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Executives

Barbara J. Doyle - Vice President of Investor Relations

Philip C. Mezey - Chief Executive Officer, President and Director

Steven M. Helmbrecht - Chief Financial Officer, Principal Accounting Officer and Executive Vice President

John W. Holleran - Chief Operating Officer, Executive Vice President, Interim President of Energy Segment and Interim Chief Operating Officer of Energy Segment

Analysts

Benjamin J. Kallo - Robert W. Baird & Co. Incorporated, Research Division

Paul Coster - JP Morgan Chase & Co, Research Division

Ryan M. Connors - Janney Montgomery Scott LLC, Research Division

John Quealy - Canaccord Genuity, Research Division

Craig E. Irwin - Wedbush Securities Inc., Research Division

Patrick Jobin - Crédit Suisse AG, Research Division

Itron (ITRI) Q3 2013 Earnings Call October 30, 2013 5:00 PM ET

Operator

Good day, everyone, and welcome to the Itron Q3 2013 Earnings Conference Call. Today's call is being recorded. For opening remarks, I would like to turn the call over to Barbara Doyle. Please go ahead.

Barbara J. Doyle

Thank you, Elise, and welcome to everyone on the call. Good afternoon. I'd like to welcome you to Itron's Third Quarter Fiscal 2013 Earnings Conference Call. We issued a press release earlier today announcing our results. The press release includes replay information about today's call. We have also prepared presentation slides to accompany our remarks. The presentation is available to the webcast and to our corporate website under the Investor Relations tab.

On the call today, we have Philip Mezey, Itron President and Chief Executive Officer; Steve Helmbrecht, Itron Executive Vice President and Chief Financial Officer; and John Holleran, Itron Executive Vice President and Chief Operating Officer. Philip will begin our call today with a summary of our operating results and the business environment. Steve Helmbrecht will cover our Q3 financial metrics. Philip will then close the prepared portion -- the prepared remarks portion of the call with some summary comments, and then we'll open it up for questions.

Before we get started, please let me remind you of our non-GAAP financial presentation and our safe harbor statement. Our earnings release and financial presentation include non-GAAP financial information that we believe enhances the overall understanding of our current and future performance. We have included reconciliations of differences between GAAP and non-GAAP financial measures in our earnings release and financial presentation. We will be making statements during this call that are forward-looking. These statements are based on current expectations and assumptions that are subject to risks and uncertainties. Actual results could differ materially from these expectations because of factors discussed in today's earnings release and the comments made during this conference call and in the risk factors section of our Form 10-K and other reports and filings with the Securities and Exchange Commission. We do not undertake any duty to update any forward-looking statements.

Now please turn to Page 4 in the presentation, and I'll turn the call over to our CEO, Philip Mezey.

Philip C. Mezey

Thank you, Barbara, and good afternoon to everyone. Before I discuss Q3 results, let me remind you of what we have said, what we are looking to accomplish in 2013.

Our near-term financial focus is on improving profitability, with earnings improvement in the second half of the year compared to the first half. We are driving to get better quarter-after-quarter, strengthening the company's core financials.

In Q3, total revenues of $495 million declined by 1% in constant currency. Sequentially, revenues increased by 3% from the second quarter, with improvement in each business line: electric, gas and water. We had good revenue performance in water globally, including record quarterly revenues in North America.

Electric business results were mixed, with underlying strength in North America. Business in EMEA continues to be soft, which is impacting our results, particularly in gas. We anticipate continued weakness in this region in the near term.

I'm encouraged by the higher revenue trend each quarter this year in a business environment that is improving, but still uneven. And we are making progress on earnings improvement.

Now I'll provide insight into our segment performance, starting with the energy segment on Slide 5. Electric revenues of $217 million were down from last year by 2% in constant currency. We continue to see underlying strength in our core electricity business. Excluding the revenue from the large OpenWay contracts, global electric revenues grew 25% on a constant currency basis, driven by Smart Metering projects in North America. We are generating meaningful revenues from multiple projects, including Detroit Edison, Duke Energy, Consumers Energy, the Los Angeles Department of Water and Power, National Grid and others. 12% growth in electric revenues in the EMEA region offset weakness in Asia Pacific and Latin America. EMEA growth was driven by the completion of the large project in North Africa.

The Energy segment gross margin of 28.6% declined 460 basis points in the quarter. Product mix and lower volumes put pressure on the margin compared to last year, but the majority of the decline, 350 basis points, resulted from increased costs on our project with BC Hydro. This impacted operating margin as well.

In Q3, we booked $13.6 million of additional costs to complete the project. Our initial network design did not accurately reflect some of the meter reading challenges in the British Columbia province, including meter locations in many of the high-rises in Vancouver, as well as very mountainous rural lake areas. We have been deploying this project over the last 2 years, recognizing more than $260 million in revenue to date, and this is a successful, profitable project.

