ITRI 10Q 9.30.11
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 September 30, 2011

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 September 30, 2011 there were outstanding 40,732,045 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
September 30,
 
Nine Months Ended
September 30,
 
2011
 
2010
 
2011
 
2010
 
 
 
(restated)
 
 
 
(restated)
 
(in thousands, except per share data)
Revenues
$
615,555

 
$
573,651

 
$
1,791,647

 
$
1,638,613

Cost of revenues
439,377

 
391,888

 
1,240,276

 
1,125,730

Gross profit
176,178

 
181,763

 
551,371

 
512,883

 
 
 
 
 
 
 
 
Operating expenses
 
 
 
 
 
 
 
Sales and marketing
45,037

 
41,197

 
138,530

 
123,708

Product development
38,672

 
34,038

 
120,048

 
100,100

General and administrative
32,212

 
30,710

 
100,661

 
97,052

Amortization of intangible assets
16,013

 
16,882

 
47,807

 
51,459

Restructuring
1,096

 

 
3,003

 

Goodwill impairment
540,400

 

 
540,400

 

Total operating expenses
673,430

 
122,827

 
950,449

 
372,319

 
 
 
 
 
 
 
 
Operating income (loss)
(497,252
)
 
58,936

 
(399,078
)
 
140,564

Other income (expense)
 
 
 
 
 
 
 
Interest income
155

 
166

 
631

 
444

Interest expense
(10,796
)
 
(13,328
)
 
(34,330
)
 
(42,216
)
Other income (expense), net
(3,147
)
 
(4,423
)
 
(7,220
)
 
(5,440
)
Total other income (expense)
(13,788
)
 
(17,585
)
 
(40,919
)
 
(47,212
)
 
 
 
 
 
 
 
 
Income (loss) before income taxes
(511,040
)
 
41,351

 
(439,997
)
 
93,352

Income tax provision
(6,042
)
 
(13,712
)
 
(15,529
)
 
(15,152
)
Net income (loss)
$
(517,082
)
 
$
27,639

 
$
(455,526
)
 
$
78,200

 
 
 
 
 
 
 
 
Earnings (loss) per common share - Basic
$
(12.70
)
 
$
0.68

 
$
(11.21
)
 
$
1.94

Earnings (loss) per common share - Diluted
$
(12.70
)
 
$
0.68

 
$
(11.21
)
 
$
1.91

 
 
 
 
 
 
 
 
Weighted average common shares outstanding - Basic
40,725

 
40,400

 
40,648

 
40,307

Weighted average common shares outstanding - Diluted
40,725

 
40,828

 
40,648

 
40,950

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


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ITRON, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands)
 
 
September 30, 2011
 
December 31, 2010
 
(unaudited)
 
 
ASSETS
 
 
 
Current assets
 
 
 
Cash and cash equivalents
$
129,514

 
$
169,477

Accounts receivable, net
377,107

 
371,662

Inventories
240,565

 
208,157

Deferred tax assets current, net
44,953

 
55,351

Other current assets
88,214

 
77,570

Total current assets
880,353

 
882,217

 
 
 
 
Property, plant, and equipment, net
287,565

 
299,242

Deferred tax assets noncurrent, net
28,053

 
35,050

Other long-term assets
66,878

 
28,242

Intangible assets, net
264,223

 
291,670

Goodwill
714,606

 
1,209,376

Total assets
$
2,241,678

 
$
2,745,797

 
 
 
 
LIABILITIES AND SHAREHOLDERS’ EQUITY
 
 
 
Current liabilities
 
 
 
Accounts payable
$
260,148

 
$
241,949

Other current liabilities
31,198

 
49,690

Wages and benefits payable
83,173

 
110,479

Taxes payable
23,812

 
19,725

Current portion of debt
15,000

 
228,721

Current portion of warranty
50,798

 
24,912

Unearned revenue
43,814

 
28,258

Total current liabilities
507,943

 
703,734

 
 
 
 
Long-term debt
481,252

 
382,220

Long-term warranty
28,234

 
26,371

Pension plan benefit liability
66,550

 
61,450

Deferred tax liabilities noncurrent, net
41,974

 
54,412

Other long-term obligations
88,744

 
89,315

Total liabilities
1,214,697

 
1,317,502

 
 
 
 
Commitments and contingencies

 

 
 
 
 
Shareholders’ equity
 
 
 
Preferred stock

 

Common stock
1,343,940

 
1,328,249

Accumulated other comprehensive income (loss), net
3,547

 
(34,974
)
(Accumulated deficit) retained earnings
(320,506
)
 
135,020

Total shareholders’ equity
1,026,981

 
1,428,295

Total liabilities and shareholders’ equity
$
2,241,678

 
$
2,745,797

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)
 
 
Nine Months Ended
September 30,
 
2011
 
2010
 
 
 
(restated)
 
(in thousands)
Operating activities
 
 
 
Net income (loss)
$
(455,526
)
 
$
78,200

Adjustments to reconcile net income (loss) to net cash provided by operating activities:
 
 
 
Depreciation and amortization
96,919

 
97,184

Stock-based compensation
12,401

 
14,222

Amortization of prepaid debt fees
5,365

 
4,219

Amortization of convertible debt discount
5,336

 
7,505

Deferred taxes, net
(1,410
)
 
(1,237
)
Goodwill impairment
540,400

 

Other adjustments, net
1,961

 
4,008

Changes in operating assets and liabilities, net of acquisition:
 
 
 
Accounts receivable
(21,940
)
 
(53,425
)
Inventories
(32,750
)
 
(57,698
)
Other current assets
(8,672
)
 
(1,776
)
Other long-term assets
(17,499
)
 
1,642

Accounts payables, other current liabilities, and taxes payable
12,347

 
38,139

Wages and benefits payable
(28,018
)
 
26,799

Unearned revenue
22,862

 
(2,814
)
Warranty
28,028

 
16,535

Other operating, net
(6,003
)
 
(4,387
)
Net cash provided by operating activities
153,801

 
167,116

 
 
 
 
Investing activities
 
 
 
Acquisitions of property, plant, and equipment
(45,799
)
 
(45,507
)
Business acquisition, net of cash equivalents acquired
(14,635
)
 

Other investing, net
634

 
5,412

Net cash used in investing activities
(59,800
)
 
(40,095
)
 
 
 
 
Financing activities
 
 
 
Proceeds from borrowings
670,000



Payments on debt
(804,304
)
 
(106,524
)
Issuance of common stock
3,512

 
7,931

Other financing, net
(5,319
)
 
(2,330
)
Net cash used in financing activities
(136,111
)
 
(100,923
)
 
 
 
 
Effect of foreign exchange rate changes on cash and cash equivalents
2,147

 
123

Increase (decrease) in cash and cash equivalents
(39,963
)
 
26,221

Cash and cash equivalents at beginning of period
169,477

 
121,893

Cash and cash equivalents at end of period
$
129,514

 
$
148,114

 
 
