Barbara J. Doyle - Vice President-Investor Relations Philip C. Mezey - President, Chief Executive Officer & Director John W. Holleran - Chief Operating Officer & Executive Vice President William Mark Schmitz - Chief Financial Officer & Executive Vice President.

Sean K. Hannan - Needham & Company, LLC John Quealy - Canaccord Genuity, Inc. Ben J. Kallo - Robert W. Baird & Co., Inc. (Broker) Patrick S. Jobin - Credit Suisse Securities (USA) LLC (Broker) Noah Duke Kaye - Northland Capital Markets Jeffrey Osborne - Cowen & Co. LLC Andrew Hughes - Bank of America Merrill Lynch Andrew M.

Weisel - Macquarie Capital (USA), Inc..

Good day, everyone, and welcome to the Itron Incorporated Q1 2015 Earnings Conference Call. Today's call is being recorded. For opening remarks, it is my pleasure to turn the call over to Barbara Doyle. Please go ahead..

Thank you, Nicole, and welcome everyone to Itron's conference call. We issued a press release earlier today announcing our results. The press release includes replay information about today's call. We have also prepared presentation slides to accompany our remarks on this call.

The presentation is available through the webcast and through our corporate website under the Investor Relations tab.

On our call today, we have Philip Mezey, Itron's President and Chief Executive Officer; and Mark Schmitz, Itron's Executive Vice President and Chief Financial Officer; and John Holleran, Itron Executive Vice President and Chief Operating Officer.

Following our prepared remarks, we will open up the call to take questions using the process that the operator will describe. 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. Reconciliations of differences between GAAP and non-GAAP financial measures are included 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 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 let me turn the call over to our CEO, Philip Mezey..

Thank you, Barbara, and good afternoon to everyone. Before we review the quarter's results, I'd like to take a minute to recognize John Holleran. Itron announced today that John will be departing the company at the end of the year.

John will continue in his position as Executive Vice President and Chief Operating Officer until a successor is named to ensure a seamless transition of responsibilities. John came into the COO role with a three-year commitment to help me position the company for growth and improved profitability.

In reviewing our key project and in consideration of this commitment, John and I have jointly determined that 2015 is the right time for this transition. During his tenure as COO, John developed comprehensive strategies for each business line to put Itron on track to greater growth and profitability.

He has driven new levels of vigor, visibility and efficiency across our operations and he has built a strong operations team accountable to clear goals. We've retained an executive search firm to identify internal and external candidates.

The new COO will have the operation's leadership experience to build on John's successes and accelerate our sales growth and leadership in our industry. The board and I deeply thank John for his commitment to Itron's success. John is on the call to add his comments on today's announcements.

John?.

Thanks, Philip. It's been a pleasure and a privilege to lead Itron's global operations team. We've accomplished a lot over the last two-and-a-half years. There is still much work to do and I have a number of things I want to complete throughout the remainder of the year.

I'm very optimistic about Itron's future and assure you that I will be fully engaged and committed until a successor is identified and we have completed a successful transition. So Philip, let me turn the call back to you..

Thanks, John. And now let's move on to our quarterly results, I will review the overall highlights for the quarter and then Mark will cover the financials. For the first quarter we reported $0.20 of non-GAAP EPS on revenues of $448 million. Revenues grew by 4% compared with last year excluding the negative effect of foreign currency translation.

Non-GAAP EPS declined compared with last year. The largest factors contributing to lower EPS were a higher tax rate in the quarter and unplanned warranty costs. While the warranty costs were of course disappointing, I was otherwise encouraged by our performance in the quarter.

Electricity had solid revenue growth and notable margin improvement, predominantly driven by North America. The growth of our smart grid business and benefits from prior cost reductions are increasingly becoming evident in our Electricity results.

Achieving our target of high single digit EBITDA margin by the end of 2016 also requires the success of our restructuring plan in EMEA. We've been actively engaged with works council since January. While the process is rigorous, we remain on track with our plans and expect the timing of the savings.

While the Gas segment had a tough comparison to exceptionally strong results a year ago, the team delivered on its plans for gross margin improvement from the fourth quarter. Gross margin increased sequentially by six percentage points to 34.8%.

Gas continues to benefit from strong business performance in North America and we made progress toward our cost and efficiency targets on our new Gas product lines. In the Water segment, we encountered a setback in gross margin in the quarter. However, Water is fundamentally a strong business with macro trends that favor our solution.

