Barbara Doyle - Vice President, Investor Relations Philip Mezey - President and Chief Executive Officer Joan Hooper - Senior Vice President and Chief Financial Officer Tom Deitrich - Executive Vice President and Chief Operating Officer.

Joseph Osha - JMP Securities David Katter - Baird Noah Kaye - Oppenheimer Pavel Molchanov - Raymond James Sophie Karp - Guggenheim Securities.

Good day, everyone. And welcome to the Itron Incorporated Q2 2018 Earnings Conference Call. Please note that today's conference is being recorded. For opening remarks, I would like to turn the call over to Ms. Barbara Doyle. Please go ahead..

Thank you, John. Good afternoon. And welcome to Itron's second quarter 2018 earnings conference call. We issued a press release earlier today announcing our results. The press release includes replay information about today's call.

A presentation to accompany our remarks on this call is also available through the webcast and on our corporate Web site under the Investor Relations tab.

On the call today we have Philip Mezey, Itron President and Chief Executive Officer; Joan Hooper, Senior Vice President and Chief Financial Officer; and Tom Deitrich, Executive Vice President and Chief Operating Officer and Ken Gianella, who is Itron’s new Vice President of Investor Relations, officially as of tomorrow.

Ken and I have been working closely together for several weeks now, ensuring that we have a very smooth transition for our investors. Following our prepared remarks, we will open up the call to take question using the process the operator describes.

Before I turn the call over to Philip, please let me please 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 available in our earnings release and on our Investor Relations Web site. 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 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 four in the presentation, and I'll turn the call over to our CEO, Philip Mezey..

Thank you, Barbara. Our second quarter results reflect solid customer demand and a stabilizing supply chain. We continue to be very pleased with advancements in our product portfolio and strong progress on the integration of Silver Spring Networks. The revenue outlook is strong and supply chain visibility has improved.

Let me begin with an update on the supply chain issues that we identified on last quarter's call. While we were disappointed with gross margin in the quarter, we made considerable progress in the supply chain. We focused on securing materials and commodity supplies needed to keep customer projects largely on track.

Over the past several weeks, supply chain conditions have begun to stabilize, component lead times and pricing appear to have plateaued. And we believe we have secured the needed materials for customer demand we see through year-end. We are experiencing elevated costs, however.

We're estimating approximately $70 million of total impact from supply chain costs and internal production inefficiencies for the full year of 2018 compared with our original outlook. About half of this is attributable to supplier cost increases.

We have taken aggressive measures that are partially mitigating these headwinds in 2018 and that will also drive longer term sustainable cost improvement. As Joan will discuss, we've captured the incremental supply chain cost in our EPS guidance update. As always, our focus on our customers remains a priority at Itron.

Our efforts are paying off, resulting in solid revenue production in the second quarter and forecasted for the full year. In fact, we're raising our revenue guidance for the full year of 2018. Now, I'll cover bookings and backlog, turning to Slide 5 in the presentation. Customer activity continues to be very healthy.

The book-to-bill ratio in the quarter was approximately 1:1. Total backlog at the end of the quarter was $3.1 billion and 12 month backlog was $1.4 billion. The 12 month backlog increased nearly 5% sequentially from the first quarter as several large customer projects continued to ramp up.

Notable deals in the quarter include contracts for approximately 1.3 million OpenWay Riva endpoints with Tampa Electric Company and Nova Scotia Power. The utilities are part of a consortium that we previously announced had selected OpenWay Riva for their grid modernization and customer engagement initiatives.

In the Samoan Islands, we will be deploying our OpenWay Riva IoT solution, smart meters and our new prepayment management platform, for 40,000 customers of Electric Power Corporation. We're also pleased to announce that Enedis has selected Itron for 4.2 million meters for the next phase of the Linky smart grid program.

Including this award, Itron will surpass more than 12 million meters on the successful and innovative project in France. This new business will be included in our third quarter bookings.

Distributed energy management wins in the quarter include Eversource where Itron is deploying a demand response program, targeting the utilities small business customers. At Georgia Power, we signed a contract to manage field services for the utilities demand response program.

Georgia Power already utilizes Itron’s IntelliSOURCE demand response software and load control devices. This is a great example of selling new outcome services into a key account. Water bookings in the quarter included new business with the cities of Pearland and Waco in Texas, and Havaco Group in Hanoi, Vietnam.

Water continued a strong backlog trend with book-to-bill rates greater than 1:1 in seven of the last eight quarters. Itron continues to lead the industry in delivering innovation for our customers. In June, we launched new static metering technology for gas and water customers under our Intelis brand.

The gas product is a significant advancement in the metering space with integrated safety features that are critical to gas utilities. We also introduced a new static water metering platform.

