Itron's (ITRI) CEO Philip Mezey on Q2 2014 Results - Earnings Call Transcript

Aug. 5.14 | About: Itron, Inc. (ITRI)

Itron (NASDAQ:ITRI)

Q2 2014 Earnings Call

August 05, 2014 5:00 pm ET

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

Analysts

Sean K.F. Hannan - Needham & Company, LLC, Research Division

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

Patrick Jobin - Crédit Suisse AG, Research Division

John Quealy - Canaccord Genuity, Research Division

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

Andrew Hughes - BofA Merrill Lynch, Research Division

Operator

Good day, everyone, and welcome to the Itron Incorporated Quarter 2 2014 Earnings Conference Call. Today's call is being recorded. For opening remarks, I'd like to turn the call over to Ms. Barbara Doyle. Please go ahead, ma'am.

Barbara J. Doyle

Thank you, Blake, and good afternoon, to everyone on the call. Welcome to Itron's Second Quarter 2014 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. This presentation is available through the webcast and through 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 lead off the call with a summary of our operating results and the business environment. Steve Helmbrecht will cover our second quarter financial metrics and provide updated financial guidance for the full year of 2014. Philip will close the prepared remarks portion of the call with some summary comments. Then Philip, Steve, John Holleran and I will respond to questions using the process that the operator will describe for you.

Before I turn the call over to Philip, 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 SEC. 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

Good afternoon to everyone and thank you for joining us today. Itron's second quarter results were positive and show our continued improvement in operating performance. We reported $489 million of revenue and $0.54 of non-GAAP EPS. Non-GAAP operating income increased 10% on revenue growth of 1.5%, reflecting benefits from increased volumes of high-margin products and company cost reductions.

Steve will cover segment performance in more detail, but let me review revenue highlights for the quarter on Slide 4. Double-digit revenue growth in both Gas and Water more than offset a decline in the Electricity segment. Our Gas and Water businesses continued perform very well with growth in every region. Electricity performance was largely as expected, as we continue to reduce exposure to low-margin business and focus our resources on solutions where we have strategic differentiation.

I'm pleased with our sales performance in the quarter. In the first half of 2014, I truly believe that Itron's products, services and technology for the utility industry are unmatched. We have a broad range of smart grid alternatives for both public and private networks, deployed at scale around the world. Good customer wins this year in all 3 of our business segments, served to validate the strength of our competitive position and the breadth of our product portfolio. In addition, utility spending is higher in several key markets. In particular, North America business has improved and looks to be strong through the end of the year.

In Water, budgets are getting approved, projects are moving forward and we are seeing higher demand in our distribution channel. In particular, we are seeing growth in smart and advanced systems in communication modules. Attendance was noticeably up at the American Water Works Association conference in Boston earlier this year, which is often a leading indicator of sales activity. In Gas, several of our customers are increasing their capital spending, following a colder-than-usual winter. This is driving higher volumes of gas meters, regulators and communication modules.

And in electricity, our backlog has increased this year with significant contracts for electric smart grid projects. These projects include FirstEnergy, Duke Energy and the Los Angeles Department of Water and Power among others. In the Asia-Pacific region, we see good potential sales activity across all 3 business sectors. Latin America looks relatively consistent to last year overall with increased opportunities in Gas and Water. EMEA is not as strong as the other geographies. Business in EMEA remains uneven with bright spots in Gas and Water, including heat metering and heat allocation business in the Water segment. The situations in the Ukraine and the Middle East add to uncertainty, so we'll continue to monitor the outlook for EMEA.

Overall, our sales performance in the first half of the year, our strong competitive position worldwide and improved utility spending give us cautious optimism for the remainder of 2014. Now let me turn to backlog in bookings on Slides 5 and 6. Total backlog of $1.3 billion was up by 25% year-over-year. 12 months backlog at $675 million increased by 21% year-over-year, and increased by 10% sequentially from Q1. Our backlog in a number of substantial frame orders, such as 3.7 million meters with gas to France and the 4 million end points with Duke provide added visibility for increased revenues in 2015 and beyond.

In the second quarter, we had a solid bookings totaling $478 million with a number of very good bookings from a diverse set of customers. For example, we booked $23 million with Duke Energy in Q2. This was the first booking under the agreement we announced in April for up to 4 million OpenWay endpoints in support of their electric grid modernization project. Other notable bookings in the quarter include a contract for electric cellular meters with the Los Angeles Department of Water and Power, a managed hosting contract with the Southern Connecticut Gas and significant water bookings with Veolia in France, Aqua America Utility Group in Ohio and Sanepar in Brazil, among others.

