Itron Inc (ITRI) 2013 Q3 法說會逐字稿

Good day, everyone, and welcome to the Itron Q3 2013 earnings conference call. Today's call is been recorded. For opening remarks, I would like to turn the call over to Barbara Doyle. Please go ahead.

Thank you, Elise, and welcome to everyone on the call. Good afternoon. I'd like to welcome you to Itron's third quarter fiscal 2013 earnings 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. Our presentation is available through the webcast at through our corporate website under the Investor Relations tab. On the call today we have Philip Mezey, Itron President and Chief Executive Officer, Steve Helmbrecht, Itron Executive Vice President and Chief Financial Officer, and John Holleran, Itron Executive Vice President and Chief Operating Officer.

Philip will begin our call today with a summary of our operating results and the business environment. Steve Helmbrecht will cover our Q3 financial metrics. Philip will then close the prepared portion -- the prepared remarks portion of the call with some summary comments, and then we will open it up for questions. Before we get started, please let me remind you of our non-GAAP financial presentation and our Safe Harbor statement. Our earnings release and financial presentation include non-GAAP financial information that we believe enhances the overall understanding of our current and future performance. We have included reconciliations of differences between GAAP and non-GAAP financial measures in our earnings release and financial presentation.

We will be making statements during this call that are forward-looking. These statements are based on current expectations and assumptions that are subject to risks and uncertainties. Actual results could differ materially from these expectations because of factor's discussed in today's earnings release, in the comments made during this conference call and in the risk factor section of our form 10-K and other reports and filings with the Securities and Exchange Commission. We do not undertake any duty to update any forward-looking statements.

Now please turn to Page 4 in the presentation, and I will turn the call over to our CEO, Philip Mezey.

Thank you, Barbara, and good afternoon to everyone. Before I discuss Q3 results let me remind you of what we have said and what we are looking to accomplish and 2013. Our near-term financial focus is on improving profitability with earnings improvements in the second half of the half of the year compared to the first half. We are driving to get better quarter-after-quarter strengthening the Company's core financials. In Q3 total revenues of $495 million declined by 1% in constant currency. Sequentially, revenues increased by 3% from the second quarter with improvement in each business line, electric, gas and water. We had good revenue performance in water, globally including record quarterly revenues in North America.

Electric business results were mixed with underlying strength in North America. Business in EMEA continues to be soft which is impacting our results particularly in gas. We anticipate continued weakness in this region in the near-term. I'm encouraged by the higher revenue trend each quarter this year and a business environment that is improving but still uneven. And we are making progress on earnings improvement. Now I'll provide insight into our segment performance starting with the energy segment on Slide 5. Electric revenues of $217 million were down from last year by 2% in constant currency. We continue to see underlying strength in our core electricity business, excluding the revenue from the large OpenWay contracts, global electric revenues grew 25% on a constant currency basis driven by smart metering projects in North America.

We are generating meaningful revenues from multiple projects including Detroit Edison, Duke Energy, Consumers Energy, Los Angeles Department of Water and Power, National Grid and others. 12% growth in electric revenues in the EMEA region offset weakness in Asia-Pacific and Latin America. EMEA growth was driven by the completion of a large project in North Africa. The energy segment gross margin of 28.6% decline 460 basis points in the quarter. Product mix and lower volumes put pressure on the margin compared to last year, but the majority of the decline, 350 basis points, resulted from increased costs on our project with BC Hydro. This impacted operating margin as well. In Q3 we booked $13.6 million of additional costs to complete the project. Our initial network design did not accurately reflect some of the meter reading challenges in the British Columbia province including meter locations in many of the high rises in Vancouver as well as very mountainous rural lake areas.

We have been deploying this project over the last two years recognizing more than $260 million in revenue to date, and this is a successful, profitable project. As the project is substantially complete, and the majority of the revenue is already been recognized, the added costs for the tail end of the project had to be accrued in the third quarter. We expect these costs to be incurred over the next nine months as we complete the project. This is an important project for both Itron and our customer and one that showcases our OpenWay SmartGrid technology. The impact of the additional costs to complete the contract was, however, disappointing in an otherwise good quarter in our electricity business. Looking forward, the more robust solution designed for vertical urban and mountainous areas will benefit future OpenWay customers with similar topology challenges.