 
 
Non-cash transactions:
 
 
 
Property, plant, and equipment purchased but not yet paid, net
$
(3,130
)
 
$
(5,998
)
Fair value of contingent and deferred consideration payable for business acquisition
5,108

 

 
 
 
 
Supplemental disclosure of cash flow information:
 
 
 
Cash paid during the period for:
 
 
 
Income taxes, net
$
12,904

 
$
17,447

Interest, net of amounts capitalized
25,964

 
31,666

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
September 30, 2011
(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 for the three and nine months ended September 30, 2011 and 2010, the Consolidated Balance Sheets as of September 30, 2011 and December 31, 2010, and the Consolidated Statements of Cash Flows for the nine months ended September 30, 2011 and 2010 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 2010 audited financial statements and notes included in our Annual Report on Form 10-K for the year ended December 31, 2010, as filed with the SEC on February 25, 2011. The results of operations for the three and nine months ended September 30, 2011 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. Variable interest entities of which we are the primary beneficiary are consolidated. At September 30, 2011, our investments in variable interest entities and noncontrolling interests were not material. Intercompany transactions and balances have been eliminated upon consolidation.

Business Acquisition
On January 10, 2011, we completed the acquisition of Asais S.A.S. and Asais Conseil S.A.S. (collectively Asais), an energy information management software and consulting services provider, located in France. The acquisition consisted of cash and contingent consideration. The acquisition was immaterial to our financial position, results of operations, and cash flows. (See Business Combinations policy below.)

Cash and Cash Equivalents
We consider all highly liquid instruments with remaining maturities of three months or less at the date of acquisition to be cash equivalents.

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

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

Derivative Instruments
All derivative instruments, whether designated in hedging relationships or not, are recorded on the Consolidated Balance Sheets

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

Derivatives are not used for trading or speculative purposes. Our derivatives are with major international 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. Refer to Note 7 and Note 12 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 10 years for machinery and equipment, computers and purchased software, and furniture. Leasehold improvements are capitalized and amortized over the term of the applicable lease, including renewable periods if reasonably assured, or over the useful lives, whichever is shorter. Construction in process represents capital expenditures incurred for assets not yet placed in service. Costs related to internally developed software and software purchased for internal uses are capitalized and are amortized over the estimated useful lives of the assets. Repair and maintenance costs are expensed as incurred. We have no major planned maintenance activities.

We review long-lived assets for impairment whenever events or circumstances indicate the carrying amount of an asset or asset group may not be recoverable. We have had no significant impairments of long-lived assets. 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. We had no assets held for sale at September 30, 2011 and December 31, 2010. Gains and losses from asset disposals and impairment losses are classified within the statement of operations according to the use of the asset.

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 results of operations are also included as of the date of acquisition in our consolidated results. Intangible assets that arise from contractual/legal rights, or are capable of being separated, as well as in-process research and development, are measured and recorded at fair value, and amortized over the estimated useful life. 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.


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

Goodwill is assigned to our reporting units based on the expected benefit from the synergies arising from each business combination, determined by using certain financial metrics, including the forecasted discounted cash flows associated with each reporting unit. Our Itron North America operating segment represents one reporting unit, while our Itron International operating segment has three reporting units. In the first quarter of 2012, we will reallocate our goodwill from our existing reporting units to the new reporting units within the Energy and Water operating segments based on the relative fair values of the existing and new reporting units on January 1, 2012.

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

Determining the fair value of a reporting unit is judgmental in nature and involves the use of significant estimates and assumptions. We forecast discounted future cash flows at the reporting unit level using risk-adjusted discount rates and estimated future revenues and operating costs, which take into consideration factors such as existing backlog, expected future orders, supplier contracts, and expectations of competitive and economic environments. We also identify similar publicly traded companies and develop a correlation, referred to as a multiple, to apply to the operating results of the reporting units. These combined fair values are then reconciled to our aggregate market value of our shares of 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. Changes in these factors and related estimates could materially affect our financial position and results of operations.

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

Warranty
We offer standard warranties on our hardware products and large application software products. We accrue the estimated cost of warranty claims based on historical and projected product performance trends and costs. 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. If our quality control efforts fail to detect a fault in one of our products, we could 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. 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 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.

Defined Benefit Pension Plans
We sponsor both funded and unfunded defined benefit pension plans for our international employees. We recognize a liability for

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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.

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

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

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

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

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

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

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

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

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

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

VSOE is generally limited to the price charged when the same or similar product is sold separately or, if applicable, the stated

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

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

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 $66.2 million and $42.8 million at September 30, 2011 and December 31, 2010 related primarily to professional services and software associated with our smart metering contracts, extended or noncustomary warranty, and prepaid post-contract support. Deferred cost is recorded for products or services for which ownership (typically defined as title and risk of loss) has transferred to the customer, but the criteria for revenue recognition have not been met as of the balance sheet date. Deferred costs were $15.9 million and $10.0 million at September 30, 2011 and December 31, 2010 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 generally do not capitalize product and software development expenses due to the relatively short period of time between technological feasibility and the completion of product and software development, and the immaterial nature of these costs.

Stock-Based Compensation
We measure and recognize compensation expense for all stock-based awards made to employees and directors, including stock options, stock sold pursuant to our Employee Stock Purchase Plan (ESPP), and the issuance of restricted stock units and unrestricted stock awards, based on estimated fair values. The fair value of stock options is estimated at the date of grant using the Black-Scholes option-pricing model, which includes assumptions for the dividend yield, expected volatility, risk-free interest rate, and expected life. For ESPP awards, the fair value is the difference between the market close price of our common stock on the date of purchase and the discounted purchase price. For restricted stock units and unrestricted stock awards, the fair value is the market close price of our common stock on the date of grant. We expense stock-based compensation at the date of grant for unrestricted stock awards. For awards with only a service condition, we expense stock-based compensation, adjusted for estimated forfeitures, using the straight-line method over the requisite service period for the entire award. For awards with both performance and service conditions, 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.

Loss on Extinguishment of Debt, Net
Upon partial or full redemption of our borrowings, we recognize a gain or loss for the difference between the cash paid and the net carrying amount of the debt redeemed. Included in the net carrying amount is any unamortized premium or discount from the original issuance of the debt.

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

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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 tax 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 not more likely than not that such assets will be realized. We do not record tax liabilities on undistributed earnings of international subsidiaries that are permanently reinvested.

Our accounting for uncertain tax positions utilizes a two step approach. 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 a non-U.S. dollar functional currency 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 these subsidiaries are translated to U.S. dollars using a weighted average rate for the relevant reporting period. Translation adjustments resulting from this process are included, net of tax, in OCI. Gains and losses that arise from exchange rate fluctuations for monetary asset and liability balances that are not denominated in an entity’s functional currency are included within other income (expense), net in the Consolidated Statements of Operations. Currency gains and losses of intercompany balances deemed to be long-term in nature or designated as a hedge of the net investment in international subsidiaries are included, net of tax, in OCI.