Scarcity of fresh water and inefficient distribution systems exist around the globe. Municipalities, utilities and governments are reaching a point where actions must be accelerated.

Our growth trend in Water is driven by smart water projects around the world, including Saudi Arabia, Jordan, Germany, France, Turkey, Australia, India, Ireland, Mexico and many here in the United States.

Itron's portfolio of non-revenue Water solutions, advanced networks and analytics efficiently collect interval data, monitor and analyze usage and deliver information to consumers to help them better manage this critical resource.

Recent attention to drought conditions in California and newly mandated requirements targeting a 25% reduction in water usage puts a focus on the issue. We are in discussions with water utilities in California and we are well positioned to help them address the new conservation mandates.

Itron has a strong established global presence in water, an industry that is expected to grow. Overall, I am reassured by our first quarter results in Electricity, our improvement from Q4 in Gas and the significant customer opportunities in the Water segment.

In terms of bookings and backlog, we had $424 million of bookings in the quarter, slightly below 1:1 book-to-bill rate. Bookings in the quarter reflected a diverse amount of business for many customers. Our 12 month backlog at $779 million increased by 27% compared with last year, supporting our expectations for revenue growth this year.

We ended the quarter with a healthy backlog of $1.4 billion and we anticipate additional backlog growth in 2015. Now let me turn the call over to Mark to review the financials in more detail..

Thank you, Philip. I'll begin with slide four in our presentation which summarizes consolidated company revenue results for the first quarter of 2015 compared with the first quarter last year. The strengthening of the dollar during the quarter affected nearly foreign currencies that impact our business.

Currency translation reduced our revenue by $44 million. On a constant currency basis, revenues in the quarter grew nearly 4% compared with the first quarter of 2014. This growth was driven by Electricity which experienced constant currency growth of 14%. Earnings were impacted to a lesser degree than revenue.

As shown on slide five, non-GAAP EPS was reduced by $0.03 compared with last year due to a currency translation. Higher taxes and increased warranty costs also reduced EPS in the quarter. This was partially offset by decreased other expenses, reflecting a foreign exchange gains in the quarter versus a loss in the quarter last year.

The non-GAAP effective tax rate in the quarter was 49% compared with 30% last year. This was not a surprise to us. Our tax rate this year was adversely affected by valuation allowances on certain deferred tax assets and some relatively minor discrete tax items; favorable last year and unfavorable this year.

We continue to anticipate an average effective tax rate of 37% for the year consistent with our guidance. As for the higher warranty charge, we experienced higher costs in the Water segment due to a supplier quality matter. We are proactively dealing with the matter to ensure our customers are kept satisfied.

It hurt Water segment earnings in the quarter but doesn't detract from the growth and profitability we foresee from this segment over the long haul. Slide six summarizes other key financial metrics in the quarter. Total gross margin of 30.8% in the quarter decreased by 170 basis points.

Improved gross margin in Electricity partially offset the impact of less favorable year-over-year gross margins in the Gas and Water segments. Non-GAAP operating margin of 4.1% decreased 70 basis points. Adjusted EBITDA was $29.3 million and the Adjusted EBITDA margin of 6.5% declined by 80 basis points.

Non-GAAP operating expenses declined compared with last year due to the impact of foreign currency translation. However, this was not sufficient to offset the reduction in gross margin.

Non-GAAP diluted earnings per share which excludes the impact of goodwill impairment, restructuring charges, acquisition-related expenses and amortization of intangible assets and debt fees were $0.20 for the quarter compared with $0.31 in the first quarter of 2014.

As I mentioned, earnings in the quarter were impacted by higher warranty expenses, currency translation and the higher tax rate. Free cash flow was negative $13 million in the quarter, a significant decrease compared with the prior year. Several significant payments were made as scheduled during the quarter.

As outlined on slide seven, these payments were related to taxes or legal settlements or annual variable compensation plan and cash restructuring expenses. For the full year, we do expect free cash flow to be lower than 2014, principally due to the anticipated severance payments for our restructuring activities.

We continue to have a strong balance sheet and ample liquidity and ended the quarter with $118 million in cash. During the quarter, we also used $16.3 million to repurchase 419,000 shares of common stock. This includes shares repurchased under the 2014 repurchase plan as well as the new $50 million plan authorized by our board in February.

Now I will turn to segment performance beginning with the Electricity segment on slide eight. Electricity started the year off well with strong revenue growth and a significant margin improvement compared with the first quarter of last year, continuing the momentum seen in the fourth quarter.

