Itron Inc (ITRI) 2014 Q4 法說會逐字稿

Good day, everyone, and welcome to the Itron Q4 and year-end 2014 earnings conference call. Today's call is being recorded.

For opening remarks, I would like to turn the call over to Barbara Doyle. Please go ahead.

Thank you, Robert. Good afternoon and welcome to Itron's fourth-quarter 2014 earnings conference call.

We issued a press release earlier today announcing our results. The press release includes replay information for today's call. We have also prepared presentation slides to accompany our remarks on this call. The presentation is available to the webcast and to our corporate website under the investor relations tab.

On the call today we have Philip Mezey, Itron President and Chief Executive Officer, and Mark Schmitz, Itron Executive Vice President and Chief Financial Officer. Following our prepared remarks, we will open up the call to take questions, using the process that the operator described.

Before I turn the call over to Philip, please let me remind you of our non-GAAP financial presentation and our Safe Harbor statement.

Our earnings release and financial presentation include a 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 the call today that are forward looking. These statements are based on current expectations and assumptions that are subject to risks and uncertainties. Actual results could differ materially from these expectations because of factors discussed in today's earnings release and the comments made during this conference call and in the risk factors section of our Form 10-K and other reports and filings with the Securities and Exchange Commission.

We do not undertake any duty to update any forward-looking statements. Now, please let me turn the call over to our CEO, Philip Mezey.

Thank you, Barbara, and good afternoon to everyone.

I will begin today's call with a look at sales, bookings, and backlog, and the overall health of the business. Mark will review our fourth-quarter financials and provide our financial guidance for 2015. I will add some closing comments, including my focus areas going forward. Then we will open up the call to take some questions.

For the fourth quarter, we reported $0.36 of non-GAAP EPS, which was even with last year, on revenues of $510 million. As you can see on slide 4, adjusting for $25 million of currency impacts, Itron's revenues increased by 2% when compared with last year, with growth in each business segment. Mark will cover our business segment performance in more detail.

I will say that although currency impacted our revenues, strong sales execution in the quarter delivered revenue growth in constant currency and significant growth in our bookings and backlog, which is important to our future. Bookings and backlog performance is shown on slides 5 and 6.

Total bookings in Q4 of $648 million reflected a 1.27 book-to-bill ratio, driven by a record quarter for gas bookings. Gas bookings of $348 million included $82 million of our contract with GrDF for the first tranche of the gas power smart meters and more than $200 million of gas bookings in North America.

For the full year, gas bookings increased more than 35% compared with 2013.

We had other notable bookings in the quarter, including the 120,000 endpoint smart water solution with the Jordan Water Company and new orders for ongoing projects at Tucson Electric Power Company and Consumers Energy.

12-month backlog of $747 million grew by 36% year over year. Our 12-month backlog increased sequentially in each quarter in 2014 and this trend helps to strengthen our confidence level for our 2015 revenue forecast.

Total backlog of $1.48 billion grew by nearly 40% year over year. Our total backlog stands at the highest level in three years.

Our backlog and other large project awards not yet booked provide revenue visibility upward to more than $2 billion. Key large contracts we have won in the last 18 months, which are driving our backlog growth, are at healthy margins.

In addition, we are implementing expense reductions with our restructuring projects. This combination provides good visibility for revenue growth and margin expansion, which will become notably evident in 2016.

Before I turn the call over to Mark, I will comment on our two largest regions, which make up 85% of our total business. Our business in North America was strong in the fourth quarter, as well as for the full year, with growth in the mid-single digits. Given our backlog and expectations of project deployment timing, our North American business growth potential remains healthy.

In addition, our margins in North America are generally the strongest of all the geographic regions. To date, North America has led the world in smart grid and smart system adoption. As we have discussed, customers place a high value on the technology that drives smart systems, as well as the expertise of their technology partners that deliver the systems. Itron is a leading provider of smart systems in electricity, gas, and water in our business results in the region reflect this.

For the full year of 2014, EMEA revenues were flat in constant currency; however, EMEA profitability lagged the US, particularly in the fourth quarter. Foreign-exchange weakness began to have a notable impact on our EMEA results. We have factored this risk into our plans and financial guidance for 2015.

Restructuring projects we are undertaking in 2015 and 2016 in Europe are designed to improve profitability in that region. Many key smart projects in Europe, as well as across EMEA, have been tendered and several have begun deployment. These make good data points for increasing smart grid investment in the region. For the near term, however, we are cautious in our expectations for EMEA.