Fair Value Measurements
For assets and liabilities measured at fair value, the GAAP fair value hierarchy prioritizes the inputs used in different valuation methodologies, assigning the highest priority to unadjusted quoted prices for identical assets and liabilities in actively traded markets (Level 1) and the lowest priority to unobservable inputs (Level 3). Level 2 inputs consist of quoted prices for similar assets and liabilities in active markets; quoted prices for identical or similar assets and liabilities in non-active markets; and model-derived valuations in which significant inputs are corroborated by observable market data either directly or indirectly through correlation or other means (inputs may include yield curves, volatility, credit risks, and default rates). We hold no assets or liabilities measured using Level 1 fair value inputs.

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.


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Restatement
The unaudited quarterly financial information for the first three quarters of 2010 was restated in the fourth quarter of 2010. The restatement was made primarily to defer revenue previously recognized on one contract due to a misinterpretation of an extended warranty provision. While the restatement was not deemed material to the first three quarters of 2010, we concluded that the aggregate correction of such amounts would be material to the fourth quarter of 2010. Accordingly, although not material to our financial statements for the first three quarters of 2010, the results of operations for the three and nine months ended September 30, 2010 and cash flows for the nine months ended September 30, 2010 have been restated, as well as certain balance sheet components as of September 30, 2010. The consolidated statement of operations, consolidated balance sheet, and consolidated statement of cash flows have been restated, as follows:
 
Consolidated statement of operations
Three Months Ended
September 30, 2010
 
Nine Months Ended
September 30, 2010
 
As previously
reported
 
As restated
 
As previously
reported
 
As restated
 
(in thousands, except per share data)
Revenues
$
575,968

 
$
573,651

 
$
1,644,708

 
$
1,638,613

Cost of revenues
391,761

 
391,888

 
1,125,282

 
1,125,730

Gross profit
184,207

 
181,763

 
519,426

 
512,883

Operating income
61,380

 
58,936

 
147,107

 
140,564

Income before income taxes
43,795

 
41,351

 
99,895

 
93,352

Income tax (provision) benefit
(14,687
)
 
(13,712
)
 
(17,100
)
 
(15,152
)
Net income
29,108

 
27,639

 
82,795

 
78,200

 
 
 
 
 
 
 
 
Earnings per common share - Basic
$
0.72

 
$
0.68

 
$
2.05

 
$
1.94

Earnings per common share - Diluted
$
0.71

 
$
0.68

 
$
2.02

 
$
1.91


 Consolidated balance sheet
September 30, 2010
 
As previously reported
 
As restated
 
(in thousands)
Accounts receivable, net
383,814

 
383,431

Deferred tax assets noncurrent, net
49,612

 
51,560

Long-term warranty
24,993

 
25,441

Other long-term obligations
68,417

 
74,167

Accumulated other comprehensive loss, net
(1,688
)
 
(1,726
)
Retained earnings
113,045

 
108,450


 Consolidated statement of cash flow
Nine Months Ended
September 30, 2010
 
As previously reported
 
As restated
 
(in thousands)
Operating activities
 
 
 
Net income
$
82,795

 
$
78,200

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Deferred taxes, net
711

 
(1,237
)
Changes in operating assets and liabilities, net of acquisition:
 
 
 
Accounts receivable
(53,770
)
 
(53,425
)
Unearned revenue
(8,564
)
 
(2,814
)
Warranty
16,087

 
16,535


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Note 2:    Earnings (Loss) Per Share and Capital Structure

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

 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2011
 
2010
 
2011
 
2010
 
(in thousands, except per share data)
Net income (loss) available to common shareholders
$
(517,082
)
 
$
27,639

 
$
(455,526
)
 
$
78,200

 
 
 
 
 
 
 
 
Weighted average common shares outstanding - Basic
40,725

 
40,400

 
40,648

 
40,307

Dilutive effect of convertible notes

 

 

 
138

Dilutive effect of stock-based awards

 
428

 

 
505

Weighted average common shares outstanding - Diluted
40,725

 
40,828

 
40,648

 
40,950

Earnings (loss) per common share - Basic
$
(12.70
)
 
$
0.68

 
$
(11.21
)
 
$
1.94

Earnings (loss) per common share - Diluted
$
(12.70
)
 
$
0.68

 
$
(11.21
)
 
$
1.91


Convertible Notes
Prior to the repayment/redemption of our convertible notes, we were required to settle the principal amount of the convertible notes in cash and could elect to settle the remaining conversion obligation (stock price in excess of conversion price) in cash, shares, or a combination thereof. During the periods in which the convertible notes were outstanding, we included in the EPS calculation the amount of shares it would have taken to satisfy the conversion obligation, assuming that all of the convertible notes were converted. The average quarterly closing prices of our common stock were used as the basis for determining the dilutive effect on EPS. The average price of our common stock for the three and nine months ended September 30, 2011 and the three months ended September 30, 2010 did not exceed the conversion price of $65.16 and, therefore, did not have an effect on diluted shares outstanding. The average price of our common stock for the nine months ended September 30, 2010 exceeded the conversion price of $65.16 and, therefore, approximately 138,000 shares were included in the diluted EPS calculation for that period. The convertible notes were no longer outstanding as of September 30, 2011.

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 1.4 million and 1.2 million stock-based awards were excluded from the calculation of diluted EPS for the three and nine months ended September 30, 2011, and approximately 526,000 and 432,000 stock-based awards were excluded from the calculation of diluted EPS for the three and nine months ended September 30, 2010, respectively, because they were anti-dilutive. These stock-based awards could be dilutive in future periods.

Preferred Stock
We have authorized the issuance of 10 million shares of preferred stock with no par value. In the event of a liquidation, dissolution, or winding up of the affairs of the corporation, whether voluntary or involuntary, the holders of any outstanding preferred stock will be entitled to be paid a preferential amount per share to be determined by the Board of Directors prior to any payment to holders of common stock. Shares of preferred stock may be converted into common stock based on terms, conditions, and rates as defined in the Rights Agreement, which may be adjusted by the Board of Directors. There was no preferred stock sold or outstanding at September 30, 2011 and December 31, 2010.


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Note 3:    Certain Balance Sheet Components
 
Accounts receivable, net
September 30, 2011
 
December 31, 2010
 
(in thousands)
Trade receivables (net of allowance of $7,452 and $9,045)
$
340,641

 
$
328,811

Unbilled receivables
36,466

 
42,851

Total accounts receivable, net
$
377,107

 
$
371,662


At September 30, 2011 and December 31, 2010, $887,000 and $12.5 million were recorded within trade receivables as billed but not yet paid by customers in accordance with contract retainage provisions. At September 30, 2011 and December 31, 2010, contract retainage amounts that were unbilled and classified as unbilled receivables were $5.8 million and $2.1 million. These contract retainage amounts within trade receivables and unbilled receivables are expected to be collected within the following 12 months.

