Itron Inc (ITRI) 2015 Q4 法說會逐字稿

Good day, everyone, and welcome to the Itron Incorporated Q4 2015 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, Melissa, and good afternoon to everyone. Welcome to Itron 's fourth-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 that the operator will also repeat. We have also prepared a presentation to accompany our remarks on this call.

The presentation is available through the webcast and through our corporate website under the Itron 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 all open up the call to take questions using the process the operator will describe.

First, 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 on 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 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 our forward-looking statements.

Now, I will turn the call over to our CEO, Philip Mezey.

Thank you, Barbara. And thank you to everyone on the webcast for joining us today.

I will review some key highlights in the fourth quarter and then turn the call over to Mark Schmitz to cover our financial results and guidance for 2016. Overall, Itron ended 2015 on strong footing. Q4 showed solid operational results with the highest revenues, margins, earnings and bookings in the year. As you can see on slide 5, bookings were very strong in the quarter with a 1.7 to 1 book-to-bill ratio, the highest book-to-bill ratio since 2007.

Bookings included a significant $250 million contract with Consumers Energy to help modernize the Company's gas distribution system through their smart energy program. The contract expands upon our current work upgrading their electric system with our OpenWay cellular communications. In total, the contract covers 1 million electricity endpoints and 630,000 gas endpoints. This is a great example of a customer growing their project with Itron and using even more of Itron's solutions.

We had other notable bookings with Duke Energy and Electricity, NiSource, Questar, and CenterPoint Energy and Gas, and water bookings with Theolia France and the city of Grand Prairie, Texas. Slides 6 and 7 review backlog trends. Total backlog at year-end of $1.55 billion increase 4% from year-end 2014 and 12-month backlog of $833 million increased 11.5%. This gives us improved visibility to revenue levels in 2016 and beyond. 2015 was the third consecutive year of backlog growth at Itron.

Our backlog has increased more than $500 million since 2012 at a compound annual growth rate of 14%. Our backlog performance points to two things: a healthy level of utility and municipal spending on smart systems and analytics; and Itron's strong share of the growing customer demand in all three end markets, electricity, gas and water. And our selection as vendor for several upcoming projects helps increase our backlog visibility for 2016.

I am also very encouraged by a healthy pipeline of opportunities and the competitive positioning of our next generation OpenWay Riva platform in several active bids. OpenWay Riva provides a fully integrated electrical, gas, and water IoT solution for customers beyond anything else in the industry. First, we built in better network performance with adaptive communications technology that dynamically integrates radio frequency, power line carrier, and cellular communications.

ACT assures connectivity through the most reliable and fastest communication path available for robust networks at lower total cost of ownership. Then we added powerful distributed computing at the edge of the network with Itron Riva delivering more IoT functionality. Our secure standards-based approach at every level of this solution allows application processing, not just data collection, at the device level, whether it be a smart meter, a solar inverter, or street light sensor.

Working together, Itron's ACT and Riva technologies improve integration and connectivity for active smart grids. These technologies enable secure and truly interoperable communications that can crossover between utility and city networks, creating synergies and new potential revenue opportunities for our customers.

Our Riva demos at DistribuTECH were sold out as we spoke with customers about the potential to increase the value from their smart grid investments by deploying Itron's new technologies.

Now let me turn the call over to Mark.

Thank you, Philip.

Itron posted solid results for quarter four, achieving constant currency revenue growth in the quarter of 4% and non-GAAP EPS of $0.76. Highlights of the quarter were strong revenue growth in the water segment, improved gross margin in gas, strong bookings and backlog in both electricity and gas, and improved cash flow. Earnings per share for the full year was $1.01.

Earnings for the year were negatively affected by the warranty charge taken in our water business in quarter two 2015, accounting for $0.42 per share. Partially offsetting the warranty impact, we also had lower incentive compensation expenses for the year, amounting to $23 million or $0.33 per share. This reflects earnings for the year which fell below the threshold at which we felt it appropriate to pay incentive compensation.

Slide 10 summarizes consolidated company results for quarter for 2015 versus quarter four of last year. Total revenue was $490 million, down by $20 million or 4% from the year-ago period, but up by 4% in constant currency. On a full-year basis, revenue and constant currency was up by 5%.