Now, I will turn the call over to Mark.

Thank you, Philip.

Our business recorded mixed results in Quarter 4, although electricity in particular gained solid traction, increasing our confidence that we are on the right path towards improved performance and results.

While we had a strong quarter for gas bookings and revenue growth in constant currency, we were disappointed with the margin results in gas, particularly in EMEA. However, we understand the reasons for downward pressure in margins and corrective actions are underway.

Our water business remained strong with continued steady growth. Margins contracted somewhat in the fourth quarter, partly related to factors that are temporary in nature.

Slide 7 summarizes consolidated Company results for the fourth quarter of 2014, compared with the fourth quarter last year. Let me first address the currency impacts of our quarterly results. The strengthening of the dollar that began in the middle of 2014 has been pervasive, affecting nearly all currencies that impact our business. Currency translation impacts our earnings to a lesser degree than revenues. While currency negatively impacted our topline by $25 million, it impacted non-GAAP EPS by only $0.01 in the quarter.

In addition to translation effects, currency can impact our gross margins due to electronic components procured in US dollars and sold outside the US. In the fourth quarter, favorable pricing on other commodities, including copper, brass, or aluminum, offset the electronics impact. We expect these largely offsetting trends to continue in 2015.

Total gross margin of 30.3% in the fourth quarter decreased by 120 basis points. Improved gross margin in electricity partially offset the impact of less favorable gross margins in gas and water. Non-GAAP operating margin of 5.7% increased by 160 basis points. Adjusted EBITDA margin of 7.7% declined by 190 basis points.

Total non-GAAP operating expenses declined slightly compared to last year. However, this was not sufficient to offset the reduction in gross margin.

On a GAAP basis, we had a net loss per share of $1.25, compared with a loss of $3.93 per share in 2013. The GAAP net loss in the fourth quarter of last year was driven by $173 million of goodwill impairments. We had no goodwill impairments in 2014.

We recorded special charges in the fourth quarter of 2014 that did impact our results under GAAP. We recorded $55.8 million for costs of restructuring in our electricity segment and related G&A activities, which we announced on November 4. We also recorded a charge of $14.7 million for the settlement of a legal dispute associated with our acquisition of SmartSynch in 2012. Both of these charges are excluded from our non-GAAP results.

Also during Quarter 4, we recorded an additional $2 million of charges on our BC Hydro contract to reflect a contract amendment we have now signed with the customer.

Non-GAAP diluted earnings per share, which excludes the impact of goodwill impairment, restructuring charges, acquisition-related expenses, and amortization of intangible assets and debt fees, were $0.36 for the quarter, the same result as in the fourth quarter of 2013.

As you can see on the non-GAAP EPS bridge on slide 8, lower gross profit compared with last year was offset by modestly lower operating expenses and a lower effective tax rate. Last year's fourth-quarter tax rate was adversely affected by valuation allowances placed on certain deferred tax assets, while the rate in the fourth quarter of 2014 benefited from the US R&D credit extension enacted at the end of the year.

Free cash flow of $4 million was down compared to the fourth quarter of last year, largely due to timing of receivables and payables. We had good performance in inventory management, achieving a 12% reduction year over year in days inventory outstanding.

For the full year, free cash flow was $88 million, nearly double the free cash flow of 2013. The increase was largely driven by improvements in net working capital and lower capital expenditures. Capital expenditures in 2014 were $44 million, compared with $60 million in 2013.

We ended the year with $112 million in cash and equivalents.

During the quarter, we utilized $24 million to repurchase 600,000 shares of stock. As we stated in our third-quarter earnings call, we increased our rate of share repurchase in the quarter, given our confidence in our plans for revenue growth and profit improvement. As of today, we fully utilized the $50 million Board authorization, repurchasing 1.2 million shares under the plan.

Now I will turn to segment performance, beginning with the electricity segment on slide 9. The fourth quarter was the strongest quarter of the year for electricity. We saw a benefit from higher year-end spend in North America. Overall, the growth in our smart grid business, in addition to prior restructuring and improvement initiatives, is becoming more evident in the results.

Revenues declined by 2% in nominal terms, but grew by 2% in constant currency. North America growth in smart grid business more than offset some of the slowdown in EMEA and a $3 million revenue loss due to our planned exit from the basic residential meter market in Brazil.

