ITRI 10Q 6.30.13
Table of Contents

 
 
 
 
 
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 June 30, 2013

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 July 31, 2013 there were outstanding 39,111,850 shares of the registrant’s common stock, no par value, which is the only class of common stock of the registrant.
 


Table of Contents

Itron, Inc.
Table of Contents
 
 
 
 
Page    
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Item 1A: Risk Factors
 
 
 
 
 
 
Item 6: Exhibits
 
 
 
 


Table of Contents

PART I: FINANCIAL INFORMATION
Item 1: Financial Statements (Unaudited)
ITRON, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2013
 
2012
 
2013
 
2012
 
(in thousands, except per share data)
Revenues
$
482,175

 
$
579,140

 
$
929,711

 
$
1,150,780

Cost of revenues
322,587

 
382,395

 
630,000

 
770,930

Gross profit
159,588

 
196,745

 
299,711

 
379,850

 
 
 
 
 
 
 
 
Operating expenses
 
 
 
 
 
 
 
Sales and marketing
46,182

 
50,847

 
94,398

 
100,703

Product development
43,481

 
46,640

 
87,689

 
90,996

General and administrative
38,317

 
33,450

 
71,912

 
70,020

Amortization of intangible assets
10,247

 
12,025

 
20,991

 
23,938

Restructuring expense
3,385

 
7,720

 
4,398

 
8,509

Total operating expenses
141,612

 
150,682

 
279,388

 
294,166

 
 
 
 
 
 
 
 
Operating income
17,976

 
46,063

 
20,323

 
85,684

Other income (expense)
 
 
 
 
 
 
 
Interest income
194

 
177

 
1,255

 
370

Interest expense
(2,336
)
 
(2,606
)
 
(4,674
)
 
(5,043
)
Other income (expense), net
(1,742
)
 
(779
)
 
(2,559
)
 
(2,955
)
Total other income (expense)
(3,884
)
 
(3,208
)
 
(5,978
)
 
(7,628
)
 
 
 
 
 
 
 
 
Income before income taxes
14,092

 
42,855

 
14,345

 
78,056

Income tax benefit (provision)
(1,896
)
 
(10,564
)
 
1,347

 
(20,193
)
Net income
12,196

 
32,291

 
15,692

 
57,863

Net income (loss) attributable to noncontrolling interests
(203
)
 
676

 
723

 
895

Net income attributable to Itron, Inc.
$
12,399

 
$
31,615

 
$
14,969

 
$
56,968

 
 
 
 
 
 
 
 
Earnings per common share - Basic
$
0.31

 
$
0.79

 
$
0.38

 
$
1.43

Earnings per common share - Diluted
$
0.31

 
$
0.79

 
$
0.38

 
$
1.42

 
 
 
 
 
 
 
 
Weighted average common shares outstanding - Basic
39,431

 
39,887

 
39,426

 
39,900

Weighted average common shares outstanding - Diluted
39,678

 
40,126

 
39,724

 
40,170

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


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

 
Three Months Ended
June 30,
 
Six Months Ended
June 30,
 
2013
 
2012
 
2013
 
2012
 
(in thousands)
Net income
$
12,196

 
$
32,291

 
$
15,692

 
$
57,863

Other comprehensive income (loss), net of tax:
 
 
 
 
 
 
 
Foreign currency translation adjustments
7,180

 
(52,331
)
 
(24,120
)
 
(23,790
)
Net unrealized gain (loss) on derivative instruments, designated as cash flow hedges
845

 
(849
)
 
772

 
(849
)
Pension plan benefit liability adjustment
183

 
22

 
(197
)
 
45

Total other comprehensive income (loss), net of tax
8,208

 
(53,158
)
 
(23,545
)
 
(24,594
)
Total comprehensive income (loss), net of tax
20,404

 
(20,867
)
 
(7,853
)
 
33,269

Comprehensive income (loss) attributable to noncontrolling interests, net of tax:
 
 
 
 
 
 
 
Net income (loss) attributable to noncontrolling interests
(203
)
 
676

 
723

 
895

Foreign currency translation adjustments
5

 
40

 

 
40

Amounts attributable to noncontrolling interests
(198
)
 
716

 
723

 
935

Comprehensive income (loss) attributable to Itron, Inc.
$
20,602

 
$
(21,583
)
 
$
(8,576
)
 
$
32,334

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

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ITRON, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands)
 
June 30, 2013
 
December 31, 2012
 
(unaudited)
 
 
ASSETS
 
 
 
Current assets
 
 
 
Cash and cash equivalents
$
103,662

 
$
136,411

Accounts receivable, net
372,240

 
375,326

Inventories
190,414

 
170,719

Deferred tax assets current, net
33,138

 
33,536

Other current assets
112,014

 
104,958

Total current assets
811,468

 
820,950

 
 
 
 
Property, plant, and equipment, net
249,372

 
255,212

Deferred tax assets noncurrent, net
55,397

 
44,584

Other long-term assets
26,607

 
28,908

Intangible assets, net
210,849

 
238,771

Goodwill
696,215

 
701,016

Total assets
$
2,049,908

 
$
2,089,441

 
 
 
 
LIABILITIES AND EQUITY
 
 
 
Current liabilities
 
 
 
Accounts payable
$
203,092

 
$
227,739

Other current liabilities
54,988

 
49,950

Wages and benefits payable
84,831

 
91,802

Taxes payable
15,481

 
9,305

Current portion of debt
22,500

 
18,750

Current portion of warranty
24,709

 
27,115

Unearned revenue
50,799

 
42,712

Total current liabilities
456,400

 
467,373

 
 
 
 
Long-term debt
387,500

 
398,750

Long-term warranty
25,923

 
26,490

Pension plan benefit liability
89,948

 
90,533

Deferred tax liabilities noncurrent, net
11,235

 
16,682

Other long-term obligations
81,229

 
80,100

Total liabilities
1,052,235

 
1,079,928

 
 
 
 
Commitments and contingencies

 

 
 
 
 
Equity
 
 
 
Preferred stock

 

Common stock
1,290,226

 
1,294,213

Accumulated other comprehensive loss, net
(57,929
)
 
(34,384
)
Accumulated deficit
(251,893
)
 
(266,862
)
Total Itron, Inc. shareholders' equity
980,404

 
992,967

Noncontrolling interests
17,269

 
16,546

Total equity
997,673

 
1,009,513

Total liabilities and equity
$
2,049,908

 
$
2,089,441

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

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ITRON, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
 
 
Six Months Ended
June 30,
 
2013
 
2012
 
(in thousands)
Operating activities
 
 
 
Net income
$
15,692

 
$
57,863

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Depreciation and amortization
49,031

 
54,271

Stock-based compensation
10,122

 
9,256

Amortization of prepaid debt fees
829

 
763

Deferred taxes, net
(11,543
)
 
628

Restructuring expense, non-cash
27

 
1,487

Other adjustments, net
324

 
(11
)
Changes in operating assets and liabilities, net of acquisition:
 
 
 
Accounts receivable
(4,278
)
 
8,046

Inventories
(25,124
)
 
(2,786
)
Other current assets
(9,408
)
 
(13,663
)
Other long-term assets
4,489

 
3,559

Accounts payable, other current liabilities, and taxes payable
(10,280
)
 
(5,817
)
Wages and benefits payable
(5,661
)
 
(11,244
)
Unearned revenue
10,497

 
5,627

Warranty
(1,797
)
 
(11,991
)
Other operating, net
(3,946
)
 
(3,598
)
Net cash provided by operating activities
18,974

 
92,390

 
 
 
 
Investing activities
 
 
 
Acquisitions of property, plant, and equipment
(28,895
)
 
(23,547
)
Business acquisitions, net of cash and cash equivalents acquired
(860
)
 
(79,605
)
Other investing, net
241

 
3,993

Net cash used in investing activities
(29,514
)
 
(99,159
)
 
 
 
 
Financing activities
 
 
 
Proceeds from borrowings
15,000


70,000

Payments on debt
(22,500
)
 
(67,502
)
Issuance of common stock
2,590

 
2,407

Repurchase of common stock
(16,126
)
 
(25,976
)
Other financing, net
2,220

 
(271
)
Net cash used in financing activities
(18,816
)
 
(21,342
)
 
 
 
 
Effect of foreign exchange rate changes on cash and cash equivalents
(3,393
)
 
(2,175
)
Decrease in cash and cash equivalents
(32,749
)
 
(30,286
)
Cash and cash equivalents at beginning of period
136,411

 
133,086

Cash and cash equivalents at end of period
$
103,662

 
$
102,800

 
 
 
 
Non-cash transactions:
 
 
 
Property, plant, and equipment purchased but not yet paid
$
7,284

 
$
4,364

 
 
 
 
Supplemental disclosure of cash flow information:
 
 
 
Cash paid during the period for:
 
 
 
Income taxes, net
$
8,200

 
$
20,173

Interest, net of amounts capitalized
3,804

 
4,275

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

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ITRON, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2013
(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 six months ended June 30, 2013 and 2012, the Consolidated Balance Sheets as of June 30, 2013 and December 31, 2012, and the Consolidated Statements of Cash Flows for the six months ended June 30, 2013 and 2012 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 2012 audited financial statements and notes included in our Annual Report on Form 10-K filed with the SEC on February 22, 2013. The results of operations for the three and six months ended June 30, 2013 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 are 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.

Business Acquisitions
On May 1, 2012, we completed the acquisition of SmartSynch, Inc. (SmartSynch). SmartSynch provides smart grid solutions that utilize cellular networks for communications.

In January 2011, we completed the acquisition of a software and consulting services company in France, which included contingent and deferred consideration amounts that were paid in the first quarters of 2012 and 2013. 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.

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

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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. Ineffective portions of cash flow hedges are recognized in other income (expense) in the Consolidated Statements of Operations. 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 software, and furniture. Leasehold improvements are capitalized and depreciated 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 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 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

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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 finite-lived intangible assets are amortized over their estimated useful lives based on estimated discounted cash flows. IPR&D is considered an indefinite-lived intangible asset and is not subject to amortization until the associated projects are completed or terminated. Finite-lived 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. Indefinite-lived intangible assets are tested for impairment annually, when events or changes in circumstances indicate the asset may be impaired, or at the time when their useful lives are determined to be no longer indefinite.

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.

We test goodwill for impairment each year as of October 1, or more frequently should a significant impairment indicator occur. As part of the impairment test, we may elect to perform an assessment of qualitative factors. If this qualitative assessment indicates that it is more likely than not that the fair value of a reporting unit, including goodwill, is less than its carrying amount, or if we elect to bypass the qualitative assessment, we would then proceed with the two-step impairment test. The impairment test involves comparing the fair values 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 the goodwill impairment loss amount. This second step determines the current fair values of all assets and liabilities of the reporting unit 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.

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,

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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 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 less costs to sell are less than the net book value. 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, a portion of the Company's goodwill balance is allocated to it based on relative fair value.

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 up to $50 million of shares of Itron common stock under a twelve-month program, which was authorized by our Board of Directors on March 8, 2013. 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; the value of the repurchased shares is deducted from common stock.

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

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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.
If, among other factors, the data collection system does not use standard internet protocols and network design services are deemed complex and extensive, hardware revenues are recognized at the time of shipment, receipt by customer, or, if applicable, upon completion of customer acceptance provisions. Revenue from network software and services is recognized using the units-of-delivery method of contract accounting, as network design services and network software are essential to the functionality of the related hardware (network). This methodology results in the deferral of costs and revenues as professional services and software implementation commence prior to deployment of hardware.

In all other instances, hardware revenues are recognized at the time of shipment, receipt by customer, or, if applicable, upon completion of customer acceptance provisions. Network software is recognized when shipped if all other revenue recognition criteria are met and services are not essential to the functionality of the software. If implementation services are essential to the functionality of the network software, software and implementation revenues are recognized using the percentage-of-completion methodology of contract accounting when project costs are reliably estimated.

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 that 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). 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. If neither VSOE nor TPE of selling price exists for a unit of accounting, we use estimated selling price (ESP) 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. The factors considered include the cost to produce the deliverable, the anticipated margin on that deliverable, our ongoing pricing strategy and policies, 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 $83.7 million and $74.9 million at June 30, 2013 and December 31, 2012 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 $27.7 million and $24.4 million at June 30, 2013 and December 31, 2012 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 as the costs incurred are immaterial for the relatively short period of time between technological feasibility and the completion of software development.

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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 term. 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 performance-based restricted stock units and unrestricted stock awards with no market conditions, the fair value is the market close price of our common stock on the date of grant. For restricted stock units with market conditions, the fair value is estimated at the date of award using a Monte Carlo simulation model, which includes assumptions for dividend yield and expected volatility for our common stock and the common stock for companies within the Russell 3000 index, as well as the risk-free interest rate and expected term of the awards. 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 performance and service conditions, if vesting is 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. For awards with a market condition, we expense the fair value over the requisite service period. 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 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 uncertain tax positions, amount other items. 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 that includes the enactment date. A valuation allowance is recorded to reduce the carrying amount of deferred tax assets if it is more likely than not that such assets will not 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.


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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.

New Accounting Pronouncements
The Financial Accounting Standards Board issued Accounting Standards Update (ASU) 2013.11, "Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists" on July 18, 2013. The ASU concludes an unrecognized tax benefit should be presented as a reduction of a deferred tax asset when settlement in this manner is available under the law. We will adopt this amendment as of January 2014. The result of adoption may be to reclassify certain long term liabilities to long term deferred tax assets, and the adoption will not result in a change to the tax provision. Management does not believe that the impact on the balance sheet will be significant.

