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EX-32.1 - EXHIBIT 32.1 - ITRON, INC.itriex-32103312017.htm
EX-31.2 - EXHIBIT 31.2 - ITRON, INC.itriex-31203312017.htm
EX-31.1 - EXHIBIT 31.1 - ITRON, INC.itriex-31103312017.htm
EX-12.1 - EXHIBIT 12.1 - ITRON, INC.itriex-12103312017.htm
EX-10.3 - EXHIBIT 10.3 - ITRON, INC.itriex-10303312017rsuagree.htm
EX-10.2 - EXHIBIT 10.2 - ITRON, INC.itriex-10203312017ltprsuag.htm
EX-10.1 - EXHIBIT 10.1 - ITRON, INC.itriex-10103312017isonsoop.htm

 
 
 
 
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
 
 
FORM 10-Q
 
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2017
OR
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from             to             
Commission file number 000-22418
ITRON, INC.
(Exact name of registrant as specified in its charter)
Washington
 
91-1011792
(State of Incorporation)
 
(I.R.S. Employer Identification Number)
2111 N Molter Road, Liberty Lake, Washington 99019
(509) 924-9900
(Address and telephone number of registrant’s principal executive offices)
 
 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,”and “emerging growth company” in Rule 12b-2 of the Exchange Act.
 
 
Large accelerated filer
 
Accelerated filer
 
 
Non-accelerated filer
(Do not check if a smaller reporting company)
Smaller reporting company
 
 
 
 
 
Emerging growth company
 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x
As of March 31, 2017 there were outstanding 38,648,567 shares of the registrant’s common stock, no par value, which is the only class of common stock of the registrant.
 



Itron, Inc.
Table of Contents
 



PART I: FINANCIAL INFORMATION
Item 1:    Financial Statements (Unaudited)
ITRON, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)

 
Three Months Ended March 31,
 
2017
 
2016
 
(in thousands, except per share data)
Revenues
$
477,592

 
$
497,590

Cost of revenues
320,367

 
334,387

Gross profit
157,225

 
163,203

 
 
 
 
Operating expenses
 
 
 
Sales and marketing
41,468

 
40,767

Product development
40,868

 
45,346

General and administrative
37,246

 
45,069

Amortization of intangible assets
4,549

 
6,210

Restructuring
3,052

 
2,237

Total operating expenses
127,183

 
139,629

 
 
 
 
Operating income
30,042

 
23,574

Other income (expense)
 
 
 
Interest income
269

 
271

Interest expense
(2,674
)
 
(2,918
)
Other income (expense), net
(2,576
)
 
(1,517
)
Total other income (expense)
(4,981
)
 
(4,164
)
 
 
 
 
Income before income taxes
25,061

 
19,410

Income tax provision
(9,047
)
 
(8,626
)
Net income
16,014

 
10,784

Net income attributable to noncontrolling interests
169

 
695

Net income attributable to Itron, Inc.
$
15,845

 
$
10,089

 
 
 
 
Earnings per common share - Basic
$
0.41

 
$
0.27

Earnings per common share - Diluted
$
0.40

 
$
0.26

 
 
 
 
Weighted average common shares outstanding - Basic
38,474

 
38,059

Weighted average common shares outstanding - Diluted
39,215

 
38,376

The accompanying notes are an integral part of these condensed consolidated financial statements.


1


ITRON, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(UNAUDITED)

 
Three Months Ended March 31,
 
2017
 
2016
 
(in thousands)
Net income
$
16,014

 
$
10,784

 
 
 
 
Other comprehensive income (loss), net of tax:
 
 
 
Foreign currency translation adjustment
15,016

 
10,106

Net unrealized gain (loss) on derivative instruments, designated as cash flow hedges
292

 
(2,606
)
Pension benefit obligation adjustment
401

 
(318
)
Total other comprehensive income (loss), net of tax
15,709

 
7,182

 
 
 
 
Total comprehensive income, net of tax
31,723

 
17,966

 
 
 
 
Comprehensive income attributable to noncontrolling interests, net of tax
169

 
695

 
 
 
 
Comprehensive income attributable to Itron, Inc.
$
31,554

 
$
17,271

The accompanying notes are an integral part of these condensed consolidated financial statements.

2


ITRON, INC.
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
 
March 31, 2017
 
December 31, 2016
 
(in thousands)
ASSETS
 
 
 
Current assets
 
 
 
Cash and cash equivalents
$
187,928

 
$
133,565

Accounts receivable, net
344,411

 
351,506

Inventories
178,060

 
163,049

Other current assets
95,424

 
84,346

Total current assets
805,823

 
732,466

 
 
 
 
Property, plant, and equipment, net
178,647

 
176,458

Deferred tax assets, net
106,896

 
94,113

Other long-term assets
50,166

 
50,129

Intangible assets, net
69,485

 
72,151

Goodwill
462,906

 
452,494

Total assets
$
1,673,923

 
$
1,577,811

 
 
 
 
LIABILITIES AND EQUITY
 
 
 
Current liabilities
 
 
 
Accounts payable
$
194,012

 
$
172,711

Other current liabilities
46,359

 
43,625

Wages and benefits payable
82,010

 
82,346

Taxes payable
18,736

 
10,451

Current portion of debt
15,469

 
14,063

Current portion of warranty
23,500

 
24,874

Unearned revenue
84,705

 
64,976

Total current liabilities
464,791

 
413,046

 
 
 
 
Long-term debt
288,266

 
290,460

Long-term warranty
18,036

 
18,428

Pension benefit obligation
87,663

 
84,498

Deferred tax liabilities, net
3,214

 
3,073

Other long-term obligations
109,346

 
117,953

Total liabilities
971,316

 
927,458

 
 
 
 
Commitments and contingencies (Note 11)

 

 
 
 
 
Equity
 
 
 
Preferred stock, no par value, 10 million shares authorized, no shares issued or outstanding

 

Common stock, no par value, 75 million shares authorized, 38,649 and 38,317 shares issued and outstanding
1,276,298

 
1,270,467

Accumulated other comprehensive loss, net
(213,618
)
 
(229,327
)
Accumulated deficit
(379,326
)
 
(409,536
)
Total Itron, Inc. shareholders' equity
683,354

 
631,604

Noncontrolling interests
19,253

 
18,749

Total equity
702,607

 
650,353

Total liabilities and equity
$
1,673,923

 
$
1,577,811

The accompanying notes are an integral part of these condensed consolidated financial statements.

3


ITRON, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
 
Three Months Ended March 31,
 
2017
 
2016
 
(in thousands)
Operating activities
 
 
 
Net income
$
16,014

 
$
10,784

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Depreciation and amortization
14,378

 
16,674

Stock-based compensation
5,211

 
3,900

Amortization of prepaid debt fees
266

 
276

Deferred taxes, net
882

 
4,507

Restructuring, non-cash

 
1,114

Other adjustments, net
946

 
66

Changes in operating assets and liabilities:
 
 
 
Accounts receivable
13,119

 
(33,308
)
Inventories
(11,274
)
 
3,244

Other current assets
(11,169
)
 
(5,457
)
Other long-term assets
646

 
2,945

Accounts payable, other current liabilities, and taxes payable
28,277

 
10,161

Wages and benefits payable
(1,796
)
 
9,349

Unearned revenue
14,020

 
14,343

Warranty
(2,303
)
 
(4,045
)
Other operating, net
(3,960
)
 
(748
)
Net cash provided by operating activities
63,257

 
33,805

 
 
 
 
Investing activities
 
 
 
Acquisitions of property, plant, and equipment
(9,122
)
 
(8,791
)
Other investing, net
(78
)
 
558

Net cash used in investing activities
(9,200
)
 
(8,233
)
 
 
 
 
Financing activities
 
 
 
Payments on debt
(2,813
)
 
(23,406
)
Issuance of common stock
405

 
660

Other financing, net
155

 
(2,289
)
Net cash provided used in financing activities
(2,253
)
 
(25,035
)
 
 
 
 
Effect of foreign exchange rate changes on cash and cash equivalents
2,559

 
1,060

Increase in cash and cash equivalents
54,363

 
1,597

Cash and cash equivalents at beginning of period
133,565

 
131,018

Cash and cash equivalents at end of period
$
187,928

 
$
132,615

 
 
 
 
Supplemental disclosure of cash flow information:
 
 
 
Cash paid during the period for:
 
 
 
Income taxes, net
$
1,224

 
$
3,680

Interest, net of amounts capitalized
2,422

 
2,624

The accompanying notes are an integral part of these condensed consolidated financial statements.

4


ITRON, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2017
(UNAUDITED)
In this Quarterly Report on Form 10-Q, the terms “we,” “us,” “our,” “Itron,” and the “Company” refer to Itron, Inc.

Note 1:    Summary of Significant Accounting Policies

Financial Statement Preparation
The condensed consolidated financial statements presented in this Quarterly Report on Form 10-Q are unaudited and reflect entries necessary for the fair presentation of the Consolidated Statements of Operations and the Consolidated Statements of Comprehensive Income (Loss) for the three months ended March 31, 2017 and 2016, the Consolidated Balance Sheets as of March 31, 2017 and December 31, 2016, and the Consolidated Statements of Cash Flows for the three months ended March 31, 2017 and 2016 of Itron, Inc. and its subsidiaries. All entries required for the fair presentation of the financial statements are of a normal recurring nature, except as disclosed. The results of operations for the three months ended March 31, 2017 are not necessarily indicative of the results expected for the full year or for any other period.

Certain information and notes normally included in financial statements prepared in accordance with U.S. generally accepted accounting principles (GAAP) have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission (SEC) regarding interim results. These condensed consolidated financial statements should be read in conjunction with the audited financial statements and notes included in our 2016 Annual Report on Form 10-K filed with the SEC on March 1, 2017. There have been no significant changes in financial statement preparation or significant accounting policies since December 31, 2016 with the exception of the adoption of Accounting Standards Update (ASU) 2016-09 as discussed below.

