisition

 
5,108

 
 
 
 
Supplemental disclosure of cash flow information:
 
 
 
Cash paid during the period for:
 
 
 
Income taxes, net
$
33,368

 
$
12,904

Interest, net of amounts capitalized
6,386

 
25,964

The accompanying notes are an integral part of these condensed consolidated financial statements.

4


ITRON, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2012
(UNAUDITED)
In this Quarterly Report on Form 10-Q, the terms “we,” “us,” “our,” “Itron,” and the “Company” refer to Itron, Inc.

Note 1:    Summary of Significant Accounting Policies

We were incorporated in the state of Washington in 1977. We provide a portfolio of products and services to utilities for the energy and water markets throughout the world.

Financial Statement Preparation
The condensed consolidated financial statements presented in this Quarterly Report on Form 10-Q are unaudited and reflect entries necessary for the fair presentation of the Consolidated Statements of Operations and the Consolidated Statements of Comprehensive Income (Loss) for the three and nine months ended September 30, 2012 and 2011, the Consolidated Balance Sheets as of September 30, 2012 and December 31, 2011, and the Consolidated Statements of Cash Flows for the nine months ended September 30, 2012 and 2011 of Itron, Inc. and its subsidiaries. All entries required for the fair presentation of the financial statements are of a normal recurring nature, except as disclosed.

Certain information and notes normally included in financial statements prepared in accordance with U.S. generally accepted accounting principles (GAAP) have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission (SEC) regarding interim results. These condensed consolidated financial statements should be read in conjunction with the 2011 audited financial statements and notes included in our Current Report on Form 8-K filed with the SEC on May 24, 2012. The results of operations for the three and nine months ended September 30, 2012 are not necessarily indicative of the results expected for the full fiscal year or for any other fiscal period.

Basis of Consolidation
We consolidate all entities in which we have a greater than 50% ownership interest or in which we exercise control over the operations. We use the equity method of accounting for entities in which we have a 50% or less investment and exercise significant influence. Entities in which we have less than a 20% investment and where we do not exercise significant influence are accounted for under the cost method. Intercompany transactions and balances have been eliminated upon consolidation.

Noncontrolling Interests
In several of our consolidated international subsidiaries, we have joint venture partners, who are minority shareholders. Although these entities are not wholly-owned by Itron, we consolidate them because we have a greater than 50% ownership interest or because we exercise control over the operations. The noncontrolling interest balance is adjusted each period to reflect the allocation of net income (loss) and other comprehensive income (loss) attributable to the noncontrolling interests, as shown in our Consolidated Statements of Operations and our Consolidated Statements of Comprehensive Income (Loss). The noncontrolling interest balance in our Consolidated Balance Sheets represents the proportional share of the equity of the joint venture entities, which is attributable to the minority shareholders.

Reclassifications
Certain 2011 amounts have been reclassified to conform to the current classifications in the Consolidated Statements of Operations. These reclassifications relate to certain administrative expenses in the former Itron North America segment that were in prior periods allocated to cost of revenues and sales and marketing and product development operating expenses but have been reclassified to general and administrative operating expenses to conform to our worldwide presentation across our new segment structure. These reclassifications did not have a material impact to gross profit and had no impact on income before income taxes, net income attributable to Itron, Inc., earnings per share, or total equity.

Business Acquisitions
On May 1, 2012, we completed the acquisition of SmartSynch, Inc. (SmartSynch). The acquisition was financed through borrowings on our multicurrency revolving line of credit and cash on hand. SmartSynch was a provider of smart grid solutions that utilize cellular networks for communications. We have included supplemental pro forma financial information related to the acquisition in Note 16 Business Combinations.

In January 2011, we completed the acquisition of Asais S.A.S. and Asais Conseil S.A.S. (collectively Asais), an energy information management software and consulting services provider, located in France. The acquisition consisted of cash and contingent consideration. Additional acquisitions were completed in 2011, which were immaterial to our financial position, results of

5


operations, and cash flows. (See Business Combinations policy below.)

Cash and Cash Equivalents
We consider all highly liquid instruments with remaining maturities of three months or less at the date of acquisition to be cash equivalents. The cash and cash equivalents balance in our Consolidated Balance Sheets includes amounts that reside in our joint venture entities. As a result, the minority shareholders of these entities control their proportional share of the cash and cash equivalents balance, and there may be limitations on Itron's ability to repatriate cash to the U.S. from these entities.

Accounts Receivable and Allowance for Doubtful Accounts
Accounts receivable are recorded for invoices issued to customers in accordance with our contractual arrangements. Interest and late payment fees are minimal. Unbilled receivables are recorded when revenues are recognized upon product shipment or service delivery and invoicing occurs at a later date. We record an allowance for doubtful accounts representing our estimate of the probable losses in accounts receivable at the date of the balance sheet based on our historical experience of bad debts and our specific review of outstanding receivables. Accounts receivable are written-off against the allowance when we believe an account, or a portion thereof, is no longer collectible.

Inventories
Inventories are stated at the lower of cost or market using the first-in, first-out method. Cost includes raw materials and labor, plus applied direct and indirect costs.

Derivative Instruments
All derivative instruments, whether designated in hedging relationships or not, are recorded on the Consolidated Balance Sheets at fair value as either assets or liabilities. The components and fair values of our derivative instruments are determined using the fair value measurements of significant other observable inputs (Level 2), as defined by GAAP. The net fair value of our derivative instruments may switch between a net asset and a net liability depending on market circumstances at the end of the period. We include the effect of our counterparty credit risk based on current published credit default swap rates when the net fair value of our derivative instruments are in a net asset position and the effect of our own nonperformance risk when the net fair value of our derivative instruments are in a net liability position.

For any derivative designated as a fair value hedge, the changes in the fair value of the derivative and of the hedged item attributable to the hedged risk are recognized in earnings. For any derivative designated as a cash flow hedge, the effective portions of changes in the fair value of the derivative are recorded as a component of other comprehensive income (loss) (OCI) and are recognized in earnings when the hedged item affects earnings. For a hedge of a net investment, the effective portion of any unrealized gain or loss from the foreign currency revaluation of the hedging instrument is reported in OCI as a net unrealized gain or loss on derivative instruments. Upon termination of a net investment hedge, the net derivative gain/loss will remain in accumulated OCI until such time when earnings are impacted by a sale or liquidation of the associated operations. Ineffective portions of fair value changes or the changes in fair value of derivative instruments that do not qualify for hedging activities are recognized in other income (expense) in the Consolidated Statements of Operations. We classify cash flows from our derivative programs as cash flows from operating activities in the Consolidated Statements of Cash Flows.

Derivatives are not used for trading or speculative purposes. Our derivatives are with credit worthy multinational commercial banks, with whom we have master netting agreements; however, our derivative positions are not disclosed on a net basis. There are no credit-risk-related contingent features within our derivative instruments. Refer to Note 7 and Note 13 for further disclosures of our derivative instruments and their impact on OCI.

Property, Plant, and Equipment
Property, plant, and equipment are stated at cost less accumulated depreciation. Depreciation is computed using the straight-line method over the estimated useful lives of the assets, generally 30 years for buildings and improvements and three to ten years for machinery and equipment, computers and purchased software, and furniture. Leasehold improvements are capitalized and amortized over the term of the applicable lease, including renewable periods if reasonably assured, or over the useful lives, whichever is shorter. Construction in process represents capital expenditures incurred for assets not yet placed in service. Costs related to internally developed software and software purchased for internal uses are capitalized and are amortized over the estimated useful lives of the assets. Repair and maintenance costs are expensed as incurred. We have no major planned maintenance activities.

We review long-lived assets for impairment whenever events or circumstances indicate the carrying amount of an asset or asset group may not be recoverable. Assets held for sale are classified within other current assets in the Consolidated Balance Sheets, are reported at the lower of the carrying amount or fair value less costs to sell, and are no longer depreciated. Gains and losses from asset disposals and impairment losses are classified within the Consolidated Statement of Operations according to the use

6


of the asset, except those gains and losses recognized in conjunction with our restructuring activities, which are classified as restructuring expense.

Prepaid Debt Fees
Prepaid debt fees represent the capitalized direct costs incurred related to the issuance of debt and are recorded as noncurrent assets. These costs are amortized to interest expense over the lives of the respective borrowings, including contingent maturity or call features, using the effective interest method, or straight-line method when associated with a revolving credit facility. When debt is repaid early, the related portion of unamortized prepaid debt fees is written off and included in interest expense.

Business Combinations
On the date of acquisition, the assets acquired, liabilities assumed, and any noncontrolling interests in the acquiree are recorded at their fair values. The acquiree's results of operations are also included as of the date of acquisition in our consolidated results. Intangible assets that arise from contractual/legal rights, or are capable of being separated, as well as in-process research and development (IPR&D), are measured and recorded at fair value, and amortized over the estimated useful life. IPR&D is not amortized until such time as the associated development projects are completed or terminated. If a development project is completed, the IPR&D is reclassified as a core technology intangible asset and amortized over its estimated useful life. If the development project is terminated, the recorded value of the associated IPR&D is immediately expensed. If practicable, assets acquired and liabilities assumed arising from contingencies are measured and recorded at fair value. If not practicable, such assets and liabilities are measured and recorded when it is probable that a gain or loss has occurred and the amount can be reasonably estimated. The residual balance of the purchase price, after fair value allocations to all identified assets and liabilities, represents goodwill. Acquisition-related costs are expensed as incurred. Restructuring costs associated with an acquisition are generally expensed in periods subsequent to the acquisition date, and changes in deferred tax asset valuation allowances and acquired income tax uncertainties, including penalties and interest, after the measurement period are recognized as a component of the provision for income taxes. Our acquisitions may include contingent consideration, which require us to recognize the fair value of the estimated liability at the time of the acquisition. Subsequent changes in the estimate of the amount to be paid under the contingent consideration arrangement are recognized in the consolidated statements of operations. Cash payments for contingent or deferred consideration are classified within cash flows from investing activities within the consolidated statements of cash flows.

