Itron, Inc. — Q3 2016 Form 10-Q
Reporting period: Three and nine months ended September 30, 2016. The filing is unaudited. Itron provides metering and related software and services to electric, gas, and water utilities through its Electricity, Gas, and Water segments.
Financial performance
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Revenue | $506.9 million | $469.5 million | $1,517.5 million | $1,387.1 million |
| Gross profit / margin | $170.7 million / 33.7% | $147.3 million / 31.4% | $503.7 million / 33.2% | $404.3 million / 29.1% |
| Operating income | $6.4 million | $26.9 million | $65.5 million | $36.5 million |
| Net income (loss) attributable to Itron | $(9.9) million | $12.6 million | $20.1 million | $3.7 million |
| Diluted GAAP EPS | $(0.26) | $0.33 | $0.52 | $0.10 |
| Adjusted EBITDA (non-GAAP) | $62.7 million | $41.5 million | $154.8 million | $75.1 million |
| Non-GAAP diluted EPS | $0.77 | $0.44 | $1.87 | $0.28 |
Q3 revenue grew 8%; nine-month revenue grew 9%. Gross-margin improvement reflected better product mix and performance in Electricity and Gas, and, for the nine-month comparison, lower Water warranty costs versus 2015. Q3 operating expenses rose $44.0 million, mainly due to $40.1 million of higher restructuring expense. The $13.4 million Q3 income-tax provision against $4.5 million of pretax income produced a reported 297% effective tax rate; management cited earnings mix and losses in jurisdictions with valuation allowances.
Cash flow, debt, and liquidity
- For the first nine months, operating cash flow was $81.9 million, versus $20.2 million in 2015; capital expenditures were $30.6 million, resulting in non-GAAP free cash flow of $51.3 million, versus negative $13.2 million.
- Cash was $151.4 million at September 30, 2016, up from $131.0 million at December 31, 2015. Working capital was $352.5 million.
- Credit-facility borrowings totaled $343.5 million: $210.9 million on the term loan and $132.6 million on the revolver. The balance sheet reports current debt of $12.7 million and long-term debt of $330.0 million, net of unamortized term-loan fees.
- The revolver had $321.3 million available for additional borrowings or letters of credit; $46.1 million of standby letters of credit were outstanding. The term loan and revolver mature in June 2020. Reported rates were 1.78% for the term loan and USD revolver and 1.25% for the EUR revolver.
- Itron repaid $29.0 million of debt during the nine months. Management said existing liquidity was expected to fund operations and obligations for the next 12 months and foreseeable future, while cautioning that there were no assurances.
Material changes and operating trends
- Segments: Q3 Electricity revenue increased 17% to $242.7 million, Gas increased 5% to $144.2 million, and Water declined 5% to $120.0 million. Electricity and Gas gross margins improved; Water’s Q3 gross margin fell to 32.7% from 35.0%, with lower volumes and unfavorable mix cited.
- Backlog: Total backlog was $1.51 billion and estimated 12-month backlog was $731 million at quarter-end. Q3 bookings were $670 million. The filing cautions backlog can fluctuate and is subject to rescheduling or cancellation.
- Shipments: Q3 meter shipments were 5.91 million versus 6.03 million a year earlier; advanced and smart meter shipments increased while standard meter shipments declined.
- Prior-period revision: Itron revised previously reported 2015 quarterly financial statements, primarily for the timing of revenue and cost recognition on certain software-related contracts. Comparatives in this filing reflect those revisions.
- Customer concentration: The 10 largest customers represented 33% of Q3 revenue and 31% of nine-month revenue, up from 24% and 23%, respectively, in 2015.
Outlook, risks, and unusual items
- Restructuring: Projects announced September 1, 2016 involve facility closures or consolidation and workforce reductions. Estimated pretax costs are approximately $66 million, with expected annualized savings of approximately $40 million upon completion, targeted by the end of 2018. More than 90% of costs are expected to be cash expenditures. Actual timing and costs may vary, including due to consultation and regulatory processes.
- Controls and reporting: Management concluded disclosure controls were ineffective at September 30, 2016 because a material weakness in revenue controls remained. The weakness concerned evidence of fair value for certain software maintenance elements and whether software was essential to hardware functionality. Remediation was in progress but not complete.
- Tax matters: Unrecognized tax benefits were $56.2 million. Examinations cover tax years 2000–2014 in several jurisdictions; management said it had accrued for expected outcomes and did not anticipate a material adverse effect, but could not estimate possible changes in unrecognized benefits over the next 12 months.
- Contingencies: Itron settled Transdata litigation in July and received a patent license. A Brazil water-meter investigation was settled on October 18, 2016; the settlement was reported as immaterial. Customer guarantees, indemnifications, warranty obligations, and other legal proceedings remain relevant exposures.
- Market and execution risks: The filing identifies customer demand and order timing, contract milestones, warranty and litigation estimates, foreign exchange and interest rates, competition, international operations, and access to capital as risks. Foreign-currency-denominated revenues were 44% in Q3 and 47% year to date. Itron uses interest-rate and foreign-exchange derivatives to manage exposures.
- Guidance: The filing provides restructuring cost and savings estimates but no clear company-wide revenue or EPS guidance for the full year.
Important facts for investors to verify
- Review the revised 2015 comparatives and the revenue-recognition material weakness, including the status and effectiveness of remediation.
- Track restructuring charges, cash payments, completion timing, and whether targeted annual savings are achieved.
- Assess the drivers and sustainability of improved gross margins, especially Water’s weaker Q3 results and the prior-year warranty comparison.
- Monitor customer concentration, backlog conversion and cancellation risk, and demand across the three segments.
- Evaluate cash generation, debt repayment, covenant compliance, interest-rate exposure, and the availability of revolver and letter-of-credit capacity.
- Follow tax examinations, warranty claims, legal matters, and the potential effects of currency movements.