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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 June 30,
 
Six Months Ended June 30,
 
2013
 
2012
 
2013
 
2012
 
(in thousands, except per share data)
Net income available to common shareholders
$
12,399

 
$
31,615

 
$
14,969

 
$
56,968

 
 
 
 
 
 
 
 
Weighted average common shares outstanding - Basic
39,431

 
39,887

 
39,426

 
39,900

Dilutive effect of stock-based awards
247

 
239

 
298

 
270

Weighted average common shares outstanding - Diluted
39,678

 
40,126

 
39,724

 
40,170

Earnings per common share - Basic
$
0.31

 
$
0.79

 
$
0.38

 
$
1.43

Earnings per common share - Diluted
$
0.31

 
$
0.79

 
$
0.38

 
$
1.42


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 1.1 million and 1.2 million stock-based awards were excluded from the calculation of diluted EPS for each of the three and six months ended June 30, 2013, and approximately 1.4 million and 1.3 million stock-based awards were excluded from the calculation of diluted EPS for each of the three and six months ended June 30, 2012, 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 would 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. There was no preferred stock issued or outstanding at June 30, 2013 and December 31, 2012.

Stock Repurchase Plan
On March 8, 2013, the Board authorized a twelve-month repurchase program of up to $50 million of our common stock. As of June 30, 2013, we have repurchased 384,800 shares of our common stock, totaling $16.1 million, with $33.9 million remaining under the repurchase program. Repurchases are made in the open market or in privately negotiated transactions, and in accordance with applicable securities laws. Refer to Part II, Item 2: "Unregistered Sales of Equity Securities and Use of Proceeds" for additional information related to our share repurchase program.
Note 3:    Certain Balance Sheet Components
 
Accounts receivable, net
June 30, 2013
 
December 31, 2012
 
(in thousands)
Trade receivables (net of allowance of $6,948 and $7,372)
$
330,956

 
$
329,352

Unbilled receivables
41,284

 
45,974

Total accounts receivable, net
$
372,240

 
$
375,326


At June 30, 2013 and December 31, 2012, $19.0 million and $20.0 million were recorded within trade receivables as billed but not yet paid by customers, in accordance with contract retainage provisions. At June 30, 2013 and December 31, 2012, contract retainage amounts that were unbilled and classified as unbilled receivables were $11.1 million. We had no long-term unbilled receivables or long-term retainage contract receivables at June 30, 2013 and December 31, 2012, as we expect to collect all contract retainage receivables within the following 12 months.


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Allowance for doubtful account activity
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2013
 
2012
 
2013
 
2012
 
(in thousands)
Beginning balance
$
6,144

 
$
5,983

 
$
7,372

 
$
6,049

Provision (release) of doubtful accounts, net
1,075

 
(230
)
 
171

 
(290
)
Accounts written-off
(198
)
 
(22
)
 
(303
)
 
(261
)
Effects of change in exchange rates
(73
)
 
(350
)
 
(292
)
 
(117
)
Ending balance
$
6,948

 
$
5,381

 
$
6,948

 
$
5,381

 
Inventories
June 30, 2013
 
December 31, 2012
 
(in thousands)
Materials
$
104,283

 
$
92,038

Work in process
13,879

 
12,568

Finished goods
72,252

 
66,113

Total inventories
$
190,414

 
$
170,719


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 $5.7 million and $5.0 million at June 30, 2013 and December 31, 2012, respectively.

Property, plant, and equipment, net
June 30, 2013
 
December 31, 2012
 
(in thousands)
Machinery and equipment
$
290,500

 
$
287,791

Computers and software
88,186

 
84,980

Buildings, furniture, and improvements
143,420

 
146,191

Land
24,663

 
25,318

Construction in progress, including purchased equipment
33,529

 
26,097

Total cost
580,298

 
570,377

Accumulated depreciation
(330,926
)
 
(315,165
)
Property, plant, and equipment, net
$
249,372

 
$
255,212


Depreciation expense and capitalized interest
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2013
 
2012
 
2013
 
2012
 
(in thousands)
Depreciation expense
$
14,027

 
$
15,019

 
$
28,040

 
$
30,333

Capitalized interest
21

 

 
64

 


In conjunction with the upgrade of our global enterprise resource planning software systems, we have capitalized $11.1 million within construction in progress at June 30, 2013. Amounts capitalized include internal labor costs and related benefits, software, third-party consulting fees, and $21,000 and $64,000 of interest for the three and six months ended June 30, 2013, respectively.

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Note 4:    Intangible Assets

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

 
June 30, 2013
 
December 31, 2012
 
Gross Assets
 
Accumulated
Amortization
 
Net
 
Gross Assets
 
Accumulated
Amortization
 
Net
 
(in thousands)
Core-developed technology
$
420,055

 
$
(338,145
)
 
$
81,910

 
$
407,024

 
$
(332,763
)
 
$
74,261

Customer contracts and relationships
281,644

 
(159,231
)
 
122,413

 
292,252

 
(154,890
)
 
137,362

Trademarks and trade names
71,356

 
(64,897
)
 
6,459

 
72,770

 
(65,090
)
 
7,680

Other
11,091

 
(11,024
)
 
67

 
11,094

 
(11,026
)
 
68

Total intangible assets subject to amortization
784,146

 
(573,297
)
 
210,849

 
783,140

 
(563,769
)
 
219,371

In-process research and development

 
 
 

 
19,400

 
 
 
19,400

Total intangible assets
$
784,146

 
$
(573,297
)
 
$
210,849

 
$
802,540

 
$
(563,769
)
 
$
238,771


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

 
Six Months Ended June 30,
 
2013
 
2012
 
(in thousands)
Beginning balance, intangible assets, gross
$
802,540

 
$
749,194

Intangible assets acquired
(1,500
)
 
43,400

Effect of change in exchange rates
(16,894
)
 
(13,835
)
Ending balance, intangible assets, gross
$
784,146

 
$
778,759


Intangible assets acquired in 2012 were related to the SmartSynch acquisition on May 1, 2012, including IPR&D assets that consisted primarily of projects to upgrade the hardware components of cellular communication modules to be compatible with 3G cellular network standards. Upon completion of these projects in March 2013, we performed a qualitative assessment and determined that it was more than likely that the carrying amount of IPR&D was not impaired. Accordingly, the carrying amount of IPR&D was reclassified as core-developed technology and will be amortized over its expected useful life of seven years based on the SmartSynch acquisition discounted cash flow valuation model. For the six months ended June 30, 2013, the adjustment of $1.5 million to intangible assets acquired is associated with the correction of an error for a long-term revenue contract from the SmartSynch acquisition. See Note 5 for further discussion of the correction of the error and its impact on goodwill.

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)
2013 (amount remaining at June 30, 2013)
$
20,734

2014
43,434

2015
34,800

2016
27,345

2017
20,314

Beyond 2017
64,222

Total intangible assets, net
$
210,849


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Note 5:    Goodwill

The following table reflects the goodwill balance as of June 30, 2013:

 
Energy
 
Water
 
Total Company
 
(in thousands)
Balance at January 1, 2013
 
 
 
 
 
Goodwill before impairment
$
859,454

 
$
414,394

 
$
1,273,848

Accumulated impairment losses
(249,502
)
 
(323,330
)
 
(572,832
)
Goodwill, net
609,952

 
91,064

 
701,016

 
 
 
 
 
 
Adjustments of previous acquisition
3,958

 

 
3,958

Effect of change in exchange rates
(7,551
)
 
(1,208
)
 
(8,759
)
 
 
 
 
 
 
Balance at June 30, 2013
 
 
 
 
 
Goodwill before impairment
851,471

 
407,497

 
1,258,968

Accumulated impairment losses
(245,112
)
 
(317,641
)
 
(562,753
)
Goodwill, net
$
606,359

 
$
89,856

 
$
696,215


During the second quarter of 2013, we finalized the purchase price allocation related to the SmartSynch acquisition, which was completed on May 1, 2012, and recorded certain adjustments that are reflected as Adjustments of previous acquisition. These adjustments primarily affected the fair value calculation of certain accrued liabilities associated with specific contracts. Among these adjustments is the correction of an error associated with a long-term revenue contract acquired from SmartSynch. In May 2013, we determined that certain manufacturing costs were not reflected in the model used to value this contract at acquisition. Once these costs were properly added to the total cost and profitability estimates, we determined the total contract would result in a loss of $2.4 million over the contract term. Therefore, we recognized a liability for this expected loss on the contract and made a corresponding adjustment to goodwill. Further, we had previously recognized a customer relationship intangible asset of $1.5 million associated with this contract, with amortization scheduled to begin in 2014 based on the contract's original projected cash flow. Since the contract is in an overall loss position, we determined that the intangible asset had no value. We reduced the value of this intangible asset to zero with a corresponding adjustment to goodwill. In accordance with relevant accounting guidance, we evaluated the materiality of the error from a qualitative and quantitative perspective. Based on such evaluation, we concluded that recognizing the contract liability and adjusting the intangible asset value would not be material, quantitatively or qualitatively, to our results of operations for the three months ended June 30, 2013 or our expected full year results of operations for 2013 and would not have had a material impact on our results for the year ended December 31, 2012. Because these adjustments were not material individually or in aggregate, we have not retrospectively adjusted the comparative amounts on the Consolidated Balance Sheet as of December 31, 2012.

Accumulated impairment losses relate to goodwill impairment charges recorded during 2011 as a result of a significant decline in the price of our shares of common stock at the end of September 2011, which reduced our aggregate market value significantly below the carrying value of our net assets as of September 30, 2011.

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.

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Note 6:    Debt

The components of our borrowings were as follows:

 
June 30, 2013
 
December 31, 2012
 
(in thousands)
Credit facility:
 
 
 
USD denominated term loan
$
270,000

 
$
277,500

Multicurrency revolving line of credit
140,000

 
140,000

Total debt
410,000

 
417,500

Less: current portion of debt
22,500

 
18,750

Long-term debt
$
387,500

 
$
398,750


Credit Facility
Our credit facility is dated August 5, 2011. The 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. 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 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 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 credit facility, are guaranteed by the foreign subsidiary and by its direct and indirect foreign parents. The 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 credit facility at June 30, 2013.

Scheduled principal repayments for the term loan are due quarterly in the amounts of $5.6 million from September 2013 through June 2014 and $7.5 million from September 2014 through June 2016, with 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 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 June 30, 2013, the interest rate for both the term loan and the revolver was 1.45% (the LIBOR rate plus a margin of 1.25%).

Total credit facility repayments were as follows:

 
Six Months Ended June 30,
 
2013
 
2012
 
(in thousands)
Term loan
$
7,500

 
$
7,502

Multicurrency revolving line of credit (1)
15,000

 
60,000

Total credit facility repayments
$
22,500

 
$
67,502


(1)
We borrowed $15.0 million and $70.0 million under the multicurrency revolving line of credit during the six months ended June 30, 2013 and 2012.

At June 30, 2013, $140.0 million was outstanding under the credit facility revolver, and $47.0 million was utilized by outstanding standby letters of credit, resulting in $473.0 million available for additional borrowings.

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Unamortized prepaid debt fees were as follows:

 
June 30, 2013
 
December 31, 2012
 
(in thousands)
Unamortized prepaid debt fees
$
4,588

 
$
5,367

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 include 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 for these inputs. We include, as a discount to the derivative asset, 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 June 30, 2013 and December 31, 2012 were as follows:
 
 
 
 
 
Fair Value
 
 
Balance Sheet Location
 
June 30,
2013
 
December 31,
2012
 
 
 
 
(in thousands)
Asset Derivatives
 
 
 
 
Derivatives not designated as hedging instruments under ASC 815-20
 
 
 
 
Foreign exchange forward contracts
 
Other current assets
 
$
122

 
$
146

 
 
 
 
 
 
 
Liability Derivatives
 
 
 
 
 
 
Derivatives designated as hedging instruments under ASC 815-20
 
 
 
 
Interest rate swap contracts
 
Other current liabilities
 
$
1,348

 
$
629

Interest rate swap contracts
 
Other long-term obligations
 
134

 
2,096

Derivatives not designated as hedging instruments under ASC 815-20
 
 
 
 
Foreign exchange forward contracts
 
Other current liabilities
 
108

 
114

Total liability derivatives
 
 
 
$
1,590

 
$
2,839


A summary of the potential effect of netting arrangements on our financial position related to the offsetting of our recognized derivative assets and liabilities under master netting arrangements or similar agreements is as follows:
Offsetting of Derivative Assets
 
 
 
 
 
 
 
 
Gross Amounts Not
Offset in the Consolidated Balance Sheets
 
 
 
Gross Amounts of Recognized Assets Presented in the Consolidated Balance Sheets
 
Derivative Financial Instruments
 
Cash Collateral Received
 
Net Amount
 
(in thousands)
June 30, 2013
$
122

 
$
(122
)
 
$

 
$

 
 
 
 
 
 
 
 
December 31, 2012
$
146

 
$
(135
)
 
$

 
$
11



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Table of Contents

Offsetting of Derivative Liabilities
 
 
 
 
 
 
 
 
Gross Amounts Not
Offset in the Consolidated Balance Sheets
 
 
 
Gross Amounts of Recognized Liabilities Presented in the Consolidated Balance Sheets
 
Derivative Financial Instruments
 
Cash Collateral Pledged
 
Net Amount
 
(in thousands)
June 30, 2013
$
1,590

 
$
(122
)
 
$

 
$
1,468

 
 
 
 
 
 
 
 
December 31, 2012
$
2,839

 
$
(135
)
 
$

 
$
2,704


Our derivative assets and liabilities consist of foreign exchange forward and interest rate swap contracts with nine counterparties at June 30, 2013 and eight counterparties at December 31, 2012. None of our counterparties were individually significant at June 30, 2013 or December 31, 2012. Our derivative contracts with each of these counterparties exist under agreements that provide for the net settlement of all contracts through a single payment in a single currency in the event of default. We have no pledges of cash collateral against our obligations nor have we received pledges of cash collateral from our counterparties under the associated derivative contracts.

