Itron, Inc. (ITRI) Q4 2013 Earnings Report, Transcript and Summary

Good day, everyone, and welcome to Itron's Fourth Quarter 2013 Earnings Conference Call. Today's call is being recorded. As a reminder, there will be a question-and-answer session following the company's prepared remarks. (Operator Instructions) For opening remarks, I would like to turn the call over to Barbara Doyle, Vice President of Investor Relations. Please go ahead.

Thank you, operator, and good afternoon to everyone and welcome to Itron's fourth quarter 2013 conference call. We issued a press release earlier today announcing our results. The press release includes replay information about today's call. As you'll also see in our press release in the fourth quarter the company is reporting new segment information. We are reporting operating income results for Electric, Gas, and Water segments. We have also prepared a presentation to accompany our remarks in this call. The presentation is available through the webcast and to our corporate website under the Investor Relations tab. On the call today, we have Philip Mezey, Itron President and Chief Executive Officer; Steve Helmbrecht, Itron Executive Vice President and Chief Financial Officer; and John Holleran, Itron Executive Vice President and Chief Operating Officer. Before I turn the call over to Philip, please let me remind you of 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. We have included reconciliations of differences between GAAP and non-GAAP financial measures in our earnings release and financial presentation. 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 these expectations because of factors discussed in today's call and the comments made during our call and in the Risk Factors section of 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 4 in the presentation, and I will turn the call over to our CEO, Philip Mezey.

Thank you, Barbara, and good afternoon to everyone. I will begin the call with comments on our fourth quarter results and segment performance. As you can see in our press release we are now reporting operating income for three segments, Electric, Gas, and Water providing additional transparency into our business. Steve Helmbrecht will review our financial results, key metrics, and our financial guidance for 2014. He will also discuss the goodwill impairment charge in the quarter. I will wrap up with some closing comments focused on our outlook and then we'll open up to take some questions. In the fourth quarter, we continued to make progress on many fronts. A goodwill impairment charge and a large tax item impacted our results. However, steps we have taken throughout the year led to improved core operating profitability. In addition, revenues increased sequentially each quarter in 2013 and Q4 revenues were the highest level in six quarters. Our outlook for 2014 has some continuing pressure in our electric segment, particularly outside of North America, balanced by stability in our water and gas business. We will provide greater detail on this later in the call. Now let's move to segment performance, beginning with Q4 revenues on Slide 4. Year-over-year growth in electric and water revenues offset lower gas revenues and a negative effect from currency translations. The water segment is summarized on Slide 5. Revenues grew by 5.5% compared to the fourth quarter in 2012 driven by smart water projects in India and growth in heat meters and our heat cost allocation solution EquaScan in Europe. Gross margin increased 300 basis points to 35% due to increased smart meter endpoints and improved service margins. Non-GAAP operating margin also increased more than 500 basis points to 14.7% on lower operating expenses and higher gross profit…

Thank you, Philip, and good afternoon. Before I get into the details of the quarter and our guidance let me discuss goodwill. We took a non-cash goodwill impairment charge of $173 million in the quarter. We performed an annual goodwill evaluation during the quarter, which requires an assessment of each segment's estimated fair value based on a long-term forecast. As a result of this evaluation in the updated forecast, we determine that the carrying value of the electricity segment was higher than its fair value, which results in a write down of goodwill. The impairment was driven primarily by delays in global smart grid projects, lower volumes, and more conservative pricing assumptions in certain regions of Europe and Asia. The water and gas segments did not incur any impairment charges. I will move now to Slide 8, which summarizes the consolidated financial results for the quarter compared with the fourth quarter of 2012. You can see total revenues were about the same as last year and our consolidated gross margin improved 30 basis points. Non-GAAP operating margin was 7.3%, up 150 basis points over last year. The improvement reflects increased gross profit and lower non-GAAP operating expenses. We're continuing to focus on reducing our operating expenses and are starting to see the impact of our restructuring efforts. In the quarter, total non-GAAP operating expenses decreased 5% compared to last year with sales and marketing reflecting a 19% decrease year-over-year. Adjusted EBITDA was $50.3 million this quarter, with adjusted EBITDA margin of 9.6%. This is an increase of 120 basis points from a year ago. However, earnings per share were negatively impacted by goodwill and by taxes. On a GAAP basis we had a net loss of $3.93 per share compared with net income of $0.40 per share in 2012. The…