And today, we announced that the city of Bismarck, North Dakota has selected Itron to help modernize its water distribution system. The city purchased Itron's AMI solution, Itron analytics and services. They will share the Itron fixed network installed at Montana Dakota Utilities Company, which provides a cost effective solution for both utilities. We are proud to be a part of this innovative public-private partnership, which may also service as a template for other municipalities. While large contracts like we signed in the first quarter certainly add to our backlog, consistent book and ship business in our core customer base adds to our revenue stability.

Now I'll turn the call over to Steve to cover our financial performance.

Steven M. Helmbrecht

Thank you, Philip, and good afternoon. I will begin with Slide 7, which summarizes consolidated company results for the quarter compared with the second quarter of 2013. As Philip highlighted, total revenues of $489 million grew 1.5% compared with last year, due to strong performance in both Water and Gas. Gross margins of 33.3% improved by 20 basis points. Non-GAAP operating margin of 7.2% increased by 50 basis points. Our margins are benefiting from the higher relative contribution from the Water and Gas segments, as well as lower manufacturing costs in our Electricity segment and other operating expense controls across the company. Adjusted EBITDA also increased year-over-year. Adjusted EBITDA was $47.3 million this quarter, representing a margin of 9.7%, an increase of 40 basis points from a year ago.

On a GAAP basis, we had diluted earnings per share of $0.49 compared with $0.31 per share in 2013. Higher revenues and a restructuring adjustment were partially offset by a higher tax rate compared with last year. Non-GAAP diluted earnings per share, which exclude the impact of goodwill impairment, restructuring charges, acquisition related expenses and amortization and intangible assets and debt fees, were $0.54 for the quarter, compared with $0.58 in 2013.

EPS improved with strong sales execution in the Water and Gas segments and overall operational cost management, offset by higher interest and tax expense. Slide 8 provides more detail behind our EPS performance. Revenue growth and gross margin improvement drove $0.06 of improved earnings, while non-GAAP operating expenses were flat year-over-year, let me add some color to our operating expense performance.

Reduced headcount and lower litigation expense and reserves were offset by 2 key items. First, higher variable compensation being accrued in areas where we are meeting bonus targets. And second, hiring at our Bangalore R&D facility and our newly opened global business service center in Ireland. The building and staffing of these centers created approximately $2 million of duplicative expenses in the second quarter. However, these investments will drive long-term sustainable savings and efficiencies in the business.

Below the operating line, increased interest expense impacted earnings by $0.03 and a higher effective tax rate impacted earnings by $0.07 compared to last year. The higher interest expense is due to a rate swap agreement that took effect during the third quarter of last year to fix the rate on a portion of our debt. The higher tax rate is being driven by the expiration of the U.S. R&D tax credit, which has not yet been reinstated this year and the treatment of certain deferred tax assets we discussed when we provided our original guidance for the year. While these items are impacting our reported effective tax rate, they are not increasing our cash taxes.

Free cash flow in the quarter was negative $10.4 million, compared with a positive $4.2 million in the second quarter of 2013. During the quarter, higher operating profits were offset by a temporary build up in net working capital, specifically an increase in receivables. And as we mentioned on the first quarter's earnings call, many payables recorded in Q1 were settled in the second quarter.

Looking at free cash flow for the first half of the year provides some more normalized view due to the timing of certain payables and receivables. During the first 6 months, free cash flow was $47.8 million, an improvement of nearly $58 million over 2013 due to higher profits, better relative working capital metrics and lower capital expenditures. Since quarter end, we've already collected a number of the outstanding receivables. We are confident that our cash flow generation will improve this year, excluding any extraordinary items. Looking ahead, we expect free cash flow for the full year to be in the range of 3% to 4% of total revenues.

Turning to liquidity. We finished the quarter with $115 million in cash. During the quarter, we repaid about $20 million in debt, bringing our balance down to $328 million. In addition, we repurchased about 107,000 shares of stock for $4 million. Now I will update you on the status of the restructuring projects we announced in 2013. In September last year, we announced a restructuring plan to reduce our workforce by 9%, representing approximately 750 positions. In Q2, we reassessed certain restructuring actions, which resulted in a reduction in expected costs. We continue to estimate an annualized savings of about $30 million once complete. We are now about 75% complete with the workforce reductions and are on track with the facility activities. We are making good progress and the savings to date are contributing to the steady improvement we have seen in gross margin.