OCI during the reporting periods for our derivative hedging instruments, net of tax, was as follows:

 
2013
 
2012
 
(in thousands)
Net unrealized loss on hedging instruments at January 1,
$
(16,069
)
 
$
(14,380
)
Unrealized gain (loss) on derivative instruments
772

 
(849
)
Net unrealized loss on hedging instruments at June 30,
$
(15,297
)
 
$
(15,229
)

Included in the net unrealized loss on hedging instruments at June 30, 2013 and 2012 is a loss of $14.4 million, net of tax, related to our nonderivative net investment hedge, which terminated in 2011. This loss on our net investment hedge 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. These 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 $1.3 million. At June 30, 2013, our LIBOR based debt balance was $410.0 million.

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.


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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 six months ended June 30 were 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
 
 
2013
 
2012
 
 
 
2013
 
2012
 
 
 
2013
 
2012
 
 
(in thousands)
 
 
 
(in thousands)
 
 
 
(in thousands)
Three Months Ended June 30,
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest rate swap contracts
 
$
1,336

 
$
(1,365
)
 
Interest expense
 
$

 
$

 
Interest expense
 
$

 
$

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Six Months Ended June 30,
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest rate swap contracts
 
$
1,244

 
$
(1,365
)
 
Interest expense
 
$

 
$

 
Interest Expense
 
$

 
$


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 247 contracts were entered into during the six months ended June 30, 2013), which are not designated for hedge accounting, with the intent to reduce earnings volatility associated with certain of these non-functional currency assets and liabilities. The notional amounts of the contracts ranged from $251,000 to $11.0 million, offsetting our exposures to the euro, Saudi riyal, Canadian dollar, Australian dollar, Brazilian real, South African rand, and various other currencies.

The effect of our foreign exchange forward derivative instruments on the Consolidated Statements of Operations for the three and six months ended June 30 was as follows:
 
Derivatives Not Designated as
Hedging Instrument under ASC 815-20
 
Gain (Loss) Recognized on Derivatives in Other Income (Expense)
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
 
2013
 
2012
 
2013
 
2012
 
 
(in thousands)
Foreign exchange forward contracts
 
$
(971
)
 
$
(244
)
 
$
(757
)
 
$
(421
)
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, 2012.
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:
 
 
June 30, 2013
 
December 31, 2012
 
(in thousands)
Assets
 
 
 
Plan assets in other long-term assets
$
226

 
$
227

 
 
 
 
Liabilities
 
 
 
Current portion of pension plan liability in wages and benefits payable
3,157

 
2,899

Long-term portion of pension plan liability
89,948

 
90,533

 
 
 
 
Net pension plan benefit liability
$
92,879

 
$
93,205


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

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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 $110,000 and $355,000 to the defined benefit pension plans for the six months ended June 30, 2013 and 2012, respectively. The timing of when contributions are made can vary by plan and from year to year. For 2013, 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 $568,000 to our defined benefit pension plans. We contributed $440,000 to the defined benefit pension plans for the year ended December 31, 2012.
Net periodic pension benefit costs for our plans include the following components:

 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2013
 
2012
 
2013
 
2012
 
(in thousands)
Service cost
$
1,011

 
$
676

 
$
1,992

 
$
1,414

Interest cost
786

 
909

 
1,586

 
1,835

Expected return on plan assets
(79
)
 
(82
)
 
(158
)
 
(167
)
Settlements and other

 

 
(814
)
 

Amortization of actuarial net loss
246

 
2

 
497

 
4

Amortization of unrecognized prior service costs
17

 
17

 
34

 
34

Net periodic benefit cost
$
1,981

 
$
1,522

 
$
3,137

 
$
3,120

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 requisite service period. Capitalized stock-based compensation amounts were not material for the three and six months ended June 30, 2013 and 2012. For the three and six months ended June 30, stock-based compensation expense and the related tax benefit were as follows:
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2013
 
2012
 
2013
 
2012
 
(in thousands)
Stock options
$
519

 
$
337

 
$
992

 
$
609

Restricted stock units
4,158

 
4,375

 
8,393

 
7,891

Unrestricted stock awards
205

 
205

 
402

 
410

ESPP
144

 
141

 
335

 
346

Total stock-based compensation
$
5,026

 
$
5,058

 
$
10,122

 
$
9,256

 
 
 
 
 
 
 
 
Related tax benefit
$
1,391

 
$
1,375

 
$
2,755

 
$
2,564


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 June 30, 2013, 431,758 shares were available for grant under the Stock Incentive Plan. The Stock Incentive Plan shares are subject to a fungible share provision such that, with respect to grants made after December 31, 2009, the authorized share reserve is reduced by (i) one share for every one share subject to a stock option or share appreciation right granted under the Plan and (ii) 1.7 shares for every one share of common stock that was subject to an award other than an option or stock appreciation right.

Stock Options
Options to purchase our common stock are granted to employees and members of 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.


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Table of Contents

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 June 30,
 
Six Months Ended June 30,
 
2013(1)
 
2012(1)
 
2013
 
2012
Dividend yield
%
 
%
 
%
 
%
Expected volatility
%
 
%
 
38.1
%
 
42.7
%
Risk-free interest rate
%
 
%
 
1.0
%
 
0.9
%
Expected term (years)

 

 
5.45

 
5.14


(1) 
There were no employee stock options granted for the three months ended June 30, 2013 and 2012.

Expected volatility is based on a combination of the historical volatility of our common stock and the implied volatility of our traded options for the related expected term. We believe this combined approach is reflective of current and historical market conditions and is 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.

A summary of our stock option activity for the six months ended June 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, 2012
1,109

 
$
55.97

 
4.51
 
$
2,323

 
 
Granted
54

 
48.23

 
 
 
 
 
$
18.64

Exercised
(28
)
 
20.32

 
 
 
$
576

 
 
Expired
(32
)
 
69.69

 
 
 
 
 
 
Outstanding, June 30, 2012
1,103

 
$
56.10

 
4.32
 
$
3,090

 
 
 
 
 
 
 
 
 
 
 
 
Outstanding, January 1, 2013
1,137

 
$
54.06

 
4.81
 
$
3,815

 
 
Granted
128

 
42.76

 
 
 
 
 
$
15.44

Exercised
(32
)
 
23.36

 
 
 
$
639

 
 
Expired
(8
)
 
49.92

 
 
 
 
 
 
Outstanding, June 30, 2013
1,225

 
$
53.71

 
4.99
 
$
2,388

 
 
 
 
 
 
 
 
 
 
 
 
Exercisable, June 30, 2013
901

 
$
57.52

 
3.43
 
$
2,186

 
 
 
 
 
 
 
 
 
 
 
 
Expected to vest, June 30, 2013
304

 
$
43.17

 
9.32
 
$
190

 
 

(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 June 30, 2013, total unrecognized stock-based compensation expense related to nonvested stock options was approximately $4.1 million, which is expected to be recognized over a weighted average period of approximately 2.3 years.

Restricted Stock Units
Certain employees, senior management, and members of the Board of Directors 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 requisite service period.


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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.

Prior to 2013, the performance-based restricted stock units issued under the Long-Term Performance Restricted Stock Unit Award Agreement (Performance Award Agreement) were determined based on the attainment of certain performance goals after the end of the one-year performance period. During the year, if management determined that it was probable that the targets would be achieved, compensation expense, net of forfeitures, was 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 vested and were 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 vesting period, unvested restricted stock units immediately vest at the date of retirement. For the 2012 performance awards, no awards became eligible for vesting as minimum performance thresholds for the 2012 performance year were not met.

For 2013, the performance-based restricted stock units to be issued under the Performance Award Agreement are determined based on (1) our achievement of specified non-GAAP EPS targets, as established at the beginning of each year for each of the calendar years contained in the performance periods (2-year and 3-year awards) (the performance condition) and (2) our total shareholder return (TSR) relative to the TSR attained by companies that are included in the Russell 3000 Index during the performance periods (the market condition). Compensation expense, net of forfeitures, is recognized on a straight-line basis, and the units vest upon achievement of the performance condition, provided participants are employed by Itron at the end of the respective performance periods. 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.
Depending on the level of achievement of the performance condition, the actual number of shares to be earned ranges between 0% and 160% of the awards originally granted. At the end of the 2-year and 3-year performance periods, if the performance conditions are achieved at or above threshold, the number of shares earned is further adjusted by a TSR multiplier payout percentage, which ranges between 75% and 125%, based on the market condition. Therefore, based on the attainment of the performance and market conditions, the actual number of shares that vest may range from 0% to 200% of the awards originally granted. Due to the presence of the TSR multiplier market condition, we utilize a Monte Carlo valuation model to determine the fair value of the awards at the grant date. This pricing model uses multiple simulations to evaluate the probability of our achievement of various stock price levels to determine our expected TSR performance ranking. The weighted-average assumptions used to estimate the fair value of performance-based restricted stock units awarded and the resulting weighted average fair-value are as follows:

 
Three Months Ended
June 30, 2013
 
Six Months Ended
June 30, 2013
Dividend yield
%
 
%
Expected volatility
39.1
%
 
39.1
%
Risk-free interest rate
0.3
%
 
0.3
%
Expected term (years)
2.53

 
2.53

 
 
 
 
Weighted-average fair value
$
45.70

 
$
45.03


Expected volatility is based on the historical volatility of our common stock for the related expected term. We believe this approach is reflective of current and historical market conditions and is 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 term of the award. The expected term is the term of an award based on the period of time between the date of the award and the date the award is expected to vest. The expected term assumption is based upon the plan's performance period as of the date of the award. We have not paid dividends in the past and do not plan to pay dividends in the foreseeable future.


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Table of Contents

The following table summarizes restricted stock unit activity for the six months ended June 30:

 
Number of
Restricted Stock Units
 
Weighted
Average  Grant
Date Fair Value
 
Aggregate
Intrinsic Value(1)
 
(in thousands)
 
 
 
(in thousands)
Outstanding, January 1, 2012
625

 
 
 
 
Granted(2)
443

 
$
47.33

 
 
Released
(176
)
 
 
 
$
11,536

Forfeited
(28
)
 
 
 
 
Outstanding, June 30, 2012
864

 
 
 
 
 
 
 
 
 
 
Outstanding, January 1, 2013
774

 
 
 
 
Granted(2)
255

 
$
42.51

 
 
Released
(253
)
 
 
 
$
13,562

Forfeited
(11
)
 
 
 
 
Outstanding, June 30, 2013
765

 
 
 
 
 
 
 
 
 
 
Vested but not released, June 30, 2013
29

 
 
 
$
1,244

 
 
 
 
 
 
Expected to vest, June 30, 2013
672

 
 
 
$
28,496


(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) 
Restricted stock units granted in 2012 and 2013 do not include awards under the Performance Award Agreement for the respective years, as these awards are not granted until final attainment of performance goals has been determined at the conclusion of the performance period, which had not occurred as of June 30, 2012 and 2013, respectively.

At June 30, 2013, unrecognized compensation expense on restricted stock units was $24.2 million, which is expected to be recognized over a weighted average period of approximately 1.9 years.

Unrestricted Stock Awards
We grant unrestricted stock awards to members of 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 six months ended June 30:
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2013
 
2012
 
2013
 
2012
Shares of unrestricted stock granted
4,518

 
4,526

 
8,847

 
9,979

 
 
 
 
 
 
 
 
Weighted average grant date fair value per share
$
45.37

 
$
45.26

 
$
45.40

 
$
41.05


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.


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Table of Contents

The following table summarizes ESPP activity for the three and six months ended June 30:

 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2013
 
2012
 
2013
 
2012
Shares of stock sold to employees(1)
27,489

 
30,619

 
47,308

 
53,676

 
 
 
 
 
 
 
 
Weighted average fair value per ESPP award(2)
$
6.37

 
$
6.19

 
$
6.69

 
$
6.55


(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 six months ended June 30.

At June 30, 2013, all compensation cost associated with the ESPP had been recognized. There were approximately 553,000 shares of common stock available for future issuance under the ESPP at June 30, 2013.
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 uncertain tax positions, among other items.

Our tax benefit for the first six months of 2013 reflects the favorable discrete tax benefit for the retroactive extension of the 2012 research and experimentation credit in the amount of $4.0 million. The American Taxpayer Relief Act of 2012 was signed into law on January 2, 2013 and extended several business tax provisions including the research and experimentation credit. Our annual estimated effective tax rate for 2013 was favorably impacted by a higher percentage of projected earnings in foreign jurisdictions with tax rates below 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.  Accordingly, our 2013 annual estimated effective tax rate is lower than our 2012 annual estimated effective tax rate.

Our tax provision in 2012 was lower than the federal statutory rate of 35% 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.

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 June 30,
 
Six Months Ended June 30,
 
2013
 
2012
 
2013
 
2012
 
(in thousands)
Net interest and penalties expense
$
168

 
$
(22
)
 
$
339

 
$
265


Accrued interest and penalties recorded are as follows:

 
June 30, 2013
 
December 31, 2012
 
(in thousands)
Accrued interest
$
3,251

 
$
3,095

Accrued penalties
3,009

 
3,030



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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:
 
 
June 30, 2013
 
December 31, 2012
 
(in thousands)
Unrecognized tax benefits related to uncertain tax positions
$
26,853

 
$
26,433

The amount of unrecognized tax benefits that, if recognized, would affect our effective tax rate
26,141

 
25,852


We believe it is reasonably possible that our unrecognized tax benefits may decrease by approximately $1.3 million within the next twelve months due to the expiration of the statute of limitations. At June 30, 2013, 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 (LOCs) or bonds in support of our obligations for customer contracts. These standby LOCs 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 LOCs, and bonds are as follows:
 
 
June 30, 2013
 
December 31, 2012
 
(in thousands)
Credit facilities(1)
 
 
 
Multicurrency revolving line of credit
$
660,000

 
$
660,000

Long-term borrowings
(140,000
)
 
(140,000
)
Standby LOCs issued and outstanding
(47,037
)
 
(54,328
)
Net available for additional borrowings and LOCs
$
472,963

 
$
465,672

 
 
 
 
Unsecured multicurrency revolving lines of credit with various financial institutions
 
 
 
Multicurrency revolving lines of credit
$
97,456

 
$
67,308

Standby LOCs issued and outstanding
(29,581
)
 
(29,906
)
Short-term borrowings(2)
(2,731
)
 
(851
)
Net available for additional borrowings and LOCs
$
65,144

 
$
36,551


 
 
 
Unsecured surety bonds in force
$
136,934

 
$
164,820


(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.