New Accounting Pronouncements
In May 2014, the Financial Accounting Standards Board (FASB) issued ASU 2014-09, Revenue from Contracts with Customers: Topic 606 (ASU 2014-09), to supersede nearly all existing revenue recognition guidance under U.S. GAAP. The core principle of ASU 2014-09 is to recognize revenues when promised goods or services are transferred to customers in an amount that reflects the consideration that is expected to be received for those goods or services. In August 2015, the FASB issued ASU 2015-14, Revenue from Contracts with Customers: Deferral of the Effective Date, which deferred the effective date for implementation of ASU 2014-09 by one year and is now effective for annual reporting periods beginning after December 15, 2017, with early adoption permitted but not earlier than the original effective date. In March 2016, the FASB issued ASU 2016-08, Principal versus Agent Considerations (Reporting Revenue Gross versus Net) (ASU 2016-08), which clarifies the implementation guidance of principal versus agent considerations. In April 2016, the FASB issued ASU 2016-10, Identifying Performance Obligations and Licensing (ASU 2016-10), which clarifies the identification of performance obligations and licensing implementation guidance. In May 2016, the FASB issued ASU 2016-12, Narrow-Scope Improvements and Practical Expedients (ASU 2016-12), to improve guidance on assessing collectability, presentation of sales taxes, noncash consideration, and completed contracts and contract modifications at transition. The effective date and transition requirements in ASU 2016-08, ASU 2016-10, and ASU 2016-12 are the same as the effective date and transition requirements of ASU 2015-14.

The revenue guidance permits two methods of adoption: retrospectively to each prior reporting period presented (full retrospective method), or retrospectively with the cumulative effect of initially applying the guidance recognized at the date of initial application (the cumulative catch-up transition method). We currently anticipate adopting the standard effective January 1, 2018 using the cumulative catch-up transition method, and therefore, will recognize the cumulative effect of initially applying the revenue standard as an adjustment to the opening balance of retained earnings in the period of initial application. We currently believe the most significant impact relates to our accounting for software and software-related elements, and the increased financial statement disclosures, but are continuing to evaluate the effect that the updated standard will have on our consolidated results of operations, financial position, cash flows, and related financial statement disclosures.

In July 2015, the FASB issued ASU 2015-11, Inventory (Topic 330) - Simplifying the Measurement of Inventory (ASU 2015-11). The amendments in ASU 2015-11 apply to inventory measured using first-in, first-out (FIFO) or average cost and will require entities to measure inventory at the lower of cost and net realizable value. Net realizable value is the estimated selling price in the normal course of business, minus the cost of completion, disposal and transportation. Replacement cost and net realizable value less a normal profit margin will no longer be considered. We adopted this standard on January 1, 2017 and it did not materially impact our consolidated results of operations, financial position, cash flows, and related financial statement disclosures.

In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842), which requires substantially all leases be recognized by lessees on their balance sheet as a right-of-use asset and corresponding lease liability, including leases currently accounted for as

5


operating leases. The new standard also will result in enhanced quantitative and qualitative disclosures, including significant judgments made by management, to provide greater insight into the extent of revenue and expense recognized and expected to be recognized from existing leases. The standard requires modified retrospective adoption and will be effective for annual reporting periods beginning after December 15, 2018, with early adoption permitted. We are currently assessing the impact of adoption on our consolidated results of operations, financial position, cash flows, and related financial statement disclosures.

In March 2016, the FASB issued ASU 2016-09, Improvements to Employee Share-Based Payment Accounting (Topic 718) (ASU 2016-09), which simplifies several areas within Topic 718. These include income tax consequences, classification of awards as either equity or liabilities, forfeitures, and classification on the statement of cash flows. The amendments in this ASU becomes effective on a modified retrospective basis for accounting for income tax benefits recognized and forfeitures, retrospectively for accounting related to the presentation of employee taxes paid, prospectively for accounting related to recognition of excess tax benefits, and either prospectively or retrospectively for accounting related to presentation of excess employee tax benefits for annual periods, and interim periods within those annual periods, beginning after December 15, 2016.

We adopted this standard effective January 1, 2017 using a modified retrospective transition method. We recognized a $14.6 million one-time reduction in accumulated deficit and increase in deferred tax assets related to cumulative unrecognized excess tax benefits . All future excess tax benefits and tax deficiencies will be recognized prospectively as income tax provision or benefit in the Consolidated Statement of Operations, and as an operating activity on the Consolidated Statement of Cash Flows. We also recognized a $0.2 million one-time increase in accumulated deficit and common stock related to our policy election to prospectively recognize forfeitures as they occur.

In January 2017, the FASB issued ASU 2017-01, Clarifying the Definition of a Business (ASU 2017-01), which narrows the definition of a business and provides a framework that gives entities a basis for making reasonable judgments about whether a transaction involves an asset or a business. ASU 2017-01 states that when substantially all of the fair value of the gross assets acquired (or disposed of) is concentrated in a single identifiable asset or group of similar identifiable assets, the set is not a business. If this initial test is not met, a set cannot be considered a business unless it includes an input and a substantive process that together significantly contribute to the ability to create output. ASU 2017-01 is effective for fiscal years beginning after December 15, 2019 with early adoption permitted. We adopted this standard on January 1, 2017, and it did not materially impact our consolidated results of operations, financial position, cash flows, and related financial statement disclosures.

In January 2017, the FASB issued ASU 2017-04, Simplifying the Test for Goodwill Impairment (ASU 2017-04), which simplifies the measurement of goodwill impairment by removing step two of the goodwill impairment test that requires the determination of the fair value of individual assets and liabilities of a reporting unit. ASU 2017-04 requires goodwill impairment to be measured as the amount by which a reporting unit’s carrying value exceeds its fair value; however, the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit. ASU 2017-04 is effective for fiscal years beginning after December 15, 2019 with early adoption permitted for interim or annual goodwill impairment tests performed after January 1, 2017. We adopted this standard on January 1, 2017, and it did not materially impact our consolidated results of operations, financial position, cash flows, and related financial statement disclosures.

In March 2017, the FASB issued ASU 2017-07, Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost (ASU 2017-07), which provides additional guidance on the presentation of net benefit costs in the income statement. ASU 2017-07 requires an employer disaggregate the service cost component from the other components of net benefit cost and to disclose other components outside of a subtotal of income from operations. It also allows only the service cost component of net benefit costs to be eligible for capitalization. ASU 2017-07 is effective for fiscal years beginning after December 15, 2017 with early adoption permitted. We are currently assessing the impact of adoption on our consolidated results of operations, financial position, cash flows, and related financial statement disclosures.


6


Note 2:    Earnings Per Share

The following table sets forth the computation of basic and diluted earnings per share (EPS):

 
Three Months Ended March 31,
 
2017
 
2016
 
(in thousands, except per share data)
Net income available to common shareholders
$
15,845

 
$
10,089

 
 
 
 
Weighted average common shares outstanding - Basic
38,474

 
38,059

Dilutive effect of stock-based awards
741

 
317

Weighted average common shares outstanding - Diluted
39,215

 
38,376

Earnings per common share - Basic
$
0.41

 
$
0.27

Earnings per common share - Diluted
$
0.40

 
$
0.26


Stock-based Awards
For stock-based awards, the dilutive effect is calculated using the treasury stock method. Under this method, the dilutive effect is computed as if the awards were exercised at the beginning of the period (or at time of issuance, if later) and assumes the related proceeds were used to repurchase common stock at the average market price during the period. Related proceeds include the amount the employee must pay upon exercise and the future compensation cost associated with the stock award. Approximately 0.2 million and 1.2 million stock-based awards were excluded from the calculation of diluted EPS for the three months ended March 31, 2017 and 2016 because they were anti-dilutive. These stock-based awards could be dilutive in future periods.

Note 3:    Certain Balance Sheet Components

Accounts receivable, net
March 31, 2017
 
December 31, 2016
 
(in thousands)
Trade receivables (net of allowance of $3,424 and $3,320)
$
307,065

 
$
299,870

Unbilled receivables
37,346

 
51,636

Total accounts receivable, net
$
344,411

 
$
351,506


Allowance for doubtful accounts activity
Three Months Ended March 31,
 
2017
 
2016
 
(in thousands)
Beginning balance
$
3,320

 
$
5,949

Provision (release) for doubtful accounts, net
303

 
(8
)
Accounts written-off
(330
)
 
(1,478
)
Effect of change in exchange rates
131

 
78

Ending balance
$
3,424

 
$
4,541


Inventories
March 31, 2017
 
December 31, 2016
 
(in thousands)
Materials
$
111,832

 
$
103,274

Work in process
10,573

 
7,925

Finished goods
55,655

 
51,850

Total inventories
$
178,060

 
$
163,049



7


Property, plant, and equipment, net
March 31, 2017
 
December 31, 2016
 
(in thousands)
Machinery and equipment
$
287,378

 
$
279,746

Computers and software
101,648

 
98,125

Buildings, furniture, and improvements
125,383

 
122,680

Land
17,604

 
17,179

Construction in progress, including purchased equipment
29,612

 
29,358

Total cost
561,625

 
547,088

Accumulated depreciation
(382,978
)
 
(370,630
)
Property, plant, and equipment, net
$
178,647

 
$
176,458


Depreciation expense
Three Months Ended March 31,
 
2017
 
2016
 
(in thousands)
Depreciation expense
$
9,829

 
$
10,464


Note 4:    Intangible Assets

The gross carrying amount and accumulated amortization of our intangible assets, other than goodwill, were as follows:

 
March 31, 2017
 
December 31, 2016
 
Gross Assets
 
Accumulated
Amortization
 
Net
 
Gross Assets
 
Accumulated
Amortization
 
Net
 
(in thousands)
Core-developed technology
$
381,788

 
$
(365,766
)
 
$
16,022

 
$
372,568

 
$
(354,878
)
 
$
17,690

Customer contracts and relationships
230,382

 
(176,960
)
 
53,422

 
224,467

 
(170,056
)
 
54,411

Trademarks and trade names
62,817

 
(62,802
)
 
15

 
61,785

 
(61,766
)
 
19

Other
11,077

 
(11,051
)
 
26

 
11,076

 
(11,045
)
 
31

Total intangible assets
$
686,064

 
$
(616,579
)
 
$
69,485

 
$
669,896

 
$
(597,745
)
 
$
72,151


A summary of intangible asset activity is as follows:

 
Three Months Ended March 31,
 
2017
 
2016
 
(in thousands)
Beginning balance, intangible assets, gross
$
669,896

 
$
702,507

Effect of change in exchange rates
16,168

 
6,474

Ending balance, intangible assets, gross
$
686,064

 
$
708,981


Estimated future annual amortization expense is as follows:

Year Ending December 31,
 
Estimated Annual Amortization
 
 
(in thousands)
2017 (amount remaining at March 31, 2017)
 
$
13,709

2018
 
12,673

2019
 
9,935

2020
 
8,077

2021
 
7,031

Beyond 2021
 
18,060

Total intangible assets subject to amortization
 
$
69,485



8


Note 5:    Goodwill

The following table reflects goodwill allocated to each reporting unit:
 
Electricity
 
Gas
 
Water
 
Total Company
 
(in thousands)
Balances at January 1, 2017
 
 
 
 
 
 
 
Goodwill before impairment
$
400,299

 
$
319,913

 
$
334,505

 
$
1,054,717

Accumulated impairment losses
(348,926
)
 

 
(253,297
)
 
(602,223
)
Goodwill, net
51,373

 
319,913

 
81,208

 
452,494

 
 
 
 
 
 
 
 
Effect of change in exchange rates
776

 
7,774

 
1,862

 
10,412

 
 
 
 
 
 
 
 
Balances at March 31, 2017
 
 
 
 
 
 
 
Goodwill before impairment
409,960

 
327,687

 
345,042

 
1,082,689

Accumulated impairment losses
(357,811
)
 

 
(261,972
)
 
(619,783
)
Goodwill, net
$
52,149

 
$
327,687

 
$
83,070

 
$
462,906


Note 6:    Debt

The components of our borrowings were as follows:
 
March 31, 2017
 
December 31, 2016
 
(in thousands)
Credit facility:
 
 
 
USD denominated term loan
$
205,313

 
$
208,125

Multicurrency revolving line of credit
99,125

 
97,167

Total debt
304,438

 
305,292

Less: current portion of debt
15,469

 
14,063

Less: unamortized prepaid debt fees - term loan
703

 
769

Long-term debt less unamortized prepaid debt fees - term loan
$
288,266


$
290,460


Credit Facility
On June 23, 2015, we entered into an amended and restated credit agreement providing for committed credit facilities in the amount of $725 million U.S. dollars (the 2015 credit facility). The 2015 credit facility consists of a $225 million U.S. dollar term loan (the term loan) and a multicurrency revolving line of credit (the revolver) with a principal amount of up to $500 million. The revolver also contains a $250 million standby letter of credit sub-facility and a $50 million swingline sub-facility (available for immediate cash needs at a higher interest rate). Both the term loan and the revolver mature on June 23, 2020, and amounts borrowed under the revolver are classified as long-term and, during the credit facility term, may be repaid and reborrowed until the revolver's maturity, at which time the revolver will terminate, and all outstanding loans, together with all accrued and unpaid interest, must be repaid. Amounts not borrowed under the revolver are subject to a commitment fee, which is paid in arrears on the last day of each fiscal quarter, ranging from 0.18% to 0.30% per annum depending on our total leverage ratio as of the most recently ended fiscal quarter. Amounts repaid on the term loan may not be reborrowed. The 2015 credit facility permits us and certain of our foreign subsidiaries to borrow in U.S. dollars, euros, British pounds, or, with lender approval, other currencies readily convertible into U.S. dollars. All obligations under the 2015 credit facility are guaranteed by Itron, Inc. and material U.S. domestic subsidiaries and are secured by a pledge of substantially all of the assets of Itron, Inc. and material U.S. domestic subsidiaries, including a pledge of 100% of the capital stock of material U.S. domestic subsidiaries and up to 66% of the voting stock (100% of the non-voting stock) of their first-tier foreign subsidiaries. In addition, the obligations of any foreign subsidiary who is a foreign borrower, as defined by the 2015 credit facility, are guaranteed by the foreign subsidiary and by its direct and indirect foreign parents.

Under the 2015 credit facility, we elect applicable market interest rates for both the term loan and any outstanding revolving loans. We also pay an applicable margin, which is based on our total leverage ratio (as defined in the credit agreement). The applicable rates per annum may be based on either: (1) the LIBOR rate or EURIBOR rate (floor of 0%), plus an applicable margin, or (2) the Alternate Base Rate, plus an applicable margin. The Alternate Base Rate election is equal to the greatest of three rates: (i) the prime rate, (ii) the Federal Reserve effective rate plus 1/2 of 1%, or (iii) one month LIBOR plus 1%. At March 31, 2017 and December 31, 2016, the interest rate for both the term loan and the USD revolver was 2.24% and 2.02%, respectively, which includes the LIBOR rate plus a margin of 1.25%. At March 31, 2017 and December 31, 2016, the interest rate for the EUR revolver was 1.25% (the EURIBOR floor rate plus a margin of 1.25%).


9


At March 31, 2017, $99.1 million was outstanding under the 2015 credit facility revolver, and $29.2 million was utilized by outstanding standby letters of credit, resulting in $371.7 million available for additional borrowings or standby letters of credit. At March 31, 2017, $220.8 million was available for additional standby letters of credit under the letter of credit sub-facility and no amounts were outstanding under the swingline sub-facility.

Note 7:    Derivative Financial Instruments

As part of our risk management strategy, we use derivative instruments to hedge certain foreign currency and interest rate exposures. Refer to Note 13 and Note 14 for additional disclosures on our derivative instruments.

The fair values of our derivative instruments are determined using the income approach and significant other observable inputs (also known as “Level 2”). We have used observable market inputs based on the type of derivative and the nature of the underlying instrument. The key inputs include interest rate yield curves (swap rates and futures) and foreign exchange spot and forward rates, all of which are available in an active market. We have utilized the mid-market pricing convention for these inputs. We include, as a discount to the derivative asset, the effect of our counterparty credit risk based on current published credit default swap rates when the net fair value of our derivative instruments is in a net asset position. We consider our own nonperformance risk when the net fair value of our derivative instruments is in a net liability position by discounting our derivative liabilities to reflect the potential credit risk to our counterparty through applying a current market indicative credit spread to all cash flows.

The fair values of our derivative instruments were as follows:

 
 
 
 
Fair Value
Asset Derivatives
 
Balance Sheet Location
 
March 31, 2017
 
December 31, 2016
Derivatives designated as hedging instruments under ASC 815-20
 
(in thousands)
Interest rate cap contracts
 
Other current assets
 
$
5

 
$
3

Interest rate swap contracts
 
Other long-term assets
 
1,922

 
1,830

Interest rate cap contracts
 
Other long-term assets
 
290

 
376

Derivatives not designated as hedging instruments under ASC 815-20
 
 
 
 
Foreign exchange forward contracts
 
Other current assets
 
137

 
169

Interest rate cap contracts
 
Other current assets
 
7

 
4

Interest rate cap contracts
 
Other long-term assets
 
434

 
563

Total asset derivatives
 
 
 
$
2,795

 
$
2,945

 
 
 
 
 
 
 
Liability Derivatives
 
 
 
 
 
 
Derivatives designated as hedging instruments under ASC 815-20
 
 
 
 
Interest rate swap contracts
 
Other current liabilities
 
$
509

 
$
934

Derivatives not designated as hedging instruments under ASC 815-20
 
 
 
 
Foreign exchange forward contracts
 
Other current liabilities
 
337

 
449

Total liability derivatives
 
 
 
$
846

 
$
1,383


The changes in accumulated other comprehensive income (loss) (AOCI), net of tax, for our derivative and nonderivative hedging instruments, were as follows:

 
2017
 
2016
 
(in thousands)
Net unrealized loss on hedging instruments at January 1,
$
(14,337
)
 
$
(14,062
)
Unrealized gain (loss) on hedging instruments
60

 
(2,782
)
Realized losses reclassified into net income
232

 
176

Net unrealized loss on hedging instruments at March 31,
$
(14,045
)
 
$
(16,668
)

Reclassification of amounts related to hedging instruments are included in interest expense in the Consolidated Statements of Operations for the periods ended March 31, 2017 and 2016. Included in the net unrealized loss on hedging instruments at March 31, 2017 and 2016 is a loss of $14.4 million, net of tax, related to our nonderivative net investment hedge, which terminated in 2011. This loss on our net investment hedge will remain in AOCI until such time when earnings are impacted by a sale or liquidation of the associated foreign operation.


