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ITRI > SEC Filings for ITRI > Form 10-K on 26-Feb-2014All Recent SEC Filings

Show all filings for ITRON INC /WA/

Form 10-K for ITRON INC /WA/


26-Feb-2014

Annual Report


ITEM 7: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis should be read in conjunction with Item 8:
"Financial Statements and Supplementary Data."

Overview

We are a technology company, offering end-to-end smart metering solutions to electric, natural gas, and water utilities around the world. Our smart metering solutions, meter data management software, and knowledge application solutions bring additional value to a utility's metering and grid systems. Our professional services help our customers project-manage, install, implement, operate, and maintain their systems.

In March 2013, we separated the management of our Energy operating segment into Electricity and Gas to allow each business line to develop its own go-to-market strategy, prioritize its marketing and product development requirements, and focus on its strategic investments. Our sales, marketing, and delivery functions are managed under three business lines - Electricity, Gas, and Water. Our product development and manufacturing operations are now managed on a worldwide basis to promote a global perspective in our operations and processes and still maintain alignment with the business lines. The transition to the new organizational structure, including changes to operations and financial reporting systems, was completed in the fourth quarter of 2013. Our historical segment information for the years ended December 31, 2012 and 2011 has been recast to reflect our new operating segments.

Our Water operating segment includes both our global water and heat solutions.

We have three measures of segment performance: revenue, gross profit (margin), and operating income (margin). Intersegment revenues were minimal. Corporate operating expenses, interest income, interest expense, other income (expense), and income tax provision (benefit) are not allocated to the segments, nor included in the measure of segment profit or loss.

Revenues decreased 11% in 2013, compared with 2012. The revenue decrease was due primarily to the completion of several large OpenWay® projects in the Electricity segment in 2012, partially offset by a $15.2 million increase in revenues in the Water segment. Revenues decreased 11% in 2012, compared with 2011. Similar to 2013, the 2012 revenue decline was the result of our large OpenWay projects nearing completion in the Electricity and Gas segments, while our Water operating segment increased $4.9 million, or 1%, from 2011.

Total backlog was $1.1 billion, and twelve-month backlog was $549.0 million at December 31, 2013.

Total company gross margin decreased 130 basis points in 2013, compared with 2012. Gross margin decline in 2013 over the prior year was primarily driven by decreased volumes in our Electricity and Gas segments and less favorable product mix within all three segments. Additionally, we recognized a charge for increased costs associated with specific contract components with an OpenWay project in North America. Total company gross margin increased 210 basis points in 2012, compared with 2011, primarily due to lower warranty charges in the Electricity and Water operating segments. Additionally, benefits from our restructuring actions and manufacturing efficiencies partially offset the impact of decreased volumes.

During the fourth quarter of 2013 in conjunction with our annual goodwill impairment test, which is performed as of October 1, we recognized a goodwill impairment of $173.2 million in our Electricity reporting unit as the result of delays in global smart grid projects and lower volumes and pricing pressures in certain regions in Europe and Asia/Pacific. The revised forecast for the Electricity business drove a decrease in the fair value of the reporting unit. A portion of the goodwill impairment was deductible for income tax purposes, resulting in an associated income tax benefit of $11.8 million. The goodwill impairment charge is a non-cash expense that does not adversely affect the debt covenants under our existing credit facility. There were no goodwill impairments in the Gas and Water reporting units.

We recognized income tax (benefit)/provisions of $(3.6) million, $26.0 million, and $4.4 million for the years ended December 31, 2013, 2012, and 2011. In 2013, our actual tax rate differed from the 35% U.S. federal statutory tax rate due to the following items which decreased the tax benefit: (1) nondeductible portion of the goodwill impairment; (2) increase in valuation allowance related to deferred tax assets in France for which we do not anticipate future realization; and (3) disallowed deductions due to a change in foreign legislation. The following items increased our tax benefit: (1) recognition of research and experimentation credits for 2012 and 2013 due to the signing of The American Relief Act of 2012 on January 2, 2013; (2) earnings of our subsidiaries outside of the U.S. in jurisdictions where our statutory tax rate is lower than in the U.S.; (3) the benefit of certain interest expense deductions; and (4) benefits of certain acquisition related elections for tax purposes. Our tax provisions for 2012 and 2011 reflect


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the benefits of lower statutory tax rates on foreign earnings as compared with our U.S. federal statutory rate, foreign interest expense deductions and the benefits of certain acquisition related elections for tax purposes. During 2012 we recognized a benefit related to the release of certain reserves for uncertain tax positions. No foreign tax benefit was recorded for the goodwill impairment charge in 2011.

