Itron, Inc. (NASDAQ:ITRI) Q4 2022 Earnings Call Transcript

Itron, Inc. (NASDAQ:ITRI) Q4 2022 Earnings Call Transcript February 27, 2023

Operator: Good morning ladies and gentlemen and welcome to the Itron’s Fourth Quarter 2022 Earnings Conference Call. Please note that today’s conference is being recorded. I will now hand the conference over to your speaker host today, David Means, Director of Investor Relations. Please go ahead.

David Means: Thank you, operator. Good morning and welcome to Itron’s fourth quarter 2022 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 website under the Investor Relations tab. On the call today, we have Tom Dietrich, Itron’s President and Chief Executive Officer; and Joan Hooper, Senior Vice President and Chief Financial 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 Tom, 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 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 that were presented in today’s earnings release in 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.

All company comments, estimates or forward-looking statements are made in a good faith attempt to provide appropriate insight to our current and future operating and financial environment. Materials discussed today, February 27, 2023, may materially change and we do not undertake any duty to update any of our forward-looking statements. Now, please turn to Page 4 of the presentation and turn the call over to our CEO, Tom Deitrich.

Tom Deitrich: Thank you, David. Good morning and thank you for joining us. You will hear fourth quarter details from Joan coming up shortly but here is a brief overview of the quarter, revenue was $467 million. Adjusted EBITDA was $34 million and non-GAAP earnings per share was $0.71. Our fourth quarter financial results were a step in the right direction. The team executed well to convert and deliver additional components that were supplied late in the quarter which unlocked revenue and EBITDA ahead of our expectations. Turning to Slide 5. For the third consecutive quarter, we achieved a new record level for total backlog which reached $4.6 billion. Continued strong demand drove bookings in the fourth quarter to $898 million or a 1.9 book-to-bill ratio.

The full year bookings were approximately $2.5 billion which is a book-to-bill ratio of 1.4. Our key bookings in the fourth quarter continued to be driven by distributed intelligence and analytics over our network technologies. Our network solution to outcomes offerings continue to contribute over 90% of the total backlog. Itron received regulatory approval for their AMI 2.0 program which is an important step in moving forward with deploying our Gen 5 Riva solution. This includes our distributed intelligence capabilities across their service territory in Ontario, Canada to support grid reliability, resiliency and consumer engagement initiatives. In the water vertical, the city of Detroit is upgrading to our water network and Itron will also provide managed services.

CPS Energy extended our SaaS contract by an additional 10-plus years which strengthens our technology partnership in San Antonio, Texas, a fast-growing community that is now leveraging Itron’s network technology to deploy AMI and distribution automation across electricity and gas as well as water in conjunction with a sister utility saws. We are now excited to begin deployment of our Intelis gas solution, bringing market-leading safety functionality and increase edge intelligence to CPS Energy. Lastly, in Paris, France, CLS and Itron entered a long-term strategic collaboration to provide Paris, a citywide Canopy network, connecting more than 200,000 street and traffic lights across the city. Coupled with deploying innovative breakthrough services, Paris will be able to cut public lighting energy by up to 30% beyond the impact of LEDs resulting in massive energy savings and improvements in sustainability.

Now turning to Slide 6, I would like to provide some operational updates and insights from around the business. We have a robust pipeline of opportunities ahead as our customers’ needs are aligned with our technology portfolio and continued investments. While quarter-to-quarter bookings will vary, we anticipate the strong demand environment to continue. Seasonally, I note that first quarter bookings are typically lower than the fourth quarter. The current supply environment is showing improvement with choppy component deliveries in the near term, specifically for some analog and power semiconductors. We will continue to work aggressively to mitigate these constraints, including increasing inventory levels of selected components as it becomes available to improve supply chain security.

