Itron Inc (ITRI) 2016 Q2 法說會逐字稿

Good day, everyone, and welcome to the Itron, Inc. Q2 2016 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.

Hi. Thank you, operator.

Good afternoon and welcome, everyone, to Itron's second-quarter 2016 earnings conference call. We issued a press release earlier today announcing our results. The press release includes replay information for today's call. We also prepared a presentation to accompany our remarks from this call, and the 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; Mark Schmitz, Itron Executive Vice President and Chief Financial Officer; and Tom Deitrich, Itron Executive Vice President and Chief Operating Officer. Following our prepared remarks we will open up the call to take questions using the process that the operator will describe.

First, let me remind you of our non-GAAP financial presentation and our Safe 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 also 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 call, in the comments made in our Q&A session and in the risk factors section in 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 let me turn the call over to our CEO, Philip Mezey.

Thanks, Barbara, and welcome to everyone on the call. It is good to speak with you all today.

Over the last six months we have remained focused on running our business and executing on our strategic initiatives, which is evident in our strong financial results in the first half of 2016. There's a lot we're going to discuss today so to summarize there are three key points that we want to communicate. First, we delivered strong performance in the first half with healthy sales growth and good operational execution. Second, we are raising our full-year 2016 guidance, which reflects our solid first half and our outlook for continuing improvement in the second half.

And, third, we see opportunities for additional synergies and efficiencies in our business. This includes the new restructuring projects we announced today, as well as broader initiatives across our business. Tom Deitrich will discuss this more later on today's call.

Looking at our Q2 results we realized solid revenues of $513 million, gross margin of 33%, adjusted EBITDA of 10% of revenues and non-GAAP EPS of $0.65. These strong results reflect our growing smart business as we continue to target opportunities where our technologies can best serve customers profitably. We are also realizing benefits from our cost savings initiatives and our focus on driving more efficient operations around the world.

Lastly, I'll comment on our backlog and then I'll turn the call over to Tom. Our backlog at the end of Q2 remained healthy at $1.3 billion with $395 million of bookings in the quarter. A note that these figures exclude more than $300 million of business that has been awarded or at which we have been selected and has not yet been booked.

This includes several projects we have announced this year. Avista selected Itron's OpenWay Riva platform to modernize its electric and gas network in Washington state and lay the foundation for smart city applications. We are delighted to be working with Avista on this large-scale Riva deployment in North America.

Additionally, National Grid has recommended deploying Itron OpenWay across Massachusetts, following a successful pilot of our technology in Worcester. Itron will provide the advanced meter and communications network to modernize its grid for 1.3 million customers.

In August we announced a contract with People's Natural Gas in Pennsylvania to install 460,000 OpenWay Riva communications modules over the next five years. With a Riva solution, People's will improve operational efficiency and customer support by automating meter reading with the ability to expand the system to include a multi-purpose network to support smart city applications and to diverse ecosystem of meters, network devices and distributed access.

We have also signed key contracts with ENEDIS, formerly ERDF, in France for the Linky project, and smart water projects in Rogers, Arkansas and Lancaster, Pennsylvania. We are confident and upbeat about our healthy backlog and a solid pipeline of business, especially in North America.

Importantly, our investment in our multi-purpose open standards IOT network OpenWay Riva unifies our solutions and accelerates our competitive position. As a common IOT platform across electric, gas and water, Riva provides a foundation for utilities to share networks and run smart city applications such as smart street lighting or electric vehicle charging.

Itron's OpenWay Riva solution is unique in that it's the only utilities IOT solution available that delivers both adaptive communications technology and distributed intelligence to meters, grid devices and sensors at the edge of the network. Riva's adaptive communications technology combines radio frequency, power line carrier and Wi-Fi on the same chipset to deliver high communications performance with connectivity. ACT dynamically selects the most reliable and fastest communication path based on location, network operating conditions, and the type of grid application or data.

Our Riva technology enables utilities to run multiple applications in edge devices and make near real-time decisions in the field. Our edge intelligence differentiates Riva from competitors' solutions in their traditional software role of solely collecting data for billing and back-office analysis.