Revenues grew by 8% in nominal terms and 14% in constant currency. Our North America smart grid business drove most of the revenue growth, including the ramp-up of deliveries to FirstEnergy, Duke, Duquesne and Tucson Electric, as well as continuing deliveries to Detroit Edison, FortisBC and Consumers Energy.

Gross margin improved significantly compared with last year, driven by smart grid volumes in North America, lower warranty costs and efficiencies from prior restructuring plans. Non-GAAP operating margin also improved by nearly 12 percentage points to 3.1% in the quarter.

The margin improvement was driven by higher gross profit combined with lower operating expenses. Overall, we were very pleased with Electricity's growth and margin expansion. Now, let's turn to the Water segment on slide nine. Revenues were down by 13% compared with last year in nominal terms and flat in constant currency.

Gross margin declined by more than 500 basis points to 30.6% and non-GAAP operating margin decreased 830 basis points due to lower gross profit. To some extent both revenue and gross margin suffered from a tough compare with last year which benefited from higher volumes of heat meters.

However, the principal factor affecting Water's gross margin was the supplier part warranty matter I explained earlier. Absent this item, we would overall be pleased with Water segment results this quarter. Now turning to the Gas segment on slide 10. Gas revenue of $125 million declined by 14% in nominal terms and 6% in constant currency.

Revenues from smart meter projects in Western Europe increased compared with last year. However, this growth was offset by decreased volumes on other projects on EMEA and lower conventional meter replacements as transition to smart systems continues.

Gross margin of 34.8% was down 520 basis points year-over-year due to lower volumes in EMEA and a less favorable product mix. Nonetheless a key takeaway for Gas this quarter is the improvement in gross margin of nearly six percentage points sequentially over last quarter.

Non-GAAP operating margin of 12.8% declined from last year due to the lower gross profit. The results in Gas were in line with our expectations and, as Philip mentioned, the team is working diligently on cost improvements and factory efficiencies. Let me also provide an update on the restructuring that we announced in November.

Our original estimate was that we would incur restructuring charges of $65 million to $75 million to deliver approximately $40 million in annual cost savings by the end of 2016. During the first quarter, we lowered our total cost estimate by $5.4 million and now expect total charges of approximately $60 million.

This reflects a small reduction in the number of employees affected due to voluntary resignations and reassignments. We continue to expect annualized savings of $40 million as we exit 2016 when all activities are completed. We also initiated discussions with various works councils during the quarter and are proceeding as planned.

As anticipated, this is a challenging phase of the process and we have experienced some work disruptions in certain locations. This is not unexpected and we remain confident in our schedule and projected savings. In closing, entering 2015 we forecasted that the first quarter would be the low point in the year.

Overall, our results for the quarter exceeded our internal expectations. Electricity's revenue growth and margin expansion continue to improve. Gas was on track and delivered a noteworthy improvement in gross margin from the fourth quarter and Water was tracking to plan but was impacted by warranty.

We remain confident in the remainder of the year and continue to believe the second half of the year will have stronger revenue and earnings than the first half. Philip, I'll now turn the call back over to you..

smart metering backlog growth, exit from non-strategic businesses and sustainable cost structure reductions. As an example, we announced today that Eletrobras, a major Brazilian electric utility will implement Itron's OpenWay Riva communications technology on Cisco's IPv6 network.

Itron Riva delivers high performance distributed computing that incorporates RF and PLC communications, working in concert in the same device. Riva will be embedded into third-party electricity meters and provide it as a part of a consortium that includes Siemens, Itron, Telefónica and Telemont.

The Gas segment will also be driven by the transition to smart technologies. We see strong growth opportunities in North America and EMEA and targeted areas of growth in the Asia Pacific and Latin American regions. We are taking the necessary steps to return Gas profitability to historic levels of high teens EBITDA.

Our Gas backlog in Q1 is up 40% compared with last year from healthy bookings in the U.S and Europe.

In addition to good business levels in North America, we are already shipping smart gas meters on the tenders we won in Italy and the Netherlands and we have $82 million booked in our backlog for the first tranche of meters to GrDF which we'll begin shipping in the second half of 2016.

In addition to backlog and revenue growth, key milestones in the near term involve product cost improvement on our EMEA smart meters, increased smart volumes and factory efficiencies in EMEA and in the U.S. These actions are well underway.

