February 13, 2015 Itron, Inc. Current Recommendation Prior Recommendation Neutral Date of Last Change 02/08/2015 Current Price (02/12/15) $35.87 Target Price $33.00 SUMMARY DATA UNDERPERFORM 52-Week High $43.35 52-Week Low $33.64 One-Year Return (%) -8.47 Beta 1.86 Average Daily Volume (sh) 323,340 Shares Outstanding (mil) 39 Market Capitalization ($mil) $1,399 Short Interest Ratio (days) 9.76 Institutional Ownership (%) N/A Insider Ownership (%) N/A Annual Cash Dividend $0.00 Dividend Yield (%) 0.00 5-Yr. Historical Growth Rates Sales (%) -0.3 Earnings Per Share (%) -12.3 Dividend (%) N/A using TTM EPS 22.4 using 2015 Estimate 20.2 using 2016 Estimate 14.9 Zacks Rank *: Short Term 1 3 months outlook 5 - Strong Sell * Definition / Disclosure on last page SUMMARY Risk Level * (ITRI-NASDAQ) Itron s adjusted earnings remained flat year over year at $0.36 per share in the fourth-quarter of 2014 and fell short of the Zacks Consensus Estimate of $0.39. Revenues in the quarter declined 2.7% year over year to $510 million due to unfavorable currency fluctuations. Itron guided adjusted earnings per share for 2015 in the range of $1.60 and $2.00 and revenue to be around $1.8 and $1.9 billion. Itron remains concerned about the change in exchange rates that will have a large impact on 2015 results - approximately of $150 million on revenues and $0.20 on earnings per share. Further, the planned product exits in the electricity segment will impact revenues by $50 million compared with 2014. Moreover, business challenges and near-term weakness in EMEA will also hurt growth. We thus maintain our Underperform recommendation on Itron with a target price of $33.00. Average, Type of Stock Mid-Value Industry Elec Test Equip Zacks Industry Rank * 222 out of 267 ZACKS CONSENSUS ESTIMATES Revenue Estimates (In millions of $) Q1 Q2 Q3 Q4 Year (Mar) (Jun) (Sep) (Dec) (Dec) 2013 448 A 482 A 495 A 524 A 1,949 A 2014 475 A 489 A 496 A 510 A 1,971 A 2015 433 E 451 E 491 E 475 E 1,850 E 2016 2,108 E Note: 2014 Quarterly figures will not add up due to rounding off. Earnings Per Share Estimates (EPS is operating earnings before non-recurring items, but including employee stock options expenses) Q1 Q2 Q3 Q4 Year (Mar) (Jun) (Sep) (Dec) (Dec) 2013 $0.31 A $0.58 A $0.65 A $0.36 A $1.90 A 2014 $0.31 A $0.54 A $0.39 A $0.36 A $1.60 A 2015 $0.39 E $0.46 E $0.60 E $0.33 E $1.78 E 2016 $2.40 E Projected EPS Growth - Next 5 Years % 11 2015 Zacks Investment Research, All Rights reserved. www.zacks.com 10 S. Riverside Plaza, Chicago IL 60606
RECENT NEWS Itron Lags Q4 Earnings; Currency to Impact 2015 Results Feb 11, 2015 Shares of Itron lost over 3% and closed at $36.01 on Feb 11, after the company reported its fourthquarter and fiscal 2014 results. Although, adjusted earnings remained flat year over year at $0.36 per share in the reported quarter, it fell short of the Zacks Consensus Estimate of $0.39. Including one-time items, such as amortization, restructuring and acquisition-related expenses, the company reported a loss of $1.25 per share, narrower than the year-ago quarter s loss of $3.93 a share. Operational Update Total revenue declined 2.7% to $510 million from $524 million in the year-ago quarter. Revenues, however, surpassed the Zacks Consensus Estimate of $476 million. Improvement in revenues in each segment Electricity, Gas and Water were offset by currency fluctuations. Cost of goods sold went down to $355 million from $358.8 million in the prior-year quarter. Gross profit also decreased 6% year over year to $154.8 million. Gross margin decreased 120 basis points (bps) to 30.3% primarily due to an unfavorable product mix in the Gas and Water segments, partially offset by improved performance in Electricity. Adjusted operating expenses increased marginally to $125.5 million from $126.7 million in the year-ago quarter. Adjusted operating profit decreased 23% year over year to $29 million. Including one-time items, Itron reported an operating loss of $49 million in the quarter, narrower from the loss of $149 million in the year-ago quarter. Segment Performance Electricity Segment: Net sales at the Electricity Segment decreased 1.7% year over year to $226.7 million. The segment reported an adjusted operating income of $13.3 million compared with $1.3 million in the year-ago quarter. Gas Segment: The segment s sales went down 3% year over year to $149 million. Adjusted operating income for the quarter was $13.7 million, down 48.5% from $26.5 million in the year-ago quarter. Water Segment: The Water Segment reported sales of $134 million in the quarter, down 3.5% from $138.8 million in the prior-year quarter. Adjusted operating income for the quarter was $13.8 million, which plunged 32% from $20.4 million in the year-ago quarter. Financial Position Itron ended the quarter with cash and cash equivalents of $112.4 million versus $124.8 million as of 2013-end. The company generated cash flow from operations of $133 million in 2014 compared with $105 million in 2013. The debt-to-capitalization ratio was 31.2% as of Dec 31, 2014 as against 30.3% as of Dec 31, 2013. Free cash flow in the reported quarter was $4 million, compared with $24 million in the fourth quarter of 2013, largely due to the timing of collection of certain accounts receivables and cash disbursements for payables, partially offset by improved inventory management and lower capital expenditures. During the quarter, the company repurchased 599,813 shares for about $243.4 million. The repurchases Equity Research ITRI Page 2
