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(Exact name of registrant as specified in its charter)
iWashington
i91-1011792
(State
of Incorporation)
(I.R.S. Employer Identification Number)
i2111 N Molter Road, iLiberty Lake, iWashingtoni99019
(i509) i924-9900
(Address and telephone number of registrant's principal executive offices)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. iYes☒ No ☐
Indicate
by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). iYes☒ No ☐
Indicate by check mark whether
the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of "large accelerated filer,""accelerated filer,""smaller reporting company," and "emerging growth company" in Rule 12b-2 of the Exchange Act.
iLarge
accelerated filer
☒
Accelerated filer
☐
Non-accelerated filer
☐
(Do not check if a smaller reporting company)
Smaller reporting company
i☐
Emerging
growth company
i☐
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate
by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes i☐ No ☒
Securities registered pursuant to Section 12(b) of the Act:
In this Quarterly Report on Form 10-Q, the terms "we,""us,""our,""Itron," and the "Company"
refer to Itron, Inc.
Note 1: iSummary of Significant Accounting Policies
Financial Statement Preparation
The condensed consolidated financial statements presented in this Quarterly Report on Form 10-Q are unaudited and reflect entries necessary
for the fair presentation of the Consolidated Statements of Operations and the Consolidated Statements of Comprehensive Income (Loss) for the three and nine months ended September 30, 2019 and 2018, Consolidated Statements of Equity for the three months ended September 30, 2019 and 2018, June 30, 2019 and 2018, and March
31, 2019 and 2018, Consolidated Statements of Cash Flows for the nine months ended September 30, 2019 and 2018, and the Consolidated Balance Sheets as of September 30, 2019 and December 31, 2018, of Itron, Inc. and its subsidiaries. All entries required for the fair presentation of the financial statements are of a normal recurring nature, except as disclosed. The results of operations for the three
and nine months ended September 30, 2019 are not necessarily indicative of the results expected for the full year or for any other period.
Certain information and notes normally included in financial statements prepared in accordance with U.S. generally accepted accounting principles (GAAP) have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission (SEC) regarding interim results. These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and the notes thereto for the fiscal year ended December 31, 2018 filed with the SEC in our
Annual Report on Form 10-K on February 28, 2019 (2018 Annual Report). There have been no significant changes in financial statement preparation or significant accounting policies since December 31, 2018 other than the adoption of Accounting Standards Codification (ASC) 842, Leases.
i
Restricted
Cash and Cash Equivalents
Cash and cash equivalents that are contractually restricted from operating use are classified as restricted cash and cash equivalents.
ii
The following
table provides a reconciliation of cash, cash equivalents, and restricted cash reported within the Consolidated Balance Sheets that sum to the total of the same such amounts shown in the Consolidated Statements of Cash Flows:
Subsequent
to the issuance of our September 30, 2018 consolidated financial statements, we determined $i150 million of proceeds from borrowings and payments on debt, originally transacted during the first quarter of 2018, had been improperly netted within the financing activities section of the Consolidated Statements of Cash
Flows for the first three quarters of 2018. We corrected this presentation for the 2018 Annual Report on Form 10‑K. The accompanying Consolidated Statement of Cash Flows for the nine months endedSeptember 30, 2018 has been revised from amounts previously reported to separately present the $i150
million of proceeds from borrowings and the payments on debt. We assessed the significance of the misstatement and concluded that it was not material to any prior periods. There were no changes to net cash flows from operating, investing, or financing activities as a result of this change.
/i
Leases
We
determine if an arrangement is a lease at inception. A lease exists when a contract conveys to the customer the right to control the use of identified property, plant, or equipment for a period of time in exchange for consideration. The definition of a lease embodies two conditions: (1) there is an identified asset in the contract that is land or a depreciable asset (i.e., property, plant, and equipment), and (2) the customer has the right to control the use of the identified asset.
Operating leases are included in operating lease right-of-use ("ROU") assets, other current liabilities, and operating lease liabilities on our Consolidated Balance Sheets. Finance leases are included in property,
plant, and equipment, other long-term assets, other current liabilities, and other long-term obligations on our Consolidated Balance Sheets.
ROU assets represent our right to use an underlying asset for the lease term and lease liabilities represent our obligation to make lease payments arising from the lease. Operating lease ROU assets and liabilities are recognized at commencement date based on the present value of lease payments over the lease term. We use the implicit rate when readily determinable. As most of our leases do not provide an implicit rate, we use our incremental borrowing
rate based on the information available at the lease commencement date in determining the present value of lease payments. The Operating lease ROU asset also includes any lease payments made and excludes lease incentives received and initial direct costs incurred. Our lease terms may include options to extend or terminate the lease when it is reasonably certain that we will exercise that option. Lease expense for operating lease payments is recognized on a straight-line basis over the lease term.
We have lease agreements that include lease and nonlease components. When nonlease components are fixed, we have elected the practical expedient to account for lease and nonlease components as a single lease component, except for leases embedded in service contracts.
We
have not elected to utilize the short-term lease exemption for any leased asset class. All leases with a lease term that is greater than one month are subject to recognition and measurement on the balance sheet.
Lease expense for variable lease payments, where the timing or amount of the payment is not fixed, are recognized when the obligation is incurred. Variable lease payments generally arise in our net lease arrangements where executory and other lease-related costs are billed to Itron when incurred by the lessor.
i
Recently
Adopted Accounting Standards
In February 2016, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2016-02, Leases (Topic 842) (ASU 2016-02), which required substantially all leases be recognized by lessees on their balance sheet as a right-of-use asset and corresponding lease liability, including leases previously accounted for as operating leases. The new standard also resulted in enhanced quantitative and qualitative disclosures, including significant judgments made by management, to provide greater insight into the extent of revenue and expense recognized and expected to be recognized from existing leases. The standard required modified retrospective adoption. We adopted ASC 842, as amended, on January 1, 2019, and it resulted in the recognition
to operating lease right-of-use assets, other current liabilities, and operating lease liabilities of $i74.6 million, $i14.5 million,
and $i61.5 million, respectively, and a decrease in other current assets and other long-term obligations of $i1.5
million and $i2.9 million, respectively.
In August 2018, the FASB issued ASU 2018-15, Customer's Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract.
The amendments in this ASU align the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software (and hosting arrangements that include an internal-use software license). Accordingly, the amendments require an entity (customer) in a hosting arrangement that is a service contract to follow the guidance in ASC 350-40 to determine which implementation costs to capitalize as an asset related to the service contract and which costs to expense. The amendments also require us to amortize the capitalized implementation costs
of a hosting arrangement that is a service contract over the term of the hosting arrangement, which includes reasonably certain renewals. We adopted ASU 2018-15 as of January 1, 2019, and it did not have a material impact on our financial condition, results of operations, or cash flows. We classify the capitalized implementation costs as prepaid, within other current assets and other long-term assets on our Consolidated Balance Sheets.
In October 2018, the FASB issued ASU 2018-16, Inclusion of the Secured Overnight Financing Rate (SOFR) Overnight Index Swap (OIS) Rate as a Benchmark Interest Rate for Hedge Accounting Purposes. We adopted this standard on January
1, 2019, and it did not materially impact our consolidated financial statements. This update establishes OIS rates based on SOFR as an approved benchmark interest rate in addition to existing rates such as the LIBOR swap rate.
/
i
Recent Accounting Standards Not Yet Adopted
In
June 2016, the FASB issued ASU 2016-13, Financial Instruments - Credit Losses (Topic 326) (ASU 2016-13), which replaces the incurred loss impairment methodology in current GAAP with a methodology based on expected credit losses. This estimate of expected credit losses uses a broader range of reasonable and supportable information. This change will result in earlier recognition of credit losses. ASU 2016-13, as amended, will be effective as of January 1, 2020 for us. We are currently evaluating the impact of this standard on our consolidated financial statements, as well as our accounting policies, processes, and systems.
In August 2018, the FASB issued ASU 2018-13, Disclosure Framework-Changes to the Disclosure Requirements for Fair Value Measurement (ASU 2018-13), which amends the disclosure requirements under ASC 820, Fair Value Measurements. ASU 2018-13 is effective for us beginning with our interim financial reports for the first quarter of 2020. We are currently evaluating the impact this standard will have on our consolidated financial statement disclosures related to assets and liabilities subject to fair value measurement.
In August 2018, the FASB issued ASU 2018-14, Disclosure Framework-Changes to the Disclosure Requirements for Defined Benefit Plans (ASU 2018-14),
which amends the disclosure requirements under ASC 715-20, Compensation-Retirement Benefits-Defined Benefit Plans. ASU 2018-14 is effective for our financial reporting in 2020. We are currently evaluating the impact this standard will have on our financial statement disclosures for our defined benefit plans.
Note 2: iEarnings Per Share
i
The
following table sets forth the computation of basic and diluted earnings (loss) per share (EPS):
Three Months Ended September 30,
Nine Months Ended September 30,
In thousands, except per share
data
2019
2018
2019
2018
Net income (loss) available to common shareholders
$
i16,847
$
i19,882
$
i34,386
$
(i123,127
)
Weighted
average common shares outstanding - Basic
i39,478
i39,340
i39,508
i39,177
Dilutive
effect of stock-based awards
i425
i569
i376
i—
Weighted
average common shares outstanding - Diluted
i39,903
i39,909
i39,884
i39,177
Net
income (loss) per common share - Basic
$
i0.43
$
i0.51
$
i0.87
$
(i3.14
)
Net
income (loss) per common share - Diluted
$
i0.42
$
i0.50
$
i0.86
$
(i3.14
)
/
Stock-based
Awards
For stock-based awards, the dilutive effect is calculated using the treasury stock method. Under this method, the dilutive effect is computed as if the awards were exercised at the beginning of the period (or at time of issuance, if later) and assumes the related proceeds were used to repurchase our common stock at the average market price during the period. Related proceeds include the amount the employee must pay upon exercise and the future compensation cost associated with the stock award. Approximately i0.2
million and i0.4 million stock-based awards were excluded from the calculation of diluted EPS for the three and nine months ended September 30, 2019, respectively, because they were anti-dilutive. Approximately i0.5
million and i1.1 million stock-based awards were excluded from the calculation of diluted EPS for the three and nine months ended September 30, 2018, respectively, because they were anti-dilutive. These stock-based awards could be dilutive in future periods.
Note
3: iCertain Balance Sheet Components
A summary of accounts receivable from contracts with customers is as follows:
A summary of intangible assets and liabilities activity is as follows:
Nine
Months Ended September 30,
In thousands
2019
2018
Beginning balance, intangible assets, gross
$
i981,160
$
i769,851
Intangible
assets acquired
i—
i242,039
Effect
of change in exchange rates
(i15,574
)
(i15,352
)
Ending
balance, intangible assets, gross
$
i965,586
$
i996,538
Beginning
balance, intangible liabilities, gross
$
(i23,900
)
$
i—
Intangible
liabilities assumed
i—
(i23,900
)
Effect
of change in exchange rates
i—
i—
Ending
balance, intangible liabilities, gross
$
(i23,900
)
$
(i23,900
)
/
On
January 5, 2018, we completed our acquisition of Silver Spring Networks, Inc. (SSNI) by purchasing i100% of the voting stock. Acquired intangible assets include in-process research and development (IPR&D), which is not amortized until such time as the associated development projects are completed. Of these projects, $i3.1 million
were completed during the first half of 2019 and are included in core-developed technology. Assumed intangible liabilities reflect the present value of the projected cash outflows for an existing contract where remaining costs are expected to exceed projected revenues.
i
Estimated future annual amortization (accretion) is as follows:
Total
intangible assets subject to amortization (accretion)
$
i202,321
$
(i12,508
)
$
i189,813
/
Amortization
Expense
Three Months Ended September 30,
Nine Months Ended September 30,
In thousands
2019
2018
2019
2018
Amortization Expense
$
i16,095
$
i17,960
$
i48,185
$
i53,699
We
have recognized amortization expense within operating expenses in the Consolidated Statement of Operations. These expenses relate to intangible assets acquired and liabilities assumed as part of business combinations.
The acquisition of SSNI was financed through incremental borrowings and cash on hand. Refer to "Note 6: Debt" for further discussion of our debt. SSNI provided smart network and data platform solutions for electricity, gas, water and smart cities including advanced metering, distribution automation, demand-side management, and street lights.
The fair values for the identified trademarks and core-developed technology intangible assets were estimated using the relief from royalty method. The fair value of customer contract and relationship were estimated using the income approach. The IPR&D was valued utilizing the replacement cost method. These consolidated financial statements should be read in conjunction
with the audited financial statements and notes included in our 2018 Annual Report.
The purchase price of SSNI was $i809.2 million, which was net of $i97.8
million of acquired cash and cash equivalents. Of the total consideration, $i802.5 million was paid in cash. The remaining $i6.7
million relates to the fair value of pre-acquisition service for replacement awards of unvested SSNI options and restricted stock unit awards with an Itron equivalent award. We allocated the purchase price to the assets acquired and liabilities assumed based on estimated fair value assessments. During the three months ended March 31, 2019, we recognized additional contract assets totaling $i8.0
million and additional deferred tax liabilities of $i2.0 million, for a net reduction in goodwill of $i6.0
million. As of the first quarter of 2019, the measurement period for the acquisition of SSNI was complete, and any further adjustments to assets acquired or liabilities assumed would be recognized through the Consolidated Statement of Operations.
On January 5, 2018, we entered into a credit agreement providing for committed credit facilities in the amount of $i1.2 billion U.S. dollars (the 2018 credit facility), which amended and restated in its entirety our credit agreement dated June 23, 2015 and replaced committed facilities in the amount of $i725
million. The 2018 credit facility consists of a $i650 million U.S. dollar term loan (the term loan) and a multicurrency revolving line of credit (the revolver) with a principal amount of up to $i500 million.