As the project is substantially complete and majority of the revenue has already been recognized, the added costs for the tail end of the project had to be accrued in the third quarter. We expect these costs to be incurred over the next 9 months as we complete the project. This is an important project for both Itron and our customer, and one that showcases our OpenWay smart grid technology.

The impact of the additional costs to complete the contract was, however, disappointing in an otherwise good quarter in our electricity business. Looking forward, the more robust solution design for vertical urban and mountainous areas will benefit future OpenWay customers with similar topology challenges.

Electricity bookings in the quarter were $166 million, including an OpenWay contract with FortisBC in Canada and a cellular solution contract with Grayson-Collin Electric Cooperative in Texas. One of our key initiatives is a focus on collaboration to accelerate innovation. We announced several examples of this innovation in Q3.

Our industry-leading OpenWay smart grid network is now available globally, supporting multiple communication options. Our global standards-based platform connects utilities with their customers in grid assets using RF Mesh, cellular and power line communications. Itron's global OpenWay network provides true interoperability to support smart grid applications. The platform strengthens Itron's competitiveness in key markets, and it increases our efficiency, helping us to streamline development and reduce expenses while we accelerate delivery of new products and applications.

We also announced that Itron's solar meter solution is being used by more than 50,000 homes and businesses in North America, establishing Itron as the leading provider of solar metering in the region.

Solar meters account for approximately 1% of our electric revenues currently, and we see the potential for high growth rates of this stream of revenues in 2014 and beyond, including good recurring revenues from our managed cellular services.

I'll wrap up Electricity with an update on the opportunities we are pursuing. As previously communicated, FirstEnergy had selected Itron for its smart grid project in Pennsylvania. We await regulatory approval to proceed with the contract.

In Europe, the commentary at European Utility Week in Amsterdam earlier this month validated that smart grid projects are advancing. The Linky project tender at ERDF for the first 3 million meters was published earlier in October, indicating another step forward for this project. The tender award is anticipated to be announced in early 2014, with installation expected to begin in early 2015.

In Spain, Iberdrola is moving forward on their Smart Metering project, and we have been notified that we received a small award of the recent 1.4 million meter tender. Iberdrola is an important Itron customer using our meter data collection software for their project, and we will evaluate the level of our future participation on the metering side.

Our focus is to prioritize projects where we can differentiate our solution and value to the customer.

Now moving on to the gas business. Gas Q3 revenues of $143 million were down 6% year-over-year in constant currency. The decline was primarily in EMEA. As we have discussed on previous calls, our project with Azerigas in Azerbaijan is one of Itron's largest smart gas meter contracts. Shipments to Azerigas are down year-over-year, given the completion of the deployment in the capital region of Baku. The project outside of the capital city has been approved for 2014 rollout. The good news is that we have already begun shipping meters for this next phase of the project.

Elsewhere in EMEA, gas revenues in Italy grew in the quarter, driven by residential meters and services. Orders in France and the U.K. have slowed, given their pending Smart Meter rollouts. Shipments to Germany remain on target.

In the U.S., gas endpoint sales are lower on a year-to-date basis, as utilities focus on pipeline infrastructure and safety. However, we did see a rebound to modest growth in North America in Q3, driven by a large new order at CenterPoint Energy.

Total gas bookings in the quarter were $167 million for a 1.2:1 book-to-bill ratio. This includes a contract worth $61 million in the quarter for CenterPoint Energy's natural gas distribution business. CenterPoint will complete installation of Itron's advanced metering technology across the remainder of their 6-state service territory by the end of 2015.

In terms of new tenders, one of the largest upcoming gas opportunities is the GrDF project in France for 11 million meters. This multiphase project is expected to begin in 2015 and extend through 2020. GrDF issued an RFP in Q2 for the first phase of the project covering 5 million meters, with the award anticipated in early 2014. This is a substantial Smart Metering project that continues to move forward.

In the U.K., tenders for the initial phase of their Smart Meter projects have begun for 2014 and 2015 deployments. Itron is competing for these tenders with the goal of continuing our strong presence with utilities in the region. On the innovation front, Itron announced a new gas Cyble communication module and a new commercial Smart Meter, both targeted to customers in Europe. Itron's Ecora meter is a compact diaphragm Smart Meter with temperature and pressure compensation and GPRS communications integrated in the meter. The meter provides high billing accuracy, as well as ease of installation, reducing implementation costs.

As we have discussed, a transition to smart gas metering is occurring globally, admittedly slower than we'd like. With Itron's leadership and reliable and accurate metrology, and our expansion of smart gas solutions targeted at pipeline integrity, monitoring and detection, we are optimistic about future gas growth opportunities.