Electricity bookings in the quarter were $166 million including an OpenWay contract with FortisBC in Canada and a cellular solution contract with Grayson-Collin Electric Cooperative in Texas. One of our key initiatives is a focus on collaboration to accelerate innovation. We announced several examples of this innovation in Q3. Our industry-leading OpenWay SmartGrid network is now available globally supporting multiple communication options. Our global standards-based platform connects utilities with their customers and rid assets using RF Mesh, cellular and power line communications. Itron's global OpenWay network provides true interoperability to support SmartGrid applications. The platform strengthens Itron's competitiveness in key markets, and it increases our efficiency, helping us to streamline development and reduce expenses while we accelerate delivery of new products and applications.

We also announced that Itron's solar meter solution it being used by more than 50,000 homes and businesses in North America, establishing Itron as the leading provider of solar metering in the region. Solar meters account for approximately 1% of our electric revenues currently, and we see the potential for high growth rates of this stream revenues in 2014 and beyond including good recurring revenues from our managed cellular services. I will wrap up Electricity with an update on the opportunities we are pursuing. As previously communicated, First Energy has selected Itron for its SmartGrid project in Pennsylvania. We await regulatory approval to proceed with the contract. In Europe, the commentary European Utility Week in Amsterdam earlier this month validated that SmartGrid projects are advancing.

The Linky Project tender at eRDF for the first 3 million meters was published earlier in October, indicating another step forward for this project. The tender award is anticipated to be announced in early 2014 with installation expected to begin in early 2015. In Spain Iberdrola is moving forward of their smart metering project, and we have been notified that we received a small award of the recent $1.4 million meter tender. Iberdrola is an important Itron customer using our meter data collection software for their project, and we will evaluate the level of our future participation on the metering side. Our focus is to prioritize projects where we can differentiate our solution and value to the customer. Now moving onto the gas business.

Gas Q3 revenues of $143 million were down 6% year-over-year in constant currency. The decline was primarily in EMEA. As we have discussed on previous calls, our project Azeri Gas in Azerbaijan is one of Itron's largest smart gas meter contracts. Shipments to Azeri Gas are down year-over-year given the completion of the deployment in the capital region of Baku. The project outside of the capital city has been approved for 2014 roll out. The good news is that we have already begun shipping meters for this next phase of the project. Elsewhere in EMEA, gas revenues in Italy grew in the quarter driven by residential meters and services. Orders in France and the UK have slowed given their pending smart meter rollouts. Shipments to Germany remain on target.

In the US, gas end point cells are lower on a year-to-date basis as utilities focus on pipeline infrastructure and safety. However, we did see a rebound to modest growth in North America and Q3 given by a large new order at CenterPoint Energy. Total Gas bookings in the quarter were $167 million for 1.2 to 1 book-to-bill ratio. This includes a contract with $61 million in the quarter with CenterPoint Energy's natural gas distribution business. CenterPoint will complete installation of Itron's advanced metering technology across the remainder of their six state service territory by the end of 2015. In terms of new tenders, one of the largest upcoming gas opportunities is the GRDF project in France for 11 million meters.

This multi phase project is expected to begin in 2015 and extend through 2020. GRDF issued an RFP in Q2 for the first phase of the project covering 5 million meters with the award anticipated in early 2014. This is a substantial smart metering project that continues to move forward. In the UK tenders for the initial phase of their smart meter projects have begun for 2014 and 2015 deployments. Itron is competing for these tenders with the goal of continuing our strong presence with utilities in the region. On the innovation front, Itron announced a new gas Cyble communication module and a new commercial smart meter both targeted to customers in Europe.

Itron's Ecora meter is a compact diaphragm smart meter with temperature and pressure compensation and GPRS communications integrated in the meter. The meter provides high billing accuracy as well as ease of installation reducing implementation costs. As we have discussed, a transition to smart gas metering is occurring globally, admittedly slower than we'd like. With Itron's leadership and reliable and accurate metrology and our expansion of smart gas solutions targeted at pipeline integrity, monitoring and detection, we are optimistic about future gas growth opportunities. Turning to our water segment on Slide 6. Itron is a clear leader in automated and smart water technologies, and this shows up in our performance.