10


A summary of the effect of netting arrangements on our financial position related to the offsetting of our recognized derivative assets and liabilities under master netting arrangements or similar agreements is as follows:

Offsetting of Derivative Assets
Gross Amounts of Recognized Assets Presented in
the Consolidated
Balance Sheets
 
Gross Amounts Not Offset in the Consolidated Balance Sheets
 
 
 
 
Derivative Financial Instruments
 
Cash Collateral Received
 
Net Amount
 
(in thousands)
March 31, 2017
$
2,795

 
$
(687
)
 
$

 
$
2,108

 
 
 
 
 
 
 
 
December 31, 2016
$
2,945

 
$
(1,322
)
 
$

 
$
1,623


Offsetting of Derivative Liabilities
Gross Amounts of Recognized Liabilities Presented in the Consolidated Balance Sheets
 
Gross Amounts Not Offset in the Consolidated Balance Sheets
 
 
 
 
Derivative Financial Instruments
 
Cash Collateral Pledged
 
Net Amount
 
(in thousands)
March 31, 2017
$
846

 
$
(687
)
 
$

 
$
159

 
 
 
 
 
 
 
 
December 31, 2016
$
1,383

 
$
(1,322
)
 
$

 
$
61


Our derivative assets and liabilities subject to netting arrangements consist of foreign exchange forward and interest rate contracts with three counterparties at March 31, 2017 and December 31, 2016. No derivative asset or liability balance with any of our counterparties was individually significant at March 31, 2017 or December 31, 2016. Our derivative contracts with each of these counterparties exist under agreements that provide for the net settlement of all contracts through a single payment in a single currency in the event of default. We have no pledges of cash collateral against our obligations nor have we received pledges of cash collateral from our counterparties under the associated derivative contracts.

Cash Flow Hedges
As a result of our floating rate debt, we are exposed to variability in our cash flows from changes in the applicable interest rate index. We enter into swaps to achieve a fixed rate of interest on a portion of our debt in order to increase our ability to forecast interest expense. The objective of these swaps is to reduce the variability of cash flows from increases in the LIBOR based borrowing rates on our floating rate credit facility. The swaps do not protect us from changes to the applicable margin under our credit facility.

In May 2012, we entered into six interest rate swaps, which were effective July 31, 2013 and expired on August 8, 2016, to convert $200 million of our LIBOR based debt from a floating LIBOR interest rate to a fixed interest rate of 1.00% (excluding the applicable margin on the debt). The cash flow hedges were expected to be highly effective in achieving offsetting cash flows attributable to the hedged risk through the term of the hedge. Consequently, effective changes in the fair value of the interest rate swaps were recognized as a component of other comprehensive income (loss) (OCI) and recognized in earnings when the hedged item affected earnings. The amounts paid on the hedges were recognized as adjustments to interest expense.

In October 2015, we entered into an interest rate swap, which is effective from August 31, 2016 to June 23, 2020, and converts $214 million of our LIBOR based debt from a floating LIBOR interest rate to a fixed interest rate of 1.42% (excluding the applicable margin on the debt). The notional balance will amortize to maturity at the same rate as required minimum payments on our term loan. The cash flow hedge is expected to be highly effective in achieving offsetting cash flows attributable to the hedged risk through the term of the hedge. Consequently, effective changes in the fair value of the interest rate swap is recognized as a component of OCI and will be recognized in earnings when the hedged item affects earnings. The amounts paid or received on the hedge will be recognized as an adjustment to interest expense. The amount of net losses expected to be reclassified into earnings in the next 12 months is $0.5 million. At March 31, 2017, our LIBOR-based debt balance was $245.3 million.

In November 2015, we entered into three interest rate cap contracts with a total notional amount of $100 million at a cost of $1.7 million. The interest rate cap contracts expire on June 23, 2020 and were entered into in order to limit our interest rate exposure on $100 million of our variable LIBOR based debt up to 2.00%. In the event LIBOR is higher than 2.00%, we will pay interest at the capped rate of 2.00% with respect to the $100 million notional amount of such agreements. The interest rate cap contracts do not include the effect of the applicable margin. As of December 31, 2016, due to the accelerated revolver payments from surplus

11


cash, we elected to de-designate two of the interest rate cap contracts as cash flow hedges and discontinued the use of cash flow hedge accounting. The amounts recognized in AOCI from de-designated interest rate cap contracts will continue to be reported in AOCI unless it is not probable that the forecasted transactions will occur. As a result of the discontinuance of cash flow hedge accounting, all subsequent changes in fair value of the de-designated derivative instruments are recognized within interest expense instead of OCI. The amount of net losses expected to be reclassified into earnings for all interest rate cap contracts in the next 12 months is $0.2 million.

The before-tax effects of our cash flow derivative instruments on the Consolidated Balance Sheets and the Consolidated Statements of Operations were as follows:

Derivatives in ASC 815-20
Cash Flow
Hedging Relationships
 
Amount of Gain (Loss)
Recognized in OCI on
Derivative (Effective
Portion)
 
Gain (Loss) Reclassified from Accumulated
OCI into Income (Effective Portion)
 
Gain (Loss) Recognized in Income on
Derivative (Ineffective Portion)
Location
 
Amount
 
Location
 
Amount
 
 
2017
 
2016
 
 
 
2017
 
2016
 
 
 
2017
 
2016
 
 
(in thousands)
 
 
 
(in thousands)
 
 
 
(in thousands)
Three Months Ended March 31,
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest rate swap contracts
 
$
181

 
$
(3,779
)
 
Interest expense
 
$
(335
)
 
$
(286
)
 
Interest expense
 
$

 
$

Interest rate cap contracts
 
(84
)
 
(734
)
 
Interest expense
 
(43
)
 

 
Interest expense
 

 


Derivatives Not Designated as Hedging Relationships
We are also exposed to foreign exchange risk when we enter into non-functional currency transactions, both intercompany and third party. At each period-end, non-functional currency monetary assets and liabilities are revalued with the change recognized to other income and expense. We enter into monthly foreign exchange forward contracts, which are not designated for hedge accounting, with the intent to reduce earnings volatility associated with currency exposures. As of March 31, 2017, a total of 49 contracts were offsetting our exposures from the euro, Saudi Riyal, Indian Rupee, Chinese Yuan, Indonesian Rupiah, and various other currencies, with notional amounts ranging from $167,000 to $45.3 million.

The effect of our foreign exchange forward derivative instruments on the Consolidated Statements of Operations was as follows:

Derivatives Not Designated as Hedging Instrument under ASC 815-20
 
Location
 
Gain (Loss) Recognized on Derivatives in Other Income (Expense)
 
 
 
 
Three Months Ended March 31,
 
 
 
 
2017
 
2016
 
 
 
 
(in thousands)
Foreign exchange forward contracts
 
Other income (expense), net
 
$
(1,742
)
 
$
(855
)
Interest rate cap contracts
 
Interest expense
 
(126
)
 


Note 8:    Defined Benefit Pension Plans

We sponsor both funded and unfunded defined benefit pension plans offering death and disability, retirement, and special termination benefits for our international employees, primarily in Germany, France, Italy, Indonesia, Brazil, and Spain. The defined benefit obligation is calculated annually by using the projected unit credit method. The measurement date for the pension plans was December 31, 2016.

Amounts recognized on the Consolidated Balance Sheets consist of:

 
March 31, 2017
 
December 31, 2016
 
(in thousands)
Assets
 
 
 
Plan assets in other long-term assets
$
702

 
$
654

 
 
 
 
Liabilities
 
 
 
Current portion of pension benefit obligation in wages and benefits payable
3,281

 
3,202

Long-term portion of pension benefit obligation
87,663

 
84,498

 
 
 
 
Pension benefit obligation, net
$
90,242

 
$
87,046


12



Our asset investment strategy focuses on maintaining a portfolio using primarily insurance funds, which are accounted for as investments and measured at fair value, in order to achieve our long-term investment objectives on a risk adjusted basis. Our general funding policy for these qualified pension plans is to contribute amounts sufficient to satisfy regulatory funding standards of the respective countries for each plan.

Net periodic pension benefit costs for our plans include the following components:

 
Three Months Ended March 31,
 
2017
 
2016
 
(in thousands)
Service cost
$
928

 
$
986

Interest cost
525

 
633

Expected return on plan assets
(146
)
 
(126
)
Settlements and other

 
(3
)
Amortization of actuarial net loss
391

 
327

Amortization of unrecognized prior service costs
15

 
15

Net periodic benefit cost
$
1,713

 
$
1,832


Note 9:    Stock-Based Compensation

We maintain the Amended and Restated 2010 Stock Incentive Plan (Stock Incentive Plan), which allows us to grant equity-based compensation awards, including stock options, restricted stock units, phantom stock, and unrestricted stock units. Under the Stock Incentive Plan, we have 7,473,956 shares of common stock reserved and authorized for issuance subject to stock splits, dividends, and other similar events. At March 31, 2017, 1,608,588 shares were available for grant under the Stock Incentive Plan. We issue new shares of common stock upon the exercise of stock options or when vesting conditions on restricted stock units are fully satisfied. These shares are subject to a fungible share provision such that the authorized share reserve is reduced by (i) one share for every one share subject to a stock option or share appreciation right granted under the Plan and (ii) 1.7 shares for every one share of common stock that was subject to an award other than an option or share appreciation right.

We also periodically award phantom stock units, which are settled in cash upon vesting and accounted for as liability-based awards with no impact to the shares available for grant.

In addition, we maintain the Employee Stock Purchase Plan (ESPP), for which approximately 365,000 shares of common stock were available for future issuance at March 31, 2017.

Unrestricted stock and ESPP activity for the quarters ended March 31, 2017 and 2016 was not significant.