Thanks, Steve. A year ago when I started as CEO, I laid out a series of key initiatives in quality, collaboration, and innovation to drive our business forward. I'm encouraged by our progress on these initiatives in 2013. We've launched a companywide program to reinforce our culture of quality at Itron. The initiative has yielded real results with special warranty costs that the company declining by 85% from a peak level in 2011. We also made significant strides in collaboration and innovation. We extended our collaboration with Microsoft to its CityNext initiative focused on technology solutions for smart cities. We extended our partnership with Cisco to bring true IP multiservice networks to customers around the world launching OpenWay as a platform for global markets. And we enhanced our distribution automation offering by providing seamless integration of multivendor, multiservice communicating devices under our OpenWay IPv6 network. We had a number of very successful customer projects that highlight the value of our technology across electricity, gas, and water. CenterPoint Energy extended the project to its gas business by installing advanced gas communications modules to 3 million meters in the company's service territory. BC Hydro substantially completed its deployment of 2 million smart meters using OpenWay's IPv6 network architecture. Detroit Edison continued progress on its smart metering program, which is now more than 50% complete. ATCO Gas completed its gas automation project in 2013, which is one of the largest automation projects in Canada. Azeri Gas in Azerbaijan successfully completed the first phase of their advanced prepayment system deployment and has now moved the territories outside of the capital region. And in water, Irish Water, RWW in Germany, DJB Delhi in India, and the City of Baltimore among others selected Itron for their smart water automation projects addressing critical needs such as leakage…

Thank you. (Operator Instructions) We'll take our first question from Vishal Shah with Deutsche Bank.

Hi, this is Susie Min for Vishal Shah. I had two quick questions on the target for a high single-digit EBITDA. Can you just talk a little bit about what the timeframe is here and what are puts and takes? I know Philip you had mentioned that there are substantive changes in your -- in the process of evaluating them. But any color there in how to get to that target would be really helpful?

Sure, Susie. I mean, the first is the electric segment has performed at that level in the past when volumes were higher. So for that portion of the electric business that's already hitting our financial targets we see growth and volume in that business, which is going to help us out and then as we take a look at this process that I mentioned these three big parts for the small part of the business of reengineering, repositioning, and reevaluation. We are working on that. And as I said we'll update you as soon as that takes place. But that is really a focus area and we're moving as quickly as we can.

And we would also add Susie that the gas and water segments are really already on track to that model. So the gas and water segments and a large part of our electric segment are already on track.

And I know you guys have done a great job of decreasing your OpEx over the last couple of years. But as volumes come back and hopefully sooner than later, how much does that have to flex back up to accommodate expected increases in volume?

It would be our objective to keep those as flat as possible and to the extent we need to add sales and marketing or other functions to help support that growth we would look at making those investments in people, but we're going to try and leverage what we've got.

Next we have Sean Hannan with Needham & Company. Sean Hannan - Needham & Company: Yes, can you hear me?

Yes.

Yes, Sean. Sean Hannan - Needham & Company: Okay, great, thanks. Thanks for taking my question. So I want to see if we can get a little bit more color on what's embedded within your expectations for that guidance. And Philip, I think that you had commented you are looking for gas and water to have a little bit of modest growth this year, electric down a little bit. But actually I think actually Steve; you made a comment on that. If we can have a little bit more detail on that mix, and then secondarily to that as we looked at the impact on the earnings is this really the loss leverage that we have on the OpEx there and are there other actions perhaps that we might be able to take at some point during the year? Thanks.

I mean, Sean you got it right that the gas and water we see growth so that makes the shifting towards, I mean in terms of the overall revenue number you are seeing more of these higher gross margin, higher EBITDA margin as we've commented and you now have visibility to on our gas and water businesses. However, we do see strengthening in backlog in that electric business giving us more visibility as we move out in time. Second part of your question about operating expenses further leverage there, Steve's comment in which he has updated you on John's excellent efforts on the restructuring side in which yet about, we are about 50% of the way through, there are continued efforts throughout 2014 to continue to reduce our costs and improve efficiency. Sean Hannan - Needham & Company: Okay. Is that embedded though within the guidance that you provided? I'm assuming it probably would be given that you have visibility into the actions you could take yourself?

Yes, Sean, this is Steve that is embedded as well in the expectations, the restructuring as well. And again as I had mentioned in my earlier remarks there is the headwinds from the tax as well, it's just a higher rate in 2014 for some of those items I mentioned. Sean Hannan - Needham & Company: Right. So net taxes all else equal we would have otherwise be looking at about $1.06 for 2010?

Yes, with a difference in the tax about $0.30, yes.

We will move next to John Quealy with Canaccord Genuity.

Hey good afternoon folks. Do you hear me?

Yes, John.

Yes, John.

So the first question back to the financials for a minute, to make the midpoint of the revenues work in modest growth, so you're under 2% growth in gas and water and you're down electric, 11%, 12%, am I off by a magnitude or am I close there?

