Good day, everyone and welcome to the Itron Inc. Q1 2019 Earnings Conference Call. Today's call is being recorded. For opening remarks I would like to turn the call over to Ken Gianella. Please go ahead..

Thank you, Operator. Good afternoon and welcome to Itron's First Quarter 2019 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 our webcast and on our corporate website under the Investor Relations tab.

On today's call today, we have Philip Mezey, Itron's President and Chief Executive Officer; Joan Hooper, Senior Vice President and Chief Financial Officer; and Tom Deitrich, Executive Vice President and Chief Operating Officer. Following our prepared remarks, we will open the call to take questions using the process the operator described.

Before I turn the call over to Philip, please let 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 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, 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 4 in the presentation and I'll turn the call over to our CEO, Philip Mezey..

Thank you, Ken. Good afternoon and thanks for joining us. We are pleased to announce a strong and productive first quarter with improved operating performance.

Combined with signs of a recovering supply chain environment and continued strong demand signals in the marketplace we are well positioned as we exit our second full quarter under new operating segments of Device Solutions, Network Solutions and Outcomes.

You will hear details from Joan in a moment but to highlight our Q1 2019 performance, revenue was $615 million, adjusted EBITDA was $66 million, adjusted non-GAAP EPS was $0.70 and free cash flow of $14 million.

These results combined with a healthy cash position allowed us to continue to accelerate delevering and begin a $50 million share repurchase plan in the first quarter. Turning to our sales performance, we continue to see robust customer demand and have a very strong pipeline.

Traditionally Q1 can be seasonally low for bookings and that trend continued in Q1 2019 with bookings of $473 million. However we saw solid deal flow, submitted numerous large-scale networks solution and outcome project bids, and remain on track to have a book-to-bill ratio of approximately 1:1 for 2019.

Our total backlog at the end of the quarter was $3 billion and our 12-month backlog increased sequentially to $1.4 billion. This past quarter we continued to execute on our strategy. I'd like to provide brief examples where we are extending our leadership position.

In Q1 our Outcomes segment reached an agreement with Exelon's Utility Analytics team to help them harness and analyze the terabytes of data that is delivered monthly over their Itron network that supports their smart meter initiatives.

This project will enable Exelon Utility Analytics to move beyond customer usage analysis by implementing our Itron's advanced data analytic tools Exelon will be able to create predictive models that will assist with the prevention of outages, recovering from storms faster and in improving the overall grid reliability for every Exelon customer.

Another example we're pleased to announce is a network solutions deal with Louisville Water Company to modernize its distribution system with Itron's OpenWay Riva IoT solution, including nearly 300,000 Open Way, Riva water communication modules.

Louisville Water Company will utilize Itron's IoT solution to increase metering accuracy, improve customer service, and provide greater visibility into its operations. The utility will also use Itron Analytics to detect water loss and make faster more informed decisions.

These are just two brief examples of the market momentum we are seeing from our new segments that will deliver long-term value for our customers and our investors. Next I'd like to highlight the progress we're making with our supply chain.

While some of our component costs and inventory remain at elevated levels we continue to see an easing in supply chain lead times as expected. Last year we reported over 550 parts with lead times over six months and that number is currently down over 25% from last year's high.

Our supply chain optimization strategy is well underway and we are seeing improvements in our book and ship performance, an increase of multisourced component qualification and significant progress on our component replacement efforts.

Through these actions we've improved delivering on our customer commitments and are starting to see gross margin improvements materialize. While this is going in the right direction we still have a way to go and are not standing still on our long-term gross margin improvement efforts.

Finally our committed to executing on our restructuring and integration efforts are showing in our results as evidenced by the year-over-year improvement. We continue to be laser focused on improving operating efficiency in 2019 and we remain committed to delivering the full $140 million in cumulative savings from our projects by the end of 2020.

Overall we are making steady progress on our strategy and look forward to the rest of the year. I'll now hand the call off to Joan to discuss the full Q1 results..

Thank you, Philip. As Philip mentioned we are pleased with our first quarter results. Operationally we performed better than our expectations due to the acceleration of customer projects from the quarters improving execution on book and ship orders and some timing related under runs in OpEx spending.

A summary consolidated GAAP results is shown on Slide 7 and non-GAAP results are shown on Slide 8. Revenue of $615 million increased 1% versus last year driven by strong performance in the Networks Solutions and Outcomes segments.