The revolver also contains a $i300 million standby letter of credit sub-facility and a $i50 million
swingline sub-facility. Both the term loan and the revolver mature on January 5, 2023 and can be repaid without penalty. Amounts repaid on the term loan may not be reborrowed, and amounts borrowed under the revolver may be repaid and reborrowed until the revolver's maturity, at which time all outstanding loans together with all accrued and unpaid interest must be repaid. Amounts not borrowed under the revolver are subject to a
commitment fee, which is paid in arrears on the last day of each fiscal quarter, ranging from i0.18%
to i0.35% per annum depending on our total leverage ratio as of the most recently ended fiscal quarter.
The 2018 credit facility permits us and certain of our foreign subsidiaries to borrow in U.S. dollars, euros, British pounds, or, with lender approval,
other currencies readily convertible into U.S. dollars. iAll obligations under the 2018 credit facility are guaranteed by Itron, Inc. and material U.S. domestic subsidiaries and are secured by a pledge of substantially all of the assets of Itron, Inc. and material U.S. domestic subsidiaries, including a pledge of their related assets. This includes a pledge of 100% of the capital stock of material U.S. domestic subsidiaries
and up to 66% of the voting stock (100% of the non-voting stock) of first-tier foreign subsidiaries. In addition, the obligations of any foreign subsidiary who is a foreign borrower, as defined by the 2018 credit facility, are guaranteed by the foreign subsidiary and by its direct and indirect foreign parents. The 2018 credit facility includes debt covenants, which contain certain financial thresholds and place certain restrictions on the incurrence of debt, investments, and the issuance of dividends. We were in compliance with the debt covenants under the 2018 credit facility at September 30, 2019.
Under the 2018 credit facility, we elect applicable market
interest rates for both the term loan and any outstanding revolving loans. We also pay an applicable margin, which is based on our total leverage ratio as defined in the credit agreement. The applicable rates per annum may be based on either: (1) ithe LIBOR rate or iEURIBOR
rate (subject to a floor of 0%), plus an applicable margin, or (2) the iAlternate Base Rate, plus an applicable margin. The Alternate Base Rate election is equal to the greatest of three rates: (i) ithe
prime rate, (ii) ithe Federal Reserve effective rate plus i0.50%,
or (iii) ione-month LIBOR plus i1.00%.
At September 30, 2019, the interest rate for both the term loan and revolver was i3.80%, which includes the LIBOR rate plus a margin of i1.75%.
On October 18, 2019, we amended our 2018 credit facility by entering into the First Amendment to the credit agreement entered on January 5, 2018. This amendment extended the maturity date from January 5, 2023, to October 18, 2024, and re-amortized the term loan payments based on the balance and payment terms as of the amendment date. The amendment also modified the required interest payments and made it based on total net leverage instead of total leverage. Amounts not borrowed under the revolver are now subject to a commitment fee ranging from i0.15%
to i0.25%, and drawn amounts are subject to a margin ranging from i1.00%
to i1.75%. The current portion of debt and long-term debt presented in the Consolidated Balance Sheets at September 30, 2019 do not reflect this amendment.
Senior Notes
On December 22,
2017 and January 19, 2018, we issued $i300 million and $i100 million, respectively, of aggregate principal amount of i5.00%
senior notes maturing January 15, 2026 (Senior Notes). The proceeds were used to refinance existing indebtedness related to the acquisition of SSNI, pay related fees and expenses, and for general corporate purposes. Interest on the Senior Notes is payable semi-annually in arrears on January 15 and July 15, commencing on July 15, 2018. The Senior Notes are fully and unconditionally guaranteed, jointly and severally, on a senior unsecured basis by each of our subsidiaries that guarantee the 2018 credit facility.
Prior to maturity, we may redeem some or all of the Senior Notes, together with accrued and unpaid interest, if any, plus a "make-whole" premium. On or after January
15, 2021, we may redeem some or all of the Senior Notes at any time at declining redemption prices equal to i102.50% beginning on January 15, 2021, i101.25%
beginning on January 15, 2022 and i100.00% beginning on January 15, 2023 and thereafter to the applicable redemption date. In addition, before January 15, 2021, and subject to certain conditions, we may redeem up
to i35% of the aggregate principal amount of Senior Notes with the net proceeds of certain equity offerings at i105.00%
of the principal amount thereof to the date of redemption; provided that (i) at least i65% of the aggregate principal amount of Senior Notes remains outstanding after such redemption and (ii) the redemption occurs within 60 days of the closing of any such equity offering.
Debt Maturities
i
The
amount of required minimum principal payments on our long-term debt in aggregate is as follows:
As part of our risk management strategy,
we use derivative instruments to hedge certain foreign currency and interest rate exposures. Refer to "Note 13: Shareholder's Equity" and "Note 14: Fair Values of Financial Instruments" for additional disclosures on our derivative instruments.
The fair values of our derivative instruments are determined using the income approach and significant other observable inputs (also known as "Level 2"). We have used observable market inputs based on the type of derivative and the nature of the underlying instrument. The key inputs include interest rate yield curves (swap rates and futures) and foreign exchange spot and forward rates, all of which are available in an active market. We have utilized the mid-market pricing convention for these inputs. We include, as a discount to the derivative asset, the effect of our counterparty credit risk based on current published
credit default swap rates when the net fair value of our derivative instruments is in a net asset position. We consider our own nonperformance risk when the net fair value of our derivative instruments is in a net liability position by discounting our derivative liabilities to reflect the potential credit risk of our counterparty through applying a current market indicative credit spread to all cash flows.
i
The fair values of our derivative instruments were as follows:
The
changes in accumulated other comprehensive income (loss) (AOCI), net of tax, for our derivative and nonderivative hedging instruments designated as hedging instruments, net of tax, were as follows:
In thousands
2019
2018
Net unrealized loss on hedging instruments at January 1,
$
(i13,179
)
$
(i13,414
)
Unrealized
gain (loss) on hedging instruments
i4,995
i4,770
Realized
(gains) losses reclassified into net income (loss)
(i5,799
)
(i2,207
)
Net
unrealized loss on hedging instruments at September 30,
$
(i13,983
)
$
(i10,851
)
/
Reclassification
of amounts related to hedging instruments are included in interest expense in the Consolidated Statements of Operations for the periods ended September 30, 2019 and 2018. Included in the net unrealized gain (loss) on hedging instruments at September 30, 2019 and 2018 is a loss of $i14.4
million, net of tax, related to our nonderivative net investment hedge, which terminated in 2011. This loss on our net investment hedge will remain in AOCI until earnings are impacted by a sale or liquidation of the associated foreign operation.
A summary of the effect of netting
arrangements on our financial position related to the offsetting of our recognized derivative assets and liabilities under master netting arrangements or similar agreements is as follows:
Offsetting of Derivative Assets
Gross Amounts of Recognized Assets Presented in
the Consolidated
Balance Sheets
Gross
Amounts Not Offset in the Consolidated Balance Sheets
Our
derivative assets and liabilities subject to netting arrangements consist of foreign exchange forwards and options and interest rate contracts with isix counterparties at September 30, 2019 and ifive
counterparties at December 31, 2018. No derivative asset or liability balance with any of our counterparties was individually significant at September 30, 2019 or December 31, 2018. Our derivative contracts with each of these counterparties exist under agreements that provide for the net settlement of all contracts through a single payment in a single currency in the event of default. We have no pledges of cash collateral against our obligations, and we have not received pledges of cash collateral from our
counterparties under the associated derivative contracts.
Cash Flow Hedges
As a result of our floating rate debt, we are exposed to variability in our cash flows from changes in the applicable interest rate index. We enter into interest rate caps and swaps to reduce the variability of cash flows from increases in the LIBOR based borrowing rates on our floating rate credit facility. These instruments do not protect us from changes to the applicable margin under our credit facility. At September 30, 2019, our LIBOR-based debt balance was $i587.5 million.
In
October 2015, we entered into an interest rate swap, which is effective from August 31, 2016 to June 23, 2020, and converts $i214 million of our LIBOR-based debt from a floating LIBOR interest rate to a fixed interest rate of i1.42%
(excluding the applicable margin on the debt). The notional balance will amortize to maturity at the same rate as required minimum payments on our term loan. Changes in the fair value of the interest rate swap are recognized as a component of other comprehensive income (OCI) and are recognized in earnings when the hedged item affects earnings. The amounts paid or received on the hedge are recognized as an adjustment to interest expense along with the earnings effect of the hedged item. The amount of net gains expected to be reclassified into earnings in the next 12 months is $i0.3
million.
In November 2015, we entered into three interest rate cap contracts with a total notional amount of $i100 million at a cost of $i1.7 million.
The interest rate cap contracts expire on June 23, 2020 and were entered into in order to limit our interest rate exposure on $i100 million of our variable LIBOR based debt up to i2.00%.
In the event LIBOR is higher than i2.00%, we will pay interest at the capped rate of i2.00%
with respect to the $i100 million notional amount of such agreements. As of December 31, 2016, due to the accelerated revolver payments from surplus cash, we elected to de-designate two of the interest rate cap contracts as cash flow hedges and discontinued the use of cash flow hedge accounting. The amounts recognized in AOCI from de-designated interest
rate cap contracts were maintained in AOCI as the forecasted transactions were still probable to occur, and subsequent changes in fair value were recognized within interest expense. In April 2018, due to increases in our total LIBOR-based debt, we elected to re-designate the two interest rate cap contracts as cash flow hedges. As of that date and going forward changes in the fair value of these instruments are recognized as a component of OCI, and these changes together with amounts previously maintained in AOCI will be recognized in earnings when the hedged item affects earnings. The amounts paid or received on the hedge are recognized as an adjustment to interest expense along with the earnings effect of the hedged item. The amount of net losses expected to be reclassified into earnings
for all interest rate cap contracts in the next 12 months is $i0.5 million.
In April 2018, we entered into a cross-currency swap, which converts $i56.0
million of floating LIBOR-based U.S. Dollar denominated debt into i1.38% fixed rate euro denominated debt. This cross-currency swap matures on April 30, 2021 and mitigates the risk associated with fluctuations in interest and currency rates impacting cash flows related to U.S. Dollar denominated debt in a euro functional currency entity. Changes in the fair value of the cross-currency swap are recognized as a component
of OCI
and are recognized in earnings when the hedged item affects earnings. The amounts paid or received on the hedge are recognized as an adjustment to interest expense along with the earnings effect of the hedged item. The amount of net gains expected to be reclassified into earnings in the next 12 months is $i1.2
million.
As a result of our forecasted inventory purchases in a non-functional currency, we are exposed to foreign exchange risk. We hedge portions of these purchases. During January 2019, we entered into foreign exchange option contracts for a total notional amount of $i72 million
at a cost of $i1.3 million. The contracts mature ratably throughout the year with final maturity in October 2019. Changes in the fair value of the option contracts are recognized as a component of OCI and are recognized in product cost of revenues when the hedged item affects earnings.
i
The
before-tax effects of our accounting for derivative instruments designated as hedges on AOCI were as follows:
These
reclassification amounts presented above also represent the loss (gain) recognized in net income (loss) on hedging relationships under ASC 815-20 on the Consolidated Statements of Operations. For the three months and nine months ended September 30, 2019 and 2018, there were no amounts reclassified from AOCI as a result that a forecasted transaction is no longer probable of occurring, and there were no amounts excluded from effectiveness testing recognized in earnings based on changes in fair value.
Derivatives Not Designated as Hedging Relationships
We are also exposed to foreign exchange risk when
we enter into non-functional currency transactions, both intercompany and third party. At each period-end, non-functional currency monetary assets and liabilities are revalued with the change recognized within other income and expense. We enter into monthly foreign exchange forward contracts, which are not designated for hedge accounting, with the intent to reduce earnings volatility associated with currency exposures. As of September 30, 2019, a total of i50contracts
were offsetting our exposures from the euro, pound sterling, Indonesian rupiah, Chinese yuan, Canadian dollar, Indian rupee and various other currencies, with notional amounts ranging from $i120,000 to $i26.4 million.
i
The
effect of our derivative instruments not designated as hedges on the Consolidated Statements of Operations was as follows:
Derivatives Not Designated as Hedging Instrument under ASC 815-20
Location
Gain (Loss) Recognized on Derivatives in Other Income (Expense)
We sponsor both funded and unfunded defined benefit
pension plans offering death and disability, retirement, and special termination benefits for certain of our international employees, primarily in Germany, France, Italy, Indonesia, and India. The defined benefit obligation is calculated annually by using the projected unit credit method. The measurement date for the pension plans was December 31, 2018.
i
Amounts recognized on the Consolidated Balance Sheets consist of:
Current
portion of pension benefit obligation in wages and benefits payable
i3,239
i2,730
Long-term
portion of pension benefit obligation
i88,374
i91,522
Pension
benefit obligation, net
$
i91,041
$
i93,680
/
Our
asset investment strategy focuses on maintaining a portfolio using primarily insurance funds, which are accounted for as investments and measured at fair value, in order to achieve our long-term investment objectives on a risk adjusted basis. Our general funding policy for these qualified pension plans is to contribute amounts sufficient to satisfy regulatory funding standards of the respective countries for each plan.
i
Net periodic pension benefit cost for our plans include the following components:
Three
Months Ended September 30,
Nine Months Ended September 30,
In thousands
2019
2018
2019
2018
Service cost
$
i868
$
i1,008
$
i2,839
$
i3,025
Interest
cost
i564
i567
i1,719
i1,767
Expected
return on plan assets
(i151
)
(i160
)
(i460
)
(i510
)
Settlements
and other
i250
i—
i250
i—
Amortization
of actuarial net loss
i332
i383
i1,019
i1,178
Amortization
of unrecognized prior service costs
i16
i16
i49
i50
Net
periodic benefit cost
$
i1,879
$
i1,814
$
i5,416
$
i5,510
/
The
components of net periodic benefit cost, other than the service cost component, are included in total other income (expense) on the Consolidated Statements of Operations.
Note 9: iStock-Based Compensation
We grant stock-based
compensation awards under the Second Amended and Restated 2010 Stock Incentive Plan (Stock Incentive Plan), including stock options, restricted stock units, phantom stock, and unrestricted stock units. In the Stock Incentive Plan, we have i12,623,538 shares of common stock reserved and authorized for issuance subject to stock splits, dividends, and other similar events.