In Water, we will return to 15% to 17% EBITDA margin through a continued growth in the business and better managing supplier quality and warranty cost. As I've discussed Water is a business with strong fundamental growth characteristics. We had record revenues in 2014 and macro drivers favored continued growth in this segment.

To sustain our momentum in 2015, we will focus on the following key milestones. First, continue to grow our backlog. Given the customer activity we see we are targeting meaningful growth in backlog in frame orders from 2014. This is on top of 39% backlog growth in 2014.

Second, successfully execute our restructuring plan which will result in annualized savings of $40 million by the end of 2016. Third, complete our global ERP system rollout and transition to our global shared services center in Ireland. Fourth, deliver a comprehensive services strategy by the end of 2015.

Our strategy includes growing and optimizing our current business and extending our portfolio of services offerings. For example, we're engaged with multiple customers on new managed services opportunities. I am very pleased to announce today that we have signed a multiyear agreement with Duquesne Light in Pennsylvania to run their network operations.

We are both rolling out these customers' network and helping them run it. We see the potential for healthy growth in this part of our business. And finally, we will bring on board a new Chief Operating Officer to accelerate our global business transformation and further build our leadership in the industry. Thanks for being on the call today.

I know we covered a lot of ground. Now let's take some questions..

Thank you. Our first question will come from Sean Hannan, Needham & Company..

Yes, thanks, folks for taking my question here and thanks for all to detail so far tonight. I just wanted to see if I could follow up on the new business environment that we have today.

Clearly, your backlog through the course of a number of quarters stands in pretty decent shape but I wanted to drill in to the bookings specifically within the quarter. The numbers are down I think for each segment a bit year-over-year.

There is a tough comparison there in electric but can you provide perhaps a little bit more color for us on how you're seeing the environment today, expectations perhaps for that to get some acceleration and any other color for us that might be helpful there? Thanks..

Sure, Sean. So there is some variability in our bookings. There was no single very large booking in the quarter, so we like the fact that it's almost one-to-one with a broad diversity across all of the business lines. We are up.

While total backlog is not up this quarter, our 12 months backlog is up significantly which gives us this better near-term visibility and, as I said in my comments, we are very confident of our ability to grow that backlog in 2015 even beyond the very strong growth we saw in 2014.

So that clearly indicates that we see in our developing contracts which we feel will continue this upward backlog trends through 2015 giving us the visibility that we need into 2016 and beyond..

Okay, thanks. And then on a different topic in on this Eletrobras announcement that you have today.

Is there a way to provide a little bit more color around the context in terms of timing, scale – I think a lot of the deployments that we've seen in general within Central or Latin America have been a little bit more surgical in nature and just trying to get a perspective from you around the expectations of the approach and how that can work into your expectations and model? Thanks..

Yeah. So first of all we're very excited about this announcement. It's on as you heard our latest Itron Riva technology. We are providing communications modules not the meters which we exited in the Brazil market as a low margin portion. So we're focusing on critical differentiated technology and working with very strong partners.

Eletrobras is among the largest utilities in Latin America – it has six subsidiaries and this initial order that is really a first tranche to get this technology out in the field and prove it out with the expectation that there is a significant growth opportunity for us. We expect shipments to begin at the end of this year and beginning into 2016..

Okay, that's helpful.

But is there any sort of a sense that you might have that if the first tranche is successful that there is a preference to move toward more of a mass deployment over the service territory or is that something more to be determined down the road?.

It will be determined as a part of the deployment. I will say that this Itron Riva technology, it really goes beyond smart metering to capturing some very significant smart grid benefits which we feel will build an economic case for doing broad based rollout and we are working with Eletrobras on developing that idea.

The expectation is that this will be a broad based rollout and not a surgical deployment. We would not put together a consortium the likes of Siemens and Telefónica and Telemont without the expectation that we are heading to a broad rollout..

Fair point. Thanks so much for the color..

And we'll go next to John Quealy, Canaccord..

Hey, good afternoon, folks. First question is on the operational side. John, first of all best of luck hopefully we see you before you head out.

On Duquesne Light, Philip, can you talk what exactly are you doing for them? Is it in that sort of $2 per meter bucket that we've seen in the industry a lot? Can you just flesh out Duquesne Light a little bit and then I have a follow-up?.

Sure.

So yes this is the kind of deal that we see developing more frequently in the marketplace in which we are in addition as we've said to deploying the smart meters in our case the meters, the communications, the services and software along with those that we're offering the added-value of actually operating that network as it's deployed over the next five to seven years.