First quarter gross margin of 30.5% improved 90 basis points versus last year primarily due to favorable product mix including a higher margin software revenue. Moving to earnings per share the GAAP net loss was $2 million or $0.05 per share compared with a net loss of $3.74 per share in the prior year.

You may recall the net loss in Q1 2018 was driven by $151 million in restructuring, acquisition, integration related charges. Regarding non-GAAP metrics, adjusted EBITDA was $66 million or 10.7% of revenue. Non-GAAP net income for the quarter was $28 million or $0.70 per diluted share compared with $5 million or $0.13 per share in 2018.

Free cash flow was $14 million in the first quarter significantly higher than the prior year primarily due to the higher earnings and lower restructuring, acquisition, and integration related cash outlays. Cash and equivalents at the end of the first quarter was $111 million.

Turning to Slide 9, total debt decreased to $1.02 billion as we paid down an additional $10 million in debt. This helped reduce net leverage to $3.5 times. Our strong cash position also enabled us to repurchase stock during the quarter. In March our Board authorized a $50 million share repurchase program over a 12-month period.

We repurchased $8 million of common stock during the first quarter and subsequent to quarter end we have completed the total $25 million that we planned for 2019. Now turning to the first quarter year-over-year revenue bridge on Slide 10, total company revenue grew 1% or 5% on a constant currency basis.

Device solutions revenue was down 11% as reported and 5% in constant currency. The constant currency decline was primarily due to lower EMEA volumes, which was expected. This was partially offset by improved performance in our book and ship business which allowed us to fulfil more intra-quarter demand.

Network Solutions revenue grew 13% in constant currency driven by growing North America AMI deployments. Outcomes revenue was up 4% in constant currency due to strength in North America particularly recurring managed services offerings. The non-GAAP year-over-year EPS bridge is on Slide 11.

Q1 non-GAAP EPS was $0.70 per diluted share compared with 13% in the prior year. Year-over-year net operating improvements added $0.24 per share. A lower non-GAAP effective tax rate contributed $0.35 of year-over-year improvement. You may recall the Q1 of 2018 the non-GAAP effective tax rate was unusually high at 64%.

The Q1 2019 non-GAAP tax rate is 31% which is in line with the full year tax guidance we provided on last quarter's call. Slides 12 through 14 show results by business segment for the first quarter compared with the prior year. Device Solutions revenue was $222 million on gross margin of 18% and operating margin of 11.5%.

While we are seeing the supply chain environment improve sequentially, Q1 margins are still impacted by higher component costs compared with last year. Network Solutions revenue was $336 million on gross margin of 37.8%.

The margin percentage was flat year-over-year with benefits from higher margin software sales offset by other less favorable product and service mix. Operating margin improved 190 basis points to 28.3% driven by lower OpEx including the benefits of integration synergies.

Outcomes revenue was $56 million on gross margin of 36% up 14 percentage points year-over-year. The improvement was driven by favorable product mix and scale benefits from the integration of Silver Spring Networks. Operating margins of 18.5% was up 20 percentage points reflecting a significant contribution from synergies.

Overall we were very pleased with our first quarter performance. Results were better than our expectations with some pulling of revenue and EBITDA from the second half of 2019. While it is still early in the year we remain confident in the full year guidance range.

Given the Q1 overachievement and timing issues I mentioned, we expect Q2 could be sequentially flat to slightly down for both revenue and earnings. From a gross margin perspective we continue to expect second half improvement with the Q4 exit rate being approximately 150 basis points higher than the Q1 level.

As is our normal practice, we intend to provide an official update to our annual guidance on our Q2 call in early August. Now I'll turn the call back to Philip..

Thank you, Joan. Our Q1 results exceeded our expectations and we are working hard to continue the momentum. The demand outlook for our industry is strong. Our pipeline is expanding and we are making progress on improving our supply chain execution and our new business segments are executing and performing as planned.

Finally, just as a reminder, we invite you to join us for our Investor Day on the 27th June at the NASDAQ Market Site in New York City or via a live webcast on our investor page. We will delve deeper into our strategy, the market outlook, our new business segments and provide an update on our technology roadmap.

Thank you and operator, would you please open up the call to take some questions?.