At September 30, 2019, i5,972,601 shares were available for grant under the Stock Incentive Plan. We issue new shares of common stock upon the exercise of stock options or when vesting conditions on restricted stock units are fully satisfied. These shares are
subject to a fungible share provision such that the authorized share reserve is reduced by (i) ione share for every one share subject to a stock option or share appreciation right granted under the Plan and (ii) i1.7 shares
for every one share of common stock that was subject to an award other than an option or share appreciation right.
As part of the acquisition of SSNI, we reserved and authorized i2,880,039 shares, collectively, of Itron common stock to be issued under the Stock Incentive Plan for certain
SSNI common stock awards that were converted to Itron common stock awards on January 5, 2018 (Acquisition Date) pursuant to the Agreement and Plan of Merger or were available for issuance pursuant to future awards under the Silver Spring Networks, Inc. 2012 Equity Incentive Plan (SSNI Plan). New stock-based compensation awards originally from the SSNI Plan may only be made to individuals who were not employees of Itron as of the Acquisition Date. Notwithstanding the foregoing, there is no fungible share provision for shares originally from the SSNI Plan.
We
also periodically award phantom stock units, which are settled in cash upon vesting and accounted for as liability-based awards with no impact to the shares available for grant.
In addition, we maintain the Employee Stock Purchase Plan (ESPP), for which i242,399
shares of common stock were available for future issuance at September 30, 2019.
Unrestricted stock and ESPP activity for the three and nine months ended September 30, 2019 and 2018 was not significant.
Stock-Based Compensation Expense
i
Total
stock-based compensation expense and the related tax benefit were as follows:
Three Months Ended September 30,
Nine Months Ended September 30,
In thousands
2019
2018
2019
2018
Stock
options
$
i389
$
i911
$
i1,413
$
i2,694
Restricted
stock units
i6,734
i5,381
i19,178
i19,803
Unrestricted
stock awards
i158
i158
i473
i572
Phantom
stock units
i822
i762
i2,265
i2,039
Total
stock-based compensation
$
i8,103
$
i7,212
$
i23,329
$
i25,108
Related
tax benefit
$
i1,443
$
i1,259
$
i4,161
$
i4,387
/
Stock
Options
i
A summary of our stock option activity is as follows:
At
September 30, 2019, total unrecognized stock-based compensation expense related to nonvested stock options was $i3.0 million, which is expected to be recognized over a weighted average period of approximately i2.5
years.
The weighted average assumptions used to estimate the fair value of stock options granted and the resulting weighted average fair value are as follows:
(1)Shares released is presented gross of shares netted for employee payroll tax obligations.
/
At September 30, 2019, total unrecognized compensation expense on restricted stock units was $i38.1 million,
which is expected to be recognized over a weighted average period of approximately i2.1 years.
i
The
weighted average assumptions used to estimate the fair value of performance-based restricted stock units granted and the resulting weighted average fair value are as follows:
At
September 30, 2019, total unrecognized compensation expense on phantom stock units was $i5.4 million, which is expected to be recognized over a weighted average period of approximately i2.3
years. As of September 30, 2019 and December 31, 2018, we have recognized a phantom stock liability of $i1.4 million and $i1.5 million,
respectively, within wages and benefits payable in the Consolidated Balance Sheets.
Note 10: iIncome Taxes
We determine the interim tax benefit (provision) by applying an estimate of the annual effective tax rate to the year-to-date pretax book income (loss) and adjusting for discrete items during the
reporting period, if any. Tax jurisdictions with losses for which tax benefits cannot be realized are excluded.
Our tax rates for the three and nine months ended September 30, 2019 of i25% and i35%,
respectively, differed from the federal statutory rate of i21% primarily due to losses in jurisdictions for which no benefit is recognized because of valuation allowances on deferred tax assets as well as the forecasted mix of earnings in domestic and international jurisdictions.
Our tax rates for the three
and nine months ended September 30, 2018 of i22% and i1%,
respectively, differed from the federal statutory rate of i21% primarily due to losses in jurisdictions for which no benefit is recognized because of valuation allowances on deferred tax assets as well as the forecasted mix of earnings in domestic and international jurisdictions, a benefit related to excess stock-based compensation, and uncertain tax positions.
We
classify interest expense and penalties related to unrecognized tax liabilities and interest income on tax overpayments as components of income tax expense. iThe net interest and penalties expense amounts recognized were as follows:
Three
Months Ended September 30,
Nine Months Ended September 30,
In thousands
2019
2018
2019
2018
Net interest and penalties expense
$
i324
$
i414
$
i583
$
i1,152
Accrued
interest and penalties recognized were as follows:
Unrecognized tax benefits related to uncertain tax positions and the amount of unrecognized tax benefits that, if recognized, would affect our effective tax rate were as follows:
Unrecognized tax benefits related to uncertain tax positions
$
i113,552
$
i112,558
The
amount of unrecognized tax benefits that, if recognized, would affect our effective tax rate
i112,273
i111,224
At
September 30, 2019, we are under examination by certain tax authorities for the i2010 to i2017 tax years. The material jurisdictions where we are subject to examination for the 2010 to 2017 tax years include, among others, the United States,
France, Germany, Italy, Brazil and the United Kingdom. No material changes have occurred to previously disclosed assessments. We believe we have appropriately accrued for the expected outcome of all tax matters and do not currently anticipate that the ultimate resolution of these examinations will have a material adverse effect on our financial condition, future results of operations, or liquidity.
Based upon the timing and outcome of examinations, litigation, the impact of legislative, regulatory, and judicial developments, and the impact of these items on the statute of limitations, it is reasonably possible that the related unrecognized tax benefits could change from those recognized within the next twelve months. However, at this time, an estimate of the range of reasonably possible adjustments to the balance of unrecognized tax benefits cannot be made.
Note
11: iCommitments and Contingencies
Guarantees and Indemnifications
We are often required to obtain standby letters of credit (LOCs) or bonds in support of our obligations for customer contracts. These standby LOCs or bonds typically provide a guarantee to the customer for our future performance, which usually covers the installation phase of a
contract and may, on occasion, cover the operations and maintenance phase of outsourcing contracts.
i
Our available lines of credit, outstanding standby LOCs, and performance bonds were as follows:
Net
available for additional borrowings under the multi-currency revolving line of credit
$
i455,845
$
i459,017
Net
available for additional standby LOCs under sub-facility
$
i255,845
$
i259,017
Unsecured
multicurrency revolving lines of credit with various financial institutions
Multicurrency revolving lines of credit
$
i105,020
$
i108,039
Standby
LOCs issued and outstanding
(i22,895
)
(i19,386
)
Short-term
borrowings
(i70
)
(i2,232
)
Net
available for additional borrowings and LOCs
$
i82,055
$
i86,421
Unsecured
surety bonds in force
$
i96,276
$
i94,365
/
In
the event any such standby LOC or bond is called, we would be obligated to reimburse the issuer of the standby LOC or bond; however, as of November 4, 2019, we do not believe that any outstanding LOC or bond will be called.
We generally provide an indemnification related to the infringement of any patent, copyright, trademark, or other intellectual property right on software or equipment within our sales contracts, which indemnifies the customer from and pays the resulting costs, damages, and attorney's fees awarded against a customer with respect to such a claim provided that (a) the customer promptly notifies us in writing of the claim and (b) we have the sole control of the defense and all
related settlement negotiations. We may also provide an indemnification to our customers for third-party claims resulting from damages caused by the negligence or willful misconduct of our employees/agents in connection with the performance of certain contracts. The terms of our indemnifications
generally do not limit the maximum potential payments. It is not possible to predict the maximum potential amount of future payments under these or similar agreements.
Legal
Matters
We are subject to various legal proceedings and claims of which the outcomes are subject to significant uncertainty. Our policy is to assess the likelihood of any adverse judgments or outcomes related to legal matters, as well as ranges of probable losses. A determination of the amount of the liability required, if any, for these contingencies is made after an analysis of each known issue. A liability would be recognized and charged to operating expense when we determine that a loss is probable and the amount can be reasonably estimated. Additionally, we would disclose contingencies for which a material loss is reasonably possible, but not probable.
Warranty
i
A
summary of the warranty accrual account activity is as follows:
Three Months Ended September 30,
Nine Months Ended September 30,
In thousands
2019
2018
2019
2018
Beginning
balance
$
i57,112
$
i43,719
$
i60,443
$
i34,862
Assumed
liabilities from acquisition
i—
i—
i—
i5,742
New
product warranties
i1,388
i869
i3,645
i3,151
Other
adjustments and expirations
i4,603
i659
i12,533
i9,141
Claims
activity
(i8,453
)
(i2,164
)
(i21,970
)
(i8,981
)
Effect
of change in exchange rates
(i768
)
i277
(i769
)
(i555
)
Ending
balance
i53,882
i43,360
i53,882
i43,360
Less:
current portion of warranty
i38,018
i29,736
i38,018
i29,736
Long-term
warranty
$
i15,864
$
i13,624
$
i15,864
$
i13,624
/
Total
warranty expense is classified within cost of revenues and consists of new product warranties issued, costs related to insurance and supplier recoveries, other changes and adjustments to warranties, and customer claims. iWarranty expense was as follows:
Three
Months Ended September 30,
Nine Months Ended September 30,
In thousands
2019
2018
2019
2018
Total warranty expense
$
i5,991
$
i1,528
$
i13,957
$
i12,291
Health
Benefits
We are self-insured for a substantial portion of the cost of our U.S. employee group health insurance. We purchase insurance from a third party, which provides individual and aggregate stop loss protection for these costs. Each reporting period, we expense the costs of our health insurance plan including paid claims, the change in the estimate of incurred but not reported (IBNR) claims, taxes, and administrative fees (collectively, the plan costs).
i
Plan
costs were as follows:
Three Months Ended September 30,
Nine Months Ended September 30,
In thousands
2019
2018
2019
2018
Plan
costs
$
i9,378
$
i9,205
$
i24,179
$
i25,559
The
IBNR accrual, which is included in wages and benefits payable, was as follows:
Our
IBNR accrual and expenses may fluctuate due to the number of plan participants, claims activity, and deductible limits. For our employees located outside of the United States, health benefits are provided primarily through governmental social plans, which are funded through employee and employer tax withholdings.
On February 22, 2018, our Board of Directors approved a restructuring plan (the 2018 Projects) to continue our efforts to optimize our global supply chain and manufacturing operations, research and development, and sales and marketing organizations. We expect to substantially complete expense recognition on the plan by the end of 2020. Many of the affected employees are represented by unions or works councils, which require consultation, and potential restructuring projects may be subject to regulatory approval, both of which could impact the timing of charges, total expected charges, cost recognized, and planned savings in certain jurisdictions.
i
The
total expected restructuring costs, the restructuring costs recognized, and the remaining expected restructuring costs related to the 2018 Projects were as follows:
On September 1, 2016, we announced projects (2016 Projects) to restructure various company activities in order to improve operational efficiencies, reduce expenses and improve competitiveness. We closed or consolidated several facilities and reduced our global workforce as a result of the restructuring. The 2016 Projects were initiated during the third quarter of 2016 and were substantially completed at December 31, 2018.
In April 2019, we completed the sale of our property in Stretford, United Kingdom. A gain on sale of $i5.4
million was included in restructuring expense in the Consolidated Statement of Operations.
i
The total expected restructuring costs, the restructuring costs recognized, and the remaining expected restructuring costs related to the 2016 Projects are as follows:
Asset
impairments & net loss (gain) on sale or disposal
(i68
)
i5,664
(i5,732
)
i—
Other
restructuring costs
i14,167
i11,763
i1,704
i700
Total
$
i51,009
$
i53,272
$
(i2,963
)
$
i700
/
i
The
following table summarizes the activity within the restructuring related balance sheet accounts for the 2018 and 2016 Projects during the nine months ended September 30, 2019:
In thousands
Accrued Employee Severance
Asset
Impairments & Net Loss (Gain) on Sale or Disposal
Asset impairments are determined at the asset group level. Revenues and net operating income from the activities we have exited or will exit under the restructuring projects are not material to our operating segments or consolidated results.
Other restructuring costs include expenses for employee relocation, professional fees associated with employee severance, and costs to exit the facilities once the operations in those facilities have ceased. Costs associated with restructuring activities are generally presented in the Consolidated Statements of Operations as restructuring, except for certain costs associated with inventory
write-downs, which are classified within cost of revenues, and accelerated depreciation expense, which is recognized according to the use of the asset.
The current portion of restructuring liabilities was $i18.5 million and $i36.0
million as of September 30, 2019 and December 31, 2018. The current portion of restructuring liabilities is classified within other current liabilities on the Consolidated Balance Sheets. The long-term portion of restructuring liabilities balances was $i43.0 million and $i39.6
million as of September 30, 2019 and December 31, 2018. The long-term portion of restructuring liabilities is classified within other long-term obligations on the Consolidated Balance Sheets and includes severance accruals and facility exit costs.
Note 13: iShareholders'
Equity
Preferred Stock
We have authorized the issuance of i10 million shares of preferred stock with no par value. In the event of a liquidation, dissolution, or winding up of the affairs of the corporation, whether voluntary or involuntary, the holders of any outstanding preferred stock will be entitled to be paid a preferential amount per share to be determined by the Board of Directors prior
to any payment to holders of common stock. There was no preferred stock issued or outstanding at September 30, 2019 and December 31, 2018.
Stock Repurchase Authorization
On March 14, 2019, Itron's Board of Directors authorized the Company to repurchase up to $i50
million of our common stock over a 12-month period (the 2019 Stock Repurchase Program). Following the announcement of the program and through September 30, 2019, we repurchased i529,396 shares at an average share price of $i47.22
(including commissions) for a total of $i25 million. The remaining amount authorized for repurchase under the 2019 Stock Repurchase Program is $i25 million.
