Itron Inc (ITRI) 2015 Q2 法說會逐字稿

Good day, everyone, and welcome to the Itron Q2, 2015 earnings conference call. Today's call is being recorded. For opening remarks, I'd like to turn the call over to Barbara Doyle. Please go ahead, ma'am.

Thank you, Kevin, and good afternoon, and welcome to Itron's second-quarter 2015 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. This presentation is available through the webcast, and through 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 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 non-GAAP financial information that we believe enhances the overall understanding of our current and future performance. Reconciliations of differences between GAAP and non-GAAP financial measures are available in our earnings release, and on our Investor Relations website.

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

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

Thanks, Barbara. Good afternoon, everyone, and thank you for joining us on the call today. In a few moments, I will turn the call over to our CFO, Mark Schmitz, to review the second-quarter results in detail. First, I'd like to provide some perspective on the quarter, including the challenges we faced and these steps we're taking to improve our performance and predictability going forward. First, an overview of our results. Our second-quarter revenues of $470 million increased 6% year over year, on a constant currency basis. Itron's growing.

Importantly, we saw a significant growth in electricity. Year-over-year revenues grew by 19% at constant currency. Adjusted EBITDA margin improved to 2%, compared with 1% last year. Our efforts are delivering visible results in electricity, and we remain on track to achieve our high, single-digit EBITDA margin target by the end of 2016. This rate of growth in the segment demonstrates that we are beginning to realize the benefits of the R&D investments we have made in our business, to create innovative best-in-class solutions, and it underscores our confidence in our long-term strategy.

While our Company growth was solid, our earnings were negatively impacted by three things. A special warranty charge we disclosed during the quarter, gas segment performance in EMEA, and tax. The warranty charge and tax adjustments in the quarter impacted non-GAAP earnings by $0.56. Given these impacts, our reported results in Q2 are not a true reflection of Itron's ongoing operations. It's unacceptable to have the growth and improvement in our electricity business offset by these types of temporary or nonrecurring issues. We are taking immediate actions to improve our performance, including specific, identifiable cost reductions.

Let me address the special warranty charge first, which was the largest impact on our EPS. In Q1, we reported a component quality issue, at which time we accrued $3 million of warranty costs, based on the failure rates at that time. The failure rates accelerated as we performed additional field investigation. Based on the additional data, we made the decision in May to do a full product recall of all modules in the field that contained the failing component. This decision resulted in an additional $24 million warranty accrual in the second quarter. This component issue was a setback to our otherwise improving cost of quality trend, and we are moving aggressively to address it.

We are implementing several new changes to strengthen our quality management organization and process, including hiring additional experienced quality engineers and instituting more stringent component quality test parameters. We've also initiated an independent third-party review of our quality and supplier processes, to identify further improvements. Itron has filed an insurance claim for this extraordinary event. Costs in excess of a $10 million self-insured retention may be eligible for recovery under the policy. We're working closely with our claims adjuster, so that we may be reimbursed for the maximum amount allowed under our policy.

We have not factored any insurance recovery into our projections for 2015, under the expectation that no reimbursement would be received before the end of the year. While the charge is significant, it's evidence of Itron's high customer standards and commitment to our customer base. We've been working closely with customers to act quickly and proactively, and we do not anticipate any long-term customer retention issues as a result of the product replacements.

Weak performance in our EMEA gas gross margin also impacted earnings in the quarter. We continue to see strong performance and solid backlog in our North American gas business. The gross margin in the EMEA region is under pressure primarily by three factors. Lower volumes of basic meters, as customers prepare for smart meter rollout in Europe. Non-cost optimized first generation smart meters. And factory inefficiencies due to volumes, product mix, and a temporary work stoppage in the quarter, associated with our restructuring activities. In addition, some high end C&I produce shipments were delayed due to our global ERP system transition.

This issue has been resolved, and the shipments will be made in the third quarter. The positive trend in Europe is that smart volumes are increasing, and are becoming a greater proportion of our total shipments. Gross margin on gas smart meters will improve as project deployments and volumes ramp up, and as our cost reduced meters move into production. We will begin to see this improvement late in the second half of this year, continuing in 2016, given our contracted volumes and our product development schedules. We are already ramping up volumes in Italy and the Netherlands, and shipments on new smart gas projects with GRDF in France, and EDF in the UK, are planned to begin in the fourth quarter.