Goodwill and Intangible Assets
Goodwill and intangible assets may result from our acquisitions. We use estimates, including estimates of useful lives of intangible assets, the amount and timing of related future cash flows, and fair values of the related operations, in determining the value assigned to goodwill and intangible assets. Our intangible assets have finite lives and are amortized over their estimated useful lives based on estimated discounted cash flows. Intangible assets are tested for impairment at the asset group level when events or changes in circumstances indicate the carrying value may not be recoverable.

Goodwill is assigned to our reporting units based on the expected benefit from the synergies arising from each business combination, determined by using certain financial metrics, including the forecasted discounted cash flows associated with each reporting unit. Prior to 2012, we had four reporting units: Itron North America (INA), Itron International (INL) Electricity, INL Gas, and INL Water. Effective January 1, 2012, our three new reporting units are Electricity, Gas, and Water. Our new Energy operating segment consists of the Electricity and Gas reporting units, while our new Water operating segment consists of the Water reporting unit. In the first quarter of 2012, we reallocated the goodwill from our former INA reporting unit to the three new reporting units based on the relative fair values of the electricity, gas, and water product lines within INA on January 1, 2012. We also reassigned the goodwill from our former INL Electricity, INL Gas, and INL Water reporting units to the new reporting units, Electricity, Gas, and Water, respectively.

We test goodwill for impairment each year as of October 1, or more frequently should a significant impairment indicator occur. The impairment test involves comparing the fair value of the reporting units to their carrying amounts. If the carrying amount of a reporting unit exceeds its fair value, a second step is required to measure for a goodwill impairment loss. This second step revalues all assets and liabilities of the reporting unit to their current fair values and then compares the implied fair value of the reporting unit's goodwill to the carrying amount of that goodwill. If the carrying amount of the reporting unit's goodwill exceeds the implied fair value of the goodwill, an impairment loss is recognized in an amount equal to the excess.

Determining the fair value of a reporting unit is judgmental in nature and involves the use of significant estimates and assumptions. We forecast discounted future cash flows at the reporting unit level using risk-adjusted discount rates and estimated future revenues and operating costs, which take into consideration factors such as existing backlog, expected future orders, supplier contracts, and expectations of competitive and economic environments. We also identify similar publicly traded companies and develop a correlation, referred to as a multiple, to apply to the operating results of the reporting units. These combined fair values are then reconciled to the aggregate market value of our common stock on the date of valuation, while considering a reasonable control premium.

7



Contingencies
A loss contingency is recorded if it is probable that an asset has been impaired or a liability has been incurred and the amount of the loss can be reasonably estimated. We evaluate, among other factors, the degree of probability of an unfavorable outcome and our ability to make a reasonable estimate of the amount of the ultimate loss. Loss contingencies that we determine to be reasonably possible, but not probable, are disclosed but not recorded. Changes in these factors and related estimates could materially affect our financial position and results of operations. Legal costs to defend against contingent liabilities are expensed as incurred.

Bonus and Profit Sharing
We have various employee bonus and profit sharing plans, which provide award amounts for the achievement of annual financial and nonfinancial targets. If management determines it is probable that the targets will be achieved, and the amounts can be reasonably estimated, a compensation accrual is recorded based on the proportional achievement of the financial and nonfinancial targets. Although we monitor and accrue expenses quarterly based on our progress toward the achievement of the annual targets, the actual results at the end of the year may require awards that are significantly greater or less than the estimates made in earlier quarters.

Warranty
We offer standard warranties on our hardware products and large application software products. We accrue the estimated cost of new product warranties based on historical and projected product performance trends and costs during the warranty period. Testing of new products in the development stage helps identify and correct potential warranty issues prior to manufacturing. Continuing quality control efforts during manufacturing reduce our exposure to warranty claims. When our quality control efforts fail to detect a fault in one of our products, we experience an increase in warranty claims. We track warranty claims to identify potential warranty trends. If an unusual trend is noted, an additional warranty accrual may be assessed and recorded when a failure event is probable and the cost can be reasonably estimated. When new products are introduced, our process relies on historical averages of similar products until sufficient data is available. As actual experience becomes available, it is used to modify the original estimate to ensure the expected warranty costs are within a range of likely outcomes. Management continually evaluates the sufficiency of the warranty provisions and makes adjustments when necessary. The warranty allowances may fluctuate due to higher than anticipated material, labor, and other costs we may incur to repair or replace projected product failures, and we may incur additional warranty and related expenses in the future with respect to new or established products, which could adversely affect our financial position and results of operations. The long-term warranty balance includes estimated warranty claims beyond one year. Warranty expense is classified within cost of revenues.

Restructuring and Asset Impairments
We record a liability for costs associated with an exit or disposal activity at its fair value in the period in which the liability is incurred. Employee termination benefits considered postemployement benefits are accrued when the obligation is probable and estimable, such as benefits stipulated by human resource policies and practices or statutory requirements. One-time termination benefits are expensed at the date the employee is notified. If the employee must provide future service greater than 60 days, such benefits are expensed ratably over the future service period. For contract termination costs, we record a liability upon the later of when we terminate a contract in accordance with the contract terms or when we cease using the rights conveyed by the contract.

Asset impairments, net, are determined at the asset group level. An impairment may be recorded for assets that are to be abandoned, are to be sold for less than net book value, or are held for sale in which the estimated proceeds are less than the net book value less costs to sell. We may also recognize impairment on an asset group, which is held and used, when the carrying value is not recoverable and exceeds the asset group's fair value. If an asset group is considered a business, the asset group may consist of property, plant, equipment, intangible assets, and goodwill.

Defined Benefit Pension Plans
We sponsor both funded and unfunded defined benefit pension plans for certain international employees. We recognize a liability for the projected benefit obligation in excess of plan assets or an asset for plan assets in excess of the projected benefit obligation. We also recognize the funded status of our defined benefit pension plans on our Consolidated Balance Sheets and recognize as a component of OCI, net of tax, the actuarial gains or losses and prior service costs or credits, if any, that arise during the period but that are not recognized as components of net periodic benefit cost.

Share Repurchase Plan
We may repurchase shares of Itron common stock under a twelve-month program, which was authorized by our Board of Directors on October 24, 2011. Share repurchases are made in the open market or in privately negotiated transactions and in accordance with applicable securities laws. Under applicable Washington State law, shares repurchased are retired and not displayed separately as treasury stock on the financial statements. Instead, the value of the repurchased shares is deducted from common stock. On September 13, 2012, the Board approved the extension of the expiration date of the stock repurchase program until February 15,

8


2013, or until the aggregate limit of $100 million of outstanding common stock has been repurchased, whichever occurs first.

Revenue Recognition
Revenues consist primarily of hardware sales, software license fees, software implementation, project management services, installation, consulting, and post-sale maintenance support. Revenues are recognized when (1) persuasive evidence of an arrangement exists, (2) delivery has occurred or services have been rendered, (3) the sales price is fixed or determinable, and (4) collectability is reasonably assured.

The majority of our revenue arrangements involve multiple deliverables, which combine two or more of the following: hardware, meter reading system software, installation, and/or project management services. Revenue arrangements with multiple deliverables are divided into separate units of accounting if the delivered item(s) has value to the customer on a standalone basis and delivery/performance of the undelivered item(s) is probable. The total arrangement consideration is allocated among the separate units of accounting based on their relative fair values and the applicable revenue recognition criteria considered for each unit of accounting. The amount allocable to a delivered item is limited to the amount that we are entitled to collect and that is not contingent upon the delivery/performance of additional items. Revenues for each deliverable are then recognized based on the type of deliverable, such as 1) when the products are shipped, 2) services are delivered, 3) percentage-of-completion when implementation services are essential to other deliverables in the arrangement, 4) upon receipt of customer acceptance, or 5) transfer of title and risk of loss. The majority of our revenue is recognized when products are shipped to or received by a customer or when services are provided.

We primarily enter into two types of multiple deliverable arrangements, which include a combination of hardware and associated software and services:

Arrangements that do not include the deployment of our smart metering systems and technology are recognized as follows:

Hardware revenues are recognized at the time of shipment, receipt by customer, or, if applicable, upon completion of customer acceptance provisions.
If implementation services are essential to the functionality of the associated software, software and implementation revenues are recognized using either the percentage-of-completion methodology of contract accounting if project costs can be reliably estimated or the completed contract methodology if project costs cannot be reliably estimated.

Arrangements to deploy our smart metering systems and technology are recognized as follows:

Hardware revenues are recognized at the time of shipment, receipt by customer, or, if applicable, upon completion of customer acceptance provisions.
Revenue from associated software and services is recognized using the units-of-delivery method of contract accounting, as the software is essential to the functionality of the related hardware and the implementation services are essential to the functionality of the associated software. This methodology results in the deferral of costs and revenues as professional services and software implementation commence prior to deployment of hardware.