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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 June 30, 2013 were not material to our financial condition or results of operations.

In 2010 and 2011, Transdata Incorporated (Transdata) filed lawsuits against four of our customers, CenterPoint Energy (CenterPoint), TriCounty Electric Cooperative, Inc. (Tri-County), San Diego Gas & Electric Company (San Diego), and Texas-New Mexico Power Company (TNMP), as well as 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, subject to certain exceptions, to indemnify and defend them in these lawsuits. The complaints seek unspecified damages as well as injunctive relief. CenterPoint, Tri-County, San Diego, and TNMP have denied all of the substantive allegations and filed counterclaims seeking a declaratory judgment that the patents are 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 parties conducted a claim construction hearing on February 5, 2013 on one claim term -- "electric meter circuitry." After initially adopting defendants' proposed construction of the term, the Court granted TransData's motion for reconsideration by order of June 25, 2013, and has adopted TransData's proposed construction. A claim construction hearing on the remaining terms is scheduled for late September 2013. Most of the remaining deadlines are based on the date of the Court's decision relating to those remaining terms. No trials are scheduled. 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.

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. The Court has construed key terms of the three patents and has granted requests to file motions for summary judgment. We do not believe this matter will have a material adverse effect on our business or financial condition.

In a series of cases, approximately 270 former employees of Itron Sistemas e Technologia Ltda. (Itron Brazil), the majority of whose employment contracts were terminated in 2011, have sued Itron Brazil seeking payment of overtime and salary differential and alleging that the assumption of the employment relationship by Itron Brazil constituted illegal outsourcing under Brazilian law. In 2008, Itron Brazil entered into an agreement to provide installation and maintenance services to one of its customers and, to perform such services, hired over 800 employees of the previous provider of such services. In 2011, Itron Brazil determined to terminate the contract with its customer, which led to the termination of approximately 870 employees. Under applicable statutes of limitation, most additional employee claims must be brought prior to October 31, 2013. Itron Brazil intends to vigorously defend these cases but the ultimate outcome of the cases, and the amount of any liability, cannot be determined at this time.

The Company and its subsidiaries are parties to various employment-related proceedings in jurisdictions where it does business. None of the proceedings are individually material to the Company, and management believes that the Company has made adequate provision such that the ultimate disposition of the proceedings will not materially affect the Company's business or financial condition.

Warranty
A summary of the warranty accrual account activity is as follows:

 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2013
 
2012
 
2013
 
2012
 
(in thousands)
Beginning balance
$
50,754

 
$
77,251

 
$
53,605

 
$
79,536

New product warranties
1,961

 
3,507

 
2,822

 
5,636

Other changes/adjustments to warranties
3,611

 
(3,770
)
 
5,638

 
2,061

Claims activity
(5,289
)
 
(8,255
)
 
(10,388
)
 
(19,575
)
Effect of change in exchange rates
(405
)
 
(2,365
)
 
(1,045
)
 
(1,290
)
Ending balance
50,632

 
66,368

 
50,632

 
66,368

Less: current portion of warranty
24,709

 
42,861

 
24,709

 
42,861

Long-term warranty
$
25,923

 
$
23,507

 
$
25,923

 
$
23,507



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Total warranty expense is classified within cost of revenues and consists of new product warranties issued, costs related to extended warranty contracts, and other changes and adjustments to warranties. Warranty expense for the three and six months ended June 30 is as follows:
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2013
 
2012
 
2013
 
2012
 
(in thousands)
Total warranty expense
$
5,572

 
$
(263
)
 
$
8,460

 
$
7,697


Warranty expense increased during the three and six months ended June 30, 2013, compared with the same periods in 2012. Warranty expense during the three and six months ended June 30, 2012 reflected a $4.3 million adjustment, which reduced a warranty accrual, originally recorded in 2011, as a result of lower than estimated replacements.

Unearned Revenue Related to Extended Warranty
A summary of changes to unearned revenue for extended warranty contracts is as follows:
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2013
 
2012
 
2013
 
2012
 
(in thousands)
Beginning balance
$
32,363

 
$
27,140

 
$
31,960

 
$
24,448

Unearned revenue for new extended warranties
1,664

 
2,243

 
2,625

 
5,189

Unearned revenue recognized
(525
)
 
(331
)
 
(995
)
 
(631
)
Effect of change in exchange rates
(107
)
 
(41
)
 
(195
)
 
5

Ending balance
33,395

 
29,011

 
33,395

 
29,011

Less: current portion of unearned revenue for extended warranty
2,472

 
1,572

 
2,472

 
1,572

Long-term unearned revenue for extended warranty within Other long-term obligations
$
30,923

 
$
27,439

 
$
30,923

 
$
27,439


Health Benefits
We are self insured for a substantial portion of the cost of our U.S. employee group health insurance. We purchase insurance from a third party, which provides individual and aggregate stop-loss protection for these costs. Each reporting period, we expense the costs of our health insurance plan including paid claims, the change in the estimate of incurred but not reported (IBNR) claims, taxes, and administrative fees (collectively, the plan costs).

Plan costs are as follows:
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2013
 
2012
 
2013
 
2012
 
(in thousands)
Plan costs
$
5,662

 
$
7,217

 
$
10,500

 
$
12,878


The IBNR accrual, which is included in wages and benefits payable, is as follows:

 
June 30, 2013
 
December 31, 2012
 
(in thousands)
IBNR accrual
$
2,345

 
$
2,552


Our IBNR accrual and expenses may fluctuate due to the number of plan participants, claims activity, and deductible limits. For our employees located outside of the United States, health benefits are provided primarily through governmental social plans, which are funded through employee and employer tax withholdings.

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Note 12:     Restructuring

During the fourth quarter of 2011, we announced the approval of projects to restructure our manufacturing operations to increase efficiency and lower our cost of manufacturing. We began implementing these projects in the fourth quarter of 2011.

As of June 30, 2013, we have substantially completed these restructuring projects. We do not anticipate substantial expenses related to these restructuring projects to be recognized in the Consolidated Statements of Operations in future periods.

The total expected restructuring costs, the costs recognized in prior periods, the restructuring costs recognized during the six months ended June 30, 2013, and the remaining expected restructuring costs as of June 30, 2013 are as follows:

 
Total Expected Costs at
 June 30, 2013
 
Costs Recognized in Prior Periods
 
Costs Recognized During the Six Months Ended June 30, 2013
 
Remaining Costs to be Recognized at June 30, 2013 (1)
 
(in thousands)
Employee severance costs
$
46,850

 
$
44,196

 
$
2,654

 
$

Asset impairments
20,332

 
20,305

 
27

 

Other restructuring costs
6,963

 
5,246

 
1,717

 

Total
$
74,145

 
$
69,747

 
$
4,398

 
$

 
 
 
 
 
 
 
 
Segments:
 
 

 
 
 
 
Energy
$
53,385

 
$
53,190

 
$
195

 
$

Water
15,675

 
14,556

 
1,119

 

Corporate unallocated
5,085

 
2,001

 
3,084

 

Total
$
74,145

 
$
69,747

 
$
4,398

 
$


(1)
There are no significant restructuring costs expected to be incurred after June 30, 2013 for these restructuring projects.

Other restructuring costs include expenses to exit the facilities once the operations in those facilities have ceased. Costs associated with restructuring activities are generally presented as restructuring expense in the Consolidated Statements of Operations, except for certain costs associated with inventory write-downs, which are classified within cost of revenues, and accelerated depreciation expense, which is recognized according to the use of the asset.

The following table summarizes the activity within the restructuring related balance sheet accounts during the six months ended June 30, 2013:

 
Accrued Employee Severance
 
Asset Impairments & Net Loss on Sale or Disposal
 
Other Accrued Costs
 
Total
 
(in thousands)
Beginning balance, January 1, 2013
$
14,498

 
$

 
$
3,216

 
$
17,714

Costs incurred and charged to expense
2,654

 
27

 
1,717

 
4,398

Cash payments
(3,155
)
 

 
(833
)
 
(3,988
)
Non-cash items

 
(27
)
 

 
(27
)
Effect of change in exchange rates
(447
)
 

 
(28
)
 
(475
)
Ending balance, June 30, 2013
$
13,550

 
$

 
$
4,072

 
$
17,622


The current portions of the restructuring related liability balances were $13.9 million and $13.2 million as of June 30, 2013 and December 31, 2012, respectively. The current portion of the liability is classified within "Other current liabilities" on the Consolidated Balance Sheets. The long-term portions of the restructuring related liability related balances were $3.7 million and $4.5 million as of June 30, 2013 and December 31, 2012, respectively. The long-term portion of the restructuring liability is classified within "Other long-term liabilities" on the Consolidated Balance Sheets.

Asset impairments are determined at the asset group level. Assets held for sale are classified within other current assets and are reported at the lower of the carrying amount or the fair value, less costs to sell, and are no longer depreciated or amortized.

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The following table includes assets that were measured at fair value on a nonrecurring basis as of June 30, 2013 and December 31, 2012, and the related losses recognized during the period:

 
Net Carrying Value
 
Fair Value Measurement (Level 3)
 
Total Loss Recognized in Period
 
(in thousands)
June 30, 2013
 
 
 
 
 
Long-lived assets held for sale
$
3,128

 
$
3,128

 
$

 
 
 
 
 
 
December 31, 2012
 
 
 
 
 
Long-lived assets held for sale
$
3,184

 
$
3,184

 
$
2


The fair values of the disposal groups included in long-lived assets held for sale were determined based on the estimated proceeds from their expected sales, net of estimated selling costs. Long-lived assets held for sale at June 30, 2013 and December 31, 2012 consist of one asset group that includes land, a building, and building improvements.

Revenues and net operating income from the activities we have exited or will exit under the restructuring plan are not material to our operating segments or consolidated results.
Note 13:    Other Comprehensive Income (Loss)

OCI is reflected as a net increase (decrease) to Itron, Inc. shareholders’ equity and is not reflected in our results of operations. The before-tax amount, income tax (provision) benefit, and net-of-tax amount related to each component of other comprehensive income (loss) during the reporting periods were as follows:

 
Three Months Ended
June 30,
 
Six Months Ended
June 30,
 
2013
 
2012
 
2013
 
2012
 
(in thousands)
Before-tax amount
 
 
 
 
 
 
 
Foreign currency translation adjustment
$
6,798

 
$
(52,847
)
 
$
(20,649
)
 
$
(24,145
)
Net unrealized gain (loss) on derivative instruments designated as cash flow hedges
1,336

 
(1,365
)
 
1,244

 
(1,365
)
Pension plan benefits liability adjustment
263

 
19

 
(283
)
 
38

Total other comprehensive income (loss), before tax
8,397

 
(54,193
)
 
(19,688
)
 
(25,472
)
 
 
 
 
 
 
 
 
Tax (provision) benefit
 
 
 
 
 
 
 
Foreign currency translation adjustment
377

 
476

 
(3,471
)
 
315

Net unrealized gain (loss) on derivative instruments designated as cash flow hedges
(491
)
 
516

 
(472
)
 
516

Pension plan benefits liability adjustment
(80
)
 
3

 
86

 
7

Total other comprehensive income (loss) tax (provision) benefit
(194
)
 
995

 
(3,857
)
 
838

 
 
 
 
 
 
 
 
Net-of-tax amount
 
 
 
 
 
 
 
Foreign currency translation adjustment
7,175

 
(52,371
)
 
(24,120
)
 
(23,830
)
Net unrealized gain (loss) on derivative instruments designated as cash flow hedges
845

 
(849
)
 
772

 
(849
)
Pension plan benefits liability adjustment
183

 
22

 
(197
)
 
45

Total other comprehensive income (loss), net of tax
$
8,203

 
$
(53,198
)
 
$
(23,545
)
 
$
(24,634
)


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The changes in the components of accumulated other comprehensive income (loss) (AOCI), net of tax, were as follows:

 
Foreign Currency Translation Adjustments
 
Net Unrealized Gain (Loss) on Derivative Instruments
 
Net Unrealized Gain (Loss) on Nonderivative Instruments
 
Pension Plan Benefit Liability Adjustments
 
Total
 
(in thousands)
Balances at January 1, 2012
$
(24,718
)
 
$

 
$
(14,380
)
 
$
1,938

 
$
(37,160
)
OCI before reclassifications
(23,830
)
 
(849
)
 

 

 
(24,679
)
Amounts reclassified from AOCI

 

 

 
45

 
45

Total other comprehensive income (loss)
(23,830
)

(849
)


 
45

 
(24,634
)
Balances at June 30, 2012
$
(48,548
)
 
$
(849
)
 
$
(14,380
)
 
$
1,983

 
$
(61,794
)
 
 
 
 
 
 
 
 
 
 
Balances at January 1, 2013
$
(3,313
)
 
$
(1,689
)
 
$
(14,380
)
 
$
(15,002
)
 
$
(34,384
)
OCI before reclassifications
(24,120
)
 
772

 

 
(566
)
 
(23,914
)
Amounts reclassified from AOCI

 

 

 
369

 
369

Total other comprehensive income (loss)
(24,120
)

772

 

 
(197
)
 
(23,545
)
Balances at June 30, 2013
$
(27,433
)
 
$
(917
)
 
$
(14,380
)
 
$
(15,199
)
 
$
(57,929
)

Details about the AOCI components reclassified to the Consolidated Statements of Operations during the reporting periods are as follows:

 
 
Amount Reclassified from AOCI(1)
 
 

 
Three Months Ended
June 30,
 
Six Months Ended
June 30,
 
Affected Line Item in the Income Statement
 
 
2013
 
2012
 
2013
 
2012
 
 
 
 
(in thousands)
 
 
Amortization of defined benefit pension items
 
 
 
 
 
 
 
 
 
 
Prior-service costs
 
$
(17
)
 
$
(17
)
 
(34
)
 
(34
)
 
(2) 
Actuarial losses
 
(246
)
 
(2
)
 
(497
)
 
(4
)
 
(2) 
Total, before tax
 
(263
)
 
(19
)
 
(531
)
 
(38
)
 
Income before income taxes
Tax benefit (provision)
 
80

 
(3
)
 
162

 
(7
)
 
Income tax provision
Total, net of tax
 
(183
)
 
(22
)
 
(369
)
 
(45
)
 
Net income
 
 
 
 
 
 
 
 
 
 
 
Total reclassifications for the period, net of tax
 
$
(183
)
 
$
(22
)
 
$
(369
)
 
$
(45
)
 
Net income

(1)
Amounts in parenthesis indicate debits to the Statements of Operations.
(2) 
These AOCI components are included in the computation of net periodic pension cost. Refer to Note 8 for additional details.