In accordance with the terms of our 5% senior notes indenture maturing January 15, 2026, we are limited to a total of $i25 million in stock repurchases in 2019. We met the threshold by June 30, 2019. No additional shares will be repurchased for the remainder of 2019.
The
following methods and assumptions were used in estimating fair values:
Cash, cash equivalents, and restricted cash: Due to the liquid nature of these instruments, the carrying amount approximates fair value (Level 1).
Credit Facility - term loan and multicurrency revolving line of credit: The term loan and revolver are not traded publicly. The fair values, which are determined based upon a hypothetical market participant, are calculated using a discounted cash flow model with Level 2 inputs, including estimates of incremental borrowing rates for debt with similar terms, maturities, and credit profiles. Refer to "Note 6: Debt" for a further discussion of our debt.
Senior
Notes: The Senior Notes are not registered securities nor listed on any securities exchange but may be actively traded by qualified institutional buyers. The fair value is estimated using Level 1 inputs, as it is based on quoted prices for these instruments in active markets.
Derivatives: See "Note 7: Derivative Financial Instruments" for a description of our methods and assumptions in determining the fair value of our derivatives, which were determined using Level 2 inputs.
The
fair values at September 30, 2019 and December 31, 2018 do not reflect subsequent changes in the economy, interest rates, tax rates, and other variables that may affect the determination of fair value.
Note 15: iSegment
Information
Effective October 1, 2018, we reorganized our operational reporting segmentation from Electricity, Gas, Water, and Networks to Device Solutions, Networked Solutions, and Outcomes. Prior period segment results have been recast to conform to the new segment structure. As part of our reorganization, we actively integrated our recent acquisitions and are making investment decisions and implementing an organizational structure that aligns with these new segments. In conjunction with the rollout of our new operating segments, we unified our go-to-market strategy with a single, global, sales force that sells the full portfolio of Itron solutions, products and services. We continue to manage our research and development, service delivery, supply chain, and manufacturing operations on a worldwide basis to promote global,
integrated oversight of our operations and to ensure consistency and interoperability between our operating segments.
With this reorganization, we continue to operate under the Itron brand worldwide and manage and report under the three operating segments: Device Solutions, Networked Solutions, and Outcomes.
We have three GAAP measures of segment performance: revenues, gross profit (gross margin), and operating income (operating margin). Intersegment revenues are minimal. Certain operating expenses are allocated to the operating segments based upon internally established allocation methodologies. Corporate operating expenses, interest income, interest expense, other income (expense), and the income tax provision (benefit) are neither allocated
to the segments, nor are they included in the measure of segment performance. In addition, we allocate only certain production assets and intangible assets to our operating segments. We do not manage the performance of the segments on a balance sheet basis.
Segment Products
Device Solutions
Device Solutions - includes hardware products used for measurement, control, or sensing that do not have communications capability embedded for use with our broader Itron systems, i.e., products where Itron is not offering the complete "end-to-end" solution, but only the hardware elements. Examples of the Device
Solutions portfolio include standard endpoints that are shipped without Itron communications, such as our standard gas meters, electricity IEC meters, and water meters, in addition to our heat and allocation products; communicating meters that are not a part of an Itron solution such as the Linky meter; and the implementation and installation of non-communicating devices, such as gas regulators.
Networked Solutions
Networked Solutions - includes a combination of communicating devices (smart meters, modules, endpoints, and sensors), network infrastructure, and associated application software designed and sold as a complete solution for acquiring and transporting robust application-specific data.
Networked Solutions combines, into one operating segment, the majority of the assets from the recently acquired SSNI organization with our legacy Itron networking products and software and the implementation and installation of communicating devices into one segment. This includes: communicating measurement, control, or sensing endpoints such as our Itron® and OpenWay® Riva meters, Itron traditional ERT® technology, Intelis smart gas or water meters, 500G gas communication modules, 500W water communication modules; GenX networking products, network modules and interface cards; and specific network control and management software applications. Solutions supported by this segment include automated meter reading (AMR), advanced metering infrastructure (AMI), smart grid and distribution automation (DA), and smart street lighting and smart city solutions.
Outcomes
Outcomes
- includes our value-added, enhanced software and services operating segment in which we manage, organize, analyze, and interpret data to improve decision making, maximize operational profitability, drive resource efficiency, and deliver results for consumers, utilities, and smart cities. Outcomes places an emphasis on delivering to Itron customers high-value, turn-key, digital experiences by leveraging the footprint of our Device Solutions and Networked Solutions segments. The revenues from these offerings are primarily recurring in nature and would include any direct management of Device Solutions, Networked Solutions, and other products on behalf of our end customers. Examples of these offerings include our meter data management and analytics offerings; our managed service solutions including network-as-a-service and platform-as-a-service, forecasting software and services; and any consulting-based engagement. Within the Outcomes segment, we also identify new business
models, including performance-based contracting, to drive broader portfolio offerings across utilities and cities.
Revenues, gross profit, and operating income associated with our operating segments were as follows:
Three
Months Ended September 30,
Nine Months Ended September 30,
In thousands
2019
2018
2019
2018
Product revenues
Device
Solutions
$
i211,096
$
i216,371
$
i644,254
$
i693,544
Networked
Solutions
i330,487
i297,726
i978,259
i852,819
Outcomes
i11,314
i11,619
i41,281
i32,377
Total
Company
$
i552,897
$
i525,716
$
i1,663,794
$
i1,578,740
Service
revenues
Device Solutions
$
i2,253
$
i3,879
$
i8,573
$
i12,219
Networked
Solutions
i25,734
i22,782
i70,305
i66,193
Outcomes
i43,590
i43,585
i131,415
i131,921
Total
Company
$
i71,577
$
i70,246
$
i210,293
$
i210,333
Total
revenues
Device Solutions
$
i213,349
$
i220,250
$
i652,827
$
i705,763
Networked
Solutions
i356,221
i320,508
i1,048,564
i919,012
Outcomes
i54,904
i55,204
i172,696
i164,298
Total
Company
$
i624,474
$
i595,962
$
i1,874,087
$
i1,789,073
Gross
profit
Device Solutions
$
i40,945
$
i46,484
$
i122,451
$
i148,831
Networked
Solutions
i135,406
i133,057
i388,717
i359,588
Outcomes
i20,053
i17,556
i63,713
i45,110
Total
Company
$
i196,404
$
i197,097
$
i574,881
$
i553,529
Operating
income (loss)
Device Solutions
$
i27,905
$
i33,019
$
i81,717
$
i105,721
Networked
Solutions
i105,637
i103,998
i298,994
i265,882
Outcomes
i10,843
i6,372
i35,620
i9,966
Corporate
unallocated
(i104,946
)
(i101,713
)
(i312,511
)
(i459,778
)
Total
Company
i39,439
i41,676
i103,820
(i78,209
)
Total
other income (expense)
(i15,110
)
(i16,174
)
(i44,983
)
(i45,193
)
Income
(loss) before income taxes
$
i24,329
$
i25,502
$
i58,837
$
(i123,402
)
/
For
the three months ended September 30, 2019, one customer represented i10% of total company revenues. For the nine months ended September 30, 2019, the same customer represented i11%
of total company revenues. For the three and nine months ended September 30, 2018, no customer represented more than i10% of total company revenues.
iWe
currently buy a majority of our integrated circuit board assemblies from three suppliers. Management believes that other suppliers could provide similar products, but a change in suppliers, disputes with our suppliers, or unexpected constraints on the suppliers' production capacity could adversely affect operating results.
i
Revenues by region were as follows:
Three
Months Ended September 30,
Nine Months Ended September 30,
In thousands
2019
2018
2019
2018
United States and Canada
$
i405,973
$
i376,676
$
i1,221,448
$
i1,080,709
Europe,
Middle East, and Africa
i157,159
i177,356
i495,715
i564,178
Other(1)
i61,342
i41,930
i156,924
i144,186
Total
revenues
$
i624,474
$
i595,962
$
i1,874,087
$
i1,789,073
(1)
Other
includes our operations in Latin America and Asia Pacific.
Revenues recognized from beginning contract liability
(i50,018
)
Increases
due to amounts collected or due
i257,949
Revenues recognized from current period increases
(i202,029
)
Other
(i6,673
)
Ending
balance, September 30
$
i101,359
/
On January 1, 2019,
total contract assets were $i34.3 million and total contract liabilities were $i136.5 million.
On September 30, 2019, total contract assets were $i34.6 million and total contract liabilities were $i136.0 million.
The contract assets primarily relate to contracts that include a retention clause and allocations related to contracts with multiple performance obligations. The contract liabilities primarily relate to deferred revenue, such as extended warranty and maintenance cost.
Transaction price allocated to the remaining performance obligations
Total transaction price allocated to remaining performance obligations represents committed but undelivered products and services for contracts
and purchase orders at period end. Twelve-month remaining performance obligations represent the portion of total transaction price allocated to remaining performance obligations that we estimate will be recognized as revenue over the next 12 months. Total transaction price allocated to remaining performance obligations is not a complete measure of our future revenues as we also receive orders where the customer may have legal termination rights but are not likely to terminate.
Total transaction price allocated to remaining performance obligations related to contracts is approximately $i1.2 billion
for the next twelve months and approximately $i983 million for periods longer than 12 months. The total remaining performance obligations consist of product and service components. The service component relates primarily to maintenance agreements for which customers pay a full year's maintenance
in advance, and service revenues are generally recognized over the service period. Total transaction price allocated to remaining performance obligations also includes our extended warranty contracts, for which revenue is recognized over the warranty period, and hardware, which is recognized as units are delivered. The estimate of when remaining performance obligations will be recognized requires significant judgment.
Cost to obtain a contract and cost to fulfill a contract with a customer
Cost to obtain a contract
and costs to fulfill a contract are capitalized and amortized using a systematic rational approach to align with the transfer of control of underlying contracts with customers. While amounts were capitalized, they are not material.
Disaggregation of revenue
Refer to "Note 15: Segment Information" and the Consolidated Statement of Operations for disclosure regarding the disaggregation of revenue into categories, which depict how revenue and cash flows are affected by economic factors. Specifically, our operating segments, geographical regions, and categories for products, which include hardware and software and services, are presented.
We lease certain factories, service and distribution locations, offices, and equipment under operating leases. Our operating
leases have initial lease terms ranging from i1 to i9 years, some of which include options to extend or renew the leases for up to i10
years. Certain lease agreements contain provisions for future rent increases. Our leases do not contain material residual value guarantees, and finance leases are not material.
We have not elected the short-term lease exemption. All leases with a lease term of greater than one month are included in the following tables.
i
The components of operating lease expense are as follows:
Item
2: Management's Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis should be read in conjunction with the unaudited condensed consolidated financial statements and notes included in this report and with the consolidated financial statements and the notes thereto for the fiscal year ended December 31, 2018 filed with the Securities and Exchange Commission (SEC) in our Annual Report on Form 10-K on February 28, 2019 (2018 Annual Report).
Documents we provide to the SEC are available free of charge under the Investors section of our website
at www.itron.com as soon as practicable after they are filed with or furnished to the SEC. In addition, these documents are available at the SEC's website (http://www.sec.gov), at the SEC's Headquarters at 100 F Street, NE, Washington, DC 20549, or by calling 1-800-SEC-0330.
Certain Forward-Looking Statements
This document contains forward-looking statements concerning our operations, financial performance, revenues, earnings growth, liquidity, restructuring, and
other items. This document reflects our current plans and expectations and is based on information currently available as of the date of this Quarterly Report on Form 10-Q. When we use the words "expect,""intend,""anticipate,""believe,""plan,""project,""estimate,""future,""objective,""may,""will,""will continue," and similar expressions, they are intended to identify forward-looking statements. Forward-looking statements rely on a number of assumptions and estimates. Although we believe that these assumptions and estimates are reasonable, any of these assumptions and estimates could prove to be inaccurate, and the forward -looking statements based on them could be incorrect and cause our actual results to vary materially from expected results. For a more complete description of these and other risks, refer to Item 1A: "Risk Factors" included in
our 2018 Annual Report and our other reports on file with the SEC. We do not undertake any obligation to update or revise any forward-looking statement in this document.
Overview
We are a technology company, offering end-to-end solutions to enhance productivity and efficiency, primarily focused on utilities and municipalities around the globe. Our solutions generally include robust industrial grade networks, smart meters, meter data management software, and knowledge application solutions, which bring additional value to the customer. Our professional services help our customers project-manage, install, implement, operate, and maintain their systems.
We operate under the Itron brand worldwide
and manage and report under three operating segments: Device Solutions, Networked Solutions, and Outcomes. The product and operating definitions of the three segments are as follows:
Device Solutions: primarily includes hardware products used for measurement, control, or sensing that do not have communications capability embedded for use with our broader Itron systems, i.e., products where Itron is not offering the complete “end-to-end” solution, but only the hardware elements. Examples of the Device Solutions portfolio include standard endpoints that are shipped without Itron communications, such as our standard gas meters, electricity IEC meters, and water meters, in addition to our heat and allocation products; communicating meters that are not a part of an Itron solution such as the Linky meter; and the implementation
and installation of non-communicating devices, such as gas regulators.
Networked Solutions: primarily includes a combination of communicating devices (smart meters, modules, endpoints and sensors), network infrastructure, and associated application software designed and sold as a complete solution for acquiring and transporting robust application-specific data. Networked Solutions combines, into one operating segment, the majority of the assets from the recently acquired Silver Spring Networks organization with our legacy Itron networking products and software, and the implementation and installation of communicating devices into one segment. This includes: communicating measurement, control, or sensing endpoints such as our Itron® and OpenWay® Riva meters, Itron traditional ERT® technology, Intelis Smart gas or
water meters, 500G gas communication modules, 500W water communication modules; GenX networking products, network modules and interface cards, and specific network control and management software applications. The industrial Internet of Things (IIoT) solutions supported by this segment include automated meter reading (AMR), advanced metering infrastructure (AMI), smart grid and distribution automation (DA), and smart street lighting and smart city solutions.