We also enter into multiple deliverable software arrangements that do not include hardware. For this type of arrangement, revenue recognition is dependent upon the availability of vendor specific objective evidence (VSOE) of fair value for each of the deliverables. The lack of VSOE, or the existence of extended payment terms or other inherent risks, may affect the timing of revenue recognition for multiple deliverable software arrangements.

Certain of our revenue arrangements include an extended or noncustomary warranty provision which covers all or a portion of a customer’s replacement or repair costs beyond the standard or customary warranty period. Whether or not the extended warranty is separately priced in the arrangement, a portion of the arrangement’s total consideration is allocated to this extended warranty deliverable. This revenue is deferred and recognized over the extended warranty coverage period. Extended or noncustomary warranties do not represent a significant portion of our revenue.

We allocate consideration to each deliverable in an arrangement based on its relative selling price. We determine selling price using VSOE, if it exists, otherwise we use third-party evidence (TPE). If neither VSOE nor TPE of selling price exists for a unit of accounting, we use estimated selling price (ESP).

VSOE is generally limited to the price charged when the same or similar product is sold separately or, if applicable, the stated renewal rate in the agreement. If a product or service is seldom sold separately, it is unlikely that we can determine VSOE for the product or service. We define VSOE as a median price of recent standalone transactions that are priced within a narrow range. TPE is determined based on the prices charged by our competitors for a similar deliverable when sold separately.

9



If we are unable to establish selling price using VSOE or TPE, we use ESP in the allocation of arrangement consideration. The objective of ESP is to determine the price at which we would transact if the product or service were regularly sold by us on a standalone basis. Our determination of ESP involves a weighting of several factors based on the specific facts and circumstances of the arrangement. Specifically, we consider the cost to produce the deliverable, the anticipated margin on that deliverable, the selling price and profit margin for similar parts, our ongoing pricing strategy and policies (as evident in the price list established and updated by management on a regular basis), the value of any enhancements that have been built into the deliverable, and the characteristics of the varying markets in which the deliverable is sold. We analyze the selling prices used in our allocation of arrangement consideration on an annual basis. Selling prices are analyzed on a more frequent basis if a significant change in our business necessitates a more timely analysis or if we experience significant variances in our selling prices.

Unearned revenue is recorded when a customer pays for products or services, but the criteria for revenue recognition have not been met as of the balance sheet date. Unearned revenues of $71.9 million and $61.0 million at September 30, 2012 and December 31, 2011 related primarily to professional services and software associated with our smart metering contracts, extended or noncustomary warranty, and prepaid post-contract support. Deferred costs are recorded for products or services for which ownership (typically defined as title and risk of loss) has transferred to the customer, but the criteria for revenue recognition have not been met as of the balance sheet date. Deferred costs were $15.4 million and $11.7 million at September 30, 2012 and December 31, 2011 and are recorded within other assets in the Consolidated Balance Sheets.

Hardware and software post-sale maintenance support fees are recognized ratably over the life of the related service contract. Shipping and handling costs and incidental expenses billed to customers are recorded as revenue, with the associated cost charged to cost of revenues. We record sales, use, and value added taxes billed to our customers on a net basis.

Product and Software Development Costs
Product and software development costs primarily include employee compensation and third party contracting fees. We do not capitalize product development costs, and we do not generally capitalize software development expenses due to the immaterial nature of these costs as a result of the relatively short period of time between technological feasibility and the completion of software development.

Stock-Based Compensation
We measure and recognize compensation expense for all stock-based awards made to employees and directors, including stock options, stock sold pursuant to our Employee Stock Purchase Plan (ESPP), and the issuance of restricted stock units and unrestricted stock awards, based on estimated fair values. The fair value of stock options is estimated at the date of grant using the Black-Scholes option-pricing model, which includes assumptions for the dividend yield, expected volatility, risk-free interest rate, and expected life. For ESPP awards, the fair value is the difference between the market close price of our common stock on the date of purchase and the discounted purchase price. For restricted stock units and unrestricted stock awards, the fair value is the market close price of our common stock on the date of grant. We expense stock-based compensation at the date of grant for unrestricted stock awards. For awards with only a service condition, we expense stock-based compensation, adjusted for estimated forfeitures, using the straight-line method over the requisite service period for the entire award. For awards with both performance and service conditions, if probable we expense the stock-based compensation, adjusted for estimated forfeitures, on a straight-line basis over the requisite service period for each separately vesting portion of the award. Excess tax benefits are credited to common stock when the deduction reduces cash taxes payable. When we have tax deductions in excess of the compensation cost, they are classified as financing cash inflows in the Consolidated Statements of Cash Flows.

Income Taxes
We compute our interim income tax provision through the use of an estimated annual effective tax rate (ETR) applied to year-to-date operating results and specific events that are discretely recognized as they occur. In determining the estimated annual ETR, we analyze various factors, including projections of our annual earnings, taxing jurisdictions in which the earnings will be generated, the impact of state and local income taxes, our ability to use tax credits and net operating loss carryforwards, and available tax planning alternatives. Discrete items, including the effect of changes in tax laws, tax rates, and certain circumstances with respect to valuation allowances or other unusual or non-recurring tax adjustments, are reflected in the period in which they occur as an addition to, or reduction from, the income tax provision, rather than included in the estimated annual ETR.

Deferred tax assets and liabilities are recognized based upon anticipated future tax consequences, in each of the jurisdictions in which we operate, attributable to: (1) the differences between the financial statement carrying amounts of existing assets and liabilities and their respective income tax bases; and (2) operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The calculation of our tax liabilities involves applying complex tax regulations in different jurisdictions to our tax positions. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the period

10


that includes the enactment date. A valuation allowance is recorded to reduce the carrying amount of deferred tax assets if it is not more likely than not that such assets will be realized. We do not record tax liabilities on undistributed earnings of international subsidiaries that are permanently reinvested.

We utilize a two step approach to account for uncertain tax positions. A tax position is first evaluated for recognition based on its technical merits. Tax positions that have a greater than fifty percent likelihood of being realized upon ultimate settlement are then measured to determine amounts to be recognized in the financial statements. This measurement incorporates information about potential settlements with taxing authorities. A previously recognized tax position is derecognized in the first period in which the position no longer meets the more-likely-than-not recognition threshold or upon expiration of the statute of limitations. We classify interest expense and penalties related to uncertain tax positions and interest income on tax overpayments as part of income tax expense.

Foreign Exchange
Our consolidated financial statements are reported in U.S. dollars. Assets and liabilities of international subsidiaries with non-U.S. dollar functional currencies are translated to U.S. dollars at the exchange rates in effect on the balance sheet date, or the last business day of the period, if applicable. Revenues and expenses for each subsidiary are translated to U.S. dollars using a weighted average rate for the relevant reporting period. Translation adjustments resulting from this process are included, net of tax, in OCI. Gains and losses that arise from exchange rate fluctuations for monetary asset and liability balances that are not denominated in an entity’s functional currency are included within other income (expense), net in the Consolidated Statements of Operations. Currency gains and losses of intercompany balances deemed to be long-term in nature or designated as a hedge of the net investment in international subsidiaries are included, net of tax, in OCI.

Fair Value Measurements
For assets and liabilities measured at fair value, the GAAP fair value hierarchy prioritizes the inputs used in different valuation methodologies, assigning the highest priority to unadjusted quoted prices for identical assets and liabilities in actively traded markets (Level 1) and the lowest priority to unobservable inputs (Level 3). Level 2 inputs consist of quoted prices for similar assets and liabilities in active markets; quoted prices for identical or similar assets and liabilities in non-active markets; and model-derived valuations in which significant inputs are corroborated by observable market data either directly or indirectly through correlation or other means. Inputs may include yield curves, volatility, credit risks, and default rates.

Use of Estimates
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions. These estimates and assumptions affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Due to various factors affecting future costs and operations, actual results could differ materially from these estimates.

11



Note 2:    Earnings Per Share and Capital Structure

The following table sets forth the computation of basic and diluted earnings per share (EPS):

 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2012
 
2011
 
2012
 
2011
 
(in thousands, except per share data)
Net income (loss) available to common shareholders
$
35,347

 
$
(517,082
)
 
$
92,315

 
$
(455,526
)
 
 
 
 
 
 
 
 
Weighted average common shares outstanding - Basic
39,472

 
40,725

 
39,756

 
40,648

Dilutive effect of stock-based awards
319

 

 
286

 

Weighted average common shares outstanding - Diluted
39,791

 
40,725

 
40,042

 
40,648

Earnings per common share - Basic
$
0.90

 
$
(12.70
)
 
$
2.32

 
$
(11.21
)
Earnings per common share - Diluted
$
0.89

 
$
(12.70
)
 
$
2.31

 
$
(11.21
)

Stock-based Awards
For stock-based awards, the dilutive effect is calculated using the treasury stock method. Under this method, the dilutive effect is computed as if the awards were exercised at the beginning of the period (or at time of issuance, if later) and assumes the related proceeds were used to repurchase common stock at the average market price during the period. Related proceeds include the amount the employee must pay upon exercise, future compensation cost associated with the stock award, and the amount of excess tax benefits, if any. Approximately 881,000 and 1.2 million stock-based awards were excluded from the calculation of diluted EPS for the three and nine months ended September 30, 2012, and approximately 1.4 million and 1.2 million stock-based awards were excluded from the calculation of diluted EPS for the three and nine months ended September 30, 2011, respectively, because they were anti-dilutive. These stock-based awards could be dilutive in future periods.