And yes, John, it's in that kind of range of revenues over time, a recurring revenue stream in this sort of basic couple of dollar range. This is a platform for us to extend with other added value software what we can do for these customers over time..

And so for this particular question, Duquesne Light, is it all Itron software technology or will there be third-party technology offered on the platform?.

So far for Duquesne it is all Itron but we are very actively working on engaging with other partners as necessary to meet business, future business requirements. This initial phase is the actual operation of our technology, so it is all Itron..

Got it.

And then just lastly for Mark, the negative free cash flow I guess for this quarter, I don't see an 8-K or a Q yet, do you mind just giving us buckets of how much was what if you don't mind, just give us a range on the cash drags?.

Sure. So there were several pretty significant cash disbursements during the quarter. One is that we paid taxes, federal and state taxes totaling about $20 million this year; last year we had a small refund. We paid the settlement amount related to the legal item that was discussed and described in 8-K last quarter.

We had our annual variable compensation planned payouts and some cash restructuring amounts. And I'll add to that to say that when you see the balance sheet, you probably already seen it there in the cash flow statement that inventories were up pretty significantly.

They were offset by accounts payable – accounts payable were up by just about the same amount as inventories and but the inventory increases pretty well understood and we're actually not discouraged by that at all because it is a preparation for higher production levels and also reflect some transitions we're making in supply of electronic goods and other things.

So overall, you sure it's not a good news story in cash flow but I do feel it's something we pretty well signaled with our guidance that cash flow would be weaker this year than last year, and it's largely a result, if you cancel everything else out, you look at the cash payments related to severance and our restructuring plan that is the major reason..

And severance, is it going to be all four quarters, Mark, or should it tail off or how should we think about the cadence of the cash for the four quarters? Thanks, guys..

Yeah, most of the severance related expenses will actually occur in the second half of 2015..

John, are you still there?.

No, he isn't..

Okay..

We'll go next to Ben Kallo, Robert W. Baird..

Hi. Thanks for taking my questions.

Could you guys just talk about the warranty or supplier issues on the Water side? It seems like you had good business in the Electricity side, improvement on Gas and then we get hit with Water, so what's the confidence level that we'll get a clean quarter here going forward on all three segments?.

Well, Ben, I want to differentiate, when you reference clean quarter, there are a variety of issues here, the one that we've discussed on the call most frequently of course is BC Hydro, a project related issue having to do with network design and project control.

In this case, the supplier quality issue is something that of course we are working to manage through very quickly. I want to emphasize that one of the reasons that we resolved this so quickly and transparently is that we are working with customers to ensure the smooth growth of our business. There is a visible impact here.

We have a rigorous quality program in place and supplier quality management program in place. We do not expect these types of things to occur but we react to them quickly and continuously improve.

We are confident about our ability to manage these costs over time; as a part of one of the measures that we were using for CEO Executive comp this year is cost of non-quality. It's a metric that we monitor very, very closely that actually impacts our internal management system and has extremely high visibility..

Okay.

And Philip, you're entering your third year, as far as a strategic view and looking out at acquisitions – I know there's been a lot of stuff in the news with Elster and such, can you just refresh us where you're at as far as thinking about acquisitions or about anything you could do with your business strategically?.

Well, Ben, the focus, as I've mentioned in the last couple of calls really is on the software and services area.

And this comment I made about getting this strong plan in place to increase that business both by improving our internal focus and results in the software and services area, which are already considerable, expanding as you heard this discussion about Duquesne today, continuing to expand our opportunities with our existing customer base, and then looking at inorganic growth opportunities in order to get more value out of all the data that we're producing across Electricity, Gas and Water.

That said, we continue to look at the opportunities to extend our Electric, Gas and Water business with other devices and offerings as an additional avenue for growth to those underlying businesses..

Okay. And then finally could you just – because margin is front and center here on Gas and Water, could you just talk about the competitive environment, just update us there with what you guys are seeing out in the marketplace, if that's having an impact on margins at all? And thanks a lot, guys..

So I would say first of all on the electric side, we're clearly on the mend here on the margin side, on the upward improving, exiting non-strategic businesses, focusing on these value-added projects. And so, we see a strong growth profile there. As you mentioned Gas and Water, are they concerns here.

And the margin story largely in Gas is a volume related story, that is to say that our volumes are down. We mentioned this that prior to smart implementations, we've seen fall-offs in standard metering volumes. We saw that in North America. We're seeing that in Europe.