Customer support remains strong and we have not experienced nor expect any material cancellation of backlog. Looking forward, we expect improving supply availability across the year. We are watching the macro situation closely, including the timing of supplier capacity expansion, demand in the automotive industry potential impacts from China reopening and the overall inventory level across the full spectrum of the supply chain. The underlying improvement supply trend is positive with some degree of volatility as the global supply chain rebalances. Input cost inflation rates have leveled out but component costs remain elevated. Tactical pricing actions, combined with the increased pricing flexibility and more recent contracts have improved margin on a portion of the backlog.

Finally, I want to cover that we announced a plan to further streamline our global manufacturing operations and company overhead as we continue to execute our stated strategy. When complete, this plan will improve our operational and financial performance. I will now hand off to Joan to cover the fourth quarter results, 2023 outlook and the details of our recently launched restructuring plan.

Joan Hooper: Thank you. As Tom mentioned, we received earlier than anticipated component supply late in the fourth quarter, allowing us to ship and recognize more revenue than expected. The additional component supply had been anticipated in Q1 of ’23, so a portion of Q4 strong performance was a shift from Q1. I’ll provide more color on our 2023 expectations but first, let me cover fourth quarter and fiscal year 2022 results. Please turn to Slide 7 for a summary of consolidated GAAP results. Fourth quarter revenue of $467 million decreased 4% versus last year and was flat in constant currency. Revenue declined year-over-year due to the sale of our C&I gas business in our Device Solutions segment. This decline was offset by higher revenue in both our Network Solutions and Outcomes segments.

Gross margin for the quarter was 30.1%, 510 basis points higher than last year, primarily due to favorable mix partially offset by elevated component costs. GAAP net income of $22 million or $0.49 per diluted share compares with a net loss of $59 million or $1.30 per share in the prior year. The improvement in the current period was due to higher GAAP operating income, partially offset by a lower tax benefit. Regarding non-GAAP metrics on Slide 8. Non-GAAP operating income was $25 million. Adjusted EBITDA was $34 million. Non-GAAP net income for the quarter was $32 million or $0.71 per diluted share. Free cash flow was negative $18 million in Q4, driven by an increase in working capital, particularly inventory. We will continue to invest in critical components as they become available.

Looking at revenue by business segment on Slide 9. Device Solutions revenue was $100 million, a $42 million or 27% year-over-year decline on a constant currency basis. The decline was due to the sale of our C&I gas business as well as continued product pruning. Network Solutions revenue was $301 million, a $39 million or 15% increase in constant currency. The increase was driven by a ramp of new and existing deployments. Network Solutions benefited from the extra component supply received late in the fourth quarter. Revenue in the outcomes segment was $66 million, a $4 million or 7% increase in constant currency. The increase was due to higher software license and product sales partially offset by the continuing decline in the EMEA prepay business.

Lastly, foreign currency changes resulted in $19 million lower revenue versus the prior year. Moving to the non-GAAP year-over-year EPS bridge on Slide 10. Our Q4 non-GAAP EPS was $0.71 per diluted share, down $0.04 from the prior year. Net operating performance had a positive $0.48 per share impact due to the fall-through of higher gross profit and lower operating expenses. A negative tax impact of $0.52 per share more than offset our positive operating performance. The negative year-over-year tax impact was due to a large tax benefit booked in Q4 of 2021. Turning to Slides 11 through 13, I’ll discuss Q4 results by business segment compared with the prior year. Device Solutions revenue was $100 million with gross margin of 11% and operating margin of 3%.

Gross margin increased 230 basis points due to improving mix, partially offset by elevated component costs. Operating margin increased 40 basis points due to the fall-through of the higher gross margin, partially offset by a higher percentage of operating expenses. Network Solutions revenue was $301 million with gross margin of 33%. Gross margin increased 260 basis points from the prior year due to favorable mix, partially offset by higher component costs. Operating margin of 23% increased 480 basis points due to the fall-through of higher gross profit and lower operating expenses. Outcomes revenue was $66 million with gross margin of 46%. Gross margin increased 390 basis points due to very favorable solutions mix and improved operational efficiencies.