I'm also pleased to announce the establishment of a new global business services center in Ireland, as I mentioned. The center is now open and we've hired 35 employees at the site. Currently, the center is consolidating finance, accounting and other previously decentralized activities in Europe, Africa and the Middle East. The benefits to Itron include reduced costs for more efficient resource utilization and a greater degree of standardization that comes from centralized control and oversight. We have identified 70 positions that are being consolidated into the center, resulting in more than $3 million in annualized savings in 2016. We are on schedule and have already migrated functions from 8 countries into the center. Our savings over time will increase as we transition more roles and functions into our shared services model concurrent with our global ERP platform rollout.

Now let's move to segment performance beginning with the Water segment on Slide 9. The Water team continues to deliver strong results, with record revenue of a $151 million in the quarter and growth in every region. Water revenues grew by 14% compared with the second quarter of 2013, driven by global smart water projects, strong book and ship business and thermal and heat allocation business in Europe. Gross margin decreased slightly to 35.3%, due to product mix and warranty costs. Last year, our results included a warranty reversal that benefited the gross margin by about 100 basis points. Non-GAAP operating margin also increased more than 140 basis points to 15.3%, driven by the higher gross profit compared with last year. The improved performance of water drove a slight increase in sales commissions. Water is a profitable, growing business for Itron and we are very pleased with the performance in the quarter.

Now turning to the Gas segment on Slide 10. Gas also had a strong quarter. Gas revenues of $154 million grew 13.5%, compared with last year. Every region grew on a constant currency basis driven by higher shipments in virtually all product categories. Both North America and EMEA delivered particularly strong growth. High-margin gas modules drove much of the benefit in North America. EMEA's growth was driven by a pickup in frame order shipments on Smart Meter projects in the Netherlands, Azerbaijan and Belgium. Gross margin was down 20 basis points due mainly to product mix. Non-GAAP operating margin was 17.8% in the quarter, up 170 basis points compared with last year. The higher gross profit combined with lower G&A costs more than offset increased product development investments for new products.

Now I will discuss the Electricity segment on Slide 11. Electricity revenues decreased 14% year-over-year on the lower volumes, driven by timing of projects in EMEA, our exit from low-cost basic metering business in Brazil and a temporary production delay in North America. Performance in the Asia-Pacific region in the quarter improved over last year, with increases in Indonesia and Australia. We also had a higher software and services revenues in Japan, resulting from the contract we announced in April to provide our smart grid software to Mitsubishi Electric for the smart grid deployment at Chubu Electric Power Company.

While electric gross margin and non-GAAP operating margin were impacted from the decrease in volumes and mix, it's important to note that we are reducing costs and expenses in the segment. Lower manufacturing costs are partly mitigating the volume declines on the gross margin line and non-GAAP operating expenses declined by 6% year-over-year. Steps we have taken to date are driving improvements in margins and adjusted EBITDA. We will continue to implement changes that are necessary to bring profitability to our targeted level. This is a top priority for the company, which Philip will discuss further in his closing remarks.

Now let's turn to Slide 12 and review our updated guidance for 2014. For the full year 2014, we expect revenues to be in the range of $1.9 billion to $1.975 billion, and non-GAAP diluted EPS to be in the range of $1.50 to $1.80. This guidance assumes annual gross margin between of 31% and 32%, and average shares outstanding of 39.5 million. It also assumes an average euro to U.S. dollar exchange rate of $1.36 for the year compared with the $1.33 assumed in our original guidance. The change in foreign exchange rates resulted in about $25 million to $30 million of revenue benefit in our updated guidance and minimal impact on EPS.

We also forecast a higher effective tax rate than originally planned, which impacts EPS guidance by about $0.09 a share. This is driven primarily by a change in taxable income by jurisdiction. Our annual non-GAAP tax rate will be between 33% and 34%, exclusive of any additional discreet items. And the guidance we provided last February, we estimated a tax rate of 30% to 32% for the year. So our EPS guidance range would have been about $1.60 to $1.90, had the tax rate stayed constant.

With that, I will turn it back to Philip.