Gross margin for the quarter was at 31.7%, up 140 basis points from the year-ago period, helped by lower incentive compensation and by a significant improvement in the gas business segment. Operating expenses were down year over year, reflecting currency and the reduction in incentive compensation expense. As a result, non-GAAP EBITDA showed a $14 million improvement to $53 million and a margin of 10.8%, up 310 basis points from the year-earlier period.

The year-over-year reduction in incentive compensation expense for Q4 amounted to $23.5 million. We also have roughly $20 million of other nonrecurring items that reduced our non-GAAP EBITDA. So looking through the nonrecurring items, we can see a non-GAAP EBITDA run rate of roughly $50 million for the quarter. The effective tax rate for the quarter was 27%, well below last year's rate due to an improved mix of earnings by jurisdiction and favorable discrete tax items.

Non-GAAP EPS was $0.76 versus $0.36 in the year-ago quarter. Free cash flow was $42.6 million, up from $4 million a year earlier, reflecting improved working capital metrics. Itron finished the year with $131 million in cash and debt balances are down by $15 million from quarter three. GAAP results are shown on slide 11. The significant improvement seen in GAAP operating income reflects a $53 million restructuring charge recorded in Q4 of last year as well as a $15 million acquisition related legal settlement.

GAAP EPS was $0.56, up from a loss of $1.25 per share a year earlier. Turning to segment results, beginning with the electricity segment on slide 12. Electricity revenue in quarter four was flat in constant currency and up by 11% for the year as a whole. This reflects the traction gained in smart meter projects and managed services, particularly in North America, where our full-year revenue grew by more than 20%.

Electricity gross margin was up by 50 basis points in the quarter to 30%, while non-GAAP operating margin was up by 460 basis points to 10.5%, reflecting lower incentive compensation expense. Electricity continues to enjoy a strong pipeline of new business witnessed by its exceptionally strong Q4 bookings. In addition, while electricity's non-GAAP operating margin got a nonrecurring boost from reduced incentive compensation, there were a number of other nonrecurring items that reduced reported results.

We can look behind these nonrecurring items and see real improvement in electricity's run rate. Gas segment revenue, showed on slide 13, was up 1.3 % in constant currency on the strength of record North American revenues. Gross margin improved by 580 basis points year over year to 34.7%, further improving on the 33.6% gross margin recorded in quarter three. Gas gross margin benefited from favorable North American volume and mix as well as improved mix in EMEA.

Our next generation lower-cost smart gas meters for selected EMEA markets will be launched in Q2 of this year. Non-GAAP operating margin in the gas segment improved year-over-year by 730 basis points to 16.4%, driven by the higher gross margin as well as reductions in operating expenses. Reduced incentive compensation expense was an insignificant factor in these improvements.

Water segment revenue grew year over year by 13% in constant currency, as shown on slide 14. Gross margin declined by 210 basis points to 31.3% due to weak business conditions in Brazil and an adjustment to warranty costs, offsetting strong business in North America and EMEA as well as improved services margins. Non-GAAP operating margin was down only 30 basis points year over year with the decline in gross margin offset by reduced incentive compensation expense and other discretionary expense reductions.

Finally, before turning back over to Philip, I would like to discuss our guidance for 2016 as shown on slide 15. We expect 2016 revenues of between $1.85 billion and $1.95 billion based on a euro to US dollar exchange rate of $1.10. This represents constant currency revenue growth of between 1% and 7%. We expect non-GAAP diluted earnings per share of between $1.95 and $2.25 based on 38 million shares outstanding and an effective tax rate of 37%.

While we are not providing specific guidance on gross margin, it is noted that the special warranty charge taken in our water business in 2015, offset by higher incentive compensation expense in 2016, should provide a modest lift to gross margin. As in prior years, we should also note that Q1 will be the weakest quarter of the year and that the second half will have stronger revenue and profit that the first half. Our guidance for 2016 excludes any costs and benefits related to further structural operational changes being planned.

As discussed in last quarter's call, Philip has asked our COO, Tom Deitrich, to lead a comprehensive review of supply chain and R&D improvements in addition to important process changes. This review is likely to lead to manufacturing and R&D footprint changes and consolidations. We will have more to say on our quarter one earnings call in early May.

Now, I would like to turn it back over to Philip.

Thank you, Mark.

As we progressed through 2015, we delivered operational improvements, gained share, and delivered industry-leading innovation and we are taking this momentum into 2016. In electricity, we saw benefits from our decisions to focus more of our investments on high-value smart grid technologies and reduce our business in certain non-strategic standard metering. Full-year electricity revenues grew 11% to constant currency, driven by smart project revenues.