Stock-Based Compensation Expense
Total stock-based compensation expense and the related tax benefit were as follows:

 
Three Months Ended March 31,
 
2017
 
2016
 
(in thousands)
Stock options
$
659

 
$
554

Restricted stock units
4,297

 
3,096

Unrestricted stock awards
255

 
250

Phantom stock units
392

 
76

Total stock-based compensation
$
5,603

 
$
3,976

 
 
 
 
Related tax benefit
$
1,228

 
$
1,208



13


Stock Options
A summary of our stock option activity is as follows:

 
Shares
 
Weighted
Average Exercise
Price per Share
 
Weighted Average
Remaining
Contractual Life
 
Aggregate
Intrinsic Value
 
Weighted
Average Grant
Date Fair Value
 
(in thousands)
 
 
 
(years)
 
(in thousands)
 
 
Outstanding, January 1, 2016
1,180

 
$
48.31

 
5.7
 
$
405

 
 
Granted
185

 
40.04

 
 
 
 
 
$
13.15

Exercised
(12
)
 
35.29

 
 
 
73

 
 
Forfeited
(35
)
 
35.29

 
 
 
 
 
 
Expired
(1
)
 
48.51

 
 
 
 
 
 
Outstanding, March 31, 2016
1,317

 
$
47.61

 
5.5
 
$
2,859

 
 
 
 
 
 
 
 
 
 
 
 
Outstanding, January 1, 2017
959

 
$
45.64

 
6.6
 
$
19,125

 
 
Granted
121

 
65.55

 
 
 
 
 
$
22.01

Exercised
(5
)
 
35.29

 
 
 
120

 
 
Forfeited

 

 
 
 
 
 
 
Expired

 

 
 
 
 
 
 
Outstanding, March 31, 2017
1,075

 
$
47.92

 
6.7
 
$
17,236

 
 
 
 
 
 
 
 
 
 
 
 
Exercisable March 31, 2017
707

 
$
48.34

 
5.5
 
$
11,657

 
 
 
 
 
 
 
 
 
 
 
 
Expected to vest, March 31, 2017
368

 
$
47.13

 
9.0
 
$
5,579

 
 

At March 31, 2017, total unrecognized stock-based compensation expense related to nonvested stock options was $5.1 million, which is expected to be recognized over a weighted average period of approximately 2.0 years.

The weighted-average assumptions used to estimate the fair value of stock options granted and the resulting weighted average fair value are as follows:

 
Three Months Ended March 31,
 
2017
 
2016
Expected volatility
32.7
%
 
33.5
%
Risk-free interest rate
2.0
%
 
1.3
%
Expected term (years)
5.5

 
5.5

 
 
 
 
Weighted average fair value
$
22.01

 
$
13.15



14


Restricted Stock Units
The following table summarizes restricted stock unit activity:

 
Number of
Restricted Stock Units
 
Weighted
Average Grant
Date Fair Value
 
Aggregate
Intrinsic Value
 
(in thousands)
 
 
 
(in thousands)
Outstanding, January 1, 2016
756

 
 
 
 
Granted
172

 
$
40.02

 
 
Released
(262
)
 
 
 
$
10,098

Forfeited
(30
)
 
 
 
 
Outstanding, March 31, 2016
636

 
 
 
 
 
 
 
 
 
 
Outstanding, January 1, 2017
701

 
$
38.04

 
 
Granted
131

 
63.12

 
 
Released
(317
)
 
38.13

 
$
12,066

Forfeited
(3
)
 
35.68

 
 
Outstanding, March 31, 2017
512

 
44.45

 
 
 
 
 
 
 
 
Vested but not released, March 31, 2017
6

 
 
 
$
374

 
 
 
 
 
 
Expected to vest, March 31, 2017
410

 
 
 
$
24,894


At March 31, 2017, total unrecognized compensation expense on restricted stock units was $35.5 million, which is expected to be recognized over a weighted average period of approximately 2.1 years.

The weighted-average assumptions used to estimate the fair value of performance-based restricted stock units granted and the resulting weighted average fair value are as follows:

 
Three Months Ended March 31,
 
2017
 
2016
Expected volatility
28.0
%
 
30.0
%
Risk-free interest rate
1.0
%
 
0.7
%
Expected term (years)
1.7

 
1.8

 
 
 
 
Weighted average fair value
$
77.78

 
$
44.77



15


Phantom Stock Units
The following table summarizes phantom stock unit activity:

 
Number of Phantom Stock Units
 
Weighted
Average Grant
Date Fair Value
 
(in thousands)
 
 
Outstanding, January 1, 2016

 
 
Granted
61

 
$
41.72

Forfeited

 
 
Outstanding, March 31, 2016
61

 
 
 
 
 
 
Expected to vest, March 31, 2016
53

 
 
 
 
 
 
Outstanding, January 1, 2017
62

 
$
40.11

Granted
32

 
65.55

Released
(19
)
 
40.05

Forfeited
(2
)
 
40.05

Outstanding, March 31, 2017
73

 
51.40

 
 
 
 
Expected to vest, March 31, 2017
73

 



At March 31, 2017, total unrecognized compensation expense on phantom stock units was $4.2 million, which is expected to be recognized over a weighted average period of approximately 2.4 years. We have recognized a phantom stock liability of $0.2 million within wages and benefits payable in the Consolidated Balance Sheets as of March 31, 2017.

Note 10: Income Taxes

Our tax provision as a percentage of income before tax typically differs from the federal statutory rate of 35%, and may vary from period to period, due to fluctuations in the forecast mix of earnings in domestic and international jurisdictions, new or revised tax legislation and accounting pronouncements, tax credits, state income taxes, adjustments to valuation allowances, and uncertain tax positions, among other items.

Excess tax benefits and tax deficiencies resulting from employee share-based payments have been recognized as income tax provision or benefit in the 2017 Consolidated Statement of Operations pursuant to implementing ASU 2016-09 (see Note 1).

Our tax expense for the three months ended March 31, 2017 differed from the federal statutory rate of 35% due to the forecasted mix of earnings in domestic and international jurisdictions, a benefit related to excess tax benefits under ASU 2016-09, and losses experienced in jurisdictions with valuation allowances on deferred tax assets.

Our tax expense for the three months ended March 31, 2016 differed from the federal statutory rate of 35% due to the forecasted mix of earnings in domestic and international jurisdictions and losses experienced in jurisdictions with valuation allowances.

We classify interest expense and penalties related to unrecognized tax liabilities and interest income on tax overpayments as components of income tax expense. The net interest and penalties expense recognized were as follows:

 
Three Months Ended March 31,
 
2017
 
2016
 
(in thousands)
Net interest and penalties expense
$
206

 
$
99



16


Accrued interest and penalties recognized were as follows:

 
March 31, 2017
 
December 31, 2016
 
(in thousands)
Accrued interest
$
2,730

 
$
2,473

Accrued penalties
2,432

 
2,329


Unrecognized tax benefits related to uncertain tax positions and the amount of unrecognized tax benefits that, if recognized, would affect our effective tax rate were as follows:

 
March 31, 2017
 
December 31, 2016
 
(in thousands)
Unrecognized tax benefits related to uncertain tax positions
$
59,358

 
$
57,626

The amount of unrecognized tax benefits that, if recognized, would affect our effective tax rate
58,101

 
56,411


At March 31, 2017, we are under examination by certain tax authorities for the 2000 to 2015 tax years. The material jurisdictions under examination include, among others, the United States, France, Germany, Italy, Brazil and the United Kingdom. No material changes have occurred to previously disclosed assessments. We believe we have appropriately accrued for the expected outcome of all tax matters and do not currently anticipate that the ultimate resolution of these examinations will have a material adverse effect on our financial condition, future results of operations, or liquidity.

Based upon the timing and outcome of examinations, litigation, the impact of legislative, regulatory, and judicial developments, and the impact of these items on the statute of limitations, it is reasonably possible that the related unrecognized tax benefits could change from those recognized within the next twelve months. However, at this time, an estimate of the range of reasonably possible adjustments to the balance of unrecognized tax benefits cannot be made.


17


Note 11:    Commitments and Contingencies

Guarantees and Indemnifications
We are often required to obtain standby letters of credit (LOCs) or bonds in support of our obligations for customer contracts. These standby LOCs or bonds typically provide a guarantee to the customer for future performance, which usually covers the installation phase of a contract and may, on occasion, cover the operations and maintenance phase of outsourcing contracts.

Our available lines of credit, outstanding standby LOCs, and performance bonds were as follows:

 
March 31, 2017
 
December 31, 2016
 
(in thousands)
Credit facilities
 
 
 
Multicurrency revolving line of credit
$
500,000

 
$
500,000

Long-term borrowings
(99,125
)
 
(97,167
)
Standby LOCs issued and outstanding
(29,205
)
 
(46,103
)
 
 
 
 
Net available for additional borrowings under the multi-currency revolving line of credit
$
371,670

 
$
356,730

Net available for additional standby LOCs under sub-facility
220,795

 
203,897

 
 
 
 
Unsecured multicurrency revolving lines of credit with various financial institutions
 
 
 
Multicurrency revolving lines of credit
$
93,230

 
$
91,809

Standby LOCs issued and outstanding
(21,332
)
 
(21,734
)
Short-term borrowings
(235
)
 
(69
)
Net available for additional borrowings and LOCs
$
71,663

 
$
70,006

 
 
 
 
Unsecured surety bonds in force
$
48,080

 
$
48,221


In the event any such standby LOC or bond is called, we would be obligated to reimburse the issuer of the standby LOC or bond; however, we do not believe that any outstanding LOC or bond will be called.

We generally provide an indemnification related to the infringement of any patent, copyright, trademark, or other intellectual property right on software or equipment within our sales contracts, which indemnifies the customer from and pays the resulting costs, damages, and attorney’s fees awarded against a customer with respect to such a claim provided that: 1) the customer promptly notifies us in writing of the claim and 2) we have the sole control of the defense and all related settlement negotiations. We may also provide an indemnification to our customers for third party claims resulting from damages caused by the negligence or willful misconduct of our employees/agents in connection with the performance of certain contracts. The terms of our indemnifications generally do not limit the maximum potential payments. It is not possible to predict the maximum potential amount of future payments under these or similar agreements.