Q3 water revenues increased 6% year-over-year in constant currency with growth in North America and Latin America regions. Gross margin of 34.8% was down compared to 36.6% last year on the heavier mix of lower margin professional services. Although services margin did improve from the second quarter. Non-GAAP operating margin increased by 20 basis points year-over-year as a result of lower operating expenses excluding restructuring costs. Water bookings were $123 million in the quarter reflecting a 0.9 to 1 book-to-bill ratio. This was a quarter of multiple modest sized bookings in water rather than any single large contract. On the innovation front we delivered our first units of Itron's EquaScan solution that we announced in the second quarter entering the large market opportunity for heat cost allocation systems for multifamily housing.

We also announced a new residential ultrasonic water meter called Intelis with integrated communications and advanced sensors to increase visibility into water distribution systems. And I am pleased that the latest IMS research report again ranked Itron as the top global supplier of total water meter and communication module shipments. Overall we had strong performance in our water business in Q3. We also see continued opportunities for growth given by demand for automated water meter networks worldwide and our new products targeting heat metering.

Now I'll the call over to Steve Helmbrecht to cover our financials in more detail, comment on our restructuring and provide some color on our full-year expectations.

Thank you, Philip, and good afternoon. I will begin with Slide 7 which summarizes our financial results for the quarter compared with the third quarter of 2012. Philip provided a good overview of our revenue, so my remarks will start with gross margin. Consolidated gross margin was 30.3%, down 380 basis points over last year. The BC Hydro charge drove the majority of the decline, accounting for 260 basis points at the consolidated Company level. Gross margin was also negatively impacted year-over-year by product mix and lower volumes overall. Non-GAAP operating margin was 6.6% down from 10.8%, driven by the lower gross profit. We continue to focus on reducing our operating expenses.

In the quarter non-GAAP sales and marketing and research and development expenses were down 3% compared to last year and sequentially. General and administrative expenses in the quarter increased year-over-year due to provisions for bad debt and legal expenses. Employee related expenses in G&A declined compared to last year. Expense reductions helped partially offset the revenue decline and the decreased gross margin in the quarter. Adjusted EBITDA was $46.4 million this quarter with adjusted EBITDA margin of 9.4%, down from 13.5% a year ago. On a GAAP basis, we had a net loss of $0.19 per share compared with net earnings of $0.89 per share in 2012.

The decrease was driven primarily by lower gross profit and higher operating expenses related to the restructuring charge of $28 million. Non-GAAP earnings per share, which exclude the impact of restructuring charges, acquisition related expenses and amortization of intangible assets and debt fees, were $0.65 for the quarter compared with $0.97 in 2012. As shown on the non-GAAP EPS bridge chart on Slide 8, the decrease in our non-GAAP earnings was driven by lower gross profit partially offset by lower expenses, reduced share count and lower tax expense. Earnings in the quarter reflect lower tax expense that had a $0.07 per share impact. An updated non-GAAP effective tax rate of 15% for the full year reflects slower business in several jurisdictions in Europe lower-than-expected profit in the third quarter and full year.

Free cash flow for the quarter was $31.3 million compared with $33.9 million in the third quarter of 2012. We had strong cash collections from accounts receivable in the quarter, primarily the scheduled release of retainage provisions on a large OpenWay contract. Now turning to capital. In March our board authorized a new one-year share repurchase plan for up to $50 million. We have re-purchased 559,000 shares under this plan at an average price of about $42 per share leaving $26 million available. We ended the quarter with $399 million in debt, down $11 million from last quarter. Our interest expense was $2.8 million in the quarter and reflects the interest rate swaps that became effective in August resulting an in increase in our interest rate to 2% from 1.5%. I will move on to bookings and backlog now using the next three slides.

Turning to Slide 9, total backlog at September 30 was about $1.1 billion with 12 month backlog at $582 million. Our base business backlog as shown in the red bars on Slide 10 continues to grow and was $825 million at the end of the quarter. The yellow bars on the slide represent the backlog related to the large OpenWay deployments. These projects are substantially complete with the exception of Detroit Edison, which has installed more than $1.3 million OpenWay in points to date, and will continue its deployment over the next several years. Turning to Slide 11, we have $457 million bookings during the quarter representing a book-to-bill ratio of 0.9 to 1. Our largest booking was $61 million related to CenterPoint Energy's smart gas module deployment. I will also provide an update on the restructuring we announced in September.