Planned reductions in certain low margin electric business cost us about two percentage points of growth in 2015, while positively impacting electricity segment EBITDA by approximately 70 basis points. We will see an even greater margin and mix benefit in electricity going forward as we fully exit non-strategic business. Overall, we are well on our path to achieve sustainable high single-digit EBITDA in electricity by the end of 2016.

In gas, our North American business continued to perform very well in revenues, margins, and new bookings. Itron has a clear leadership position in the North American gas market. According to the Q3 2015 Scott report, Itron's share of AMR and AMI gas shipments in North America was 60%, up nearly 5 percentage points from 2014. In addition, our European gas business results showed improvement in the second half of the year with savings following the closure of our Naples factory in the second half and better product mix in EMEA volumes. Our focus in 2016 is to continue this progress, including delivery of our cost improved second generation smart meters.

In water, we grew revenues significantly, driven by exceptional growth of 19% in EMEA and 16% in North America. In North America, revenues increased while we also maintained an aggressive delivery schedule for the warranty replacement units. The replacement program was the right decision. We gained customer loyalty and led the competition with 30% share of shipments to North American water utilities.

Overall, in a challenging macro environment, we continue to build market share and make progress in all three segments. Importantly, we continue to invest for the future as our customers look to further increase their operational efficiencies in customer service levels by embracing new technologies.

Against this backdrop, we had an unacceptable level of unplanned costs and charges. Reducing the variability in our performance is a top priority for me and my leadership team. We are aggressively addressing this with several actions including: strengthening our quality processes, additional project risk management controls, centralized global supplier and procurement management, more operational process rigor and intensive focus on working capital.

We also invested in our organization capabilities in several key areas. In addition to bringing Tom Deitrich to Itron as our new COO, we made changes in our gas business leadership. We added new head of local sales and operations planning under Tom to help drive aggressive operational process and performance improvements throughout the supply chain.

We grew our Flextronics contract for more flexible manufacturing, design and procurement. We further augmented our software and services team and reorganized our cloud-based development and systems operations under Bruce Douglas, bringing additional resources and synergies to this critical growth area.

We doubled the size of our India development center in preparation for additional R&D efficiencies through new global centers of excellence and we made substantial progress in global business shared services which enables more G&A efficiencies in 2016 and 2017. We also bolstered our financial team with a new treasurer and new head of financial planning and analysis to help our CFO, Mark Schmitz, drive business, forecasting and planning process improvements. We have more to do and we will make additional, meaningful changes to our operational structure that will increase our agility in global markets and drive further margin improvements.

I would also like to mention a recent Navigant research report ranking Itron as the top leader in meter data management systems. The Q4 2015 report identified Itron as the Company to beat in this highly competitive space. 73 energy companies use Itron's software to manage data for more than 37 million meters across six continents. Our MDM solution is a highly scalable application, pre-integrated with Itron analytics, and can be delivered off the shelf or through cloud-based services solutions. The top ranking of our MDM solution is a strong validation of Itron's focus on delivering outcomes to our customers through software and services.

And earlier this month, we announced the launch of Itron Idea Labs to focus on rapidly developing new solutions that exploit the power of Itron Riva technology. Itron's Idea Labs run as an entrepreneurial development team within our CTO office. The focus of the lab is to design and pilot new Itron solutions and continue to build the developers network to broaden the ecosystem for our Riva platform. The recognition of our industry-leading MDM software and our new idea labs showcase our software and services vision in action. I'm very excited about both of these announcements.

I will wrap up our remarks by saying I'm upbeat about our position entering 2016. We have taken decisive actions on the operational front, increased our backlog and revenue visibility and will deliver substantially higher earnings in 2016.

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

Thank you.

(Operator Instructions)

We will take our first question from Noah Kaye with Oppenheimer.

Good afternoon. Thank you for taking the question.

Philip, may we just start with your comments on a couple of related items. First, the software demos at DistribuTECH that were sold out and your comments around the growth of software and services.

Could you maybe just give us an update on where that part of the business stands in your 2016 guidance? How much is coming from software and services? What kind of growth does that represent? And what is driving the growth? Thanks.

Sure.

Noah, we have not broken that number out. The reference is that this is an increasingly important portion of our revenue, not only as a standalone growth opportunity, but with our Riva software, we are actually embedding analytics into the endpoints themselves and into the system. And this is giving us unparalleled insight of what is happening at the edge of the network that is on the side of the house.

