Good day, ladies and gentlemen. And welcome to the Itron Inc. Year-End Q4 2018 Earnings Conference Call. Today's call is being recorded. For opening remarks and introduction, I would like to hand things over to Mr. Ken Gianella. Please go ahead, sir.

Thank you, Operator. Good afternoon. And welcome to Itron's Fourth Quarter 2018 Earnings Conference Call. We issued a press release earlier today announcing our results. The press release includes replay information about today's call. A presentation to accompany our remarks on this call is also available through the webcast and on our corporate Web site under the Investor Relations tab. On our call today, we have Philip Mezey, Itron's President and Chief Executive Officer; Joan Hooper, Senior Vice President, Chief Financial Officer; and Tom Deitrich, Executive Vice President and Chief Operating Officer. Following our prepared remarks, we will open the call to take questions using the process the operator described. Before I turn the call over to Philip, please let remind you of our non-GAAP financial presentation and our safe harbor statement. Our earnings release and financial presentation include non-GAAP financial information that we believe enhances the overall understanding of our current and future performance. Reconciliations of differences between GAAP and non-GAAP financial measures are available in our earnings release and on our Investor Relations Web site. 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, the comments made during this conference call and the Risk Factors 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 any forward-looking statements. Now please turn to Page 4 in the presentation, and I'll turn the call over to our CEO, Philip Mezey.

Thank you, Ken. Good afternoon and thank you for joining us. We have a lot to cover today, so let's get started. We ended 2018 with Q4 performance as expected, while also operating our first full quarter under our new segments of device solutions, network solutions and outcomes. You will hear details for Joan in a moment. But to highlight our Q4 2018 performance; revenue was $587 million, adjusted EBITDA was $59 million; adjusted non-GAAP EPS of $0.88 was above our guidance due to one-time favorable tax items; and we had another strong quarter of free cash flow performance of $25 million; customer pipeline continues to be healthy with the Q4 book-to-bill ratio of just over 1.3: 1; we ended 2018 with a book-to-bill ratio of greater than 1:1. Our total backlog at the end of the year was a record $3.17 billion and our 12 months backlog was $1.35 billion. As I'll reflect on this past year, while we made tremendous progress in many areas of the business, we also had mixed financial results. We encountered unexpected headwinds, both internal and external in our supply chain, which resulted in lower revenue and profitability than we expected. In terms of strategy execution, we gained strong market momentum, which will lead to long-term value for our customers and our investors. First, we strengthened our position as the industrial Internet of Things leader in the smart energy and smart cities space with the acquisition of Silver Spring Networks. This acquisition allowed us to extend our software and services capability deeper into solutions, such as distribution automation and smart street lighting. By expanding our product portfolio, this allows us to offer our customers end-to-end support in navigating the evolving complexity of their business environment. As a combined company, we have delivered over $200…

Thank you, Philip. Before I discuss our fourth quarter results, let me remind you that this is our first quarter reporting under the realigned business segments of device solutions, networked solutions and outcomes. We held an informational call on February 21st to review historical results for these new segments. As Philip mentioned, fourth quarter results were in line with our expectations. A summary of consolidated GAAP results is shown on Slide 7 and non-GAAP results are shown on Slide 8. Revenue of $587 million increased 7% versus last year, driven by strong performance in the networked solutions segment and the acquisition of Silver Spring Networks. Fourth quarter gross margin of 30.1% was lower than last year, primarily due to a higher special warranty cost in 2018. Moving to earnings per share, fourth quarter GAAP net income was $24 million or $0.60 per diluted share, compared with $2 billion or $0.05 cents last year. You may recall Q4 2017 results included a one-time tax charge related to the newly enacted U.S. tax reform legislation. Regarding non-GAAP metrics, adjusted EBITDA was $59 million or 10% of revenue. Non-GAAP net income for the quarter was $35 million or $0.88 per diluted share, compared with $40 million or $1.01 per share in 2017. A lower 2018 effective tax rate contributed $0.22 per share year-over-year EPS increase. Free cash flow was $25 million in the fourth quarter, lower than the prior year, primarily due to the timing of working capital, as well as restructuring and acquisition related outflows. Cash equivalents and restricted cash at the end of the fourth quarter was $122 million, up $11 million from Q3. Turning to Slide 9, total debt decreased slightly from Q3 to just over $1 billion following further payments under revolving credit facility and the required principal payments…