We announced projects to reduce approximately 750 employees or 9% of our workforce and restructure operations to increase efficiency and lower cost. These are proactive cost reductions as part of our ongoing effort to streamline operations, reduce our global footprint and costs and improve profitability. As we have discussed publicly throughout the year, reducing costs is one of Itron's key focus areas been led by John Holleran in his global COO role. The announcement reflects a step in these ongoing efforts. The restructuring is underway, and we incurred $28 million of charges in the third quarter associated with the projects. The projects predominately impact the electricity business line in our energy segment, although we are implementing projects across all areas of the business.

The actions taken to date include the reduction of 260 positions and notification to 65 additional positions. We have announced plans to close our Sumare, Brazil plant and discontinue the electro-mechanical meter business line in Latin America. We will close the meter production line by your end and consolidate the remaining operations into our Americana facility. We have consolidated our cellular integration facility in Mississippi into our factory in South Carolina. We have announced the closure of an R&D location in San Mateo, we began the process of consolidating other administrative offices in the US, Canada, Mexico, Brazil, Germany, Australia, China and India.

Many of the projects are outside the US and are subject to labor and employment regulations which can impact time tables. We currently expect all projects to be substantially complete by the end of June next year. Once completed, we anticipate these projects will result in $30 million of sustainable annualized savings, which is approximately 150 basis points of margin improvement. Lastly, I'd like to make a comment on our financial guidance. Given our Q3 results and softness in Europe, we anticipate our full-year results will be at the low end of our prior guidance range of $1.95 billion to $2 billion of revenue and $2.25 to $2.55 of non-GAAP EPS.

Now let me turn the call back to Philip.

Thanks, Steve. In my 10 months as Itron's CEO, I've gained a wider perspective of our organization, and I would like to conclude our remarks with my assessment of where we are now. We remain committed to the key initiatives I set in January that are focused on quality, collaboration and innovation. Under these initiatives we have strengthened the Company. Our focus on quality spans our entire Company. It includes purchasing, manufacturing, product design, delivery commitments, project controls and financial operations.

This commitment to quality must be at the center of everything that we do, and we are instilling that commitment in our employees around the world. The strong turnout and customer testimonials at our Itron utility week conference in Orlando this month validates that we are on the right track. Our customers recognize this commitment and appreciate our renewed emphasis on delivering high-quality solutions to them. Yet the project charge we took this quarter is a reminder that we have more work to do. We will not be complacent when it comes to quality and are working to improve every day. Through our quality program we will be recognized by our customers as the provider of choice in our industry, and we will drive improved and more predictable financial results.

We have a wealth of knowledge, experience and expertise across Itron, things that are a true competitive advantage. We unlock our potential and through collaboration. By realigning our operations and removing barriers to collaboration, we have been able to continue to streamline our business and reduce cost. John Holleran and his team are leading a globalization and restructuring initiative that is beginning to deliver results. John's team has already produced organizational and process changes that are reducing OpEx in the near-term and that will also drive meaningful and sustainable improvements. Our global ERP system and shared services roll out led by Steve Helmbrecht's team will drive significant G&A savings.

And as revenues increase, our improved operating efficiency will result in even stronger bottom-line results. Driving innovation allows us to accelerate new product availability even as we are reducing R&D expenditures. We've launched more than a dozen significant new products and solutions so far this year including taking our OpenWay solution global. We are converging technology platforms, leveraging technology partners and building offshore development and delivery capability to reduce costs and free up engineering resources to create new innovative technology. We also continue to look at ways to extend our capabilities through investment and acquisition opportunities.

Now 10 months into the job I'm encouraged by the progress we are making in a macro-environment that has been tough. While there is more work to do, we have improved our results each quarter. The pace of revenue growth largely depends on project timing and customer schedules. Our focus on innovation, efficiency and lower costs builds a solid foundation for increased earnings generation and for future investments to expand into new software and services markets. I am confident in the direction we are taking the Company.

Thank you, and now let's take some questions.

(Operator Instructions)

Ben Kallo, Robert Baird.

My question was about the BC Hydro margin impact. The way I understand it is you incurred all the costs this quarter even though it is going to roll up in the next nine months. So do we see that flow through in the P&L or not?

So Ben we accrued for the cost. The actual cost will be incurred over the next nine months.

This is Steve, Ben, just to build on that, we will not incur additional future expense in future quarters related to that. That is already reflected in the results for the quarter.

So we shouldn't expect that to impact future quarters on margin basis on the P&L?

Correct.

