Itron, Inc. (ITRI) Q1 2014 Earnings Report, Transcript and Summary

Good day, everyone, and welcome to the Itron Incorporated Q1 2014 Earnings Conference Call. Today's call is being recorded. For opening remarks, I like to turn the call over to Ms Barbara Doyle. Please go ahead, ma’am.

Thank you very much Blake, and good afternoon to everyone. 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 from this call. 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; Steve Helmbrecht, Itron Executive Vice President and Chief Financial Officer; John Holleran, Itron Executive Vice President and Chief Operating Officer and Shannon Votava, Itron Vice President, General Counsel and Corporate Secretary. Philip will lead off the call with a summary of our operating results and the business environment. Steve Helmbrecht will cover our Q1 financials. Philip will then close the call with come prepared remarks and will hold a Q&A session with the process that the operator will provide. 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 earnings release and the comments made during this conference call and in the Risk Factor 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. Before we get into the quarterly results, I’d like to take a minute to recognize Steve Helmbrecht. Steve -- Itron announced now today that Steve will be departing the company at the end of the year. He will remain in his role through December 31, 2014 to ensure an orderly transition. Steve has been instrumental in building Itron’s strong financial foundation as we grew from a $200 million company to a $2 billion company. His competency in capital market transactions provided the financial flexibility for more than $2 billion of acquisitions. He built the strong financial organization with the skills, processes, and systems to ensure a sound, control posture, and he has instilled a sense of integrity and transparency into the organization. What’s important for you to know is that Steve and I made this decision together. We both acknowledge that bringing in a seasoned, external CFO with a different set of skills and experiences would be a beneficial move to accelerate Itron’s growth. The Board and I thank Steve for his deep commitment to our company’s success. With Steve remaining in his role through his departure date, he will certainly continue to represent Itron with the financial community, so nothing changes for any analysts or investors on the call. Steve, would you like to make any comments?

Yes, I would, Philip, thank you. I want to say what an honor it has been for me to lead Itron’s financial organization, especially given the tremendous growth and change that has occurred at Itron over the last 10 years. We have a great team and I thank them. It also has been a privilege to represent Itron and work with our analysts and investors, and I look forward to working with you through the remainder of the year. I am proud of what Itron has accomplished to this point, and I am excited about Itron’s future. In this decision, Philip and I have the company's best interest in mind. I remain committed to continuing the important work we are doing as part of Philip's team over the course of the year. We have much to do. Philip, I will turn the call back to you.

Thanks, Steve. Okay, now let’s move on to our quarterly results. I'll begin the call with highlights from our first quarter performance, including revenue bookings and backlog; Steve will then review the financials in more detail. I will conclude with an update on our profitability improvement plans, and then we'll open the call up to take some questions. Looking at Q1 performance, we had substantial improvement in operating results compared to last year. Our Gas and Water financials continue to be strong with growth in revenues and profitability in both of these segments year-over-year. In Electricity, we had meaningful growth in revenues, bookings, and backlog, as well as reduced employee-related expenses, although these benefits were offset by $5 million of legal and warranty costs in the quarter. Overall, I am encouraged by our first-quarter results and improvements in the underlying profitability in the business. Now, let me turn to revenue performance on slide four of the presentation. Revenues, bookings, and backlog were definitely highlights for Itron in the quarter. Revenues increased in each of our three business segments compared to last year. Total revenues grew 7% excluding currency impacts. Bookings and backlog are shown on slide five and six. Strong bookings of $745 million with a 1.6 to 1 book-to-bill ratio increased our backlog substantially. Total backlog of 1.3 billion increased 30% year-over-year. 12-month backlog increased by more than 8%. Our Q1 bookings included 2 million endpoint OpenWay contract with FirstEnergy for their grid modernization project in Pennsylvania. This is a truly transformative project for FirstEnergy's Electric grid. Itron's IPv6 smart grid platform, that we jointly developed with Cisco supports an extensive set of capabilities including voltage monitoring and outage management, time of use pricing, demand response, theft detection, and net metering. Our flexible multi-service platform also supports distribution automation…