Philip C. Mezey

Thank you for that update, Steve. Q2 was our third consecutive quarter of year-over-year growth in revenue, gross margin and non-GAAP operating profit. Our 12 month in total backlog have both increased more than 20%. Our execution is certainly improving and we are pleased to raise our full year guidance for 2014.

During our last earnings call, I reiterated Itron's financial goal for mid-30s gross margin and mid-teens EBITDA margin and I would like to update you on the steps we are taking to achieve these targets. Looking at our Gas and Water businesses, we are executing well in both segments. This includes day-to-day transactional business in addition to large tenders, such as Gaz de France, Irish Water and City of Baltimore, among others.

Gas and Water are performing very well with the opportunity to get even better. The Electricity business is operating in a challenging environment, which we are aggressively addressing. I stated on our last call that we're turning our Electricity business to profitable growth is my top priority. Our financial target for the Electricity business is to achieve high-single digit EBITDA margin by the end of the 2016. We will achieve this target with long-term sustainable cost reductions and with other actions to rebalance our existing electric business portfolio. And we will grow revenues in our high-value, high-margin businesses.

We have announced several actions, including additional printed circuit board outsourcing and the closure of electric product factories in Sumaré, Brazil, and Saudi Arabia. We are nearly complete with a review of the additional activities to streamline the Electricity business and I will continue to update you with more specifics as we move forward with plans and actions.

In all, I expect the combined efforts to drive more than $40 million of annualized cost and expense improvements in the Electricity segment. While we are moving aggressively, given the legal and regulatory environment in different countries, the full benefits will take a minimum of 24 months to achieve. However, we will demonstrate EBITDA improvements during this timeframe as we execute our plans.

I have also asked our corporate team to aggressively reduce Itron's G&A structure and costs. The opening of our global business services center in Ireland that Steve described, is an important step among others. Michel Cadieux, Itron's Senior Vice President of Human Resources is leading an effort to further reduce spending across the company. To be clear on this, my expectation is to reduce the current level of G&A expense, as well as to reduce it as a percentage of revenue. The goal is to drive scalable process improvements that we can leverage as we grow the business. As we strengthen our business profitability, we will not lose sight of growth.

As I discussed last quarter, we have been awarded numerous smart grid electricity contracts that total more than $1 billion of revenue. Many of the contracts are large multiyear projects. We forecast that these contracts will generate more than $80 million of incremental OpenWay revenue by year end 2016. Our efforts to reduce costs and realign the business, combined with over $1 billion of new electricity revenue, will drive significant profitability and cash flow improvements. These actions put us on track to achieve our high-single digit EBITDA financial target in electricity as we exit 2016.

We will also keep intently focused on innovation, which is imperative for the utility industry. Innovation remains a core initiative at Itron as we reshape our business. Itron has a deep domain expertise, centered on technology that provides valuable, actionable data to our customers. We invest in R&D to bring this expertise to market through new products and solutions.

As an example, we announced today the China Light and Power in Hong Kong is testing Itron's new adaptive communications technology on their OpenWay smart grid platform and network. This is Itron's latest technology that combines RF Mesh and power line carrier communications on the same chipset. It enables meters and other grid devices to intelligently and dynamically switch communications modes between RF and PLC to provide optimum network performance and connectivity. This means better performance at lower total cost of ownership and better support for grid analytics at the device level, such as load management and distribution automation.

Itron is first to bring this new technology to the market and we are delighted to work with China Light and Power to simplify deployment and improve conductivity across the high density in Hong Kong environment. Fundamentally, Itron's long-term growth lies in leveraging our smart technologies and data expertise through innovative new software and services that deliver business outcomes to our customers. New software and services will accelerate payback opportunities for utilities to deploy smart systems, by helping them to unlock more value from the data. With this focus, we will secure a recurring high margin revenue stream in addition to our core metering and network product revenues.

Today, our software and services business is less than 10% of Itron's total revenues. We see opportunity to materially expand this business organically, through our partners and with targeted M&A. As we continue to execute our strategy with healthy growth in Gas and Water, and as we move from a market share first focus to a profitable growth focus in our electric business, I am confident that we will drive long-term -- value creation for our customers and our shareholders.

Thank you. Now let's take some questions.

Barbara J. Doyle

Hello, Blake will open up the call to some questions, please?

Question-and-Answer Session

Operator

[Operator Instructions] And we'll take our first question from Sean Hannan at Needham & Company.