Going onto backlog, this CenterPoint announcement that you announced is that included in this quarter's backlog? It was right on the cusp there?

Yes, it is included.

Okay. And then it sounded like you are backing off Iberdrola a little bit. For us they are very electricity Europe focused out there, and we are looking at these things as catalysts. Can you guys give us maybe two to three different spots that we should be focused on more intently than Iberdrola maybe with better margins and that might come sooner?

I think our opportunities -- of course we talked about eRDF where volumes are potentially higher and competitive dynamics are somewhat different. We discussed the UK where we see the market coming along nicely, and I think that there are differentiated opportunities for us in that market. And then we see Germany starting to really come to life, and I think nice opportunities there. But I'd point out again this distinction between Europe and EMEA. EMEA, 100 countries in which we have tremendous opportunities in Africa and the Middle East and some of the former Soviet republic. So there are opportunities outside of those few Western European --

Great. And then my last question, Philip and Steve, on the balance sheet front, balance sheet remains very strong. Here in the past you've outlined acquisitions as your number one target for use of the balance sheet. Can you give us an update where you are there? What type of business is you are looking at? And I will jump back in queue, thanks

Ben, one of the -- as I've made the point, one of the first things I did when I got the job was appoint Russ Vanos to head up a strategy and development group. And one of their first tasks was to really build an evaluation of what our market opportunities were and where the adjacencies lie. We've done some very promising work in that area. I've talked about going -- moving beyond the meter, and we are starting to see opportunities and projects that we're already doing in which we are driving more software and analysis component, more recurring services opportunities. And we do see a number of opportunities of those kinds out there in the market.

Thanks, guys. See you next week.

Thanks, Ben.

Thank you. We will go next to Paul Coster with JPMorgan. Please go ahead.

Philip, I just wanted to go back on -- to EBITDA and your comments there. It sounds like you're turning away from certain type of business. Can you just elaborate on that and whether there's broader implications in Europe?

Sure. On many prior calls we've talked about the dynamic of certain of the European bids in which the customers provided a specification and there essentially is an auction process where we don't have the same kind of opportunity to create differentiated value. Iberdrola and France are examples of that kind of dynamic. And based on how the auction process has gone in Spain, you've see a little less emphasis from us there. But there are strong opportunities for value differentiation in the other European markets that we've talked about and certainly much more broadly around the world.

Then I realize this is more art than science, but my impression is that European ramp, which we have been waiting for for so long it is really a 2015 phenomenon now with some visibility into that maybe in the first-half of 2014. Is that now your latest thought on this? I know it changes.

Paul, I think that's fair that there are some initial and pilot quantities that are available starting to build in a second half of '14, but that the volume really is in '15 at this point.

All right, thanks very much.

Thank you. We will go next to Ryan Connors with Janney Montgomery Scott. Please go ahead.

Great, thank you. Just kind of a bigger question for you, Philip, that has to do with the margin profile and the cost structure improvements going on. Have you thought about the longer-term goal or target of where you think the margin profile of the business should be just from a high-level perspective? We've been kind of running in this mid to high single-digit operating margin which is kind of below the historical run rate. So I guess my question is as you look out a couple years and you do get some improvement in volumes and so forth, where should we be thinking about the potential of the business to go in terms of a more normalized operating margin? Have we done any -- given that any kind of thought?

Ryan, we absolutely have, and on last quarter's call I talked about our goal of mid-30s gross margins and mid-teens EBITDA margins. Which we feel are absolutely attainable through not only increased volumes but product mix and maybe just handing to John to talk about a couple of initiatives.

It is a number of things, Ryan, and we will be turning all of those dials. But to Philip's point, we absolutely believe those targets are achievable. It will take some time, but we think we are taking some steps in the right direction at present. And it will include also some of the products that were pushing through our R&D group and bringing to market. And as we find more value enhancing products, we will be able to improve our margins on those.

I guess just to expand on that so how much of that improvement to let's say that mid-teens level, how much of that is driven by the cost structure improvements, which in theory should have a pretty high visibility level associated with them? And how much of that is driven by the volume improvement be it Europe or elsewhere where we just don't have that kind of visibility and so it is a little more guess work in terms of timing?