Legal Matters
We are subject to various legal proceedings and claims of which the outcomes are subject to significant uncertainty. Our policy is to assess the likelihood of any adverse judgments or outcomes related to legal matters, as well as ranges of probable losses. A determination of the amount of the liability required, if any, for these contingencies is made after an analysis of each known issue. A liability is recognized and charged to operating expense when we determine that a loss is probable and the amount can be reasonably estimated. Additionally, we disclose contingencies for which a material loss is reasonably possible, but not probable.


18


Warranty
A summary of the warranty accrual account activity is as follows:

 
Three Months Ended March 31,
 
2017
 
2016
 
(in thousands)
Beginning balance
$
43,302

 
$
54,512

New product warranties
2,361

 
2,404

Other adjustments and expirations
1,682

 
1,034

Claims activity
(6,351
)
 
(7,390
)
Effect of change in exchange rates
542

 
182

Ending balance
41,536

 
50,742

Less: current portion of warranty
23,500

 
32,244

Long-term warranty
$
18,036

 
$
18,498


Total warranty expense is classified within cost of revenues and consists of new product warranties issued, costs related to extended warranty contracts, and other changes and adjustments to warranties. Warranty expense was as follows:

 
Three Months Ended March 31,
 
2017
 
2016
 
(in thousands)
Total warranty expense
$
4,043

 
$
3,438


Unearned Revenue Related to Extended Warranty
A summary of changes to unearned revenue for extended warranty contracts is as follows:

 
Three Months Ended March 31,
 
2017
 
2016
 
(in thousands)
Beginning balance
$
31,549

 
$
33,654

Unearned revenue for new extended warranties
322

 
581

Unearned revenue recognized
(1,005
)
 
(857
)
Effect of change in exchange rates
32

 
120

Ending balance
30,898

 
33,498

Less: current portion of unearned revenue for extended warranty
4,304

 
3,750

Long-term unearned revenue for extended warranty within other long-term obligations
$
26,594

 
$
29,748


Health Benefits
We are self insured for a substantial portion of the cost of our U.S. employee group health insurance. We purchase insurance from a third party, which provides individual and aggregate stop-loss protection for these costs. Each reporting period, we expense the costs of our health insurance plan including paid claims, the change in the estimate of incurred but not reported (IBNR) claims, taxes, and administrative fees (collectively, the plan costs).

Plan costs were as follows:

 
Three Months Ended March 31,
 
2017
 
2016
 
(in thousands)
Plan costs
$
8,754

 
$
6,774



19


The IBNR accrual, which is included in wages and benefits payable, was as follows:

 
March 31, 2017
 
December 31, 2016
 
(in thousands)
IBNR accrual
$
2,488

 
$
2,441


Our IBNR accrual and expenses may fluctuate due to the number of plan participants, claims activity, and deductible limits. For our employees located outside of the United States, health benefits are provided primarily through governmental social plans, which are funded through employee and employer tax withholdings.

Note 12:    Restructuring

2016 Projects
On September 1, 2016, we announced projects (2016 Projects) to restructure various company activities in order to improve operational efficiencies, reduce expenses and improve competiveness. We expect to close or consolidate several facilities and reduce our global workforce as a result of the restructuring.

The 2016 Projects began during the three months ended September 30, 2016, and we expect to substantially complete the 2016 Projects by the end of 2018. Many of the affected employees are represented by unions or works councils, which requires consultation, and potential restructuring projects may be subject to regulatory approval, both of which could impact the timing of charges, total expected charges, cost recognized, and planned savings in certain jurisdictions.

The total expected restructuring costs, the restructuring costs recognized during the three months ended March 31, 2017, and the remaining expected restructuring costs as of March 31, 2017 related to the 2016 Projects are as follows:

 
Total Expected Costs at March 31, 2017
 
Costs Recognized in Prior Periods
 
Costs Recognized During the Three Months Ended March 31, 2017
 
Expected Remaining Costs to be Recognized at March 31, 2017
 
(in thousands)
Employee severance costs
$
45,502

 
$
39,686

 
$
1,316

 
$
4,500

Asset impairments & net loss on sale or disposal
7,219

 
7,219

 

 

Other restructuring costs
15,125

 
889

 
1,736

 
12,500

Total
$
67,846

 
$
47,794

 
$
3,052

 
$
17,000

 
 
 
 
 
 
 
 
Segments:
 
 
 
 
 
 
 
Electricity
$
10,151

 
$
8,827

 
$
(176
)
 
$
1,500

Gas
33,552

 
23,968

 
1,084

 
8,500

Water
20,579

 
13,061

 
1,018

 
6,500

Corporate unallocated
3,564

 
1,938

 
1,126

 
500

Total
$
67,846

 
$
47,794

 
$
3,052

 
$
17,000


2014 Projects
In November 2014, our management approved restructuring projects (2014 Projects) to restructure our Electricity business and related general and administrative activities, along with certain Gas and Water activities, to improve operational efficiencies and reduce expenses. We began implementing these projects in the fourth quarter of 2014, and substantially completed them in the third quarter of 2016. Project activities will continue through the fourth quarter of 2017; however, no further costs are expected to be recognized related to the 2014 Projects.

The 2014 Projects resulted in $48.5 million of restructuring expense, which was recognized from the fourth quarter of 2014 through the third quarter of 2016.


20


The following table summarizes the activity within the restructuring related balance sheet accounts for the 2016 and 2014 Projects during the three months ended March 31, 2017:

 
Accrued Employee Severance
 
Asset Impairments & Net Loss on Sale or Disposal
 
Other Accrued Costs
 
Total
 
(in thousands)
Beginning balance, January 1, 2017
$
45,368

 
$

 
$
2,602

 
$
47,970

Costs charged to expense
1,316

 

 
1,736

 
3,052

Cash payments
(3,291
)
 

 
(1,558
)
 
(4,849
)
Non-cash items

 

 

 

Effect of change in exchange rates
1,193

 

 
2

 
1,195

Ending balance, March 31, 2017
$
44,586

 
$

 
$
2,782

 
$
47,368


Asset impairments are determined at the asset group level. Revenues and net operating income from the activities we have exited or will exit under the restructuring projects are not material to our operating segments or consolidated results.

Other restructuring costs include expenses for employee relocation, professional fees associated with employee severance, and costs to exit the facilities once the operations in those facilities have ceased. Costs associated with restructuring activities are generally presented in the Consolidated Statements of Operations as restructuring, except for certain costs associated with inventory write-downs, which are classified within cost of revenues, and accelerated depreciation expense, which is recognized according to the use of the asset.

The current restructuring liabilities were $31.0 million and $26.2 million as of March 31, 2017 and December 31, 2016. The current restructuring liabilities are classified within other current liabilities on the Consolidated Balance Sheets. The long-term restructuring liabilities balances were $16.4 million and $21.8 million as of March 31, 2017 and December 31, 2016. The long-term restructuring liabilities are classified within other long-term obligations on the Consolidated Balance Sheets, and include facility exit costs and severance accruals.

Note 13:    Shareholders' Equity

Preferred Stock
We have authorized the issuance of 10 million shares of preferred stock with no par value. In the event of a liquidation, dissolution, or winding up of the affairs of the corporation, whether voluntary or involuntary, the holders of any outstanding preferred stock would be entitled to be paid a preferential amount per share to be determined by the Board of Directors prior to any payment to holders of common stock. There was no preferred stock issued or outstanding at March 31, 2017 and December 31, 2016.

Stock Repurchase Authorization
On February 23, 2017, Itron's Board of Directors authorized the Company to repurchase up to $50 million of our common stock over a 12-month period, beginning February 23, 2017. We repurchased no shares of common stock during the three months ended March 31, 2017.

21



Other Comprehensive Income (Loss)
The before-tax amount, income tax (provision) benefit, and net-of-tax amount related to each component of OCI were as follows:

 
Three Months Ended March 31,
 
2017
 
2016
 
(in thousands)
Before-tax amount
 
 
 
Foreign currency translation adjustment
$
15,066

 
$
10,458

Net unrealized gain (loss) on derivative instruments designated as cash flow hedges
97

 
(4,513
)
Net hedging loss reclassified into net income
378

 
286

Net unrealized gain (loss) on defined benefit plans

 
(113
)
Net defined benefit plan gain (loss) reclassified to net income
406

 
(342
)
Total other comprehensive income (loss), before tax
15,947

 
5,776

 
 
 
 
Tax (provision) benefit
 
 
 
Foreign currency translation adjustment
(50
)
 
(352
)
Net unrealized gain (loss) on derivative instruments designated as cash flow hedges
(37
)
 
1,731

Net hedging loss reclassified into net income
(146
)
 
(110
)
Net unrealized gain (loss) on defined benefit plans

 
34

Net defined benefit plan gain (loss) reclassified to net income
(5
)
 
103

Total other comprehensive income (loss) tax benefit
(238
)
 
1,406

 
 
 
 
Net-of-tax amount
 
 
 
Foreign currency translation adjustment
15,016

 
10,106

Net unrealized gain (loss) on derivative instruments designated as cash flow hedges
60

 
(2,782
)
Net hedging loss reclassified into net income
232

 
176

Net unrealized gain (loss) on defined benefit plans

 
(79
)
Net defined benefit plan gain (loss) reclassified to net income
401

 
(239
)
Total other comprehensive income (loss), net of tax
$
15,709

 
$
7,182


The changes in the components of AOCI, net of tax, were as follows:

 
Foreign Currency Translation Adjustments
 
Net Unrealized Gain (Loss) on Derivative Instruments
 
Net Unrealized Gain (Loss) on Nonderivative Instruments
 
Pension Benefit Obligation Adjustments
 
Total
 
(in thousands)
Balances at January 1, 2016
$
(158,009
)
 
$
318

 
$
(14,380
)
 
$
(28,536
)
 
$
(200,607
)
OCI before reclassifications
10,106

 
(2,782
)
 

 
(79
)
 
7,245

Amounts reclassified from AOCI

 
176

 

 
(239
)
 