And so we are both broadening our expertise in the center of the network at the meter data management level and above in analytics, but strengthening it throughout the network. And we've said that we consider this to be a strong growth opportunity as a separate business area but also embedded in strengthening our electric, gas and water offering.

I understand.

You mentioned continuing to invest in technology, just noted [in segment B], the decline sequentially in R&D. Can you talk abut how you expect that to trend in 2016? And kind of how you are managing the continued investment in technology versus spend levels there?

Noah, this is Mark and I will give the first answer on Philip may follow up.

First of all, yes, we do continue to invest in technology. We have no intention of stopping or trimming down or stopping that in anyway. We expect R&D to be roughly flat in 2016 versus 2015.

But bear in mind that our emphasis here is to become more productive and more efficient, and in some ways, more targeted in our R&D spend, a much more disciplined approach with better productivity. Getting more for less.

I would just like to follow up with one last question if I might and that is on the market and the pipeline. I think in the last quarter or two, you have had some very positive views on the RFP environment.

What are you seeing now and maybe if you could kind of give us a bit of color in terms of number of large RFPs that you are seeing increase where those opportunities are coming from and, in particular, to what extent the complexity of those RFPs is increasing to reflect the development and improvements in the core networking technology that you have been able to achieve. Thanks.

Sure, Noah.

First of all, pointing out strengthening RFPs activity. We saw that in the book-to-bill ratio of 1.7 and 1.05 for all of 2015. So increasing momentum in bookings at the end of the year.

Starting out in North America where we see some of these very large contracts develop. I've talked before about a strengthening regulatory environment in the northeast; Pennsylvania, Massachusetts, New Jersey and New York, Ohio.

But we've got a broadening of deals actually and opportunities that we see in the northwest. And we are actually starting to see replacement activity and follow-on opportunities in some of the initial installs that went in in North America smart metering. Gas had a very strong bookings performance in the fourth quarter and, as we've commented, record performance in North America.

We see strong opportunities for that to continue as well. The water business showed very strongly. Rest of world, of course, there are follow-on tender activities as we build momentum in these large European deals that we expect to see volume starting to ramp up latter 2016/2017. That is still ongoing.

Thank you very much for the color. I will jump back in queue.

Thank, Noah.

We will take our next question from Patrick Jobin with Credit Suisse.

This is Jennifer King on the line for Patrick.

Given the recent award risk [con ed] to a competitor, do you think the competitive landscape has materially changed for Itron? Do you have any thoughts on why the market shouldn't view the loss as an indication of chances in future tenders?

Electric revenues in North America were up 20% in 2015. So we see strong momentum in market share gains for Itron. The release of Riva, we think, puts us at the forefront of the marketplace. And based upon both RFP activity and selection activity for deals not yet announced, we see a robust and healthy competitive marketplace.

Great. And how much of your business is services today?

We commented on the order of $100 million to $200 million.

And how much do you have in your 2016 guidance?

We do not break that number out separately.

Great. Thanks.

We will take our next question from John Quealy with Canaccord Genuity.

Hello, good afternoon, folks, do you have me?

Yes, John, thanks.

Hi, Philip.

A couple of things. First, on the quarter and FY15, just recap for us, what do we take for restructuring charges? What is left to be done in 2016 and 2017? Can you just give us a brief overview there?

Yes, I can say that actually, we are on track, I think, with what we promised earlier that we would be roughly 50% complete by the end of 2015 and that is about where we stand, 50% done. You should be seeing 50% of our, I think we have indicated, $40 million run rate savings when the program is complete. You should see something close to that 50% in our 2016 numbers.

And by the end of 2016, we will be all but say 95% complete with that program.

Okay.

And Mark, so does that translate into free cash? Or walk us through your free cash thoughts for 2016 versus 2015.

Well, it's a bigger subject than just restructuring, of course. We will have some, something in the teens, I would say, in terms of restructuring cash outflow in 2016.

But what we're seeing in 2016 is really a much greater contribution to cash flow from base profitability and the potential for some significant release of working capital. We are looking for a -- I don't want to promise a number here, but I think I feel quite sanguine about free cash flow in 2016.

And again, I would imagine that would align with your comments or Phillips comments earlier about the second half better than first half. Is that right?

I would expect so, yes. Okay.

Then just the last couple. On the visibility, so good bookings performance and all that. Underlying organic guide of 1.7%, that is a big sort of window. Can you talk about US versus non-US, smart versus not smart, just the puts and takes on that?