Gross margin improved significantly compared to last year, driven by the strong smart grid volumes in North America and related manufacturing efficiencies, reduced headcount, and lower operating expenses.

Non-GAAP operating margin also improved to 5.9% in the quarter and adjusted EBITDA margin was 7.6%. While these Quarter 4 margins were above the trend line we would expect, our fourth-quarter performance was an encouraging sign of the margin expansion we are driving in this business.

Now let's turn to the water segment on slide 10. Our water business delivered strong performance and record revenue for the year, achieving constant-currency growth for the year of 8%. In the fourth quarter, revenues were down by 3.5% compared with last year in nominal terms and grew by 2.5% in constant currency.

Revenue growth in the quarter was driven by strong shipments in EMEA, smart water projects around the world, and new business growth in the Latin America region.

Gross margin in the quarter declined by 190 basis points to 33.4%, as the benefit of increased volumes was offset by higher services costs and product mix. Services costs increased due to excess costs on several large North American projects. The mix-related reduction was caused by global business expansion initiatives at healthy margins, but somewhat less favorable than last year.

Non-GAAP operating margin decreased by 440 basis points. This was driven by lower gross margin, higher sales and compensation expenses in the quarter, and R&D investment in new products. The water team generated sales growth above its targets for the year and the variable compensation in the quarter reflected that overachievement.

Now turning to the gas segment on slide 11, gas revenues of $149 million declined by 3% in nominal terms and increased by 2% in constant currency. Full-year gas revenues grew at 7% in constant currency. Quarter 4 growth was driven by strong meter and regulator sales in North America and increased smart meters in EMEA, which offset lower sales of standard meters in the region.

However, gas margins declined in the fourth quarter, particularly in EMEA. Gross margin was down by 470 basis points, driven by product mix, cost, and factory inefficiencies.

In North America, we experienced a shift in product mix with lower gas communication module shipments and higher meter and regulator sales. In EMEA, we experienced higher costs associated with first-generation smart meters, compounded by a slowdown in volumes in standard meter replacements in advance of upcoming smart grid projects. We also experienced some manufacturing inefficiencies for new products.

Non-GAAP operating margin fell to 9% from 17% in Quarter 4 of 2013, primarily due to lower gross margin, as well as higher R&D expenses associated with development of new products and enhancements.

While we are taking steps to correct the downturn in EMEA's gross margin, it is noteworthy that our North American gas business is very strong and is offsetting some of the weakness in EMEA. As Philip mentioned, we had record gas bookings in the quarter, the largest share being in North America, which tends to have healthy margins.

Let me also provide an update on the restructuring that we announced in November. On November 4, we announced that we would incur restructuring charges of $65 million to $75 million for projects to improve efficiency and reduce costs in the electricity segment and related G&A functions. We estimated approximately $40 million in annual cost savings by the end of 2016.

We can reaffirm the overall expected charges and estimated savings for these projects and we have taken several steps toward implementation. We recorded a restructuring charge of $55.8 million in the fourth quarter; remaining charges will be recorded in 2015 and 2016.

On January 15, 2015, we began discussions about a restructuring project with the European Works Council, as well as with country Works Council members. Things are progressing as expected, but we cannot comment on specific details while we are in consultation with the councils. It is early in the process and we are on track at this point.

I would like to emphasize that this is a project involving not only electricity operations, but also related areas of R&D and G&A support functions. We expect the restructuring to have a $40 million benefit on our cost structure as we exit 2016, when all the activities are completed.

Now I would like to review our financial guidance for 2015, turning to slide 12. We anticipate currency impacted full-year 2015 revenues in the range of $1.8 billion to $1.9 billion and non-GAAP diluted EPS in the range of $1.60 to $2 per share. As part of this guidance, we anticipate a modest increase in average gross margin to 32% to 33%, a non-GAAP effective tax rate for the year of 37%, average shares outstanding of approximately 39 million, and a euro to US dollar exchange rate of $1.14 on average for the full year, compared with $1.33 for 2014.

Two factors in particular are impacting our outlook. First, we anticipate that the change in exchange rates will have a large impact on our 2015 results compared with 2014, including approximately $150 million of revenue impact and approximately $0.20 of earnings per share. Secondly, the planned product exits in the electricity segment will impact revenues by $50 million compared with 2014. Excluding these impacts, our revenue growth in 2015 would be in the low to mid single digits.