Preferred Stock
We have authorized the issuance of 10 million shares of preferred stock with no par value. In the event of a liquidation, dissolution, or winding up of the affairs of the corporation, whether voluntary or involuntary, the holders of any outstanding preferred stock will be entitled to be paid a preferential amount per share to be determined by the Board of Directors prior to any payment to holders of common stock. Shares of preferred stock may be converted into common stock based on terms, conditions, and rates as defined in the Rights Agreement, which may be adjusted by the Board of Directors. There was no preferred stock sold or outstanding at September 30, 2012 and December 31, 2011.
Stock Repurchase Plan
On October 24, 2011, our Board of Directors authorized a twelve-month repurchase program of up to $100 million of our common stock with an expiration date of October 23, 2012. On September 13, 2012, the Board approved the extension of the expiration date of the stock repurchase program until February 15, 2013, or until the aggregate limit of $100 million of outstanding common stock has been repurchased, whichever occurs first. Repurchases are made in the open market or in privately negotiated transactions, and in accordance with applicable securities laws. As of September 30, 2012, we have repurchased $70.1 million of our common stock, with $29.9 million remaining under the repurchase program.
Note 3:    Certain Balance Sheet Components
 
Accounts receivable, net
September 30, 2012
 
December 31, 2011
 
(in thousands)
Trade receivables (net of allowance of $5,355 and $6,049)
$
307,062

 
$
328,845

Unbilled receivables
56,049

 
42,796

Total accounts receivable, net
$
363,111

 
$
371,641


At September 30, 2012 and December 31, 2011, $19.2 million and $2.5 million were recorded within trade receivables as billed but not yet paid by customers in accordance with contract retainage provisions. At September 30, 2012 and December 31, 2011, contract retainage amounts that were unbilled and classified as unbilled receivables were $10.6 million and $7.4 million. These contract retainage amounts within trade receivables and unbilled receivables are expected to be collected within the following 12 months.

12



We had no long-term unbilled receivables or long-term retainage contracts at September 30, 2012 as we expect to bill and collect all contract retainage receivables within the following 12 months. At December 31, 2011, long-term unbilled receivables and long-term retainage contracts totaled $31.5 million.

Allowance for doubtful account activity
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2012
 
2011
 
2012
 
2011
 
(in thousands)
Beginning balance
$
5,381

 
$
8,980

 
$
6,049

 
$
9,045

Provision (release) of doubtful accounts, net
(124
)
 
175

 
(414
)
 
128

Accounts written-off
(53
)
 
(1,127
)
 
(314
)
 
(1,680
)
Effects of change in exchange rates
151

 
(576
)
 
34

 
(41
)
Ending balance
$
5,355

 
$
7,452

 
$
5,355

 
$
7,452

 
Inventories
September 30, 2012
 
December 31, 2011
 
(in thousands)
Materials
$
104,404

 
$
112,470

Work in process
14,720

 
16,306

Finished goods
82,651

 
67,061

Total inventories
$
201,775

 
$
195,837


Our inventory levels may vary period to period as a result of our factory scheduling and the timing of contract fulfillments, which may include the buildup of finished goods for shipment.

Consigned inventory is held at third-party locations; however, we retain title to the inventory until purchased by the third-party. Consigned inventory, consisting of raw materials and finished goods, was $6.8 million and $7.4 million at September 30, 2012 and December 31, 2011, respectively.

Property, plant, and equipment, net
September 30, 2012
 
December 31, 2011
 
(in thousands)
Machinery and equipment
$
278,615

 
$
269,611

Computers and purchased software
82,760

 
74,885

Buildings, furniture, and improvements
143,486

 
140,064

Land
27,460

 
26,126

Construction in progress, including purchased equipment
23,391

 
20,687

Total cost
555,712

 
531,373

Accumulated depreciation
(304,009
)
 
(268,703
)
Property, plant, and equipment, net
$
251,703

 
$
262,670


Depreciation expense
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2012
 
2011
 
2012
 
2011
 
(in thousands)
Depreciation expense
$
15,656

 
$
16,607

 
$
45,989

 
$
49,112


13



Note 4:    Intangible Assets

The gross carrying amount and accumulated amortization of our intangible assets, other than goodwill, are as follows:

 
September 30, 2012
 
December 31, 2011
 
Gross Assets
 
Accumulated
Amortization
 
Net
 
Gross Assets
 
Accumulated
Amortization
 
Net
 
(in thousands)
Core-developed technology
$
402,897

 
$
(323,629
)
 
$
79,268

 
$
387,606

 
$
(305,285
)
 
$
82,321

Customer contracts and relationships
288,429

 
(147,614
)
 
140,815

 
278,581

 
(131,418
)
 
147,163

Trademarks and trade names
71,992

 
(63,922
)
 
8,070

 
71,854

 
(62,206
)
 
9,648

Other
11,096

 
(11,013
)
 
83

 
11,153

 
(10,785
)
 
368

Total intangible assets subject to amortization
774,414

 
(546,178
)
 
228,236

 
749,194

 
(509,694
)
 
239,500

In-process research and development
19,400

 
 
 
19,400

 

 
 
 

Total intangible assets
$
793,814

 
$
(546,178
)
 
$
247,636

 
$
749,194

 
$
(509,694
)
 
$
239,500


A summary of the intangible asset account activity is as follows:

 
Nine Months Ended September 30,
 
2012
 
2011
 
(in thousands)
Beginning balance, intangible assets, gross
$
749,194

 
$
759,152

Intangible assets acquired
43,400

 
10,297

Assets no longer in use written-off

 
(8,450
)
Effect of change in exchange rates
1,220

 
12,263

Ending balance, intangible assets, gross
$
793,814

 
$
773,262


Intangible assets acquired in 2012 are based on the preliminary purchase price allocation relating to our acquisition of SmartSynch on May 1, 2012. SmartSynch's intangible assets include IPR&D, which is not amortized until such time as the associated development projects are completed. These projects are expected to be completed in the next 12 months. Refer to Note 16 for additional information regarding this acquisition. Intangible assets of our international subsidiaries are recorded in their respective functional currency; therefore, the carrying amounts of intangible assets increase or decrease, with a corresponding change in accumulated OCI, due to changes in foreign currency exchange rates.

Estimated future annual amortization expense is as follows:

 
Years ending December 31,
Estimated Annual
Amortization
 
(in thousands)
2012 (amount remaining at September 30, 2012)
$
12,015

2013
41,917

2014
37,595

2015
30,700

2016
24,275

Beyond 2016
81,734

Total intangible assets subject to amortization, net
$
228,236


14



Note 5:    Goodwill

Effective January 1, 2012, our reporting segments were changed from two geographic operating segments, Itron North America and Itron International, to two product operating segments, Energy and Water. As a result, we reallocated the goodwill balance as of January 1, 2012 to the Electricity, Gas, and Water reporting units within these two operating segments.

The following table reflects the goodwill balance as of September 30, 2012:

 
Total Company
 
Energy
 
Water
 
(in thousands)
Balance at January 1, 2012
 
 
 
 
 
Goodwill before impairment
$
1,221,757

 
$
808,601

 
$
413,156

Accumulated impairment losses
(584,847
)
 
(254,735
)
 
(330,112
)
Goodwill, net
636,910

 
553,866

 
83,044

 
 
 
 
 
 
Goodwill acquired
46,881

 
46,881

 

Other
4,767

 
3,994

 
773

Effect of change in exchange rates
(1,126
)
 
(6,348
)
 
5,222

 
 
 
 
 
 
Balance at September 30, 2012
 
 
 
 
 
Goodwill before impairment
1,242,159

 
840,009

 
402,150

Accumulated impairment losses
(554,727
)
 
(241,616
)
 
(313,111
)
Goodwill, net
$
687,432

 
$
598,393

 
$
89,039


Goodwill acquired in 2012 is based on the preliminary purchase price allocation relating to the SmartSynch acquisition on May 1, 2012. Refer to Note 16 for additional information regarding this acquisition.

In the preceding table, "Other" includes activity associated with our restructuring announced in the fourth quarter of 2011. During the third quarter of 2012, we identified an error in our consolidated financial statements for the year ended December 31, 2011, which resulted in an overstatement of restructuring expense related to the expected sale of a non-core business. The identified assets to be disposed originally included $6.7 million of goodwill, which was impaired and charged to restructuring expense as a result of the expected sale proceeds being less than the carrying value of the identified assets. During the third quarter of 2012, we determined the amount of goodwill that should have been allocated to the asset disposal group was $1.3 million. In accordance with the relevant guidance, management evaluated the materiality of the error from a qualitative and quantitative perspective. Based on such evaluation, we concluded that correcting the goodwill allocated to this business asset group is not material, quantitatively or qualitatively, to our results of operations for the three months ended September 30, 2012 or our expected full year results of operations for 2012 and would not have had a material impact on our results for the year ended December 31, 2011. Accordingly, we recorded a non-cash adjustment during the third quarter of 2012 to reduce restructuring expense and increase goodwill by $5.4 million. Refer to Note 12 for additional disclosure on Itron's restructuring costs. Additionally, during the three months ended September 30, 2012, we sold a non-core business in Europe to which we allocated $675,000 of goodwill and recognized as restructuring expense.