Outcomes: represents our value-added, enhanced software and services operating segment in which we manage, organize, analyze, and interpret data to
improve decision making, maximize operational profitability, drive resource efficiency, and deliver results for consumers, utilities and smart cities. Outcomes places an emphasis on delivering Itron customers high-value, turn-key, digital experiences by leveraging the footprint of our Device Solutions and Networked Solutions segments. The revenues from these offerings are primarily recurring in nature and would include any direct management of Device Solutions, Networked Solutions, and other products on behalf of our end customers. Examples of these offerings include our meter data management and analytics offerings, our managed service solutions including network-as-a-service and platform-as-a-service, forecasting software and services, and any consulting-based engagement. Within the Outcomes segment we also identify new business models, including performance-based contracting, to drive broader portfolio offerings across utilities and cities.
We
have three measures of segment performance: revenues, gross profit (margin), and operating income (margin). Intersegment revenues are minimal. Certain operating expenses are allocated to the operating segments based upon internally established allocation methodologies. Interest income, interest expense, other income (expense), the income tax provision (benefit), and certain corporate operating expenses are neither allocated to the segments nor included in the measures of segment performance.
Non-GAAP Measures
The following discussion includes financial information prepared in accordance with accounting principles generally accepted in the United States (GAAP), as well as certain adjusted or non-GAAP financial measures such as constant currency, free cash flow, non-GAAP operating expenses,
non-GAAP operating income, non-GAAP net income, adjusted EBITDA, and non-GAAP diluted earnings per share (EPS). We believe that non-GAAP financial measures, when reviewed in conjunction with GAAP financial measures, can provide more information to assist investors in evaluating current period performance and in assessing future performance. For these reasons, our internal management reporting also includes non-GAAP measures. We strongly encourage investors and shareholders to review our financial statements and publicly-filed reports in their entirety and not to rely on any single financial measure. Non-GAAP measures as presented herein may not be comparable to similarly titled measures used by other companies.
In our discussions of the operating results below, we sometimes refer to the impact of foreign currency exchange rate fluctuations, which are references to the differences
between the foreign currency exchange rates we use to convert operating results from local currencies into U.S. dollars for reporting purposes. We also use the term "constant currency," which represents results adjusted to exclude foreign currency exchange rate impacts. We calculate the constant currency change as the difference between the current period results translated using the current period currency exchange rates and the comparable prior period's results restated using current period currency exchange rates. We believe the reconciliations of changes in constant currency provide useful supplementary information to investors in light of fluctuations in foreign currency exchange rates.
Refer to the Non-GAAP Measures section below
on pages 46-48 for information about these non-GAAP measures and the detailed reconciliation of items that impacted free cash flow, non-GAAP operating expense, non-GAAP operating income, non-GAAP net income, adjusted EBITDA, and non-GAAP diluted EPS in the presented periods.
Revenues were $1.87 billion compared with $1.79 billion
in 2018, an increase of $85.0 million, or 5%
•
Gross margin was 30.7% compared with 30.9% in 2018
•
Operating expenses decreased $160.7 million, or 25%, compared with 2018
•
Net
income attributable to Itron, Inc. was $34.4 million, compared with a net loss of $123.1 million in 2018
•
GAAP diluted EPS increased by $4.00 to $0.86 as compared with 2018
•
Non-GAAP net income attributable to Itron, Inc. was $103.9 million compared with $70.6
million in 2018
•
Non-GAAP diluted EPS was $2.60, an increase of $0.83 compared with 2018
•
Adjusted EBITDA increased $36.2 million, or 20%, compared with 2018
Amend Credit Facility
On
October 18, 2019, we amended our 2018 credit facility by entering into the First Amendment to the credit agreement entered on January 5, 2018. This amendment extended the maturity date from January 5, 2023, to October 18, 2024, and re-amortized the term loan payments based on the balance and payment terms as of the amendment date. The amendment also modified the required interest payments and made it based on total net leverage instead of total leverage. Amounts not borrowed under the revolver are now subject to a commitment fee ranging from 0.15% to 0.25%, and drawn amounts are subject to a margin ranging from 1.00% to 1.75%. The current portion of debt and long-term debt presented in the Consolidated Balance Sheets at September
30, 2019 do not reflect this amendment.
Stock Repurchase Authorization
On March 14, 2019, Itron's Board of Directors authorized the Company to repurchase up to $50 million of our common stock over a 12-month period (the 2019 Stock Repurchase Program). Following the announcement of the program and through September 30, 2019, we repurchased 529,396 shares at an average share price of $47.22 (including commissions) for a total of $25 million.
The remaining amount authorized for repurchase under the 2019 Stock Repurchase Program is $25 million. In accordance with the terms of our 5% senior notes indenture maturing January 15, 2026, we are limited to a total of $25 million in stock repurchases in 2019. We met the threshold by June 30, 2019. No additional shares will be repurchased for the remainder of 2019.
2018 Restructuring Projects
On February 22, 2018, our Board of Directors approved a restructuring plan (the 2018 Projects) to continue our efforts to optimize our global supply chain and
manufacturing operations, research and development, and sales and marketing organizations. We expect to substantially complete expense recognition on the plan by the end of 2020. We recognized restructuring expense of $10.6 million related to the 2018 Projects during the nine months ended September 30, 2019, and we anticipate an additional $13.0 million to be recognized in future periods. At the conclusion of the 2018 Projects, we anticipate annualized savings of $45 million to $50 million. For further discussion of restructuring activities, refer to Item 1: "Financial Statements (Unaudited), Note 12: Restructuring."
The following table summarizes the changes in GAAP and Non-GAAP financial measures:
Three
Months Ended September 30,
Nine Months Ended September 30,
In thousands, except margin and per share data
2019
2018
% Change
2019
2018
% Change
GAAP
Revenues
Product
revenues
$
552,897
$
525,716
5%
$
1,663,794
$
1,578,740
5%
Service
revenues
71,577
70,246
2%
210,293
210,333
—%
Total
revenues
624,474
595,962
5%
1,874,087
1,789,073
5%
Gross
profit
$
196,404
$
197,097
—%
$
574,881
$
553,529
4%
Operating
expenses
156,965
155,421
1%
471,061
631,738
(25)%
Operating
income (loss)
39,439
41,676
(5)%
103,820
(78,209
)
N/A
Other
income (expense)
(15,110
)
(16,174
)
(7)%
(44,983
)
(45,193
)
—%
Income
tax benefit (provision)
(6,152
)
(5,715
)
8%
(20,692
)
1,692
N/A
Net
income (loss) attributable to Itron, Inc.
16,847
19,882
(15)%
34,386
(123,127
)
N/A
Non-GAAP(1)
Non-GAAP
operating expenses
$
130,387
$
126,716
3%
$
388,985
$
411,257
(5)%
Non-GAAP
operating income
66,017
70,381
(6)%
185,896
142,272
31%
Non-GAAP
net income attributable to Itron, Inc.
41,396
45,046
(8)%
103,886
70,596
47%
Adjusted
EBITDA
74,456
80,531
(8)%
213,180
176,986
20%
GAAP
Margins and Earnings Per Share
Gross margin
Product
gross margin
29.5
%
32.1
%
29.3
%
29.9
%
Service
gross margin
46.5
%
40.7
%
41.8
%
38.7
%
Total
gross margin
31.5
%
33.1
%
30.7
%
30.9
%
Operating
margin
6.3
%
7.0
%
5.5
%
(4.4
)%
Basic
EPS
$
0.43
$
0.51
$
0.87
$
(3.14
)
Diluted
EPS
$
0.42
$
0.50
$
0.86
$
(3.14
)
Non-GAAP
Earnings Per Share(1)
Non-GAAP diluted EPS
$
1.04
$
1.13
$
2.60
$
1.77
(1)
These
measures exclude certain expenses that we do not believe are indicative of our core operating results. See pages 46-48 for information about these non-GAAP measures and reconciliations to the most comparable GAAP measures.
Our revenue is driven significantly by sales of endpoints. We classify our endpoints into two categories:
•
Standard
Endpoints – an Itron product delivered primarily via our Device Solutions segment. The majority of our standard endpoint devices are used for delivery and metrology in the electricity, water, and gas distribution industries, and have no built-in remote reading communication technology. However, some standard endpoint devices are shipped with non-Itron communications capabilities and are not a part of an Itron solution, such as the Smart Spec or Linky meter, and are classified as a standard endpoint.
•
Networked Endpoints – an Itron product with one-way communication or two-way communication of data including remote device configuration and upgrade
(consisting primarily of our OpenWay® or Gen X technology). This primarily includes Itron devices used in electricity, water, and gas distribution industries. Networked endpoints also include smart communication modules and network interface cards (NICs). NICs are communicating modules that can be sold separately from the device directly to our customers or to third party manufacturers for use in endpoints such as electric, water, and gas meters; streetlights and smart city devices; sensors or another standard device that the end customer would like to connect to our OpenWay or Gen X Networked Solutions. These endpoints are primarily delivered via our Networked Solutions segment.
A summary of our endpoints shipped is as follows:
Three
Months Ended September 30,
Nine Months Ended September 30,
Units in thousands
2019
2018
2019
2018
Itron Endpoints
Standard
endpoints (1)
5,420
5,760
16,460
17,400
Networked endpoints (1)
3,940
3,720
12,180
11,190
Total
endpoints
9,360
9,480
28,640
28,590
(1)
As of the second quarter of 2019, we have refined the definition of a standard endpoint to more closely align to the segment performance of Device Solutions and Networked Solutions as reported in the Operating Segment Results section below. The quantities presented for the three and nine months ended September 30, 2018 and for the three months ended March 31, 2019, as included in the nine-month period for 2019, have been recast to align with the refined definitions of standard and networked endpoints. The total endpoints shipped for each period is unchanged.
Results of Operations
Revenues and Gross Margin
The
actual results and effects of changes in foreign currency exchange rates in revenues and gross profit were as follows:
Effect
of Changes in Foreign Currency Exchange Rates
Constant Currency Change(1)
Total Change
Three Months Ended September 30,
In thousands
2019
2018
Total
Company
Revenues
$
624,474
$
595,962
$
(10,512
)
$
39,024
$
28,512
Gross
profit
196,404
197,097
(2,946
)
2,253
(693
)
Effect
of Changes in Foreign Currency Exchange Rates
Constant Currency Change(1)
Total Change
Nine Months Ended September 30,
In thousands
2019
2018
Total
Company
Revenues
$
1,874,087
$
1,789,073
$
(48,189
)
$
133,203
$
85,014
Gross
profit
574,881
553,529
(11,457
)
32,809
21,352
(1)
Constant
currency change is a non-GAAP financial measure and represents the total change between periods excluding the effect of changes in foreign currency exchange rates.
Revenues
Revenues increased$28.5 million, or 5%, for the three months endedSeptember 30, 2019, compared with the same period in 2018. The growth for the three months endedSeptember 30, 2019
was driven primarily by the Networked Solutions segment,
which increased $35.7 million. For the three months endedSeptember 30, 2019, the Outcomes segment revenue decreased by $0.3 million when compared with 2018, and the Device Solutions segment revenue decreased by $6.9 million. Changes in exchange rates unfavorably impacted total revenues by $10.5
million during the third quarter, of which $8.3 million unfavorably impacted the Device Solutions segment total revenue. Product revenues during the third quarter of 2019 increased $27.2 million, or 5%. Service revenues during the third quarter of 2019 increased $1.3 million, or 2%.
Revenues increased $85.0 million, or 5%, for the nine months endedSeptember 30,
2019, compared with the same period in 2018. New deployments in the Networked Solutions segment increased revenue by $129.6 million for thenine months endedSeptember 30, 2019as compared with the same period in 2018. For the nine months endedSeptember 30, 2019, the Outcomes segment increased revenue by $8.4 million when compared with the same period last year, and the Device Solutions segment revenue
decreased by $52.9 million. During the nine months endedSeptember 30, 2019, changes in exchange rates unfavorably impacted total revenues by $48.2 million, of which $37.4 million unfavorably impacted the Device Solutions segment total revenue. For the nine months endedSeptember 30, 2019, new deployments increased product revenues by $85.1 million as compared with the same period in 2018.
Service revenues were substantially flat during the nine months endedSeptember 30, 2019 as compared with the same period in 2018.
Gross Margin
Gross margin for the three months endedSeptember 30, 2019 was 31.5%, compared with 33.1% for the same period in 2018. Our gross margin associated with product sales decreased to 29.5%
for the three months endedSeptember 30, 2019, compared with 32.1% for the same period in 2018. Gross margin associated with our service revenues increased to 46.5% for the three months endedSeptember 30, 2019, compared with 40.7% for the same period in 2018.
Gross margin for the nine months endedSeptember 30,
2019 was 30.7%, compared with 30.9% for the same period in 2018. Our gross margin associated with product sales decreased to 29.3% for the nine months endedSeptember 30, 2019, compared with 29.9% for the same period in 2018. Gross margin associated with our service revenues increased to 41.8% for the nine months endedSeptember 30, 2019,
compared with 38.7% for the same period in 2018.
Refer to Operating Segment Results section below for further detail on total company revenues and gross margin.
Operating Expenses
The actual results and effects of changes in foreign currency exchange rates of operating expenses were as follows:
Effect
of Changes in Foreign Currency Exchange Rates
Constant Currency Change(1)
Total Change
Three Months Ended September 30,
In thousands
2019
2018
Total
Company
Sales, general and administrative
$
83,666
$
89,556
$
(1,229
)
$
(4,661
)
$
(5,890
)
Research
and development
50,612
47,239
(156
)
3,529
3,373
Amortization
of intangible assets
16,095
17,960
(127
)
(1,738
)
(1,865
)
Restructuring
6,592
666
45
5,881
5,926
Total
Operating expenses
$
156,965
$
155,421
$
(1,467
)
$
3,011
$
1,544
Effect
of Changes in Foreign Currency Exchange Rates
Constant Currency Change(1)
Total Change
Nine Months Ended September 30,
In thousands
2019
2018
Total
Company
Sales, general and administrative
$
264,640
$
332,833
$
(7,989
)
$
(60,204
)
$
(68,193
)
Research
and development
150,551
162,298
(1,325
)
(10,422
)
(11,747
)
Amortization
of intangible assets
48,185
53,699
(565
)
(4,949
)
(5,514
)
Restructuring
7,685
82,908
(7,252
)
(67,971
)
(75,223
)
Total
Operating expenses
$
471,061
$
631,738
$
(17,131
)
$
(143,546
)
$
(160,677
)
(1)
Constant
currency change is a non-GAAP financial measure and represents the total change between periods excluding the effect of changes in foreign currency exchange rates.
