Itron, Inc. — Q2 2016 Form 10-Q Summary
Reporting period: Three and six months ended June 30, 2016. Itron provides smart metering, software, and related services to electricity, gas, and water utilities. Financial statements are unaudited.
Financial results
| Metric | Q2 2016 | Q2 2015 | Six months 2016 | Six months 2015 |
|---|---|---|---|---|
| Revenue | $513.0m | $470.8m | $1,010.6m | $917.6m |
| Gross profit / margin | $169.7m / 33.1% | $118.6m / 25.2% | $332.9m / 32.9% | $257.0m / 28.0% |
| Operating income (loss) | $35.5m | $(4.0)m | $59.0m | $9.5m |
| Net income (loss) attributable to Itron | $19.9m | $(14.3)m | $30.0m | $(8.9)m |
| Diluted EPS | $0.52 | $(0.37) | $0.78 | $(0.23) |
| Adjusted EBITDA (non-GAAP) | $51.8m | $4.0m | $92.1m | $33.6m |
Revenue increased 9% in Q2 and 10% in the first half. All three segments grew. Q2 segment revenue was Electricity $232.8m, Gas $150.3m, and Water $129.9m. For the first half, it was $450.1m, $289.5m, and $271.0m, respectively. Foreign exchange reduced reported revenue by $6.5m in Q2 and $22.5m in the first half.
Management attributed improved gross margin to higher revenue and favorable product mix, as well as substantially lower Water warranty charges than in 2015. The prior-year periods included warranty accruals for certain communication modules of $23.6m in Q2 and $26.8m in the first half. Operating expenses rose $11.7m in Q2 and $26.4m in the first half; higher corporate costs, including professional fees tied to financial statement revisions and legal costs, were a major factor. First-half effective tax rate was 40%, versus 35% statutory, reflecting earnings mix and losses in jurisdictions with deferred-tax valuation allowances.
Cash flow, debt, and liquidity
- First-half operating cash flow was $51.1m, versus $17.6m; capital expenditures were $19.9m. Free cash flow, a non-GAAP measure, was $31.2m versus $(3.4)m.
- Cash was $132.0m at June 30, 2016, compared with $131.0m at year-end 2015. Working capital was $310.6m, up from $281.2m.
- Gross borrowings were $345.7m: $213.8m term loan and $131.9m revolver. Balance-sheet debt carrying value was approximately $344.8m after debt fees. The revolver had $322.6m available for borrowing or letters of credit; $45.5m of letters of credit were outstanding.
- First-half financing cash outflow was $28.9m, including $26.2m of debt repayments. Management stated existing liquidity should fund operations and obligations for at least the next 12 months, while noting there are no assurances.
Material changes and notable items
- Prior-period revisions: Itron revised previously reported 2015 quarterly statements, primarily for the timing of revenue and cost recognition on certain software-related contracts where vendor-specific evidence of fair value or software functionality assessments were inadequate.
- Control weakness: Disclosure controls were deemed ineffective at June 30, 2016 because a material weakness in revenue recognition controls remained unremediated. Management described continuing remediation efforts.
- Credit covenant reporting: Itron was not compliant with the credit facility’s financial reporting requirements at June 30. Amendments provided waivers extending specified 2015 annual and Q1/Q2 2016 reporting deadlines through September 12, 2016.
- Backlog: Total backlog was $1.345bn and estimated 12-month backlog was $688m at June 30. Backlog is subject to timing, customer rescheduling, and cancellations, and does not include all book-and-ship revenue.
- Customer concentration: One customer represented 12% of Q2 and 13% of first-half Electricity segment revenue. The ten largest customers represented 32% of Q2 and 30% of first-half total revenue.
Outlook, risks, and contingencies
- No specific operating revenue or earnings guidance is provided. On September 1, 2016, Itron announced a new restructuring program, expected to be substantially completed by the end of 2018, with estimated pre-tax charges of $55m–$65m and expected annualized savings of about $40m upon completion. More than 90% of charges are expected to be cash expenditures; labor consultation and regulatory approvals may affect timing.
- The existing 2014 restructuring program was expected to be substantially complete by Q4 2016. Approximately $19.9m remained accrued at June 30, including $16.2m expected to be paid within 12 months.
- Risks cited include customer demand and order timing, contract performance and delivery milestones, warranty and litigation estimates, foreign exchange and interest rates, competition, regulation, and access to capital. About 48% of Q2 revenue and 49% of first-half revenue was denominated in non-U.S. dollar functional currencies.
- Tax authorities were examining tax years 2000–2013 in several jurisdictions. Unrecognized tax benefits were $55.2m; the company said it could not estimate the range of possible changes over the next 12 months.
- Itron disclosed a Brazil competition investigation and various legal matters. It said it had made adequate provisions and did not expect the Brazil matter to materially affect operations or financial condition. A July 14, 2016 settlement with Transdata dismissed pending patent litigation and provided a patent license.
Important facts for investors to verify
- Whether the revenue-recognition control weakness was remediated and whether the related revisions affect subsequent periods.
- Whether the extended credit-facility reporting deadlines were met and whether any further waivers or covenant issues arose.
- Whether improved margins persist after accounting for the unusually high 2015 Water warranty accruals.
- The timing, cash costs, savings, and execution risks of the new $55m–$65m restructuring program.
- Backlog conversion, customer concentration, warranty developments, and outcomes of tax and legal contingencies.