Good morning ladies and gentlemen and welcome to the Itron's Fourth Quarter 2022 Earnings Conference Call. [Operator Instructions] Please note that today's conference is being recorded. I will now hand the conference over to your speaker host today, David Means, Director of Investor Relations. Please go ahead.

Thank you, operator. Good morning and welcome to Itron's fourth quarter 2022 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 website under the Investor Relations tab. On the call today, we have Tom Dietrich, Itron's President and Chief Executive Officer; and Joan Hooper, Senior Vice President and Chief Financial 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 Tom, 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 in 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 that were presented in today's earnings release in the comments made during this conference call and in the Risk Factors section of our Form 10-K and other reports and filings with the Securities and Exchange Commission. All company comments, estimates or forward-looking statements are made in a good faith attempt to provide appropriate insight to our current and future operating and financial environment. Materials discussed today, February 27, 2023, may materially change and we do not undertake any duty to update any of our forward-looking statements. Now, please turn to Page 4 of the presentation and turn the call over to our CEO, Tom Deitrich.

Thank you, David. Good morning and thank you for joining us. You will hear fourth quarter details from Joan coming up shortly but here is a brief overview of the quarter, revenue was $467 million. Adjusted EBITDA was $34 million and non-GAAP earnings per share was $0.71. Our fourth quarter financial results were a step in the right direction. The team executed well to convert and deliver additional components that were supplied late in the quarter which unlocked revenue and EBITDA ahead of our expectations. Turning to Slide 5. For the third consecutive quarter, we achieved a new record level for total backlog which reached $4.6 billion. Continued strong demand drove bookings in the fourth quarter to $898 million or a 1.9 book-to-bill ratio. The full year bookings were approximately $2.5 billion which is a book-to-bill ratio of 1.4. Our key bookings in the fourth quarter continued to be driven by distributed intelligence and analytics over our network technologies. Our network solution to outcomes offerings continue to contribute over 90% of the total backlog. Itron received regulatory approval for their AMI 2.0 program which is an important step in moving forward with deploying our Gen 5 Riva solution. This includes our distributed intelligence capabilities across their service territory in Ontario, Canada to support grid reliability, resiliency and consumer engagement initiatives. In the water vertical, the city of Detroit is upgrading to our water network and Itron will also provide managed services. CPS Energy extended our SaaS contract by an additional 10-plus years which strengthens our technology partnership in San Antonio, Texas, a fast-growing community that is now leveraging Itron's network technology to deploy AMI and distribution automation across electricity and gas as well as water in conjunction with a sister utility saws. We are now excited to begin deployment of…

Thank you. As Tom mentioned, we received earlier than anticipated component supply late in the fourth quarter, allowing us to ship and recognize more revenue than expected. The additional component supply had been anticipated in Q1 of '23, so a portion of Q4 strong performance was a shift from Q1. I'll provide more color on our 2023 expectations but first, let me cover fourth quarter and fiscal year 2022 results. Please turn to Slide 7 for a summary of consolidated GAAP results. Fourth quarter revenue of $467 million decreased 4% versus last year and was flat in constant currency. Revenue declined year-over-year due to the sale of our C&I gas business in our Device Solutions segment. This decline was offset by higher revenue in both our Network Solutions and Outcomes segments. Gross margin for the quarter was 30.1%, 510 basis points higher than last year, primarily due to favorable mix partially offset by elevated component costs. GAAP net income of $22 million or $0.49 per diluted share compares with a net loss of $59 million or $1.30 per share in the prior year. The improvement in the current period was due to higher GAAP operating income, partially offset by a lower tax benefit. Regarding non-GAAP metrics on Slide 8. Non-GAAP operating income was $25 million. Adjusted EBITDA was $34 million. Non-GAAP net income for the quarter was $32 million or $0.71 per diluted share. Free cash flow was negative $18 million in Q4, driven by an increase in working capital, particularly inventory. We will continue to invest in critical components as they become available. Looking at revenue by business segment on Slide 9. Device Solutions revenue was $100 million, a $42 million or 27% year-over-year decline on a constant currency basis. The decline was due to the sale of our…