At September 30, 2011 and December 31, 2010, long-term unbilled receivables and long-term retainage contract receivables totaled $31.4 million and $5.9 million. The net increase in long-term other assets from December 31, 2010 to September 30, 2011 includes $11.7 million of retainage contract receivables and $7.5 million of unbilled receivables, which were reclassified to long-term as of September 30, 2011 due to delays in reaching certain contract milestones required for payment. These long-term unbilled receivables and retainage contract receivables are classified within other long-term assets as collection is not anticipated within the following 12 months. However, collection is expected within the following 18 months.

Allowance for doubtful account activity
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2011
 
2010
 
2011
 
2010
 
(in thousands)
Beginning balance
$
8,980

 
$
6,298

 
$
9,045

 
$
6,339

Provision (release) of doubtful accounts, net
175

 
(904
)
 
128

 
(242
)
Accounts written-off
(1,127
)
 
(21
)
 
(1,680
)
 
(194
)
Effects of change in exchange rates
(576
)
 
393

 
(41
)
 
(137
)
Ending balance
$
7,452

 
$
5,766

 
$
7,452

 
$
5,766

 
Inventories
September 30, 2011
 
December 31, 2010
 
(in thousands)
Materials
$
132,309

 
$
106,021

Work in process
17,209

 
18,389

Finished goods
91,047

 
83,747

Total inventories
$
240,565

 
$
208,157


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 $14.5 million and $17.6 million at September 30, 2011 and December 31, 2010, respectively.

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Table of Contents

Property, plant, and equipment, net
September 30, 2011
 
December 31, 2010
 
(in thousands)
Machinery and equipment
$
281,205

 
$
265,113

Computers and purchased software
75,657

 
63,077

Buildings, furniture, and improvements
146,841

 
146,661

Land
32,402

 
35,968

Construction in progress, including purchased equipment
20,104

 
20,531

Total cost
556,209

 
531,350

Accumulated depreciation
(268,644
)
 
(232,108
)
Property, plant, and equipment, net
$
287,565

 
$
299,242


Depreciation expense
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2011
 
2010
 
2011
 
2010
 
(in thousands)
Depreciation expense
$
16,607

 
$
15,231

 
$
49,112

 
$
45,725

Note 4:    Intangible Assets

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

 
September 30, 2011
 
December 31, 2010
 
Gross Assets
 
Accumulated
Amortization
 
Net
 
Gross Assets
 
Accumulated
Amortization
 
Net
 
(in thousands)
Core-developed technology
$
394,990

 
$
(303,634
)
 
$
91,356

 
$
378,705

 
$
(274,198
)
 
$
104,507

Customer contracts and relationships
292,479

 
(131,370
)
 
161,109

 
282,997

 
(110,539
)
 
172,458

Trademarks and trade names
74,701

 
(63,361
)
 
11,340

 
73,194

 
(59,235
)
 
13,959

Other
11,092

 
(10,674
)
 
418

 
24,256

 
(23,510
)
 
746

Total intangible assets
$
773,262

 
$
(509,039
)
 
$
264,223

 
$
759,152

 
$
(467,482
)
 
$
291,670


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

 
Nine Months Ended September 30,
 
2011
 
2010
 
(in thousands)
Beginning balance, intangible assets, gross
$
759,152

 
$
806,256

Intangible assets acquired
10,297

 

Assets no longer in use written-off
(8,450
)
 

Effect of change in exchange rates
12,263

 
(33,730
)
Ending balance, intangible assets, gross
$
773,262

 
$
772,526


Intangible assets that were written-off had been fully amortized and were no longer in use. 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.


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Table of Contents

Estimated future annual amortization expense is as follows:

 
Years ending December 31,
Estimated Annual
Amortization
 
(in thousands)
2011 (amount remaining at September 30, 2011)
$
15,497

2012
48,042

2013
39,582

2014
32,532

2015
26,698

Beyond 2015
101,872

Total intangible assets, net
$
264,223

Note 5:    Goodwill

The following table reflects goodwill allocated to each reporting segment at September 30, 2011 and 2010:

 
Itron North
America
 
Itron
International
 
Total Company
 
(in thousands)
Goodwill balance at January 1, 2010
$
197,515

 
$
1,108,084

 
$
1,305,599

Effect of change in exchange rates
130

 
(69,146
)
 
(69,016
)
Goodwill balance at September 30, 2010
$
197,645

 
$
1,038,938

 
$
1,236,583

 
 
 
 
 
 
Goodwill balance at January 1, 2011
$
198,048

 
$
1,011,328

 
$
1,209,376

Goodwill acquired

 
10,251

 
10,251

Goodwill impairment

 
(540,400
)
 
(540,400
)
Effect of change in exchange rates
(317
)
 
35,696

 
35,379

Goodwill balance at September 30, 2011
$
197,731

 
$
516,875

 
$
714,606


As a result of the considerable decline in the price of our shares of common stock at the end of September 2011, our aggregate market value was significantly lower than the aggregate carrying value of our net assets. Therefore, we performed an interim impairment test of our goodwill as of September 30, 2011, which resulted in an estimated goodwill write-down of $540.4 million in the third quarter of 2011. Pursuant to the procedures required to complete the two step goodwill impairment test, we will finalize the amount of the goodwill impairment charge during the fourth quarter of 2011, which could result in an increase or decrease to the estimated impairment charge recognized in the third quarter. The goodwill impairment charge does not affect the debt covenants under the Company's existing credit facility.

The goodwill impairment was associated with two reporting units from the Itron International operating segment. The goodwill balance before and after the estimated goodwill impairment is as follows:

 
 
September 30, 2011
Reporting Unit
 
Before Estimated Impairment
 
Estimated Impairment
 
After Estimated Impairment
 
 
(in thousands)
Itron International - Electricity
 
$
363,626

 
$
216,085

 
$
147,541

Itron International - Water
 
389,308

 
324,315

 
64,993

 
 
 
 
$
540,400

 
 

Refer to Note 1: Summary of Significant Accounting Policies for a description of our reporting units and the methods used to determine the fair value of our reporting units and the amount of goodwill impairment.