Sean K.F. Hannan - Needham & Company, LLC, Research Division

So you have provided a lot of color certainly around the outlook regionally. I was just looking to see if perhaps we could break down a little bit more some perspective in some context, particularly as we look to the EMEA region? When we pull out the impact, say, Ukraine and we think about the conditions in Europe today, and specifically what's going on with some of the more identifiable tenders and in the countries, willingness to actually move forward with projects and the big picture. Has there really been that much that's actually changed in the past 3 months since you've last reported or deteriorated? Or just really much of the same choppiness and slow decision-making that we were already seen?

Philip C. Mezey

Yes. Sean, so as you point out, I think you're focusing in largely on an electric topic, although, it would clearly affect Water and Gas. We said that Water and Gas has been strong in the EMEA region x those markets of concern that you mentioned. And we really don't have any new news on the large electric tenders.

Sean K.F. Hannan - Needham & Company, LLC, Research Division

Okay. So it's not like we have an issue that is fundamentally changing on us. It's just more of the same frustration in, in some manner of speaking, a subsegment of your business?

Philip C. Mezey

Yes, there is no fundamental change. I think what our Q2 results show is a strength in diverse revenues. And this comment I made about no individual large booking but a great breadth of strong business, both within EMEA and across our other regions.

Sean K.F. Hannan - Needham & Company, LLC, Research Division

Okay, that's great. That's helpful. Now I guess on the other side of the coin for that, when you look at the pipeline of opportunities and what you expect could materialize in the back end of the year, it sounds thematically like we're very positive around water and gas. When we think about awards in there -- for the remainder of '14, how do you feel about the different applications and, particularly, the different regions? Is there anymore color you can provide around how perhaps some press-worthy announcements could materialize in any of those application segments or regions?

Philip C. Mezey

So Sean, yes. In terms of larger color, I mean, I'd point back to this general strengthening of the backlog, particularly the 12-month backlog, so an improvement in visibility in our large-contracted and in frame-order business and, again, this diversity of bookings. While there certainly are opportunities for, as you say, newsworthy bookings, we really are looking at just the steady growth of the broad business portfolio.

Operator

And we'll take our next question from Craig Irwin at Wedbush Securities.

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

I wanted to ask you a big-picture question about the outlook for North America. So I guess it was probably 2 years ago this time we described the 25-million-unit opportunity, 25 million units in some stage of procurement. Now that you've taken down Duke, a nice chunk from Northeast utilities, it's just probably about 20 million left? Is 20 million still a good number? And can you update us on how the conversations are evolving, how things have developed over the last couple of quarters, and if you see anything likely to change in the back half of the year?

Philip C. Mezey

So the last discussions we've had on this, Craig, are further regional developments, as we see increased regulatory support in Pennsylvania, Ohio, moving to Indiana, strong discussions in Massachusetts, New York and New Jersey. So we have a sense of just the market advancing of a discussion about the increased reliability of the grid, as we see a strong business returns on the projects that have gone out there that there is a strong business case for the market to continue to move forward. There is a bull case in the longer-term on North America with the EPA ruling on CO2 and energy efficiency goals that have been set at the state level or the carbon caps, essentially, that have been set at the state level. That this is a stimulus, potentially, for energy efficiency over the mid to longer term. So I would say that the market continues to evolve with regulatory support in selected markets. And I really can't say that we've looked at that 20 million number recently, but there are a broad range of opportunities out there.

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

And another big-picture question, if I can. So every time I attend one of the working-group meetings, I go to with some different utility executives. The conversation usually devolves into how do we fix the expected disintermediation of the grid from solar power. And looking at what [indiscernible] is doing in the New York ISO and concept of net metering for solar, it's fairly obvious that you have 2 meters on a house, one for the electricity generation and one for the actual production of the solar panels. Can you update us whether or not you have any products with the match for dual metering at residences if we were to see rate striped between similar to what's done in commercial and industrial markets? Is this something that would create an incremental opportunity for Itron over the next several years?