I imagine US is okay with home starts, maybe solar, not a huge business for you. But maybe flattish, given what the solar installers have reported. Just help us dig down a little bit on your visibility and where the variances are.

Yes, well I think this is a question that almost every international company is struggling with right now. And we are being deliberately on the cautious side in revenue projections and guidance for 2016. With economies weakening almost everywhere except North America and that perhaps extending to North America, we have got some reason to be a little bit cautious.

But having said that, the North American pipeline is strong. We are not seeing any weakening of business conditions that affect our business in particular in North America. So if anything, I would say we are going to see robust growth in North America and we are a little more concerned about especially emerging markets and we are concerned to some extent about EMEA.

But that is why we have the wide range. The visibility is quite limited right now with the turbulence going on in international markets.

Okay. And then, I'm sorry. Lastly, so back to the competitive landscape, not necessarily on anyone RFP, but with some capital coming in with GE and putting it into a Clara, clearly, I would imagine some dynamics have changed and maybe some alliances versus networking and metrology take off.

So Philip, so far, what have you seen in that respect and what would you expect in the next year in terms of entrance or exits from your competitors? Thanks again.

You know, John, I can speak for the data that we have seen without speculating about the competition in which there is third-party data available that indicates market share and has us gaining share in a healthy position, specifically in the North American market, but I will save third-party data on a global basis. And that's even including this selectivity that we talked about in which we are taking a pass on lower margin business to focus on a higher profitability market.

As to specifically the transaction that you talked about, that is a pretty lumpy market. But we are happy with, although we could always do a better job at just our basic electric meter market share, but we are very pleased with the performance of the electric group, again up 20% in 2015 when into strong bookings visibility in 2016.

Great. Thanks. Nice job, guys.

Thanks, John.

We will take our next question from Sean Hannan with Needham and Company.

Yes, thanks, folks. Can you hear me?

Yes, Sean.

Okay, great.

First question here, from an application standpoint, when I look at gas and some of the commentary you folks had in the slide deck, Europe picking up, what I'm trying to understand and see if I can get a little bit more color on, what is the driver behind this? Is this underlying market getting generally healthier? Is it the projects that perhaps you've won in the past starting to move? I think that there has been a little bit more movement on the gas front, or is this uptake momentum really in terms of your progressive new products?

If there's a way we can get some better color around what the improvements here are in EMEA.

Sure. I will take the first shot at that, Sean.

First of all, what we are seeing happen in the gas business, really, it is the North American mix and volume growth that overshadows other factors and has contributed to the improvement in gas profitability, gross margin climbing by 580 basis points year over year.

But, having said that, we have also seen a significant contribution to gross margin coming from improved mix in EMEA. It's true. And it is not so much volume driven as it is the mix of business there where we are seeing more attractive margins and especially -- well, it should improve further with the introduction of our next generation smart meters in EMEA markets which starts in quarter two of this year.

And I will say that we expect volume to build the back of 2016 and into 2017 as we see projects like GRDF and the Italy residential market increase. So, as Mark said, we haven't quite seen the full volume affect there, but improved mix and efficiency with the closure of our Naples facility and some cost optimization.

Okay, that's helpful.

Now if I could which to software and services, and particularly, as I think about software related to the Riva offering, now that's an offering I think that you are continuing to step up here and just trying to understand the recent project that you have won in North America. How much are we expecting there to be momentum with most upgraded platform where we are today? And any more color around what we are getting some customers on that front outside of the concept of demonstrations in DistribuTECH?

Sean, what I would say is that, and you know this well, is that the standard business case that we have seen in the smart meter and smart grid space is really around largely operational efficiency with some customer service benefits.

What Riva, as a platform offers, is the ability to optimize distribution and provide customers with much greater visibility. And you have seen industry quotes and competitive quotes about the opportunities expressed in dollars for endpoint per year of ranging in the several dollars up to higher numbers that are possible as that business case really broadens beyond the revenue cycle that we have traditionally gone after. So we certainly see that opportunity starting to develop.

So stronger business case that gives us an opportunity to sell this more advanced technology initially and then build on top of it over time with additional offerings that broaden out the business benefit that our customers see.

Okay. So, in essence, there is an opportunity to have the software and services outpace in terms of growth versus the rest of business now coming from a small base but it sounds like there should be good momentum there, correct?