We have also completed closure of a gas factory in Naples, Italy, consolidating production into our factory in Reims, France, leading to additional efficiencies beginning in Q3. We are implementing other longer-term plans to streamline our gas product lines, from more than a dozen different platforms to three, and we are making greater investments in C&I products. All of these actions will drive our gas EBITDA margin back to the high-teens historical levels.

Taxes in the second quarter impacted EPS by $0.18 a share. We experienced an elevated tax rate in the first half of the year, which spiked in the second quarter. Adverse market conditions and weak business performance in Europe have impacted our ability to utilize tax assets in certain countries. I will let Mark address any tax questions in more detail. However, I will say that the solution to reduce our effective tax rate is sustained, improved profitability across our European operations.

Given our contracted volumes, revenue forecast and cost reduction plans that are in process, profitability in EMEA will begin to improve through the remainder of the year, which should result in a lower tax rate in the second half of the year. Let me also give you an update on Itron's restructuring, which is a critical initiative to achieve our mid-teens EBITDA margin goals.

In July, we completed the review and negotiation with European Works Councils, which was a key milestone. This means we can now begin the notification process. We anticipate a net workforce reduction of approximately 500 positions by the end of 2016. We anticipate that 300 positions will be eliminated by the end of this year, primarily in the fourth quarter. In addition to the closure of our gas factory in Naples, which was completed in the second quarter, we are also in final stages of divesting a non-core business and closing two electricity facilities, a factory in South Africa and an assembly facility in Saudi Arabia.

We are making strong progress on our restructuring initiative, and we are on track to achieve $40 million of annualized savings by the end of 2016, with approximately $15 million of the total achieved by the end of this year. The go-forward ongoing impact of the restructuring will be a significant positive long-term impact on our margins and profitability.

I am also pleased to announce the hire of Tom Dietrich to the position of Executive Vice President and Chief Operating Officer. Tom joins us from Freescale Semiconductor, where he most recently served as Senior Vice President and General Manager for Digital Networking. Tom has over 20 years of experience, with expertise in designing and delivering quality networking and sensor products. He has a proven track record of leading global operations and driving successful transformations, including positions at Freescale, Flextronics, Stony and GE. Tom is completing transition plans at Freescale, and will begin at Itron in October.

To summarize, Itron is growing, and we continue to take significant steps to propel our business into the next phase. With that, I will turn it over to Mark.

Thank you, Philip, and good afternoon, everyone. I would like to begin by restating a point that Philip made a couple of times. We're very disappointed by the poor operating results recorded in the first half of this year. We have put in place an immediate freeze on non-strategic hires, and deep cuts in all categories of discretionary spending. We are, however, optimistic about the outlook for this business. The turnaround in our largest segment, electricity, the progress made in our restructuring program, the continued strength in water, and the improvement we expect to see in our gas business. We are on an action footing at Itron.

Now, if you will refer to slide 4 in our presentation, which summarizes consolidated Company revenue for the second quarter of 2015, revenues were $470 million for the quarter, compared with $489 million in 2014. As Philip said, Itron is growing. On a constant currency basis, revenues increased by $31 million, or 6%, driven by our electricity business. This revenue growth was offset by changes in foreign currency exchange rates, which decreased revenues by about $50 million. As you can see on slide 5, foreign currency headwinds negatively impacted non-GAAP EPS by $0.08 compared with last year. EPS was also impacted by an elevated tax rate and increased totally warranty costs.

These three items, currency, tax and warranty costs, reduced non-GAAP earnings by $0.73 compared with last year. Operationally, EPS was impacted by lower gross margin performance in our EMEA gas business, and higher operating expenses. Operating expenses increased compared with last year, driven by higher sales and compensation in electricity, due to improved performance in that business, increased product development investments in gas and water, and higher personnel professional services and IT costs in G&A. In addition, we continue to have duplicate costs in product development and G&A, while in the process of executing our restructuring plans.

Slide 6 summarizes key financial metrics in the quarter. Total gross margin was 25% compared with the prior-year period margin of 33%. Gross margin, excluding the Q2 special warranty charge in the water business, would've been 30%. Excluding the special warranty charge in water, non-GAAP operating margin would have been 4%, and adjusted EBITDA margin would have been nearly 6%. Free cash flow was $10 million in the second quarter. For the full year, we anticipate total free cash flow will be lower than 2014, principally due to higher cash taxes and interest, and the anticipated severance payments related to our restructuring activities.