In September 2013, we announced restructuring projects (the 2013 Projects) to restructure our operations to improve profitability and increase efficiencies. The 2013 Projects will reduce headcount and close or consolidate several manufacturing and office facilities. Overall we expect to reduce our workforce by 9%, and we are approximately 50% complete as of December 31, 2013. We expect to substantially complete the 2013 Projects by the end of 2014. We have begun to realize savings from our 2013 Projects during 2013, and we expect full realization of the savings of the 2013 Projects by the end of 2014 and into 2015. Under the 2013 Projects, we recognized $31.1 million in restructuring expenses, primarily related to severance, since these projects were announced in September 2013. Our 2011 projects were substantially complete as of June 30, 2013. Under the 2011 Projects, we incurred $74.1 million in costs, including $4.4 million in 2013. This was a reduction in the restructuring expense of approximately $3.7 million from the expected total expense of $77.8 at December 31, 2012. Restructuring expenses of $1.7 million were recognized in 2012, associated with severance accruals and other facility exit costs, offset by a $5.4 million correction to the goodwill impairment. For further details regarding the correction of the goodwill impairment, refer to Item 8: "Financial Statements and Supplementary Data, Note 5: Goodwill." The remaining expense of $68 million associated with the 2011 Projects was incurred in 2011. Revenues and net operating income from the activities we have exited or will exit under the restructuring plan are not material to our operating segments or consolidated results.

On February 7, 2014, Itron's Board of Directors authorized a new repurchase program of up to $50 million of our common stock over a 12-month period, which will take effect following the expiration of the current stock repurchase program on March 7, 2014. Repurchases are made in the open market or in privately negotiated transactions and in accordance with applicable securities laws. Refer to Part II, Item 5: "Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities" for additional information related to our current share repurchase program.

Total Company Revenues, Gross Profit and Margin, and Unit Shipments

                                         Year Ended December 31,
                   2013          % Change         2012          % Change         2011
              (in thousands)                 (in thousands)                 (in thousands)
Revenues     $     1,948,728      (11)%     $     2,178,178      (11)%     $     2,434,124
Gross Profit $       614,533      (14)%     $       715,147       (4)%     $       746,458
Gross Margin            31.5 %                         32.8 %                         30.7 %



                                                Year Ended December 31,
                                           2013           2012           2011
                                                     (in thousands)
Revenues by region
United States and Canada               $   851,295    $ 1,014,739    $ 1,182,775
Europe, Middle East, and Africa (EMEA)     858,026        878,615        899,642
Other                                      239,407        284,824        351,707
Total revenues                         $ 1,948,728    $ 2,178,178    $ 2,434,124

Meter and Module Summary
We classify meters into three categories:
• Standard metering - no built-in remote reading communication technology

• Advanced metering - one-way communication of meter data

• Smart metering - two-way communication including remote meter configuration and upgrade (consisting primarily of our OpenWay technology)

In addition, advanced and smart meter communication modules can be sold separately from the meter.


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Our revenue is driven significantly by sales of meters and communication modules. A summary of our meter and communication module shipments is as follows:

                                      Year Ended December 31,
                                     2013        2012      2011
                                       (units in thousands)
Meters
Standard                           17,850       17,920    19,570
Advanced and smart                  5,930        8,030     9,320
Total meters                       23,780       25,950    28,890

Stand-alone communication modules
Advanced and smart                  5,550        6,460     6,330

Revenues
Revenues decreased 11%, or $229.5 million, in 2013, compared with 2012. Revenues in 2013 were lower, primarily driven by the substantial completion of four of our five largest OpenWay projects in the Electricity segment in 2012 and by $14.6 million in the unfavorable net translation impact of operations denominated in foreign currencies, partially offset by an increase in Water revenues during the year. Revenues decreased 11%, or $255.9 million, in 2012, compared with 2011. Similar to 2013, revenues in 2012 were lower, primarily driven by several of our largest OpenWay projects nearing completion in 2012 in the Electricity and Gas segments and by $92.2 million in unfavorable net translation of our operations denominated in foreign currencies, partially offset by an increase in Water revenues during the year. A more detailed analysis of these fluctuations is provided in Operating Segment Results.