In terms of directionally there is modest growth in gas and water and decline in electric, the specific of that percentage but, yes that's overall we're seeing some modest growth in both water and gas.

And I hope this doesn't count as my follow-up, but for the OpEx, you did $500 million in OpEx excluding one-times in '13 I think. Now that we've restructuring on the way does that grow or shrink in '14 just ballpark?

It will grow a little bit.

And then secondly, Philip, a lot of moving pieces here. Competition, product cycle, just can we talk big picture for a minute? Do we buy something and pivot away from metering? Where do we go in the next couple years because there's just so much moving with product cycle and timing? Just help frame where we are, if you will, in your thoughts or strategy? Thanks guys.

You're welcome, John. I think it's pretty widely accepted that the data that these smart systems are producing is -- has a lot of upside value for our utility customers. You see us -- hear us talking on the call about we mentioned a couple of times growth in managed services and analytics. We see strong opportunities both with products we're developing ourselves and evaluations that we're doing in the marketplace for continued and highly profitable growth by focusing on the value of the data coming out of the system. So there are strong opportunities for us in expanding throughout the distribution grid. You see in announcements from us in distribution automation, and sensing product, leak detection non-revenue water on services and analytics. There are opportunities both for us organically and inorganically in those spaces.

And John let's just make some, I think John wants a final comment.

I need to clarify the one comment on OpEx. It actually will go down in 2014 compared to 2013 not up?

Thanks, operator. John, are you still there or can we move on to the next question, operator?

And Mr. Quealy do you have anything additional?

No, I'm good sorry, thanks.

Okay thank you. We'll move to the next question from Patrick Jobin with Credit Suisse.

Just first on the electric segment. So I guess you mentioned in your prepared remarks that some businesses were trending towards your profit targets within that segment, which suggests others are clearly not at that level. I guess I was surprised to see it for such a long period of time just looking back, when do you make the exit decision versus fixed decision, just how do you think about that?

So Patrick what's changed somewhat in our thinking after we've been studying in the market here over the past year is, in a number of markets we have remained present with low cost basic metering solutions. Based on the assumptions that as these markets went to smart metering that our local incumbency position would give us an advantage. And as we look at the market a couple of things are going on, one what's clear to all of you is it's taking longer for that transition to take place. In certain markets incumbency does not provide an advantage in the switch to smart metering as those markets have gone to sort of auction-based procurement in which relationship is not a primary driver. And in the case of what we referred to as highly specified markets where the smart metering solution that is specified does not give us differentiation and there is an incredible emphasis on reducing initial procurement cost, it just is, it may not be advantageous for us to remain focused on smart metering in those markets. So what's changed to your question of what's taken so long to see some of these is that as we've really been able to study the transition in a number of markets from basic metering to smart metering we've seen some trends emerge that allow us to then go back in some of the markets where we have traditionally have been market share focused and really focused on -- increase our focus on profitability.

Then a follow-up. You mentioned managed services and data analytics is a big focus for you. How much of your business today would you think is recurring in nature and how much would -- what are the near-term milestones for you on the data analytics side, so I guess it's kind of two questions? Thanks.

Yes, we in past discussion we've talked about that somewhere in a range of $100 million to $200 million a year of our revenues is in this recurring software and services area. It's our intention and we have tremendous opportunity to grow that significantly beyond its current levels. In terms of milestones we are very actively launching analytic offerings. We have initiated an offering called Itron Total in which we are bringing a service based offering to the marketplace. We are brining distribution automation solutions to the marketplace. So there is organic product growth that is going on in order to really increase our focus on software and services.

Next we'll move to Craig Irwin with Wedbush Securities.

Just a housekeeping question first. You gave us the $0.36 impact from the deferred tax asset but I didn't hear a number for the legal reserve you mentioned in the quarter and were there any costs associated with the discontinuation of the electromechanical meters in South America?

Craig, this is Steve. We did not mention any additional legal reserve and in terms of the restructuring expense that is already been accounted for in terms of the planned reduction of our activities in Brazil.

Then it's a tough question right with the business contracting in '14 why not go ahead and take out more cost and preserve the profitability and give yourselves the opportunity to strategically redeploy capital when you see the top line growing again. Can you walk us through the process in the evaluation you go through internally? And what gives you confidence that this 15% growth in your base business backlog really does drive '15 in a way that delivers the earnings that we would all like to see?