Operating expenses increased $1.5 million for the three months ended September 30, 2019 as compared with the same period in 2018. This was primarily due to the increase of $5.9 million
in restructuring and the increase of $3.4 million in research and development. The increases were offset by decreases of $6.2 million in acquisition and integration costs, which are classified within sales, general and administrative expenses. Operating expenses decreased $160.7 million for the nine months ended September 30, 2019 as compared with the same period in 2018. This was primarily due to the $75.2 million decrease in restructuring expense, which was elevated during the nine months ended September 30, 2018
following the announcement of the 2018 Project, and a $68.2 million decrease in sales, general and administrative expenses of which acquisition and integration costs decreased by $59.3 million compared with the same period in 2018.
Other Income (Expense)
The following table shows the components of other income (expense):
Three
Months Ended September 30,
% Change
Nine Months Ended September 30,
% Change
In thousands
2019
2018
2019
2018
Interest
income
$
517
$
431
20%
$
1,379
$
1,725
(20)%
Interest
expense
(11,584
)
(12,948
)
(11)%
(36,213
)
(38,495
)
(6)%
Amortization
of prepaid debt fees
(1,284
)
(1,223
)
5%
(3,686
)
(5,825
)
(37)%
Other
income (expense), net
(2,759
)
(2,434
)
13%
(6,463
)
(2,598
)
149%
Total
other income (expense)
$
(15,110
)
$
(16,174
)
(7)%
$
(44,983
)
$
(45,193
)
—%
Total
other income (expense) for the three and nine months ended September 30, 2019 was a net expense of $15.1 million and $45.0 million, compared with $16.2 million and $45.2 million in the same periods in 2018.
The decrease in other income (expense), net, for the three months ended September 30, 2019, as compared with the same period in 2018, was primarily the result of $1.3
million decrease in interest expense for the credit facility. The change in other income (expense), net, for the nine months ended September 30, 2019, as compared with the same period in 2018, was substantially flat.
Income Tax Provision
For the three and nine months ended September 30, 2019, our income tax expense was $6.2 million and $20.7
million, respectively, compared with income tax expense of $5.7 million and benefit of $(1.7) million for the same periods in 2018. Our tax rate for the three and nine months ended September 30, 2019 of 25% and 35%, respectively, differed from the federal statutory rate of 21% due to the forecasted mix of earnings in domestic and international jurisdictions and losses experienced in jurisdictions with valuation allowances on deferred tax assets. Our tax rate for the three
and nine months ended September 30, 2018 of 22% and 1%, respectively, differed from the federal statutory rate of 21% due to the forecasted mix of earnings in domestic and international jurisdictions, a benefit related to excess stock based compensation, and losses experienced in jurisdictions with valuation allowances on deferred tax assets.
The effects of changes in foreign currency exchange rates and the constant currency changes in certain Device Solutions operating segment financial results were as follows:
Effect
of Changes in Foreign Currency Exchange Rates
Constant Currency Change(1)
Total Change
Three Months Ended September 30,
In thousands
2019
2018
Device
Solutions Segment
Revenues
$
213,349
$
220,250
$
(8,251
)
$
1,350
$
(6,901
)
Gross
profit
40,945
46,484
(2,039
)
(3,500
)
(5,539
)
Operating
expenses
13,040
13,465
(167
)
(258
)
(425
)
Effect
of Changes in Foreign Currency Exchange Rates
Constant Currency Change(1)
Total Change
Nine Months Ended September 30,
In thousands
2019
2018
Device
Solutions Segment
Revenues
$
652,827
$
705,763
$
(37,378
)
$
(15,558
)
$
(52,936
)
Gross
profit
122,451
148,831
(8,277
)
(18,103
)
(26,380
)
Operating
expenses
40,734
43,110
(852
)
(1,524
)
(2,376
)
(1)
Constant
currency change is a non-GAAP financial measure and represents the total change between periods excluding the effect of changes in foreign currency exchange rates.
Revenues decreased $6.9 million, or 3% for the three months ended September 30, 2019 compared with the same period in 2018. Changes in foreign currency exchange rates
unfavorably impacted revenues by $8.3 million. During the three months ended September 30, 2019, product revenue decreased due to lower electricity shipments, offset by higher shipments for water devices.
Revenues decreased$52.9 million, or 8%. Changes in foreign currency exchange rates unfavorably
impacted revenues by $37.4 million. The overall decrease in revenue was also due to lower electricity shipments, offset by higher shipments for water devices.
Gross margin was 19.2% for the three months ended September 30, 2019, compared with 21.1% for the same period in 2018. The 190 basis
point decrease over the prior year was primarily the result of product mix and higher warranty expense.
For the nine months endedSeptember 30, 2019, gross margin was 18.8%, compared with 21.1% for the nine months in 2018. During 2019,
the 230 basis point reduction over the prior year was primarily the result of increased component costs and partially offset by reduced warranty expense.
Operating expenses decreased $0.4 million, or 3%, for the three months ended September 30, 2019, compared with the same period in 2018.
The decrease was primarily a result of lower product marketing expense, offset by higher research and development expense.
Operating expenses decreased $2.4 million, or 6%, for the nine months endedSeptember 30, 2019, compared with the same period in 2018. The decrease was primarily a result
of lower research and development expense, offset by higher product marketing expense.
The effects of changes in foreign currency exchange rates and the constant currency changes in certain Networked Solutions operating segment financial results were as follows:
Effect
of Changes in Foreign Currency Exchange Rates
Constant Currency Change(1)
Total Change
Three Months Ended September 30,
In thousands
2019
2018
Networked
Solutions Segment
Revenues
$
356,221
$
320,508
$
(1,587
)
$
37,300
$
35,713
Gross
profit
135,406
133,057
(604
)
2,953
2,349
Operating
expenses
29,769
29,059
(20
)
730
710
Effect
of Changes in Foreign Currency Exchange Rates
Constant Currency Change(1)
Total Change
Nine Months Ended September 30,
In thousands
2019
2018
Networked
Solutions Segment
Revenues
$
1,048,564
$
919,012
$
(7,975
)
$
137,527
$
129,552
Gross
profit
388,717
359,588
(2,619
)
31,748
29,129
Operating
expenses
89,723
93,706
(160
)
(3,823
)
(3,983
)
(1)
Constant
currency change is a non-GAAP financial measure and represents the total change between periods excluding the effect of changes in foreign currency exchange rates.
Revenues increased$35.7 million, or 11%, for the three months ended September 30, 2019 compared with the same period in 2018.
The increase was primarily driven by higher product sales in North America, partially offset by $1.6 million of unfavorable changes in foreign currency exchange rates.
Revenues increased $129.6 million, or 14%, for the nine months endedSeptember 30, 2019 compared with the same period in 2018.
The increase was primarily driven by higher product sales in North America, partially offset by $8.0 million of unfavorable changes in foreign currency exchange rates.
Gross margin was 38.0% for the three months ended September 30, 2019, compared with 41.5% for the same period in 2018. The 350
basis point decrease was related to unfavorable product mix compared with 2018 and increased warranty costs.
Gross margin was 37.1% for the nine months endedSeptember 30, 2019, compared with 39.1% for the same period in 2018. The 200 basis point decrease
was primarily related to unfavorable product mix and increased warranty costs.
Operating expenses increased $0.7 million, or 2%, for the three months ended September 30, 2019, compared with the same period in 2018. The increase was primarily related to higher research and development expenses.
Operating expenses decreased$4.0 million, or 4%, for the nine months endedSeptember 30, 2019, compared with the same period in 2018. The decrease was primarily related to lower research and development expenses.
The effects of changes in foreign currency exchange rates and the constant currency changes in certain Outcomes operating segment financial results were as follows:
Effect
of Changes in Foreign Currency Exchange Rates
Constant Currency Change(1)
Total Change
Three Months Ended September 30,
In thousands
2019
2018
Outcomes
Segment
Revenues
$
54,904
$
55,204
$
(674
)
$
374
$
(300
)
Gross
profit
20,053
17,556
(308
)
2,805
2,497
Operating
expenses
9,210
11,184
(13
)
(1,961
)
(1,974
)
Effect
of Changes in Foreign Currency Exchange Rates
Constant Currency Change(1)
Total Change
Nine Months Ended September 30,
In thousands
2019
2018
Outcomes
Segment
Revenues
$
172,696
$
164,298
$
(2,836
)
$
11,234
$
8,398
Gross
profit
63,713
45,110
(824
)
19,427
18,603
Operating
expenses
28,093
35,144
(111
)
(6,940
)
(7,051
)
(1)
Constant
currency change is a non-GAAP financial measure and represents the total change between periods excluding the effect of changes in foreign currency exchange rates.
Revenues decreased$0.3 million, or 1%, for the three months ended September 30, 2019, compared with the same period in 2018.
Revenue growth in managed services and customer projects was unfavorably impacted by $0.7 million due to changes in foreign currency exchange rates.
Revenues increased $8.4 million, or 5%, for the nine months endedSeptember 30, 2019, compared with the same period in 2018.
This growth was driven by software licenses, managed services, and customer projects. Revenues were unfavorably impacted by $2.8 million due to changes in foreign currency exchange rates.
Gross margin increased to 36.5%, compared with 31.8% in 2018. The 470 basis point increase in gross margin was
driven primarily by the growth in managed services and customer projects and lower costs.
Gross margin increased to 36.9% for the nine months endedSeptember 30, 2019, compared with 27.5% for the same period last year. The 940 basis point increase was
driven by growth in higher margin software licenses and professional services and lower costs.
Operating expenses for the three months ended September 30, 2019 decreased $2.0 million, or 18%, compared with 2018. This was primarily related to lower research and development expenses.
Operating expenses for the nine months endedSeptember 30, 2019decreased$7.1 million, or 20%, compared with the same period last year. This was primarily related to lower research and development and product marketing expenses.
Operating expenses not directly associated with an operating segment are classified as "Corporate unallocated." These expenses increased by $3.2 million, or 3%, for the three months ended September 30, 2019 compared with the same period in 2018. This
was primarily due to higher restructuring expense and increased research and development spending, net of a decrease in SSNI acquisition and integration expense in 2019.
Corporate unallocated expenses decreased by $147.3 million, or 32%,
for the nine months ended September 30, 2019 compared with the same period in 2018. The decrease was primarily due to lower restructuring expense and lower SSNI acquisition and integration expense in 2019.
Bookings and Backlog of Orders
Bookings for a reported period represent customer contracts and purchase orders received during the period for
hardware, software, and services that have met certain conditions, such as regulatory and/or contractual approval. Total backlog represents committed but undelivered products and services for contracts and purchase orders at period-end. Twelve-month backlog represents the portion of total backlog that we estimate will be recognized as revenue over the next 12 months. Backlog is not a complete measure of our future revenues as we also receive significant book-and-ship orders, as well as frame contracts. Bookings and backlog may fluctuate significantly due to the timing of large project awards. In addition, annual or multi-year contracts are subject to rescheduling and cancellation by customers due to
the long-term nature of the contracts. Beginning total backlog, plus bookings, minus revenues, will not equal ending total backlog due to miscellaneous contract adjustments, foreign currency fluctuations, and other factors. Total bookings and backlog include certain contracts with termination for convenience clause, which will not agree to the total transaction price allocated to the remaining performance obligations disclosed in Item 1: "Financial Statements (Unaudited), Note 16: Revenues".
Effect of exchange rates
on cash, cash equivalents, and restricted cash
(543
)
(6,175
)
Increase (decrease) in cash, cash equivalents, and restricted cash
$
19,372
$
(376,185
)
Cash,
cash equivalents, and restricted cash was $141.7 million at September 30, 2019, compared with $122.3 million at December 31, 2018. The $19.4 million increase in cash, cash equivalents, and restricted cash for the nine months ended September 30, 2019 was primarily the result of cash flows from operations, partially offset by acquisitions of property, plant, and equipment; repurchases of shares; and net payments on debt.
Operating
activities
Cash provided by operating activities during the nine months ended September 30, 2019 was $128.1 million compared with cash provided by operating activities of $67.4 million during the same period in 2018. The increase was primarily due to increased gross profit and lower cash outflows for acquisition and integration costs and restructuring costs.
Investing activities
Cash used by investing activities during the nine
months ended September 30, 2019 was $811.2 million lower compared with the same period in 2018. This decrease in use of cash was primarily related to the acquisition of SSNI in 2018.
Net cash used in financing activities during the nine months ended September 30,
2019 was $73.6 million, compared with net cash provided of $408.4 million for the same period in 2018. In 2018, we had net draws on our debt of $429.6 million to fund the acquisition of SSNI, as well as cash payments of $24.0 million for debt origination fees. In 2019, we had net repayments of debt of $50.3 million and stock repurchases of $25.0 million.
Effect of exchange rates on cash and cash equivalents
The effect of exchange rates on the cash balances of currencies held in foreign denominations
for the nine months ended September 30, 2019 was a decrease of $0.5 million, compared with a decrease of $6.2 million for the same period in 2018. The impact of exchange rates is the result of a decrease in the U.S. dollar value compared with most foreign currencies during both the nine months ended September 30, 2019 and September 30, 2018.