were made under the $50 million share repurchase program authorized by its board of directors for a 12- month period beginning Mar 2013. On Feb 11, Itron was selected by the City of North Miami Beach water utility to help modernize its water distribution system and recover lost water. The utility will use Itron s advanced metering infrastructure (AMI), leak detection solution and cloud-based analytics to more effectively manage the delivery of water resources, reduce non-revenue water and conserve resources. Itron s water AMI solution will enable North Miami Beach to enhance customer service, protect revenue, forecast consumption, analyze flow and support district metering by leveraging detailed consumption and meter alerts collected by Itron Analytics. The Itron solution being deployed at North Miami Beach consists of water communication modules and acoustic leak sensors as well as cloud-based leak monitoring, network and Itron Analytics software applications. Installation of the solution will be complete in summer 2015. Restructuring Itron announced its plans to restructure the Electricity business segment and related general and administrative activities to improve operational efficiencies and reduce expenses. The company expects to substantially complete the plans by the end of 2016 and achieve annualized cost savings of approximately $40 million upon completion. The company estimates total pre-tax restructuring charges of $65 to $75 million and hopes to record the majority of the charges in the fourth quarter of 2014. Fiscal 2014 Performance Itron posted adjusted earnings of $1.60 per share for 2014, decreasing 15.8% from $1.90 a share in 2013. Higher gross profit was offset by increased operating expenses, resulting in the decline in earnings. Earnings also missed the Zacks Consensus Estimate by a penny. Including special items, the company reported a loss of $0.58 per share for the year compared with a loss of $3.74 in 2013. Revenues for the full year increased 1.1% year over year to $1.97 billion from $1.95 billion in 2013, driven by growth in the Water and Gas segments, partly offset by decrease in the Electricity segment. Revenues came ahead of the Zacks Consensus Estimate of $1.94 billion. Bookings and Backlog Itron had bookings of $648 million in the quarter. Total backlog increased 40% year over year and came in at $1.48 billion at 2014-end. 2015 Guidance Itron guided adjusted earnings per share for 2015 in the range of $1.60 and $2.00. The company expects revenue to be around $1.8 and $1.9 billion for the full year and assumes gross margin in the band of 32% to 33%. The company is concerned that the change in exchange rates will have a large impact on 2015 results, approximately of $150 million on revenues and $0.20 on earnings per share. Further, the planned product exits in the electricity segment will impact revenues by $50 million compared with 2014. Excluding these impacts, revenue growth in 2015 would be in the low to mid single digits. Moreover near-term weakness in EMEA will also hurt growth. Itron expects stronger revenue and earnings in the second half of 2015 due to project deployment schedules for several large contracts in backlog and timing of planned product cost reductions and manufacturing efficiency gains in the gas business. Equity Research ITRI Page 3
Additionally, the restructuring plans which will be put into operation in 2015 and 2016 will bring in sustained financial improvement in Electricity. Significant backlog expansion, operational efficiency projects and expanded services focus for smart cities and the Internet of Things (IOT), will drive revenue growth and improved profitability going forward. VALUATION Currently, shares of Itron Inc. are trading at 20.2x our 2015 EPS estimate of $1.78. The company s current trailing 12-month earnings multiple is 22.4x, compared with the 21.7x average for the peer group and 19.0x for the S&P 500. Over the last five years, Itron s shares have traded in a range of 7.3x to 32.0x trailing 12-months earnings. We have maintained our underperform recommendation on Itron, which indicates that it will perform below the overall market. Our $33 target price, 18.5x our 2015 EPS estimate, reflects this view. Key Indicators F1 F2 Est. 5-Yr EPS Gr% P/CF 5-Yr High 5-Yr Low Itron, Inc. (ITRI) 20.2 14.9 10.8 4.0 22.4 32.0 7.3 Industry Average 22.7 18.6 15.1 16.3 21.7 48.5 12.9 S&P 500 16.5 15.4 10.7 15.1 19.0 19.4 12.0 Ametek Inc. (AME) 19.2 17.6 13.6 18.5 20.5 25.1 14.7 Agilent Technologies Inc. (A) 22.8 19.7 10.8 9.4 12.9 35.5 11.3 Teradyne Inc. (TER) 19.6 14.1 12.1 8.1 15.7 28.4 5.5 National Instruments Corporation (NATI) 28.7 22.9 N/A 19.0 28.9 59.7 22.2 TTM is trailing 12 months; F1 is 2015 and F2 is 2016, CF is operating cash flow P/B Last Qtr. P/B 5-Yr High P/B 5-Yr Low ROE D/E Last Qtr. Div Yield Last Qtr. EV/EBITDA Itron, Inc. (ITRI) 1.7 2.4 1.0 7.3 0.3 0.0 11.5 Industry Average 2.9 2.9 2.9 14.4 0.2 0.7 16.0 S&P 500 5.3 9.8 3.2 25.5 N/A 2.1 N/A Equity Research ITRI Page 4