Yes, that's -- I think it is a really interesting question, Ryan and if I had to take a whack at it I'd say it is about half and half of those things. On the cost side we really are working as you've heard through this restructuring on factory consolidation, head count reduction, about the line of course, you heard us say that we are -- withdrawing from electro-mechanical metering market in Brazil, so we are taking a look at very critical markets in areas where we are not able to achieve our margin targets. So that's partially market selection more to the discussion about Iberdrola where we are really focusing on profitability. But there is also operating margin opportunity in which you are seeing John and Steve and the teams managing down operating expenses, which are really generating some nice leverage for us as well.

Okay. And then, Philip, you mentioned your utility week conference earlier in the month, and I'd be interested to get your perspective on customer feedback there as regard to sort of the business case behind SmartGrid in the US. I know there's been a lot of debate around that and it is obviously it is at least in part maybe responsible for some of that deceleration of deployment. Was or any kind of color you can give us a terms of what you're hearing from customers about their business case and how they communicate with the regulators around that topic?

There absolutely was. Ryan, thank you -- in which our customers are making presentations leading sections at our -- at this conference in which -- Detroit Edison is talking about achieving 130% of their submitted business case. CenterPoint again talking about the many millions of [track rolls] -- I think now to 4 million track rolls that have been saved through the use of this system and the economic impact that has for them. San Diego Gas and Electric made a presentation about the integration with their average management system and the increasing reliability and reduction in cost that they are getting there. And actually BC Hydro made a very strong presentation on the benefits that they are getting out of their system as well. So we are now starting to see documented proof points and customers that are actively engaging and talking about the benefits, sharing those with those with the regulators but also with other prospective customers as well.

Okay, that's great. Thanks for your time.

You are very welcome.

Thank you.

(Operator Instructions).

We will go next to Ben Kallo with Robert Baird. Please go ahead.

Hey, guys. As a follow-up with an earlier question, I think, Philip, you might have misunderstood me and Paul's question about 2015 being the real roll out of the big electricity projects. Maybe could you address some non-electricity and non-European locations on the gas and the water side, too that will begin rolling out in 2014? I know you kind of touched on that, but if there's any more you can add.

Sure, Ben, and also before we go to gas and water, which you have heard us make very positive comments about, I'd like to also speak to the fact that we're -- in North America the electricity market is building. We talked about very strong growth there as well, and we've got some nice projects that are coming online and even some acceleration in the North American market that's going on. But moving over to gas and water. We made comments about GRDF. We've talked about Italy before, a continuation in Azerbaijan for the smart gas payment project. We've talked about the work that we're doing in South Africa that starts out as an electricity project but has the opportunity to grow into an integrative electricity and water project with the scope increasing down there. And on the water side, of course, we've made announcements about a couple projects in India that were beginning to roll out. John, others that we --

Ireland.

Yes. Ireland, which we talked about last quarter in which we are going to start seeing volumes as well. So, there are some nice projects. And then moving on over to Asia, of course we've got this pilot of the China Light and Power that's currently in regulatory review in order to move to a broader roll out. And then the Tepco initial meter bid which is coming up here in the fourth quarter with a roll out that is due to begin in 2014 in which we see a nice opportunity as well.

Great. Thanks.

Thank you. We will go next to John Quealy with Canaccord Genuity.

I guess a couple of questions here. First on the production, and I'm sorry if you said this, but I missed it. So the production was down pretty significantly quarter-on-quarter. Revenues didn't fall off as much. Can you bridge the volume at price for us? Was it higher mix but higher-priced mix? Was it more services? What was it given that production went down pretty notably?

John, it was a better mix in some of the product -- some of our business lines than it had been previously, so the tail off in volume didn't hurt nearly as much.

Okay. Just in terms of -- obviously we can infer given your guidance, toward the low end, we can infer where that goes. But, for the most part, on pricing you are seeing fine pricing trends, or is still somewhat uncertain as we get into smart around the world?

I think that's a bit of a mixed bag, because what you're hearing from us is in terms of pricing trends where the competitive pricing has gotten so fierce, electro-mechanical meters in Brazil being example. The discussion about some of the pricing dynamics in places like Spain you're going to see deemphasis, and we're going to seek those places where we're able to hold price. So far the US, certain part of our business in Europe, gas and water clearly, we've maintained pricing well.

And John also this is Steve, just on the comments I did provide regarding our low-end of the guidance clearly reflects the additional charge in Q3 on the earning side and wanted to reflect that in providing the update.