We expect stronger revenue and earnings in the second half of 2015 than in the first half. This is due to project deployment schedules for several large contracts in our backlog and timing of planned product cost reductions and manufacturing efficiency gains in the gas business. We may also see our effective tax rate skewed somewhat higher in the first half than the second half of the year, based on the mix of taxable income by geography.

This guidance range reflects benefits we anticipate from our backlog growth and cost-reduction activities. It also prudently reflects continued near-term weakness in EMEA and impacts due to currency.

Overall, we are executing well on a number of fronts. We continue to build our backlog and increase our visibility for revenue growth. Benefits from backlog growth and cost focus are both becoming evident in the improving performance in the electricity business. While we acknowledge the downturn in Quarter 4 margins in gas and water, we are confident that we are taking the appropriate actions.

Philip, I will now turn the call back over to you.

Thanks, Mark, for the financial update.

I'd like to close the call with my focus areas for 2015, business execution, innovation, and growth.

My first area of focus is continued solid business execution. Our competitive position is strong. We are winning more deals. Our bookings in 2014 were $2.4 billion, up 23% from 2013.

Overall, we are executing better today than we were 12 or 18 months ago, but we have more work to do. We will continue to drive for consistent improvement in every business segment.

As we entered 2014, improving our operational efficiencies and performance, especially in our electricity business, was a top priority. We set a goal to improve the segment's profitability from breakeven adjusted EBITDA margin in fiscal-year 2013 to a high single-digit EBITDA margin.

In November, we announced a restructuring plan to streamline electricity's operations and product portfolio, consolidate certain facilities, and rebalance our global workforce to support a more focused and profitable business. These efforts will better align Itron's resources with the target markets where we can provide true business insights and outcomes to our customers, and do so profitably.

Although we still have work to do, we are executing our plans and starting to see results.

Driving efficiencies within the organization is not limited to our electricity business line. We have and will continue to aggressively pursue business efficiencies Companywide, including in water and gas. In parallel with these efforts, we are pursuing strategic opportunities to further strengthen our product portfolios and grow these businesses.

The path to our Company goal of mid-teens EBITDA will not be a straight line always pointing up and to the right. However, we are making progress and we will achieve our goal. You can see a good indication of the operating improvement we are creating in the electricity business in our fourth-quarter results.

My second area of focus is continued investment in innovation for our customers. Innovation fuels our competitive position worldwide in electricity, gas, and water. It's the foundation for bookings and backlog growth.

In 2014, we launched our OpenWay Riva platform with adaptive communication technology, a first-to-market offering for our industry. We released new software analytics and we launched the Itron TOTAL Managed Services offering.

In January, we announced a new 4G LTE smart metering solution, the latest technology in Itron's cellular portfolio.

And at DistribuTECH last week, Itron was honored with the 2014 North America Frost & Sullivan Company of the Year Award for smart cities. The award recognizes Itron's smart city growth strategy, diversified offerings, and excellence in implementation.

Adding leaders with demonstrated success in areas that are vital to Itron's strategy is an important part of my commitment to innovation. I am pleased to announce that Bruce Douglas has joined Itron to lead our software and services business. Bruce has extensive services experience at large established companies and as an entrepreneur. I have asked Bruce to quickly develop a plan to accelerate Itron's software and services growth.

Itron has an extensive portfolio that we can grow organically and through value-added acquisitions, all to deliver more innovation to our customers.

I am also looking ahead to new strategic growth opportunities for Itron's business. The pipeline of electricity, gas, and water projects we see around the world provides opportunity to again grow our backlog of AMI and smart projects in 2015.

We will also expand our software and services offerings for customers in the utility space. There is tremendous opportunity to deliver our communications on ancillary devices, both within our traditional customer base and even outside of the utility sector. This expansion of Itron's solutions creates new growth opportunities for recurring streams of revenue.

I would also like to provide some color for 2016. Although we are not in a position to provide specific guidance parameters, we have some increased visibility into future revenues and profitability as we have discussed on this call.

Based upon our backlog and committed customer revenue on the books today, as well as expected new tender activity, we see the potential for revenue growth in the low double digits in 2016. We also anticipate that our 2016 earnings can increase at an even higher rate when considering the benefit from restructuring activities and the positive impact of higher volumes on our factories.

Last week, I gave a keynote address at DistribuTECH and discussed Itron's second annual resourcefulness index. How effectively we use energy and water directly impacts our economic competitiveness. In North America alone, we waste over $39 billion a year in the transmission and delivery of electricity, gas, and water. End users have the opportunity to save an even larger amount. Even a 1% improvement in efficiency using Itron solutions will result in billions saved.