Yes, that is correct. And that software and services spans from the actual operation of the system to analytics that are running at the core of the system to analytics that are running across the system and actually at the endpoint.

Understood. And then, when I think about the offering within software and services relative to the past, is there also a migration toward richer solutions, improving leverage within that general stage where you ultimately, you get a better margin profile from this revenue contribution as we move forward as well?

So Sean, I want to make sure that, yes. Let me say this back to make sure I get it, which is, we expect that this expanded value proposition that we can offer with our system both enhances our margin profiles for our core Riva offering, as well as offering a very attractive margin pure software stream. So there's an integrated affect here that both strengthens the core offering and adds additional capabilities.

It sounds like it improves in both ways; independently just as software and services and obviously as it lifts a broader platform (inaudible).

Yes. And okay, there's another aspect you've raised which is a well executed strategy in the space broadens beyond just the traditional smart grid connectivity that we're starting to see opportunities in smart cities and other areas to bring on additional endpoints that represent yet another additional stream for us.

Great. Thanks so much for the call, folks.

Sure, Sean, thanks.

Thank you. And our next question comes from Sven Eenmaa with Stifel.

Yes, thanks for taking my questions.

First, I wanted to ask, in terms of your gross margin guidance for the next year, you mentioned water a gross margin improvement potentially here but could you also comment on your expectations for electric segment cross margins relative to what you delivered in the fourth quarter as well as in the gas segment?

Okay, I think your question is what are our expectations relative to electric and the gas segments.

Yes, for a margin performance.

We haven't provided discrete guidance on segment margins to that degree in the past. I think the flavor I would be willing to give you on this is that electricity is improving. Electricity, we see the continued march forward in improvements in electricity as a result of the optimization plans that have been put in place, restructuring plans from 2014, the movement away from very low margin business, and the concentration on opportunities where we can earn attractive margins.

And bearing in mind, also the strong pipeline we've got an electricity business in North America that Philip commented at some length here just a few moments ago. North America, we tend to enjoy pretty attractive margins in the electricity segment. So all I would like to spell out there is to say that there is a secular positive trend in electricity gross margins.

Bear in mind that we do expect to see some headwind from increased incentive compensation in electricity and in, frankly, in all segments in 2016. So I don't want to get anymore specific than that.

In gas, the gas business, the improvement that we have seen in quarter three and now again in quarter four is encouraging. I that we said to you that we expected to see this improvement occur. We do expect to see further improvement but it's not going to be on a straight line. The gas business has some additional improvement ahead of it, but it, because mix is such a significant impact on the business, there could be variations from quarter to quarter.

Got it (multiple speakers).

I hope that probably gives you enough flavor.

That is helpful, yes.

The second question I had, you mentioned also that, in the month of April, you will -- I mean following the next earnings print, you will provide an update on some of the additional cost reduction initiatives you're working on. At this pace, could you just give us a framework in terms of how the part of your current cost base is affected by those initiatives?

So, Sven, first of all, I want to be very clear about something that Tom has, from the day he showed up, has already had a very positive impact on the overall operations of the business. You see this in our strong fourth-quarter results. I have mentioned a number of initiatives already underway in supply chain optimization and planning and steps that are under execution currently and under development that are contained within our current projections for the business.

The comments that Mark had made about additional optimization opportunity here is that we see the opportunity to continue to take a look at our overall manufacturing footprint at our supply chain and our R&D and the work that Tom has done have identified some very helpful opportunities for us really to continue on the path that we started several years ago of asking some hard questions about the number of manufacturing facilities that we're operating, how much of that work that we are doing in-house versus on an out-sourced basis and how it is that we can continue to simplify our business overall.

So I see -- the messages here are the work is already underway. We have made substantial and strong progress with the restructuring work that we have began last time. We are making urgent operational improvements currently and throughout 2016. And that we see additional opportunities that we will share with you in more detail on the next call.

And I'd just add to that, Sven, that you asked, I believe, how much of our cost base could be affected by these activities that are part of the studies and structural operational improvements that we will be making and it's, I mean, it is almost all of it. It is our direct spend and indirect spend in the factories. It is our purchased raw materials and parts. It is our product development R&D spend. It is almost everything is touched by this.

Got it. Thanks so much.

We'll next go to Ben Kallo with Baird.

Hi, guys. This is Dave Delahunt on for Ben. Congrats on a good quarter.

