Itron, Inc.
Q3 2016 Earnings Call Transcript

Published: 3 Nov 2016

[Operator:]

Good day, everyone, and welcome to the Itron, Inc. Q3 2016 Earnings Conference Call. Today's call is being recorded. For opening remarks, I would like to turn the call over to Barbara Doyle. Please go ahead.

[Barbara J. Doyle:]

Thank you, Lynette. Good afternoon and welcome to Itron's third quarter 2016 earnings conference call. We issued a press release earlier today announcing our results. The press release includes replay information for today's call. We have also prepared presentation slides to accompany our remarks today. The presentation is available through the webcast and through our corporate website under the Investor Relations tab. On the call today, we have Philip Mezey, Itron President and Chief Executive Officer; and Mark Schmitz, Itron Executive Vice President and Chief Financial Officer. Following our prepared remarks, we will open up the call to take questions using the process the operator will describe. Before I turn the call over to Philip, please let me remind you on our non-GAAP financial presentation and our safe harbor statement. Our earnings release and financial presentation include non-GAAP financial information that we believe enhances the overall understanding of our current and future performance. Reconciliations of differences between GAAP and non-GAAP financial measures are available in our earnings release and on our Investor Relations website. We will be making statements during this call that are forward-looking. These statements are based on current expectations and assumptions that are subject to risks and uncertainties. Actual results could differ materially from the expectations we discussed today because of factors discussed in the earnings release and the comments made during this conference call and in the Risk Factor section in our Form 10-K, and other reports and filings with the Securities and Exchange Commission. We do not undertake any duty to update any forward-looking statements. Now, please turn to page four in the presentation and I'll turn the call over to our CEO, Philip Mezey.

[Philip C. Mezey:]

Thank you, Barbara, and welcome, everyone, on the call. We are pleased with Itron's strong third quarter results, which demonstrate the continued successful execution of our growth and margin improvement plan. Some key metrics to highlight from the quarter include revenues of $507 million, which grew by 8%, year-over-year; and 9%, excluding foreign currency translation effect; non-GAAP earnings per share of $0.77, which increased from $0.44 in the third quarter of last year; and $670 million of bookings in the quarter at a 1.3

[William Mark Schmitz:]

Thank you, Philip. The momentum we established in the first half of the year carried forward into quarter three, with constant currency revenue growth of 9%. This reflects favorable North American volume and strength in the Electricity and Gas segment. We also had sequential improvements in gross margin to 33.7% and improvement in non-GAAP EBITDA margins to 12.4%. As Philip mentioned, bookings also accelerated with backlog now above $1.5 billion and all segments recording book-to-bill ratios above 1

[Philip C. Mezey:]

Thanks, Mark. Our results demonstrate solid execution of our operating plans and positive momentum, and show that we're firmly on the path to achieve our mid-teens EBITDA target. We are realizing benefits from operational improvements started in 2014, and we have begun new projects to drive additional efficiencies in 2018 and beyond. Operational rigor has become part of the DNA of our global team across every function in our company. Efficiencies will continue to yield operating benefit and business flexibility, and provide leverage in our earnings generation capabilities. Importantly, our topline is growing, driven by adoption of smart systems and increasing interest in unified multi-service network and our new advanced services and analytics offerings. The R&D investment we are making in core technologies, like our OpenWay Riva IoT platform, that adds distributed intelligence, edge processing, dynamic applications and sensing technologies, fuels new organic growth opportunities. We also have strong relationships with customers as we help them drive operational savings and build foundations to deliver the value of smart grids and smart cities. We had more than 1,100 attendees at Itron Utility Week in Orlando in mid-October. We made several important announcements around our cloud-based Itron Total Outcomes, new applications in our growing partner ecosystem. At IUW, we announced that we're standardizing our services and software onto a single platform built on Microsoft Azure. Azure will be the backbone for Itron's managed services, which utilizes an Outcomes as a Service model to lower cost and improve performance. We also plan to enable a range of software and services on Azure that will allow Itron's customers to take advantage of a world-class platform that benefits from billions of dollars in ongoing investment. We're also partnering with SAP to run our meter-data management on the SAP HANA platform. Using SAP HANA will help utilities more easily integrate their enterprise data as they rollout smart systems. The relationship also provides Itron another key channel for our software. We also announced an award for a Riva crowdsourced app contest sponsored by Itron Idea Labs. The team from Cyient won for a mobile and web application for outage management that proactively predicts and communicates outages to customers. The challenge is a great example of our third-party developers' ecosystem utilizing Riva to create new imaginative IoT solutions to empower smarter utilities in smart cities. And finally, we launched Itron Mobile. With this app, utilities can securely collect data on the device of their choice, including smartphones, tablet and laptop. This flexible and affordable data collection is another example of new applications being developed by Itron Idea Labs. Q3 was certainly an energizing quarter of Itron. I'll wrap up the call by saying that we continue to focus intently on achieving our mid-teens EBITDA target and we're already laying the foundation for the next step of Itron's growth and success because we see even more potential for our business. I couldn't feel more confident about our growth opportunities. Operator, now let's open up the call to take some questions.