Turning to our Water segment on Slide 6. Itron is a clear leader in automated and smart water technologies, and this shows up in our performance. Q3 water revenues increased 6% (sic) [7%] year-over-year in constant currency, with growth in North America and Latin America regions. Gross margin of 34.8% was down compared to 36.6% last year on the heavier mix of lower margin professional services, although services margin did improve for the -- from the second quarter.

Non-GAAP operating margin increased by 20 basis points year-over-year as a result of lower operating expenses, excluding restructuring costs. Water bookings were $123 million in the quarter, reflecting a 0.9:1 book-to-bill ratio. This was a quarter of multiple modest sized bookings in water rather than any single large contract. On the innovation front, we delivered our first units of Itron's EquaScan solutions that we announced in the second quarter, entering the large market opportunity for heat cost allocation systems for multifamily housing. We also announced a new residential ultrasonic water meter called Intelis with integrated communications and advanced sensors to increase visibility into water distribution systems. And I'm pleased that the latest IMS research report, again, ranked Itron as the top global supplier of total water meter and communication module shipments.

Overall, we had strong performance in our water business in Q3. We also see continued opportunities for growth, driven by demand for automated water meter networks worldwide and our new products targeting heat metering.

Now I'll turn the call over to Steve Helmbrecht to cover our financials in more detail, comment on our restructuring and provide some color on our full year expectations.

Steven M. Helmbrecht

Thank you, Philip, and good afternoon. I will begin with Slide 7, which summarizes the financial results for the quarter compared with the third quarter of 2012. Philip provided a good overview of our revenue, so my remarks will start with gross margin.

Consolidated gross margin was 30.3%, down 380 basis points over last year. The BC Hydro charge drove the majority of the decline, accounting for 260 basis points at the consolidated company level. Gross margin was also negatively impacted year-over-year by product mix and lower volumes overall.

Non-GAAP operating margin was 6.6%, down from 10.8%, driven by the lower gross profit. We continue to focus on reducing our operating expenses. In the quarter, non-GAAP sales, marketing and research and development expenses were down 3% compared to last year and sequentially.

General and administrative expenses in the quarter increased year-over-year, due to provisions for bad debt and legal expenses. Employee-related expenses and G&A declined compared to last year. Expense reductions helped partially offset the revenue decline and the decreased gross margin in the quarter.

Adjusted EBITDA was $46.4 million this quarter, with adjusted EBITDA margin of 9.4%, down from 13.5% a year ago. On a GAAP basis, we had a net loss of $0.19 per share, compared with net earnings of $0.89 per share in 2012. The decrease was driven primarily by lower gross profit and higher operating expenses related to the restructuring charge of $28 million.

Non-GAAP earnings per share, which exclude the impact of restructuring charges, acquisition-related expenses and amortization of intangible assets and debt fees, were $0.65 for the quarter, compared with $0.97 in 2012.

As shown on the non-GAAP EPS bridge chart on Slide 8, the decrease in our non-GAAP earnings was driven by lower gross profit, partially offset by lower expenses, reduced share count and lower tax expense.

Earnings in the quarter reflect lower tax expense, but had a $0.07 per share impact. And updated non-GAAP effective tax rate of 15% for the full year reflects slower business and several jurisdictions in Europe and lower-than-expected profit in the third quarter and full year.

Free cash flow for the quarter was $31.3 million, compared with $33.9 million in the third quarter of 2012. We had strong cash collections from accounts receivable in the quarter, primarily the scheduled release of retainage provisions on a large OpenWay contract.

Now turning to capital. In March, our board authorized a new 1-year share repurchase plan for up to $50 million. We have repurchased 559,000 shares under this plan at an average price of about $42 per share, leaving $26 million available. We ended the quarter with $399 million in debt, down $11 million from last quarter.

Our interest expense was $2.8 million in the quarter and reflects the interest rate swaps that became effective in August, resulting in an increase in our interest rate to 2% from 1.5%.

I will move on to bookings and backlog now using the next 3 slides. Turning to Slide 9. Total backlog at September 30 was about $1.1 billion, with 12-month backlog at $582 million. Our base business backlog shown in the red bars on Slide 10, continues to grow and was $825 million at the end of the quarter. Yellow bars on the slide represent the backlog related to the large OpenWay deployments. These projects are substantially complete, with the exception of Detroit Edison, which has installed more than 1.3 million OpenWay endpoints to date and will continue its deployment over the next several years.

Turning to Slide 11. We had $457 million bookings during the quarter, representing a book-to-bill ratio of 0.9:1. Our largest booking was $61 million related to CenterPoint Energy's smart gas module deployment.

I will also provide an update on the restructuring we announced in September. We announced projects to reduce approximately 750 employees, or 9% of our workforce, and restructure operations to increase efficiency and lower costs. These are proactive cost reductions as part of our ongoing effort to streamline operations, reduce our global footprint and costs and improve profitability.