We are very pleased that in June Itron's OpenWay Riva IOT solution was recognized by Greentech Media with a Grid Edge 2016 award. Riva was recognized for its demonstrated potential to shape the distributed energy system of tomorrow.

Now I'd like to introduce Tom Deitrich. Tom joined Itron in October 2015 as Executive Vice President and Chief Operating Officer. Tom has substantial global experience in operations at leading technology firms where he drove strategies that transformed and significantly and improved business results. He hit the ground running in October and will now share some comments about his approach to accelerate our transformation at Itron.

Tom, let me hand the call to you.

Thank you, Philip. Good afternoon.

I am pleased to speak with everyone today. Nearly 11 months ago I came to Itron filled with determination and energy to improve the performance of the Company. Today I'm even more excited about what we can accomplish.

Itron has many strengths, including deep customer relationships, innovative solutions and expertise around the world. My focus is to leverage these capabilities to improve the predictability of our business, increase our earnings and drive profitable growth.

Key to achieving these goals is a unified approach to our culture, common platforms that leverage our R&D and manufacturing resources and rigorous disciplined processes and measurements. As you may recall, the first order of business was to perform an evaluation of our R&D, supply chain and manufacturing operations. Mark Schmitz and I undertook this comprehensive review.

With the support of global consulting firm ET Kearney, we benchmarked Itron's performance against best-in-class standards across various sectors ranging from technology to industrials. Based on this evaluation we immediately began to systematically refine our processes, tools and organization to drive stronger profitability and more consistent results.

I'm pleased to say that we are beginning to realize the benefits of these efforts. Combined with a number of other initiatives, many of which predate my joining the Company, this work, which includes the restructuring activities announced in 2014, has already begun to change the way we operate, putting us on a path to increased profitability and growth.

Over the past few quarters we have implemented a number of new processes and approaches throughout our organization to propel us towards benchmark performance levels. While these changes are too numerous to discuss here, I would like to give you a list of some of the key initiatives.

We implemented a Company-wide operational cadence that focuses on quantifiable leading indicators that improve our visibility. This cadence, which includes standardized metrics, allows us to measure our operations around the globe and drive focused improvements. We've unified our incentive plans to ensure clear alignment to Company objectives.

We've created and filled a Senior Vice President of Supply Chain role to drive synergy and scale in our manufacturing footprint and global supply chain. We've elevated the focus on quality with the appointment of a Senior Vice President of Quality to standardize a holistic quality system for the Company. We've developed a consolidated platform for sales pipeline management and sales operations planning.

We've established a disciplined portfolio management approach to ensure that new product development efforts are targeted to expand margin and returns. This approach also gives us clear eyes on projects that are potentially going off track so that we can rapidly address and redirect as necessary.

We've adjusted the product development process and teams to drive efficiency and effectiveness in our R&D investments. We've fostered a clear attention to detail culture, expanded our center of excellence in India, and opened Itron Idea Labs to drive solution innovation.

We've accelerated our software activities with cloud-based targeted solutions that complement our distributed computing Riva platform to improve the operational efficiency of our customers. We have refined our go-to-market strategy to ensure value pricing for products and services and target the unique needs of our customers.

And, finally, we've expanded our evaluation of the global sales profile. This process started in the electricity segment a few years ago to ensure that we are focusing our efforts on the right geographies and segments to optimize value and return. As a result, we have exited certain businesses that were not strategic. We are now rigorously continuing this approach across the entire Company.

With these initiatives we've taken solid steps towards transforming our Company, but there is still much to do. Today we announced some new restructuring projects as another step in our ongoing operation transformation.

As part of the plan, Itron will reduce its workforce and close or consolidate several facilities. These projects are part of the continued effort to optimize the global operations, increase our competitiveness, and provide strong support for our customers. Some of these reductions will begin immediately, and we target these projects to be substantially complete by the end of 2018.

We forecast annualized savings of approximately $40 million upon completion. Through this process we will incur pretax restructuring charges in the range of $55 million to $65 million.

Many of our employees are represented by unions or works councils. In these cases employment actions may be subject to prior consultation with work councils and authorities. This may affect the timing of the charges and the plan savings in certain areas.