Our research, along with the tone at DistribuTECH, reinforced the imperative for change and investment needed to modernize infrastructure and deal with urgent challenges. The opportunity is substantial for Itron, here in North America and around the world, and we are well positioned to capture that opportunity.

Now, let's take some questions.

(Operator Instructions). Patrick Jobin, Credit Suisse.

Thanks for taking the question and good work on the bookings. First question, just going back to the gas gross margin for a second, just help me understand maybe your expectations of that margin trend over the next few quarters. Is it structural to that market, that customer that that's ramping up or how should we think about margin on smart gas offerings in EMEA? Thank you.

Sure. Mark covered a number of the issues here. The first is something we saw in North America, which is that prior to smart deployments, we see somewhat of a volume decline of our standard meters, so we are in the process of adjusting capacity to deal with that situation.

As Mark commented, we have introduced some smart products that have not yet been cost optimized. We expect cost reductions to be in place for the second half of the year, so margin improvement as a result of that.

So those are EMEA-focused comments. I will say that North America, as we have said before, is just going along very, very strongly, both in terms of revenue growth and its very strong profitability, although we have increased the metrology component there and so that mix has shifted somewhat. We expect to see strong recovery of the gas gross margin.

Thanks, and then just one follow-up here. Can you talk more towards your M&A appetite to broaden out your product offering, just how you would evaluate the M&A opportunities out there?

Then, just a housekeeping item. The $2 million charge in electricity segment, is that the same project, BC Hydro, that you reserved for the $11 million charge in Q3 or -- just any more context on that charge? Thanks.

Great, okay, got that. So the first question on M&A color, as I have discussed before, two categories. One is a great opportunity to extend our electricity, gas, and water segments with adjacencies, other points under the network where we continue to look at moving up the network with pressure sensing and corrosion and vehicles and lighting and all these sorts of things that extend our networks.

Then the other area that I've talked about, software and services, building upon our $100 million to $200 million worth of software and services business, expanding that both organically and inorganically where we see tremendous opportunity from the data that we are already collecting on behalf of our customers.

In terms of the $2 million charge, and I will hand this to Mark if I miss this, yes, it is the same BC Hydro adjustment that we made in the third quarter and this was just a finalization as we signed the final memorandum of understanding with the customer, so it was a change in some estimates.

Thank you.

Noah Kaye, Northland Capital Markets.

Just to touch on your last comment, you mentioned software and services as a $100 million, $200 million business today. Obviously, you are seeing a lot of growth potential there. What are your expectations for how big that business will be over the next one to two years?

Thanks, great -- thank you for asking. One of the comments that I made was the hiring of Bruce Douglas to head that business up because we really see my target is a $500 million business over time there of really taking that $100 million to $200 million and increasing it, both organically and inorganically, through the expansion of managed services that we are offering to our customers and data analysis that we are able to provide in order to really move beyond the revenue cycle that Itron has historically focused on to this other area that I mentioned at the end of my remarks, really about waste, and those numbers were just North America, the $39 billion a year of waste where there are just tremendous optimization opportunities for us in looking at that data, both in North America and around the world.

Okay, great. Second question, the bookings number for this quarter in gas, can you tell us a little bit about the cadence of how that gets recognized over the next couple of years? And what the margin impacts could be in 2016?

There are two elements of this record gas bookings. One, the $82 million that we booked on GrDF, and I would point out that is the first tranche of the GrDF contract, which is substantially larger, but given contract structure, that was the element that we were able to book using our stringent criteria, so that represents business that is going to come online in 2016 -- latter 2016 and into 2017, so there will be benefit from that booking specifically.

The North American bookings are nice, long-term duration deals that really secure the level of business that we have done in somewhat metering, but largely in communications over five- to seven-year periods. These are long-duration contracts, very healthy gross margins that really just continue to secure our very strong North American market share in communications.

Okay, great. Thank you so much. Nice job in the quarter.

Tyler Frank, Robert Baird.

Thanks for taking the question. I was wondering if you can just comment on -- I realize the numbers that you threw out for 2016 wasn't official guidance, but can you comment on a little bit more if that was including upcoming tenders that you plan to win? And can you give us just a little bit of information on what you're thinking about the upcoming tenders and where we should be looking in terms of the markets that those are going to be in?