As we have discussed publicly throughout the year, reducing costs is one of Itron's key focus areas, being led by John Holleran in his global COO role. The announcement reflects a step in these ongoing efforts.

The restructuring is underway, and we incurred $28 million of charges in the third quarter associated with the projects. The projects predominately impact the electricity business line in our energy segment, although we are implementing projects across all areas of the business. The actions taken to date include: the reduction of 260 positions and notifications to 65 additional positions. We have announced plans to close our Sumaré, Brazil plant and discontinue the electromechanical meter business line in Latin America. We will close the meter production line by year-end and consolidate the remaining operations into our Americana facility. We have consolidated our cellular integration facility in Mississippi into our factory in South Carolina.

We have announced the closure of an R&D location in San Mateo. And we began the process of consolidating other administrative offices in the U.S., Canada, Mexico, Brazil, Germany, Australia, China and India. Many of the projects are outside the U.S. and are subject to labor and employment regulations, which can impact timetables. We currently expect all projects to be substantially complete by the end of June next year. Once completed, we anticipate these projects will result in $30 million of sustainable annualized savings, which is approximately 150 basis points of margin improvement.

Lastly, I'd like to make a comment on our financial guidance. Given our Q3 results and softness in Europe, we anticipate our full year results will be at the low end of our prior guidance range of $1.95 billion to $2 billion of revenue and to $2.25 to $2.55 of non-GAAP EPS.

Now let me turn the call back to Philip.

Philip C. Mezey

Thanks, Steve. In my 10 months as Itron's CEO, I've gained a wider perspective of our organization, and I'd like to conclude our remarks with my assessment of where we are now.

I remain committed to the key initiatives I set in January that are focused on quality, collaboration and innovation. Under these initiatives, we have strengthened the company. Our focus includes purchasing, manufacturing, product design, delivery commitments, project controls and financial operations. This commitment to quality must be at the center of everything that we do, and we're instilling that commitment in our employees around the world.

The strong turnout and customer testimonials at our Itron Utility Week Conference in Orlando this month validates that we are on the right track. Our customers recognize this commitment and appreciate our renewed emphasis on delivering high-quality solutions to them, yet the project charge we took this quarter is a reminder that we have more work to do. We will not be complacent when it comes to quality and are working to improve every day.

Through our quality program, we will be recognized by our customers as the provider of choice in our industry. And we will drive improved and more predictable financial results. We have a wealth of knowledge, experience and expertise across Itron, things that are a true competitive advantage. We unlock our potential through collaboration. By realigning our operations and removing barriers to collaboration, we have been able to continue to streamline our business and reduce cost.

John Holleran and his team are leading a globalization and restructuring initiative that is beginning to deliver results. John's team has already produced organizational and process changes that are reducing OpEx in the near term, and that will also drive meaningful and sustainable improvements.

Our global ERP system and shared services rollout led by Steve Helmbrecht's team will drive significant G&A savings. And as revenues increase, our improved operating efficiency will result in even stronger bottom line results. Driving innovation allows us to accelerate new product availability, even as we are reducing R&D expenditures. We've launched more than a dozen significant new products and solutions so far this year, including taking our OpenWay solution global.

We are converging technology platforms, leveraging technology partners and building offshore development and delivery capability to reduce costs and free up engineering resources to create new innovative technology. We also continue to look at ways to expand our capabilities through investment and acquisition opportunities.

Now 10 months into the job, I'm encouraged by the progress we are making in a macro environment that has been tough. While there is more work to do, we have improved our results each quarter. The pace of revenue growth largely depends on project timing and customer schedule. Our focus on innovation, efficiency and lower costs builds a solid foundation for increased earnings generation and for future investments to expand into new software and services markets. I am confident in the direction we are taking the company. Thank you. And now let's take some questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from Ben Kallo with Robert Baird.

Benjamin J. Kallo - Robert W. Baird & Co. Incorporated, Research Division

My question was about the BC Hydro margin impact. The way I understand it is you incurred all the costs this quarter, even though it's going to roll up in the next 9 months. So do we see that flow through in the P&L or not?

Philip C. Mezey

So Ben, we accrued for the costs. The actual costs will be incurred over the next 9 months.

Steven M. Helmbrecht

And this is Steve, Ben. Just to build on that, we will not incur additional future expense in future quarters related to that. That is already reflected in the results for the quarter.

Benjamin J. Kallo - Robert W. Baird & Co. Incorporated, Research Division

So we shouldn't expect that to impact future quarters on a margin basis on the P&L?

Steven M. Helmbrecht

Correct.

Benjamin J. Kallo - Robert W. Baird & Co. Incorporated, Research Division

And then going onto backlog. The CenterPoint announcement that you announced, is that included in this quarter's backlog? It was right on the costs there.

Steven M. Helmbrecht

Yes, it is included.