We've talked about the fact that these smart rollouts in which average selling prices are higher are on the horizon, some in backlog and some already committed. So we expect margin improvement there. There are competitive pressures from other low cost suppliers.

We continue to focus on smart differentiated products that combine measurement, communications and at times software and implementation service as a way of dealing with that. And the margin pressure in Water is not really a competitive or price related issue per se. We've got to manage these quality issues and manage our growth opportunities.

So there is pressure. I would say that we are focusing on cost reductions, we see volume increases and continue to invest in technology to differentiate..

Thank you..

We'll go next to Patrick Jobin, Credit Suisse..

Hi, good afternoon. Thanks for taking my question.

The first question, just as I think about your comments about results exceeding expectations, I guess perhaps absent the warranty charge, were there any other gives and takes in the quarter as we think about kind of putting this in context to guidance for the full year and the strong second half ramp? Thanks..

Yeah, Patrick actually what we've said is that our results in the first quarter exceeded our internal expectations even including the warranty charge. So we're little ahead of our internal expectations on which of course we based our guidance and we're positive about the outlook for the year..

Got it. That's helpful. Thanks. And then, just some simple follow-up items. Should we envision any warranty related charges for that water project in Q2, or is the charge fully reflected now? And then on the Eletrobras contract, can you size that initial phase, that initial award that's been granted and should we expect that to be a Q2 booking? Thanks..

I'll take the question on the warranty charge first. That warranty charge on the water communication modules reflected our best estimates at this time. Of course, you can never say it couldn't get larger, couldn't get smaller – estimates may change – but it is a full best guesstimate at this time. And I think Philip wants to speak about the....

Yeah, Eletrobras, the comment that it's an initial tranche, Patrick. So we're in the $50ish million to $200ish million range. So this is not – it's absolutely a good progress and will be contained within our bookings but it's not in one huge outsized award we expect with success in the project to follow on the significantly more potential business..

Thank you very much..

We'll go next to Noah Kaye, Northland Capital Markets..

Thanks. Just a more specific question on – I heard you're thinking about acquisitions – you mentioned at the outset the challenges and opportunities faced by water scarcity.

How are you thinking about a smart water technology like leak detection, water volume measurement, are you looking at those for potential acquisitions and if so how high in the priority list is that – you also mentioned software as a service, so? Thank you..

Yeah, no I mean, I clearly don't want to go into signaling, very – given your very specific signals here. But absolutely to your point water scarcity is very interesting and important to us.

And we actually did make an acquisition in the leak detection technology space which we are using to embed that technology in more endpoints that we put out into the field. It is an example – we have partners that focus on things like pressure management.

And so there are many aspects of water scarcity analytics that we are both exploring internally, making decisions about what it is that we develop partner, invest and require and do track range of technologies in that space.

And just to connect the software as a service comment, we do find given the water space where there are tens of thousands of water utilities in North America and another set of tens of thousands in Europe, that these companies are not really of a scale that it is easy for them to set up free-standing implementations.

And so the water market is ripe for a software as a service type offering just because of the scale of the customers..

Okay, great. And I think in the past you talked about your aspirations for the software as a service business.

Can you benchmark a little bit for us where that is at today? What you had posted (41:08) in the quarter versus your growth aspiration?.

So what we said is that of the existing revenues of the company that somewhere between $100 million to $200 million is already in this software and services area and the aspirational growth target that we've talked about in the past is on the order of $500 million.

And so this is really for us a matter of building on a base of 8,000 utility customers and putting more focus in the space in which we feel that we can expand the current offerings across our customer base and actually broaden that offering in order to get to the overall target number..

And what do you feel as you talk to your customers you obviously have a good relationship with, are kind of the gating factors here in converting some of those networks with an upsell to more managed SaaS? And what if anything do you feel is going to accelerate the pace of your being able to grow that part of the business?.

Well, certainly, the big accelerator is that the technology is becoming more complicated over time – operating sophisticated multi-tenant networks and running large scale data analytics platforms is – we have large sophisticated utility customers that have those kinds of capabilities internally but there certainly are significant number of utilities that may not have all of the internal skills or that may not consider that their core competency.

So that's an accelerant. There are economic pressures on utilities as they're facing new challenges in markets where demand may not be increasing and the rate base is not growing, that represent some unique pressures for them.