As a result of a significant decline in the price of our shares of common stock at the end of September 2011, our aggregate market value was significantly lower than the aggregate carrying value of our net assets. As a result, we performed an impairment test of our goodwill as of September 30, 2011, and recorded total goodwill impairment charges of $584.8 million in the year ended December 31, 2011, of which $540.4 million was recorded during the three months ended September 30, 2011. These goodwill impairment charges were associated with our previous reporting units of Itron International Electricity and Itron International Water. The accumulated impairment losses were reallocated to our new operating segments, Energy and Water, effective January 1, 2012.

Goodwill and accumulated impairment losses associated with our international subsidiaries are recorded in their respective functional currency; therefore, the carrying amounts of these balances increase or decrease, with a corresponding change in accumulated OCI, due to changes in foreign currency exchange rates.

15



Note 6:    Debt

The components of our borrowings are as follows:

 
September 30, 2012
 
December 31, 2011
 
(in thousands)
2011 credit facility:
 
 
 
USD denominated term loan
$
281,250

 
$
292,502

Multicurrency revolving line of credit
140,000

 
160,000

Total debt
421,250

 
452,502

Less: Current portion of debt
16,875

 
15,000

Long-term debt
$
404,375

 
$
437,502


Credit Facilities
In August 2011, we entered into a senior secured credit facility (2011 credit facility), which replaced the senior secured credit facility we entered into in 2007 (2007 credit facility). The 2011 credit facility consists of a $300 million U.S. dollar term loan (the term loan) and a multicurrency revolving line of credit (the revolver) with a principal amount of up to $660 million, which was increased from $500 million in April 2012. Both the term loan and the revolver mature on August 8, 2016, and amounts borrowed under the revolver are classified as long-term. Amounts borrowed under the revolver during the credit facility term may be repaid and reborrowed until the revolver's maturity, at which time the revolver will terminate, and all outstanding loans, together with all accrued and unpaid interest, must be repaid. Amounts not borrowed under the revolver are subject to a commitment fee, which is paid in arrears on the last day of each fiscal quarter, ranging from 0.20% to 0.40% per annum depending on our total leverage ratio as of the most recently ended fiscal quarter. Amounts repaid on the term loan may not be reborrowed. The 2011 credit facility permits us and certain of our foreign subsidiaries to borrow in U.S. dollars, euros, British pounds, or, with lender approval, other currencies readily convertible into U.S. dollars. All obligations under the 2011 credit facility are guaranteed by Itron, Inc. and material U.S. domestic subsidiaries and are secured by a pledge of substantially all of the assets of Itron, Inc. and material U.S. domestic subsidiaries, including a pledge of 100% of the capital stock of material U.S. domestic subsidiaries and up to 66% of the voting stock (100% of the non-voting stock) of their first-tier foreign subsidiaries. In addition, the obligations of any foreign subsidiary who is a foreign borrower, as defined by the 2011 credit facility, are guaranteed by the foreign subsidiary and by its direct and indirect foreign parents. The 2011 credit facility includes debt covenants, which contain certain financial ratios and place certain restrictions on the incurrence of debt, investments, and the issuance of dividends. We were in compliance with the debt covenants under the 2011 credit facility at September 30, 2012.

Scheduled principal repayments for the term loan are due quarterly in the amounts of $3.8 million through June 2013, $5.6 million from September 2013 through June 2014, $7.5 million from September 2014 through June 2016, and the remainder due at maturity on August 8, 2016. The term loan may be repaid early in whole or in part, subject to certain minimum thresholds, without penalty.

Under the 2011 credit facility, we elect applicable market interest rates for both the term loan and any outstanding revolving loans. We also pay an applicable margin, which is based on our total leverage ratio (as defined in the credit agreement). The applicable rates per annum may be based on either: (1) the LIBOR rate, plus an applicable margin, or (2) the Alternate Base Rate, plus an applicable margin. The Alternate Base Rate election is equal to the greatest of three rates: (i) the prime rate, (ii) the Federal Reserve effective rate plus 1/2 of 1%, or (iii) one month LIBOR plus 1%. At September 30, 2012, the interest rate for both the term loan and the revolver was 1.47% (the LIBOR rate plus a margin of 1.25%).


16


Total credit facility repayments were as follows:
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2012
 
2011
 
2012
 
2011
 
(in thousands)
2011 credit facility term loan
$
3,750

 
$
3,750

 
$
11,252

 
$
3,750

2011 credit facility multicurrency revolving line of credit
30,000

 

 
90,000

 

2007 credit facility term loans

 
351,320

 

 
406,950

2007 credit facility multicurrency revolving line of credit

 
170,000

 

 
170,000

Total credit facility repayments
$
33,750

 
$
525,070

 
$
101,252

 
$
580,700


At September 30, 2012, $140.0 million was outstanding under the 2011 credit facility revolver, and $49.4 million was utilized by outstanding standby letters of credit, resulting in $470.6 million available for additional borrowings.

Upon repayment of the 2007 credit facility in August 2011, unamortized prepaid debt fees of $2.4 million were written-off to interest expense. Prepaid debt fees of approximately $6.6 million were capitalized in the third quarter of 2011 associated with the 2011 credit facility, and $897,000 were capitalized in the second quarter of 2012 associated with the increase in the revolver in April 2012. Unamortized prepaid debt fees were as follows:
 
September 30, 2012
 
December 31, 2011
 
(in thousands)
Unamortized prepaid debt fees
$
5,763

 
$
6,027


Convertible Senior Subordinated Notes
On August 1, 2011, in accordance with the terms of the convertible senior subordinated notes (convertible notes), we repurchased $184.8 million of the convertible notes at their principal amount plus accrued and unpaid interest. On September 30, 2011, we redeemed the remaining $38.8 million of the convertible notes, plus accrued and unpaid interest.

The convertible notes were separated between the liability and equity components using our estimated non-convertible debt borrowing rate at the time the convertible notes were issued, which was determined to be 7.38%. This rate also reflected the effective interest rate on the liability component for all periods during which the convertible notes were outstanding. The carrying amount of the equity component of $31.8 million is retained as a permanent component of our shareholders' equity, and no gain or loss was recognized upon derecognition of the convertible notes as the fair value of the consideration transferred to the holders equaled the fair value of the liability component.

The discount on the liability component was fully amortized by the end of the second quarter of 2011. The interest expense relating to both the contractual interest coupon and amortization of the discount on the liability component was as follows:

 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2012
 
2011
 
2012
 
2011
 
(in thousands)
Contractual interest coupon
$

 
$
625

 
$

 
$
3,420

Amortization of the discount on the liability component

 

 

 
5,336

Total interest expense on convertible notes
$

 
$
625

 
$

 
$
8,756

Note 7:    Derivative Financial Instruments

As part of our risk management strategy, we use derivative instruments to hedge certain foreign currency and interest rate exposures. Refer to Note 1, Note 13, and Note 14 for additional disclosures on our derivative instruments.

The fair values of our derivative instruments are determined using the income approach and significant other observable inputs (also known as “Level 2”). We have used observable market inputs based on the type of derivative and the nature of the underlying instrument. The key inputs used at September 30, 2012 included interest rate yield curves (swap rates and futures) and foreign exchange spot and forward rates, all of which are available in an active market. We have utilized the mid-market pricing convention

17


for these inputs at September 30, 2012. We include the effect of our counterparty credit risk based on current published credit default swap rates when the net fair value of our derivative instruments is in a net asset position. We consider our own nonperformance risk when the net fair value of our derivative instruments is in a net liability position by discounting our derivative liabilities to reflect the potential credit risk to our counterparty through applying a current market indicative credit spread to all cash flows.

The fair values of our derivative instruments at September 30, 2012 and December 31, 2011 were as follows:
 
 
 
 
 
Fair Value
 
 
Balance Sheet Location
 
September 30,
2012
 
December 31,
2011
 
 
 
 
(in thousands)
Asset Derivatives
 
 
 
 
Derivatives not designated as hedging instruments under ASC 815-20
 
 
 
 
Foreign exchange forward contracts
 
Other current assets
 
$
57

 
$
241

 
 
 
 
 
 
 
Liability Derivatives
 
 
 
 
 
 
Derivatives designated as hedging instruments under ASC 815-20
 
 
 
 
Interest rate swap contracts
 
Other current liabilities
 
$
256

 
$

Interest rate swap contracts
 
Other long-term obligations
 
2,441

 

Derivatives not designated as hedging instruments under ASC 815-20
 
 
 
 
Foreign exchange forward contracts
 
Other current liabilities
 
103

 
222

Total liability derivatives
 
 
 
$
2,800

 
$
222


OCI during the reporting period for our derivative and nonderivative instruments designated as hedging instruments (collectively, hedging instruments), net of tax, was as follows:
 
 
2012
 
2011
 
(in thousands)
Net unrealized loss on hedging instruments at January 1,
$
(14,380
)
 
$
(10,034
)
Unrealized gain (loss) on derivative instruments
(1,677
)
 
1,922

Unrealized gain (loss) on a nonderivative net investment hedging instrument

 
(8,854
)
Realized (gains) losses reclassified into net income (loss)

 
2,598

Net unrealized loss on hedging instruments at September 30,
$
(16,057
)
 
$
(14,368
)

Following the termination of our net investment hedge in August 2011, the net derivative loss of $14.4 million will remain in accumulated OCI until such time when earnings are impacted by a sale or liquidation of the associated foreign operation.

Cash Flow Hedges
As a result of our floating rate debt, we are exposed to variability in our cash flows from changes in the applicable interest rate index. We enter into swaps to achieve a fixed rate of interest on the hedged portion of debt in order to increase our ability to forecast interest expense. The objective of these swaps is to reduce the variability of cash flows from increases in the LIBOR base borrowing rates on our floating rate credit facility. The swaps do not protect us from changes to the applicable margin under our credit facility.