Benjamin J. Kallo - Robert W. Baird & Co. Incorporated, Research Division

Okay. And then, it sounded like you're backing up Iberdrola a little bit. For us, they are very electricity Europe-focused out there and we're looking at these things as catalyst. Can you, guys, give us maybe 2 to 3 different response that we should be focused on more intently than Iberdrola, maybe with better margins that might come sooner?

Philip C. Mezey

I think our opportunities, of course, we've talked about ERDF, where volumes are potentially higher and competitive dynamics are somewhat different. We discussed the U.K., where we see the market coming along nicely. And I think that there are differentiated opportunities for us in that market. And then you see Germany starting to really come to life. And I think nice opportunities there. But I'd point out, again, this distinction between Europe and EMEA. EMEA, 100 countries in which we have tremendous opportunities in Africa and the Middle East and some of the former Soviet republic. So there are opportunities outside of those few Western European countries.

Benjamin J. Kallo - Robert W. Baird & Co. Incorporated, Research Division

Great. And then my last question, Philip and Steve, on the balance sheet front, balance sheet remains very strong here. In the past, you've outlined acquisitions as your #1 target for use of the balance sheet. Can you give us an update where you are there? What type of businesses you're looking at?

Philip C. Mezey

So, Ben, one of the -- as I made the point, one of the first things I did when I got the job was appoint Russ Vanos to head up a Strategy and Business Development Group. And one of their first tasks was really build an evaluation of what our market opportunities were and where the adjacencies lie. We've done some very promising work in that area. I've talked about going -- moving beyond the meter. And we are starting to see opportunities in projects that we're already doing, in which we're driving more software and analysis component, more recurring services, opportunities. And we do see a number of opportunities of those kinds out there in the market.

Operator

We'll go next to Paul Coster with JPMorgan.

Paul Coster - JP Morgan Chase & Co, Research Division

Philip, I just wanted to go back on -- to Iberdrola and your comments there. It sounds like you're turning away from certain type of business. Can you just elaborate on that and whether there's broader implications in Europe?

Philip C. Mezey

Sure. So on -- in many private calls, we have talked about the dynamic of certain of the European bids in which the customers provide a specification and there essentially is an auction process, where we don't have the same kind of opportunity to create differentiated value. Iberdrola and France are examples of that kind of dynamic. And based on how the auction process has gone in Spain, you'll see a less emphasis from us there. But there are strong opportunities for value differentiation in the other European markets that we've talked about and, certainly, much more broadly around the world.

Paul Coster - JP Morgan Chase & Co, Research Division

Okay. And then I realize this is more art than science. But my impression is that the European ramp that you've been waiting for, for so long, it's really a 2015 phenomenon now with some visibility into that maybe in the first half 2014. Is that now your latest thought on this? I know it changes.

Philip C. Mezey

I mean, Paul, I think that's fair. That there were some initial and pilot quantities that are available starting to build in the second half of '14, but the volume really is in '15 at this point.

Operator

We'll go next to Ryan Connors with Janney Montgomery Scott.

Ryan M. Connors - Janney Montgomery Scott LLC, Research Division

Just kind of a bigger question for you, Philip, kind of has to do with the margin profile and the cost structure improvements going on. And have you thought about kind of a longer-term goal or target of where you think the margin profile of the business should be, just from a high-level perspective? I mean, we've been kind of running in this mid- to high-single-digit operating margin rate and -- which is kind of below the historical run rate. So I guess my question is, as you look out a couple of years and you do get some improvement in volumes and so forth, where should we be thinking about the potential of the business to go in terms of a more normalized operating margin? Have you done any -- can you sort of give me any kind of thought?

Philip C. Mezey

Ryan, we absolutely have. On last quarter's call, I talked about our goal of mid-30s gross margins and mid-teens EBITDA margins, which we feel are absolutely attainable through not only increased volumes but product mix. And maybe just handing to John to talk about a couple of initiatives.

John W. Holleran

It's a number of things, Ryan, and we'll be turning all of those dials. But to Philip's plan, we absolutely believe those targets are achievable. It will take some time, but we think we're taking some steps in the right direction at present. And it will include also some of the products that we're pushing through our R&D group and bringing to market. And as we find more value-enhancing products, we'll be able to improve our margins on this.

Ryan M. Connors - Janney Montgomery Scott LLC, Research Division

And then, I guess, just to expand on that, so how much of the improvement to, let's say, that mid-teens level, how much of that is driven by the cost structure improvements, which, in theory, should be -- have a pretty high visibility level associated with them? And how much of that is driven by the volume improvement in Europe or elsewhere, where we just don't have that kind of visibility, and so it's a little more work guesswork in terms of timing?