Thank you, Joan. As Joan discussed, while our device solutions business is facing a softer European market, we are very pleased with our bookings momentum in North America where we expect network solutions and the outcome business units will continue to grow at significant rates in 2019. This will be supported by our record backlog and strong pipeline of up-sell and book and ship business. In our guidance, we do see a slight easing in supply-chain lead times. Last quarter, we've reported over 550 parts with lead times over six months. That has now decreased by approximately 14%. While the decrease is promising, we still have a ways to go and are not standing still on our gross margin improvement efforts. We continue to introduce selective price increases, and are aggressively targeting lower manufacturing costs, and we'll continue to rotate our business to solutions with higher profit margins. As Joan mentioned, we have an upcoming Investor Day where we will go deeper into our strategy and outlook for both the company and our new segments. Before we turn it over to Q&A, I wanted to get some insight into our segment realignment strategy and our planned execution for 2019. Starting with the device solutions business. The meters and sensors that we manufacture are a critical part of our customers' infrastructure. Safety and quality continue to be our top priority in delivering products to our customers. With factory optimization and the impact of supply chain headwinds in 2018, we are focused on meeting our customers' demand with improved quality and the prompt delivery of product in 2019. We will continue to expand the device solutions product portfolio with the introduction of new products across our regions, including the release of a new intelistatic meter for our gas and water market, a…

[Operator Instructions] We'll take the first question today from Chip Moore, Canaccord.

I appreciate the color you gave on guidance on margins in the first half versus the back half. Joan maybe is there a way to talk about margin progression with the new reporting structure. How should we think about that they by segment?

We're not going to provide specific segment guidance. But I mean you can get a feel based on looking historical segments' margins relative contribution. But again, the first half versus second half is more a function of the easing of the supply chain as well as some of the restructuring things that we're doing kicking in.

And just a follow up on margins, the special warranty in the quarter. What was going on there and anything lingering from that to think about into the current quarter?

This is Tom, I'll take that one. What was behind that was an error that we had made in a product transfer as part of our manufacturing restructuring that was going on. We moved a product from location X to location Y, and had some problems in the bring-up. The product that was affected there was time bound, meaning it was manufactured during a certain period. Since then, we've understood the problem, corrected it and made sure we learn from the mistake going forward. So, no overhang expected into 2019.

The next question is Noah Kaye, Oppenheimer.

Maybe if we can just start with the top line. Your comments around devices being down high single digits and you pointed to EMEA. Is high-single digit decline year-over-year your view of where the market is going to be?

I'll start and then Tom may want to answer. I would say, no. The market the market build for devices is probably anywhere from zero to 3% growth. But we had a very strong 2018 with our Linky program in France and some of our other programs. So it's more a function of projects that really ramped up in 2018 and they won't continue into 2019.

No, I think Joan nailed it. It is more a function of specific project transitions and country specific rollouts and timing. I don't know that I would reference a full trend based on that. There's no other way I would think about that. Noah, the way we thought about that is in the past we talked about the migration from standard meters to smart meters. This is a similar transition that's occurring over time. It's now just expressing between what we're calling devices and networks.

I guess just a related question for the avoidance of doubt. I mean, last quarter you talked about just not being able to fill some of that book and ship business because of the supply constraints. Is that embedded in your guidance or is that no longer an issue in your view for '19?

What we do see is the supply chain environment starting to improve, the fall is actually happening it take a little while to work through. We think the supply chain environment will continue to improve during 2019, and that's reflected in the guidance. So the revenue overhang I guess that we saw back in the back half of last year continues on. Although, it's probably at a lower rate in this year, but should improve throughout 2019.

And then I guess just turning to thinking about the profitability profile of the business. You had a nice strong bookings number in network, so backlog looks good exiting the year. Really where you're losing revenues is in that lower margin devices business and you're going to see -- you said close to double digit on the other side. And I'm not sure if I'm doing my math right. But just taking the midpoint of your guidance and working backwards from the assumptions. I'm coming out to around, call it, 250 type EBITDA million number implied in the guidance, which is healthy but about 40 bps margin expansion year-over-year. And I guess just wanted to understand you called out tariffs. Are there any other considerations that we should really be thinking about as a headwind to profitability in '19? It seems like a little bit slower than we might look for.