In May 2012, we entered into six forward starting pay-fixed receive one-month LIBOR interest rate swaps. The interest rate swaps convert $200 million of our LIBOR based debt from a floating LIBOR interest rate to a fixed interest rate of 1.00% (excluding the applicable margin on the debt) and are effective July 31, 2013 to August 8, 2016. The cash flow hedges are expected to be highly effective in achieving offsetting cash flows attributable to the hedged risk through the term of the hedge. Consequently, effective changes in the fair value of the interest rate swaps are recorded as a component of OCI and will be recognized in earnings when the hedged item affects earnings. The amounts paid or received on the hedges will be recognized as adjustments to interest expense. The amount of net losses expected to be reclassified into earnings in the next 12 months is $256,000. At September 30, 2012, our LIBOR based debt balance was $421.3 million.

In 2007, we entered into a pay fixed 6.59% receive three-month Euro Interbank Offered Rate (EURIBOR), plus 2%, amortizing interest rate swap to convert a significant portion of our euro denominated variable-rate term loan to fixed-rate debt, plus or minus

18


the variance in the applicable margin from 2%, through December 31, 2012. The objective of this swap was to protect us from increases in the EURIBOR base borrowing rates. The swaps did not protect us from changes to the applicable margin under our credit agreement. Throughout the duration of the hedging relationship, this cash flow hedge was expected to be highly effective in achieving offsetting cash flows attributable to the hedged risk. Consequently, effective changes in the fair value of the interest rate swap were recorded as a component of OCI and were recognized in earnings when the hedged item affected earnings. The amounts paid or received on the hedge were recognized as adjustments to interest expense. In August 2011, we repaid our 2007 credit facility, which included the euro-denominated term loan. In conjunction with the debt repayment, we paid $2.9 million to terminate the related interest rate swap, and the accumulated loss in OCI was reclassified to interest expense.

In 2010, we entered into two interest rate swaps with one-year terms, which each converted $100 million of our U.S. dollar term loan from a floating LIBOR interest rate to fixed interest rates of 2.11% and 2.15%, respectively. These swaps expired on June 30, 2011 and did not include the additional interest rate margin applicable to our term debt.

We will continue to monitor and assess our interest rate risk and may institute additional interest rate swaps or other derivative instruments to manage such risk in the future.

The before-tax effect of our cash flow derivative instruments on the Consolidated Balance Sheets and the Consolidated Statements of Operations for the three and nine months ended September 30 are as follows:
 
Derivatives in ASC 815-20
Cash Flow
Hedging Relationships
 
Amount of Gain (Loss)
Recognized in OCI on
Derivative  (Effective
Portion)
 
Gain (Loss) Reclassified from Accumulated
OCI into Income (Effective Portion)
 
Gain (Loss) Recognized in Income on
Derivative (Ineffective Portion)
Location
 
Amount
 
Location
 
Amount
 
 
2012
 
2011
 
 
 
2012
 
2011
 
 
 
2012
 
2011
 
 
(in thousands)
 
 
 
(in thousands)
 
 
 
(in thousands)
Three Months Ended September 30,
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest rate swap contracts
 
$
(1,332
)
 
$
277

 
Interest expense
 
$

 
$
(3,083
)
 
Interest expense
 
$

 
$
(121
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Nine Months Ended September 30,
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest rate swap contracts
 
$
(2,697
)
 
$
(4,200
)
 
Interest expense
 
$

 
$
(7,254
)
 
Interest expense
 
$

 
$
(201
)

Net Investment Hedge
We are exposed to foreign exchange risk through our international subsidiaries. As a result of our acquisition of an international company in 2007, we entered into a euro denominated term loan, which exposed us to fluctuations in the euro foreign exchange rate. Therefore, we designated this foreign currency denominated term loan as a hedge of our net investment in international operations. The non-functional currency term loan was revalued into U.S. dollars at each balance sheet date, and the changes in value associated with currency fluctuations were recorded as adjustments to long-term debt with offsetting gains and losses recorded in OCI. The loan was repaid in full in August 2011 as part of our repayment of the 2007 credit facility. The net derivative loss will remain in accumulated OCI until such time when earnings are impacted by a sale or liquidation of the associated foreign operation.

The before tax and net of tax effects of our net investment hedge nonderivative financial instrument on OCI for the three and nine months ended September 30 are as follows:
 
Nonderivative Financial Instruments in ASC 815-20
Net Investment Hedging Relationships
 
Euro Denominated Term Loan Designated as a Hedge
of Our Net Investment in International Operations
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2012
 
2011
 
2012
 
2011
 
 
(in thousands)
Gain (loss) recognized in OCI on derivative
   (Effective Portion)
 
 
 
 
 
 
 
 
Before tax
 
$

 
$
645

 
$

 
$
(14,278
)
Net of tax
 
$

 
$
408

 
$

 
$
(8,854
)

Derivatives Not Designated as Hedging Relationships
We are also exposed to foreign exchange risk when we enter into non-functional currency transactions, both intercompany and third-party. At each period-end, non-functional currency monetary assets and liabilities are revalued with the change recorded to other income and expense. We enter into monthly foreign exchange forward contracts (a total of 429 contracts were entered into during the nine months ended September 30, 2012), which are not designated for hedge accounting, with the intent to reduce

19


earnings volatility associated with certain of these balances. The notional amounts of the contracts ranged from $120,000 to $51 million, offsetting our exposures from the euro, British pound, Canadian dollar, Australian dollar, Brazilian real, and various other currencies.

The effect of our foreign exchange forward derivative instruments on the Consolidated Statements of Operations for the three and nine months ended September 30 is as follows:
 
Derivatives Not Designated as
Hedging Instrument under ASC 815-20
 
Gain (Loss) Recognized on Derivatives in Other Income (Expense)
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2012
 
2011
 
2012
 
2011
 
 
(in thousands)
Foreign exchange forward contracts
 
$
(245
)
 
$
2,464

 
$
(666
)
 
$
(877
)
Note 8:    Defined Benefit Pension Plans

We sponsor both funded and unfunded defined benefit pension plans for our international employees, primarily in Germany, France, Italy, Indonesia, and Spain, offering death and disability, retirement, and special termination benefits. The defined benefit obligation is calculated annually by using the projected unit credit method. The measurement date for the pension plans was December 31, 2011.
Our defined benefit pension plans are denominated in the functional currencies of the respective countries in which the plans are sponsored; therefore, the balances increase or decrease, with a corresponding change in OCI, due to changes in foreign currency exchange rates. Amounts recognized on the Consolidated Balance Sheets consist of:
 
 
September 30, 2012
 
December 31, 2011
 
(in thousands)
Plan assets in other long-term assets
$
(473
)
 
$
(449
)
Current portion of pension plan liability in wages and benefits payable
2,763

 
2,621

Long-term portion of pension plan liability
63,041

 
62,449

Net pension plan benefit liability
$
65,331

 
$
64,621

Our asset investment strategy focuses on maintaining a portfolio using primarily insurance funds, which are accounted for as investments and measured at fair value, in order to achieve our long-term investment objectives on a risk adjusted basis. Our general funding policy for these qualified pension plans is to contribute amounts sufficient to satisfy regulatory funding standards of the respective countries for each plan. We contributed $33,000 and $388,000 to the defined benefit pension plans for the three and nine months ended September 30, 2012, and $40,000 and $431,000 for the three and nine months ended September 30, 2011, respectively. The timing of when contributions are made can vary by plan and from year to year. For 2012, assuming that actual plan asset returns are consistent with our expected rate of return, and that interest rates remain constant, we expect to contribute approximately $474,000 to our defined benefit pension plans. We contributed $520,000 to the defined benefit pension plans for the year ended December 31, 2011.
Net periodic pension benefit costs for our plans include the following components:

 
Three Months Ended September 30,
 
Nine Months Ended
September 30,
 
2012
 
2011
 
2012
 
2011
 
(in thousands)
Service cost
$
655

 
$
637

 
$
2,069

 
$
1,855

Interest cost
887

 
947

 
2,722

 
2,833

Expected return on plan assets
(80
)
 
(80
)
 
(247
)
 
(243
)
Settlements and termination benefits
97

 

 
97

 

Amortization of actuarial net loss (gain)
1

 
14

 
5

 
42

Amortization of unrecognized prior service costs
16

 
18

 
50

 
55

Net periodic benefit cost
$
1,576

 
$
1,536

 
$
4,696

 
$
4,542


20



Note 9:    Stock-Based Compensation

We record stock-based compensation expense for awards of stock options, stock sold pursuant to our ESPP, and the issuance of restricted stock units and unrestricted stock awards. We expense stock-based compensation primarily using the straight-line method over the vesting requirement period. For the three and nine months ended September 30, stock-based compensation expense and the related tax benefit were as follows:
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2012
 
2011
 
2012
 
2011
 
(in thousands)
Stock options
$
333

 
$
(320
)
 
$
942

 
$
1,224

Restricted stock units
4,390

 
2,916

 
12,281

 
10,320

Unrestricted stock awards
179

 
140

 
589

 
330

ESPP
161

 
147

 
507

 
527

Total stock-based compensation
$
5,063

 
$
2,883

 
$
14,319

 
$
12,401

 
 
 
 
 
 
 
 
Related tax benefit
$
1,358

 
$
700

 
$
3,922

 
$
3,359


We issue new shares of common stock upon the exercise of stock options or when vesting conditions on restricted stock units are fully satisfied.