Philip C. Mezey

Yes. I mean, that's a -- I think it's a really interesting question, Ryan. And if I had to take a wag at it, I'd say it's about half and half of those things. I mean, on the cost side, we really are working, as you've heard through this restructuring on factory consolidation, headcount reduction, above the line, of course, on -- you heard us say that we're withdrawing from the electromechanical metering market in Brazil. So we're taking a look at very critical markets in areas where we're not able to achieve our margin targets. So that's partially market selection similar to the discussion about Iberdrola, where we're really focusing on profitability. But there is also operating margin opportunity, in which you're seeing John and Steve and the teams managing down operating expenses, which are really generating some nice leverage for us as well.

Ryan M. Connors - Janney Montgomery Scott LLC, Research Division

Okay. And then, Philip, you mentioned your Utility Week Conference earlier in the month. And I'm interested to get your perspective on customer's feedback there as regard to sort of business case behind smart grid in the U.S. I know there's been a lot of data around that and it's, obviously, at least a part maybe responsible for some of the deceleration and deployment. So was there any kind of color you can give us in terms of what you're hearing from customers about their business case and how they communicate with their regulators around that topic?

Philip C. Mezey

There absolutely was Ryan, thank you, in which there -- our customers are making presentations on leading sections at our -- at this conference in which their -- Detroit Edison is talking about achieving 130% of their submitted business case. CenterPoint, again, talking about the many millions of truck rolls, I think now up to 4 million truck rolls that have been saved through the use of their system and the economic impact that, that has for them. San Diego Gas & Electric made a presentation about the integration with their outage management system and the increasing reliability and reduction in costs that they're getting there. And actually, BC Hydro made a very strong presentation on the benefits that they are getting out of their system as well. So we are now starting to see documented proof points and customers that are actively engaging and talking about the benefit, sharing those with their regulators but also with other perspective customers as well.

Operator

[Operator Instructions] We'll go next to Ben Kallo with Robert Baird.

Benjamin J. Kallo - Robert W. Baird & Co. Incorporated, Research Division

I'm just following up with the earlier question. I think, Philip, you might have misunderstood me and Paul's question about 2015 being the real rollout of the big electricity projects. Maybe -- could you address some non-electricity and non-European locations on the gas and the water side, too, that will begin rolling out in 2014? I know you kind of touched on that, but if there's any more you can add.

Philip C. Mezey

Sure, Ben. And also, I'd like to -- before we go to gas and water, which you've heard us make very positive comments about, I'd like to also speak to the fact that we're, in North America, the electricity market is building. We've talked about very strong growth there as well. And we've got some nice projects that are coming online and even some acceleration in the North American market that's going on. But moving over to gas and water, we've made comments about GrDF. We've talked about Italy before, a continuation, Azerbaijan's smart gas payment project. We've talked about the work that we're doing in South Africa that starts out as an electricity project but has the opportunity to grow to an integrated electricity and water project with the scope increasing down there. And on the water side, of course, we've made announcements about a couple of projects in India that we're beginning to roll out. As John and others at...

Steven M. Helmbrecht

Ireland.

Philip C. Mezey

Yes, Ireland, which we talked about last quarter and which we're going to start seeing volumes as well. So there are some nice projects. And then moving on over to Asia, of course, we've got this pilot at China Light and Power that's currently in regulatory review in order to move to a broader rollout, and then the TEPCO initial meter bid, which is coming up here in the fourth quarter with a rollout that is due to begin in 2014, in which we see a nice opportunity as well.

Operator

We'll go next to John Quealy with Canaccord Genuity.

John Quealy - Canaccord Genuity, Research Division

So I guess, a couple of questions here. First on the production. And I'm sorry if you said this, but I missed it. So the production was down pretty significantly quarter-on-quarter. Revenues didn't fall off as much. Can you bridge the volume at price for us? Was it higher mix or higher price mix? Was it more services? What was it, given that production went down pretty notably?

Philip C. Mezey

Yes. John, it was a better mix in some of the product -- some of our business lines, than it had been previously. So the tail-off in volume didn't hurt nearly as much.

John Quealy - Canaccord Genuity, Research Division

Okay. And just in terms of -- obviously, we can infer, given your guidance sort of at the low end. We can infer where that goes. But for the most part, on pricing, you're seeing higher pricing trends? Or is it still somewhat uncertain as we get into smart around the world?

Philip C. Mezey

I think that's a bit of a mixed bag because what you're hearing from us is, in terms of pricing trends, where the competitive pricing has gotten so fierce, electromechanical meters in Brazil being an example. The discussion about some of the pricing dynamics in places like Spain, you're going to see de-emphasis, and we're going to seek those places where we're able to hold price. So far, the U.S., certain parts of our business in Europe with gas and water, clearly, we have maintained pricing well.

Steven M. Helmbrecht

And John, also -- this is Steve. Just on the comments I did provide regarding low-end of the guidance, clearly, reflects the additional charge in Q3 on the earnings side and wanted to reflect that in providing the update.