(63
)
Total other comprehensive income (loss)
10,106


(2,606
)


 
(318
)
 
7,182

Balances at March 31, 2016
$
(147,903
)
 
$
(2,288
)
 
$
(14,380
)
 
$
(28,854
)
 
$
(193,425
)
 
 
 
 
 
 
 
 
 
 
Balances at January 1, 2017
$
(182,986
)
 
$
43

 
$
(14,380
)
 
$
(32,004
)
 
$
(229,327
)
OCI before reclassifications
15,016

 
60

 

 

 
15,076

Amounts reclassified from AOCI

 
232

 

 
401

 
633

Total other comprehensive income (loss)
15,016


292

 

 
401

 
15,709

Balances at March 31, 2017
$
(167,970
)
 
$
335

 
$
(14,380
)
 
$
(31,603
)
 
$
(213,618
)


22


Note 14:    Fair Values of Financial Instruments

The following table presents the fair values of our financial instruments:

 
March 31, 2017
 
December 31, 2016
 
Carrying
Amount
 
Fair
Value
 
Carrying
Amount
 
Fair
Value
 
 
 
(in thousands)
 
 
Assets
 
 
 
 
 
 
 
Cash and cash equivalents
$
187,928

 
$
187,928

 
$
133,565

 
$
133,565

Foreign exchange forwards
137

 
137

 
169

 
169

Interest rate swaps
1,922

 
1,922

 
1,830

 
1,830

Interest rate caps
736

 
736

 
946

 
946

 
 
 
 
 
 
 
 
Liabilities
 
 
 
 
 
 
 
Credit facility
 
 
 
 
 
 
 
USD denominated term loan
$
205,313

 
$
202,913

 
$
208,125

 
$
205,676

Multicurrency revolving line of credit
99,125

 
97,780

 
97,167

 
95,906

Interest rate swaps
509

 
509

 
934

 
934

Foreign exchange forwards
337

 
337

 
449

 
449


The following methods and assumptions were used in estimating fair values:

Cash and cash equivalents: Due to the liquid nature of these instruments, the carrying amount approximates fair value (Level 1).

Credit facility - term loan and multicurrency revolving line of credit: The term loan and revolver are not traded publicly. The fair values, which are valued based upon a hypothetical market participant, are calculated using a discounted cash flow model with Level 2 inputs, including estimates of incremental borrowing rates for debt with similar terms, maturities, and credit profiles. Refer to Note 6 for a further discussion of our debt.

Derivatives: See Note 7 for a description of our methods and assumptions in determining the fair value of our derivatives, which were determined using Level 2 inputs.

The fair values at March 31, 2017 and December 31, 2016 do not reflect subsequent changes in the economy, interest rates, tax rates, and other variables that may affect the determination of fair value.


23


Note 15:    Segment Information

We operate under the Itron brand worldwide and manage and report under three operating segments: Electricity, Gas, and Water. Our Water operating segment includes both our global water and heat solutions. This structure allows each segment to develop its own go-to-market strategy, prioritize its marketing and product development requirements, and focus on its strategic investments. Our sales, marketing, and delivery functions are managed under each segment. Our product development and manufacturing operations are managed on a worldwide basis to promote a global perspective in our operations and processes and yet still maintain alignment with the segments.

We have three GAAP measures of segment performance: revenue, gross profit (margin), and operating income (margin). Our operating segments have distinct products, and, therefore, intersegment revenues are minimal. Certain operating expenses are allocated to the operating segments based upon internally established allocation methodologies. Corporate operating expenses, interest income, interest expense, other income (expense), and income tax provision are not allocated to the segments, nor included in the measure of segment profit or loss. In addition, we allocate only certain production assets and intangible assets to our operating segments. We do not manage the performance of the segments on a balance sheet basis.

Segment Products
Electricity
Standard electricity (electromechanical and electronic) meters; smart metering solutions that include one or several of the following: smart electricity meters; smart electricity communication modules; prepayment systems, including smart key, keypad, and smart card communication technologies; smart systems including handheld, mobile, and fixed network collection technologies; smart network technologies; meter data management software; knowledge application solutions; installation; implementation; and professional services including consulting and analysis.
 
 
Gas
Standard gas meters; smart metering solutions that include one or several of the following: smart gas meters; smart gas communication modules; prepayment systems, including smart key, keypad, and smart card communication technologies; smart systems, including handheld, mobile, and fixed network collection technologies; smart network technologies; meter data management software; knowledge application solutions installation; implementation; and professional services including consulting and analysis.
 
 
Water
Standard water and heat meters; smart metering solutions that include one or several of the following: smart water meters and communication modules; smart heat meters; smart systems including handheld, mobile, and fixed network collection technologies; meter data management software; knowledge application solutions; installation; implementation; and professional services including consulting and analysis.


24


Revenues, gross profit, and operating income associated with our segments were as follows:

 
Three Months Ended March 31,
 
2017
 
2016
 
(in thousands)
Revenues
 
 
 
Electricity
$
238,751

 
$
217,295

Gas
124,211

 
139,256

Water
114,630

 
141,039

Total Company
$
477,592

 
$
497,590

 
 
 
 
Gross profit
 
 
 
Electricity
$
67,192

 
$
64,586

Gas
50,504

 
48,577

Water
39,529

 
50,040

Total Company
$
157,225

 
$
163,203

 
 
 
 
Operating income (loss)
 
 
 
Electricity
$
16,862

 
$
10,632

Gas
21,256

 
16,299

Water
8,735

 
18,076

Corporate unallocated
(16,811
)
 
(21,433
)
Total Company
30,042

 
23,574

Total other income (expense)
(4,981
)
 
(4,164
)
Income before income taxes
$
25,061

 
$
19,410


For the three months ended March 31, 2017 and 2016, one customer represented 18% and 13%, respectively, of total Electricity segment revenues. For the three months ended March 31, 2017 and 2016, no single customer represented more than 10% of the Gas or Water operating segment revenues, or total company revenues.

Revenues by region were as follows:

 
Three Months Ended March 31,
 
2017
 
2016
 
(in thousands)
United States and Canada
$
269,097

 
$
262,037

Europe, Middle East, and Africa
162,815

 
195,710

Other(1)
45,680

 
39,843

Total revenues
$
477,592

 
$
497,590


(1) 
The Other region includes our operations in Latin America and Asia Pacific.

Depreciation and amortization expense associated with our segments was as follows:

 
Three Months Ended March 31,
 
2017
 
2016
 
(in thousands)
Electricity
$
5,311

 
$
7,262

Gas
4,244

 
4,921

Water
3,959

 
4,382

Corporate unallocated
864

 
109

Total Company
$
14,378

 
$
16,674



25


Item 2:    Management's Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis should be read in conjunction with the unaudited condensed consolidated financial statements and notes included in this report and with our Annual Report on Form 10-K for the year ended December 31, 2016, filed with the Securities and Exchange Commission (SEC) on March 1, 2017.

Documents we provide to the SEC are available free of charge under the Investors section of our website at www.itron.com as soon as practicable after they are filed with or furnished to the SEC. In addition, these documents are available at the SEC’s website (http://www.sec.gov), at the SEC’s Headquarters at 100 F Street, NE, Washington, DC 20549, or by calling 1-800-SEC-0330.

Certain Forward-Looking Statements

This document contains forward-looking statements concerning our operations, financial performance, revenues, earnings growth, liquidity, restructuring, and other items. This document reflects our current plans and expectations and is based on information currently available as of the date of this Quarterly Report on Form 10-Q. When we use the words “expect,” “intend,” “anticipate,” “believe,” “plan,” “project,” “estimate,” “future,” “objective,” “may,” “will,” “will continue,” and similar expressions, they are intended to identify forward-looking statements. Forward-looking statements rely on a number of assumptions and estimates. Although we believe that these assumptions and estimates are reasonable, any of these assumptions and estimates could prove to be inaccurate and the forward looking statements based on them could be incorrect and cause our actual results to vary materially from expected results. Our operations involve risks and uncertainties which could materially affect our results of operations and whether the forward looking statements ultimately prove to be correct. These risks and uncertainties include 1) the rate and timing of customer demand for our products, 2) failure to meet performance or delivery milestones in customer contracts, 3) changes in estimated liabilities for product warranties and/or litigation, 4) rescheduling or cancellations of current customer orders and commitments, 5) our dependence on customers' acceptance of new products and their performance, 6) competition, 7) changes in foreign currency exchange rates and interest rates, 8) changes in domestic and international laws and regulations, 9) international business risks, 10) future business combinations, 11) key personnel are critical to the success of our business, 12) our own and our customers' or suppliers' access to and cost of capital, and 13) other factors. For a more complete description of these and other risks, refer to Item 1A: “Risk Factors” included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2016, which was filed with the SEC on March 1, 2017 and our other reports on file with the SEC. We do not undertake any obligation to update or revise any forward looking statement in this document.

Overview

We are a technology company, offering end-to-end solutions to enhance productivity and efficiency, primarily focused on utilities and municipalities around to globe. Our solutions generally include robust industrial grade networks, smart meters, meter data management software, and knowledge application solutions, which bring additional value to the customer. Our professional services help our customers project-manage, install, implement, operate, and maintain their systems. We operate under the Itron brand worldwide and manage and report under three operating segments, Electricity, Gas, and Water. Our Water operating segment includes both our global water and heat solutions. This structure allows each segment to develop its own go-to-market strategy, prioritize its marketing and product development requirements, and focus on its strategic investments. Our sales, marketing, and delivery functions are managed under each segment. Our product development and manufacturing operations are managed on a worldwide basis to promote a global perspective in our operations and processes and yet maintain responsiveness to the market.