So, Craig I'd say that, John Holleran's team has done an excellent job this year in really scrubbing through his line items in operations as Steve on the G&A side. And the question that we really are focused on is how to build the long-term profitable business. And so as an example you see us continue to invest in R&D because we think that that's the growth engine. Where we see the opportunity for cost reduction is in consolidation of factories and some of the initiatives that John has already begun as a part of the restructuring process. And further opportunities which really fall into this focus area for me of underperforming areas of the electric business where there is a cost reduction opportunity because there is revenue a very low earnings quality in there, and by increasing our focus on areas that have more future promise for differentiation we will have strong opportunities. So reacting in the very short-term has some very negative impact for our long-term growth possibility and we've tried to keep strong balance. I'll turn it John here for any additional comments.

I was just going to echo what Philip just said. It's really a balance between what we're trying to do today to preserve our profitability and what we need to do for the future recognizing that we have to make some of these investments now to be in a position to take advantage of these opportunities when they start rolling out a year or two years from now. And unfortunately that makes for a tough '14 but that's the course we've decided to stay at this point.

And you will see Craig as you saw in 2013 significant reductions in sales and marketing. We'll begin to see more significant reductions in G&A with the shared services, business services model that we're pursuing. So we will continue to make expense -- you will continue to see expense reduction not necessarily in R&D because that is something we're going to preserve.

And then if I can squeeze another one in, I guess most people listening this call know that I'm pretty aggressive in looking into what the available opportunities are in North America. I think you just answered in the previous question a year to two years from now as potential timeframe for those projects to materialize, that's not as positive of you as what we've been hearing from some that are involved in the early assembly of these projects and preparation of these projects. May be can you give us a little bit more color as far as what the short-term, medium term, intermediate term pipeline looks like and what it would take for those projects to basically get green lighted in the appropriate areas?

So I want to thank you Craig and I know this is an area where you do cover in great detail. So the first thing I want to point out is the strength of the gas and the water businesses as water of course but then we see gas returning to the slow and steady growth path solidly moving forward, not as heavily project driven, yet, but we do see projects picking up, which you see in that better than one to one book-to-bill ratio that they are beginning to develop. We are sounding a more cautious note here in terms of expectations about some of the large European projects and some of the other opportunities, because we wish to focus on the areas that we can control internally within the company. So you've seen us focusing on cost reduction and this focus for me in really evaluating some of the less profitable markets in which we're currently participating in portions -- smaller portions of our electric business. Now going back to focusing on some of the larger deals in terms of the build up to those, you do see positive bookings momentum I mentioned a couple of projects that are announced that begin their deployments and continue to ramp up through 2014. Examples of that FortisBC, Duquesne, others that are really establishing momentum in '14 for continued deployments moving forward. There are regulatory hurdles that are being cleared in Pennsylvania, Massachusetts has made a favorable pronouncement in a move to smart metering or seems to be a greater acceptance in the Northeast after super storm Sandy, the focus on smart infrastructures waving, hardening and increasing reliability in the North American grid. We are very heartened to see the opportunity at places like Public Service of New Hampshire where not only did we win an AMR deal but sold our bridge meter and as we have in a number of clients now providing a way to bridge 45 million currently installed electric AMR endpoints over to smart metering as that transition occurs, and so we're providing a very strong product in that category. And then on the Europe side of course those deals has have been likely discussed continue to move forward and we continue to participate in them as they develop. But there is regulatory focus in pockets within the U.S., strengthening business cases, broadening application of smart metering. We sell your solutions with distributor automation solutions that will lead to organic and extended growth within North America as well.

(Operator Instructions) That does conclude our question-and-answer session at this time. I'll turn the call back over to Barbara Doyle for any final or additional comments.

Thank you, operator. And I think Philip may be would have some final comments to say and then we'll conclude our call.

Just I want to summarize for everybody that out of the three business lines that we are now giving you more information about that we see this strong and very profitable growth within our gas and water businesses and a large segment of our electric business. John Holleran's team is focused on the continued improvement in gross margin and ultimately EBITDA margin within those segments and we see some strong opportunities for continued growth there. Within a portion of our electric business we have some challenges; we are speaking about those in a forthright way and are very, very focused on getting those resolved and meeting, as I've said, our longer-term financial targets within that electric business. Beyond that there are great growth opportunities for us. You see a strengthening in our bookings and visibility in building our backlog throughout '14 and '15 and beyond. And the team is extremely focused on improving those EBITDA results throughout '14 as we prepare for growth in those markets. Thanks very much for your time.

Thank you everyone. That concludes our call.

And everyone, there will be an audio replay of today's conference available this evening. You can access the audio replay by dialing (888) 203-1112 or (719) 457-0820, with the passcode of 5975912, or go to the company's website, www.itron.com. This does conclude our conference call. Thank you all for your participation.