John Quealy - Canaccord Genuity, Research Division

Okay. And then, just to touch on this Iberdrola, just playing back the tapes. This is one where Itron wasn't quick out-of-the-box, with a spec meter a year plus ago. And now the turn away doesn't seem terribly surprising. But are those mutually exclusive events? Or is it just pricing determining it, Philip? Because it looks like it wasn't the utility you focused on early and that's the way these deals go.

Philip C. Mezey

It really is pricing, John. There are 5 or 6 awarded bidders in these tenders. It's a highly competitive bid environment. Volumes are fairly very low. And where, I think, there was rightly really an issue with us was -- did we have product development capability to have a certified a meter. We've decertified the meter. Is Iberdrola a bellwether of European utilities moving forward with Smart Metering? It sure is. We see both of those things now. It's as if the pricing dynamics are such that we will participate, but we're going to focus elsewhere.

John Quealy - Canaccord Genuity, Research Division

Okay. And then, lastly, for me. Just in terms of the cost to build the metrology and then also the comps on the smart meters. I know, over in Amsterdam, there was quite a number of chip providers talking about next-generation chips. I know you guys have done it with smart in North America. But is there any material savings involved from an EBIT -- or a costing perspective to help you increase EBIT leverage when you do get these awards? So for example, STMicro came out with a system-on-a-chip or meter-on-a-chip just in terms of packaging some of the components together. Does that move the needle for you, folks, on the bill of materials or not?

Philip C. Mezey

It absolutely does move the needle. The question is, what's the relationship between the selling price and the TMC. The TMC is coming down, we're monitoring those suppliers. It's not just system-on-a-chip. It's relays and switches. There are all kinds of components that go in the meter, where they're very competitive suppliers and we can continue to lower our bill of materials cost and as well as the efforts John is putting into lowering our labor costs. And there are going to be markets where we can expand margin, and markets where selling prices are going to come down commensurately. So it's a mix.

Operator

We'll go next to Craig Irwin with Wedbush.

Craig E. Irwin - Wedbush Securities Inc., Research Division

The first thing I wanted to ask was about the tax rate. 20% on the GAAP line. But it looks like your adjustment to basically put things back in line on a non-GAAP basis, you used a much lower percentage, probably something closer to the mid-teens. I was hoping you could give us a little bit more color about what impacted that and why that was significantly below your GAAP rate.

Steven M. Helmbrecht

Yes, Craig, this is Steve. So the driver there on the tax side has been the lowered results and the charges, as well as the somewhat lowered outlook and higher tax jurisdictions. And so we're seeing now, for the year, is about 15% rate this year, which is about a 17% rate in the fourth quarter to get to that average on a non-GAAP basis. On a GAAP basis, we're actually seeing a benefit, just given the restructuring charges and other items that have fallen through on the GAAP side. So the driver for that has been the lower rate. And then there's been good work on, as we always do, in planning. And we did, at the beginning of the year, receive the retroactive research credits that is benefiting the rate for the whole year. And that was the legislation that was passed right at the beginning of the year, and it benefited us this year with the retroactive. So that accounted for a fairly substantial amount of the lower rate we had this year.

Craig E. Irwin - Wedbush Securities Inc., Research Division

Great. My next question is much more high-level. So I'm curious about your sales funnel. As you look at your different geographies and the different potential technologies that customers could adopt over the next couple of years, what do you see as most significantly changing over the course of the last year? And where do you think things are likely to change within -- most significantly within the next couple of quarters?

Philip C. Mezey

I mean, it's a pretty diverse world out there. So I think, maybe I'll take a start and then have John fill in with the regional view. I mean, many of the projects that we're working on, as others have pointed out, are things that have shifted to the right, where customers had an intent all along about the type of technology and the approach that they're going to use. And it's just really a timing issue as to when these things are going to be tendered. And so we don't necessarily see a particular change there. One change I would point out, interesting thing that's going on in Japan, we saw in the bid a request for a radio frequency power line carrier and cellular, in which having a diversity of technologies is actually very useful because of the complex terrain, particularly these very vertical cities. And so you've seen us put real emphasis in ramping out our technology portfolio, particularly on the electric side. On the gas and the water side, what we're seeing is an increased emphasis on networks, where, in the past, we had, had stand-alone or drive-by systems. We're seeing a much stronger demand for networking, which, again, provides opportunity for us to really drive some differentiated value in how we provide those networks. And maybe, John, if you can provide a comment on regions.