Thank you very much. [Operator Instructions] We'll take our first question from Ben Kallo with Baird. Please go ahead..

Hi good afternoon. Thanks for taking my questions.

Philip, you mentioned you had severe bids on large projects out there, could you just talk maybe just maybe little bit more color about what type of projects and if it is lean with the Silver Spring offering or your Itron offering or any color you can give there would be good? And then can you talk may be more about the exiting gross margin there and how much confidence you have from both the input side as well as what you have in backlog and the mix there to be exiting with the 150 bps or greater gross margin? Thank you..

Sure Ben. The bids I would I would characterize as large North American electric AMI related bids. To your question about distinguishing between the former Silver Spring technology offering versus Itron it is a mix of technologies.

I would remind everyone on the call that we have outlined and we'll talk more on Investor Day about our convergence plans such that customers who are taking this technology actually have a strong assurance about a unified platform moving forward. We are very pleased with the progress we are making on this pipeline that we are pursuing.

On the gross margin I'll pass to Tom to take that one..

Thank you, Philip. Ben the way I would characterize that is the supply chain environment is definitely improving. We've seen lead times start to normalize. We still have some inventory that we procured last year at some elevated levels, but we're starting to see the environment return to a much more normal kind of world.

The way it will work is as lead times start to retract back into a more normal range and then you start to have suppliers working for business, so you get a bit more commercial leverage in terms of managing our way through it. We look closely at the back half of the year and that was part of how we guided for the year.

We still feel very good about our progression throughout the year. Lots of work to go. We've got to keep moving along the path of component replacements and design cost reductions as we go through the balance of the year, but from my point of view we are very much on track for the year..

Yes, the only other thing I would add to that is, we've got our restructuring and integration plans that are continuing in those effects of both OpEx and cost of goods sold, so those will contribute as we go through the year as well..

Thanks Joan, thanks Tom..

And we'll take our next question from Joseph Osha with JMP Securities. Please go ahead..

Hello, hello.

A couple of questions, first it's interesting that you're staying with the whole year guidance and I'm just wondering is this just kind of normal quarter-to-quarter puts and takes or is there some kind of perhaps seasonality you have emerging to this business, because again comparing the way it acts the past years is not necessarily valid, could we be seeing a pattern where Q1 is strong and then things soften up a bit over the summer and then recovery coming out of the year? And then I have a followup..

Let me take the broader question first in terms of holding full year guidance. So our normal practice is to give the full year guidance at the end of Q4 on that call and then to update it two quarters later. So as I mentioned in the prepared remarks we will do the same thing.

We did indicate that obviously we're still comfortable with the range that we provided on last quarter's call. In terms of the quarter, I don't know that there is a new pattern emerging.

I did mention a couple of timing related things, a little bit of a pulling from revenue and EBITDA that we would have expected in later quarters related to the timing of customer deployments as well as some timing issues around OpEx spending. So that's why I gave a little bit additional color around Q2.

But I would say I don't think there is a new pattern emerging in terms of any kind of seasonality. I mean a lot of our customer deployments can be quite large and there's an ebb and flow to those deployment, but I would say unrelated to calendar quarters..

Okay, so it's just lumpiness, thank you.

And then also following a bit on what Ben asked looking more specifically at the backlog I'm wondering if we can talk a bit about how the composition of that 12-month in total backlog is changing as your revenue mix changes?.

I mean we provided a little bit of color on the backlog last quarter and I would say really hasn't changed which is I think it's about two thirds of the backlog is kind of Network Solutions type backlog and so that really hasn't changed. We don't see a lot of change in that from quarter-to-quarter..

Right. I think the backlog composition is very similar to what we've seen in the past Joe and the fact that there's lesser amount of devices in there, you shouldn’t read into that anything other than device business tends to be a bit more book and ship based type of revenue.

But the backlog is similar to what you've seen in past quarters where backlog for the next 12 months did go up between the start of the quarter and end of the quarter I think we're up just around $100 million or around 1.4, so decent coverage, but obviously still plenty of work to do..

Yes, before I ring off though, what's challenging you about the backlog number, I'm just trying to figure out whether it's you know obviously because your business is changing right, whether those trends are becoming discernible in the composition of your backlog, that's all I'm asking and how we should think about that going forward?.