I know you touched on this earlier, but I was wondering if you could add a little more color on the improving the R&D optimization and what segments you are going to be focusing on and just a little more color about the changes that will be happening there.

Sure. So, the first and most important point is that as we bring this Riva capability to market, this we think, really changes the game in the market, broadens it and is an enabling platform for some very exciting opportunities in the growth of software and services and actually broadening beyond our traditional metering and utility marketplace. So we are clearly focusing on providing a unifying standards-based platform across electricity, gas and water, adding other elements of an ecosystem to that platform.

Mark made the comment that R&D will be held essentially flat in 2016. That indicates that we are taking a very hard look at a broad portfolio of product, of legacy product, that we have been supporting globally and making some very focused decisions similar to the ones that we made in the electric business on lower margin metering opportunities, looking at our R&D portfolio and ensuring that we are focusing dollars on forward-looking, high-return projects that are going to really drive the vitality of our business and put us at the forefront of innovation and leadership.

So it is really a realignment and some very clear thinking about how it is that we are using that invested capital most productively.

Great. Thank you.

We'll next go to David Rose with Wedbush Securities.

Good afternoon. Thank you for taking my call.

Sure, David.

I wanted to touch on a little bit on the leverage and what our expectations should be in the operating leverage, that is, and what can we assume in terms of the add back in comp expense for next year? What sort of hurdle rates on the top line or operating income do you need to hit as we add back that comp expense?

And then maybe you could paint a little bit of a clearer picture for us in terms of the puts and takes on the margins. What drives it a little bit higher? Is it material cost? Is it labor? Is it product mix?

Maybe you can kind of break it down for us in pockets.

Yes, to start with on your question on operating leverage, you should think in terms of us adding back something in the order of $25 million in cost in 2016. Bear in mind, as in any company, it depends very much on the curve and where you are on that curve. So you think about being at the middle of the range of guidance we provided, we are probably talking about $25 million of additional offering leverage from incentive compensation expense.

Okay.

And then, David, I'm going to have to ask you to repeat the second part of your question, if you don't mind. I could not get it all.

Sure. So the second part is as you think about the offset to that $23 million increase and for you to get to the guidance level, how do you break it down in terms of the cost savings between labor, material and product mix?

Well of course, first of all, you've got the flow-through from revenue growth and we do, although we have given a cautious guidance range, we do expect to see revenue growth. We do expect to see some accretion in gross margin. How's it come from material versus factory labor, productivity, and so on, it would be difficult for me to spell that out here.

But we do expect to see some accretion in gross margin. And then, overall, we are looking to hold operating expenses roughly level year over year.

There are a lot of other factors here, David, and I mean I'll just spell out, a couple of that you might know about and picked up on. One of course is the special warranty charge, which we're surely not going to repeat in 2016. That was $29 million.

Sure.

And then another housekeeping question is just on the tax rate. Is there some reason that you would be at the higher end of the range given what we are seeing in terms of growth internationally? I would've expected a couple points lower, perhaps. Or is this kind of a conservative view to start with and then work your way down?

And then does that include the R&D tax credit?

It does include the R&D tax credit, since that was made permanent by Congress just at the end of last year.

Right.

No, I would not characterize it as being conservative, no. We have been careful but not conservative in this. Our tax rate has been quite variable, partly as a result of having valuation allowances in place in three or four jurisdictions. We put one in Brazil just in quarter three of this year.

And the existence of those valuation allowances causes more variability than we would like to see in our tax rate in the event of low profitability or negative profitability in the jurisdictions where those valuation allowances are in effect.

I would like to add to say that, as we move forward, and I think we have said this in prior calls, we do have a plan in mind to begin to reduce that variability in the tax rate and expect to see some of that happen in 2016.

Okay. That is helpful.

And then if I may, just one last one. And I know you don't like to talk about specific awards. But perhaps, Philip, you could put it in the context of competitiveness. How would you have been better positioned in the Con Edison contract both on the networking site and metering side with OpenWay Riva had that been a bigger part of the solution earlier on?

David, I will say it this way. Both we and our competitors have been involved in piloting our technology with various large customers. Some of those pilots have been in place for several years. And once in a pilot, if the supplier does a good job, the conversion rate is typically quite high.

Had we had Riva in the marketplace several years ago when the pilot initiated, I think that would very likely have had an impact upon the process. And we are also have a high conversion rate in success where our technology has been piloted and been in place over a several-year period.