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Note 6:    Debt

The components of our borrowings are as follows:

 
September 30, 2011
 
December 31, 2010
 
(in thousands)
2011 credit facility
 
 
 
USD denominated term loan
$
296,252

 
$

Multicurrency revolving line of credit
200,000

 

2007 credit facility
 
 
 
USD denominated term loan

 
218,642

EUR denominated term loan

 
174,031

Convertible senior subordinated notes

 
218,268

Total debt
496,252

 
610,941

Current portion of long-term debt
(15,000
)
 
(228,721
)
Long-term debt
$
481,252

 
$
382,220


Credit Facilities
On August 5, 2011, we entered into an $800 million senior secured credit facility (the 2011 credit facility), which replaced the senior secured credit facility we entered into in 2007 (the 2007 credit facility). The 2011 credit facility consists of a $300 million U.S. dollar term loan (the term loan) and a multicurrency revolving line of credit (the revolver) with a principal amount of up to $500 million. Both the term loan and the revolver mature on August 8, 2016, and amounts borrowed under the revolver are classified as long-term but may be repaid and reborrowed prior to the revolver's maturity. The 2011 credit facility permits us and certain of our foreign subsidiaries to borrow in U.S. dollars, euros, British pounds, or, with lender approval, other currencies readily convertible into U.S. dollars. All obligations under the 2011 credit facility are guaranteed by Itron, Inc. and any material U.S. domestic subsidiaries and secured by a pledge of substantially all of the assets of Itron, Inc. and any material U.S. domestic subsidiaries, including a pledge of 100% of the capital stock of material U.S. domestic subsidiaries and up to 66% of the voting stock (100% of the non-voting stock) of their first-tier foreign subsidiaries. In addition, the obligations of any foreign subsidiary who is a foreign borrower, as defined by the 2011 credit facility, are guaranteed by the foreign subsidiary and by its direct and indirect foreign parents. The 2011 credit facility includes covenants, which contain certain financial ratios and place certain restrictions on the incurrence of debt and investments. We were in compliance with the debt covenants under the 2011 credit facility at September 30, 2011.

Scheduled principal repayments for the term loan are due quarterly in the amounts of $3.8 million from September 2011 through June 2013, $5.6 million from September 2013 through June 2014, $7.5 million from September 2014 through June 2016, and the remainder due at maturity on August 8, 2016.

The 2011 credit facility permits us to borrow at various periodic rates for the term loan and the revolver based upon the London Interbank Offered Rate (LIBOR), plus a specified margin, and for the revolver we may, in lieu of LIBOR, select the U.S. prime rate, plus a specified margin. The additional margins are specified by our total leverage ratio (as defined in the credit agreement).  At September 30, 2011, the interest rate for the term loan and $190 million of the revolver was 1.73% (LIBOR plus a margin of 1.50%), and the interest rate for the remaining balance of the revolver ($10 million) was 3.75% (U.S. prime rate plus a margin of 0.50%).


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Table of Contents

Total credit facility repayments were as follows:
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2011
 
2010
 
2011
 
2010
 
(in thousands)
2011 credit facility term loan
$
3,750

 
$

 
$
3,750

 
$

2007 credit facility term loans
351,320

 
32,643

 
406,950

 
106,524

2007 credit facility revolving line of credit(1)
170,000

 

 
170,000

 

Total credit facility repayments
$
525,070

 
$
32,643

 
$
580,700

 
$
106,524

(1) See repayment of the convertible senior subordinated notes below.

At September 30, 2011, $200 million was outstanding under the 2011 credit facility revolver, and $35.9 million was utilized by outstanding standby letters of credit, resulting in $264.1 million available for additional borrowings.

Upon repayment of the 2007 credit facility, unamortized prepaid debt fees of $2.4 million were written-off to interest expense. Prepaid debt fees of approximately $6.2 million were capitalized associated with the 2011 credit facility. Unamortized prepaid debt fees were as follows:
 
September 30, 2011
 
December 31, 2010
 
(in thousands)
Unamortized prepaid debt fees
$
5,963

 
$
4,483


Convertible Senior Subordinated Notes
On August 1, 2011, in accordance with the terms of the convertible senior subordinated notes (convertible notes), at the option of the holders, we repurchased $184.8 million of the convertible notes at their principal amount plus accrued and unpaid interest. On September 30, 2011, we redeemed, at our option, the remaining $38.8 million of the convertible notes, plus accrued and unpaid interest. The convertible notes were repurchased and redeemed using $180 million of borrowings under our credit facilities and $44 million of cash on hand.

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

The discount on the liability component was fully amortized at June 30, 2011. The carrying amounts of the debt and equity components were as follows:

 
September 30, 2011
 
December 31, 2010
 
(in thousands)
Face value of convertible notes
$

 
$
223,604

Unamortized discount

 
(5,336
)
Net carrying amount of debt component
$

 
$
218,268

 
 
 
 
Carrying amount of equity component
$
31,831

 
$
31,831



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Table of Contents

The interest expense relating to both the contractual interest coupon and amortization of the discount on the liability component is as follows:
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2011
 
2010
 
2011
 
2010
 
(in thousands)
Contractual interest coupon
$
625

 
$
1,398

 
$
3,420

 
$
4,193

Amortization of the discount on the liability component

 
2,547

 
5,336

 
7,505

Total interest expense on convertible notes
$
625

 
$
3,945

 
$
8,756

 
$
11,698

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 12, and Note 13 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”), as defined by FASB Accounting Standards Codification (ASC) 820-10-20, Fair Value Measurements. We have used observable market inputs based on the type of derivative and the nature of the underlying instrument. The key inputs used at September 30, 2011 included foreign exchange spot and forward rates, both of which are available in an active market. We have utilized the mid-market pricing convention for these inputs at September 30, 2011. We include the effect of our counterparty credit risk based on current published credit default swap rates when the net fair value of our derivative instruments is in a net asset position. We consider our own nonperformance risk when the net fair value of our derivative instruments is in a net liability position by discounting our derivative liabilities to reflect the potential credit risk to our counterparty through applying a current market indicative credit spread to all cash flows.

The fair values of our derivative instruments determined using the fair value measurement of significant other observable inputs (Level 2) at September 30, 2011 and December 31, 2010 are as follows:
 
 
 
 
 
Fair Value
 
 
Balance Sheet Location
 
September 30,
2011
 
December 31,
2010
 
 
 
 
(in thousands)
Asset Derivatives
 
 
 
 
Derivatives not designated as hedging instruments under ASC 815-20
 
 
 
 
Foreign exchange forward contracts
 
Other current assets
 
$
175

 
$
63

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

 
$
5,845

Interest rate swap contracts
 
Other long-term obligations
 

 
975

Euro denominated term loan *
 
Current portion of debt
 

 
4,402

Euro denominated term loan *
 
Long-term debt
 

 
169,629

Total derivatives designated as hedging instruments under ASC 815-20
 
$

 
$
180,851

 
 
 
 
 
Derivatives not designated as hedging instruments under ASC 815-20
 
 
 
 
Foreign exchange forward contracts
 
Other current liabilities
 
$
342

 
$
457

 
 
 
 
 
 
 
Total liability derivatives
 
 
 
$
342

 
$
181,308


* The euro denominated term loan was a nonderivative financial instrument designated as a hedge of our net investment in international operations. The loan was repaid on August 8, 2011. The euro denominated term loan was recorded at its carrying value in the Consolidated Balance Sheets and was not recorded at fair value.