Thank you, Philip. I will begin with slide seven which summarizes the consolidated financial results for the quarter compared with the first quarter of 2013. Total revenues of $474.8 million grew 6% compared to last year and 7% at constant currency. Higher revenues and a favorable mix of smart versus standard volumes, especially in Gas and Water drove improvement in margins. Gross margin of 32 5% improved by 120 basis points, and we had operating margin expansion of 150 basis points over last year. Adjusted EBITDA also increased year-over-year. Adjusted EBITDA was 34.5 million this quarter with a margin of 7.3%, an increase of 130 basis points from a year ago. Now I'll turn to earnings per share which were negatively impacted by interest, currency volatility and a higher tax rate compared to the prior year. On a GAAP basis, we had a net loss of a $0.01 compared with net income of $0.06 per share in 2013. Non-GAAP diluted earnings per share which exclude the impact of the goodwill impairment, restructuring charges, acquisition related expenses and amortization of intangible assets and debt fees were $0.31 for the quarter which is consistent with last year's earnings. Slide eight provides more detail behind our EPS performance. Revenue growth and consolidated gross margin improvement drove $0.37 of improved non-GAAP earnings per share. Our core sales and marketing, product development and G&A expenses were down year-over-year driven by headcount reductions and cost controls which added another penny of improvement. While G&A headcount was down year-over-year, the expense was negatively impacted by higher legal reserves, increased professional fees and costs associated with our global ERP project to streamline business services. These expenses negatively impacted non-GAAP EPS by $0.18. Increased other expenses which include interest and foreign exchange losses related to volatile currencies in certain…

Thanks, Steve. On our last call in February I reiterated our financial goal of mid 30s gross margin and mid-teens EBITDA margin on a consolidated basis. I highlighted two of our businesses gas and water that were already performing at the level required to achieve mid-teens EBITDA, strong Q1 financial performance in gas and water moves us closer to our goal. To achieve mid-teens EBITDA margin on a consolidated basis, the Electric segment EBITDA must be in the high single-digits. On our last call I said that we will improve performance in the electric business and we are making progress. Profit improvement in the electricity business will be driven by three elements. Backlog growth, long-term sustainable cost reductions and efficiencies, and rebalancing our existing electric business. As is evident in our first quarter results, we are generating backlog growth with projects where we sell differentiated high value solutions. Projects including FirstEnergy and Duke Energy along with schedule deliveries to Duquesne FortisBC, Detroit Consumers Energy and others give us our firm visibility to increase smart volume in revenue in 2015 and beyond. We expect additional smart metering backlog growth in Asia from accounts like China Light & Power and in Japan. This list of projects provide $1 billion of smart grid project revenue visibility between booked contracts or committed future business. The new business we have won will drive more than $80 million of incremental revenue growth by the end of 2016 with the growth beginning to materialize in 2015. This added revenue will drive 300 to 400 basis points of EBITDA, which is nearly half of the improvement that we are targeting in electricity. Secondly, we are continuing our focus on cost reductions and efficiency improvements with a number of projects. As Steve discussed we continue to progress with our…

(Operator Instructions). And we’ll take our first question from Ben Kallo. Please go ahead.

Hi. Thanks for taking my question, and Steve sorry to loose you and congratulations on whatever you're moving on to do. Could you guys talk a bit about this Japanese opportunity? I know the software is a good start, but when we could expect more details there? And then my follow-up question is a great win at -- in France in the gas side. It seems like there is more activity in the gas and water side of the business. Where should investors be focused elsewhere outside of the wins that you already have won? Thank you.

Thanks, Ben. Yeah, I mean we’re very excited as I say about this first Japan win. As everyone knows, we focused quite a lot of effort on trying to get a foothold in the Japanese market, and we see an opportunity to expand. We will be announcing more details on this arrangement with MELCO as we get further along, and then we’d mentioned several times that there are other opportunities at the electric power companies as bids go out in that market. So, this one starts with software and services, but we see the opportunity for metering in communications in the Japanese market as well. I'll handoff to John to provide color on the gas and water markets.

Sure. Thanks Philip. Yeah, on the – a year ago, we separated our businesses operationally into gas and electricity, and I think we’re beginning to see the benefits of a much stronger focus on the gas side. I think when they were together in the energy segment, they tended – electricity tended to overshadow gas, now that we've got our organization in place and we've made a few changes there, we've really gotten a a much stronger focus, and I think we're starting to see those dividends. Likewise on the water side, I just think the nature of that market and the increasing focus on water scarcity is causing more and more utilities on the water side to think very critically about how they measure and manage their water supplies, and again I think if we can position our business in front of that wave, we'll catch it pretty well.

And our next question comes from Sean Hannan Sean Hannan - Needham & Company: Yes, thanks. Good evening. Can you hear me?