[Operator:]

Thank you. We'll pause for just a moment to allow everyone an opportunity to signal.

[Barbara J. Doyle:]

Hi, operator, no questions?

[Operator:]

We have a couple of callers in the queue. We'll take your first question John Quealy. Please go ahead.

[John Salvatore Quealy:]

Hey, good afternoon folks. Nice job on the quarter. So, a couple things, first, I know the policy is you don't update guidance on this particular call, but the talk sequentially that Mark was talking about, obviously, you had some really good mix towards smart, which drove the margins. Can you bracket for us the relative contribution that smart gave you, whether it's gross margin or EBITDA margin? Certainly all of those metrics worked well sequentially, but if you could help us understand that a little bit better that'd be helpful.

[William Mark Schmitz:]

John, so it's little difficult to bracket it precisely. There were three factors that came together and are really virtuous set of conditions here in quarter three. First of all, we just had very nice volume and mix in high margin environments, particularly North America. It's also true that in the Gas segment, that margin, 38.9%, was extraordinary, and was boosted by both North American mix and volume, and also better margins in EMEA. And, let's say, also, that we're seeing this continuous improvement in Electricity that is in part volume mix related, it's also related to the way the restructuring program – the prior restructuring program 2014, has now gotten close to full fruition, is benefiting those results in Electricity segment. So it could be even better if Water had not enjoyed some slowness in those (20

[John Salvatore Quealy:]

Okay. Let me – I'll try it this way, on the OpEx side, your product development came in a little bit sequentially, G&A, is that some of the things you're talking about, Mark, in terms of stepping down on some of the stage 1 optimization efforts coming to fruition?

[William Mark Schmitz:]

No, not exactly. I mean, in OpEx, if you look sequentially, principally what you're seeing is the follow-up of some of these extraordinary non-recurring costs that we had in the first-half of the year. In fact, I think we itemized them in the last call and said that there was a total of $17 million of such costs in quarter one and quarter two that were principally related to a legal settlement. And the extended 10-K filing that is now -- it came to an end -- those extraordinary costs came to an end in quarter three.

[John Salvatore Quealy:]

Okay. I'll take the rest of offline on that side. So, Philip, talk about book-to-bill if you wouldn't mind, any major 10 percenters (21

[Philip C. Mezey:]

So in terms of the notable bookings, I mean, I pointed them out in my comments. I would point to the Linky G3 announcement, a very significant booking for us. But I'm – not at the expense of the others, but I noted on the call we're seeing a healthy – we talked last quarter, that we had $300 million of visibility above, even the formally booked $1.5 billion that we have in the backlog, two-thirds of that approximately booked. We've replenished it. We've got another $300 million coming along, deals that are waiting for regulatory approval. So we're very pleased about selections that have been made and progress that we're making in the marketplace. But, specifically on the Electric site, the Gas business, again, very healthy bookings there as well, and Water, traditionally not – the bookings are not as large, as you know, in that side, but we were above 1

[John Salvatore Quealy:]

Okay. Thanks for that. And my last one. I think you mentioned 75 managed services customers signed up in the recent past. Talk about what those are, is that renewals or brand-new customers? I imagine Itron touched almost every utility in the world in some way, shape, or form. So, talk about how you categorize and create those and what that means in terms of revenues and potential margins? Thanks, again, folks.

[Philip C. Mezey:]

Sure. Thanks, John. So, we would refer to managed services generally as operating a system on our customers' behalf. So, doing data collection, if not data management, and often preparing actual billing determinants to submit to their systems. We see this as the stepping stone to actually providing higher value data analytics on top of that system, once we're managing the data collection and data storage across Electricity, Gas and Water. As to where those 75 managed services customers came from, to the question, Itron has provided traditional software solutions to thousands of utilities on a worldwide basis. And we are now increasingly seeing the request from our customers to manage those systems on their behalf in the cloud. And so, we are on an on-ramp of shifting from traditional on-premise software installations to a cloud-based offering in which we have recurring revenues, a closer working relationship and, importantly, a basis for building out further software and services revenue, delivering better outcomes and more value from the data that we're collecting.

[Operator:]

Mr. Quealy, do you have anything further?

[John Salvatore Quealy:]

I'm fine. Thanks.

[Operator:]

We'll move next to David Katter from R.W. Baird.

[David Katter:]

Hi, guys. Thanks for taking the question. I was wondering if you could talk about in what geographies, especially internationally, you're seeing the most opportunity? And along the same lines, are you expecting the softness in Water in Asia-Pacific and Latin America to persist?