We continue to have a strong balance sheet, with ample liquidity. We ended the quarter with $129 million in cash, and in June, we refinanced our existing debt. Our new credit facility provides for $725 million of bank financing over a five-year period, at terms no less favorable than our expiring facility. During the quarter, we used $6.8 million to repurchase 188,000 shares of common stock, pursuant to the $50 million repurchase plan authorized by our Board in February of this year. Now, I will turn to segment performance, beginning with the electricity segment on slide 7.

Electricity continued to see strong revenue growth compared with the second quarter of last year, continuing the momentum seen in the first quarter. Revenues grew by approximately 11% in nominal terms, and 19% in constant currency. Our North American smart grid business was the key driver of electricity's revenue growth. Electricity gross margin of 25.9% was 290 basis points lower than last year. 170 basis points of decline was due to a $3.6 million warranty reversal in the prior year, as a result of lower costs than estimated or a warranty matter in Brazil. A $2 million inventory write-off related to our restructuring activities also impacted gross margin in this quarter.

Non- GAAP operating margin improved over last year by 210 basis points, primarily driven by reduced employee litigation expenses in Brazil. Overall, we were very pleased with electricity's growth and continued operating margin improvement in the quarter. Now, let's turn to the water segment on slide 8.

Water revenues were down by 16% compared with last year in nominal terms, and 2% in constant currency. Water is more subject to weakness in the Euro than our other two segments. The currency-adjusted decline was primarily in our Latin America region, related to constrained spending in Brazil. We expect this will persist, and continue to impact our water revenues in that region for the remainder of this year.

Delivery of warranty replacement product in North America commenced in the quarter. We have begun adding additional production capacity to manage the increased warranty replacement volumes, while meeting customer requirements. We do not anticipate any material impact to our North America water revenues, for the full year, resulting from the warranty replacement activity. The warranty charge impacted water's gross margin in the quarter by 18 percentage points. Gross margin would have been approximately 36%, excluding the warranty charge, up just slightly compared with last year.

Similarly, excluding the warranty charge, operating margin would have been approximately 11%, down from 15% last year, primarily driven by increased general and administrative costs and R&D investment in solutions for water opportunities around the world. Now, turning to the gas segment on slide 9.

Gas revenue of $139 million declined compared with last year by 10% in nominal terms, and were flat with last year in constant currency. We continued to see strong performance and backlog in our North America gas business.

In EMEA, higher volumes of smart meters in Western Europe were offset by lower basic meter volume, and a decrease in prepayment gas meters, due to timing of a large project in Azerbaijan. EMEA gross margin is at the core of the profitability issue in gas. We anticipate a positive effect on EMEA gross margin in the fourth quarter, due to changing product mix and improved factory efficiencies. Bookings and backlog are summarized on slides 10 and 11.

Bookings were $398 million in the quarter. We had a number diverse bookings across many customers, including an OpenWay Riva booking with Eletrobras in Brazil, and a multi-year managed services agreement with Duquesne Light in Pennsylvania. Gas business awards from Vectren Energy in Indiana and CenterPoint Energy, and a large frame order business recorded in water, included Agbar in Barcelona, Suez Water in France, and Yorkshire Water in the UK. Our 12-month backlog of $791 million is up 17% compared with last year, supporting our guidance for revenue growth this year. We ended the quarter with a healthy backlog of $1.37 billion. Now, I will turn to our guidance update for 2015, as outlined on slide 12.

We are increasing our revenue guidance. We are now forecasting $1.85 billion to $1.95 billion of revenue for the full year. This growth reflects continued strong performance in the North American electricity business. We're expecting higher revenues in all three segments in the second half of the year, compared with the first half. Notably, in electricity, based on scheduled shipments, including FirstEnergy, Consumers, Duke Energy and Duquesne Light.

We are reducing our full-year gross margin and EPS forecasts, due to several factors. Including the warranty charge incurred in the first half of the year, greater than expected weakness in our gas business in EMEA, and the potential for continued softness in Latin America, modestly impacting our water business in the second half. These factors more than offset the continued improvement we're forecasting in the electricity segment, as well as the cuts we are imposing on discretionary expenses and hiring.