Yes, the 2016, this double-digit revenue growth potential for us in 2016 is somewhat based upon those tenders, although I will say it is firmly anchored in our official backlog, and as we've mentioned before, a couple of deals that are signed contracts but have not yet been recognized into the backlog is a substantial part of that outlook.

Then there is further tendering activity in which these are well-qualified deals in which Itron is actively engaged and has expectation of winning strong share.

These deals are both -- you asked for geographic guidance -- there are really nice opportunities in North America. We've commented on the growth of smart metering and smart grid opportunities in places like Pennsylvania, Ohio, Indiana, the Northeast that have now received strong regulatory support in which we see this North American market continuing to grow, as well as opportunities in Europe that we have discussed in the past, particularly areas like Italy, which is implementing a smart gas solution that we are participating in, but continues to expand, and the UK, where that market has made a commitment to move ahead and we should see strong activity in 2015 with implementations beyond that.

Then there are attractive markets for us in the Asia-Pacific region, active markets there being Australia, New Zealand, Hong Kong, Singapore where we are very actively engaged.

Great, thanks. Then just a quick follow-up on the margin questions. How should we think about the gas margins? Is this a short-term effect of having the lower margins year over year?

Here is the way we would think of that. We would encourage you to think about it as well. Gas margins are affected by our first-generation, somewhat sub-optimized smart meter products that are being sold in some of the key European markets.

We are taking action right now to correct those product cost issues. It's not product performance issues, but product cost issues that affect both the cost of the product itself and the manufacturing efficiencies.

These problems will be corrected. It's probably going to take us well into the second quarter, perhaps the second half of the year, before we see those improvements taking place and affecting the margins. At the same time, be aware that, and Philip already mentioned this, but I will say it again that we have got some counteracting effects going on due to strong -- our strong North American market for gas products, where we are seeing very attractive margin and backlog, and that is going to continue to benefit the margins.

So I'm going to say look towards improving or recovering gas margins in the second half of 2015.

Okay, perfect. Thanks, guys.

Andrew Hughes, Bank of America Merrill Lynch.

Thanks for taking my question. On the North American projects that are not yet in the backlog, can you talk a little bit about when you expect those to come in and maybe some of the specific traits of those projects that will signal when they can come into backlog?

Sure, the example that we've talked about before, Andrew, has been Duke Power in which we executed a blanket contract for up to 4 million points in which Duke standardized on Itron's SmartGrid architecture.

The intent there is for a deployment in Indiana as one of the first large territorial expansions, and that is in for regulatory approval and we expect that sometime -- and that approval, which will allow us to actually book the contract sometime in the second quarter of 2015.

So that's an example of criteria necessary for us in order to put something in backlog, a contract in place with approved funding, management approval, and regulatory support, so if we're missing one of those components, we would not put it into backlog.

Understood. Then product development expenditures have been pretty flat the last three years. With the renewed focus on software and services, is that an area of operating expense that we should seek increase or do you think you can manage that new focus while keeping those expenses flat?

Yes, great question. It is our goal to try to manage them flat. What we have talked about is that right now John Holleran has had a very, very strong focus on R&D spending. We have evaluated our projects very competitively internally and have decided to transition some of the development to lower-cost countries, specifically India, and that even at this flat level that we currently have, we have some duplication of cost where we have not yet been able to release certain R&D resources in advance of moving the work to India.

These restructuring activities and discussions with the works councils will allow us to continue to work that cost downward. So we have more room to go there on efficiencies in the R&D budget, even as we look at the opportunity in software and services.

All right, great, thank you.

Sean Hannan, Needham & Company.

Getting back into margins, actually, as well as mix, just trying to understand. What all is assumed in your guidance for this year? Have you explicitly assumed that the inefficiencies you talked about within gas, as well as that elevated R&D spend, that that coming down, is that fully baked into the guidance that you've provided for this year or is there some conservatism that you have, maybe, that accounts for if we don't ramp down or address that as quickly?

Also, if we can talk about mix assumptions, then, within water as well because that I think that move had moved against you as well. Thanks.

Sure. First of all, we don't feel we have got excessive conservatism, based on the numbers. We are going to see improvements in gross margins throughout the year, probably more so in the second half than the first half.

Remember that the restructuring program that we announced in November doesn't have much of an effect on 2015 until late in the year. The product cost issues that we talked about in gas will take some time into the second half of the year to get fully resolved, although we are working hard on that and we would like to get it done faster, obviously.