[Philip C. Mezey:]

So in terms of opportunity outside of the United States, Western Europe has the largest deal flow as most closely watched. We've talked about significant progress we've made there, of course, in France, both on the Electricity and the Gas side; and Italy on the Gas side; Netherlands, Electricity and Gas; and coming online in the U.K., potentially at significant volumes over the next several years. So those -- and by the way, in the past quarter also Germany has announced that its approved $28 billion of potential expenditure in its – in a great modernization effort. So, Germany, which has been a bit of a laggard is – we expect going to open up and become a significant market. So Western Europe is the largest of those markets. But we have significant opportunities in the Middle East, Asia-Pacific, and there does continue to be opportunity in Latin America. It's – Latin America for us has been largely a Water market. There are some smart electricity deals down there. So -- our largest focus outside is EMEA-based, and specifically, Western European-based. To the question about softness in Water persisting, we expect an overall correction there. As we commented, the Water business is our most globally diversified, and so, we do see fluctuations from time to time. There are already improvements in the Brazilian economy that we hope will give us some positive lift over time. China is showing some signs of coming back. So we expect that condition to lift and that, coupled with contract award timing, expect the Water business to return to its normal levels of growth and profitability.

[David Katter:]

Excellent. Thank you, guys, very much.

[Philip C. Mezey:]

Welcome.

[Operator:]

We will hear next from Noah Kaye from Oppenheimer.

[Noah Kaye:]

Yes. Thank you and good afternoon. Just starting with the gross margin improvement, 410 bps overall, year-over-year, second straight quarter of GM (28

[William Mark Schmitz:]

I think I'd answer it this way, I mean, Noah, we can't give you guidance on what to assume going forward, 100 basis points or 150 basis points. I can tell you though that we're looking at a number of significant opportunities, both in gross margin and in the OpEx categories that give us I think an opportunity-rich environment as we move forward, and bear in mind that the restructuring activities that we announced this quarter are really only part of it. So, there are a multitude of operational improvements that are underway right now that are aimed – I'm going to say principally at gross margin, but also at OpEx. And I guess the only subsequent (29

[Noah Kaye:]

And I think, I mean, maybe you can comment on the mix question in the backlog as you noted sort of an ongoing shift towards smart in that event (29

[Philip C. Mezey:]

We have commented that the backlog does represent a business that is generally accretive to the overall gross margin of the company. So, as this backlog does play out, it does tend to have that positive effect on driving gross margin.

[Noah Kaye:]

Okay, great. And you mentioned the lower warranty cost as a contributor to gross margin; can you help us understand roughly what that contribution was? If possible, in terms of basis points, and are we sort of at structurally lower accrual levels now versus before – I think, this is sort of following up on a question asked last quarter, but I just want to understand where we are now.

[William Mark Schmitz:]

Sure. Well, specifically what we're referring to is the special work charge that we took last year and it amounted to $26 million.

[Noah Kaye:]

Right. But, sort of, on a normalized basis.

[William Mark Schmitz:]

On a normalized – if you're asking, so how does warranty shape up overall year-over-year basis, I'd say that we're not seeing any deterioration in warranty cost year-over-year. It is principally that $26 million, it's not recurring, and we don't expect it to recur.

[Barbara J. Doyle:]

We've put a lot of actions and new processes in place regarding suppliers, and overall quality processes that are really focused on addressing and (31

[Philip C. Mezey:]

And Noah, the way we've encapsulated that is predictability, profitability and growth are top priorities. And this emphasis that the team has put on predictability focuses on things like warranty-related charges and things like that at minimizing those in order to produce more – significantly more consistent set of results than we've seen in several past years.

[Noah Kaye:]

Okay, great. And maybe just sort of a longer term question from me to close here. In one of the panels at your Utility Week conference a few weeks ago, a very interesting focus on multi-use communications networks for Electric, Water and Gas, some of the opportunities and challenges around that – you're a provider to all three of those segments. So, I guess, the question is, how was your role -- how do you see a role in moving some of those opportunities forward and how do you even think about the revenue benefit from that in terms of greater software or cross-selling, how do you think about that? It was a very interesting topic.

[Philip C. Mezey:]

Yeah, Noah. Thanks, yeah (32

[Noah Kaye:]

Great. Thank you very much for taking my questions.

[Philip C. Mezey:]

Thank you. (34

[William Mark Schmitz:]

Thank you.

[Philip C. Mezey:]

Welcome.

[Operator:]

And at this time, there are no additional callers in the queue. I'd like to turn the conference back over to Ms. Doyle for any additional comments or closing.

[Philip C. Mezey:]

Okay, Lynette, thank you. So, we're, as you heard, very pleased about our third quarter and year-to-date performance. But please don't read in that pleasure any backing off in terms of how excited we are about the opportunities, I think, for a very balanced approach to topline growth as well as operational discipline and an improvement in our operating metrics. And so we're firmly focused on investing in forward technology and capability in order to drive the topline, as we are making really significant progress in driving our overall operating efficiency and bottomline results. And look forward to talking to you again on our full-year call. Thank you.

[Barbara J. Doyle:]

Thanks very much, Lynette.

[Operator:]

You're welcome. That does conclude today's teleconference. There will be an audio replay of today's conference available this afternoon. You can access the audio replay by dialing 1-888-203-1112 or 1-719-457-0820 with the passcode of 780255, or you may go to the company's website, www.itron.com.