Aging workforce – so they have particular expertise retiring out of the workforce that may make it more advantageous for them to look outside for certain sorts of skill set. There are scarcities in titles like data scientific that have them look on the outside.

On the other side of the ledger, we have to understand that many investor owned utilities invest with capital and earn a rate of return on capital converting those contracts over to operations and maintenance contracts that is ongoing and recurring expenses represents a challenge for any company that is bringing a recurring offering to utilities to re-categorize capital into operations and maintenance..

That's very helpful color.

So given all of that, for our modeling, how would you think about a growth rate for this part of the business on an annual basis, ballpark?.

When I say that we're – I announced on the last call the hiring of Bruce Douglas, the Senior Vice president in charge of software and services and is focused on developing the business plan that as we really have go through these steps, we'll get into more detail with you as these plans really solidify..

Okay. Thank you very much. I appreciate it..

Welcome..

And our next question will come from Jeff Osborne with Cowen & Company..

Good evening. Good afternoon, Philip. Just two quick questions, one I was wondering if you could just update us on the Riva platform, congratulations on the order in South America but seems like there would be a lot of opportunities for the PLC capability there in Europe.

So what you're seeing there with the initial discussions? And then just broader on the electric side, if you can just update us on geographies where you're seeing RFP activity? Obviously Southeast Asia has been in the news for a couple of quarters here but any other thoughts would be helpful..

Sure, Jeff. So on Riva, of course there are opportunities in Europe, as you mentioned there is very strong use of PLC. That being said though, we're competing essentially with a – the G3 Alliance is an example where we have a good enough product.

And so the challenge with Riva is demonstrating the additional value that can be created by having this hybrid product that has distributing computing close to the edge. We do have a couple of pilot programs underway in order to demonstrate that extended business case because we are not trying to compete simply as a low cost PLC provider.

We are working on developing the unique value characteristics of the platform and there are a couple of places in Europe where that – where there is focus on added value and we certainly are focusing our sales efforts in those areas and that applies to many other markets around the world that there is a low cost good enough solution that's already available.

We may not initially focus there or we have to really work on developing the business case for the added value that Itron brings. But we are very pleased with the progress on Riva and the tremendous potential of that platform. You asked about where the other electric activity is.

First point which we've said again and again, real strength in the Northern American market as we see this already signed work and the visibility that we have in North America and to a certain extent Europe coming closer here.

So while we are excited about the opportunities in Southeast Asia, we talked about and you're tracking Australia, New Zealand of course, Hong Kong, Singapore, Thailand, Malaysia. These markets there are very, very attractive and interesting projects in these areas that have really good growth characteristics for us.

And then of course this announcement in Brazil but there are a number of other developments in Brazil, I'd say Latin America more broadly, some nice opportunities. And then Middle East and Africa, we're starting to see some smart city type RFPs of more limited scale but we certainly are very excited about a number of those opportunities as well..

Excellent. And then just one quick follow-up on the North American market. Any thoughts on the IOUs versus the munis and co-ops.

Obviously, as it relates to your backlog growth, you're talking about converting your framework deals into signed contracts that would flow through to the formal backlog but just from a high level new orders that could flow into framework deals or backlog, anything as it relates to the muni and co-op industry?.

We continue to pursue the muni and co-op market. They have not – there are large munis and co-ops that behave a little bit more or like the IOUs. But in general, it is a more cost conscious market that has not gone necessarily the most advanced technology.

There are a number of notable exceptions to that munis and co-ops market but we are winning business in that area but largely the deals that move the numbers and attract all of you are in these very large IOU deals. And the specific reference that you made from frame orders over the backlog is to this Duke contract that was up to 4 million points.

And the conversion of that into formal backlog as regulatory approval occurs I presume is really the primary example you're talking about there..

Perfect. Appreciate it. Thank you..

Sure Jeff..

And our next question will come from Andrew Hughes, Bank of America..

Good afternoon, folks. Thanks for taking the question. Philip, you sort of answered one of them, whether or not – or the opportunity for software and services revenues across segments.

I'm wondering if you can elaborate a bit on where that sort of breakdown exist today in that $100 million to $200 million range across the three segments and then as you go towards that $500 million goal, how you see that – if that breakdown changes becomes more Electricity focused or in some of the other segments?.

I'm tempted to theorize a bit there but I really think that given where we are in the planning process that there is more information I'd like to bring you there. To give you a breakdown now on the current profile of business of course we implement and install a fair amount of our product. There is a basic amount of work that we do there.