Yes, Sean. Sean Hannan - Needham & Company: Okay. Great. Just wanted to see if I could follow up on some of the comments that were provided a little bit earlier on electric. Thanks for some of the detail in terms of how we can look to improve this from a margin perspective over time. I want to get an understanding of where we stand today for being able to stem that decline and really how some of that could start to materialize or perhaps improve a little bit as we progress at least through the 2014 year during the transition period and then into 2015? Thanks.

Sean, so as I commented, we do expect to see visible improvement in 2014. The three elements that I covered again, growth, cost reduction, and rebalancing. The cost reduction comments that I made in particular, we have -- as the restructuring proceeds, we will continue to receive benefits from efficiency in 2014, so those benefits will be felt first. And then on growth, I commented on increasing visibility, most of that backlog growth is over a longer period of time, but we do have better visibility in the second half of the year. So, the combination of cost reduction and growth are where we see that improvement occurring in 2014.

And our next question comes from Craig Irwin.

Good evening and congratulations on the significant bookings in the quarter at FirstEnergy.

Thank you.

So, it appears that the revenue trajectory is starting off with a little bit of strength at the beginning of the year, maybe market conditions might not be as challenged as we might have thought a few months ago. We also saw an interesting data point today from an important component supplier indicating that there could be some strengths coming in the European market. Can you maybe give us some color as far as how things are tracking versus your expectations coming into this year, and whether or not the significant bookings that you have accumulated over the last couple of months might actually help drive a more constructive picture as the year takes shape?

So Craig, yes, I hear two questions there, one really short-term one and one sort of mid-to-longer term. We're very pleased with our results here in the first quarter, but are cautious that one quarter does not a trend make, and so we will be updating our outlook here on the next call, so we need to get a little further into the year to really understand whether or not our outlook about the economy or some of these other markets has substantially changed. That being said, however, as you point out, the strengthening of the backlog, increase in bookings, and not only the FirstEnergy announcement, but now this very important agreement with Duke and others are providing better visibility into 2015 and 2016 for us. So, we are very constructive and optimistic in the mid-to long-term and do see continued opportunity for improvement in 2014. It is just that we really want to get another quarter under our belt before we comment on that.

Okay. Excellent. And my second question is really a clarification, so in your prepared comments, you mentioned $5 million in legal and warranty costs incurred in the quarter, and when you discussed the different components on slide eight, I don’t think you broke that out specifically. So, was the $5 million in incremental legal and warranty costs included in any one of the three negative step downs in that bridge, and maybe could you give us a little bit more color there?

Yes, Craig, hi this is Steve. And that – on that slide, we talked about the increased discrete G&A items that is inclusive of that litigation, and the professional fees, as well as some of those project cost, which are being incurred in the near term as we continue to rollout the technology and the new processes.

Great. Congratulations on the impressive bookings.

Thanks very much, Craig.

(Operator Instructions) We’ll take our next question from Susie.

Hi. Thanks for taking my question. I have one more specifically on the guide, previously you said we should see incremental improvement, obviously, you're referring off of a strong quarter, and I know you're not updating your guide until next quarter, but if you could maybe give us some color on what you're seeing, how should we think about Q2, and is the 20% of the electricity business that you are evaluating, is that part of your guide?

So Susie, to the first part, we are not going to provide outlook for the second quarter. It’s not our standard policy, and again, we’re one quarter into a year, in which there's been quite a lot of economic up and down in the past couple of years, and so it’s really prudent for us to get another quarter under our belt before we provide updated information to you on the outlook for the remainder of the year. To your second part of the question about is this rebalancing of the portfolio that is this reference to 20% of the Electric business that does not meet our profitability objectives. We are in the process as you heard of reviewing what it is that we are going to do there. I would not expect significant impact from that in 2014 and we expect growth that we've seen in backlog and is better visibility going forward to be a mechanism to offset any of the impacts to revenues that we see from that rebalancing. So we have not provided you any guidance that includes or excludes that -- those numbers because it is further in the future.

Okay. And if I could just squeeze in one more question on your Water business. Obviously you saw a strong quarter. I know that’s more of a book and ship business. But is there anything else you are seeing. I know you mentioned projects from Ireland, Germany and strong performance within Latin Am. But is this sort of a good run rate to think about in that business. Obviously the highest revenue you guys have recorded for the quarter and you know longtime. So, any color there?