We're guiding to a 30% gross margin for the year, and non-GAAP diluted EPS of between $1 and $1.30 per share. Our guidance assumes a euro to US dollar exchange rate of $1.12 and average diluted shares outstanding of 38.5 million. Our EPS guidance reflects a potential for modest upward pressure to our previously provided non-GAAP effective tax rate of 37%. We expect a lower effective tax rate in the second half of the year, given our forecasts for improving profitability in EMEA.

It was a tough quarter, but market conditions continue to be favorable. We have taken some structural actions that are beginning to yield results, and we're taking the appropriate short-term actions to recover some of the first-half earnings shortfall.

And with that, I'll turn the call back over to you, Philip.

Thank you, Mark. I'll make a few closing comments before we take your questions. First, we are taking significant and aggressive actions to drive operating improvement and reduce costs. Benefits of our restructuring will begin to improve in the fourth quarter of this year. Additional headcount and facility savings will be realized through the completion of the restructuring, when $40 million of cost benefits are expected to be achieved, on a run rate basis, from the end of 2016.

I also want to emphasize that our full-year top-line guidance is tracking higher than our previous guidance, propelled by our smart technology offerings. This performance underscores our confidence in our long-term opportunities. The fundamental growth trajectory for our business remains strong, demonstrated by 17% year-over-year growth in our 12 month backlog, and the sequential increase in 12 month backlog each quarter since Q4 of 2013. We continue to innovate, and our customers recognize the value of our industry-leading products and services. We are encouraged by the results of our product development to date, and we remain confident that our focused R&D will generate long-term growth.

We are executing plans to achieve mid-teens EBITDA margin in 2017. This target is firmly supported by our backlog growth, operational improvements in our gas business in EMEA, the realization of our restructuring cost benefits, plans for streamlined, standardized smart metering platforms, and new cloud-based services. Looking toward the future, we continue to see opportunity in software and services to further differentiate Itron's solutions, and add to our long-term growth. We've established our services organizations under the leadership of Bruce Douglas.

The focus is already driving benefits, including the announcement of a new solar solution that combines production measurement, asset monitoring, sensing applications and forecasting, in a managed services offering for solar generation. In addition to the multi-year agreement we discussed last quarter with Duquesne Light in Pennsylvania to run their network operations, we won two new managed service contracts with energy providers in Germany. Both of these utilities will utilize Itron Total Services to monitor renewable generation in compliance with Germany's Renewable Energy Act.

Itron has also been selected to provide our OpenWay Riva solution on the Tongan islands in the South Pacific. Tonga Power will deploy our OpenWay Riva solution to more than 20,000 customers on the main island, as part of its Smart Island goals. After installation is complete later this year, we will also provide managed services to Tonga Power for system management and maintenance of Itron's cloud-based services for data collection.

In water, the city of Murfreesboro, Tennessee has selected Itron to modernize its water distribution. The city will use Itron smart water metering system -- leak detection and analytics to improve management of their water system.

I will close by reiterating that I'm very pleased that Tom Dietrich will be joining Itron, adding to the depth of our Leadership Team. After extensive discussions with Tom, I'm confident that he will accelerate efficiencies in our standard business beyond our current projections, while driving innovations in Itron's technology and services portfolio, to meet the changing needs of this industry and capture additional growth opportunities.

Operator, now let's open up the call and take some questions.

(Operator Instructions)

Ben Kallo, Robert Baird.

Thanks for taking my question. Philip, we saw the acquisition of Elster by Honeywell. And I think one of the questions we had was with their operating margins, EBITDA margins, compared to where your business is at. Specifically on the R&D spend that you have, without any kind of top-line growth. And we are trying to put all that together, with some of the commentary about investing in the business, but without seeing any outcomes there. So could you give us a little bit of color on what we should expect there? Or why isn't there a greater cost reduction coming? Thanks.

Ben, first, on the Elster acquisition, we're very pleased to see a strategic and disciplined buyer invest that much money in the sector, and really reiterates the promise of what is seen in this area for growth. A significant part of Elster's business in the midstream and heat combustion businesses is outside of the metering space. Elster has been very disciplined in improving their operating model and reducing costs, no question about it. But we're mixing the gas business line, the significant area of gas business where we are not present, and where we are present in the metering space.