Operating margin of 26% increased 130 basis points due to the fall-through of the higher gross profit, partially offset by higher R&D investment. Now to briefly recap full year 2022 results, please turn to Slide 14. Revenue of approximately $1.8 billion was down 9% from 2021. On a constant currency basis, revenue was down 6% and when further adjusted for the sale of our C&I gas business, revenue was down only 2%. The revenue decline was due to the component shortages which limited our ability to fulfill customer demand. Gross margin was 29.1%, 20 basis points higher than 2021. Adjusted EBITDA was $95 million compared with $115 million in the prior year. Non-GAAP earnings per share was $1.13 per share versus $1.75 in 2021. Free cash flow was $5 million compared with $120 million in the prior year.

The year-over-year decrease in free cash flow was due to higher working capital usage, higher variable compensation payments and lower EBITDA, partially offset by lower capital expenditures. Turning to Slide 15. I’ll cover liquidity and debt at the end of the fourth quarter. Total debt remained flat at $460 million and net debt was $258 million. Net leverage was 2.7x at the end of Q4. Cash and equivalents at the end of the fourth quarter were $202 million. Please turn to Slide 16. I’d like to provide you some color on our 2023 expectations. We anticipate full year 2023 revenue to be in a range of $1.85 billion to $1.95 billion. We remain cautious to start the year as component supply continues to be constrained and somewhat unpredictable, including the nonlinear timing of deliveries within a quarter but we do anticipate that the supply environment will improve gradually throughout the year.

At the midpoint, the 2023 annual guidance is approximately 6% year-over-year growth. This is driven by growth in our Networks and Outcomes segments, partially offset by a continued decline in our Devices segment. We anticipate full year non-GAAP EPS to be within a range of $0.70 to $1.10 per diluted share. At the midpoint of this guidance and normalizing the tax rate to 28% for both years, the year-over-year operational earnings growth is approximately 6%. This growth is somewhat muted due to an expected increase in variable compensation expense in 2023. The variable compensation costs in our 2022 results were not at the target payout and we are planning to achieve targeted payout in 2023. Given our expected gradual improvement in supply throughout the year, earnings will be heavily skewed to the second half of the year.

Other full year guidance assumptions are a euro to U.S. dollar foreign currency exchange rate of $1.05 and an average non-GAAP effective tax rate of approximately 28%, average shares outstanding for the full year of approximately $45.7 million. Now, please turn to Slide 17 for our first quarter outlook. Given the continued volatility in the component supply, I am also providing our view of Q1. We anticipate first quarter revenue to be in a range of $460 million to $475 million which at the midpoint is flat versus our Q4 performance. As I mentioned in my opening comments, the unexpected delivery supplied late in the fourth quarter was initially anticipated to be delivered and converted to revenue in the first quarter. This supply shift is contributing to slightly lower revenue in Q1.

We anticipate first quarter non-GAAP EPS to be within a range of $0.05 to $0.15 per diluted share. This is down sequentially from Q4 due to the very favorable product mix in Q4, an increase in variable compensation expense and a much higher tax expense given Q4’s rate was negative 30%. While we anticipate the full year 2023 tax rate to be approximately 28%, the quarterly rates will fluctuate based on the amount of earnings and any onetime true-ups. For the first quarter, we are expecting a onetime increase in tax expense of approximately $2 million. This is related to a required true-up of prior stock grants vest. Including the impact of this $2 million true-up, we expect the overall tax rate in Q1 to be in the range of 40% to 60%. In summary, the constrained and unpredictable nature of component supply continues to impact our results.

However, signs of supply improvement started to appear in our fourth quarter. We are optimistic we will see improvement of supply availability throughout 2023. Please turn to Slide 18 for details on the restructuring announcement we made this morning. Last week, our Board of Directors approved a new restructuring plan. This plan is a continuation of our asset-light strategy and includes further actions to streamline our manufacturing operations as well as overall overhead in the company. We expect this project to cost between $40 million and $45 million and generate annualized savings between $14 million and $17 million. The project should be substantially complete by early 2025. And now I’ll turn the call back to Tom.