Free
cash flow (Non-GAAP)
To supplement our Consolidated Statements of Cash Flows presented on a GAAP basis, we use the non-GAAP measure of free cash flow to analyze cash flows generated from our operations. The presentation of non-GAAP free cash flow is not meant to be considered in isolation or as an alternative to net income as an indicator of our performance, or as an alternative to cash flows from operating activities as a measure of liquidity. We calculate free cash flows, using amounts from our Consolidated Statements of Cash Flows, as follows:
Nine
Months Ended September 30,
In thousands
2019
2018
Cash provided by operating activities
$
128,100
$
67,383
Acquisitions
of property, plant, and equipment
(44,570
)
(42,493
)
Free cash flow
$
83,530
$
24,890
Free
cash flow increased primarily as a result of higher cash provided by operating activities due to a significant decrease in restructuring and acquisition and integration costs related to our acquisition of SSNI in the 2018 period. See the cash flow discussion of operating activities above. Acquisition of property, plant, and equipment increased $2.1 million during the nine months ended September 30, 2019 primarily due to investments related to our strategic sourcing projects and related manufacturing and supplier transitions in 2018.
Off-balance sheet arrangements
We have no
off-balance sheet financing agreements or guarantees as defined by Item 303 of Regulation S-K at September 30, 2019 and December 31, 2018 that we believe are reasonably likely to have a current or future effect on our financial condition, results of operations, or cash flows.
Liquidity and Capital Resources
Our principal sources of liquidity are cash flows from operations, borrowings, and sales of common stock. Cash flows may fluctuate and are sensitive to many factors including
changes in working capital and the timing and magnitude of capital expenditures and payments of debt. Working capital, which represents current assets less current liabilities, continues to be in a net favorable position.
Borrowings
On January 5, 2018, we entered into a credit agreement providing for committed credit facilities in the amount of $1.2 billion U.S. dollars (the 2018 credit facility), which amended and restated in its entirety our credit agreement dated June 23, 2015 and replaced committed facilities in the amount of $725 million. The 2018 credit facility consists of a $650 million U.S.
dollar term loan (the term loan) and a multicurrency revolving line of credit (the revolver) with a principal amount of up to $500 million. The revolver also contains a $300 million standby letter of credit sub-facility and a $50 million swingline sub-facility. Both the term loan and the revolver were to mature on January 5, 2023. During the quarter ended September 30, 2019, we made debt prepayments on the term loan in excess of required principal payments and intend to make additional payments in excess of our current portion of debt in the next year.
On October 18, 2019, we amended our 2018 credit facility by entering into the First Amendment to the credit agreement entered on January 5, 2018. This amendment extended the maturity date from January 5, 2023, to October 18, 2024, and re-amortized the term loan payments based on the balance and payment terms as of the amendment date. The amendment also modified the required interest payments and made it based on total net leverage instead of total leverage. Amounts not borrowed under the revolver are now subject to a commitment fee ranging from 0.15% to 0.25% and drawn amounts are subject to a margin ranging from 1.00% to 1.75%.
On
December 22, 2017 and January 19, 2018, we issued $300 million and $100 million, respectively, of aggregate principal amount of 5.00% senior notes maturing January 15, 2026 (Senior Notes). The proceeds were used to refinance existing indebtedness related to the acquisition of SSNI, pay related fees and expenses, and for general corporate purposes. Interest on the Senior Notes is payable semi-annually in arrears on January 15 and July 15, commencing on July 15, 2018. The Senior Notes are fully and unconditionally guaranteed, jointly and severally, on a senior unsecured basis by each of our subsidiaries
that guarantee the 2018 credit facility.
Prior to maturity, we may redeem some or all of the Senior Notes, together with accrued and unpaid interest, if any, plus a "make-whole" premium. On or after January 15, 2021, we may redeem some or all of the Senior Notes at any time at declining redemption prices equal to 102.50% beginning on January 15, 2021, 101.25% beginning on January 15, 2022 and 100.00% beginning on January 15, 2023 and thereafter to the applicable redemption date. In addition, before January
15, 2021, and subject to certain conditions, we may redeem up to 35% of the aggregate principal amount of Senior Notes with the net proceeds of certain equity offerings at 105.00% of the principal amount thereof to the date of redemption; provided that (i) at least 65% of the aggregate principal amount of Senior Notes remains outstanding after such redemption and (ii) the redemption occurs within 60 days of the closing of any such equity offering.
For further description of our borrowings, refer to Item 1: "Financial Statements (Unaudited), Note 6: Debt."
For a description of our letters of credit and performance bonds, and the amounts
available for additional borrowings or letters of credit under our lines of credit, including the revolver that is part of our credit facility, refer to Item 1: "Financial Statements (Unaudited), Note 11: Commitments and Contingencies."
Silver Spring Networks, Inc. Acquisition
As part of the acquisition of SSNI, we announced an integration plan to obtain approximately $50 million of annualized savings by the end of 2020. For the nine months ended September 30, 2019, we have paid out $24.0 million and we have approximately $25 million to $35
million of estimated cash payments remaining on the integration plan, the majority of which is expected to be paid out in the next 12 months. We have recognized $3.8 million and $24.6 million of the acquisition and integration related expenses during the three and nine months ended September 30, 2019.
Restructuring
For the nine months ended September 30, 2019, we have paid out a net $15.5
million related to the restructuring projects. As of September 30, 2019, $61.5 million was accrued for restructuring projects, of which $18.5 million is expected to be paid over the next 12 months.
For further details regarding our restructuring activities, refer to Item 1: "Financial Statements (Unaudited), Note 12: Restructuring."
Stock Repurchase Authorization
On March 14, 2019, Itron's Board of Directors authorized the
Company to repurchase up to $50 million of our common stock over a 12-month period (the 2019 Stock Repurchase Program). Following the announcement of the program and through September 30, 2019, we repurchased 529,396 shares at an average share price of $47.22 (including commissions) for a total of $25 million. The remaining amount authorized for repurchase under the 2019 Stock Repurchase Program is $25 million. In accordance with the terms of our 5% senior notes indenture maturing January 15, 2026, we are limited
to a total of $25 million in stock repurchases in 2019. We met the threshold by June 30, 2019. No additional shares will be repurchased for the remainder of 2019.
Other Liquidity Considerations
We have tax credits and net operating loss carryforwards in various jurisdictions that are available to reduce cash taxes. However, utilization of tax credits and net operating losses are limited in certain jurisdictions. Based on current projections, we expect to pay, net of refunds, approximately $2 million in state taxes and approximately $12 million in local and foreign taxes during 2019. We expect a refund of approximately
$5 million in U.S. federal taxes. For a discussion of our tax provision and unrecognized tax benefits, see Item 1: "Financial Statements (Unaudited), Note 10: Income Taxes."
At September 30, 2019, we are under examination by certain tax authorities for the 2010 to 2017 tax years. The material jurisdictions where we are subject to examination for the 2010 to 2017 tax years include, among others, the United States, France, Germany, Italy, Brazil, and the United Kingdom. No material changes have
occurred to previously disclosed assessments. We believe we have appropriately accrued for the expected outcome of all tax matters and do not currently anticipate that the ultimate resolution of these examinations will have a material adverse effect on our financial condition, future results of operations, or liquidity.
As of September 30, 2019, there was $38.2 million of cash and short-term investments held by certain foreign subsidiaries in which we are permanently reinvested for tax purposes. As a result of recent changes in U.S. tax legislation, any repatriation in the future would not result in U.S. federal income tax. Accordingly, there is no provision for U.S. deferred taxes on this
cash. If this cash were repatriated to fund U.S. operations, additional withholding tax costs may be incurred. Tax is only one of the many factors that we consider in the management of global cash. Accordingly, the amount of taxes that we would need to accrue and pay to repatriate foreign cash could vary significantly.
In several of our consolidated international subsidiaries, we have joint venture partners, who are minority shareholders. Although these entities are not wholly-owned by Itron, Inc., we consolidate them because we have a greater than 50% ownership interest and/or because we exercise control over the operations. The noncontrolling interest balance in our
Consolidated Balance Sheets represents the proportional share of the equity of the joint venture entities, which is attributable to the minority shareholders. At September 30, 2019, $4.7 million of our consolidated cash balance is held in our joint venture entities. As a result, the minority shareholders of these entities have rights to their proportional share of this cash balance, and there may be limitations on our ability to repatriate cash to the United States from these entities.
General Liquidity Overview
We expect to grow through a combination of internal new research and development, licensing technology from and to others, distribution agreements, partnering arrangements, and acquisitions
of technology or other companies. We expect these activities to be funded with existing cash, cash flow from operations, borrowings, or the sale of common stock or other securities. We believe existing sources of liquidity will be sufficient to fund our existing operations and obligations for the next 12 months and into the foreseeable future, but offer no assurances. Our liquidity could be affected by the stability of the electricity, gas, and water industries, competitive pressures, our dependence on certain key vendors and components, changes in estimated liabilities for product warranties and/or litigation, future business combinations, capital market fluctuations, international risks, and other factors described under "Risk Factors" within Item 1A of Part I of our 2018 Annual Report, as well as "Quantitative and Qualitative Disclosures About Market Risk" within Item 3 of Part I included in this Quarterly
Report on Form 10-Q.
Contingencies
Refer to Item 1: "Financial Statements (Unaudited), Note 11: Commitments and Contingencies."
Critical Accounting Estimates and Policies
The preparation of our consolidated financial statements in conformity with GAAP requires us to make estimates and assumptions that affect amounts reported in the consolidated financial statements. Changes in these estimates and assumptions are considered reasonably possible and may have a material effect
on our consolidated financial statements and thus actual results could differ from the amounts reported and disclosed herein. Our critical accounting policies that require the use of estimates and assumptions were discussed in detail in the 2018 Annual Report and have not changed materially, with the exception of the adoption of Accounting Standards Codification (ASC) 842, Leases.
Refer to Item 1: "Financial Statements (Unaudited), Note 1: Summary of Significant Accounting Policies" included in this Quarterly Report on Form 10-Q for further disclosures regarding new accounting pronouncements.
The accompanying schedule contains non-GAAP financial measures. To supplement our consolidated financial statements, which are prepared in accordance with GAAP, we use certain non-GAAP financial measures, including non-GAAP operating expense, non-GAAP operating income, non-GAAP net income, non-GAAP diluted EPS, adjusted EBITDA, free cash flow, and constant currency. The presentation of this financial information is not intended to be considered in isolation or as a substitute for, or superior to, the financial information prepared and presented in accordance with GAAP, and other companies may define such measures differently. We use these non-GAAP financial measures for financial and operational decision making and/or as a means for determining executive compensation. Management
believes that these non-GAAP financial measures provide meaningful supplemental information regarding our performance and ability to service debt by excluding certain expenses that may not be indicative of our recurring core operational results. These non-GAAP financial measures facilitate management's internal comparisons to our historical performance as well as comparisons to our competitors' operating results. Our executive compensation plans exclude non-cash charges related to amortization of intangibles and certain discrete cash and non-cash charges such as acquisition and integration related expenses, restructuring charges or goodwill impairment charges. We believe that both management and investors benefit from referring to these non-GAAP financial measures in assessing our performance and when planning, forecasting and analyzing future periods. We believe these non-GAAP financial measures are useful to investors because they provide greater transparency with
respect to key metrics used by management in its financial and operational decision making and because they are used by our institutional investors and the analyst community to analyze the health of our business.
Non-GAAP operating expenses and non-GAAP operating income – We define non-GAAP operating expenses as operating expenses excluding certain expenses related to the amortization of intangible assets, restructuring, corporate transition costs, acquisition and integration, and goodwill impairment. We define non-GAAP operating income as operating income excluding the expenses related to the amortization of intangible assets, restructuring, corporate transition costs, acquisition and integration, and goodwill impairment. Acquisition and integration related expenses include costs, which are incurred to affect
and integrate business combinations, such as professional fees, certain employee retention and salaries related to integration, severances, contract terminations, travel costs related to knowledge transfer, system conversion costs, and asset impairment charges. We consider these non-GAAP financial measures to be useful metrics for management and investors because they exclude the effect of expenses that are related to acquisitions and restructuring projects. By excluding these expenses, we believe that it is easier for management and investors to compare our financial results over multiple periods and analyze trends in our operations. For example, in certain periods expenses related to amortization of intangible assets may decrease, which would improve GAAP operating margins, yet the improvement in GAAP operating margins due to this lower expense is not necessarily reflective of
an improvement in our core business. There are some limitations related to the use of non-GAAP operating expenses and non-GAAP operating income versus operating expenses and operating income calculated in accordance with GAAP. We compensate for these limitations by providing specific information about the GAAP amounts excluded from non-GAAP operating expense and non-GAAP operating income and evaluating non-GAAP operating expense and non-GAAP operating income together with GAAP operating expense and GAAP operating income.
Non-GAAP net income and non-GAAP diluted EPS – We define non-GAAP net income as net income attributable to Itron, Inc. excluding the expenses associated with amortization of intangible assets, amortization of debt placement fees, restructuring, corporate transition costs, acquisition and
integration, goodwill impairment, and the tax effect of excluding these expenses. We define non-GAAP diluted EPS as non-GAAP net income divided by the weighted average shares, on a diluted basis, outstanding during each period. We consider these financial measures to be useful metrics for management and investors for the same reasons that we use non-GAAP operating income. The same limitations described above regarding our use of non-GAAP operating income apply to our use of non-GAAP net income and non-GAAP diluted EPS. We compensate for these limitations by providing specific information regarding the GAAP amounts excluded from these non-GAAP measures and evaluating non-GAAP net income and non-GAAP diluted EPS together with GAAP net income attributable to Itron, Inc. and GAAP diluted EPS.
For interim periods, beginning the first quarter of 2019, the budgeted annual effective
tax rate (AETR) is used, adjusted for any discrete items, as defined in ASC 740 - Income Taxes. The budgeted AETR is determined at the beginning of the fiscal year. The AETR is revised throughout the year based on changes to our full-year forecast. If the revised AETR increases or decreases by 200 basis points or more from the budgeted AETR due to changes in the full-year forecast during the year, the revised AETR is used in place of the budgeted AETR beginning with the quarter the 200 basis point threshold is exceeded and going forward for all subsequent interim quarters in the year. We continue to assess the AETR based on latest forecast throughout the year and use the most recent AETR anytime it increases or decreases by 200 basis points or more from the prior interim period.