Thank you, Joan. I would like to close today by highlighting our expanding distributed intelligence offerings. To date, we have shipped approximately 5.8 million DI capable endpoints and have approximately 7 million applications in operations today. Through partnerships, our proven and scalable DI platform will enable a new and innovative approach to improving grid resiliency and transforming the relationship between utilities and consumers. We recently announced a partnership with Smart Energy Water to transform the utility consumer relationship to enable the management of distributed energy resources. That builds upon our partnership ecosystem that already includes our long-term collaboration with Microsoft to accelerate cloud adoption and the next generation of consumer and grid solutions for the utility and smart city industries. With partnerships, we will transform how end users view and manage their energy and how utilities meet the demands of a rapidly changing industry. Thank you, everyone, for joining today. Operator, please open the line for some questions.

[Operator Instructions] Our first question coming from the line of Noah Kaye with Oppenheimer.

And Tom, I want to pick up right where you left off with remarks around the expansion of the DI platform. Can you talk a little bit about the interest you've gotten from different players in the DI ecosystem following your announcement in January? Who are you seeing the demand coming more strongly from? And I think in the release, you mentioned the revenue opportunities around this would really start to manifest in 2024 but maybe give us a sense of what the revenue model might actually look like for some of the DI offerings?

Sure. Thanks, Noah. We see interest in DI applications from a broad swath of the industry. Certainly, there are utilities that want to develop their own applications and then a host of ecosystem partners from large companies to small companies. that are interested. The applications that they are working on tend to be a mix of great efficiency types of things as well as consumer engagement types of applications. It really depends on what problem they're trying to solve. Revenue model, it is largely a maybe as a subscription kind of model where an application is used for a certain period of time and on a per usage basis or a per time basis. And the portion of that revenue that accrues to Itron is dependent on whether it's power application or whether it's a third-party if it's a third party, there's a hosting fee and think a little more we used to be in our owned applications. It's quite a bit higher in terms of the revenue that we get. You're right in terms of the timing. Think of it as a case where networks are deployed, initial applications and AMI or use case is stabilized by the utility and then they start layering in incremental services. So it tends to follow on in terms of deployments by maybe 18 months or so and that's where you're starting to see the scalability now I mentioned in our prerecorded remarks of about 7 million applications running in the field today, sometimes 1 per end point oftentimes multiple applications running in parallel in the endpoint more like a smartphone kind of model in terms of how it.

Very helpful. I might leave it for others to pull on the thread of what that means for outcomes. I do want to ask just a couple of clarifying questions around the outlook. It sounded like we had some revenue shift from 1Q '23 into 4Q. So if I just add a little bit to 1Q, it really seems like the revenue outlook for the full year is annualizing 1Q would have been with not much improvement. So just given your comments around expectations for the improving supply chain, I wonder if we could square that up a little bit. How kind of conservative is the outlook in terms of the revenue run rate? And what kind of level of increase are you assuming as we go throughout the year?

Yes. Let me take a stab at that. So the outlook that we provided is based on our current expectations after discussions with suppliers in terms of when supply will arise. Certainly, to the extent that the suppliers are able to excite our current view there is upside to the view. But right now, what we would say is that we expect gradual improvement through the year. And so all things being normal, we would expect Q1 to be the low point, we would continue to grow through the year. So the range is pretty wide. And as you said, if you take the kind of high end of the range, it's a different assumption than the low-end of the range. But I do think we will see somewhere around the midpoint or higher of revenue growth which would be over 6%.

And the way to unpack that, if I add one additional point of color is we're -- it's fourth quarter definitely demonstrated the upside potential in terms of being able to turn that revenue. We got components very late in the quarter and the team really did an exceptional job of turning that customers are eager for the products and the technology that we provide. So as we get those components, we want to be in a position to turn them as quickly as we can. We do think, as Joan mentioned, that there will be a view of improving supply over the year with variations and some volatility in terms of timing, certainly in the first half of the year.

And our next question coming from the line of Jeff Osborne with Cowen.