Well, again if you went to the Slide 17 in the deck that I talk to, the net operational improvement of $0.46 per share has a lot of puts and takes in it. So it has higher revenue. And again, the higher revenue is really going to be coming from networked solutions and outcomes and obviously lowering devices, have benefits of restructuring in there. But there is some offsets in there. So if you recall, we zeroed out variable comp in 2018. And so we have restored some various comp in 2019. So that would all be netted out in there as well. As well as just the real Silver Springs business in particular, there is some general lumpiness when we have projects in software deployments to come in and out, so that's all factored in. We’re looking at our backlog, which is quite healthy as you indicated. And we know the profile with that that there's quite a roll off in 2019, and that's been reflected in our guidance as well.

And if I can just squeeze one more in. Just for my own comprehension. I think the tariff and the incremental headwinds. Where are you really expecting that to come from? Is that list three China? Can you just give us a little bit of color? Because I think previously, we've seen it as more manageable, so just wanted to understand how it’s playing out for you this year.

It is generally an east-west not a north-south phenomenon, meaning China-based or Asia-based goods tend to be more affected; the types of commodities that are generally in focus there are metals; so casting types of products; as well as cables and connectors. Those are some of the types of things that are in play. Obviously, the environment is pretty fluid, ongoing global discussions probably even as we speak. So it's tough to call, but we wanted to make sure we were as transparent as we could be. Clearly, our objective is to mitigate as much of that as possible by working within the rules but finding better ways that we can develop our supply chain to sidestep some of those things. So that's our ongoing mission but I just pointed out to what we saw today.

Next question will come from Jeff Osborne, Cowen and Company.

Couple questions on my end. I'm just curious on the philosophy or how you sat down and came up with the guidance. Is any approach in terms of your top line assumptions different in years past, or more conservative, more aggressive? I'm just curious as you look at backlog, what the philosophy was and if there is any change versus prior years?

No, I would say it's a similar process. Obviously, there is new segment. So this time last year we would have been integrating Silver Springs when we had our old electric gas and watering, so there are new segment. So we have to go through the progress of re-casting history, which we shared last week, but it’s the same process. We look at the backlog. We look at the sales funnels. We obviously talk with the business leaders and come up with what we think is a reasonable range.

And then Joan, I don’t know if you can remind me. But when you came up with the 2018 guidance with some of those non-recurring tax benefits, were those included and called out. I forget from a year-ago.

No, most of the tax benefits that occurred in 2018, most of them occurred in Q4. So if you looked at our Q4 2018 non-GAAP tax rate it's actually negative 2%. So we had several large settlements of different countries, multi-year tax returns that settled, as well as we had some statute limitations, expirations that rolled off at the end of the year. So it was really Q4 phenomena.

And then is there any way that we can peel back the onion on Slide 17 of the $0.46 in terms of what the benefit is on an absolute dollar basis with restructuring in '19 and '20. In particular '19, I guess as you have your $140 million program. And then you called out variable comp and how people weren't paid last year but want to be paid this year. What are those two numbers in particular would be helpful?

I'm not going to give you the variable comp, that's a pretty sensitive number. But we have talked about restructuring, so I can give you that one. So as Phillip mentioned in his opening comments, we've laid out three restructuring programs, the 2016 to 2018 in Silver Spring, which totaled about $140 million. We're a little over $70 million through '18 of that. So think about it as roughly another $70 million to come, split equally between '19 and '20. And as I look at '19 think about it equally between above the line and below the line, so roughly $17 million, $18 million gross margin and $17 million, $18 million in OpEx and those are embedded in our guidance.

And then is it safe to say that the variable comp would be the next. You said there are multiple puts and takes. Is restructuring the largest and variable comp the second largest? If you want to break it out.

No I mean, the revenue fall through is quite large as well, right. So we have revenue growth embedded here as well. So again, there's lots of numbers but revenue fall through is the sizable number. The variable comp add-back. You've got mix. You've got all different things that go even merits that was happened late in '18, you get the run rate effect in the '19. So there's all things we have to factor in.

The last one I had was just on the supply chain constraints. And can you talk about specifically what you're doing to mitigate that and give investors comfort for the second half of '19 as that improves? Are you putting cash deposits on future supply, or developing or qualifying new suppliers? Anything you can give us just anecdote or specific would be helpful.