We have a different strategy in the metering space. We are moving beyond basic metering to meters communications, software and services and, ultimately, to managed services. This is a somewhat different model than what we see in industrial companies that typically invest 3% to 4% of revenues into R&D. We see, in companies in the communications networking space, investments in the 8% to 12% of R&D category, and in the software and services space, in the 12% to 20% R&D. So I get to an 8% to 9% target, as we look at the selected investments that we are making in each one of these categories.

And to the comment that we don't see the benefits of those, there is a 39% increase in our overall backlog last year, 17% increase in our 12-month backlog this year. We are seeing the benefits, in competitive differentiation and market share wins, using -- with these investments. As to the comment about cost reduction, as you know, we have been talking for some quarters about this restructuring plan. This was an extensive negotiation through some structured labor markets. We're very pleased with the progress on restructuring, and the ability to now start taking out 300 heads by the end of the year, and a total of 500, as we consolidate the number of factories. And we will see the benefits of that cost reduction.

Thanks.

John Quealy, Canaccord Genuity.

Good afternoon, folks. Just a couple of questions. I'll start with my bigger question. Warranty charges, this is a common theme. And whether it's transistors that are out of your control, whether it's BC Hydro on specs, whether there is other minor tweaks in warranty, this is a common theme. So Philip, talk to us about what the Board's thinking about to change this. I assume you're going to have to go through this with your auditor at year end, in terms of warranty accruals and things like that.

But how do we fix this? Do we lower gross margins and make our accrual higher? Or do we go to our customer and get more value for our products? I know this is an industry comment, but for you guys, it seems particularly acute. And then I have a couple of follow-ups.

Okay. John, there are two things that we're working on, performance and predictability. On the performance side, this is about continued growth in not only our revenue new line, but very importantly, at the gross margin line, by reducing variability, by consolidating factories and running them more efficiently. So an increased focus on operational performance at that level. And with the bringing in of Bruce Douglas, and somebody who is very, very focused on service delivery, the kinds of issues that we see in these complex project deliveries, we're managing much more closely.

So performance is about overall EBITDA increase through revenue growth, through gross margin expansion, by running our operations more effectively, as we are managing and reducing costs, particularly in the operating and expense category, through this restructuring initiative. Predictability is about removing the level of variance that we see in the size and frequency of these special charges. This is a significant area that we are very focused on, in terms of improving our overall quality program, our supplier management programs, making our overall quality program visible throughout the Company, with very, very strong leadership and emphasis.

And getting into stronger risk management, and developing key performance indicators, and really increasing the transparency of the organization, so we can be more proactive in anticipating these issues. As for the comment about the auditors, we work extremely closely with them on an ongoing basis in reviewing these issues. This is not something where we get to a year-end review, so there is no issue with the auditors. And as to the comment about the Board, we have recently met with and reviewed with the Board all of our operating action plans, and have a very clear path of alignment with them.

Okay. Thanks for that. Secondly, on the Enterprise selling efforts, or the software efforts, I know you have re-invigorated that effort, with new gentlemen launching right around DistribuTECH. Can you comment, qualitatively, how you feel? I know it's early, but how do you feel about those efforts? And I know you talked about solar briefly, but more broadly on software, how do you feel?

Yes, the opportunity is really terrific for us. What we've done, in the intervening time since the announcement of launch, is a full audit and survey of the services that are out there. A survey of the marketplace, of focused areas where we think that there is margin improvement opportunity for us, with the current services that we are delivering. And new opportunities for us to expand, both in managed services and analytics.

And as you have heard from the deals that we discussed in the release today, we are moving towards a much more frequent scenario, where we are winning new installation business, but also managing that Business after it has been installed. Which gives us the opportunity, then, to transition to providing new insights about the data. The gentleman I mentioned, Bruce Douglas, has developed a business plan to drive highly profitable growth in this area, and that plan has been reviewed as a part of an annual strategy process. And we are beginning to make the initial investments, and really propelling the business forward even more rapidly.

Okay, thanks. And my last question, maybe for Mark. $32 million in -- I believe it's SG&A. Is that a good run rate for the rest of the year? I know we've got some headcount reductions coming, I'm assuming, in a one-time charge. But can you comment on that level, going forward? Thank you, guys.