Tom Deitrich: Thank you, Joan. I would like to close today by highlighting our expanding distributed intelligence offerings. To date, we have shipped approximately 5.8 million DI capable endpoints and have approximately 7 million applications in operations today. Through partnerships, our proven and scalable DI platform will enable a new and innovative approach to improving grid resiliency and transforming the relationship between utilities and consumers. We recently announced a partnership with Smart Energy Water to transform the utility consumer relationship to enable the management of distributed energy resources. That builds upon our partnership ecosystem that already includes our long-term collaboration with Microsoft to accelerate cloud adoption and the next generation of consumer and grid solutions for the utility and smart city industries.

With partnerships, we will transform how end users view and manage their energy and how utilities meet the demands of a rapidly changing industry. Thank you, everyone, for joining today. Operator, please open the line for some questions.

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Q&A Session

Operator: Our first question coming from the line of Noah Kaye with Oppenheimer.

Noah Kaye: And Tom, I want to pick up right where you left off with remarks around the expansion of the DI platform. Can you talk a little bit about the interest you’ve gotten from different players in the DI ecosystem following your announcement in January? Who are you seeing the demand coming more strongly from? And I think in the release, you mentioned the revenue opportunities around this would really start to manifest in 2024 but maybe give us a sense of what the revenue model might actually look like for some of the DI offerings?

Tom Deitrich: Sure. Thanks, Noah. We see interest in DI applications from a broad swath of the industry. Certainly, there are utilities that want to develop their own applications and then a host of ecosystem partners from large companies to small companies. that are interested. The applications that they are working on tend to be a mix of great efficiency types of things as well as consumer engagement types of applications. It really depends on what problem they’re trying to solve. Revenue model, it is largely a maybe as a subscription kind of model where an application is used for a certain period of time and on a per usage basis or a per time basis. And the portion of that revenue that accrues to Itron is dependent on whether it’s power application or whether it’s a third-party if it’s a third party, there’s a hosting fee and think a little more we used to be in our owned applications.

It’s quite a bit higher in terms of the revenue that we get. You’re right in terms of the timing. Think of it as a case where networks are deployed, initial applications and AMI or use case is stabilized by the utility and then they start layering in incremental services. So it tends to follow on in terms of deployments by maybe 18 months or so and that’s where you’re starting to see the scalability now I mentioned in our prerecorded remarks of about 7 million applications running in the field today, sometimes 1 per end point oftentimes multiple applications running in parallel in the endpoint more like a smartphone kind of model in terms of how it.

Noah Kaye: Very helpful. I might leave it for others to pull on the thread of what that means for outcomes. I do want to ask just a couple of clarifying questions around the outlook. It sounded like we had some revenue shift from 1Q ’23 into 4Q. So if I just add a little bit to 1Q, it really seems like the revenue outlook for the full year is annualizing 1Q would have been with not much improvement. So just given your comments around expectations for the improving supply chain, I wonder if we could square that up a little bit. How kind of conservative is the outlook in terms of the revenue run rate? And what kind of level of increase are you assuming as we go throughout the year?

Joan Hooper: Yes. Let me take a stab at that. So the outlook that we provided is based on our current expectations after discussions with suppliers in terms of when supply will arise. Certainly, to the extent that the suppliers are able to excite our current view there is upside to the view. But right now, what we would say is that we expect gradual improvement through the year. And so all things being normal, we would expect Q1 to be the low point, we would continue to grow through the year. So the range is pretty wide. And as you said, if you take the kind of high end of the range, it’s a different assumption than the low-end of the range. But I do think we will see somewhere around the midpoint or higher of revenue growth which would be over 6%.