OCI during the reporting period for our derivative and nonderivative instruments designated as hedging instruments (collectively,

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hedging instruments), net of tax, was as follows:
 
 
2011
 
2010
 
(in thousands)
Net unrealized loss on hedging instruments at January 1,
$
(10,034
)
 
$
(30,300
)
Unrealized gain (loss) on derivative instruments
1,922

 
(2,920
)
Unrealized gain (loss) on a nonderivative net investment hedging instrument
(8,854
)
 
12,203

Realized (gains) losses reclassified into net income (loss)
2,598

 
5,874

Net unrealized loss on hedging instruments at September 30,
$
(14,368
)
 
$
(15,143
)

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. Historically, we have entered into interest rate swaps to achieve a fixed rate of interest on the hedged portion of the debt in order to reduce variability in cash flows.

In 2007, we entered into a pay fixed 6.59% receive three-month Euro Interbank Offered Rate (EURIBOR), plus 2%, amortizing interest rate swap to convert a significant portion of our euro denominated variable-rate term loan to fixed-rate debt, plus or minus the variance in the applicable margin from 2%, through December 31, 2012. The objective of this swap was to protect us from increases in the EURIBOR base borrowing rates. The swaps did not protect us from changes to the applicable margin under our credit agreement. Throughout the duration of the hedging relationship, this cash flow hedge was expected to be highly effective in achieving offsetting cash flows attributable to the hedged risk. Consequently, effective changes in the fair value of the interest rate swap were recorded as a component of OCI and were recognized in earnings when the hedged item affected earnings. The amounts paid or received on the hedge were recognized as adjustments to interest expense. The notional amount of the swap was $147.7 million (€112.4 million) as of December 31, 2010. In August 2011, we repaid our 2007 credit facility, which included the euro-denominated term loan. In conjunction with the debt repayment, we paid $2.9 million to terminate the related interest rate swap on August 4, 2011, and the accumulated loss in OCI was reclassified to interest expense.

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

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

The before-tax effect of our cash flow derivative instruments on the Consolidated Balance Sheets and the Consolidated Statements of Operations for the three and nine months ended September 30 are as follows:
 
Derivatives in ASC 815-20
Cash Flow
Hedging Relationships
 
Amount of Gain (Loss)
Recognized in OCI on
Derivative  (Effective
Portion)
 
Gain (Loss) Reclassified from Accumulated
OCI into Income (Effective Portion)
 
Gain (Loss) Recognized in Income on
Derivative (Ineffective Portion)
Location
 
Amount
 
Location
 
Amount
 
 
2011
 
2010
 
 
 
2011
 
2010
 
 
 
2011
 
2010
 
 
(in thousands)
 
 
 
(in thousands)
 
 
 
(in thousands)
Three Months Ended September 30,
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest rate swap contracts
 
$
277

 
$
(603
)
 
Interest expense
 
$
(3,083
)
 
$
(2,715
)
 
Interest expense
 
$
(121
)
 
$
(11
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Nine Months Ended September 30,
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest rate swap contracts
 
$
(4,200
)
 
$
(4,725
)
 
Interest expense
 
$
(7,254
)
 
$
(9,525
)
 
Interest expense
 
$
(201
)
 
$
(85
)

Net Investment Hedge
We are exposed to foreign exchange risk through our international subsidiaries. As a result of our acquisition of an international company in 2007, we entered into a euro denominated term loan, which exposed us to fluctuations in the euro foreign exchange rate. Therefore, we designated this foreign currency denominated term loan as a hedge of our net investment in international operations. The non-functional currency term loan was revalued into U.S. dollars at each balance sheet date, and the changes in value associated with currency fluctuations were recorded as adjustments to long-term debt with offsetting gains and losses recorded in OCI. The notional amount of the term loan was $174.0 million (€132.4 million) as of December 31, 2010. The loan was repaid in full on August 8, 2011 as part of our repayment of the 2007 credit facility. The net derivative loss will remain in accumulated

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OCI until such time when earnings are impacted by a sale or liquidation of the associated foreign operation.

The before tax and net of tax effects of our net investment hedge nonderivative financial instrument on OCI for the three and nine months ended September 30 are as follows:
 
Nonderivative Financial Instruments in ASC 815-20
Net Investment Hedging Relationships
 
Euro Denominated Term Loan Designated as a Hedge
of Our Net Investment in International Operations
 
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
 
2011
 
2010
 
2011
 
2010
 
 
(in thousands)
Gain (loss) recognized in OCI on derivative
(Effective Portion)
 
 
 
 
 
 
 
 
Before tax
 
$
645

 
$
(19,703
)
 
$
(14,278
)
 
$
19,795

Net of tax
 
$
408

 
$
(12,149
)
 
$
(8,854
)
 
$
12,203


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, foreign 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 421 contracts were entered into during the nine months ended September 30, 2011), 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 $50,000 to $72 million, offsetting our exposures from the euro, British pound, Canadian dollar, Czech koruna, Hungarian forint, and various other currencies.

The effect of our foreign exchange forward derivative instruments on the Consolidated Statements of Operations for the three and nine months ended September 30 is as follows:
 
Derivatives Not Designated as
Hedging Instrument under ASC 815-20
 
Gain (Loss) Recognized on Derivatives in Other Income (Expense)
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
 
2011
 
2010
 
2011
 
2010
 
 
(in thousands)
Foreign exchange forward contracts
 
$
2,464

 
$
(803
)
 
$
(877
)
 
$
2,244

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, 2010.
Our defined benefit pension plans are denominated in the functional currencies of the respective countries in which the plans are sponsored; therefore, the balances increase or decrease, with a corresponding change in OCI, due to changes in foreign currency exchange rates. Amounts recognized on the Consolidated Balance Sheets consist of:
 
 
September 30, 2011
 
December 31, 2010
 
(in thousands)
Plan assets in other long-term assets
$
(447
)
 
$
(412
)
Current portion of pension plan liability in wages and benefits payable
2,823

 
2,656

Long-term portion of pension plan liability
66,550

 
61,450

Net pension plan benefit liability
$
68,926

 
$
63,694

Our asset investment strategy focuses on maintaining a portfolio using primarily insurance funds, which are accounted for as investments and measured at fair value, in order to achieve our long-term investment objectives on a risk adjusted basis. Our general funding policy for these qualified pension plans is to contribute amounts sufficient to satisfy regulatory funding standards

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of the respective countries for each plan. We contributed $40,000 and $431,000 to the defined benefit pension plans for the three and nine months ended September 30, 2011, and $37,000 and $375,000 for the three and nine months ended September 30, 2010, respectively. The timing of when contributions are made can vary by plan and from year to year. For 2011, 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 $500,000 to our defined benefit pension plans. We contributed $519,000 to the defined benefit pension plans for the year ended December 31, 2010.
Net periodic pension benefit costs for our plans include the following components:
 