Philip C. Mezey

Craig, great question. The experience that we have had with solar so far is, as you say, it's been stimulus of adding a second meter to the house. As you may recall, within the past year, we've put out a press release in which Itron has been named the largest solar metering provider in North America. That's through largely a cellular offering. But of course, all the smart meters that we put out in the field are net meters. And practice, as you point out, net metering has not really told the full story because the solar business model is that a second provider is leasing space, or financing, or doing something that means there is a separate measurement opportunity, and we have benefited in selected markets from that measurement opportunity. Well, utilities do worry about being disaggregated as a result of solar. So far, that has created a larger number of metering opportunities for us. We have talked about taking the measurement in communications technology that we've embedded in the meter, working with inverter providers and electric vehicle charging providers to embed this technology directly into their devices, so that we don't have a second enclosure. And then I'll point out that I go to a lot of those meetings as well, and one of the things that we're going to see the utility is fighting back on is with community solar and other programs, in which the utility is actually building out its own solar offerings in some jurisdictions and sort of fighting back on the business model. So all of the scenarios that we see developing, there are nice opportunities for Itron in there.

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

Excellent, excellent. And last one if I could squeeze it in, is a housekeeping question. Steve, could you maybe give us a little bit of color and quantify the revenue impact from the manufacturing delays at Electricity North America?

Steven M. Helmbrecht

Yes, Craig. That was about $15-million impact in the quarter, which we expect to make up over the course of the year.

Operator

And we'll go to our next question from Patrick Jobin at Crédit Suisse.

Patrick Jobin - Crédit Suisse AG, Research Division

The first question is just back on the electric segment. Philip, you went through kind of your view to get that segment back to a high single-digit EBITDA margin. I think in the past, you've highlighted about 20% of that business that you could reshuffle to certain extent or potentially exit some of those businesses. Can you just update us on kind of evaluation and timing for kind of moving forward with that? And then I have a follow-up.

Philip C. Mezey

Okay, Patrick, sure. So just to reset that conversation, it's that there are portions of the electric business performing very well at our targeted margins' areas where there were improvement projects to get products to a higher margin in some areas where, for competitive reasons, we don't feel the current product offering is going to meet our financial objective. And we have already talked about some selective exits that we've taken. And we will, over the course of this study that we've done, take more of those through this period of getting to this total annualized $40 million expense improvement and this gross margin improvement that we forecast within this EBITDA margin period through the end of 2016. And so what we're finding is that we've gone through and studied products, customer, geography, that we have a very clear handle now on the contributions of each of these products, and that we see a period of really transitioning away from some of these less attractive markets, we call this market share focus to this profit focus, where we see growth in our higher-profitability markets, North America being an outstanding example, as we deemphasize some of the basic electric metering sales and markets that have become highly commoditized. So that number has some real flex in it. That 20% number that we took a quick look at, we really refined that and -- but expect that you're going to see not a big step function here but just a readjustment of the revenues of the businesses we move towards improving overall gross margin and bottom line performance. We are not -- and the reason that, that adjustment is going to take some time, of course, is that we are not going to abandon our customers. We're going to make this transition a smooth one.

Patrick Jobin - Crédit Suisse AG, Research Division

So just on that transition, help me understand kind of the cadence of these cost reductions and business realignment. I mean, I guess, from the high level, what are you thinking the kind of normalized growth rate should be for this industry -- not necessarily by segment, but if you looked at electric for example, over the next few years? And should we be thinking about these cost materializing -- cost-outs materializing more in the late '16 and something to understand kind of how we should be thinking about '15 at this stage?

Philip C. Mezey

Yes, it's a great question. And of course, we're in the period of the year in which we're doing our '15 business planning, and we'll update you much more precisely in our '15 guidance on our Q4 call. That said, there are kind of 2 pieces here. We've talked about a series of savings through a restructuring that you've just sort of say we're 75% through. We're starting to see the benefits of that. We expect to see EBITDA margin improvement in the electricity business steadily through 2015 as a result of those savings and other work that we are doing. And to your questions sort of about where we expect that to accelerate some -- what is yes in 2016; and again, this is driven by some regulatory and controlled labor markets in which it takes somewhat longer into order to realize some of the savings in those other markets. And so we project that those will be in 2016.

Operator

And we'll take our next question from John Quealy at Canaccord Genuity.

John Quealy - Canaccord Genuity, Research Division

First question. In terms of electricity, Philip, do you think you get that profitable on an EBIT perspective this year? Or how should we think about that?

Philip C. Mezey

That is certainly our goal, yes.

John Quealy - Canaccord Genuity, Research Division

Okay. On the gas side, things look like they're going really well. I would imagine that's some share gain. You just, I think a couple of questions ago, talked about focusing on profitable business. I imagine that's not lower margin. Or talk to us about the dynamics of what's going on in gas, please.