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Note 14:    Fair Values of Financial Instruments

The fair values at June 30, 2013 and December 31, 2012 do not reflect subsequent changes in the economy, interest rates, and other variables that may affect the determination of fair value.
 
 
June 30, 2013
 
December 31, 2012
 
Carrying
Amount
 
Fair
Value
 
Carrying
Amount
 
Fair
Value
 
 
 
(in thousands)
 
 
Assets
 
 
 
 
 
 
 
Cash and cash equivalents
$
103,662

 
$
103,662

 
$
136,411

 
$
136,411

Foreign exchange forwards
122

 
122

 
146

 
146

 
 
 
 
 
 
 
 
Liabilities
 
 
 
 
 
 
 
Credit facility
 
 
 
 
 
 
 
USD denominated term loan
$
270,000

 
$
268,219

 
$
277,500

 
$
275,365

Multicurrency revolving line of credit
140,000

 
138,930

 
140,000

 
138,751

Interest rate swaps
1,482

 
1,482

 
2,725

 
2,725

Foreign exchange forwards
108

 
108

 
114

 
114


The following methods and assumptions were used in estimating fair values:

Cash and cash equivalents: Due to the liquid nature of these instruments, the carrying value approximates fair value (Level 1).

Credit facility - term loan and multicurrency revolving line of credit: The term loan and revolver are not traded publicly. The fair values, which are valued based upon a hypothetical market participant, are calculated using a discounted cash flow model with Level 2 inputs, including estimates of incremental borrowing rates for debt with similar terms, maturities, and credit profiles. Refer to Note 6 for a further discussion of our debt.

Derivatives: See Note 7 for a description of our methods and assumptions in determining the fair value of our derivatives, which were determined using Level 2 inputs.
Note 15:    Segment Information

We operate under the Itron brand worldwide and manage and report under two operating segments, Energy and Water. The Energy operating segment includes our global electricity and gas businesses, while the Water operating segment includes our global water and heat businesses.

On March 27, 2013, we separated the management of our Energy operating segment into Electricity and Gas to allow each business line to develop its own go-to-market strategy, prioritize its marketing and product development requirements, and focus on its strategic investments. As a result, our sales, marketing, and delivery function are managed under three business lines - Electricity, Gas, and Water. At the same time, product development and operations were centralized and are managed on a global basis. Although most management positions of the new business lines have been identified, the transition to the new organizational structure is ongoing, and we are continuing to assess the implications to our operating segments and our operational and financial reporting systems.

We have three measures of segment performance: revenue, gross profit (margin), and operating income (margin). Our operating segments have distinct products, and therefore intersegment revenues are minimal. Corporate operating expenses, interest income, interest expense, other income (expense), and income tax provision (benefit) are not allocated to the segments, nor included in the measure of segment profit or loss. In addition, we allocate only certain production assets and intangible assets to our operating segments. We do not manage the performance of the segments on a balance sheet basis.


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Segment Products
Energy
Standard electricity (electromechanical and electronic) and gas meters; advanced electricity and gas meters and communication modules; smart electricity meters; smart electricity and gas communication modules; prepayment systems, including smart key, keypad, and smart card communication technologies; advanced systems including handheld, mobile, and fixed network collection technologies; smart network technologies; meter data management software; knowledge application solutions; and professional services including implementation, installation, consulting, and analysis.


 
 
Water
Standard water and heat meters; advanced and smart water meters and communication modules; advanced systems including handheld, mobile, and fixed network collection technologies; meter data management software; knowledge application solutions; and professional services including implementation, installation, consulting, analysis, and system management.


Revenues, gross profit, and operating income associated with our segments were as follows:
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2013
 
2012
 
2013
 
2012
 
(in thousands)
Revenues
 
 
 
 
 
 
 
Energy
$
349,623

 
$
444,598

 
$
662,301

 
$
882,345

Water
132,552

 
134,542

 
267,410

 
268,435

Total Company
$
482,175

 
$
579,140

 
$
929,711

 
$
1,150,780

 
 
 
 
 
 
 
 
Gross profit
 
 
 
 
 
 
 
Energy
$
112,673

 
$
148,951

 
$
208,227

 
$
283,554

Water
46,915

 
47,794

 
91,484

 
96,296

Total Company
$
159,588

 
$
196,745

 
$
299,711

 
$
379,850

 
 
 
 
 
 
 
 
Operating income (loss)
 
 
 
 
 
 
 
Energy
$
14,764

 
$
47,069

 
$
15,244

 
$
85,233

Water
15,389

 
11,666

 
27,964

 
27,603

Corporate unallocated
(12,177
)
 
(12,672
)
 
(22,885
)
 
(27,152
)
Total Company
17,976

 
46,063

 
20,323

 
85,684

Total other income (expense)
(3,884
)
 
(3,208
)
 
(5,978
)
 
(7,628
)
Income before income taxes
$
14,092

 
$
42,855

 
$
14,345

 
$
78,056


For the three and six months ended June 30, 2013, no single customer represented more than 10% of the total Company, the Energy operating segment, or the Water operating segment revenues.

For the three and six months ended June 30, 2012, one customer from the Energy operating segment accounted for 11% of the total Company revenues. During the same periods, one customer accounted for 15% of the Energy operating segment revenues, and no single customer accounted for more than 10% of the Water operating segment revenues.

Revenues by region were as follows:

 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2013
 
2012
 
2013
 
2012
 
(in thousands)
United States and Canada
$
211,565

 
$
292,999

 
$
388,771

 
$
577,586

Europe, Middle East, and Africa
215,250

 
215,899

 
427,145

 
436,855

Other
55,360

 
70,242

 
113,795

 
136,339

Total revenues
$
482,175

 
$
579,140

 
$
929,711

 
$
1,150,780



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Depreciation and amortization expense associated with our segments was as follows:
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2013
 
2012
 
2013
 
2012
 
(in thousands)
Energy
$
18,348

 
$
20,488

 
$
36,819

 
$
41,144

Water
5,909

 
6,539

 
12,178

 
13,095

Corporate Unallocated
17

 
17

 
34

 
32

Total Company
$
24,274

 
$
27,044

 
$
49,031

 
$
54,271

Note 16:    Subsequent Event

Stock Repurchases
Subsequent to June 30, 2013, we repurchased 174,200 shares of our common stock under the stock repurchase program authorized by the Board of Directors on March 8, 2013. The average price paid per share was $42.71.

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ITEM 2:
Management’s Discussion and Analysis of Financial Condition and Results of Operations

In this Quarterly Report on Form 10-Q, the terms “we,” “us,” “our,” “Itron,” and the “Company” refer to Itron, Inc.

The following discussion and analysis should be read in conjunction with the unaudited condensed consolidated financial statements and notes included in this report and with our Annual Report on Form 10-K for the year ended December 31, 2012, filed with the Securities and Exchange Commission (SEC) on February 22, 2013.

Documents we provide to the SEC are available free of charge under the Investors section of our website at www.itron.com as soon as practicable after they are filed with or furnished to the SEC. In addition, these documents are available at the SEC’s website (http://www.sec.gov) and at the SEC’s Headquarters at 100 F Street, NE, Washington, DC 20549, or by calling 1-800-SEC-0330.

Certain Forward-Looking Statements

This document contains forward-looking statements concerning our operations, financial performance, revenues, earnings growth, liquidity, and other items. This document reflects our current plans and expectations and is based on information currently available as of the date of this Quarterly Report on Form 10-Q. When we use the words “expect,” “intend,” “anticipate,” “believe,” “plan,” “project,” “estimate,” “future,” “objective,” “may,” “will,” “will continue,” and similar expressions, they are intended to identify forward-looking statements. Forward-looking statements rely on a number of assumptions and estimates. These assumptions and estimates could be inaccurate and cause our actual results to vary materially from expected results. Risks and uncertainties include 1) the rate and timing of customer demand for our products, 2) rescheduling or cancellations of current customer orders and commitments, 3) changes in estimated liabilities for product warranties and/or litigation, 4) our dependence on customers' acceptance of new products and their performance, 5) competition, 6) changes in domestic and international laws and regulations, 7) changes in foreign currency exchange rates and interest rates, 8) international business risks, 9) our own and our customers' or suppliers' access to and cost of capital, 10) future business combinations, and 11) other factors. You should not solely rely on these forward-looking statements as they are only valid as of the date of this Quarterly Report on Form 10-Q. We do not have any obligation to publicly update or revise any forward-looking statement in this document. For a more complete description of these and other risks, refer to Item 1A: “Risk Factors” included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2012, which was filed with the SEC on February 22, 2013.

Results of Operations

We are a technology company, offering end-to-end smart metering solutions to electric, natural gas, and water utilities around the world. Our smart metering solutions, meter data management software, and knowledge application solutions bring additional value to a utility’s metering and grid systems. Our professional services help our customers project-manage, install, implement, operate, and maintain their systems.

We have two operating segments. The Energy operating segment includes our global electricity and gas products, while the Water operating segment includes our global water and heat products.

On March 27, 2013, we separated the management of our Energy operating segment into Electricity and Gas to allow each business line to develop its own go-to-market strategy, prioritize its marketing and product development requirements, and focus on its strategic investments. As a result, our sales, marketing, and delivery function are managed under three business lines - Electricity, Gas, and Water. At the same time, product development and operations were centralized and are managed on a global basis. Although most management positions of the new business lines have been identified, the transition to the new organizational structure is ongoing, and we are continuing to assess the implications to our operating segments and our operational and financial reporting systems.

We have three measures of segment performance: revenue, gross profit (margin), and operating income (margin). Intersegment revenues were minimal. Corporate operating expenses, interest income, interest expense, other income (expense), and income tax provision (benefit) are not allocated to the segments, nor included in the measure of segment profit or loss. In addition, we allocate only certain production assets and intangible assets to our operating segments. We do not manage the performance of the segments on a balance sheet basis.


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Overview

Revenues for the three and six months ended June 30, 2013 were $482 million and $930 million, compared with $579 million and $1.2 billion in the same periods last year. The decrease in 2013 was the result of significantly lower revenues in the Energy segment. Gross margins for the three and six months ended June 30, 2013 were 33.1% and 32.2%, compared with gross margins of 34.0% and 33.0% for the same periods in 2012. In 2013, lower volumes and increased warranty costs, as the result of a $4.3 million warranty accrual reduction recognized in the second quarter of 2012, had a negative impact on gross margin.

Our tax benefit for the first six months of 2013 reflects the favorable discrete tax benefit for the retroactive extension of the 2012 research and experimentation credit in the amount of $4.0 million. The American Taxpayer Relief Act of 2012 was signed into law on January 2, 2013 and extended several business tax provisions including the research and experimentation credit. Our annual estimated effective tax rate for 2013 was favorably impacted by a higher percentage of projected earnings in foreign jurisdictions with tax rates below 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.  Accordingly, our 2013 annual estimated effective tax rate is lower than our 2012 annual estimated effective tax rate. During the three and six months ended June 30, 2012, we had tax provisions of 24.7% and 25.9%, based on a percentage of income before tax, which included minimal discrete benefits.

Total backlog was $1.1 billion and twelve-month backlog was $558 million at June 30, 2013.

On March 8, 2013, our Board of Directors authorized a twelve-month repurchase program of up to $50 million of our common stock. During the three months ended June 30, 2013, we repurchased 380,310 shares of our common stock for $15.9 million. Subsequent to June 30, 2013, we repurchased 174,200 shares of our common stock for $7.4 million.

Total Company Revenues, Gross Profit and Margin, and Unit Shipments
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2013
 
2012
 
% Change
 
2013
 
2012
 
% Change
 
(in thousands)
 
 
 
(in thousands)
 
 
Revenues
$
482,175

 
$
579,140

 
(17)%
 
$
929,711

 
$
1,150,780

 
(19)%
Gross Profit
$
159,588

 
$
196,745

 
(19)%
 
$
299,711

 
$
379,850

 
(21)%
Gross Margin
33.1
%
 
34.0
%
 
 
 
32.2
%
 
33.0
%
 
 
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2013
 
2012
 
2013
 
2012
 
(in thousands)
Revenues by Region
 
 
 
 
 
 
 
United States and Canada (North America)
$
211,565

 
$
292,999

 
$
388,771

 
$
577,586

Europe, Middle East, and Africa (EMEA)
215,250

 
215,899

 
427,145

 
436,855

Other
55,360

 
70,242

 
113,795

 
136,339

Total revenues
$
482,175

 
$
579,140

 
$
929,711

 
$
1,150,780


Revenues
Revenues decreased $97.0 million and $221.1 million, or 17% and 19%, for the three and six months ended June 30, 2013, compared with the same periods in 2012. This decrease was driven by the Energy segment and reflected the impact of the substantial completion of four of our five largest OpenWay projects in 2012 combined with lower gas revenues in North America, EMEA, and Asia/Pacific. Water revenues were essentially flat. A more detailed analysis of these fluctuations is provided in Operating Segment Results.