Just a couple of quick ones here. I was wondering, Joan, can you quantify what the semiconductor impact was for the quarter and the full year? Which one do you think...

Yes, I would say the fourth quarter was pretty similar to the prior quarters we experienced in 2022. So somewhere call it, $100 million or so a quarter, maybe slightly better than Q4. But exiting the year, we probably had about $400 million of revenue that was constrained because of the constraints.

Got it. And then on the restructuring, just a couple of quick housekeeping there. The $14 million to $17 million, is the majority of that savings on the cost of goods line?

Yes. I'd say 80% or so is in the cost of good line.

Got it. And then what was the outsourced production mix? And then what do you anticipate that to be sort of post these actions?

We are probably running around 45%, maybe 50% quarter-to-quarter internal, external today. And I think this takes it up probably another 5% or so. So by the time we finish it off meaningfully above 50% in terms of the amount of outsourced production.

Got it. And then my last one, Tom, was just on the book-to-bill. Obviously, a great Q4. You implied that Q1 would be a bit softer seasonally. Do you anticipate it to be above one for the year? Or how should we think about just the level of activity that you're quoting?

We do definitely think that the book-to-bill for the full year will be above 1:1 pipeline of opportunities remains very rich, very strong based on needs from our customers for resiliency and reliability as well as new technology applications, whether they be consumer side or EV and terms integration. So a rich set of opportunities and we're bullish on what the year will bring in terms of bookings. That said, the only caution I would provide is it will be a little bit lumpy quarter-to-quarter just with normal seasonality as well as timing of individual contracts come through.

And our next question coming from the line of Chip Moore EF Hutton Group.

So I wanted to ask one on the regulatory environment. It seems like more and more states are looking at performance-based mechanisms to meet their goals. Is that something you're seeing with your customers for some of the more advanced solutions.

Indeed, the regulatory environment continues to understand the need for new technology and new models the amount of states that allow some type of performance-based rates or capitalization is about -- is nearly 40 out of the 50 right now and plenty of changes underneath each one of those along the way. So in general, the regulatory model is moving in the direction of enabling the technologies that we've been investing in.

Great to hear. And Joan, you talked about the weighting in the back half on the guidance. Can you give us any color on sort of mix and perhaps cadence of implications for cadence of margins for the year?

Yes. I mean, I would say for the full year, we would look at margins being pretty similar to what they what they were in full year '22. So certainly, as we get more supply, you get the benefit of more factory even out the production and therefore, less absorption synergies but we're also fortunate would create things to that level. So for the full year, I would say, 22 levels are pretty consistent. Those will start out slower in the first quarter and then grow through the year. So for the first quarter, I would say the gross margin to be similar to Q1 of last year.

That's super helpful. And just more housekeeping, Joan, on the restructuring, can you just remind us where we are on the prior programs just to keep us abreast with the new program?

Yes. The 2020 program is basically complete. And so we still are working on our 2021 program which should be complete mostly maybe early next year and those are all on track. If anything, the payback has gotten a little bit higher because we just had a little bit less severance than we expected when we first initially booked the plan. So those are going according to plan. And again, this one will be -- the savings should be complete by early '22, the cash out is really $24 million to $26 million. So really no impact on cash for '23.

Got it. Okay. And sorry, one last one. It looked like there was an impairment charge on a software project. Any more there?

Yes. We had a software project cloud-based project going out for really the last couple of years and we continue to struggle with the vendor in terms of being able to deliver software that was born the functionality that we were expecting. So we made a determination in Q4 to basically exit that project and what we ended up having to write off was capitalize both external costs as well as income costs for a total of about $8.7 million.

And our next question coming from the line of Kashy Harrison with Piper Sandler.

So you've previously indicated 2024 OpEx target of, I think, 22% to 23% of sales. 2022 came in at 26% which is slightly up from '21. And so I'm just curious how you're thinking about the progression of OpEx for '23 and then where your confidence level is on the 2024 target.