Philip C. Mezey

So gas, let's look across meters, modules and regulators. We are having a record meter and regulator year in North America. That is largely driven by, of course, that large-contracted SoCalGas. Now that has a little bit cuts the other way, because a competitor of ours secured the modules, and their market share in the modules space is up a bit as a result of the high shipments that they're making there. But in terms of market share gain in meters and regulators, North America, things are going very well. Internationally, we do have some strong markets in which, I would say, there are some share gains in some of the more attractive gross margin markets. In meters, primarily, it's really the North American market where these modules are such a strong part of the overall revenue and profitability picture.

John Quealy - Canaccord Genuity, Research Division

And a final couple of questions. And I'm sorry if you've talked about this. CFO transition update with Steve, where are you with candidates and things like that?

Philip C. Mezey

Yes, we haven't talked about it recently and we have got some -- I'm excited about the candidates that we got. We're making very, very strong progress and we'll be -- we project through the transition well in the time that we've allotted for it.

John Quealy - Canaccord Genuity, Research Division

Okay. And then lastly, M&A. And I'm sorry, Steve, if you talked about this in your comments. But there is a little bit of a charge for M&A. Can you just talk to that number? And also, what if you looked at it what's the environment for you folks in the back half of the year?

Steven M. Helmbrecht

We talked to -- John, this is Steve. We've talked in general -- there is Philip's remarks about growing the services in the software business and looking at M&A. But I think that's more of a general comment, because we're really emphasizing the organic growth potential of that particular area as well.

Philip C. Mezey

Certainly that, John, yes. I didn't understand the reference to an M&A charge per se in the results. But rather the comment that I've made that we do see a positive outlook in this space and there certainly are adjacencies and the opportunities for us, I think I've talked about this several and several times about getting more value out of the data. We see some outstanding examples of that of contracts that we actually have signed and talked about it. Southern Connecticut Gas where we're managing services and even in Bizmarck where we're providing analytics, and they're just -- there are more opportunities for us there. And then,...

Steven M. Helmbrecht

Yes, let me just circle back on that. We haven't -- we didn't know -- noted disclosed activity in the quarter. We did have some final compensation payments related to a prior activity which flows through one of the schedules. And that's really, I think, what you're reaffirming to. I just wanted to follow-up on that original question.

Operator

And we'll take our next question from Ben Kallo at Robert W. Baird.

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

If I look at your guidance, I just kind of add up Q1 and Q2 and then look at cadence of historically, should we expect something different this year than previous years as far as the years usually being back-end loaded with the utility budget flush? I'm trying to rectify...

Philip C. Mezey

Yes, Ben. It’s -- yes, it's a fair question. It's just a -- we see the second half of the year as really being on the -- our original plan, which are already -- when we provided guidance to the originally, for 2014, we said that the second half would be stronger than the first half is what we had planned and projected for some reasons that we've discussed on the call. And in the last call, we've come out stronger in the first half, which does not necessarily translate to just projecting that same shape for the second half of the year. We still see that second half on plan. And so we're really not ready to go get out further than that.

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

Got it. And then, if I can -- and sorry if I missed this, but any update on Japan opportunities?

Philip C. Mezey

We have not provided any update. What's happened in the Japanese markets is, is that the METI, the ministry of the energy and technology, has really encouraged the utilities to go out and make selections for their initial technology. There has been a massive amount of RFP and bidding that has gone on in that market. And not surprisingly, the vast number of awards have gone to Japanese suppliers. So the market is really rushing forward, without having achieved initial -- many initial proofs points or pilots. It's an exciting market. We're very pleased with the progress that we're making on with Mitsubishi Electric on the Chubu project. So it continues to be a market of real interest for us.

Operator

And we'll now go for a follow-up to Sean Hannan now from Needham & Company. [Operator Instructions]

Sean K.F. Hannan - Needham & Company, LLC, Research Division

So just a question on the guidance. So if I look at a blended gross margin for the year with what you provided here, 31% and 32%, and I also think about how your -- the midpoint of guidance on the top line, you should still have a, perhaps, a second half that is better on the top line than the first half. But the gross margin guidance that seems to be implied for the second half seems to be materially lighter. Not that on a blended basis. This is an issue, obviously, we're all raising numbers here. But just want to understand the dynamics of what's behind that for the third and the fourth quarters.