This is John. I think that what we're seeing is a real driver in that business is our Heat and Allocation business and that’s a relatively new business for us. It’s really taking off particularly in Germany. And we're optimistic that we'll have opportunities to grow that business and other regions of the world and that’s where we're working on.

In addition to some of the large AMI contracts that we signed last year, including Baltimore, Cleveland which was sometime last year but its still in progress and Los Angeles. So we’ve got good AMI projects Susie and then as John said really good business, new business in heat and allocation business.

Okay. Thanks, Barbara. Thanks, guys.

Thanks Susie.

And we have a follow-up question on the line from Craig Irwin.

Thank you. So 4 million units for Duke, wow, that is a big contract and much bigger than what I thought it was likely to be in the near term. Can you maybe comment as far as the geographies that you plan to or that your customer plans to address and how this contract is likely to take shape for you? Are we really looking at Indiana which I think was first up on the list, still being first or is there something you could share with us that might help us model this and understand how this is really going to be rolled out over the next several years?

So Craig, we are very excited about the contract with Duke and to your point about it being larger than you had anticipated, it is that the – what we were all focused on where opportunities in specific geographies and you mentioned Indiana as one of those. The agreement with Duke is basically standardizing on Itron Technology across all of Duke’s geographies and it is a longer-term agreement that is not a specific authorized implementation. It is basically a blanket order over an extended period of time in which Duke will be purchasing their smart metering technology from Itron. So as they continue to saturate the geographies in which they are currently working and continue to work with the regulator in Indiana for approval of that project, their intent is to use Itron technology, not only in those geographies, but in all the geographies as they work towards regulatory approval and expansion.

Great. And then my second question here is, I was hoping you might be able to give us a little bit more color on the dozen utilities in the US they are at some stage in going to commission or potentially moving forward with projects. We understand that there are several working with some of the project developers and some of the third-party implementation firms evaluating these projects, but can you maybe give us a little bit of color as far as how things might have changed over the last couple of months, and if you see maybe a change in sentiment, or a change in appetite that might be impacting these projects?

Craig, without getting to specific projects , I mean what we’re seeing with FirstEnergy, of course, is the act in Pennsylvania moving – having the potential to move forward the number projects in Pennsylvania. We've seen regulatory progress in Massachusetts. We are looking for support in New York and New Jersey, so there is a healthy pipeline of business out there, and we see not only that regulatory support in those regions, but where we have demonstrated business benefit, it is now possible to go back in some of these other territories to more strongly build business case to expand pilots like the one that we have at National Grid. So, I mean that’s just the flavor I can give you on where we see the industry going in North America.

That’s helpful. Thank you. And I’ll squeeze another one in, one of the criticisms by some of the more bearish investors has been that the margin profile of the company has been impaired given the competitive environment that’s quite challenging. Your results this quarter 100 basis points or 130 basis points had a consensus seemed to indicate that maybe things aren’t quite as bad as what the most skeptical investors are looking at. How would you respond to the margin structure of your business and the fears that there might have been competitive pressures that impaired it or that the structure of our customers are asking for today might not be the products with the same margin structure we had a couple of years ago. I mean, how would you respond to that these days?

Okay. So the first part we'd point out, this is a very healthy financial metrics of our Gas and Water business. So this comment is mainly typically directed at the Electric business. And it’s based upon the theory that there is increasing commoditization and low-cost competition that is going to engulf the whole of the Electric market. And what we are seeing is a strong move to smart technologies that we said or higher margin, defensible integrated systems in North America where it’s possible for us to maintain pricing through continued investment and innovation in R&D. And then where we are facing the pressure of the barricades we have acknowledge in this 20% of the business in which there are highly commoditized metering products and maybe market dynamics where we have to rethink our presence in those markets. The barricades is predicated that that 20% is really a substantially larger portion of the global geography and we feel that by investing in technology and competing in markets with defensible margins that we will be able to strongly maintain and improve our position in the Electric market.

Fantastic. Thanks again for taking my questions.

Thanks, Craig.

Certainly.

And we'll turn the conference back over to Barbara Doyle.

All right. Thank you. I think we have covered everything that we have plan to cover Steve or Philip, is there anything else you would like to add?

No, thank you. While we have more work to do, it is a good start to the year, and as a number of you have commented we are very pleased about the bookings and backlog performance during the quarter. So thanks very much for your questions and support. Look forward to talking to you soon.

Thanks very much, Operator. We will conclude now.