Yes. So we did the 2024 targets in the fall of '21. And at that point, we did not expect the kind of supply in strength that we saw in '22 and continue to see in '23. So I would say while those are still our longer-term targets. I don't believe those targets will be met in 2024. That said, the OpEx target of 22% to 23% is the longer-term target. It's just I think that's going to be pushed out a year or so as we work through the backlog. I think it has been delayed because of the supply component. So rate long-term targets do not expect it to be 2024.

Helpful. And then as for my follow-up, I just wanted to touch just to -- just to ask a question on free cash flow. I think you generated just under $5 million in 2022. How are you thinking about free cash flow during 2023? And then to the extent that we do get some sort of recovery in the supply chain environment and you unlock that $100 million per quarter Network Solutions revenue. What is -- how do you think about use of potential free cash flow?

Yes. So the cash flow was a positive $5 million for all '22. It was actually negative in the fourth quarter to the tune of around $18 million and a lot of that was continuing to invest in inventory. So we'll continue to as components become available and test to make sure we've got all the components necessary. My expectation for free cash flow for 2023 is negative for the full year really for a couple of reasons. One is we have some large cash tax payments due in the second quarter. Those relate to 2 things. One is settling from international tough tax audits that we have crude but haven't paid. But the bigger issue is the legislative change that happened with the 2017 tax reform which essentially forced you to capitalizing R&D. We were expecting those laws to get overturned as well as everybody else and they haven't yet. So the current tax law relative to the capitalization of R&D creates quite a bit larger cash tax payments. So as an example, just cash tax alone is going to be up something like $25 million year-over-year. In addition, we will continue to invest in working capital as we grow the business. So our guidance is to grow the business. And typically when that happens, you've kind of growth in receivables and as I mentioned, we'll continue to make sure we grow. So while it's negative for the full year, I expect it to turn in the second half, so expect and 2 to be negative. Q1 also is the quarter where we will pay a discretionary bonus to the nonexecutive team. And Q2 is the large cash payments by the time we get to keep the rating for more earnings are starting to improve versus the first half. I expect cash flow to be positive. But again, for the full year, something in the range of like minus $25 million to minus $35 million.

And our next question coming from the line of Ben Kallo with Baird.

Congrats on the bookings. Just quickly, maybe, Tom, just the environment for new projects than maybe bookings this quarter explains it all but there's been some reports of smaller utilities, they more beauty and co-op of not being able to implement plans because of variety of electricity prices and that effect at all. And then I'll have a couple of follow-ups.

Very good. So the bookings environment or the pipeline of opportunities, maybe correctly stated, it continues to be very robust. The need for investment in resiliency and reliability, whether you are large or small utility are there. The need to prepare your environment for growth NAVs and continued growth in things like rooftop solar means an awful lot of investment in the distribution grid. So we feel very bullish about what the future will bring for us in terms of demand from customers. And that is something we hear directly from customers. The range of opportunities continues to expand. We launched a product called the distributed intelligence network interface card, really that allows us to put DI into third-party types of devices like smart panels and others to, again, continue to broaden out the range of applications. On your point about smaller utilities delaying investments based on affordability and energy prices. I would say I've seen that on aging but it certainly hasn't been widespread. There are a broad range of municipalities and cities that are investing and investor IOUs have been investing very aggressively and driving up big bookings projects that you see in our backlog today. The work that's going on certainly is multiyear and probably will be decade growth in terms of needs of the electricity grid and water systems and that is good future growth for the company.

And a portion of the backlog was signed before we got to inflationary environment. And just how do we think about that backlog and pricing? And how that impacts margins or if you're able to reprice with customers going forward?

Sure. I can jump in on that one and then perhaps, Joan, you want to add anything additional. The work that we've been doing over the last year plus on changing contracts for new agreements to provide a little bit more flexibility around pricing specifically and in the inflationary environment. That has gone well. I would say that vast majority of new bookings are in a place where you've got to a little bit better protection against inflation. That said, we still have a fair amount of overhang of bookings prior to that change in our operations more than a year ago. And that work has sometimes been with us and sometimes we haven't been able to achieve a price increase. So I would say that in terms of backlog, it's inflation protected. We're above 1/3 but probably less than half in terms of what the size of that is. But new projects as they continue to roll through and as deliveries happen, it rolls off that stuff where we do have a margin pitch and gets us into a better zipco [ph] from a margin perspective.