While we have been a leader in the water communication space in North America for many years, adding the meter to our portfolio opens a new $800 million per year market opportunity to Itron. Interest in our new gas and water platforms has been phenomenal. Customers are eager to get the products and we expect shipments to begin in the fourth quarter.

On the network side, product convergence activity is progressing and is increasing our visibility for revenue synergies in 2019 and beyond. We started previewing the roadmaps with key customers and the response has been very positive.

Our roadmap provides a clear convergence path that protects customers’ assets, whether they are on OpenWay Riva or the former Silver Spring networks Gen X platform. Today, we are actively enabling Itron’s electric meters on the Gen X networks, and maintaining open choice to customers on meters.

We have a backlog of third-party meters and qualifications and continue to grow the ecosystems of connected devices across Itron’s network solutions. We are also enabling Itron battery-powered endpoint solution on the Gen X network as a part of the convergence plan.

Think of this is our industry-leading gas and water under Gen X, adding a compelling choice of proven devices for customers. Sales of Itron electric, gas and water device endpoints under the Gen X network will begin in 2019. In addition, we’ve enabled the Gen X distribution, automation and streetlight vision solutions on our OpenWay Riva network.

These solutions are available today and are adding new customer opportunities in our pipeline. We are also pursuing new Gen X platform opportunities in EMEA leveraging Itron's robust sales channel, and plans for a new converged network platform that protects customers’ assets and extend our leadership in the industry are on track.

We’re very pleased with the continued smooth progress on the Silver Spring Networks’ integration. Integration of our financial and operational processes and systems is on track. Our R&D and product management teams are actively collaborating on product roadmaps.

The integration of the sales team is well underway and cross-selling opportunities from our converged portfolio of solutions are adding to our pipeline. The financial results for the Networks business in the first half of the year were better than the expectations we had for the acquisition, and we are ahead of plan for projected synergies.

Now, let me turn the call over to Joan to discuss our financials and updated guidance..

A euro to U.S dollar exchange rate of 1.18 in the second half of the year; $40 million shares outstanding; an annual average effective tax rate of approximately 30%; and annual interest expense of approximately $52 million. In conclusion, we have taken aggressive actions to stabilize and partially mitigate supply chain headwinds.

We are successfully executing on previously announced restructuring and supply chain transformation projects, and we are delivering accelerated acquisition synergies. We anticipate benefits from these efforts, both in the second half and beyond. Now, I'll turn the call back to Philip..

Thank you, Joan. We're pleased to be making real progress on our operational initiatives. The primary global supply chain transitions and related site consolidations involved in the 2016 restructuring plans are now completed, and we are in the optimization phase in the new sites. Our 2018 restructuring efforts are underway and proceeding to plan.

This progress on our transformation journey makes us a more resilient and strong company. We continue to drive aggressively to our mid-teens EBITDA goal. While external factors may defer the timing a few quarters, there are no structural impediments to achieving this goal.

Improving execution in our supply chain, accelerating cost synergies from the acquisition and continuing to deliver innovative new customer, are the keys to achieving this goal. Strong progress on these initiatives gives us confidence in our forecast for higher profitability in the second half of 2018 and for further improvements in 2019.

Lastly, I'd like to take a moment to thank Barbara Doyle. This will be her last call leading Investor Relations at Itron. Barbara has done this job beautifully for seven years. Barbara has worked to build our relationships with our analysts and investors around transparency and integrity. We will continue her work as Ken Gianella takes over.

Ken comes to us from Silver Spring Networks where he was the Senior Vice President, President of Finance and Treasurer. We welcome Ken as we wish Barbara the very best in her next endeavor. Thank you. And now let's open the call to take some questions..

Thank you. Our first question comes from Joseph Osha from JMP Securities..

I wanted to drill down on two things, first this question of accelerating savings.

Does that mean perhaps that we should think about a slower pace of improvement in 2019? And so if you talk broadly about a dollar number that you intended to take out of Silver Spring? Is that dollar cost reduction still the same number?.

So if you recall, we talked about $50 million of annualized savings by 2020, which is still our plan. Initially, we expected to be on about $20 million run rate exiting ’18 but only get the benefit of about $10 million in year P&L. We now think that's closer to $15 million to $20 million in the in year.

So the run rate might be a little bit higher but it's essentially within the quarters of 2018 we're achieving those synergies faster than we anticipated..

And so there is still another $30 million in incremental benefits to be realized in 2019 and 2020?.

That's correct..

And then the second question, obviously, lots of people struggling with supply chain tightness and so forth.

When you think about it over the course of the next two years, do you think that eventually we can return these businesses, the existing metering businesses to the margins that they were realizing at the gross margin level prior to when this all got so difficult halfway to 2017? That's it from me, thank you..