No single customer accounted for more than 10% of total Company revenues during the three and six months ended June 30, 2013, while one customer, BC Hydro and Power Authority, accounted for 11% of total Company revenues during the same periods in 2012. Our 10 largest customers accounted for 22% and 20% of total revenues during the three and six months ended June 30, 2013, and 30% and 32% for the three and six months ended June 30, 2012, respectively.


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Gross Margins
Gross margin for the second quarter of 2013 was 33.1%, compared with 34.0% for the same period in 2012. For the six months ended June 30, 2013, gross margin was 32.2%, compared with 33.0% in the same period in 2012. The decline over the prior year was due primarily to lower volumes and higher warranty costs, as the result of a $4.3 million warranty accrual reduction recognized in the second quarter of 2012, partially offset by benefits from manufacturing efficiencies in the Energy operating segment. In addition, the Water operating segment had a negative impact on gross margin as the result of increased professional services in North America, which have a lower gross margin, and less favorable product mix in other regions, which is the result a lower volume of higher margin products as a proportion of total sales. A more detailed analysis of these fluctuations is provided in Operating Segment Results.

Meter and Module Summary
We classify meters into three categories:
Standard metering – no built-in remote reading communication technology
Advanced metering – one-way communication of meter data
Smart metering – two-way communication including remote meter configuration and upgrade (consisting primarily of our OpenWay® technology)

In addition, advanced and smart meter communication modules can be sold separately from the meter. A summary of our meter and communication module shipments is as follows:

 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2013
 
2012
 
2013
 
2012
 
(units in thousands)
Meters
 
 
 
 
 
 
 
Standard
4,730

 
4,620

 
9,170

 
9,500

Advanced and smart
1,340

 
2,160

 
2,970

 
4,410

Total meters
6,070

 
6,780

 
12,140

 
13,910

 
 
 
 
 
 
 
 
Stand-alone communication modules
 
 
 
 
 
 
 
Advanced and smart
1,350

 
1,960

 
2,690

 
3,550



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Table of Contents

Operating Segment Results

For a description of our operating segments, refer to Item 1: “Financial Statements Note 15: Segment Information”.
 
 
Three Months Ended June 30,
 
 
 
Six Months Ended June 30,
 
 
 
2013
 
2012
 
% Change
 
 
 
2013
 
2012
 
% Change
 
 
Segment Revenues
(in thousands)
 
 
 
 
 
(in thousands)
 
 
 
 
Energy
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Electricity
$
213,612

 
$
283,484

 
(25)%
 
 
 
$
389,375

 
$
567,944

 
(31)%
 
 
Gas
136,011

 
161,114

 
(16)%
 
 
 
272,926

 
314,401

 
(13)%
 
 
Total Energy
349,623

 
444,598

 
(21)%
 
 
 
662,301

 
882,345

 
(25)%
 
 
Water
132,552

 
134,542

 
(1)%
 
 
 
267,410

 
268,435

 
—%
 
 
Total revenues
$
482,175

 
$
579,140

 
(17)%
 
 
 
$
929,711

 
$
1,150,780

 
(19)%
 
 
 
 
 
 
 
 
 
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2013
 
2012
 
2013
 
2012
 
Gross
Profit
 
Gross
Margin
 
Gross
Profit
 
Gross
Margin
 
Gross
Profit
 
Gross
Margin
 
Gross
Profit
 
Gross
Margin
Segment Gross Profit and Margin
(in thousands)
 
 
 
(in thousands)
 
 
 
(in thousands)
 
 
 
(in thousands)
 
 
Energy
$
112,673

 
32.2%
 
$
148,951

 
33.5%
 
$
208,227

 
31.4%
 
$
283,554

 
32.1%
Water
46,915

 
35.4%
 
47,794

 
35.5%
 
91,484

 
34.2%
 
96,296

 
35.9%
Total gross profit and margin
$
159,588

 
33.1%
 
$
196,745

 
34.0%
 
$
299,711

 
32.2%
 
$
379,850

 
33.0%
 
 
 
 
 
 
 
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2013
 
2012
 
2013
 
2012
 
Operating
Income (Loss)
 
Operating
Margin
 
Operating
Income (Loss)
 
Operating
Margin
 
Operating
Income (Loss)
 
Operating
Margin
 
Operating
Income (Loss)
 
Operating
Margin
Segment Operating Income (Loss) and Operating Margin
(in thousands)
 
 
 
(in thousands)
 
 
 
(in thousands)
 
 
 
(in thousands)
 
 
Energy
$
14,764

 
4%
 
$
47,069

 
11%
 
$
15,244

 
2%
 
$
85,233

 
10%
Water
15,389

 
12%
 
11,666

 
9%
 
27,964

 
10%
 
27,603

 
10%
Corporate unallocated
(12,177
)
 
 
 
(12,672
)
 
 
 
(22,885
)
 
 
 
(27,152
)
 
 
Total Company
$
17,976

 
4%
 
$
46,063

 
8%
 
$
20,323

 
2%
 
$
85,684

 
7%

Energy:

Revenues - Three months ended June 30, 2013 vs. Three months ended June 30, 2012
Electricity revenues decreased $69.9 million, or 25%, for the three months ended June 30, 2013, compared with the same period in 2012. Revenues in 2013 were lower primarily due to $97.7 million in scheduled decreases in our five largest OpenWay projects in North America and $9.2 million in decreased meter shipments in Asia/Pacific. These decreases were partially offset by $22.8 million in increased revenues from sources other than the five largest OpenWay projects in North America and $16.9 million in higher product shipments and services in EMEA, of which $8.8 million was in South Africa.

Gas revenues decreased $25.1 million, or 16%, for the three months ended June 30, 2013, compared with the same period in 2012, primarily as the result of $16.3 million in lower product sales in EMEA and $6.3 million in lower product sales and services in North America.

Revenues - Six months ended June 30, 2013 vs. Six months ended June 30, 2012
Electricity revenues decreased $178.6 million, or 31%, for the six months ended June 30, 2013, compared with the same period in 2012. Revenues in 2013 were lower primarily due to $219.1 million in scheduled decreases in our five largest OpenWay projects in North America, $8.2 million in decreased meter shipments in Asia/Pacific, and $6.5 million in decreased product shipments in Latin America. These decreases were partially offset by $37.9 million in increased revenues from sources other than the five largest OpenWay projects in North America and $17.4 million in EMEA.

Gas revenues decreased $41.5 million, or 13%, for the six months ended June 30, 2013, compared with the same period in 2012, primarily as the result of $26.4 million in lower product sales in EMEA and $11.3 million in lower product sales and services in North America. Revenues in Latin America and Asia/Pacific were lower, as well.

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No single customer accounted for more than 10% of the Energy operating segment revenues during the three and six months ended June 30, 2013, while one customer accounted for more than 10% of the Energy operating segment revenues during the same periods of 2012.

Gross Margin - Three months ended June 30, 2013 vs. Three months ended June 30, 2012
Energy gross margin was 32.2% for the three months ended June 30, 2013, compared with 33.5% for the same period in 2012. During the second quarter of 2013, gross margin decreased 1.3% over the prior year, primarily as the result of lower volumes and higher warranty expense. In the second quarter of 2012, we recognized a $4.3 million adjustment, which reduced a warranty accrual, originally recorded in 2011, as a result of lower than estimated replacements. These decreases were partially offset by the benefits from efficiencies from our restructuring projects.

Gross Margin - Six months ended June 30, 2013 vs. Six months ended June 30, 2012
Energy gross margin was 31.4% for the six months ended June 30, 2013, compared with 32.1% for the same period in 2012. During the first half of 2013, gross margin decreased 0.7% over the prior year as benefits from efficiencies from our restructuring projects were more than offset by higher warranty costs and the impact of lower volumes. In the second quarter of 2012, we recognized a $4.3 million adjustment, which reduced a warranty accrual, originally recorded in 2011, as a result of lower than estimated replacements.

Operating Expenses - Three months ended June 30, 2013 vs. Three months ended June 30, 2012
Energy operating expenses decreased $4.0 million, or 3.9%, for the three months ended June 30, 2013, compared with the same period in 2012, primarily due to lower sales and marketing and product development, as well as a scheduled decrease in amortization of intangible assets of $1.1 million. These decreases were partially offset by $4.6 million in higher legal reserve costs, which are included within general and administrative expenses. Operating expenses as a percentage of revenues were 28% for the three months ended June 30, 2013, compared with 23% for the same period in 2012.

Operating Expenses - Six months ended June 30, 2013 vs. Six months ended June 30, 2012
Energy operating expenses decreased $5.3 million, or 2.7%, for the six months ended June 30, 2013, compared with the same period in 2012, primarily due to lower sales and marketing and product development costs, as well as a scheduled decrease in amortization of intangible assets of $1.7 million. These decreases were partially offset by $6.6 million in higher legal reserve costs, which are included within general and administrative expenses. Operating expenses as a percentage of revenues were 29% for the six months ended June 30, 2013, compared with 22% for the same period in 2012.

Water:

Revenues - Three months ended June 30, 2013 vs. Three months ended June 30, 2012
Revenues decreased $2.0 million, or 1%, for the three months ended June 30, 2013, compared with the same period last year. This decrease was the result of lower product shipments in Asia/Pacific of $2.6 million and EMEA by $1.2 million, partially offset by $2.1 million in higher volumes in Latin America.

Revenues - Six months ended June 30, 2013 vs. Six months ended June 30, 2012
Revenues decreased $1.0 million for the six months ended June 30, 2013, compared with the same period last year. The decrease was driven primarily by $3.2 million in lower product shipments in Asia/Pacific, partially offset by higher service revenues in North America.

No single customer represented more than 10% of the Water operating segment revenues during the three and six months ended June 30, 2013 and 2012.

Gross Margin - Three months ended June 30, 2013 vs. Three months ended June 30, 2012
Water gross margin decreased to 35.4% for the three months ended June 30, 2013, compared with 35.5% for the same period last year, primarily as a result of an increase in professional services in North America, which have a lower gross margin, offset by the benefit of higher volumes in Latin America.

Gross Margin - Six months ended June 30, 2013 vs. Six months ended June 30, 2012
Water gross margin decreased to 34.2% for the six months ended June 30, 2013, compared with 35.9% for the same period last year, primarily as a result of an increase in professional services in North America, which have a lower gross margin, and unfavorable product mix in other regions.


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Table of Contents

Operating Expenses - Three months ended June 30, 2013 vs. Three months ended June 30, 2012
Operating expenses for the three months ended June 30, 2013 decreased by $4.6 million over the second quarter of 2012, primarily as the result of $3.6 million in lower restructuring expenses and lower sales and marketing costs and scheduled decreases in amortization of intangible assets. Operating expenses as a percentage of revenues were 24% for the three months ended June 30, 2013, compared with 27% for the same period in 2012.

Operating Expenses - Six months ended June 30, 2013 vs. Six months ended June 30, 2012
Operating expenses for the six months ended June 30, 2013 decreased by $5.2 million over the first half of 2012, primarily as the result of $3.0 million in lower restructuring expenses, as well as lower sales and marketing costs and scheduled decreases in amortization of intangible assets, partially offset by $1.1 million in increased product development costs. Operating expenses as a percentage of revenues were 24% for the six months ended June 30, 2013, compared with 26% for the same period in 2012.

Corporate unallocated:

Operating expenses not directly associated with an operating segment are classified as “Corporate unallocated.” These expenses were lower by $495,000 and $4.3 million in the three and six months ended June 30, 2013, primarily due to certain costs incurred in 2012. The prior year included costs for the SmartSynch acquisition of $2.9 million, management training and development costs, and preliminary planning costs for our global enterprise resource planning (ERP) software initiative.

Bookings and Backlog of Orders

Bookings for a reported period represent customer contracts and purchase orders received during the period that have met certain conditions, such as regulatory and/or contractual approval. Total backlog represents committed but undelivered contracts and purchase orders at period-end. Twelve-month backlog represents the portion of total backlog that we estimate will be recognized as revenue over the next 12 months. Backlog is not a complete measure of our future revenues as we also receive significant book-and-ship orders. Bookings and backlog may fluctuate significantly due to the timing of large project awards. In addition, annual or multi-year contracts are subject to rescheduling and cancellation by customers due to the long-term nature of the contracts. Beginning total backlog, plus bookings, minus revenues, will not equal ending total backlog due to miscellaneous contract adjustments, foreign currency fluctuations, and other factors.
 
Quarter Ended
 
Quarterly
Bookings
 
Ending
Total
Backlog
 
Ending
12-Month
Backlog
 
 
(in millions)
June 30, 2013
 
$
515

 
$
1,058

 
$
558

March 31, 2013
 
447

 
1,029

 
565

December 31, 2012
 
467

 
1,035

 
568

September 30, 2012
 
459

 
1,079

 
592

June 30, 2012
 
447

 
1,122

 
637


Information on bookings by our operating segments is as follows:
 
Quarter Ended
 
Bookings
 
Energy
 
Water
 
 
(in millions)
June 30, 2013
 
$
515

 
$
365

 
$
150

March 31, 2013
 
447

 
305

 
142

December 31, 2012
 
467

 
345

 
122

September 30, 2012
 
459

 
341

 
118

June 30, 2012
 
447

 
330

 
117



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Operating Expenses

 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2013
 
% of
Revenues
 
2012
 
% of
Revenues
 
2013
 
% of
Revenues
 
2012
 
% of
Revenues
 
(in thousands)
 
 
 
(in thousands)
 
 
 
(in thousands)
 
 
 
(in thousands)
 
 
Sales and marketing
$
46,182

 
10%
 
$
50,847

 
9%
 
$
94,398

 
10%
 
$
100,703

 
9%
Product development
43,481

 
9%
 
46,640

 
8%
 
87,689

 
9%
 
90,996

 
8%
General and administrative
38,317

 
8%
 
33,450

 
6%
 
71,912

 
8%
 
70,020

 
6%
Amortization of intangible assets
10,247

 
2%
 
12,025

 
2%
 
20,991

 
2%
 
23,938

 
2%
Restructuring
3,385

 
1%
 
7,720

 
1%
 
4,398

 
—%
 
8,509

 
1%
Total operating expenses
$
141,612

 
29%
 
$
150,682

 
26%
 
$
279,388

 
30%
 
$
294,166

 
26%

Operating expenses decreased $9.1 million and $14.8 million for the three and six months ended June 30, 2013, primarily due to reduced sales and marketing, product development, and restructuring costs, partially offset by increased litigation reserves, which are included within general and administrative operating expense. In addition, the three and six months ended June 30, 2013 include scheduled decreases in amortization of intangible assets of $1.8 million and $2.9 million.