Subject to stock splits, dividends, and other similar events, 3,500,000 shares of common stock are reserved and authorized for issuance under our 2010 Stock Incentive Plan (Stock Incentive Plan). Awards consist of stock options, restricted stock units, and unrestricted stock awards. At September 30, 2012, 1,338,142 shares were available for grant under the Stock Incentive Plan.

Stock Options
Options to purchase our common stock are granted to employees and the Board of Directors with an exercise price equal to the market close price of the stock on the date the Board of Directors approves the grant. Options generally become exercisable in three equal annual installments beginning one year from the date of grant and generally expire 10 years from the date of grant. Compensation expense is recognized only for those options expected to vest, with forfeitures estimated based on our historical experience and future expectations.

The fair values of stock options granted were estimated at the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions:
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2012(1)
 
2011
 
2012
 
2011
Dividend yield

 

 

 

Expected volatility
%
 
45.8
%
 
42.7
%
 
46.4
%
Risk-free interest rate
%
 
0.9
%
 
0.9
%
 
1.7
%
Expected life (years)

 
4.91

 
5.14

 
4.86


(1) There were no employee stock options granted for the three months ended September 30, 2012.

Expected volatility is based on a combination of historical volatility of our common stock and the implied volatility of our traded options for the related expected life period. We believe this combined approach is reflective of current and historical market conditions and an appropriate indicator of expected volatility. The risk-free interest rate is the rate available as of the award date on zero-coupon U.S. government issues with a term equal to the expected life of the award. The expected life is the weighted average expected life of an award based on the period of time between the date the award is granted and the estimated date the award will be fully exercised. Factors considered in estimating the expected life include historical experience of similar awards, contractual terms, vesting schedules, and expectations of future employee behavior. We have not paid dividends in the past and do not plan to pay dividends in the foreseeable future.


21


A summary of our stock option activity for the nine months ended September 30 is as follows:
 

Shares
 
Weighted
Average Exercise
Price per Share
 
Weighted Average
Remaining
Contractual Life
 
Aggregate
Intrinsic Value (1)
 
Weighted
Average Grant
Date Fair Value
 
(in thousands)
 
 
 
(years)
 
(in thousands)
 
 
Outstanding, January 1, 2011
1,102

 
$
55.21

 
5.58

 
$
10,883

 
 
Granted
103

 
52.13

 
 
 
 
 
$
21.81

Exercised
(29
)
 
19.53

 
 
 
$
1,050

 
 
Forfeited
(63
)
 
58.50

 
 
 
 
 
 
Expired
(1
)
 
7.00

 
 
 
 
 
 
Outstanding, September 30, 2011
1,112

 
$
55.72

 
4.68

 
$
1,518

 
 
 
 
 
 
 
 
 
 
 
 
Exercisable, September 30, 2011
1,027

 
$
55.94

 
4.30

 
$
1,518

 
 
 
 
 
 
 
 
 
 
 
 
Expected to vest, September 30, 2011
80

 
$
53.19

 
9.28

 
$

 
 
 
 
 
 
 
 
 
 
 
 
Outstanding, January 1, 2012
1,109

 
$
55.97

 
4.51

 
$
2,323

 
 
Granted
54

 
48.23

 
 
 
 
 
$
18.64

Exercised
(50
)
 
22.12

 
 
 
$
972

 
 
Expired
(83
)
 
60.06

 
 
 
 
 
 
Outstanding, September 30, 2012
1,030

 
$
56.87

 
4.35

 
$
3,127

 
 
 
 
 
 
 
 
 
 
 
 
Exercisable, September 30, 2012
904

 
$
58.04

 
3.72

 
$
2,969

 
 
 
 
 
 
 
 
 
 
 
 
Expected to vest, September 30, 2012
119

 
$
48.50

 
8.89

 
$
149

 
 

(1) 
The aggregate intrinsic value of outstanding stock options represents amounts that would have been received by the optionees had all in- the-money options been exercised on that date. Specifically, it is the amount by which the market value of Itron’s stock exceeded the exercise price of the outstanding in-the-money options before applicable income taxes, based on our closing stock price on the last business day of the period. The aggregate intrinsic value of stock options exercised during the period is calculated based on our stock price at the date of exercise.

As of September 30, 2012, total unrecognized stock-based compensation expense related to nonvested stock options was approximately $1.5 million, which is expected to be recognized over a weighted average period of approximately 1.7 years.

Restricted Stock Units
Certain employees and senior management receive restricted stock units as a component of their total compensation. The fair value of a restricted stock unit is the market close price of our common stock on the date of grant. Restricted stock units generally vest over a three year period. Compensation expense, net of forfeitures, is recognized over the vesting period.

Subsequent to vesting, the restricted stock units are converted into shares of our common stock on a one-for-one basis and issued to employees. We are entitled to an income tax deduction in an amount equal to the taxable income reported by the employees upon vesting of the restricted stock units.

The restricted stock units issued under the Long Term Performance Restricted Stock Unit Award Agreement (Performance Award Agreement) are determined based on the attainment of annual performance goals after the end of the calendar year performance period. During the year, if management determines that it is probable that the targets will be achieved, compensation expense, net of forfeitures, is recognized on a straight-line basis over the annual performance and subsequent vesting period for each separately vesting portion of the award. Performance awards typically vest and are released in three equal installments at the end of each year following attainment of the performance goals. For U.S. participants who retire during the performance period, a pro-rated number of restricted stock units (based on the number of days of employment during the performance period) immediately vest based on the attainment of the performance goals as assessed after the end of the performance period. During the vesting period, unvested restricted stock units immediately vest at the date of retirement for U.S. participants who retire during that period. For U.S. participants who are or will become retirement eligible during either the annual performance or vesting period, compensation expense is accelerated and recognized over the greater of the performance period (one year) or through the participant’s retirement eligible date. For performance awards granted in 2012, the maximum restricted stock units that may become eligible for vesting is 208,000 with a grant date fair value of $44.07.

22



The following table summarizes restricted stock unit activity for the nine months ended September 30:

 
Number of
Restricted Stock Units
 
Weighted
Average  Grant
Date Fair Value
 
Aggregate
Intrinsic Value(1)
 
(in thousands)
 
 
 
(in thousands)
Outstanding, January 1, 2011
588

 
 
 
 
Granted(2)
286

 
$
54.82

 
 
Released
(201
)
 
 
 
$
15,739

Forfeited
(37
)
 
 
 
 
Outstanding, September 30, 2011
636

 
 
 
 
 
 
 
 
 
 
Outstanding, January 1, 2012
625

 
 
 
 
Granted(2)
452

 
$
47.29

 
 
Released
(207
)
 
 
 
$
12,835

Forfeited
(34
)
 
 
 
 
Outstanding, September 30, 2012
836

 
 
 
 
 
 
 
 
 
 
Vested, September 30, 2012
48

 
 
 
$
2,049

 
 
 
 
 
 
Expected to vest, September 30, 2012
763

 
 
 
$
32,904


(1) 
The aggregate intrinsic value is the market value of the stock, before applicable income taxes, based on the closing price on the stock release dates or at the end of the period for restricted stock units expected to vest.

(2) 
These restricted stock units do not include the respective 2011 and 2012 awards under the Performance Award Agreement, which are not eligible for vesting as of September 30 of each respective year.

At September 30, 2012, unrecognized compensation expense on restricted stock units was $25.8 million, which is expected to be recognized over a weighted average period of approximately 2.0 years.

Unrestricted Stock Awards
We grant unrestricted stock awards to our Board of Directors as part of their compensation. Awards are fully vested and expensed when granted. The fair value of unrestricted stock awards is the market close price of our common stock on the date of grant.

The following table summarizes unrestricted stock award activity for the three and nine months ended September 30:
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2012
 
2011
 
2012
 
2011
Shares of unrestricted stock granted
4,342

 
2,864

 
14,321

 
6,317

 
 
 
 
 
 
 
 
Weighted average grant date fair value per share
$
41.41

 
$
48.84

 
$
41.16

 
$
52.19


Employee Stock Purchase Plan
Under the terms of the ESPP, employees can deduct up to 10% of their regular cash compensation to purchase our common stock at a 15% discount from the fair market value of the stock at the end of each fiscal quarter, subject to other limitations under the plan. The sale of the stock to the employees occurs at the beginning of the subsequent quarter.

The following table summarizes ESPP activity for the three and nine months ended September 30:

 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2012
 
2011
 
2012
 
2011
Shares of stock sold to employees(1)
22,739

 
22,518

 
76,415

 
65,143

 
 
 
 
 
 
 
 
Weighted average fair value per ESPP award(2)
$
6.47

 
$
4.43

 
$
6.52

 
$
5.56


23



(1) 
Stock sold to employees during each fiscal quarter under the ESPP is associated with the offering period ending on the last day of the previous fiscal quarter.

(2) 
Relating to awards associated with the offering period during the three and nine months ended September 30.

At September 30, 2012, all compensation cost associated with the ESPP had been recognized. There were 625,000 shares of common stock available for future issuance under the ESPP at September 30, 2012.
Note 10:    Income Taxes
Our tax provisions as a percentage of income (loss) before tax typically differ from the federal statutory rate of 35%, and may vary from period to period, due to fluctuations in the forecasted mix of earnings in domestic and international jurisdictions, new or revised tax legislation and accounting pronouncements, tax credits, state income taxes, adjustments to valuation allowances, and interest expense and penalties related to uncertain tax positions, among other items.