Yes, in general, we think our operating expenses are going to be pretty similar in second half to the first half. I would say that, keep in mind that our G&A, in particular, is still burdened by a little bit of duplicate costs, as we continue to roll out the implementation of Oracle and our global business services, or shared services operation in Ireland. And those costs will come down next year.

Jeff Osborne with Cowen and Company.

I had two questions. Most of the topics have been addressed already. But one, Philip, I was wondering if you could touch on the pace of RFP activity that you are seeing, in particular on the electric side? Regionally would be helpful. And then I was wondering, in terms of a Tom Deitrich looking at the companies that he's worked at before, how would you characterize his core competency as a COO? Is he a turnaround guy, a quality guru? What kind of -- in a nutshell, how would you characterize him, as he comes on board?

Super, Jeff. Two great questions. So RFP activity, you said, particularly in electric, regional breakdown, very strong in North America. Of course, we've talked about this increasing regulatory support for smart grid investments, Pennsylvania, New York, New Jersey, Ohio, Massachusetts. So there are very, very sizable opportunities. Obviously, a lot of talk about New York REV, and the opportunities that there are there. With the Clean Power plan we see an opportunity for long-term acceleration of business in North America. So very healthy outlook in the North American smart metering side, on electricity.

In Europe, again, targeted approach for us, and focusing on markets where we have high value differentiated offerings in which we're expanding the number of pilots in order to demonstrate value, and increase that electric metering over time. We are getting to, now, the shipment window on ERDF, and beginning the shipment of those generation 1 meters. And we have a very significant bid on a -- we have a so-called G3 qualified product, and ready for the significant next round of bidding at ERDF. UK is, as you read in the press, has experienced some delays in the overall implementation, but we are moving forward with some of the initial deliveries there. Of course, with the larger deliveries waiting on the so-called SMETS 2 standard and another round of bidding there.

And then Latin America, as you have heard, there is some activity there. Eletrobras is the deal that we have pursued. Great opportunity. And that's a particularly important one to us, because it's the new OpenWay Riva offering. That Riva win in Tonga is small but important for us, in terms of getting very advanced technology out there. In Asia-Pacific, we continue to see the opportunities be Hong Kong, Singapore, Malaysia, Thailand, Australia and New Zealand. So a nice build for us, in which we see not only the 12 month backlog increasing, but the ability to maintain or improve the overall Company backlog through that large bid performance.

As to Tom, and what is attractive about him, to boil him down, it's really, as you saw the latest assignment in networking and sensing. So very, very deep technology expertise. But also, this really important balance with this prior work in high-scale manufacturing and performance at Flextronics. So really finding somebody who is about performance improvement and excellence, and able to see both large-scale multinational operations, driving those very, very cost effectively and efficiently, understanding what we should be doing in-house and outside of the house. Very valuable insights there. And then a very strong technology background on how to drive and differentiate [embed] technology and drive profitability. So an excellent spectrum of skills for what we see coming up.

Sounds like it. Appreciate the detail, Philip. Thank you.

Thanks, Jeff.

Patrick Jobin, Credit Suisse.

First one, thinking about 2016, is this a high growth year, as some of these contracts kick in? Is this a more normal year, or is this a transition year, just given what you're seeing from a timing perspective? Then I have a few follow-ups.

So yes, Patrick, we're not in a position to give full guidance on 2016. But we have commented on the fact that we do see stronger than average growth in 2016, really as a result of the already-booked contracts, and the other contractual commitments not yet in our formal backlog. So this was the discussion about, not only did we see a significant buildup of our total Company backlog, but that we have visibility to shipments in North America, and places like Consumers and Duke not yet fully in backlog, to other European shipments with companies like ERDF and GRDF, in which there is visibility beyond the backlog, which we see deploying and committed in 2016. So we would definitely characterize 2016 as an above-normal growth year.

Thank you.

And we will also start to see some real benefit from the restructuring in 2016.

Got it. So just a housekeeping item, on tax rate. What should we expect there? And then really my second question is, how much of your mid-teen EBITDA target, by end of 2016 into 2017, is predicated on costs out versus revenue growth? Or a mix shift occurring to higher value products? This would be helpful to understand what you need to achieve, to get to that mid-teens EBITDA target. Thanks.