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2011
 
2010
 
2011
 
2010
 
(in thousands)
Service cost
$
637

 
493

 
$
1,855

 
$
1,493

Interest cost
947

 
858

 
2,833

 
2,608

Expected return on plan assets
(80
)
 
(73
)
 
(243
)
 
(221
)
Amortization of actuarial net loss (gain)
14

 
(6
)
 
42

 
(19
)
Amortization of unrecognized prior service costs
18

 

 
55

 

Net periodic benefit cost
$
1,536

 
$
1,272

 
$
4,542

 
$
3,861

Note 9:    Stock-Based Compensation

We record stock-based compensation expense for awards of stock options, stock sold pursuant to our ESPP, and the issuance of restricted stock units and unrestricted stock awards. We expense stock-based compensation primarily using the straight-line method over the vesting requirement period. For the three and nine months ended September 30, stock-based compensation expense and the related tax benefit were as follows:
 
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2011
 
2010
 
2011
 
2010
 
(in thousands)
Stock options
$
(320
)
 
$
843

 
$
1,224

 
$
3,138

Restricted stock units
2,916

 
3,962

 
10,320

 
10,344

Unrestricted stock awards
140

 
175

 
330

 
364

ESPP
147

 
121

 
527

 
376

Total stock-based compensation
$
2,883

 
$
5,101

 
$
12,401

 
$
14,222

 
 
 
 
 
 
 
 
Related tax benefit
$
700

 
$
1,421

 
$
3,359

 
$
4,153


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


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The fair values of stock options granted were estimated at the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions:
 
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2011
 
2010(1)
 
2011
 
2010
Dividend yield

 

 

 

Expected volatility
45.8
%
 

 
46.4
%
 
48.7
%
Risk-free interest rate
0.9
%
 

 
1.7
%
 
2.3
%
Expected life (years)
4.91

 

 
4.86

 
4.60


 (1) There were no employee stock options granted for the three months ended September 30, 2010.

Expected volatility is based on a combination of historical volatility of our common stock and the implied volatility of our traded options for the related expected life period. We believe this combined approach is reflective of current and historical market conditions and an appropriate indicator of expected volatility. The risk-free interest rate is the rate available as of the award date on zero-coupon U.S. government issues with a term equal to the expected life of the award. The expected life is the weighted average expected life of an award based on the period of time between the date the award is granted and the date an estimate of the award is 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.

Subject to stock splits, dividends, and other similar events, 3,500,000 shares of common stock are reserved and authorized for issuance under our 2010 Stock Incentive Plan (Stock Incentive Plan). Awards consist of stock options, restricted stock units, and unrestricted stock awards. At September 30, 2011, 2,226,303 shares were available for grant under the Stock Incentive Plan.

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


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A summary of our stock option activity for the nine months ended September 30 is as follows:
 
 
Shares
 
Weighted
Average Exercise
Price per Share
 
Weighted Average
Remaining
Contractual Life
 
Aggregate
Intrinsic Value (1)
 
Weighted
Average Grant
Date Fair Value
 
(in thousands)
 
 
 
(years)
 
(in thousands)
 
 
Outstanding, January 1, 2010
1,179

 
$
52.93

 
5.90

 
$
22,863

 
 
Granted
71

 
61.97

 
 
 
 
 
$
27.18

Exercised
(144
)
 
40.82

 
 
 
$
4,413

 
 
Outstanding, September 30, 2010
1,106

 
$
55.11

 
5.83

 
$
14,660

 
 
 
 
 
 
 
 
 
 
 
 
Exercisable and expected to vest, September 30, 2010
1,096

 
$
54.99

 
5.80

 
$
14,449

 
 
 
 
 
 
 
 
 
 
 
 
Exercisable, September 30, 2010
952

 
$
52.25

 
5.40

 
$
14,551

 
 
 
 
 
 
 
 
 
 
 
 
Outstanding, January 1, 2011
1,102

 
$
55.21

 
5.58

 
$
10,883

 
 
Granted
103

 
52.13

 
 
 
 
 
$
21.81

Exercised
(29
)
 
19.53

 
 
 
$
1,050

 
 
Forfeited
(63
)
 
58.50

 
 
 
 
 
 
Expired
(1
)
 
7.00

 
 
 
 
 
 
Outstanding, September 30, 2011
1,112

 
$
55.72

 
4.68

 
$
1,518

 
 
 
 
 
 
 
 
 
 
 
 
Exercisable and expected to vest, September 30, 2011
1,106

 
$
55.74

 
4.65

 
$
1,518

 
 
 
 
 
 
 
 
 
 
 
 
Exercisable, September 30, 2011
1,027

 
$
55.94

 
4.30

 
$
1,518

 
 

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

As of September 30, 2011, total unrecognized stock-based compensation expense related to nonvested stock options was approximately $1.5 million, which is expected to be recognized over a weighted average period of approximately one year.

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

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

The restricted stock units issued under the Long Term Performance Restricted Stock Unit Award Agreement (Performance Award Agreement) are determined based on the attainment of annual performance goals after the end of the calendar year performance period. During the year, if management determines that it is probable that the targets will be achieved, compensation expense, net of forfeitures, is recognized on a straight-line basis over the annual performance and subsequent vesting period for each separately vesting portion of the award. Performance awards typically vest and are released in three equal installments at the end of each year following attainment of the performance goals. For U.S. participants who retire during the performance period, a pro-rated number of restricted stock units (based on the number of days of employment during the performance period) immediately vest based on the attainment of the performance goals as assessed after the end of the performance period. During the vesting period, unvested restricted stock units immediately vest at the date of retirement for U.S. participants who retire during that period. For U.S. participants who are or will become retirement eligible during either the annual performance or vesting period, compensation expense is accelerated and recognized over the greater of the performance period (one year) or through the participant’s retirement eligible date. For performance awards granted in 2011, the maximum restricted stock units that may become eligible for vesting is 133,000 with a grant date fair value of $56.73.

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

 
Number of
Restricted Stock Units
 
Weighted
Average  Grant
Date Fair Value
 
Aggregate
Intrinsic Value(1)
 
(in thousands)
 
 
 
(in thousands)
Outstanding, January 1, 2010
326

 
 
 
 
Granted(2)
215

 
$
63.42

 
 
Released
(78
)
 
 
 
$
5,216

Forfeited
(14
)
 
 
 
 
Outstanding, September 30, 2010
449

 
 
 
 
 
 
 
 
 
 
Outstanding, January 1, 2011
588

 
 
 
 
Granted(2)
286

 
$
54.82

 
 
Released
(201
)
 
 
 
$
15,739

Forfeited
(37
)
 
 
 
 
Outstanding, September 30, 2011
636

 
 
 
 
 
 
 
 
 
 
Expected to vest, September 30, 2011
544

 
 
 
$
16,040


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

(2) 
These restricted stock units do not include the respective 2010 and 2011 awards under the Performance Award Agreement, which are not eligible for vesting as of September 30 of each respective year.