John W. Holleran

Yes. And on a region-by-region basis, I think it even varies within the region. As Philip mentioned, when you talk about EMEA, that's 100 countries. That's a lot of regions within a region. And we see different characteristics depending on the countries. Germany is moving forward pretty strongly on gas. As Philip mentioned, they're evaluating electricity. We've got some really good opportunities in water. You drop down to Africa and Middle East, some very strong opportunities on the waterside for us that we're evaluating and have in the hopper. Good opportunities, as Philip mentioned, in Japan, on electricity but we're also looking at some gas and water opportunities there. We've had some good business developed in India, and we've got some other opportunities in Asia as well. So in that -- North America is coming along pretty well, too. So a lot of opportunities. Some of it's timing, but really like what we see going down the road.

Craig E. Irwin - Wedbush Securities Inc., Research Division

Great. And then, last question, if I may. When I attend working groups and different events related to utility industry, I'm hearing from regulators and utility executives a huge amount of interest in cybersecurity. Obviously, it's a key issue for the industry today. Can you maybe share with us whether or not this is impacting sales of some of your products and whether or not this could potentially be an opportunity for you over the next year or 2, as we see utilities ramp up spending for cybersecurity?

Philip C. Mezey

It's a great question. Our customers are very, very concerned about cybersecurity. And I would point out privacy as well, a related topic. The products -- the OpenWay product that we put in the market has an extremely advanced cryptographic capability. And when we deploy that along with Cisco cryptography in the network, we have both network security and embedded data security in the system. And the customers that we brief on that are extremely -- and find that an extremely compelling value proposition. So to your question, is there an opportunity there? There is absolutely a tremendous opportunity. We're introducing the security approach that we've used in these more sophisticated electric offerings into our global offerings and across to our gas and water products as well. So in areas where security was not initially as much of a concern in the gas space and the water space, it is now becoming a real topic of conversation. We've benefited from the investments that we've made in the electric systems and using the same componentry to embed that security into our gas and water offerings as well. As to whether or not it's had an impact on the selling speed, in markets like the Netherlands, the most famous example, where security became a concern and essentially froze the market for 2 to 3 years, we have seen that Germany has an extremely rigorous security standard that they are proposing to embed in their product, which is having an impact on timing as they moved to finalize their standards. The DLMS/COSEM standard, which is used globally for data exchange with a number of electric devices, has a very active group that is working on strengthening the cryptography in DLMS. And so it is somewhat affecting timing. But we are in extremely strong position in terms of the investment that we've made in the technology we already have out on the field on the cybersecurity front.

Operator

We'll go last to Patrick Jobin with Crédit Suisse.

Patrick Jobin - Crédit Suisse AG, Research Division

So just first, a really simple question, then I have a follow-up. Should we expect any revenue impact from the restructuring as you leave electromechanical in Brazil?

Philip C. Mezey

Probably not material. I wouldn't think so. It's -- electromechanical round numbers is probably 10 million at best.

Patrick Jobin - Crédit Suisse AG, Research Division

Okay. And then, just kind of a higher level question for the team. So I guess, if you think of the dynamics for the Smart Meter business, I guess, with the big 5 that remain in the U.K. and then TEPCO in Japan, it's my understanding both markets have selected a communication system for some of the projects. So I guess, what gets you comfortable that you we won't see the same margin dynamics that you're alluding to for Iberdrola?

Philip C. Mezey

So the -- for one thing, the customer has not issued a specification dictating interchangeability of the product that we're providing to them. So the bid dynamic is different. We have latitude in how it is that we design our product. And the customer is not demanding in sort of lowest common denominator approach in terms of interchangeability. They are requiring interoperability that is -- that there can be more multiple suppliers underneath the communication system. But we have more design latitude, which allows us to create more value. There is also real opportunity for us to capture value, integrating communications even if it is not our communications module, but integrating that communications into the meter in order to drive down the total cost of the integrated offering. And so there is a nice opportunity for us beyond metrology there for value capture.

Barbara J. Doyle

All right. Thanks, everyone.

Philip C. Mezey

So just in summary. I think I'm pleased that we've got this message across about where our focus is going to be. What I'd like to leave you with is, well, again, while there is a lot more to do, that we are off to a very, very strong and methodical start in this restructuring program that we have underway and the cost reduction initiatives that you seen resulting in sequential quarter growth here, which we are really focused on, on continuing. We see strength in a number of really critical markets for us. To the extent that we've experienced a slowdown in growth in some of these markets, we feel they are overall market dynamics and noncompetitive losses, nor they particularly broad pricing pressures. So we are very optimistic that as these markets pick up speed, there are absolutely growth opportunities for us in 2014, that the improved expense structure of the company and efficiencies that we put in place will allow us to generate improved operating leverage. Thanks very much.

Barbara J. Doyle

All right. Thanks, everyone. And operator, this concludes our call.

Operator

Thank you. There will be an audio replay of today's conference available this afternoon. You can access the audio replay by dialing (188) 203-1112 to or 1 (719) 457-0820, with the passcode of 8002273, or go to the company's website, www.itron.com. Thank you very much, and have a great day.

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