Over the past few quarters I hope that you've started to notice a change in Itron's performance. These are the results of the combined efforts of Itron employees, management and the strong support of our customers.

However, my approach to business transformation isn't about one, or two, or even a handful of projects. This is about an ongoing evaluation, measurement and disciplined improvement in our operations to drive real synergies from our global presence and scale. While we are beginning to see the benefits from our operational focus, there is much more that we can deliver.

Ultimately the outcome we seek is really quite simple. We want to improve the predictability of our business, we want to increase our earnings and drive profitable growth. I am confident that we are taking the right steps to achieve these goals.

With that, Mark, I'd like to turn the call over to you.

Thank you, Tom. Good afternoon.

It has been some time since we presented our results, so before discussing quarter two, I'd like to comment on the delayed 201510-K filing and the software VSOE revenue recognition review.

As you know, the reason for the extended 10-K filing had to do with a more rigorous approach to the VSOE analysis of software and related revenue and costs applied to 2015 and prior years. And we have applied the same, more rigorous standard to our 2016 report results.

The 201510-K filed on June 30 displayed non-GAAP EPS of $0.73 for the year, which was $0.28 lower than we had announced in February. The variance in final EPS results for 2015 had very little to do with software revenue recognition. The $0.28 per share adjustment was principally due to subsequent events recorded to 2015, and among these the largest item is a one-time legal settlement concerning the Transdata license matter which we announced in an 8-K on July 15. All told, the effects of our revised approach to software recognition on 2015 and prior-year results, as well as on our 2016 results, are immaterial.

We are pleased to be filing our quarter two 10-Q, which will very likely take place tomorrow or at latest Tuesday, and we expect to be timely with the filing of our quarter three 10-Q and subsequent quarterly and annual reports. Work is also proceeding according to plan for remediation of the material weakness we announced in our 201510-K involving software revenue recognition.

We are also pleased that the accounting review did not interfere with operating performance the first half of the year. As we reported on August 11, quarter one results were strong. We recorded constant currency sales growth of more than 15% year over year in quarter one, with strong growth in both North America and EMEA. All three of our operating segments registered double-digit rates of growth in quarter one.

Gross margin expanded by 180 basis points on favorable mix in gas and electricity, while water support none of the special warranty expenses they incurred last year. Gas and water both achieved gross margin of about 35%, while electricity's gross margin approached 30%.

Non-GAAP EBITDA expanded by 150 basis points to 8.1%. Electricity's non-GAAP operating margin expanded year over year by 390 basis points to 6.6%, showing some of the improvements promised at the launch of our restructuring program two years ago.

Free cash flow was healthy at $25 million, and we ended the quarter with $220 million in net debt and a net debt to EBITDA ratio of 1.8 times. Note that these results were achieved despite an $11 million year-over-year increase in operating expenses, $8 million of which was due to nonrecurring audit costs associated with the extended 10-K filing, as well as legal and settlement costs and other nonrecurring professional services.

The positive momentum from quarter one carried over to quarter two with many of the same positive themes repeated, in terms of sales growth in North America and EMEA, gross margin expansion due to favorable mix and efficiencies partly offset by continued excess costs for the delayed 10-K filing and higher legal expenses.

As shown on slide 7, we recorded quarter two revenue of $513 million, constant currency growth year over year of 10%. The electricity segment led the way with revenue growth of 16%, while gas recorded 9% growth.

Gross margin improved by 790 basis points to 33.1%. About 500 basis points of this improvement is due to the special warranty charge of $23 million last year in the water segment. The rest is due to favorable volume and mix in the electricity and gas segments, as well as operational efficiencies.

Non-GAAP EBITDA improved by 9.3 percentage points to 10.1%, with 5 percentage points of the improvement due to the special warranty expense last year. EBITDA would have been better had it not been for audit, legal and other nonrecurring professional service costs. These nonrecurring costs amounted to more than $9 million for quarter two.

Non-GAAP EPS was $0.65 per share compared to a loss of $0.39 in the year-ago quarter. Our effective tax rate was 34.2% in quarter two.