For the three and nine months ended September 30, 2012, we had tax provisions of 15.4% and 22.2%, based on a percentage of income (loss) before tax, as compared with tax provisions of 1.2% and 3.6% for the same periods in 2011.

Our tax provision in 2012 differs from the federal statutory rate due to projected earnings in tax jurisdictions with rates lower than 35%, the benefit of certain interest expense deductions, and an election under U.S. Internal Revenue Code Section 338 with respect to a foreign acquisition in 2007.

Our tax provision in 2011 differs from the federal statutory rate due to the impact of the goodwill impairment, which is not deductible, projected earnings in tax jurisdictions with rates lower than 35%, the benefit of certain interest expense deductions, a benefit related to the settlement of a foreign tax litigation, and an election under U.S. Internal Revenue Code Sections 338 with respect to a foreign acquisition in 2007.

We classify interest expense and penalties related to unrecognized tax liabilities and interest income on tax overpayments as components of income tax expense. The net interest and penalties expense recognized is as follows:
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2012
 
2011
 
2012
 
2011
 
(in thousands)
Net interest and penalties expense
$
378

 
$
476

 
$
643

 
$
584


Accrued interest and penalties recorded are as follows:

 
September 30, 2012
 
December 31, 2011
 
(in thousands)
Accrued interest
$
4,225

 
$
3,781

Accrued penalties
2,847

 
2,766


Unrecognized tax benefits related to uncertain tax positions and the amount of unrecognized tax benefits that, if recognized, would affect our effective tax rate are as follows:
 
 
September 30, 2012
 
December 31, 2011
 
(in thousands)
Unrecognized tax benefits related to uncertain tax positions
$
26,163

 
$
24,737

The amount of unrecognized tax benefits that, if recognized, would affect our effective tax rate
25,667

 
24,451


We believe it is reasonably possible that our unrecognized tax benefits may decrease by approximately $5.0 million within the

24


next twelve months due to the expiration of the statute of limitations and the completion of examinations by taxing authorities. At September 30, 2012, we are not able to reasonably estimate the timing of future cash flows relating to our uncertain tax positions.
Note 11:    Commitments and Contingencies

Guarantees and Indemnifications
We are often required to obtain standby letters of credit (LOC’s) or bonds in support of our obligations for customer contracts. These standby LOC’s or bonds typically provide a guarantee to the customer for future performance, which usually covers the installation phase of a contract and may on occasion cover the operations and maintenance phase of outsourcing contracts.

Our available lines of credit, outstanding standby LOC’s, and bonds are as follows:
 
 
September 30, 2012
 
December 31, 2011
 
(in thousands)
Credit facilities(1)
 
 
 
Multicurrency revolving line of credit
$
660,000

 
$
500,000

Long-term borrowings
(140,000
)
 
(160,000
)
Standby LOC’s issued and outstanding
(49,410
)
 
(44,549
)
Net available for additional borrowings and LOC’s
$
470,590

 
$
295,451

 
 
 
 
Unsecured multicurrency revolving lines of credit with various financial institutions
 
 
 
Multicurrency revolving lines of credit
$
63,500

 
$
67,968

Standby LOC’s issued and outstanding
(29,571
)
 
(28,733
)
Short-term borrowings(2)
(834
)
 

Net available for additional borrowings and LOC’s
$
33,095

 
$
39,235

 
 
 
 
Unsecured surety bonds in force
$
154,047

 
$
139,954


(1) 
See Note 6 for details regarding our secured credit facilities.
(2) 
Short-term borrowings are included in "Other current liabilities" on the Consolidated Balance Sheets.

In the event any such standby LOC or bond is called, we would be obligated to reimburse the issuer of the standby LOC or bond; however, we do not believe that any outstanding LOC or bond will be called.

We generally provide an indemnification related to the infringement of any patent, copyright, trademark, or other intellectual property right on software or equipment within our sales contracts, which indemnifies the customer from and pays the resulting costs, damages, and attorney’s fees awarded against a customer with respect to such a claim provided that (a) the customer promptly notifies us in writing of the claim and (b) we have the sole control of the defense and all related settlement negotiations. We may also provide an indemnification to our customers for third party claims resulting from damages caused by the negligence or willful misconduct of our employees/agents in connection with the performance of certain contracts. The terms of our indemnifications generally do not limit the maximum potential payments. It is not possible to predict the maximum potential amount of future payments under these or similar agreements.

Legal Matters
We are subject to various legal proceedings and claims of which the outcomes are subject to significant uncertainty. Our policy is to assess the likelihood of any adverse judgments or outcomes related to legal matters, as well as ranges of probable losses. A determination of the amount of the liability required, if any, for these contingencies is made after an analysis of each known issue. A liability is recorded and charged to operating expense when we determine that a loss is probable and the amount can be reasonably estimated. Additionally, we disclose contingencies for which a material loss is reasonably possible, but not probable. Liabilities recorded for legal contingencies at September 30, 2012 were not material to our financial condition or results of operations.

In 2010 and 2011, Transdata Incorporated (Transdata) filed lawsuits against three of our customers, CenterPoint Energy (CenterPoint), TriCounty Electric Cooperative, Inc. (Tri-County), and San Diego Gas & Electric Company (San Diego), a customer of recently acquired SmartSynch, and several other utilities, alleging infringement of three patents owned by Transdata related to the use of an antenna in a meter. Pursuant to our contractual obligations with our customers, we agreed to indemnify and defend them in these lawsuits. The complaints seek unspecified damages as well as injunctive relief. CenterPoint, Tri-County, and San Diego have denied all of the substantive allegations and filed counterclaims seeking a declaratory judgment that the patents are

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invalid and not infringed. In December 2011, the Judicial Panel on Multi-District Litigation consolidated all of these cases in the Western District of Oklahoma for pretrial proceedings. On April 17, 2011, the Oklahoma court stayed the litigation pending the resolution of re-examination proceedings in the United States Patent and Trademark Office (U.S. PTO). The U.S. PTO has issued re-examination certificates confirming the patentability of the original claims and allowing certain new claims added by TransData. The stay of the litigation has been lifted by the district court. We do not believe this matter will have a material adverse effect on our business or financial condition, although an unfavorable outcome could have a material adverse effect on our results of operations for the period in which such a loss is recognized.

On February 23, 2011, a purported class action lawsuit was filed in U.S. District Court for the Eastern District of Washington alleging violations of federal securities laws relating to a restatement of our financial results for the quarters ended March 31, June 30, and September 30, 2010. These revisions were made primarily to defer revenue that had been incorrectly recognized on one contract due to a misinterpretation of an extended warranty obligation. The effect of the restatement was to reduce revenue and earnings in each of the first three quarters of 2010. As a result of the restatement, total revenue for the first nine months of 2010 was reduced by $6.1 million and diluted EPS was reduced by $0.11. On August 22, 2011, the lead plaintiff in the federal securities lawsuit filed a consolidated complaint, which defendants moved to dismiss. On September 11, 2012, the U.S. District Court for the Eastern District of Washington granted defendants' motion to dismiss in its entirety and dismissed all claims against all defendants asserted in the consolidated complaint. On October 30, 2012, the lead plaintiff dismissed its complaint with prejudice, and the Court subsequently approved Plaintiffs' voluntary dismissal with prejudice.

In March 2011, a lawsuit was filed in the Superior Court of the State of Washington in and for Spokane County against certain current or former officers and directors seeking unspecified damages on behalf of Itron, Inc. The complaint alleges that the defendants breached their fiduciary obligations to Itron with respect to the restatement of Itron's financial results for the quarters ended March 31, June 30, and September 30, 2010. This lawsuit is a shareholder derivative action that purports to assert claims on behalf of Itron, Inc. This purported derivative action had been stayed pending the outcome of the motion to dismiss in the federal securities lawsuit referred to above, but, as a result of the September 11, 2012 dismissal order, the stay has been lifted. Defendants intend to seek dismissal of this purported derivative action, and the Superior Court has set a schedule for briefing and hearing the motion to dismiss. Briefing on the motion to dismiss will be completed in April 2013, and the Superior Court has scheduled a hearing on the motion to dismiss for May 2013. Defendants believe they have valid defenses to this derivative action and intend to defend themselves vigorously.

In June 2011, a lawsuit was filed in the United States District Court for the Eastern District of Texas alleging infringement of three patents owned by EON Corp. IP Holdings, LLC (EON), related to two-way communication networks, network components, and related software platforms. The complaint seeks unspecified damages as well as injunctive relief. On July 16, 2012, Itron filed a Motion to Sever and Transfer Venue to the Eastern District of Washington. The decision on this motion is pending. We believe these claims are without merit and we intend to vigorously defend our interests. We do not believe this matter will have a material adverse effect on our business or financial condition, although an unfavorable outcome could have a material adverse effect on our results of operations for the period in which the claim is resolved.

Warranty
A summary of the warranty accrual account activity is as follows:
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2012
 
2011
 
2012
 
2011
 
(in thousands)
Beginning balance
$
66,368

 
$
62,838

 
$
79,536

 
$
51,283

New product warranties
1,996

 
1,512

 
7,632

 
5,591

Other changes/adjustments to warranties
(1,552
)
 
26,263

 
509

 
40,906

Claims activity
(12,050
)
 
(9,207
)
 
(31,625
)
 
(18,422
)
Effect of change in exchange rates
925