And again I think as Tom mentioned is the – the backlog is primarily North America based because a lot of the business, the device business in particular in Europe is more frame order and we don’t put that in backlog, but I don’t think that's really changed and I would say there is no new trend in the backlog.

The one thing Philip mentioned was, you do get a little seasonality in the actual bookings in the quarter, so there's a lot of sometimes because of customer budgets kind of pull into Q4 type thing, but we still feel good about the book-to-bill for the full year..

Thank you..

And we'll take our next question from Noah Kaye with Oppenheimer. Please go ahead..

Thanks very much.

So just I want to understand something a little bit, you called a couple of factors that would create a pull forward, but you also mentioned improving execution on book and ship and that just to me and tell me if I'm hearing wrong, that just sounds like your internal supply situation is improving and so you are just able to fill orders and presumably that would continue to be the case going forward.

Am I misunderstanding that?.

No, I think you're right..

No, you haven’t misunderstood at all. Clearly, we're pleased with the amount of book and ship business that we could fulfil for the quarter, that's may be an output of the improving supply chain condition overall. So that I would say it's probably slightly better on the book and ship side of things than what we came into to the quarter with.

But the real pull forward isn’t book and ship that was much more customer project deployments and the timing that goes along with that, that was more of a timing side. So both of those factors definitely helped the revenue for the quarter, but the pull forward comment was really much more around customer projects than book and ship..

And then looking at devices specifically, sequentially was down in revenues about $5 million but your gross margins were 110 bps higher sequentially.

So I don’t know what pull forward revenue you saw there, but the point is there is some gross margin expansion going on that's pretty impressive sequentially, can we just understand what drove that, because it is hard to think that that was just a timing issue..

We definitely saw supply chain health improving which was really behind the book and ship fulfilment, but the revenue change, I'm sorry, the gross margin change sequentially has probably more to do with the quarter accrual that we took in the fourth quarter of last year where we had a pretty large special warranty accrual for a customer issue in Europe that we took in Q4.

So that's I think the biggest factor that's in there, the gross margin sequential improvement..

Right, and then if I could sneak one more in, congratulations on the Louisville Water award, I didn’t quite hear, that sounded like a networks award, are you at this point with the Intelis water meter are you starting to submit RFP bids for that, are you winning any business for that, because clearly that's a market that you haven't played in for a while and you lost a pretty big growth opportunity.

How do we think about the timing there?.

Yes, the water meter samples with customers is really happening now where they are doing some long-term testing. We are submitting it for bids with customers, but by and large the Louisville Water deal specifically did not include the Intelis water piece of business.

This was a network and the analytics that go around the network that is primarily the basis for that award. We still have some opportunities then for additional sales based on expanding the portfolios we step forward in time..

Okay, but to be clear, I mean you are through for the most part qualification processing and you are now bidding on RFPs with your water meters?.

Yes, internal qualification, customer qualification is ongoing..

Okay, thank you very much..

Thanks Noah..

And we'll take our next question from Jeff Osborne with Cowen & Co. Please go ahead..

Hey, good afternoon guys.

Was there – how do we think about the 25% proposed tariff impact to you guys either on the component side or other costs?.

Yes it's – you know how to think about that one. Probably you are a wiser man than I. To be honest we saw a lot of volatility in the tariffs as to what actually was included officially in the policy from the government in the back half of last year that kind of stabilized as we came into this year.

I think there's still plenty of talk there's still plenty of negotiating positions and actually negotiation is going on now that could pull that up or down, but thus far in the year tariffs are running about where we expected they would be in the environment has been reasonably stable.

We remain very focused on adapting as much as we can and being ready should something change, but very, very difficult for us to predict exactly what will happen. That's how we're thinking about it overall..

Got it, that's helpful Tom. Maybe just two more here, one a followup on Noah's question, not to be a cynic, but when Silver Spring was a public company maybe once every six quarters or so they would blow away gross margins by having a big software license revenue come in to the utility IQ out of the deployment.

So I just want to understand that in response to his question about the sequential change, there was no sort of onetime goodness in terms of mix if you will this quarter, this is more of a normalized gross margin environment post the warranty accrual last quarter or was – because I would have thought if you have deployments accelerating that it wouldn’t just kick in for one quarter, but you would get the ball rolling and then you would continue that case of progress..