Adjusted EBITDA – We define adjusted EBITDA as net income (a) minus interest
income, (b) plus interest expense, depreciation and amortization of intangible assets, restructuring, corporate transition cost, acquisition and integration related expense, goodwill impairment and (c) excluding income tax provision or benefit. Management uses adjusted EBITDA as a performance measure for executive compensation. A limitation to using adjusted EBITDA is that it does not represent the total increase or decrease in the cash balance for the period
and the measure includes some non-cash items and excludes other non-cash items. Additionally, the items that we exclude in our calculation of adjusted EBITDA may differ from the items that
our peer companies exclude when they report their results. We compensate for these limitations by providing a reconciliation of this measure to GAAP net income.
Free cash flow – We define free cash flow as cash provided by (used in) operating activities less cash used for acquisitions of property, plant and equipment. We believe free cash flow provides investors with a relevant measure of liquidity and a useful basis for assessing our ability to fund our operations and repay our debt. The same limitations described above regarding our use of adjusted EBITDA apply to our use of free cash flow. We compensate for these limitations by providing specific information regarding the GAAP amounts and reconciling to free cash flow.
Constant currency
– We refer to the impact of foreign currency exchange rate fluctuations in our discussions of financial results, which references the differences between the foreign currency exchange rates used to translate operating results from local currencies into U.S. dollars for financial reporting purposes. We also use the term "constant currency," which represents financial results adjusted to exclude changes in foreign currency exchange rates as compared with the rates in the comparable prior year period. We calculate the "constant currency" change as the difference between the current period results and the comparable prior period's results restated using current period foreign currency exchange rates.
Reconciliation of GAAP Measures to Non-GAAP Measures
The accompanying tables have more detail on the GAAP financial measures that are most directly comparable to the non-GAAP financial measures and the related reconciliations between these financial measures.
TOTAL
COMPANY RECONCILIATIONS
Three Months Ended September 30,
Nine Months Ended September 30,
In thousands, except per share data
2019
2018
2019
2018
NON-GAAP
OPERATING EXPENSES
GAAP operating expenses
$
156,965
$
155,421
$
471,061
$
631,738
Amortization
of intangible assets
(16,095
)
(17,960
)
(48,185
)
(53,699
)
Restructuring
(6,592
)
(666
)
(7,685
)
(82,908
)
Corporate
transition cost
(57
)
—
(1,613
)
—
Acquisition
and integration related expense
(3,834
)
(10,079
)
(24,593
)
(83,874
)
Non-GAAP
operating expenses
$
130,387
$
126,716
$
388,985
$
411,257
NON-GAAP
OPERATING INCOME
GAAP operating income (loss)
$
39,439
$
41,676
$
103,820
$
(78,209
)
Amortization
of intangible assets
16,095
17,960
48,185
53,699
Restructuring
6,592
666
7,685
82,908
Corporate
transition cost
57
—
1,613
—
Acquisition
and integration related expense
3,834
10,079
24,593
83,874
Non-GAAP
operating income
$
66,017
$
70,381
$
185,896
$
142,272
NON-GAAP
NET INCOME & DILUTED EPS
GAAP income (loss) attributable to Itron, Inc.
$
16,847
$
19,882
$
34,386
$
(123,127
)
Amortization
of intangible assets
16,095
17,960
48,185
53,699
Amortization
of debt placement fees
1,240
1,178
3,555
5,693
Restructuring
6,592
666
7,685
82,908
Corporate
transition cost
57
—
1,613
—
Acquisition
and integration related expense
3,834
10,079
24,593
83,874
Income
tax effect of non-GAAP adjustments(1)
(3,269
)
(4,719
)
(16,131
)
(32,451
)
Non-GAAP
net income attributable to Itron, Inc. (1)
$
41,396
$
45,046
$
103,886
$
70,596
Non-GAAP
diluted EPS (1)
$
1.04
$
1.13
$
2.60
$
1.77
Weighted
average common shares outstanding - Diluted
39,903
39,909
39,884
39,825
ADJUSTED
EBITDA
GAAP income (loss) attributable to Itron, Inc.
$
16,847
$
19,882
$
34,386
$
(123,127
)
Interest
income
(517
)
(431
)
(1,379
)
(1,725
)
Interest
expense
12,868
14,171
39,899
44,320
Income
tax provision (benefit)
6,152
5,715
20,692
(1,692
)
Depreciation
and amortization of intangible assets
28,623
30,449
85,691
92,428
Restructuring
6,592
666
7,685
82,908
Corporate
transition cost
57
—
1,613
—
Acquisition
and integration related expense
3,834
10,079
24,593
83,874
Adjusted
EBITDA
$
74,456
$
80,531
$
213,180
$
176,986
FREE
CASH FLOW
Cash provided by operating activities
$
50,037
$
50,504
$
128,100
$
67,383
Acquisitions
of property, plant, and equipment
(18,059
)
(13,184
)
(44,570
)
(42,493
)
Free
Cash Flow
$
31,978
$
37,320
$
83,530
$
24,890
(1)
The
income tax effect of non-GAAP adjustments is calculated using the statutory tax rates for the relevant jurisdictions, provided no valuation allowance exists. If a valuation allowance exists, there is no tax impact to the non-GAAP adjustment. Effective for the first quarter of 2019, we use the budgeted annual effective tax rate (AETR) for interim periods, with adjustments for discrete items, as defined in ASC 740 - Income Taxes. This method impacts interim periods only and does not impact full year tax results, as any difference between the budgeted or revised AETR and the actual AETR for non-GAAP adjustments would be recognized in the fourth quarter of the year. If the revised methodology had been applied in the third quarter of 2018, non-GAAP net income would have decreased by $4.8 million to $40.2 million, and diluted non-GAAP EPS would have decreased by $0.12 to $1.01. If the methodology had been applied in the nine months ended September
30, 2018 non-GAAP net income would have increased by $1 million to $71.5 million, and diluted non-GAAP EPS would have increased by $0.03 to $1.80.
Item 3: Quantitative and Qualitative Disclosures about Market Risk
In the normal course of business, we are exposed to interest rate and foreign currency exchange rate risks that could impact our financial position and
results of operations. As part of our risk management strategy, we may use derivative financial instruments to hedge certain foreign currency and interest rate exposures. Our objective is to offset gains and losses resulting from these exposures with losses and gains on the derivative contracts used to hedge them, therefore reducing the impact of volatility on earnings or protecting the fair values of assets and liabilities. We use derivative contracts only to manage existing underlying exposures. Accordingly, we do not use derivative contracts for trading or speculative purposes.
Interest Rate Risk
We
are exposed to interest rate risk through our variable rate debt instruments. In October 2015, we entered into an interest rate swap, which is effective from August 31, 2016 to June 23, 2020, and converts $214 million of our LIBOR-based debt from a floating LIBOR interest rate to a fixed interest rate of 1.42% (excluding the applicable margin on the debt). The notional balance will amortize to maturity at the same rate as required minimum payments on our term loan. At September 30, 2019, our LIBOR-based debt balance was $587.5 million.
In November 2015, we entered into three interest rate cap contracts
with a total notional amount of $100 million. The interest rate cap contracts expire on June 23, 2020 and were entered into in order to limit our interest rate exposure on $100 million of our variable LIBOR-based debt up to 2.00%. In the event LIBOR is higher than 2.00%, we will pay interest at the capped rate of 2.00% with respect to the $100 million notional amount of such agreements. The interest rate cap contracts do not include the effect of the applicable margin.
In April 2018, we entered into a cross-currency swap, which converts $56.0 million of floating rate LIBOR-based U.S. Dollar denominated debt into 1.38%
fixed rate euro denominated debt. This cross-currency swap matures on April 30, 2021 and mitigates the risk associated with fluctuations in interest and currency rates impacting cash flows related to a U.S. Dollar denominated debt in a euro functional currency entity.
The table below provides information about our financial instruments that are sensitive to changes in interest rates and the scheduled minimum repayment of principal and the weighted average interest rates at September 30,
2019. Weighted average variable rates in the table are based on implied forward rates in the Reuters U.S. dollar yield curve as of September 30, 2019 and our estimated leverage ratio, which determines our additional interest rate margin at September 30, 2019.
Dollars
in thousands
2019
2020
2021
2022
2023
2024
Total
Fair
Value
Variable
Rate Debt (1)
Principal:
U.S. dollar term loan
$
6,250
$
44,688
$
60,937
$
65,000
$
410,625
$
—
$
587,500
$
582,339
Weighted
average interest rate
3.68
%
3.24
%
3.05
%
3.01
%
3.05
%
Principal:
Multicurrency revolving line of credit
$
—
$
—
$
—
$
—
$
—
$
—
$
—
$
—
Weighted
average interest rate
3.68
%
3.24
%
3.05
%
3.01
%
3.05
%
Interest
rate swap
Weighted
average interest rate (pay) Fixed
1.42
%
1.42
%
Weighted
average interest rate (receive) Floating LIBOR
1.93
%
1.60
%
Net/Spread
0.51
%
0.18
%
Interest
rate cap
Cap
rate
2.00
%
2.00
%
Weighted
average interest rate Floating LIBOR
1.93
%
1.60
%
Weighted
average interest rate (receive)
(0.07
)%
(0.40
)%
Cross
currency swap
Weighted
average interest rate (pay) Fixed - EURIBOR
1.38
%
1.38
%
1.38
%
Weighted
average interest rate (receive) Floating - LIBOR
1.93
%
1.49
%
1.31
%
(1)
The principal payments listed do not reflect the amended credit facility. Refer to Item 1: "Financial Statements (Unaudited), Note 6: Debt."
Based on a sensitivity analysis as of September 30, 2019, we estimate that, if market interest rates average one percentage point higher in 2019 than in the table above, our financial results in 2019 would not be materially impacted.
We continually monitor and assess our interest rate risk and may institute additional derivative instruments to manage such risk in the future.
Foreign
Currency Exchange Rate Risk
We conduct business in a number of countries. As a result, approximately half of our revenues and operating expenses are denominated in foreign currencies, which expose our account balances to movements in foreign currency exchange rates that could have a material effect on our financial results. Our primary foreign currency exposure relates to non-U.S. dollar denominated transactions in our international subsidiary operations, the most significant of which is the euro. Revenues denominated in functional currencies other than the U.S. dollar were 38% and 37% of total revenues for the three and nine months ended September 30, 2019 compared with 39% and 41% for the
same respective periods in 2018.
We are also exposed to foreign exchange risk when we enter into non-functional currency transactions, both intercompany and third party. At each period-end, non-functional currency monetary assets and liabilities are revalued with the change recognized to other income and expense. We enter into monthly foreign exchange forward contracts, which are not designated for hedge accounting, with the intent to reduce earnings volatility associated with currency exposures. As of September 30, 2019, a total of
50contracts were offsetting our exposures from the euro, pound sterling, Indonesian rupiah, Chinese yuan, Canadian dollar, Indian rupee and various other currencies, with notional amounts ranging from $120,000 to $26.4 million. Based on a sensitivity analysis as of September 30, 2019, we estimate that, if foreign currency exchange rates average ten percentage points higher in 2019 for these financial instruments, our financial results in 2019 would not be materially impacted.
In
future periods, we may use additional derivative contracts to protect against foreign currency exchange rate risks.
Item 4: Controls and Procedures
Evaluation of disclosure controls and procedures
An evaluation was performed under the supervision and with the participation of our Company's management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design
and operation of the Company's disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e)) under the Securities Exchange Act of 1934 as amended. Based on that evaluation, the Company's management, including the Chief Executive Officer and Chief Financial Officer, concluded that as of September 30, 2019, the Company's disclosure controls and procedures were effective to ensure the information required to be disclosed by an issuer in the reports that it files or submits under the Securities Exchange Act of 1934 is accumulated and communicated to our management, including our principal executive
and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure. There are inherent limitations to the effectiveness of any system of disclosure controls and procedures, including the possibility of human error and the circumvention or overriding of the controls and procedures. Accordingly, even effective disclosure controls and procedures can only provide reasonable assurance of achieving their control objectives.
Changes in internal controls over financial reporting
In the ordinary course of business, we review our system of internal control over financial reporting and make changes to our applications and processes to improve such controls and increase efficiency, while ensuring that we maintain an
effective internal control environment. Changes may include such activities as implementing new, more efficient applications and automating manual processes. We are continuing to upgrade our global enterprise resource software applications at certain of our locations outside of the United States. We will continue to upgrade our financial applications in stages, and we believe the related changes to processes and internal controls will allow us to be more efficient and further enhance our internal control over financial reporting.
Except for these changes, there have been no other changes in our internal control over financial reporting during the three months ended September 30, 2019 that materially affected, or are reasonably likely to materially affect, internal control over financial
reporting.
Refer to Item 1: "Financial Statements (Unaudited), Note 11: Commitments and Contingencies."
Item
1A: Risk Factors
There were no material changes to risk factors during the third quarter of 2019 from those previously disclosed in Item 1A: "Risk Factors" of Part I of our Annual Report on Form 10-K for the fiscal year ended December 31, 2018, which was filed with the Securities and Exchange Commission on February 28, 2019.
Item 2: Unregistered Sales of Equity Securities and Use of Proceeds
(a) Not applicable.
(b)
Not applicable.
(c) Issuer Repurchase of Equity Securities
Period
Total Number of
Shares Purchased (1)
Average
Price Paid per Share (2)
Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs
Maximum Dollar Value of Shares that May Yet Be Purchased Under the Plans or Programs
Shares
repurchased represent shares transferred to us by certain employees who vested in restricted stock units and used shares to pay all, or a portion of, the related taxes. On March 14, 2019, Itron's Board authorized a new repurchase program of up to $50 million of our common stock over a 12-month period. Repurchases are made in the open market or in privately negotiated transactions, and in accordance with applicable securities laws.
(2)
Includes commissions.
Item
5: Other Information
(a) No information was required to be disclosed in a report on Form 8-K during the third quarter of 2019 that was not reported.
XBRL
Instance Document. The instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document.
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.