Slides 10 to 12 display operating results by segment. Noteworthy is electricity's year-over-year gross margin expansion of 460 basis points to 30.4%, which, together with revenue growth of 16%, pushed their non-GAAP operating margin to 9.9%.

The gas segment achieved an 18% non-GAAP operating margin on 9% revenue growth and a 35.6% gross margin. Water achieved a respectable 12.1% non-GAAP operating margin on 34.9% gross margin and modest revenue growth.

Free cash flow was $6 million for the quarter, a little lower than last year's $10 million due to a number of special one-time payments in the quarter for taxes and prepayments on software programs, as well as the increased working capital requirements associated with high levels of revenue growth. A one-time payment for settlement of the Transdata litigation will be reflected in our third-quarter free cash flow. We ended quarter two with $132 million in cash and $216 million in net debt, for a net debt to EBITDA ratio of 1.4 times.

Now let me turn to our outlook and guidance for the remainder of the year, on slide 14. We are expecting revenue to be in the range of $1.95 billion to $2 billion and non-GAAP EPS of $2.20 to $2.45 per share. Our guidance for effective tax rate remains unchanged at 37%. We are basing our guidance on continuation of existing currency rates.

There are a lot of positive things happening at Itron. Our operational execution and financial results in the first half of the year have been strong, and our guidance reflects our expectation for continued strong performance in the second half. We are far from finished and a lot of hard work lies ahead in implementing the actions and operational efficiencies that Tom just spoke about.

All of us on the management team are aligned on the priorities of predictability, profitability and revenue growth. And while improvements won't be straight line, we have here in quarters one and two a good beginning.

Now I'd like to turn the call back over to Philip.

Thanks, Mark.

Overall our team is executing on our goals and performing very well. Today you heard Tom and Mark discuss the clear alignment across our Company on three key areas of predictability, profitability and growth. This alignment is evident in our results. In the first half of your we delivered significantly improved financial performance compared with last year.

In 2014 we committed to strengthening performance in the electricity segment. We are delivering on that commitment, with 17% growth at constant currency, 8% non-GAAP operating margin and 9% EBITDA in the first half of the year.

Additionally, our gas and water segment margins have shown substantial improvement from 2015, returning to solid operating margins and EBITDA performance. And are OpenWay Riva platform unifies our Company and strengthens our competitive position for utilities and smart cities.

Our current performance puts us clearly on our way to our mid-teens EBITDA targets. I firmly believe in our potential to generate greater value for all of our stakeholders and position Itron for a bright future.

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

(Operator Instructions)

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

Thank you. First of all, let's start with congratulations, Philip, to you and the team for completing the restatement, getting the filings out and the performance. It is good to be speaking with you again. Maybe we can just start, since we haven't talked publicly in a while, with the view that you have at current on the landscape, the metering landscape, the RFP activity. Certainly you have seen some significant awards here in North America. Can you just comment on the level of RFP activity at present and how you're feeling about the case of potential wins?

Overall I would say that we think there is a strong opportunity and a good outlook. What I've said in prior quarters remains true, that with expanded regulatory support -- Pennsylvania and Massachusetts, we have pending cases in Indiana and New Mexico, areas of the Northwest and the East, that there is a broad range of smart grid activity out there. And you have heard about some of these competitive wins but we really do continue to see a strong opportunity in North America.

Rest of world, we've talked about activity in France, which we see as ongoing, and are very pleased with our position there, and have some further opportunities in Western Europe that we are pleased about. So, I've characterized the overall outlook as positive.

Okay, great. And then maybe if we could turn to the restructuring, it just would be helpful to understand how you guys are thinking about the cadence of both the cost and particularly the realization of benefits from that, and perhaps, as well, if that is more likely the benefits to accrue the margin line or the OpEx line.

I will turn that over to Mark in a second. I want to place the restructuring in the context of Tom's broader comments, though, that this is an element of a much broader initiative of really strengthening the operational controls within the Company, driving down costs, organizational simplification. There are a broad range of initiatives and this formal restructuring plan is a part, really, of a broader program that we think are going to continue to drive strong benefits.

So, with that I will turn to Mark to the question specifically about restructuring.