So there is still lumpiness when you have a customer deployment in terms of some upfront software revenue recognition. So we mentioned that in terms of some of the pull forward of timing of customer projects in heavily software.

I would say it's very different, the scale of Itron now Silver Spring as part of it versus Silver Spring scale it was much more obvious when they would have lumpiness just because our numbers are so much smaller.

So there is still a little bit of lumpiness, but and we indicated the – if you looked at our guidance last quarter we were assuming our margin would be relatively flat from Q4 to Q1.

They were about 50 bps higher than that, so some of that is the software that was recognized but I would say our view of gross margins for the year has not changed which is why we still expect to see the exit rate roughly 150 bps higher than the current will get you to about 32%, so very similar gross margin discussion this last quarter..

Got it, makes sense.

And the last one for you Joan I have is just the $70 million I think you've talked about in the past of cost savings for 2019 and 2020 can you just reaffirm that that's on track and remind us of what the split is by year and then how much was it in cost of goods versus OpEx between the two years, has anything changed?.

Sure, yes, yes it's still, no so still on track. So as we reported in the last quarter we had $140 million in total we are about 50% of it complete. The remaining $70 million is split roughly puling maybe a little bit more in 2019, but roughly equally and it's actually pretty equally split between cogs and OpEx as well.

Now as you look, I was going to say, the one thing to be mindful of is we go through the year and we report quarter-over-quarter from the prior year as you might imagine you get the biggest benefit in Q1 of this year versus Q1 of last year for example in the Silver Spring synergy because we had very few synergies last year that type of thing, but basically it's split about 50-50 across the two years and 50-50 between gross margin and OpEx..

Got it, and then may be just very quickly, Philip you talked a lot about the kind of robust activity in North America, any observations internationally that you can share?.

Well, we're looking at a couple of nice opportunities in Europe as well, so I would say there absolutely is regional activity across Latin America, Asia and Europe that are project based that is not just extensions of ongoing book and ship business, but project opportunities that are sort of the scale that we've seen in North America and we'll be happy to comment on those as they progress..

Perfect great to hear, thank you..

Thanks Jeff..

[Operator Instructions] We'll take our next question from Pavel Molchanov with Raymond James. Please go ahead..

Thanks for taking the question. On the buyback looks like you guys deliberately front end loaded it shortly after the announcement just a few months ago.

Given the better-than-expected start to the year across the board in your metrics would you consider upsizing the $50 million buyback or at least perhaps completing the rest of it in 2019 rather than waiting until next year?.

Yes, actually debt covenants would preclude us from doing that.

So when file our Q later this week you'll see the details, but we're essentially capped at the $25 million this year, so the Board authorization was for 12 months so we can complete the next $25 million in the first quarter of next year and then later in 2020 we will have more flexibility, but we don't have any additional flexibility in 2019..

Okay understood. And then one more question on the component situation. The comments we're hearing from a lot of the semiconductor and consumer electronics companies throughout the last three to four months is that demand has softened markedly and as a result we obviously are seeing some softness on the component side as well.

Is there any kind of bias to the upside perhaps on $150 basis point margin improvement targets? I guess what I'm asking is, from the comments that you made back in March has anything changed perhaps higher or lower versus that original expectation?.

Pavel, Tom here. I would say that we are on track to deliver what we said for the year to the extent we are going to update it would be when we normally do our guidance update in the middle of the year itself.

I think that what you see right now is us burning through some of the inventory that we procured last year and into the beginning of this year which was at slightly higher prices probably than what we expect to see for the rest of the year.

So we'll update in the middle of the year to the extent we do see a tailwind there, but for now we said it goes..

Okay, I appreciate it..

[Operator Instructions] And seeing no further questions, I'd like to turn the call back over to Mr. Philip Mezey for any additional or closing remarks..

Thank you everyone. I mean we're very pleased. A quarter doesn’t make the year, but this is a good start for us as they said I think good momentum in the marketplace and overall demand and overall good start and I look forward to seeing all of you at our upcoming investor day. Thanks very much, bye-bye..

There will be an audio replay of today's conference available this afternoon. You can access the audio replay by dialing 1-888-203-1112, or 1-719-457-0820 with the past code of 5342456 or go to the company's website www.itroncom. This concludes today's conference. We thank you for your participation. You may now disconnect your phone lines..