No single customer represented more than 10% of total revenues for the years ended December 31, 2013, 2012, and 2011. Our 10 largest customers accounted for 28%, 27%, and 33% of total revenues in 2013, 2012, and 2011.

Gross Margins
Gross margin was 31.5% for 2013, compared with 32.8% in 2012. The decline was primarily the result of lower volumes in 2013 in both the Electricity and Gas segments, along with a less favorable mix of product sales in 2013 as compared with 2012 for all three segments and a higher warranty expense in the Gas segment. Additionally, we incurred a charge for increased costs associated with specific contract components within an OpenWay contract in North America. These decreases were partially offset by increased volumes in Water and benefits from our restructuring projects and manufacturing efficiencies. Gross margin was 32.8% in 2012, compared with 30.7% in 2011. The improvement was primarily the result of lower warranty costs in 2012 in each of the Electricity, Gas, and Water segments, which positively impacted gross margin by 170 basis points. Benefits from our restructuring projects and manufacturing efficiencies offset the impact of decreased volumes. A more detailed analysis of these fluctuations is provided in Operating Segment Results.


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Operating Segment Results

For a description of our operating segments, refer to Item 8: "Financial
Statements and Supplementary Data, Note 16: Segment Information" in this Annual
Report on Form 10-K. The following tables and discussion highlight significant
changes in trends or components of each operating segment.

                                                     Year Ended December 31,
                           2013            % Change           2012            % Change           2011
Segment Revenues      (in thousands)                     (in thousands)                     (in thousands)
Electricity          $       836,553        (18)%       $     1,024,340        (17)%       $     1,239,428
Gas                          570,297         (9)%               627,193         (7)%               672,999
Water                        541,878          3%                526,645          1%                521,697
Total revenues       $     1,948,728        (11)%       $     2,178,178        (11)%       $     2,434,124

                                                            Year Ended December 31,
                                   2013                               2012                               2011
                       Gross Profit      Gross Margin     Gross Profit      Gross Margin     Gross Profit      Gross Margin
Segment Gross Profit
and Margin            (in thousands)                     (in thousands)                     (in thousands)
Electricity          $       218,913        26.2%       $       295,005        28.8%       $       323,632        26.1%
Gas                          207,915        36.5%               235,391        37.5%               254,943        37.9%
Water                        187,705        34.6%               184,751        35.1%               167,883        32.2%
Total gross profit
and margin           $       614,533        31.5%       $       715,147        32.8%       $       746,458        30.7%

                                                            Year Ended December 31,
                                   2013                               2012                               2011
                         Operating        Operating         Operating        Operating         Operating        Operating
                       Income (Loss)        Margin        Income (Loss)        Margin        Income (Loss)        Margin
Segment Operating
Income (Loss)
and Operating Margin  (in thousands)                     (in thousands)                     (in thousands)
Electricity          $      (235,908 )      (28)%       $        24,812          2%        $      (218,284 )      (18)%
Gas                           83,882         15%                110,557         18%                105,453         16%
Water                         63,252         12%                 59,210         11%               (303,772 )      (58)%
Corporate
unallocated                  (46,407 )                          (43,453 )                          (42,580 )
Total Company        $      (135,181 )       (7)%       $       151,126          7%        $      (459,183 )      (19)%

Electricity:

Revenues - 2013 vs. 2012
Electricity revenues for 2013 decreased by $187.8 million, or 18%, compared with 2012 revenues. The decrease was primarily driven by $246.3 million in lower revenue of our five largest OpenWay projects in North America, as four of these projects were substantially completed during 2012. Lower prepayment meter shipments drove a decrease of $24.8 million in our Asia/Pacific region. These decreases were partially offset by $81.5 million in increased products and services in North America, apart from the five largest OpenWay projects, as well as by $27.3 million in increased product shipments and services in EMEA. The net translation effect of our operations in foreign currencies negatively impacted 2013 revenues by $18.1 million.

No customer represented more than 10% of the Electricity operating segment revenues in 2013.