Steven M. Helmbrecht

Sure, Sean. This is Steve. That's primarily a mix issue. A lot of the strength in the first half come from the North America gas modules, which is a very high margin. And so, as we look out over the second half, that -- just a relative shift in mix is really contributing, we're not seeing any -- or looking out towards any ASP for macro trend. It's really more mixed-based overall.

Sean K.F. Hannan - Needham & Company, LLC, Research Division

Okay. And then -- so when we think about the restructuring and the benefits, my understanding is that a lot of those benefits, at least those actions taken thus far, are impacting more so within the gross margin line. If we think about the workforce reductions now 75% complete, can we quantify where we are in terms of how much on a run rate basis are we achieving at current point of that goal of $30 million? Is that 75%? I think it's a little bit less than that. But if you can help quantify it for us, that'll be helpful.

Steven M. Helmbrecht

Yes, you bet. And we have talked about fully achieving the annualized savings in 2015. There has been some change a bit in our completion timetable with some of the headcount reductions due primarily to the labor regulations just going through the process. So the amount of savings overall for this year are slightly less than what we have originally expected. No change next year. Just a little bit slower in getting to full realization. I think we've expected about the 60% originally for the year of that savings, and now we're north of 40% to 50%, again, keeping in mind that we are continuing overall the scope of that restructuring project.

Sean K.F. Hannan - Needham & Company, LLC, Research Division

Okay. So net-net, what we accomplished in '14, we're going to do maybe $10 million to $15 million in savings in lowering cost within our structure, and you're going to get about another $15-ish plus million that comes through next year, excluding any leverage you'd have.

Steven M. Helmbrecht

Yes.

Barbara J. Doyle

That's about right.

Operator

And we'll take our next question from Andrew Hughes at Bank of America Merrill Lynch.

Andrew Hughes - BofA Merrill Lynch, Research Division

Just a quick question on the software and services opportunity. It sounds like it's about $200 million in revenue. Currently, just wondering if you can give us a little more color on where you see that going either on an absolute basis or percentage of revenue basis; and the mix of that incremental opportunity, organic growth versus the M&A opportunities you talked about.

Philip C. Mezey

Sure. So we built up a wide range of software and services over the years. A chunk of that is implementation and install-related work related to some of the large projects that we have in the field. We are globally the largest provider of back-office prepayment solutions, which is, in the U.K. and Africa, a very attractive business for us. And so that's an example of the type of service offering we'd like to expand. We announced this -- again, mentioned the Southern Connecticut Gas, which is actually a managed service in addition to the sale of our products. And what we're seeing over time is the opportunity to help our customers, as they install networks with the operations of the network, the management of the large data sets that are generated out of those networks, and we're -- we have come to market with analysis products, a greater opportunity to create value beyond the revenue cycle, which is where the company has historically have been focused. It is in measuring, for billing as opposed to optimizing distribution networks, and providing better insight to customers. So the opportunities are there. Of course, you've heard others in the marketplace talk about those. But we have a strong incumbent position with 8,000 customers globally and intend to focus more effort going forward, and see a growth rate opportunity and stronger than the projected market rate growth for the basic electric, gas and water markets, with higher-margin opportunities as well. So it's an area in which you're going to hear more from us.

Barbara J. Doyle

Are there any other questions, Blake?

Operator

No, there are no more questions in the queue.

Philip C. Mezey

Great. So just in summation, as I said, we have finished off 3 fairly strong quarters with a really good outlook for the remainder of the year. And I must say, through strengthening of the backlog and the planning activities that we have underway, we have clear visibility to a number of cost reductions and operational improvements, as we see, strengthening in a number of our markets that's anchored on just the continued good work that's been done in our gas and water businesses with a strong focus on improving the overall performance of the electric business. I think we're showing evidence of that in our results this quarter. And I hope to be talking to you again soon about steady progress. Thanks, everyone, for your time today.

Barbara J. Doyle

Thanks very much, Blake. That ends our call.

Operator

And there will be an audio replay of today's conference available this afternoon. You can access the audio replay by dialing 1 (888) 203-1112, or 1 (719) 457-0820, with the passcode of 860-7656 or go to the company's website, www.itron.com. This does conclude today's call, and we thank you for your participation.

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Itron (NASDAQ:ITRI): Q2 EPS of $0.54 beats by $0.19. Revenue of $489M (+1.4% Y/Y) beats by $23.39M.