Earnings Surprise and Estimate Revision History NOTE THIS IS A NEWS-ONLY UPDATE; THE REST OF THIS REPORT HAS NOT BEEN UPDATED YET. Equity Research ITRI Page 5
OVERVIEW Founded in 1977 and headquartered in Liberty Lake, WA, Itron Inc., is a technology company and one of the leading global suppliers of a wide range of standard, advanced, and smart meters and meter communication systems, including networks and communication modules, software, and services. Itron s communications network platform supports robust and standards-based internet protocol, powerline-carrier (PLC), and cellular network protocols as per its global customer needs. Its software provides mobile and networked meter reading, customer care, billing, distribution design and analysis, forecasting, and load research. Itron s wide range of services includes delivery solutions and managed services onsite or through private cloud solutions. Itron offer solutions that enable electric and gas utilities to build smart grids to manage assets, secure revenue, lower operational costs, improve customer service, and enable demand response. Its solutions include standard meters and next-generation advanced and smart metering products, systems, and services, which ultimately empower and benefit consumers. Itron classifies its meters into three categories: Standard metering with no built-in remote reading communication technology Advanced metering with one-way communication of meter data Smart metering with two-way communication including remote meter configuration and upgrade (consisting primarily of Itron s OpenWay technology) Itron operates under three reportable segments: Electricity, Gas and Water. Electricity (41% of revenues in the third quarter of fiscal 2014) The products include standard electricity (electromechanical and electronic) meters; advanced electricity meters and communication modules; smart electricity meters; smart electricity communication modules; prepayment systems, including smart key, keypad, and smart card communication technologies; advanced systems including handheld, mobile, and fixed network collection technologies; smart network technologies; meter data management software; knowledge application solutions; and professional services including implementation, installation, consulting, and analysis Gas (30% of revenues in the third quarter of fiscal 2014) The products include standard gas meters; advanced gas meters and communication modules; smart gas meters; smart gas communication modules; prepayment systems, including smart key, keypad, and smart card communication technologies; advanced systems, including handheld, mobile, and fixed network collection technologies; smart network technologies; meter data management software; knowledge application solutions; and professional services, including implementation, installation, consulting, and analysis. Water (29% of revenues in the third quarter of fiscal 2014) The segment includes both global water and heat solutions. The products include standard water and heat meters; advanced and smart water meters and communication modules; smart heat meters; advanced systems including handheld, mobile, and fixed network collection technologies; meter data management software; knowledge application solutions; and professional services including implementation, installation, consulting, analysis, and system management. Equity Research ITRI Page 6
REASONS TO SELL Itron s third-quarter earnings declined 40% year over year to $0.39 per share affected by higher tax rate, increased professional fees and higher variable compensation. The higher tax rate in 2014 is was due to the expiration of the U.S. R&D tax credit, which has not yet been reinstated this year and by valuation allowances placed on certain deferred tax assets. Total revenue increased by $1 million to $496 million as growth in Gas and Water revenues were offset by lower revenues in the Electricity segment. Itron s estimates have been undergoing negative revision, reflecting lower revenue base, modest margin expectations for Electricity segment, currency impacts and higher operating expenses. Hence, we have downgraded our recommendation on Itron from Neutral to Underperform. Slower replacement meter markets ahead of planned grid upgrades as well as macro headwinds in Europe are negatively impacting the Electricity and Gas segments. In 2014, as a part of rebalancing its electricity business, Itron began phasing out its presence in certain low margin areas that are not strategic markets. This had a negative impact of $40 million in 2014 revenues. In 2015, further actions will impact revenues by an additional $40 million to $50 million. In the third quarter, Itron announced restructuring actions for the Electricity segment that will lead to pre-tax restructuring charges of $65 to $75 million. The company expects to record the major portion of the charges in the fourth quarter of 2014. Savings from these actions are expected to follow through in 2016, with no expected benefits in 2015. Thus 2015 is going to be a transition year for the Electricity segment with not much improvement expected in profitability. Currency is expected to be a headwind in the fourth quarter and 2015. Itron estimates that a $0.05 reduction in the euro rate translates to a negative $20 million impact on its annual revenues. Decline in euro as well as the Brazilian real will have a negative impact on its revenues. Itron could face intensified competition in the AMI space, particularly in North America. Additionally, political unrest and macroeconomic issues have slowed the pace of smart metering projects Equity Research ITRI Page 7