Other Income (Expense)

The following table shows the components of other income (expense):
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2013
 
2012
 
2013
 
2012
 
(in thousands)
Interest income
$
194

 
$
177

 
$
1,255

 
$
370

Interest expense
(1,920
)
 
(2,191
)
 
(3,845
)
 
(4,280
)
Amortization of prepaid debt fees
(416
)
 
(415
)
 
(829
)
 
(763
)
Other income (expense), net
(1,742
)
 
(779
)
 
(2,559
)
 
(2,955
)
Total other income (expense)
$
(3,884
)
 
$
(3,208
)
 
$
(5,978
)
 
$
(7,628
)

Interest income: Interest income is generated from our cash and cash equivalents balances and certain deposits on hand with third parties. Interest income in the six months ended June 30, 2013 includes interest recognized on certain deposits with governmental entities related to tax contingencies.

Interest expense: Interest expense for the three and six months ended June 30, 2013 declined due to a lower balance of outstanding debt on our credit facility. Average total debt outstanding was $404.2 million and $475.7 million for the quarters ended June 30, 2013 and 2012, respectively, and $410.4 million and $460.7 million for the six month periods ended June 30, 2013 and 2012, respectively.

Amortization of prepaid debt fees: Amortization of prepaid debt fees for the six months ended June 30, 2013 increased from the same period in 2012 as the result of fees paid during the second quarter of 2012 for the increase in the borrowing capacity of the multicurrency revolving line of credit. Refer to Item 1: “Financial Statements Note 6: Debt” for additional details related to our long-term borrowings.

Other income (expense), net: Other expenses, net, consist primarily of unrealized and realized foreign currency gains and losses from balances denominated in currencies other than the reporting entity's functional currency and other non-operating income (expenses). Foreign currency losses, net of hedging, were $1.6 million and $2.1 million for the three and six months ended June 30, 2013, compared with net foreign currency losses of $495,000 and $1.5 million in the same periods in 2012.


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Table of Contents

Financial Condition

Cash Flow Information:
 
 
Six Months Ended June 30,
 
2013
 
2012
 
(in thousands)
Operating activities
$
18,974

 
$
92,390

Investing activities
(29,514
)
 
(99,159
)
Financing activities
(18,816
)
 
(21,342
)
Effect of exchange rates on cash and cash equivalents
(3,393
)
 
(2,175
)
Decrease in cash and cash equivalents
$
(32,749
)
 
$
(30,286
)

Cash and cash equivalents was $103.7 million at June 30, 2013, compared with $136.4 million at December 31, 2012.

Operating activities
Cash provided by operating activities during the six months ended June 30, 2013 was $73.4 million lower, compared with the same period in 2012. This decline was primarily due to (1) a decrease in net income, adjusted for non-cash items, such as depreciation and amortization, stock-based compensation, and other adjustments, of $59.8 million and (2) a larger increase in net operating assets and liabilities, primarily as a result of a larger accumulation of inventories and an increase in accounts receivable, in the six months ended June 30, 2013 as compared to the same period in 2012, when accounts receivable decreased.

Investing activities
Cash used in investing activities during the six months ended June 30, 2013 was $69.6 million lower, compared with the same period in 2012, primarily due to a decline in business acquisitions of $78.7 million, which was partially offset by an increase in acquisitions of property, plant, and equipment of $5.3 million. In the first six months of 2013, there was no significant business acquisition activity, while during the same period in 2012 we acquired SmartSynch.

Financing activities
Net cash used in financing activities during the six months ended June 30, 2013 was $2.5 million lower, compared with the same period in 2012, as a result of a decrease of $9.9 million in repurchases of our common stock and an increase of $2.5 million in other financing activities in 2013. These improvements in cash position were partially offset by increased repayments of debt, net of proceeds from borrowings, in 2013. During the first six months of 2013, we made payments on debt, net of proceeds from borrowings, of $7.5 million, compared to proceeds from borrowings, net of payments on debt, of $2.5 million during the same period in 2012. Refer to Part II, Item 2: "Unregistered Sale of Equity Securities and Use of Proceeds" for additional details related to our share repurchase program.

Effect of exchange rates on cash and cash equivalents
The effect of exchange rates on the cash balances of currencies held in foreign denominations for the six months ended June 30, 2013 was a decrease of $3.4 million, compared with an decrease of $2.2 million for the same period in 2012.

Off-balance sheet arrangements:

We have no off-balance sheet financing agreements or guarantees as defined by Item 303 of Regulation S-K at June 30, 2013 and December 31, 2012 that we believe are reasonably likely to have a current or future effect on our financial condition, results of operations, or cash flows.

Liquidity and Capital Resources:
 
Our principal sources of liquidity are cash flows from operations, borrowings, and sales of common stock. Cash flows may fluctuate and are sensitive to many factors including changes in working capital and the timing and magnitude of capital expenditures and payments on debt. Working capital, which represents current assets less current liabilities, was $355.1 million at June 30, 2013, compared with $353.6 million at December 31, 2012.

Borrowings
In August 2011, we entered into a senior secured credit facility (the credit facility). The credit facility consists of a $300 million U.S. dollar term loan and a multicurrency revolving line of credit (the revolver) with a principal amount of up to $660 million.

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At June 30, 2013, $140.0 million was outstanding under the revolver, and $47.0 million was utilized by outstanding standby letters of credit, resulting in $473.0 million available for additional borrowings.

For further description of the term loan and the revolver under our credit facility, refer to Item 1: “Financial Statements, Note 6: Debt.”

For a description of our letters of credit and performance bonds, and the amounts available for additional borrowings or letters of credit under our lines of credit, including the revolver that is part of our credit facility, refer to Item 1: “Financial Statements, Note 11: Commitments and Contingencies.”

Share Repurchase
On March 8, 2013, our Board of Directors authorized a repurchase program of up to $50 million of our common stock through March 7, 2014. Repurchases are made in the open market or in privately negotiated transactions and in accordance with applicable securities laws. Depending on market conditions and other factors, these repurchases may be commenced or suspended from time to time without prior notice. During the six months ended June 30, 2013, we repurchased 384,800 shares of our common stock, totaling $16.1 million, leaving $33.9 million remaining under the repurchase program. Refer to Part II, Item 2: "Unregistered Sales of Equity Securities and Use of Proceeds" for additional information related to our share repurchase program.

Restructuring
During the fourth quarter of 2011, we announced the approval of projects to restructure our manufacturing operations to increase efficiency and lower our cost of manufacturing. We began implementing these projects in the fourth quarter of 2011.

As of June 30, 2013, we have substantially completed these restructuring projects. We do not anticipate substantial expenses related to these restructuring projects to be recognized in the Consolidated Statements of Operations in future periods. At June 30, 2013, the current and long-term portions of the restructuring related liability balances were $13.9 million and $3.7 million, respectively. For further details regarding our restructuring activities, refer to Item 1: “Financial Statements, Note 12: Restructuring.”

Other Liquidity Considerations
We have tax credits and net operating loss carryforwards in various jurisdictions that are available to reduce cash taxes. However, utilization of tax credits and net operating losses are limited in certain jurisdictions. Based on current projections, we expect to pay, net of refunds, approximately $300,000 in state taxes and $11.6 million in local and foreign taxes in 2013. We do not expect to make any payments for U.S. federal taxes in 2013. For a discussion of our tax provision and unrecognized tax benefits, see Item 1: “Financial Statements, Note 10: Income Taxes.”

As of June 30, 2013, there was $36.3 million of cash and cash equivalents held by foreign subsidiaries that could be repatriated, if necessary to fund U.S. operations. Tax is one of the many factors that we consider in the management of global cash. Included in the determination of the tax costs in repatriating foreign cash into the United States are the amount of earnings and profits in a particular jurisdiction, withholding taxes that would be imposed, and available foreign tax credits. Accordingly, the amount of taxes that we would need to accrue and pay to repatriate foreign cash could vary significantly.

The American Taxpayer Relief Act of 2012 (the "Act") was signed into law on January 2, 2013 and extended several business tax provisions including: (1) the active financing income and controlled foreign corporation look-through exceptions to certain foreign income; and (2) the research and experimentation credit. The tax effects of the Act were recognized in the first quarter of 2013.

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, Inc, we consolidate them because we have a greater than 50% ownership interest or because we exercise control over the operations. 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. Approximately $23.0 million of our consolidated cash balance at June 30, 2013 resides in our joint venture entities. As a result, the minority shareholders of these entities control their proportional share of this cash balance, and there may be limitations on our ability to repatriate cash to the U.S. from these entities.

For a description of our funded and unfunded non-U.S. defined benefit pension plans and our expected 2013 contributions, refer to Item 1: “Financial Statements, Note 8: Defined Benefit Pension Plans.”

For a description of our bonus and profit sharing plans, including the amounts accrued at June 30, 2013 and the expected timing of payment, refer to Bonus and Profit Sharing within Critical Accounting Estimates below.


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General Liquidity Overview
We expect to grow through a combination of internal new product development, licensing technology from and to others, distribution agreements, partnering arrangements, and acquisitions of technology or other companies. We expect these activities to be funded with existing cash, cash flow from operations, borrowings, and the sale of common stock or other securities. We believe existing sources of liquidity will be sufficient to fund our existing operations and obligations for the next 12 months and into the foreseeable future, but offer no assurances. Our liquidity could be affected by unforeseen changes in the energy and water industries, competitive pressures, changes in estimated liabilities for product warranties and/or litigation, future business combinations, capital market fluctuations, international risks, and other factors described under “Risk Factors” within Item 1A of Part I of our Annual Report on Form 10-K for the fiscal year ended December 31, 2012, which was filed with the SEC on February 22, 2013, as well as “Quantitative and Qualitative Disclosures About Market Risk” within Item 3 of Part I included in this Quarterly Report on Form 10-Q.

Contingencies

Refer to Item 1: “Financial Statements, Note 11: Commitments and Contingencies”.

Critical Accounting Estimates

Revenue Recognition
The majority of our revenue arrangements involve multiple deliverables, which require us to determine the fair value of each deliverable and then allocate the total arrangement consideration among the separate deliverables based on the relative fair value percentages. 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. A majority of our revenue is recognized when products are shipped to or received by a customer or when services are provided.
Fair value represents the estimated price charged if an element were sold separately. If the fair value of any undelivered element included in a multiple deliverable arrangement cannot be objectively determined, revenue is deferred until all elements are delivered and services have been performed, or until the fair value can be objectively determined for any remaining undelivered elements. We review our fair values on an annual basis or more frequently if a significant trend is noted.
If implementation services are essential to a software arrangement, revenue is 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. The estimation of costs through completion of a project is subject to many variables such as the length of time to complete, changes in wages, subcontractor performance, supplier information, and business volume assumptions. Changes in underlying assumptions/estimates may adversely or positively affect financial performance.
Certain of our revenue arrangements include an extended or noncustomary warranty provision that 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). 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. If neither VSOE nor TPE of selling price exists for a unit of accounting, we use estimated selling price (ESP). 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. The factors considered include the cost to produce the deliverable, the anticipated margin on that deliverable, our ongoing pricing strategy and policies, 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.

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

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of new products in the development stage helps identify and correct potential warranty issues prior to manufacturing. Continuous quality control efforts during manufacturing reduce our exposure to warranty claims. If our quality control efforts fail to detect a fault in one of our products, we may 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 until sufficient data are available. As actual experience on new products becomes available, it is used to modify the historical averages 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 changes in estimates for 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 gross margin. The long-term warranty balance includes estimated warranty claims beyond one year.

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 post-employment 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 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, a portion of the Company's goodwill balance is allocated to it based on relative fair value.

In determining restructuring charges, we analyze our future operating requirements, including the required headcount by business functions and facility space requirements. Our restructuring costs and any resulting accruals involve significant estimates using the best information available at the time the estimate are made. Our estimates involve a number of risks and uncertainties, some of which are beyond our control, including real estate market conditions and local labor and employment laws, rules, and regulations. If the amounts and timing of cash flows from restructuring activities are significantly different from what we have estimated, the actual amount of restructuring and asset impairment charges could be materially different, either higher or lower, than those we have recorded.

Income Taxes
The calculation of our annual estimated effective tax rate requires significant judgment and is subject to several factors, including 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 uncertain tax positions, among other items.

We record valuation allowances to reduce deferred tax assets to the extent we believe it is more likely than not that a portion of such assets will not be realized. In making such determinations, we consider available positive and negative evidence, including scheduled reversals of deferred tax liabilities, projected future taxable income, tax planning strategies, and our ability to carry back losses to prior years. We are required to make assumptions and judgments about potential outcomes that lie outside management’s control. The most sensitive and critical factors are the projection, source, and character of future taxable income. Although realization is not assured, management believes it is more likely than not that deferred tax assets will be realized. The amount of deferred tax assets considered realizable, however, could be reduced in the near term if estimates of future taxable income during the carryforward periods are reduced or current tax planning strategies are not implemented.

We are subject to audit in multiple taxing jurisdictions in which we operate. These audits may involve complex issues, which may require an extended period of time to resolve. We believe we have recorded adequate income tax provisions and reserves for uncertain tax positions.