Revenues - 2012 vs. 2011
Electricity revenues for 2012 decreased by $215.1 million, or 17%, compared with 2011 revenues. The decrease was primarily driven by $207.6 million in lower OpenWay project revenue in North America, as four of our five largest OpenWay projects were substantially completed during 2012. This revenue decrease in North America was partially offset by $21.8 million of revenue increase as a result of the SmartSynch acquisition in May 2012. Lower prepayment meter shipments drove a decrease of $27.3 million in our Asia/Pacific region, which was partially offset by $23.0 million in higher revenue from increased product shipments and service in EMEA. The net translation effect of our operations in foreign currencies negatively impacted 2012 revenues by $34.4 million.


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One customer individually represented 17% of the Electricity operating segment revenues in 2012, while two customers individually represented 15% and 14% of the Electricity operating segment revenues in 2011.

Gross Margin - 2013 vs. 2012
Gross margin was 26.2% in 2013, compared with 28.8% in 2012. The lower margin was primarily driven by decreased volume in 2013 and less favorable product mix in all regions. Additionally, in 2013, we recognized a charge for increased costs associated with specific contract components with an OpenWay project in North America.

Gross Margin - 2012 vs. 2011
Gross margin was 28.8% in 2012, compared with 26.1% in 2011. The improved margin was primarily driven by $19.8 million in lower warranty expense in 2012, as well as improved manufacturing efficiencies, global procurement, and the realization of the benefits of our restructuring activities.

Operating Expenses - 2013 vs. 2012
Electricity operating expenses increased by $184.6 million, or 68.3%, in 2013, primarily due to the goodwill impairment of $173.2 million recognized in 2013 for the Electricity reporting unit and $23.9 million in additional restructuring expenses in 2013. We reduced sales and marketing expense by $12.1 million as a result of our restructuring projects, offset by $5.6 million in higher litigation expense within general and administrative expense. Operating expenses for sales and marketing, product development, general and administrative, and amortization of intangible assets as a percentage of revenues were 31% in 2013 and 26% in 2012.

Operating Expenses - 2012 vs. 2011
Electricity operating expenses decreased by $271.7 million million or 50%, in 2012 primarily due to a goodwill impairment charge of $254.7 million in 2011 and a decrease in restructuring charges of $25.2 million associated with the Electricity reporting unit between 2011 and 2012. This was partially offset by an increase in product development expenses over the prior year by $9.6 million, primarily as the result of the development of new and enhanced products and in preparation for sales opportunities in developing markets. Operating expenses for sales and marketing, product development, general and administrative, and amortization of intangible assets as a percentage of revenues were 26% in 2012 and 21% in 2011.

Gas:

Revenues - 2013 vs. 2012
Gas revenues decreased by $56.9 million, or 9%, in 2013, compared with 2012. Our Gas business continues to experience period-to-period variation in customer contracts and purchases. The decrease was driven by $54.2 million in lower product sales in EMEA and $18.7 million in lower communication module shipments and lower service revenue in North America, the effect of which partially offset by $21.3 million in increased North America gas meter shipments, particularly smart meters.

No single customer represented more than 10% of the Gas operating segment revenues in 2013, 2012, and 2011.

Revenues - 2012 vs. 2011
Gas revenues decreased by $45.8 million, or 7%, in 2012, compared with 2011, including $27.7 million for the unfavorable translation effect of our revenues denominated in foreign currencies. The decrease was driven by lower communication module shipments and lower service revenue, partially offset by increased gas meter shipments, particularly smart meters. The overall decrease is due to typical period-to-period fluctuations in timing of customer projects.

Gross Margin - 2013 vs. 2012
Gross margin was 36.5% in 2013, compared with 37.5% in 2012. The 100 basis point decline in gross margin was primarily the result of less favorable product mix and higher warranty costs.

Gross Margin - 2012 vs. 2011
Gross margin was 37.5% in 2012, compared with 37.9% in 2011. Decreased revenues for smart gas communication modules and non-OpenWay services were partially offset by lower warranty charges in 2012.

Operating Expenses - 2013 vs. 2012
Gas operating expenses decreased by $801,000, or 1%, in 2013. Lower sales and marketing and product development expenses were partially offset by higher general and administrative expenses. Operating expenses for sales and marketing, product development, general and administrative, and amortization of intangible assets as a percentage of revenues, were 21% in 2013 and 20% in 2012.


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Operating Expenses - 2012 vs. 2011
Gas operating expenses decreased by $24.7 million, or 16% in 2012, primarily due to a decrease in restructuring expenses of $25.4 million. This was partially offset by increases in product development for new and enhanced products. Operating expenses for sales and marketing, product development, general and administrative, and amortization of intangible assets as a percentage of revenues were 20% in 2012 and 18% in 2011.