internationally. Moreover, delay in contracts and rising expenses could affect the company s growth, going forward. RISKS On Feb 7, 2014, Itron s board of directors authorized a 12-month repurchase program of up to $50 million worth of shares that came into effect from Mar 8, 2014. As of the third-quarter end, the company repurchased 311,177 shares for about $12 million. Subsequent to the third quarter, the company repurchased 80,500 shares for $3 million. Itron intends to fully utilize the remaining $35 million available through the expiration of the authorization. Further, share repurchases will likely boost earnings and lead to the stock price appreciation. Itron had bookings of $514 million in the third quarter, an increase from $478 million in the second quarter. Total Electricity and Gas bookings came in at $375 million compared with $339 million in the second quarter, benefiting from $62 million booked for 1.2 million meter share of ErDF deployment. Total backlog increased 27% year over year and came in at $1.35 billion at the quarter-end. The company s twelve-month backlog was $700 million at the end of the third quarter, up from $675 million at the end of second quarter. Itron s book-to-bill ratio was 1.04 in the third quarter. The company s bookings this year have been strong and its backlog has increased, driven by smart grid projects around the world. DISCLOSURES & DEFINITIONS The analysts contributing to this report do not hold any shares of ITRI. The EPS and revenue forecasts are the Zacks Consensus estimates. Additionally, the analysts contributing to this report certify that the views expressed herein accurately reflect the analysts personal views as to the subject securities and issuers. Zacks certifies that no part of the analysts compensation was, is, or will be, directly or indirectly, related to the specific recommendation or views expressed by the analyst in the report. Additional information on the securities mentioned in this report is available upon request. This report is based on data obtained from sources we believe to be reliable, but is not guaranteed as to accuracy and does not purport to be complete. Because of individual objectives, the report should not be construed as advice designed to meet the particular investment needs of any investor. Any opinions expressed herein are subject to change. This report is not to be construed as an offer or the solicitation of an offer to buy or sell the securities herein mentioned. Zacks or its officers, employees or customers may have a position long or short in the securities mentioned and buy or sell the securities from time to time. Zacks uses the following rating system for the securities it covers. Outperform- Zacks expects that the subject company will outperform the broader U.S. equity market over the next six to twelve months. Neutral- Zacks expects that the company will perform in line with the broader U.S. equity market over the next six to twelve months. Underperform- Zacks expects the company will under perform the broader U.S. Equity market over the next six to twelve months. The current distribution of Zacks Ratings is as follows on the 1121 companies covered: Outperform - 15.3%, Neutral - 76.9%, Underperform 7.2%. Data is as of midnight on the business day immediately prior to this publication. Our recommendation for each stock is closely linked to the Zacks Rank, which results from a proprietary quantitative model using trends in earnings estimate revisions. This model is proven most effective for judging the timeliness of a stock over the next 1 to 3 months. The model assigns each stock a rank from 1 through 5. Zacks Rank 1 = Strong Buy. Zacks Rank 2 = Buy. Zacks Rank 3 = Hold. Zacks Rank 4 = Sell. Zacks Rank 5 = Strong Sell. We also provide a Zacks Industry Rank for each company which provides an idea of the near-term attractiveness of a company s industry group. We have 264 industry groups in total. Thus, the Zacks Industry Rank is a number between 1 and 264. In terms of investment attractiveness, the higher the rank the better. Historically, the top half of the industries has outperformed the general market. In determining Risk Level, we rely on a proprietary quantitative model that divides the entire universe of stocks into five groups, based on each stock s historical price volatility. The first group has stocks with the lowest values and are deemed Low Risk, while the 5 th group has the highest values and are designated High Risk. Designations of Below-Average Risk, Average Risk, and Above-Average Risk correspond to the second, third, and fourth groups of stocks, respectively. Equity Research ITRI Page 8