So fundamentally, I still have commented on the script. We don't see anything that is structurally different about the longer term view on the business. Yes, supply is tight right now and that leads to some inflationary pressures in the supply chain in certain commodities.

But I wouldn't say that it leads to anything longer term that is fundamentally different than what we've seen before. So structurally very much the same, maybe timing varies a bit based on near term supply constraints..

Our next question comes from David Katter from Baird..

Can you talk a little bit about your project backlog, and how that might give you guys confidence and sequential expansion in gross margin in the second half.

Any detail that can help us get a little more confidence in your ability to achieve that?.

David, I mean the first comment was that the 12 month backlog is up sequentially 5%. And if you look at that trend of the 12 month backlog is actually up significantly as a result of the acquisition of Silver Spring Networks and in the first quarter of this year. So our visibility in both total backlog and 12 months backlog has improved significantly.

As we’ve commented before, we have two different parts to our business, the purchase order replacement business and a large project driven business, the backlog represents that project driven business. And the overall gross margin of that project business tends to be quite strong. It involves more advanced technology and differentiated technology.

So it allows us to have forward visibility and a view to generally very attractive business of these advanced meters and systems and communication systems..

And then on the operating expenses front, is Q2 indicative of a starting point? I know you guys brought that down in the legacy business and we're seeing some of the acquired business flow through.

How do you expect the operating expenses to flow over the course of the year?.

Well, without giving specific line-by-line guidance, I would say Q2 is unusually low because we had, as we mentioned in the script, lower variable compensation. So we have a first half and second half essentially a bonus plan based on performance and we didn’t hit our performance in the first half.

So I would expect variable comp to go back up in the second half..

And then lastly for me, any update on Comverge and the contribution of that business it made in Q2, and your expectations for the rest of the year?.

I mean we made -- in the backlog, talked about a couple as the contracts that we've won. The integration has gone very well and we have now essentially put it into the kit of our overall sales team, and so have a broader opportunity to sell that demand response and distributed energy management offering across our global sales team.

And we have very positive growth in our overall services number, part of that is driven by the contribution of Comverge and the underlying growth in that business..

And our next question comes from Noah Kaye from Oppenheimer..

Really appreciate the visibility into the bridge for the back half for the year and calling out that cost impact. I guess I’m not sure what you're assuming for 2019 around the component cost trends. But I would like to ask about your ability to get price for the different parts of your business to reflect elevated input cost.

You have, as you mentioned Philip the purchase order business and then the project business. Can you talk a little bit about what kind of lag we might expect to see on any upward pricing adjustments to reflect this elevated costs input..

I can take a shot at responding. The way I would think about it is the backlog position that we have certainly is a blessing in terms of visibility but a lot of that backlog is indeed priced. And it would be extremely difficult to modify pricing in that portion of the business.

The other part of the business that Philip described that you referenced more of the terms based business, or PL based, there you do have some flexibility in pricing, you’re still living in very competitive world so you want to make sure that you're staying in line with the competition. But nonetheless there is a bit more flexibility there.

How long do these things take to roll through I think it is very, very market dependent but the fastest things tend to move through is probably a three month lag and sometimes it could be six or seven month lag in terms of how it really rolls through. So that’s how I would think about it overall.

But lots of things that we can do and we do every day in terms of improving the gross margin profile beyond pricing itself, multiple sourcing activities where we approve second suppliers or third suppliers, value engineering will reduce the bill of materials or the complexity of the product itself, the restructuring activities that we’ve had ongoing.

All those things are activities that we undertake as well as pricing to make sure we’re doing our very best to optimize gross margin..

And then I want to ask about something you mentioned during the comment, in your opening commentary. You talked about the technology roadmap for the convergence of Silver Spring and Itron meaning to protect assets no matter what, and that makes a lot of sense. We’ve certainly been seeing a lot of news flow lately around cyber security for the grid.

And I'm just wondering whether you’re seeing from your customers any elevated attention being paid for this.

If that requires any additional work around security for the integration of the legacy network and also what it might mean for Itron’s value proposition for customers?.

I’d say that it's a standard -- it’s a topic that comes up as you would imagine extremely frequently. And I think in prior discussions I’ve mentioned the fact that very frequently, we’re in the envious position of using some of the most advanced technology on the marketplace.

The endpoints that we’re putting out in the field are literally embedding, and Silver Spring and its materials was very clear about this military grade security.

And one of the benefits that we've gotten through the acquisition is it’s on a joint basis now have a tremendously strong security team and have embedded this security thinking deeply into the architecture that we're using.

So one never wants to be overconfident about security, but I feel that both the technology base that we're starting with, the capabilities and the team that we have at this point, put us in a very strong position.

And to your point about our value proposition, I think, are in a good position to deliver the kinds of strong, secure and private systems that our customers are looking for..

Our next question comes from Pavel Molchanov from Raymond James..