And just maybe lastly, just could you remind us of the cadence of especially outcomes. I think I saw the service revenue tick up more but just like other trajectory of how things get implemented with service before it hit something else and then the different margin profile.

Sure. So a few steps on the outcomes side of things that I think are helpful. So roughly 75% of that revenue is recurring revenue. The majority of that is sort of staff or service-based revenue which has a meaningful higher margin which is why outcomes tends to run materially above the gross margin line compared to network or even devices. The timing of outcomes revenues, generally, let's call it, 18 months after the network deployment in terms of timing, it changes a little bit project to project but that's a good time of the year number to understand what the timing would be. And that revenue tends to come over a very long period of time. So I think 10-year SaaS or managed service agreements, so you get that revenue over a very long period of time.

Now our next question coming from the line of from Graham Price with Raymond James.

It's Pavel Molchanov here. Same question I asked a few months ago in this kind of quasi recessionary environment, is there any improvement in terms of multiples from an M&A perspective as you look at private companies?

I think that valuations are certainly coming down. There's still a meaningful difference between I would say, hardware valuations and software valuations where software tends to be a bit higher. But indeed, valuations are coming down a bit. large-scale enterprise software valuations still tend to be pretty rich compared to the traditional valuation that you've seen but coming down a little.

Okay. Can you get an update also on demand response business. I mean it's obviously one slice of outcomes but we get these extreme weather dynamics which I would imagine pushes up the appetite among ISOs for demand response.

Indeed, the demand response world continues to move along pretty nicely. And honestly, what I've seen is not only using that capability from a traditional demand response, let's shave the peak off and deal with a very high pressure kind of situation, using that capability much more as a normal course of practice to understand when to charge things like EVs and how rooftop solar much more effectively. So I think it's moving from a demand response peak shaving kind of situation to much more of a localized control for distributed energy resource management is where the industry tends to be heading and a lot of the discussions we have with our customers accomplish both of those use cases.

And our next question coming from the line of Marin Malloy with Johnson Rice & Company.

I wanted to ask about the guidance. And I would have anticipated for the level of revenue that you're guiding to, that the earnings per share would be higher. Could you maybe give us some help in terms of the magnitude for the variable comp that you talked about? And also, any help would be appreciated on the gross profit margin side.

Yes. I think I answered the gross profit already. So from an annual perspective, I think at or slightly above the full year 2022 level. In terms of OpEx, I think you've sort of talked about that we're going to continue to be a little bit higher as the revenue is not at the scale level. So for OpEx, I think it's also in a percentage similar to 2022 which would imply higher dollar OpEx between '22 and '23. And as I mentioned on the call, think a lot of that is the variable comps. So I really don't want to talk about exactly how much our variable comp is but it was materially enough that we mentioned it. The other thing I would point to 2022 is EPS versus 2023, we normalized for you in the discussion point. So the tax rate in overall '22 was 4%. The tax rate in '23 is 28%. And so we had a lot of favorable discrete mostly linked to statute limitations expirations in '22. It can normalize for the same tax rate year-to-year. 2022 would have been $0.85 on the midpoint of our guidance is $0.90 so roughly 6%. And again, we've built the guidance based on our current view of supplier commitments. And to the extent they're better than that, more predictable, we'll be in a position to update the guidance in the August time frame.

Okay, that's helpful. Then in terms of the record backlog here, can you break down maybe what -- how much of that is outcomes? And how much of that is network solutions.

Yes. I mean, over 90% is networks and outcomes. It doesn't materially change much from quarter to quarter.

Thank you. And I will now turn the call back over to Mr. Tom Dietrich for any closing remarks.

Very good. Thank you all for joining us today. We look forward to updating you on our progress after Q1. Thanks, all.

Ladies and gentlemen, that does conclude our conference for today. Thank you for your participation. You may now disconnect.