At September 30, 2011, unrecognized compensation expense was $21.8 million, which is expected to be recognized over a weighted average period of approximately two years.

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

The following table summarizes unrestricted stock award activity for the three and nine months ended September 30:
 
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2011
 
2010
 
2011
 
2010
Shares of unrestricted stock issued
2,864

 
2,896

 
6,317

 
5,662

 
 
 
 
 
 
 
 
Weighted average grant date fair value
$
48.84

 
$
60.39

 
$
52.19

 
$
64.35


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

 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2011
 
2010
 
2011
 
2010
Shares of stock sold to employees(1)
22,518

 
14,819

 
65,143

 
37,905

 
 
 
 
 
 
 
 
Weighted average fair value per ESPP award(2)
$
4.43

 
$
9.16

 
$
5.56

 
$
9.69


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

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

At September 30, 2011, all compensation cost associated with the ESPP had been recognized. There were approximately 131,000 shares of common stock available for future issuance under the ESPP at September 30, 2011.
Note 10:    Income Taxes

Our tax provisions (benefits) as a percentage of income (loss) before tax typically differs from the federal statutory rate of 35%, and may vary from period to period, due to fluctuations in the forecasted mix of earnings in domestic and international jurisdictions, new or revised tax legislation and accounting pronouncements, tax credits, state income taxes, adjustments to valuation allowances, and interest expense and penalties related to uncertain tax positions, among other items.

For the three and nine months ended September 30, 2011, we had tax provisions of 1.2% and 3.5%, based on a percentage of loss before income taxes. For the three and nine months ended September 30, 2010, we had tax provisions of 33% and 16%, based on income before income taxes.

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

Our tax provisions in 2010 were the result of certain interest expense deductions and the election under U.S. Internal Revenue Code Section 338 with respect to a foreign acquisition in 2007, as well as the estimated mix of earnings in different tax jurisdictions. The 2010 tax provisions also reflect the receipt of a clean energy manufacturing tax credit awarded as part of the American Recovery and Reinvestment Act and a benefit related to the reduction of tax reserves for certain foreign subsidiaries.

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 (benefit) recognized is as follows:
 
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2011
 
2010
 
2011
 
2010
 
(in thousands)
Net interest and penalties expense (benefit)
$
476

 
$
(172
)
 
$
584

 
$
124


Accrued interest and penalties recorded are as follows:

 
September 30, 2011
 
December 31, 2010
 
(in thousands)
Accrued interest
$
4,840

 
$
4,403

Accrued penalties
3,444

 
3,233


Unrecognized tax benefits related to uncertain tax positions and the amount of unrecognized tax benefits that, if recognized, would

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affect our effective tax rate are as follows:
 
 
September 30, 2011
 
December 31, 2010
 
(in thousands)
Unrecognized tax benefits related to uncertain tax positions
$
30,477

 
$
42,175

The amount of unrecognized tax benefits that, if recognized, would affect our effective tax rate
30,404

 
30,832


We believe it is reasonably possible that our unrecognized tax benefits may decrease by approximately $5.3 million within the next twelve months due to the expiration of the statute of limitations, and completion of examinations by taxing authorities. At September 30, 2011, we are not able to reasonably estimate the timing of future cash flows relating to our uncertain tax positions.
Note 11:    Commitments and Contingencies

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

Our available lines of credit, outstanding standby LOC’s, and bonds are as follows:
 
 
September 30, 2011
 
December 31, 2010
 
(in thousands)
Credit facilities(1)
 
 
 
Multicurrency revolving line of credit
$
500,000

 
$
240,000

Long-term borrowings
(200,000
)
 

Standby LOC’s issued and outstanding
(35,872
)
 
(43,540
)
Net available for additional borrowings and LOC’s
$
264,128

 
$
196,460

 
 
 
 
Unsecured multicurrency revolving lines of credit with various financial institutions
 
 
 
Multicurrency revolving line of credit
$
76,405

 
$
49,122

Standby LOC’s issued and outstanding
(30,500
)
 
(21,784
)
Short-term borrowings(2)
(901
)
 
(66
)
Net available for additional borrowings and LOC’s
$
45,004

 
$
27,272

 
 
 
 
Unsecured surety bonds in force
$
142,336

 
$
120,109


(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

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determination of the amount of the liability required, if any, for these contingencies is made after an analysis of each known issue. A liability is recorded and charged to operating expense when we determine that a loss is probable and the amount can be reasonably estimated. Additionally, we disclose contingencies for which a material loss is reasonably possible, but not probable. Liabilities recorded for legal contingencies at September 30, 2011 were not material to our financial condition or results of operations.

In October, 2010, Transdata Incorporated (Transdata) filed a complaint in the U.S. District Court for the Eastern District of Texas against CenterPoint Energy (CenterPoint), one of our customers, and several other utilities alleging infringement of three patents owned by Transdata related to the use of an antenna in a meter. Pursuant to our contract with CenterPoint, we agreed to indemnify and defend CenterPoint in this lawsuit. The complaint seeks unspecified damages as well as injunctive relief. CenterPoint has denied all of the allegations. We believe these claims are without merit and we intend to vigorously defend our interests. We do not believe this matter will have a material adverse effect on our business or financial condition, although an unfavorable outcome could have a material adverse effect on our results of operations for the period in which such a loss is recognized.

On February 23, 2011, a class action lawsuit was filed in U.S. Federal Court for the Eastern District of Washington alleging a violation of federal securities laws relating to a restatement of our financial results for the quarters ended March 31, June 30, and September 30, 2010. These revisions were made primarily to defer revenue that had been incorrectly recognized on one contract due to a misinterpretation of an extended warranty obligation. The effect was to reduce revenue and earnings in each of the first three quarters of the year. For the first nine months of 2010, total revenue was reduced by $6.1 million and diluted EPS was reduced by $0.11. We believe the facts and legal claims alleged are without merit and we intend to vigorously defend our interests.

In March 2011, a lawsuit was filed in the Superior Court of the State of Washington, in and for Spokane County against certain officers and directors seeking unspecified damages on behalf of Itron, Inc. The complaint alleges that the defendants breached their fiduciary obligations to Itron with respect to the restatement of Itron's financial results for the quarters ended March 31, June 30, and September 30, 2010. This lawsuit is a shareholder derivative action that purports to assert claims on behalf of Itron, Inc. Defendants believe they have valid defenses and intend to defend themselves vigorously.

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

Warranty
A summary of the warranty accrual account activity is as follows:
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2011
 
2010
 
2011
 
2010
 
(in thousands)
Beginning balance
$
62,838

 
$
49,203

 
$
51,283

 
$
33,873

New product warranties
1,512

 
3,964

 
5,591

 
9,660

Other changes/adjustments to warranties
26,263

 
7,845

 
40,906

 
23,438

Reclassification from other current liabilities
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