Okay. And then just to touch on this Iberdrola -- just playing back the tapes, this is one where I term it quick-out-of-the-box with a speced meter a year plus ago. And now the turn away, it doesn't seem terribly surprising. But are those mutually exclusive events or is it just pricing determining it, Philip, because it looks like it wasn't a utility you focused on early, and that's the way these deals go?

It really is pricing, John. There are five or six awarded bidders in these tenders. It is a highly competitive bid environment. Volume are fairly low. And where I think there was rightly really an issue with us was did we have product development capability to have a certified meter. We've certified the meter. Is Iberdrola a bellwether of European utilities moving forward with smart metering? It sure is. So we see both of those things now. It's just that the pricing dynamics are such that we will participate, but we are going to focus elsewhere.

Okay. And then lastly for me just in terms of the cost to build the metrology and then also the comps on the smart meters. I know over in Amsterdam there was quite a number of chip providers talking about Next-Generation chips. I know you guys have done that with smart North America, but is there any material savings involved from an EBIT -- or a costing perspective to help you increase EBIT leverage when you do get these orders. So, for example, ST Micro came out with their system on a chip or meter on a chip in terms of packaging some of the components together. Does that move the needle for you folks on the bill of materials, or not?

It absolutely does move the needle. The question is what's the relationship between the selling price and the TMC? The TMC is coming down. We are monitoring those suppliers. It is not just system on a chip. It is relays and switches. There are all kinds of components that go on the meter where there are very competitive suppliers, and we can continue to lower our bill of materials costs as well as the efforts John's putting into lowering our labor costs. And there are going to be markets where we can expand margins and markets where selling prices are going to come down commensurately. It is a mix.

All right. Thanks, folks.

You're welcome.

Thank you. We will go next to Craig Irwin with Wedbush.

Good evening, and thank you for taking my questions. First thing I wanted to ask was about the tax rate, 20% on the GAAP line but it looks like your adjustment to basically put things back in line on a non-GAAP basis you used a much lower percentage probably something close to the mid-teens. I was hoping you could give us a little bit more color about what impacted that and why that was significantly below your GAAP rate?

Yes, Greg, this is Steve. The driver there on the tax side has been the lowered results in the charge as well as the somewhat lowered outlook and higher tax jurisdictions. So we are seeing now for the year is about 15% rate this year which is about a 17% rate in the fourth quarter to get to that average on a non-GAAP basis. On a GAAP basis we are actually going to benefit just given the restructuring charges and other items that have flown through on a GAAP side. So the driver for that has been the lower rate, and then there's been good work as we always do in planning, and we did at the beginning of the year receive the retroactive research credits that is benefiting the rate for the whole year. And that was the legislation that was passed right at the beginning of year and it benefited us this year with the retroactive. So that was accounted for a fairly substantial amount of the lower rate we had this year.

Great. My next question is much more high-level. So I'm curious about your sales funnel. As you look at your different geographies and the different potential technologies that customers could adopt over the next couple years, where do you see as most significantly changing over the course of the last year? And where do you think things are likely to change most significantly within the next couple quarters?

It is a pretty diverse world out there, so I think maybe I will take a start and then have John fill in with a regional view. Many of the projects that we are working on, as others have pointed out, are things that have shifted to the right where the customers had an intent all along about the type of technology and approach they are going to use, and it is just really a timing issue as to when these things are going to be tendered. And so we don't necessarily see a particular change there. One change I would point out, interesting thing that's going on in Japan we saw in the bid a request for radio frequency powerline carrier and cellular in which having a diversity of technologies is actually very useful, because of the complex terrain particularly these very vertical cities. So you've seen us put real emphasis in rounding out our technology portfolio particularly on the electric side. On the gas and the water side, what we are seeing is an increased emphasis on networks, where in the past we had had standalone or drive-by systems, we are seeing a much stronger demand for networking, which again provides opportunity for us to really drive some differentiated value in how we provide those efforts. And maybe, John, if you want to comment on regions?

Yes. On a region by region basis I think it even varies within the region. As Philip mentioned when we talk about EMEA, that's 100 countries. So that's a lot of regions within a region. And we see different characteristics depending on the countries. Germany is moving forward pretty strongly on gas. As Philip mentioned, they are evaluating electricity. We've got some really good opportunities in water. You drop-down to Africa and Middle East, some very strong opportunities on the water side for us that we're evaluating and have in the hopper. Good opportunities, as Philip mentioned, in Japan on electricity, but we are also looking at some gas and water opportunities there. We've had some good business develop in India, and we've got some other opportunities in Asia as well. That -- North America is coming along pretty well, too, so a lot of opportunities. Some of it's timing, but we really like what we see going down the road.