Water:

Revenues - 2013 vs. 2012
The increase in revenues of $15.2 million, or 3%, in 2013 was driven primarily by growth in projects in North America of $10.2 million. Latin America experienced growth of $7.0 million, but was negatively impacted by foreign currency translation of $4.3 million.

No single customer represented more than 10% of the Water operating segment revenues in 2013, 2012, and 2011.

Revenues - 2012 vs. 2011
Revenues increased $4.9 million, or 1%, in 2012, while the translation effect of a stronger U.S. dollar against most foreign currencies during 2012 negatively impacted revenues by 6%. All regions generated revenue growth during 2012.

Gross Margin - 2013 vs. 2012
Water gross margin decreased to 34.6% in 2013, compared with 35.1% in 2012, driven predominantly by higher service revenues in North America, which have a lower margin, and partially offset by favorable product mix in EMEA.

Gross Margin - 2012 vs. 2011
Water gross margin increased to 35.1% in 2012, compared with 32.2% in 2011, primarily driven by $12.4 million in lower warranty expense in 2012 and favorable product mix, which were partially offset by lower margin services for a large project in North America.

Operating Expenses - 2013 vs. 2012
In 2013, Water operating expenses were $124.5 million compared with $125.6 million in 2012. Decreases of $5.9 million in sales and marketing expense and $2.1 million in lower amortization of intangible expense were partially offset by increases in product development, general and administrative, and restructuring expenses. Operating expenses for sales and marketing, product development, general and administrative, and amortization of intangible assets as percentages of revenues were 22% in 2013, compared with 24% and 2012.

Operating Expenses - 2012 vs. 2011
In 2012, Water operating expenses were $125.6 million, compared with $471.7 million in 2011 including the favorable impact of foreign exchange rates of $7.6 million. Operating expenses in 2011 included a goodwill impairment charge of $330.1 million and $15.9 million in higher restructuring costs. Sales and marketing expenses in 2012 were $6.2 million higher than in 2011 due to investments in preparation for opportunities in developing markets. Product development expenses in 2012 were $4.5 million higher than in 2011 as the result of development of new and enhanced products to meet the demands of various markets. Operating expenses for sales and marketing, product development, general and administrative, and amortization of intangible assets as percentages of revenues were 24% in 2012 and 2011.

Corporate unallocated:

Operating expenses not directly associated with an operating segment are classified as "Corporate unallocated." These expenses increased 7% to $46.4 million in 2013, compared with 2012, primarily due to $2.7 million in increased restructuring expenses in 2013, as well as $3.8 million in sales and marketing costs, which are no longer allocated to the operating segments. These increases were partially offset by a decline in general and administrative expenses, including $3.0 million in acquisition-related expenses incurred in 2012 that did not recur in 2013.

Corporate unallocated expenses increased 2% to $43.5 million in 2012, compared with 2011, primarily due to acquisition related expenses for the SmartSynch acquisition, for management training and development costs in connection with the implementation of a new organizational structure, and for preliminary planning costs, prior to application development, for our global enterprise resource planning (ERP) software initiative. These increases were partially offset by lower corporate IT related and marketing spending.


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Operating Expenses

The following table details our total operating expenses in dollars and as a
percentage of revenues:

                                                          Year Ended December 31,
                                              % of                            % of                            % of
                              2013          Revenues          2012          Revenues          2011          Revenues
                         (in thousands)                  (in thousands)                  (in thousands)
Sales and marketing    $        180,371        9%      $        197,603        9%      $        185,105        8%
Product development             176,019        9%               178,653        8%               161,305        7%
General and
administrative                  142,559        7%               138,290        6%               142,908        6%
Amortization of
intangible assets                42,019        2%                47,810        2%                63,394        3%
Restructuring expense            35,497        2%                 1,665        -%                68,082        3%
Goodwill impairment             173,249        9%                     -        -%               584,847       24%
Total operating        $        749,714       38%      $        564,021       26%      $      1,205,641       50%
expenses

2013 vs. 2012
Operating expenses increased $185.7 million in 2013, compared with 2012. The 2013 operating expenses included $173.2 million in goodwill impairment charges associated with the Electricity reporting unit, as well as $35.5 million in restructuring expenses, which represented the majority of total expected . . .

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