Sure, I can take that one. What we have been doing is a number of activities. And you mentioned some of the bigger ones. It is multi-sourcing components to make sure that we can have the best diversity of supply as products roll in. We've been working hard on making sure we have forecast accuracy. We have buffered inventory. So bought more when it was available and you can see that in our balance sheet today to try to be prepared. The part of our business that’s most exposed here is the book and ship business, and making sure that we could do our best job to anticipate that and give us diversity of supply. So multi-sourcing its inventory buffering is building ahead on selected products that we had really the best medicine. And that's what we are indeed seeing and finding a way to better manage situation. We do see lead times starting to come down, while Phillip quoted the number, the number of components that are still more than six months lead time are many hundreds. But it's improved by about 15% quarter-over-quarter in terms of end using that as your measure of the health of the supply chain. We do anticipate that it will take a couple more quarters for this to fully work its way through, but do see steady improvement and better environment for the second half of the year based on the visibility we have today.

And then Jeff maybe just a structural comment that says, this is an identified plan many line items and owners that it is administered and reported on very, very regularly. There is quite a lot of structure around the achievement of these improvements.

And maybe just a follow-up on that, if you don’t mind. So is there a way to potentially, maybe it wasn’t an issue. But some of your competitors have indicated that there was lost revenue in '18. Did you lose any revenue in '18 or is there anything in the guidance as it relates to losing revenue in '19, as it relates to components issue?

We did on a recent call actually bring revenue number down by $70 million, and talked about the effect specifically on our purchase order business, which is shorter cycle within the quarter business, which is what led to providing that number of the 550 parts that are over six months to give a feeling for the challenge of capturing some of that business. And through both inventory buffering and the initiatives that Tom has talked about, we feel that we've accurately captured in the revenue and margin guidance, or EPS guidance that we've captured the effects of the supply-chain constraints in the numbers provided.

And as Tom indicated, there are still are some hangover effect if you will on net revenue, probably more so in the first half of the year than the second.

And I apologize for squeezing in one last one if you don’t mind. But Joan, the tax benefit that you had in the fourth quarter, that was unforeseen as it relates to the original guidance. So if some of those jurisdictions hadn’t showed up, obviously, the numbers would have been worst. But I'm just trying to get a sense of did you have that in the plan but you just weren't sure if they would come in. How do we think about the $0.30 headwind that you flagged in Slide 17 of the $0.28? I'm just trying to reconcile all the moving pieces on tax and what you do when and…

If you go back to our last call, we guided to an EPS range and that had probably about $5 million or $6 million of a discrete tax benefit embedded in the range, so that was basically about half of what we got. So the rest of it was settlements that came in that we weren't expecting to come in, or statute limitation exploration. So you might have a lots of different jurisdictions where the statute expires in 12/31, you really don't know whether or not you are going to have an issue with that particular jurisdiction until it expires. And so we don't typically bake that in the forecast. But I would say about half of it was baked in the EPS guidance that we provided you.

From JMP Securities, Joe Osha has the next question.

A couple of things. First, back to this issue of the warranty charges in Q4. The fact that those aren’t going to recur Joan per your comments when combined with the margin guidance suggest that there might maybe some other headwinds in the first part of the year, given the fact that the gross margin is flattish, or am I missing something?

No, it’s primarily going to be the timing of software related deployment. So if you have a lot of software in Q4 that doesn't reoccur in Q1, you're going to have a natural dip in gross margin from that. The special warranty not recurring in Q1 will go the opposite way, so it's puts and takes with a lot of different opposite way. So it's puts and takes a lot of different things. But I would say software is the biggest one that goes the other way.

And the idea of being then that those don't recur in the second half?

Well again, a software deployment is very project based. So with particular customers, they don't necessarily go every single quarter. So in the fourth quarter, we did have some large projects that concluded that allowed us to recognize the software revenue and that tends to be very high margin business.

Second one then would be as you think about the second half of the year, thank you for the detail on how those cost savings break down but to return to an earlier question. Is there any organic improvement in gross margins that occurs as the revenue rises? Or should we basically think about gross margin as being static with the exception of these benefits flowing through from the cost reduction efforts?

Well again, there's mix in there as well. So to the extent our networks, solutions and outcomes business are growing, those are higher margin businesses than the device business, which are shrinking. So you are going to have the benefit of that mix as well.