We do post implementation support. We provide platforms on a subscription basis. We forecast 80% of the energy that flows through the North American electric system with a system that largely has an annual renewal model. We are the largest global provider of electric and gas pre-payment systems.

We then operate the back office for that in the UK and in parts of Africa. There are attractive opportunities for us there.

And we provide managed services for our customers to do – support really the billing cycle and we see that now being a more standard part of the bidding process and have made a number of announcements in places where we have secured that managed service business as a platform for future growth..

Thanks. And then just on the Water segment, realizing that the bulk of the margin impact was related to the supplier issue, there is also a mention of some product mix impact.

Just curious what – I think I heard heat meters was one factor but maybe just a little bit more color there and your confidence going forward that that mix will improve to be more margin accretive? Thanks..

Yeah, Andrew, what we can say about Water, yeah, there was a modest deterioration in mix versus the prior year, principally due to the heat meter volumes that were predominant a year ago.

But if we look at the special items, and warranty was of course the biggest of the special items affecting Water, we can say to you that special items really account for all of the deterioration in gross margin on Water on a year-to-year basis. And of course those are real and we don't discount them.

The fact they're special doesn't mean that they didn't hurt us, but as we look forward, we just see that business as having no longer-term negative impact occurring in its profitability or its growth..

Great, thanks..

We'll go next to Andrew Weisel, Macquarie..

Hey, good afternoon, everyone. Just to elaborate on that last question from Andrew.

When you look at what's in the backlog what does that indicate for the future product mixes for the segments in the next 12 months or even beyond? The trend for the last several quarters has been pretty consistent, where a product mix helped in electric and hurt the other two businesses.

What are you expecting based on what's already in the backlog?.

So Andrew, the comment we've made is that the backlog generally speaking is predominantly North American and that the margin profile of the North American business is generally accretive to the overall reported margins for the segment.

So as we see backlog growth, both total backlog and year-on-year backlog, that we see accretive margin opportunity as we see more of those smart projects coming out of the backlog. You mentioned Water somewhere in there.

In the beginning, Water typically has not have (53:07) as large a backlog component to it just because of the contracting style, historically, of the Water segment, but those comments absolutely apply to the electric and Gas business.

Did that answer your question?.

Yeah, that's helpful. My other question is you mentioned a couple of times you're very optimistic about growing the backlog further as we go through the year and I know Jeff asked about the outlook for the Electric segment when you sort of gave your tour of the world answer.

What are you seeing in the Gas and Water business? And again, I guess you just addressed Water's not being so backlog driven but what gives you the confidence and what are you seeing as drivers for backlog growth in the electric, and more specifically Gas segment?.

So drivers on the Electric segment that we've talked about is a broader regulatory support for smart metering, not just in North America but in other parts of the world in which the business case is proven out and we are getting broader support in very important places like Massachusetts, New York, we hope New Jersey.

So Ohio, Pennsylvania, we hope Indiana here soon, so that as we get broader regulatory support there are greater opportunities for project growth for us here in North America on the Electric side.

Again, we see promising things like Brazil, Eletrobras, this announcement in which there has been a lot of discussion about smart metering in Brazil for many years but this announcement signals some real forward progress there. So it's regulatory support for business case that I would characterize as the driver on the electric side.

On the Gas side, this really is a transition to smart in many cases in which there are un-automated meters. And in terms of backlog growth, while we talked about $82 million of gas to France in the current backlog, the contract award as we mentioned before is a significantly larger amount.

So as these projects begin to mature more of that potential will appear in the backlog. And there are just continued opportunities for growth and re-farming of our existing business in North America to increase the Gas backlog as well..

That's great. And then lastly quick one.

The cost to achieve the synergies that you're working on for the run rate for $40 million by the end of next year, do you think there is more opportunity for the cost to come down or is that basically the number you think it will be, that $60 million is the new target?.

No, I think the $60 million number is a legitimate number. Bear in mind that it's also affected by exchange rates, but that number, we're pretty confident of..

Sounds great, thanks a lot..

. At this time, we have no further questions in queue. So I would like to turn the call back over to our speakers for any additional or closing remarks..

This is Barbara. And we'd like to thank everyone for joining the call today and look forward to speaking with you over the coming weeks. Thank you..

Thank you. Ladies and gentlemen that will conclude our call today. There will be an audio replay of today 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 7661917 or go to the company website, www.itron.com. Again thank you for your patience. You may now disconnect..