Same comments with regard to R&D expense, which you mentioned, I think, that there is going to be some temporary overlap and back-end loaded efficiencies in R&D throughout 2015.

Then specifically with regard to water, there is really two components to the water compression and margins just on the fourth quarter. One is, I'm going to call, transitory. It's excess costs experienced on some large service contracts in North America, both mobilization costs and some trailing costs, and we think we will see those excess costs go away.

The other component, which is lesser in magnitude than water, is that water is growing and it's growing nicely. In the fourth quarter, we saw some diminution in gross margins due to contracts that were begun late in 2014 at still very attractive gross margins, but a little bit lower than the average for the business.

We accept that in stride. I think we are happy to see the growth in the business at attractive margins, but you did see a little bit of compression due to mix there and that probably is going to continue.

But Sean, to your -- in answer does the guidance capture the comments that Mark has made, yes, we feel that the guidance accurately reflects these factors.

Okay. Thanks. And then, follow-up here in terms of electric. I believe that the exit of that $50 million-ish in revenue, is that -- is neutral to earnings or is this actually going to create a lift due to negative margins within those segments? I'm sorry -- within those geographies, et cetera?

Actually, it will create some lift to margins. Some of this business was unprofitable, so it was very low margins, and we are replacing that business. If you look at the electric segment -- prospects for the electric segment in 2015, it's actually growing, after you take into account that exit of the low-margin, low-profit products. So we're actually very optimistic about the continued trajectory that the electric business is on.

Great, thanks for taking the questions.

Sven Eenmaa, Stifel.

Thanks for taking my questions. Just two quick ones. First, on the electricity margins, I wanted to clarify whether your expectation is for relatively flat margin performance relative to the fourth-quarter margins achieved in electricity until the resolution of the working capital issues, or do you expect improvement there in the year?

Here is -- on electricity, we had a great quarter. I would love to tell you that that's going to continue to accrete going forward. I doubt that it will, actually. It would be -- actually, it would be great to just see it stay flat until the benefits of the current, the November, announced restructuring plan start to take hold.

Maybe that will happen, but I would tell you that more than likely it is not going to be a straight-line improvement. It is carrying -- electricity is carrying good momentum right now, but we were a bit above trend line with those fourth-quarter results. Philip, do you concur with that?

I do, yes. I think these comments about the shape of 2015 are that as we start shipping more of the backlog projects that we have talked about in North America, and those are projects like Duquesne, the continued shipment of Duke, DTE, of course, these other contracts, as volumes strengthen in 2015 and 2016 we expect accretive margins as a result of that increased volume.

Got it, that's very helpful. The second question I had is obviously you were involved in a pretty active competition for the [EDRF] and [GDRF] businesses. Now that the currency has moved lower, how do you view margins on those projects and what offsets do you have on the cost structure side on the FX impact?

That's a great question, Sven, because our primary currency exposure is translation risk, and it is not this execution issue, for those contracts we are manufacturing in facilities that operate in euros and where we are exposed to euro cost. The change in currency does not affect our level of competitiveness in those contracts.

Mark did make some comments about supply-chain costs, which are, to the extent that we are using electronic components, those are largely dollar denominated; however, we have a bit of an offsetting activity going on in which basic material prices have come down and we continue to seek purchasing efficiencies. And so, we feel that we're going to be able to offset those other supply-chain costs. Did that answer your question?

Yes, it did. Thank you very much.

Jeff Osborne, Cowen and Company.

I just had two questions, one on the France situation. I was wondering if you could just touch on at what point you think you will have a bit more to share on the negotiations with the Works Councils. I think in reviewing the French press, there has certainly been some challenges and protests and whatnot, which maybe you were expecting, but I just want to get a better sense on when you -- I understand you affirmed the cost and timeline of the restructuring, but also highlighting it is early in the stage. When do you think you'll have a bit more clarity on the whole process there?

First of all, we have clarity. Our ability to communicate on that is limited. The timeline on the current process has the Works Council consultation process completing sometime in late April or early May, and once that process is complete, then we will be at liberty to have a somewhat more detailed discussion.

However, so far everything is on track, and to the point that you have monitored these things, it was expected that there would be some level of press and publicity and we had prepared for that.

Okay, great to hear. Along the same lines with the French situation, my understanding is you'll shift the manufacturing for ERDF outside of France. Do you have to go through a requalification of that meter and is there any risk to what you have already been awarded, or would the production outside of France be proposed for future awards associated with the 35 million endpoint (multiple speakers)

We have not -- no, we are not -- we are producing the ERDF linking meter in France, so there's no requalification.