Noah, I know you saw our 8-K that was filed earlier on this, so some of this may sound a little bit repetitive. But we indicated costs of between $55 million and $65 million, severance in the range of $39 million to $46 million, so call it $40 million as a round number. Other costs are facilities, living expenses, legal, et cetera, we said in a range of $16 million to $19 million. We said we'd expect $40 million in savings by the time the projects are completed, and we think they will be substantially complete by the end of 2018.

Just in terms of cadence there, it is really too early to comment on the timing. Much of this is subject to European and country works council approvals. Except I should say on the cost side, not all of it will be recognized upfront in quarter three. You will see the costs over at least a couple or three quarters.

A lot of this is of the nature of continuous improvement. Obviously, we are going to look to get as much as we can early on. There is a lot of continuous improvement going on at Itron. This is, as Philips says, one piece of the puzzle, albeit a very important piece.

Okay, thank you very much. And then maybe just one last question from me. It's really around cash flow. As we look at that continuing to improve, potentially giving you some more wriggle room, Philip and team, how are you thinking about use of free cash flow these days? Are you considering expanding the share repurchase? Are you feeling that there are more opportunities to be acquisitive? How should we think about that?

It's always a deep question and I would say that our policy with regard to, call it, capital allocation is, first of all, investment in the business. We've got great opportunities to invest in the business at attractive returns. The restructuring program is one example of that.

Secondly, we would consider tactical or strategic opportunities that enhance our competitive position or that offer new opportunities, new avenues for growth in the business. And then, third, yes, we do actively consider returning funds to shareholders, as we have in the past. We do not have an active program in place for share repurchases at this time.

Okay, great. Thank you very much.

Our next question comes from Ben Kallo with Baird.

Hi, guys. Congratulations on the quarter. I was hoping that you could provide a little bit of commentary on the pipeline coming up, perhaps especially internationally. Are you seeing a lot of headwinds there?

International pipeline, what I would say, our characterization, really, on a regional basis is that we would consider EMEA somewhat muted. I wouldn't want to call it directly related to Brexit but we view with some level of caution economic expansion in Europe and its potential effect upon business over there. So, while we are seeing steady growth, our water business is very well diversified and grows at a steady market rate. On the large procurement side I think we are very balanced about the activity that we see there.

Latin America, remain cautious, Brazil being one of our largest markets there. As I think you can imagine, we're quite cautious about the outlook in that market.

And then in Asia it is somewhat a story of China. But we do have some attractive opportunities that we continue to pursue. So, really the strongest area for us does continue to be North America. And, as I said in my earlier comments, we are very pleased with the outlook there.

Thank you. And just one more question, I just want to make sure I heard you correctly, did you say there was $9 million in one-time unallocated corporate overhead in the second quarter?

What I said is that a combination of special audit costs and legal and settlement costs and other nonrecurring professional services costs in quarter two amounted to $9 million and in quarter one that number was $8 million.

Excellent. Thank you, guys, very much.

(Operator Instructions)

We will hear next from Sean Hannan from Needham & Company.

Good evening, folks. And also to echo some earlier comments. There has been a lot underway, I think, for you all as a management team in terms of getting back to current filings, as well as operationally what you've been accomplishing, and of course in terms of the top line and bus dev. There is certainly a lot of positives to take away here, so nice work on that front.

My question also is focused around Europe perhaps from a totally different angle. You have a number of projects that have either been underway or just started underway in very early volumes, and whether it be GrDF, ERDF, ETEL Gas, et cetera. Can you give us a little bit more color around the cadence of the volumes that are going to those customers and how you expect that to continue moving forward? There's an aspect of that that's elaborating on some of your last question, but a little bit more color would be helpful. Thanks.

Okay, Sean, sure. Thank you. As you pointed out, we have over time discussed a number of projects that are in the initial stages of ramp up. We did ship a nice volume of the Linky G1, and do have our initial award on the Linky G3. So, we will continue to see volume throughout 2017, 2018, and we hope beyond there.

GrDF does ramp up more significantly in 2017 and we continue to compete for business in ETEL Gas. We feel that we have some nice visibility for investments that we've made over the last several years there.