Great. And then last question if I may, when I attend working groups and different events related to the utility industry, I'm hearing from regulators and utility executives a huge amount of interest in cyber security. Obviously it is a key issue for the industry today. Can you maybe share with us whether or not this is impacting the sales of some of your products and whether or not this could potentially be an opportunity for you over the next year or two as we see utilities ramp up spending for cyber security?

It is a great question. Our customers are very, very concerned about cyber security, and I would point out privacy as well, a related topic. The product -- the OpenWay product that we put in the marketplace has been extremely advanced cryptographic capability, and when we deploy that along with Cisco cryptography in the network, we have both network security and embedded data security in the system. And the customers that we brief on that that are extremely -- find that an extremely compelling value proposition. So to your question is there an opportunity there? There is absolutely a tremendous opportunity. We are introducing the security approach that we've used in these more sophisticated electric offerings into our global offerings and across to our gas and water products as well. So in areas where security was not initially as much of a concern in the gas space and the water space, it is now becoming a real topic of conversation. We have benefited from the investments that we've made in the electric systems in using the same componentry to embed that security into our gas and water offerings as well.

As to whether or not it is had an impact on the selling speed, in markets like the Netherlands and the most famous example where security became a concern and essentially froze the market for two to three years, we have seen that. Germany has an extremely rigorous security standard that they are proposing to embed in their product which is having an impact on timing as they move to finalize their standards. The DLMS/COSEM standard, which is used globally for data exchange with a number of electric devices, has a very active group that is working on strengthening the cryptography in DLMS. And so it is somewhat effecting timing, but we are in an extremely strong position in terms of the investment that we've made and the technology we already have out on the field on the cyber security front.

Great. Thanks again for taking the questions.

Sure, Craig.

Thanks, Craig, and, Elise, let's take one more question if there are any more in the queue.

We will go last to Patrick Jobin with Credit Suisse. Please go ahead.

Thanks for squeezing me in and good evening. First, a really simple question, and I have a follow-up. Should we expect any revenue impact from the restructuring as you leave electro-mechanical in Brazil?

Probably not material. I wouldn't think so. It's -- electro-mechanical round numbers is probably $10 million at best. Okay. Thank you. And then just kind of higher level question for the team. So I guess if you think through the dynamics for the smart meter business I guess with the big five that remain in the UK and then Tepco in Japan, it is my understanding those markets have selected a communication system for some of the projects. So I guess what get you comfortable that we won't see the same margin dynamics that you are alluding to for Iberdrola?

So, the -- for one thing the customer has not issued a specification dictating interchangeability of the product that we are providing to them. So the bid dynamic is different. We have latitude in how it is that we design our product, and the customer is not demanding a sort of lowest common denominator approach terms of interchangeability. They are requiring interoperability that is that there can be multiple suppliers underneath the communication system, but we have more design latitude which allows us to create more value. There is also real opportunity for us to capture value in integrating communications even if it is not our communications module, but integrating that communications into the meter in order to drive down the total cost of the integrated offering. So there is a nice opportunity for us beyond metrology there for value capture.

Great. Thank you.

All right. Thanks, everyone.

In summary, I think -- I'm pleased that we've got this message across about where are focus is going to be. What I'd I like to leave you with is, again, while there is a lot more to do, that we are off to a very, very strong and methodical start in this restructuring program that we have underway and cost reduction initiatives that you see resulting in sequential quarter growth here, which we are really focused on continuing. We see strength in a number of really critical markets for us. To the extent that we've experienced a slowdown in growth in some of these markets, we feel they are overall market dynamics and not competitive losses, nor are they particularly broad pricing pressures. So, we are very optimistic that, as these markets pick up speed, there are absolutely growth opportunities for us in 2014, that the improved expense structure of the Company and efficiencies that we put in place will allow us to generate improved operating leverage. Thanks very much.

All right, thanks, everyone, and operator, this concludes our call.

Thank you. 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 passcode of 800-2273, or go to the Company's website www.itron.com. Thank you very much and have great day.