That would be the intent, though, for all 35 million meters over the course of the next decade?

We are not commenting on our -- the next decade's plan. We are simply saying that so far we have committed to the Linky meters and they are being made in France.

Got you. The last question I had, Philip, was just -- can you talk about reflecting back on 2014 and your expectations for 2015, just what was overall pricing on a like-for-like meter, in particular with electricity? Down 5%, 10%, more, less?

No, no, no. No, Jeff, it's not, actually. The selling prices in the meters in which we are actively engaged have remained reasonably healthy. There are examples of 5%-ish declines, but those are things that we -- where we have counted on improvements in our total manufacturing costs, and so we have been able through efficiencies to offset margin pressure in a number of those markets.

The more important issue that we really looked at in 2014 are are we in the right markets where we see that continued strong price and differentiation. The selective exits that we announced in 2014, with that ongoing 2015 50 million in exits, are to keep us focused on those markets where we see strong price and competitive differentiation.

Got it. Thanks for the detail there.

Andrew Weisel, Macquarie Capital.

I actually want to ask two questions about below-the-line items. First is on the tax rate. You are guiding to 37%. Can you just high-level walk through what's driving the year-over-year increase and if that's what we should think of as a new normal run rate for the taxes?

Okay. That's a difficult question. I will tell you that there's a lot of moving pieces in our tax rate, so if you wanted to boil it down, I would probably say that the biggest factor that influences the rate year over year is that we are not assuming extension of the US R&D tax credit in 2015. Of course, that may well occur, but we are being on the cautious side there.

The second part of your question, is that the new run rate, I would say no. It's not. Our tax rate has been on an upward trend, but it's also been quite volatile and it's going to remain volatile for a while going forward because of the geographical mix of earnings and the impact of valuation allowances on our overall effective tax rate.

If we have losses incurred in jurisdictions where we have valuation allowances in effect, it increases our effective tax rate. By the same token, think in terms of what happens after some of those jurisdictions turn around and begin making profits and we have the justification for releasing those valuation allowances; that will significantly reduce our effective tax rate and, obviously, we plan to see that happen in the foreseeable future.

So, the tax rate is going to be volatile. I would not call it the new normal, no.

Okay, great. Then my other question is on repurchases. You finished the authorization in January. Why not have a new authorization? Why not continue to repurchase the shares, especially since it's trading below where it had been in January or the fourth quarter?

This is a -- it's just a question of timing, frankly, because we -- the timing of this call and the earnings release precedes our ability to have Board action done, Board authorization done, for any further round of share repurchases.

But keep in mind also, and something that we didn't comment very deeply on in this call, but capital requirements in the business in 2015 will be larger than they were in 2014. The cash requirements related to restructuring, which is an investment, a significant investment we are making in improved operating performance of the business, are substantial. In addition, we expect to see continued high levels of investment in product development and an increase in CapEx.

As always, we're going to be very careful in balancing our internal priorities with fair shareholder returns, but -- and we do have plenty of liquidity. That's not an issue, but we need to be a little careful about not overpromising in terms of share repurchases in the year ahead.

Okay, thank you very much.

(Operator Instructions). This does conclude today's Q&A session. I will turn the call back to Barbara Doyle for closing remarks.

All right, thanks, Robert, and thank you, everyone. Before we end the call, Philip, are there any final comments?

Thank you, yes. Just a couple. I want to be very, very clear about something, a question that Jeff raised. We are absolutely committed to the manufacture of the Linky G1 meters in France. There are upcoming bids that we'll consider. Our strategy there is still open.

Operationally, we had a very strong fourth quarter. We are very, very pleased with the performance of the electricity business and the efforts that have been put in there in order to optimize that business. The progress that we've made on the restructuring announcement. We are on top of the issues that we have discussed, particularly in the gas business, and I want to emphasize again the strength of the overall market environment, of the increase in bookings and backlog, and the activity that we see in 2015 really building in the second half of the year with this very strong outlook into 2016 of low double-digit growth, with earnings growing faster than that. We have better visibility and a clear path here for continued operational and quarter-to-quarter improvement. Thanks, everyone.

All right, thanks, everyone, for joining. Operator, we will conclude the call.

Very good, 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 168-6085 or go to the Company's website, www.itron.com.

This does conclude today's conference call. Thank you again for your participation.