What you've heard from us, though, is also some profit discipline, both in efforts that we've made in order to cost down those products, which we are bringing those cost-optimized products to market, as well as really maintaining bidding discipline to ensure that the awards we do receive are at our target margins. And we're pleased with the progress that we have made on those fronts, as well. So, I think there's been very good profit discipline as well as a nice continued growth opportunity for us there.

That's great. There has been, over the course of the last two years, a lot of puts and takes, whichever geography we may look at on the gas side of the equation. Can you elaborate a little bit more on the current environment for gas, US versus EMEA and other geographies within the world? Thanks.

First, we are, as you can see from our results, very pleased with the performance of the gas business. And it's returning to historical levels of very attractive profitability, and that is largely driven by a very healthy market in North America, at near record levels. That is the star contributor, and that is both communications and metering there.

In Europe, improvement in our overall margins as a result of the introduction of these cost-optimized product and the ramp ups that we've just discussed. And then we have, of course, the opportunity to continue to build on our commercial industrial offerings which tend to be at higher margin levels.

We do expect the UK to come online here in the 2017-2018 timeframe, so there is a nice opportunity for us there, as well. The gas business we see is continuing to make that strong contribution to support the mid-teens EBITDA target for us.

And it seems like not only have we had the momentum but we are very optimistic that it has some good medium and longer-term legs at this point.

Yes, these awards are multi-year in nature. So, this is, we feel, a durable business.

Wonderful. Thanks so much for taking my questions.

Our next question comes from John Quealy from Canaccord Genuity.

Good afternoon, folks. Welcome back, everybody. Those of us in Boston appreciate the Worcester pronunciation, as well. (laughter)

First question for you, the M&A landscape has been hot. The Xylem Census, Honeywell Elster, Sun Capital, GE, the Badger Head Fake. So, two questions on this. They seem to be landing in a little bit more stable strategic owners. How are you thinking about that? Honeywell doesn't usually do utilities in this way, right?

So, talk about your thoughts about longer-term changing dynamics. Not going to talk about multiples, we can all do that on our own. But has that caused you to think about things differently and go to market differently?

And then on the other side of that, I want to talk about, does it change your approach in terms of Riva and OpenWay. Would you ever consider splitting metrology versus network as smart grid really seems to be taking off but a la carte is still the way a lot of customers i.e. utilities, want to talk. Sorry for the verbose first question.

No problem, John. Although we have seen absolutely, as you point out, M&A related activity, it has not, in our view, particularly changed the competitive landscape. Census Xylem, we haven't really seen Xylem in our water marketplace. And together we don't see necessarily a new vector of competitive threat there for us. And the same is true, by the way, for Honeywell Elster in terms of some combined offering that would be more competitive or would really change the dynamic for us in our market.

I think the second part of your question is hinting at the fact that these larger companies do see benefit in the communications capability, that their utility acquisitions have potentially for other markets, because that is certainly a synergy that they have discussed publicly. And we definitely, with our significant investment that we have made in OpenWay Riva, see the opportunity that we've mentioned -- smart cities several times -- that building these types of networks and having communication devices does open the door to opportunities outside the kinds of metering and sensing that we see in the distribution and delivery of electricity, gas, and water. Overall, again, competitive landscape not particularly changed by those moves.

To your second question about do we see the separation of the communications and what we would think of as metering. Looking forward to having the opportunity with all of you to talk about what we see, really, as an opportunity of the integration of sensing communications and computing at the endpoint of some very exciting opportunities that are available for us there.

We see the ability to sell networking and to work with third parties that we are developing with Riva, as well as the opportunity to really extend the value proposition beyond the revenue cycle, beyond the traditional billing types of solutions that we have looked at historically, to deliver significantly more value for our utility customers.

Okay, thank you. And then maybe my follow-up, maybe to Tom, if you could give us your thoughts on the composition of the business in terms of warranty charges. We are coming off a period of several years of discrete warranty charges for a lot of different reasons, internal or external factors. Talk about your assessment of that almost a year in. Are we always going to have a certain lumpiness in the warranty picture here? Or what is your evaluation of that picture? Should it be more reliable for us moving forward, especially as we look to see gross margins go up? Thanks, guys.