So there is some organic improvement there. And then the last question would be I think we can see how EBITDA is trending. I'm wondering what your thoughts are about the business's ability to generate free cash flow in 2019?

I think the free cash flow continues to be very healthy for the year. This year, we generated about $50 million of free cash flow. I would expect this to close to double that next year.

And is that just operational improvement or is that working capital management, or what's driving that…

It will a combination of both.

The next question will come from Pavel Molchanov, Raymond James.

InQ3 and Q4, as I recall on in talking about component shortages, the main culprit was MLCCs. And many of the component suppliers and consumers have commented in the last two, three months that the situation with MLCCs has largely normalized. Is that consistent with what you're seeing? And if so, which other components continue to be a headwind right now?

MLCCs are starting to normalize from our point of view. I don't want to go too technical, but depends on the case size some of the smaller sizes are in a little bit better shape than some of the legacy technology, some of the older versions. So MLCC is getting better, but I would say not quite solved yet, other passives and discreet, so MOSFETs being another one that tends to be troubling. So that’s in MLCC chip resistors. So you get some hotspots in each one of those depending on age of technology and specific type.

Follow up a broader question we just had the biggest electric utility in the Western United States go bankrupt. Has that had any impact, positive or negative, on AMI modernization, the willingness of utilities to invest in modernizing the grid, perhaps from the standpoint of trying to avoid the infrastructure issues that PG&E obviously ran into?

So I would say, yes, it has a beneficial -- I mean it's a sad way to say the beneficial impact. The regulatory conferences and many utility conferences that I attend, the discussion is about reliability and resiliency. It's not just wildfires in California that has to do with polar bombs and super storm Sandy and the hurricane sitting in the Southern United States. But there is a broadening awareness that volatile climatic events are going to require investments and hardening electric gas and water infrastructure. And therefore, we feel that that is a sign that additional grid infrastructure is going to be made in the coming years.

Our next question will come from David Katter, Baird.

I wanted to ask a quick one on the backlog. It seems like sequentially you booked some longer tail business. So I was wondering if you could talk some of the dynamics that play there. And whether that's a trend you're seeing with the longer -- total backlog going up and the 12 months going down?

The ratio was in our backlog, it’s just a slight change. I mean we came with the record total backlog at 3.17 and the 12 months came out about 1.35 in change. So it's flat on that perspective. As we said on the call, the mix associated with that two thirds of that heavily weighted towards the network business. And when you do that, you normally see a three to four year roll-off of backlog. So for the additions we have and the amount that I see in one year that ratio pretty much fit to the models that we see for the profile we have in backlog there.

And then one more quick one. I know you touched on this but on the restructuring with the $70 million over the next two years. I was just wondering at a high level if you could talk about how some of the supply chain headwinds have impacted the cadence of the restructuring, which was focused on the supply chain. Has that delayed progress? Or how have you managed to navigate both the headwinds and the need to optimize the supply chain?

I would say I don’t know that it has materially changed it. It certainly has put some extra stress on the team and probably it's used some outside resources here and there to best cope with the situation. But I would say I don’t know that it has materially changed the timing of what you see in motion. Certainly, it created the financial impact that you saw but I don't know that I would talk too much that it has affected the timing of programs that are in flight.

That said had we not been in the midst of restructuring, I think the supply chain hit is what has hurt us a lot more than they did. So the ability to leverage the purchasing power of contract manufacturers was very useful.

And everyone, at this time, there are no further questions. I will hand the conference back to Philip Mezey for any additional or closing remarks.

Thank you everyone. So again, tremendous amount of progress that was made in 2018 from a strategic point of view; in terms of not only our restructuring plans, but obviously the acquisition and integration of Silver Spring, which has gone extremely well; the integration of all of our financial systems and back offices; lot of heavy lifting that's gone on in 2018, some of which is obscured as you know by the supply chain headwinds that we face. And with that significant progress, we feel very strongly that the momentum that we're entering '19 is quite strong. And however based upon the misses that we had in 2018, we are appropriately projecting some continued first half margin pressure, and think that as absolutely the prudent thing for us to do. But the opportunity for us to continue to drive margins in the second half is there and in place and projects are identified. So thank you all for your interest and look forward to talking 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 past code of 9539336, or you can go to the company's Web site www.itroncom. That does conclude today's conference. Thank you all for your participation and you may now disconnect.