I know you don't typically spell out revenue guidance by category, but in terms of the increase versus the original 2018 revenue.

Can you talk directionally what segments and perhaps what geographies it's coming from?.

I would say that the strength we're seeing is across all segments and virtually all geographies as well. So it's pretty across the board..

And having had Silver Spring for about six months, I remember one of the original intentions was to see if you can use the software platform to perhaps upsell to legacy Itron relationships from a staff perspective.

What's the latest on that front?.

We have actually enabled our sales -- for the purposes of this discussion holding the legacy Itron sales force, particularly with products likes it was called operations, optimizer and analysis product and a number of others that we are working to cross sell into that environment to the former Itron customers along with distribution, automation and streetlight vision.

And conversely we've got the opportunity of selling distributed energy management solutions to the legacy Silver Spring customers. So we are actively working on that, building pipeline and we expect to see again greater of these cross selling results at the beginning in 2019..

Our next question comes from Sophie Karp from Guggenheim Securities..

I wanted to ask you about the components headwinds.

Is this something that is largely temporary and transitory? And is it fair to infer that about $0.60 headwind today could turn into $0.60 tailwind tomorrow or potential upside? Or is that something that's more or less permanent?.

I'll start with just the prepared comments, and I'll let Thom extend beyond this. So clearly in the prepared comments, we are assuming that the cost stay at the same level. So don't continue to go up but don't go down in the second half of the year. And I’ll let Tom comment about the longer term..

So I think that the pricing trends on a go forward basis change a little bit, depending on the commodity or the material sites that we're talking about. Metals are metals and they’ll ride up and down of it based on what the commodity would be.

On the electronic side of things, what you tend to see is when the supply chain gets very tight, the suppliers end up going into an allocation situation lead times stretch out prices, escalate for a period of time, you end up with double ordering in the industry and everyone is pushing hard to get their portion of the supply.

At some point, these things plateau and that's what we've reached right now, which is lead times are no longer escalating. We haven't seen lead times start to contract just yet. When lead times start to contract, pricing generally can follow that. I think that's the trend that you typically see in the industry.

It doesn’t go up or down necessarily a step function but it takes a little bit of time for these things to work their way through the system overall..

Sophie, I would add. We're not just waiting for parts prices to change as Tom has discussed, we’re value engineering, qualifying alternate sources, rotating the higher margin products. I mean there is a lot going on here to not just ride a tide of pricing, there’s quite a lot of that we are working on.

And actually as -- and Joan’s comments have offset some of these price changes..

You provided the breakdown of products versus services revenues this quarter.

I'm curious how should we look at this and think about growth rates of these two different revenue streams over a longer-term? Should one grow faster than the other and what's the right way of thinking about this?.

So we actually started in Q4 of last year. So you required one stay hit 10% of the revenue to do the split so we started in Q4 of last year. And I would say we had some quarters products ran a little faster than services and vice versa. But in general, I would expect services to grow faster than the products..

And Sophie on the Web site for some time in our investor deck, we have shown third-party data that basically breaks down growth rates in the categories of basic meters and sensing category versus networking as opposed to this more outcome-based or software and services area.

And the third-party data absolutely supports longer-term faster growth rates in that category and that is one of the areas we were really focusing on..

And nearly, one of the things we've highlighted in the past that continues, is on nearly every Riva sale that we make that also comes with some services now. So it's managed services as a big part of our solution today..

Our next question comes from Noah Kaye of Oppenheimer..

I just want to follow-up on your commentary earlier about the Silver Spring synergies, perhaps going a bit faster than expected. Any color on why that was -- was it supply chain efficiencies, more favorable mix.

Just be helpful to understand what surprised you positively and what that implies for where we go from here?.

I would say it's primarily all OpEx, not supply chain or not cost. And it really has to do with the timing of when employees left the payroll.

So for example, we might have built the plan that said we need ex-amount of people to stay for six months and then we’ll have transition the work well sometimes when they know their job is going away, they leave a little bit earlier.

So I would say in general, it was on the OpEx side and it’s from in the G&A in particular for people leaving the business earlier than we would have planned..

Okay, great. Thanks very much..

Any other questions John. Hello John, any other questions? I think that might conclude our call.

Philip, are there any closing comments you would like to make?.

I just want to reiterate once again, while we face a challenging supply-chain environment, I think that the team is done the strongest job possible of pursuing revenue opportunities, of bringing the acquisition along extremely well, execution and progress there has been very strong, both organizationally and in terms of our product and portfolio and the work that we are doing with customers.

And then what you have heard is that as you’ve heard restructuring and the other work we're doing internally is coming apace and we continue to see the benefits of that work. So it's an exciting time and we very much look forward to talking to you again next quarter. Thank you..

Thanks everyone..