Thanks, John. I will just start out there and then turn to Tom. When Tom got here and we discussed this, the priority that you heard about predictability, profitability and growth, that predictability we rated number one because of these extraordinary and lumpy charges and surprises that Itron had seen over the past years, and how upsetting those had been. So, I made it very clear to Tom and the team that looking at this problem and really getting down to root causes and driving a higher degree of predictability was, amongst three incredibly important objectives, the one that we rated first.

So, with that, Tom, I will turn it to you.

Absolutely. I will pick up really where Philip left off. If we think about predictability as one of our chief tenets of how we want to move forward, I view that very much as a very holistic thought process. So, how we design products, how we specify products, how we work with customers in terms of the robustness of the solution, how we manufacture them, how we test them and deliver them, all of that leads to the predictability.

So, quality is something that is absolutely a very holistic part of how we think about the business and an area that we worked hard on. In my prepared comments certainly you heard a number of these themes come up over and over again in terms of changes of our design processes, as well as some structural changes that we made to put a focus on these types of things.

So, I think we can very much do a very good job of building on the theme of predictability across business, whether it be financial or engineering delivery as well as quality. I very much think we are on the right track there. There is always more work to do as we work continuously to improve that and avoid any one-off types of charges.

We will take our next question from Jeff Osborne with Cowen and Company.

Good afternoon. Most of my questions have been answered but maybe just picking on the predictability, profitability, and revenue growth themes. I believe Tom mentioned in his prepared remarks that the management incentive compensation scheme is now aligned. I assume it's around those 3 tenets given you've mentioned them 10 [on] times on the call. But will it be shared in the 10-Q, or perhaps it was in the 2015 10-K, what in particular the revenue growth and profitability metrics are as it relates to the management compensation plan?

Jeff, those will appear in the 2016 proxy when it comes out because they were part of an aligned program put in place for this fiscal year. And, to your point, yes, those elements are reflected. Historically, profitability and growth have been in the compensation plan very clearly in terms of revenue and EBITDA targets that have driven the short-term incentive plan. But to the predictability, there are measures in there in the overall goals portion of our compensation plan that are now shared across not just the whole management team but the whole short-term incentive population to make very clear alignment around those themes.

Got it, that's helpful. If I could squeeze in two here. One is on Europe. You addressed it on the demand side as well as the cost side and being disciplined. I did have just a quick question. I was wondering if Riva as a concept is resonating with European utilities at this point given the challenging Dutch auction environment there? Most of the examples you highlighted are domestic but I was just curious on the European.

Jeff, it's a great question because there really is a bifurcation in that market, as you know, of what we would call specification-driven markets that are not as amenable to the extended value proposition that Riva potentially offers to them. So, we have to be very targeted.

Historically, we've seen regions like the Nordics that have driven for a somewhat higher level of functionality. So, we are being very selective in looking for markets that are looking for something more than, really, an automated meter reading with some extended level of capability to really going beyond to some level of grid sensing or extended value proposition. We need to be selective there.

We are competing in that specified market. As you've heard, though, however, in France in particular, we discussed, but across certainly competitively across our gas and water businesses, as well.

Got it, that's helpful. The last question I had, there was obviously a litany of restructuring charges that you talked about playing out through 2018. I assume it's a safe assumption that the actions announced today, and assuming that the mix that you've seen here in the first half of the year, if that remains constant, exiting 2018, that that gets you to your target of mid teens EBITDA? Or is there something else, kind of Hail Mary that needs to happen, to execute on that goal?

I will offer the first response on that, Jeff, and then I think Philip wants to add something, too. If you just look at us subjectively, we are standing at a 10% non-GAAP EBITDA number at Q2, and we've got close enough to $10 million of excess OpEx in that number. If you put that $10 million back in and look at us getting to -- we're at 33% gross margin, too -- so, you pick that gross margin up to the mid 30%s, call it 35%, and you are pretty close to that mid-teens EBITDA. We don't see it as a Hail Mary at all, honestly.

I didn't think so. I just wanted to double check that I wasn't missing anything. The last thing, on the AT Kearney analysis or any of the work that Tom did, was there any discussion or output as it related to return on investment of the R&D dollars that are being spent?