Okay, I will let Mark comment on the tax rate, and then I will come back with that mix question.

On the tax rate -- and I believe what I just said in the discussion part of the call was that we expect to see some modest upward pressure from the 37% that we had forecast, or that we had guided to earlier, as a full-year effective tax rate. What that means is that we will see a lower rate in the second half of the year than we have experienced thus far. And without being too precise on it, let me say the second half of the year, the way we look at it, should be somewhere below 30%. Why is that?

It's because of the dynamics of improving profitability, particularly in Germany and France, where we have deferred tax assets that are fully impaired. So if you understand that where we have losses in Germany and France today, we get no credit for that, because the deferred tax assets are covered by valuation allowances. To the extent we get income there, we get an actual benefit of having no tax levied on those profits. So that's what's happening, as we see it, in the second half. A better operating result in Germany and France that is heightened by a favorable tax effect, pushing our tax rate down in quarters two -- quarters three and four, below 30%. And Phil, did you want to --?

Sure. On that mix, Patrick, we're not in a position to provide full detail. I will give you just a little bit of color on that, which is, the first thing that is taking us towards that mid-teens EBITDA target is this goal that I've stated of high-single-digit EBITDA in electricity by the end of 2016. That's $40 million of low-margin exits in 2014, $50 million of exits. So electricity grew significantly year on year. That's even with the removal of a fair amount of low-margin revenue that we are taking out of the mix. So we have an overall mix improvement, by strategically exiting some markets where we were not making our targets.

At the same time that we are taking out $40 million worth of cost, and as we see an increase in the focus in shift to the North American products that are already in backlog that have higher margin. At the same time, we are consolidating some facilities, which help with our overall efficiency, which really helps us to improve our performance in a number of different areas. And we are investing in sophisticated products to drive to this higher-margin area. So yes, it is a range, a balanced range of revenue growth, again, visibility in backlog, and attractive areas, as we exit lower margin areas, reduce cost and continue to invest in higher-margin products in the future.

Thank you.

(Operator Instructions)

Andrew Hughes, Bank of America Merrill Lynch.

Good afternoon, guys. Thanks for taking the question. On the managed services and software and services revenue, Philip, in the past, you've talked about $200 million annualized run rate, with a target of $500 million, longer term. I'm wondering if there's an update on timing around that $500 million? And whether or not some of these impressive signings with Duquesne, and Germany, and in Tonga, on the managed services front, if there is an upside to the $200 million run rate we are seeing now? And maybe the $500 million longer-term target?

Yes, Andrew, it's very fair. Our intent here, as we get this business really established in the way that we see it internally, that we would provide more visibility about the separate financial metrics of the software and services business. It's both something that we intend to manage aggressively, and that we need to present to you more transparently, in terms of how it affects our overall business.

To the question of the -- do we see growth against that $200 million baseline, yes, it is growing. As we are focusing more on providing this solution up to and including managed services, and even data services beyond that. So we see the growth opportunity as being faster than overall total Company revenue growth. In terms of an update for that total targeted plan, it's -- in the 2017, 2018 time frame, we really see the opportunity to realize that growth target.

Great, that's very helpful. And on the water segment, you had the gross margin up, the operating margin down. Just curious, with some of the investments you're making in that sector, when we can expect to see some leverage there? Is it in the second-half [with] margin recovery, or is it a little bit more long-dated?

I would say that's a bit more long-dated, to get that straightened out. So those are, yes, slightly higher costs, to go after some very desirable business, by the way. We've talked about this, that Jordan Water, and a number of these opportunities we are going after, are solid-state water meters -- I mean communicating meters, where we have made investments in advanced technology, that are really going to drive the business forward. And revenues are -- as we have said, are down slightly. So as we return to revenue growth in 2016, that operating leverage, we think, will straighten itself out.

And ladies and gentlemen, that does conclude our question-and-answer session. I'd now like to turn the call back over to Barbara Doyle for any additional or closing remarks.

I think we have provided all of the answers to the questions, everyone in the queue. So we thank you for your participation today, and we look forward to seeing you, and speaking with you, in the upcoming weeks. Thanks very much.

And ladies and gentlemen, 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 5299205. Or go to the Company's website of www.Itron.com. Again, that does conclude today's call. We do appreciate everybody's participation.