In evaluating uncertain tax positions, we consider the relative risks and merits of positions taken in tax returns filed and to be filed, considering statutory, judicial, and regulatory guidance applicable to those positions. We make assumptions and judgments about potential outcomes that lie outside management’s control. To the extent the tax authorities disagree with our conclusions and depending on the final resolution of those disagreements, our actual tax rate may be materially affected in the period of final settlement with the tax authorities.


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Inventories
Items are removed from inventory using the first-in, first-out method. Inventories include raw materials, sub-assemblies, and finished goods. Inventory amounts include the cost to manufacture the item, such as the cost of raw materials, labor, and other applied direct and indirect costs. We also review idle facility expense, freight, handling costs, and wasted materials to determine if abnormal amounts should be recognized as current-period charges. We review our inventory for obsolescence and marketability. If the estimated market value, which is based upon assumptions about future demand and market conditions, falls below the original cost, the inventory value is reduced to the market value. If technology rapidly changes or actual market conditions are less favorable than those projected by management, inventory write-downs may be required. Our inventory levels may vary period to period as a result of our factory scheduling and timing of contract fulfillments.

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 finite-lived intangible assets are amortized over their estimated useful lives based on estimated discounted cash flows. IPR&D is considered an indefinite-lived intangible asset and is not subject to amortization until the associated projects are completed or terminated. Finite-lived 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. Indefinite-lived intangible assets are tested for impairment annually, when events or changes in circumstances indicate the asset may be impaired, or at the time when their useful lives are determined to be no longer indefinite.

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.
We test goodwill for impairment each year as of October 1, or more frequently should a significant impairment indicator occur. As part of the impairment test, we may elect to perform an assessment of qualitative factors. If this qualitative assessment indicates that it is more likely than not that the fair value of a reporting unit, including goodwill, is less than its carrying amount, or if we elect to bypass the qualitative assessment, we would then proceed with the two-step impairment test. The impairment test involves comparing the fair values 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 the goodwill impairment loss amount. This second step determines the current fair values of all assets and liabilities of the reporting unit 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.

Based on our most recent annual goodwill impairment test as of October 1, 2012, the percentage by which the estimated fair value of the reporting units exceeded their carrying value and amount of goodwill allocated to each of these reporting units were as follows:

 
 
October 1, 2012
Reporting Unit
 
Goodwill
 
Fair Value Exceeded Carrying Value
 
 
(in thousands)
 
 
Energy - Electricity
 
$
221,119

 
19
%
Energy - Gas
 
382,563

 
66
%
Water
 
83,750

 
317
%

Changes in market demand, fluctuations in the economies in which we operate, the volatility and decline in the worldwide equity markets, and a further decline in our market capitalization could negatively impact the remaining carrying value of our goodwill, which could have a significant effect on our current and future results of operations and financial condition.


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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 (also known as “Level 2”), as defined by U.S. generally accepted accounting principles. 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 and the effect of our own nonperformance risk when the net fair value of our derivative instruments is in a net liability position. 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). Derivatives are not used for trading or speculative purposes. Our derivatives are with credit-worthy multinational financial institutions, 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.

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. 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 other comprehensive income (OCI), net of tax, the actuarial gains or losses and prior service costs or credits, if any, that arise during the period but are not recognized as components of net periodic benefit cost.

Several economic assumptions and actuarial data are used in calculating the expense and obligations related to these plans. The assumptions are updated annually at December 31 and include the discount rate, the expected remaining service life, the expected rate of return on plan assets, and the rate of future compensation increase. The discount rate is a significant assumption used to value our pension benefit obligation. We determine a discount rate for our plans based on the estimated duration of each plan’s liabilities. For our euro denominated defined benefit pension plans, which represent 94% of our benefit obligation, we use three discount rates, with consideration of the duration of the plans, using a hypothetical yield curve developed from euro-denominated AA-rated corporate bond issues, partially weighted for market value, with minimum amounts outstanding of €250 million for bonds with less than 10 years to maturity and €50 million for bonds with 10 or more years to maturity, and excluding the highest and lowest yielding 10% of bonds within each maturity group. The discount rates used, depending on the duration of the plans, were 2.75%, 3.25% and 3.50%, respectively. The weighted average discount rate used to measure the projected benefit obligation for all of the plans at December 31, 2012 was 3.36%. A change of 25 basis points in the discount rate would change our pension benefit obligation by approximately $4.0 million. The financial and actuarial assumptions used at December 31, 2012 may differ materially from actual results due to changing market and economic conditions and other factors. These differences could result in a significant change in the amount of pension expense recorded in future periods. Gains and losses resulting from changes in actuarial assumptions, including the discount rate, are recognized in OCI in the period in which they occur.

Our general funding policy for these qualified pension plans is to contribute amounts at least sufficient to satisfy funding standards of the respective countries for each plan. Refer to Item 1: “Financial Statements, Note 8: Defined Benefit Pension Plans” for our expected contributions for 2013.

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 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 estimated 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. For the three and six months ended June 30, 2013, we accrued $2.0 million and $8.0 million for such awards, compared with $5.3 million and $11.9 million for the same periods in 2012. Awards are typically distributed in the first quarter of the following year.

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Stock-Based Compensation
We measure and recognize compensation expense for all stock-based awards made to employees and directors, including awards of 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 term. The fair value of restricted stock units with a market condition is estimated at the date of award using a Monte Carlo simulation model, which includes assumptions for the dividend yield, expected volatility, risk-free interest rate and the expected term. In valuing our stock options and restricted stock units with a market condition, significant judgment is required in determining the expected volatility of our common stock and the expected life that individuals will hold their stock options prior to exercising. Expected volatility for stock options is based on the historical and implied volatility of our own common stock while the volatility for our restricted stock units with a market condition is based on the historical volatility of our own stock and the stock for companies comprising the market index within the market condition. The expected life of stock option grants is derived from the historical actual term of option grants and an estimate of future exercises during the remaining contractual period of the option. While volatility and estimated life are assumptions that do not bear the risk of change subsequent to the grant date of stock options, these assumptions may be difficult to measure as they represent future expectations based on historical experience. Further, our expected volatility and expected life may change in the future, which could substantially change the grant-date fair value of future awards of stock options and ultimately the expense we record. 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 without a market condition and unrestricted stock awards, the fair value is the market close price of our common stock on the date of grant. We consider many factors when estimating expected forfeitures, including types of awards, employee class, and historical experience. Actual results and future estimates may differ substantially from our current estimates. 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, 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.

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Item 3:
Quantitative and Qualitative Disclosures about Market Risk
In the normal course of business, we are exposed to interest rate and foreign currency exchange rate risks that could impact our financial position and results of operations. As part of our risk management strategy, we may use derivative financial instruments to hedge certain foreign currency and interest rate exposures. Our objective is to offset gains and losses resulting from these exposures with losses and gains on the derivative contracts used to hedge them, therefore reducing the impact of volatility on earnings or protecting the fair values of assets and liabilities. We use derivative contracts only to manage existing underlying exposures. Accordingly, we do not use derivative contracts for trading or speculative purposes.

Interest Rate Risk
We are exposed to interest rate risk through our variable rate debt instruments. 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 table below provides information about our financial instruments that are sensitive to changes in interest rates and the scheduled minimum repayment of principal and the weighted average interest rates at June 30, 2013. Weighted average variable rates in the table are based on implied forward rates in the Reuters U.S. dollar yield curve as of June 30, 2013 and our estimated leverage ratio, which determines our additional interest rate margin at June 30, 2013.

 
2013
 
2014
 
2015
 
2016
 
2017
 
Total
 
Fair Value
 
(in thousands)
Variable Rate Debt
 
 
 
 
 
 
 
 
 
 
 
 
 
Principal: U.S. dollar term loan
$
11,250

 
$
26,250

 
$
30,000

 
$
202,500

 
$

 
$
270,000

 
$
268,219

Average interest rate
1.46
 %
 
1.63
 %
 
2.14
 %
 
2.86
%
 
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Principal: Multicurrency revolving line of credit
$

 
$

 
$

 
$
140,000

 
$

 
$
140,000

 
$
138,930

Average interest rate
1.46
 %
 
1.63
 %
 
2.14
 %
 
2.86
%
 
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest rate swap on LIBOR based debt
 
 
 
 
 
 
 
 
 
 
 
 
 
Average interest rate (Pay)
1.00
 %
 
1.00
 %
 
1.00
 %
 
1.00
%
 
 
 
 
 
 
Average interest rate (Receive)
0.21
 %
 
0.38
 %
 
0.89
 %
 
1.61
%
 
 
 
 
 
 
Net/Spread
(0.79
)%
 
(0.62
)%
 
(0.11
)%
 
0.61
%
 
 
 
 
 
 
  
Based on a sensitivity analysis as of June 30, 2013, we estimate that, if market interest rates average one percentage point higher in 2013 than in the table above, our financial results in 2013 would not be materially impacted.

We continually 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.

Foreign Currency Exchange Rate Risk
We conduct business in a number of countries. As a result, over half of our revenues and operating expenses are denominated in foreign currencies, which expose our account balances to movements in foreign currency exchange rates that could have a material effect on our financial results. Our primary foreign currency exposure relates to non-U.S. dollar denominated transactions in our international subsidiary operations, the most significant of which is the euro. Revenues denominated in functional currencies other than the U.S. dollar were 59% and 62% of total revenues for the three and six months ended June 30, 2013, respectively, compared with 56% for the same periods in 2012.

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 247 contracts were entered into during the six months ended June 30, 2013) not designated for hedge accounting, with the intent to reduce earnings volatility associated with certain of these balances. The notional amounts of the contracts ranged from $251,000 to $11.0 million, offsetting our exposures from the euro, Saudi riyal, Canadian dollar, Australian dollar, Brazilian real, South African rand, and various other currencies.
In future periods, we may use additional derivative contracts to protect against foreign currency exchange rate risks.

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Item 4:
Controls and Procedures

(a)
Evaluation of disclosure controls and procedures. At June 30, 2013, an evaluation was performed under the supervision and with the participation of our Company’s management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e)) under the Securities Exchange Act of 1934, as amended. Based on that evaluation, the Company’s management, including the Chief Executive Officer and Chief Financial Officer, concluded that as of June 30, 2013, the Company’s disclosure controls and procedures were effective to ensure the information required to be disclosed by an issuer in the reports that it files or submits under the Securities Exchange Act of 1934 is accumulated and communicated to our management, including our principal executive and principal financial officers, or persons performing similar functions, as appropriate, to allow timely decisions regarding required disclosure. There are inherent limitations to the effectiveness of any system of disclosure controls and procedures, including the possibility of human error and the circumvention or overriding of the controls and procedures. Accordingly, even effective disclosure controls and procedures can only provide reasonable assurance of achieving their control objectives.

(b)
Changes in internal controls over financial reporting. While we are continuing the process of upgrading our global enterprise resource software systems and information technology infrastructure, there have been no changes in our internal control over financial reporting during the three months ended June 30, 2013 that materially affected, or are reasonably likely to materially affect, internal control over financial reporting.



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PART II: OTHER INFORMATION
 

Item 1:
Legal Proceedings
There were no material changes, as defined by Item 103 of Regulation S-K, during the second quarter of 2013.

Item 1A:
Risk Factors
There were no material changes to risk factors during the second quarter of 2013 from those previously disclosed in Item 1A: "Risk Factors" of Part I of our Annual Report on Form 10-K for the fiscal year ended December 31, 2012, which was filed with the SEC on February 22, 2013.

Item 2:
Unregistered Sales of Equity Securities and Use of Proceeds
(a) Not applicable.

(b) Not applicable.

(c) Issuer Repurchase of Equity Securities
The table below summarizes information about the Company's purchases of its shares of common stock, based on settlement date, during the quarterly period ended June 30, 2013.
Period
 
Total Number of Shares Purchased(1)
 
Average Price Paid per Share(2)
 
Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs
 
Maximum Dollar Value of Shares that May Yet Be Purchased Under the Plans or Programs
 
 
 
 
 
 
 
 
(in thousands)
April 1 through April 30
 
52,839

 
$
44.19

 
52,839

 
$
47,465

May 1 through May 31
 
186,307

 
40.90

 
186,307

 
39,845

June 1 through June 30
 
141,164

 
42.30

 
141,164

 
33,874

Total
 
380,310

 
$
41.88

 
380,310

 
 
(1) 
On March 8, 2013, the Board authorized a twelve-month repurchase program of up to $50 million of our common stock. Repurchases are made in the open market or in privately negotiated transactions, and in accordance with applicable securities laws. No shares were purchased outside of this plan.
(2) 
Includes commissions.

Subsequent to June 30, 2013, we repurchased 174,200 shares of our common stock under the stock repurchase program authorized by the Board of Directors on March 8, 2013. The average price paid per share was $42.71.

Item 5:
Other Information
(a) No information was required to be disclosed in a report on Form 8-K during the second quarter of 2013 that was not reported.

(b) Not applicable.

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Item 6:
Exhibits
 

 
 
 
Exhibit
Number
  
Description of Exhibits
 
 
31.1
  
Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
 
 
31.2
  
Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
 
 
32.1
  
Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 
 
101.INS
  
XBRL Instance Document.
 
 
101.SCH
  
XBRL Taxonomy Extension Schema.
 
 
101.CAL
  
XBRL Taxonomy Extension Calculation Linkbase.
 
 
101.DEF
 
XBRL Taxonomy Extension Definition Linkbase.
 
 
 
101.LAB
  
XBRL Taxonomy Extension Label Linkbase.
 
 
101.PRE
  
XBRL Taxonomy Extension Presentation Linkbase.
 
 
 


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SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
 
 
 
ITRON, INC.
 
 
 
 
August 6, 2013
 
By:
/s/ STEVEN M. HELMBRECHT
Date
 
 
Steven M. Helmbrecht
 
 
 
Executive Vice President and Chief Financial Officer

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