Yes, that certainly was -- Tom, why don't you cover ops because it absolutely is the kind of benchmarking measures that were looked at there.

Great question. We did look at our R&D spend as well as many of the other supply chain metrics and identified a number of areas that I think we can do a bit better. And that is exactly what we are looking at today.

It really comes down to making sure that we target our R&D spend into areas of the market where we can get some decent returns. So, it is a spend targeting kind of question. It is the thought process around where we would want to play from a geographic standpoint. It's a thought process around the quality that is associated with the products so when you sell them they stay in the field. It's a thought process around the overall solution.

As Philip mentioned, there's different types of markets that are out there. In some places you can sell a piece of the solution, in other places you can create some additional innovation and value for customers by selling an entire solution and an outcome. And also, as we shift some R&D dollars into those areas, we can get some good returns.

Those are perhaps some of the clues that were derived from that, without giving you all the nuts and bolts of the study, but those are deeply embedded into the comments that I made earlier and the changes that we are making in the organization. Some good stuff has come out of that study that will help us going forward.

Great to hear. Thanks so much, guys.

We will hear again from Ben Kallo with Baird.

Hi, guys. Very quickly, John Quealy, what a great question he asked there. And then following on to Jeff's question there, how do we think about the next step of cost reductions? And how long does that take us to receive that? And then what do we have to worry about, Philip, when we look across the business to the turns business? I think you kind of answered this but as we think about ETEL Gas or ERDF or GrDF outside backlog, how much of that business do you have visibility on? And how does that move the needle? Thank you.

Ben, I want to make sure I picked up all the pieces of that. In terms of cost reduction, the restructuring plan, again, is only a part of the steps that are being taken in order to drive profitability and performance. We're continuing to invest R&D dollars in higher-margin products, greater selectivity in the targets that we are pursuing, improving our selling value-based selling techniques -- all kinds of things that go into managing that overall profitability number, in addition to just getting our costs out.

Tom enumerated a number of things going on there in terms of better supply chain discipline, coordinated planning, that even within our existing footprint give us an ability to manage out other costs of goods sold and other things that detract from our overall profitability. There are a wide range of actions being taken alongside of restructuring, and we are seeing some of those benefits already in 2016.

As to the turns business, we continue to optimize our cost performance within those contracts, are pleased with the award levels we are seeing there, again, within our profit discipline, and have good visibility. If I think I got your question on visibility, as an example, these European-based contracts, they are largely coming off on the schedules they projected in terms of their bid schedules. So, we feel that we have, again, this good visibility through 2017 and 2018 on progress against those large contracts.

Thanks guys.

Our final question comes from Jose Garza with the Gabelli & Company.

Good afternoon, guys, and congratulations on the filings. I just wanted to see if you could maybe bucket the savings on the restructuring just in terms of segment, if you could.

Actually, we are not prepared to break it out by segment, Jose, sorry. But I can tell you that the majority of these cost reductions are going to occur in cost of sales. There is some impact in the OpEx categories but mainly it is cost of sales. We are going to be reluctant to break it out by segment, though, sorry.

Okay, thanks, Mark. And if you could, just thinking about the run rate on the corporate line, presumably there will be some costs in here in the third quarter. How do we think about that going forward?

There is a small amount of carryover excess costs related to the extended 10-K filing in quarter three, but it is not a material amount. I think you should look for a pretty significant reduction in OpEx in H2 versus H1. It is going to be something north of $15 million reduction.

Okay, excellent. Thanks very much, guys.

That concludes today's question-and-answer session. At this time I will turn the conference back to your speakers for any additional or closing remarks.

Thanks, everyone. Of course, as we've said, we're very pleased to be back with you and very proud of the finance team for getting us through this filing period and getting us caught up. We are having a great time together. We are making a lot of progress. You have heard that we are very well aligned.

We have got some really favorable market conditions and still lots of opportunity for improvement. So, we are looking forward to telling you more about our progress here on the upcoming calls.

Thanks very much. Talk to you all soon.

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 833920, or go to the Company's website www.Itron.com. This concludes today's conference. You may now disconnect.