We feel that, openly, Riva will change the competitive landscape favorably for us. However, we are growing very strongly and winning with the current capability that we do have as well.

Okay, great. Thank you very much.

You're welcome.

We'll go to Jeff Osborne with Cowen and Company.

Great. Thanks for all of the details so far.

I'm just going back to Tom Deitrich's assessment that he is working on with you folks. Could you just frame, Philip, where we are at today with the manufacturing footprint? Where we might have been two years ago before some of the French announcements?

It would just be nice either if you have that information handy now or when you have the next call to set the framework of where you have been, where you are and where you're going. I know there has been a lot of changes so far but it's a bit unclear where you are actually at in terms of facility closure, so anything would be helpful on that front.

Yes, Jeff, let me answer the question this way, rather than a quantitative answer, which is that where we were was essentially a legacy environment based on an acquisition footprint. Where we got to was incremental improvement based upon that footprint and the value of Tom and the work that he has done is to define where an optimal footprint of where, or not quite optimal, I mean, but a footprint of the desired future state as opposed to getting there incrementally over time.

So the value of bringing in a strong outside view is to shape your vision, not based upon where you've been, but where you need to get to. And so he is really bringing a very strong perspective about what that desired future footprint is.

That's directionally. We're consistent with the work that we have done, which is that we are evaluating the overall capacity and capability of our facilities, looking at the rate of technology change and where we expect future volumes and desirable margins to be. But just driving that process further and faster than we have historically.

Got it. That's helpful.

And a lot of times in the technology industries, where the value has overtime shifted from hardware to software and services, which I think if you look at your strategy, you would acknowledge that you're kind of repositioning that way. A lot of the industries have moved to contract manufacturing.

Can you just touch on the delicate balance that you have as you would assess contract manufacturing use and, A, if you are allowed to with the customers that you have? Historically your industry has been less of a proponent of that, but I just wasn't sure if there's any variables that might be changing that dynamic.

Sure. And I mean, Jeff, the first point I'd make, which I think I've made before, is that one of the desirable elements in Tom's background was that, at Flextronics, he ran the mobile hand set division, so that he had in his background a very strong level of expertise about how that marketplace operated and how it is that you would manage in that type of an environment. So by specifically selecting him to bringing in, that was really one of the really conscious choices that I made in that evaluation process.

And we absolutely need to selectively look at how it is that we use contract manufacturing in order to balance our loads and make sure that we are operating as efficiently as we can. And I agree that, as we moved to high-automation solid-state technologies, that the opportunities for outside manufacturing have increased, that our industry has not necessarily been the fastest mover there, but there are strong opportunities for us that we will see in the future.

Got it.

So the type of RFP that you had with say Southern California Edison years ago that you highlight your South Carolina facility for, those types of variables around domestic manufacturing and in-house PCB manufacturing and things like that, those are the variables that are no longer at play, I would assume?

Now, Jeff, I would not go so far as to say they are no longer in place. I mean, the specific contract you referenced, we had practically continuous monitoring and quality assurance. I mean there is an embedded nature of how that was delivered.

I think it is evolving over time. But I don't want to say that this is -- that we have gone through a complete industry shift yet in that regard.

Got it.

Two other quick ones. One, is the Company's policy still to update guidance just on the after Q4 and in the midyear and the July call? Or given the wider range and the uncertainty on the broader macro, is there any thoughts about updating that on a quarterly basis?

We've got no plans to update guidance at this time.

Okay. In the past, I think you reaffirmed it or changed it in July. But, fine. If you don't want to comment on that.

Any thoughts on the December 10 press release that you had around the value enhancement committee? When we should expect any kind of outcome from that board study and what the medium of that delivery would be from? Either on an earnings call or some other event?

Yes, Jeff, I wouldn't think of it as something that's awaiting a report or an outcome. I mean, this is a continuous process and a collaboration between Management and the Board and looking at the opportunities for us to enhance shareholder value that are very consistent with the types of initiatives that we have discussed on the call today and the actions that we have been taking in which we look at operational optimization and market dynamics, and what we in-source, what we out-source. All of those types of things.

So this is not a study-and-recommend kind of process. This is an ongoing and very healthy dialogue about enhancing long-term sustainable shareholder value.

Got it. Thanks so much for the clarification there, Philip.

Sure, Jeff.

Thank you. That does conclude today's question-and-answer session. 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 297230. Or you can go to the Company's website at www.itron.com.

That concludes today's conference and thank you for your participation.