We have three measures of segment performance: revenues, gross profit (margin), and operating income (margin). Intersegment revenues are minimal. Certain operating expenses are allocated to the operating segments based upon internally established allocation methodologies. Interest income, interest expense, other income (expense), income tax provision, and certain corporate operating expenses are neither allocated to the segments nor included in the measures of segment performance.

The following discussion includes financial information prepared in accordance with accounting principles generally accepted in the United States (GAAP), as well as certain adjusted or non-GAAP financial measures such as constant currency, free cash flow, non-GAAP operating expenses, non-GAAP operating income, non-GAAP net income, adjusted EBITDA, and non-GAAP diluted earnings per share (EPS). We believe that non-GAAP financial measures, when reviewed in conjunction with GAAP financial measures, can provide more information to assist investors in evaluating current period performance and in assessing future performance. For these reasons, our internal management reporting also includes non-GAAP measures. We strongly encourage investors and shareholders to review our financial statements and publicly-filed reports in their entirety and not to rely on any single financial measure. Non-GAAP measures as presented herein may not be comparable to similarly titled measures used by other companies.


26


In our discussions of the operating results below, we sometimes refer to the impact of foreign currency exchange rate fluctuations, which are references to the differences between the foreign currency exchange rates we use to convert operating results from local currencies into U.S. dollars for reporting purposes. We also use the term constant currency, which represents results adjusted to exclude foreign currency exchange rate impacts. We calculate the constant currency change as the difference between the current period results translated using the current period currency exchange rates and the comparable prior period’s results restated using current period currency exchange rates. We believe the reconciliations of changes in constant currency provide useful supplementary information to investors in light of fluctuations in foreign currency exchange rates.

Refer to the Non-GAAP Measures section below on pages 38-40 for information about these non-GAAP measures and the detailed reconciliation of items that impacted free cash flow, non-GAAP operating expense, non-GAAP operating income, non-GAAP net income, adjusted EBITDA, and non-GAAP diluted EPS in the presented periods.

Total Company Highlights and Unit Shipments

Highlights and significant developments for the three months ended March 31, 2017

Revenues were $477.6 million compared with $497.6 million in the same period last year, a decrease of $20.0 million, or 4%.

Gross margin was 32.9% compared with 32.8% in the same period last year.

Operating expenses decreased $12.4 million, or 9%, compared with the same period last year.

Net income attributable to Itron, Inc. was $15.8 million compared with $10.1 million in the same period last year.

Adjusted EBITDA improved to $45.1 million, an increase of $4.8 million compared with the same period last year.

GAAP diluted EPS increased by $0.14 to $0.40 compared with the same period last year.

Non-GAAP diluted EPS improved by $0.13 to $0.57 compared with the same period last year.


27


The following table summarizes the changes in GAAP and Non-GAAP financial measures:
 
Three Months Ended March 31,
 
 
 
2017
 
2016
 
% Change
 
(in thousands, except margin and per share data)
GAAP
 
 
 
 
 
Revenues
$
477,592

 
$
497,590

 
(4)%
Gross profit
157,225

 
163,203

 
(4)%
Operating expenses
127,183

 
139,629

 
(9)%
Operating income
30,042

 
23,574

 
27%
Other income (expense)
(4,981
)
 
(4,164
)
 
20%
Income tax provision
(9,047
)
 
(8,626
)
 
5%
Net income attributable to Itron, Inc.
15,845

 
10,089

 
57%
 
 
 
 
 
 
Non-GAAP(1)
 
 
 
 
 
Non-GAAP operating expenses
$
119,249

 
$
131,179

 
(9)%
Non-GAAP operating income
37,976

 
32,024

 
19%
Non-GAAP net income attributable to Itron, Inc.
22,186

 
16,831

 
32%
Adjusted EBITDA
45,060

 
40,276

 
12%
 
 
 
 
 
 
GAAP Margins and Earnings Per Share
 
 
 
 
 
Gross margin
32.9
%
 
32.8
%
 
 
Operating margin
6.3
%
 
4.7
%
 
 
Basic EPS
$
0.41

 
$
0.27

 
 
Diluted EPS
0.40

 
0.26

 
 
 
 
 
 
 
 
Non-GAAP Earnings Per Share(1)
 
 
 
 
 
Non-GAAP diluted EPS
$
0.57

 
$
0.44

 
 

(1) 
These measures exclude certain expenses that we do not believe are indicative of our core operating results. See pages 38-40 for information about these non-GAAP measures and reconciliations to the most comparable GAAP measures.

Meter and Module Summary
We classify meters into two categories:
Standard metering – no built-in remote reading communication technology
Smart metering – one-way communication of meter data or two-way communication including remote meter configuration and upgrade (consisting primarily of our OpenWay® technology)

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

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

 
Three Months Ended March 31,
 
2017
 
2016
 
(units in thousands)
Meters
 
 
 
Standard
4,010

 
4,370

Smart
2,440

 
2,190

Total meters
6,450

 
6,560

 
 
 
 
Stand-alone communication modules
 
 
 
Smart
1,400

 
1,460



28


Results of Operations

Revenue and Gross Margin

The actual results and effects of changes in foreign currency exchange rates in revenues and gross profit were as follows:

 
 
 
 
 
 
Effect of Changes in Foreign Currency Exchange Rates
 
Constant Currency Change(1)
 
Total Change
 
 
Three Months Ended March 31,
 
 
 
 
 
2017
 
2016
 
 
 
 
 
(in thousands)
Total Company
 
 
 
 
 
 
 
 
 
 
Revenues
$
477,592

 
$
497,590

 
$
(5,285
)
 
$
(14,713
)
 
$
(19,998
)
 
Gross profit
157,225

 
163,203

 
(2,276
)
 
(3,702
)
 
(5,978
)

(1) 
Constant currency change is a non-GAAP financial measure and represents the total change between periods excluding the effect of changes in foreign currency exchange rates.

Revenues
Revenues decreased $20.0 million, or 4%, for the three months ended March 31, 2017, compared with the same period in 2016. Revenues in the Electricity segment increased by $21.5 million, while revenues decreased in the Gas and Water segments $15.0 million and $26.4 million, respectively, for the three months ended March 31, 2017 compared with the same period in 2016. The total change in revenues for the three months ended March 31, 2017 were unfavorably impacted by $5.3 million due to the effect of changes in foreign currency exchange rates.

No customer represented more than 10% of total revenues for the three months ended March 31, 2017 and 2016. Our 10 largest customers accounted for 33% and 29% of total revenues during the three months ended March 31, 2017 and 2016, respectively.

Gross Margin
Gross margin for the first quarter of 2017 was 32.9%, compared with 32.8% for the same period in 2016. The increased gross margin was primarily driven by improved product mix.

Operating Expenses

The actual results and effects of changes in foreign currency exchange rates in operating expenses were as follows:

 
 
 
 
Effect of Changes in Foreign Currency Exchange Rates
 
Constant Currency Change(1)
 
Total Change
 
 
Three Months Ended March 31,
 
 
 
 
 
2017
 
2016
 
 
 
 
 
(in thousands)
Total Company
 
 
 
 
 
 
 
 
 
 
Sales and marketing
$
41,468

 
$
40,767

 
$
(331
)
 
$
1,032

 
$
701

 
Product development
40,868

 
45,346

 
(614
)
 
(3,864
)
 
(4,478
)
 
General and administrative
37,246

 
45,069

 
549

 
(8,372
)
 
(7,823
)
 
Amortization of intangible assets
4,549

 
6,210

 
(164
)
 
(1,497
)
 
(1,661
)
 
Restructuring
3,052

 
2,237

 
(195
)
 
1,010

 
815

 
Total Operating expenses
$
127,183

 
$
139,629

 
$
(755
)
 
$
(11,691
)
 
$
(12,446
)

(1) 
Constant currency change is a non-GAAP financial measure and represents the total change between periods excluding the effect of changes in foreign currency exchange rates.

Operating expenses decreased $12.4 million for the three months ended March 31, 2017 as compared with the same period in 2016. The decrease was primarily due to operational efficiencies related to restructuring, and lower general and administrative expenses resulting from higher legal and professional services fees incurred in 2016.


29


Other Income (Expense)

The following table shows the components of other income (expense):

 
Three Months Ended March 31,
 
% Change
 
2017
 
2016
 
 
(in thousands)
 
 
Interest income
$
269

 
$
271

 
(1)%
Interest expense
(2,408
)
 
(2,642
)
 
(9)%
Amortization of prepaid debt fees
(266
)
 
(276
)
 
(4)%
Other income (expense), net
(2,576
)
 
(1,517
)
 
70%
Total other income (expense)
$
(4,981
)
 
$
(4,164
)
 
20%

Total other income (expense) for the three months ended March 31, 2017 was a net expense of $5.0 million compared with $4.2 million in the same period in 2016. The change in other income (expense), net, for the three months ended March 31, 2017 as compared with the same period in 2016 was a result of fluctuations in the recognized foreign currency exchange gains and losses due to balances denominated in a currency other than the reporting entity's functional currency.

Income Tax Provision

For the three months ended March 31, 2017, our income tax provision was $9.0 million compared with $8.6 million for the same period in 2016. Our tax rate for the three months ended March 31, 2017 of 36% differed from the federal statutory rate of 35% due to the forecasted mix of earnings in domestic and international jurisdictions, a benefit related to excess tax benefits under ASU 2016-09, and losses experienced in jurisdictions with valuation allowances on deferred tax assets. Our tax rate for the three months ended March 31, 2016 of 44% differed from the federal statutory rate of 35% due to the forecasted mix of earnings in domestic and international jurisdictions and losses experienced in jurisdictions with valuation allowances on deferred tax assets.


30


Operating Segment Results

For a description of our operating segments, refer to Item 1: “Financial Statements Note 15: Segment Information.”

 
Three Months Ended March 31,
 
 
 
 
 
2017

2016
 
% Change
 
 
Segment Revenues
(in thousands)
 
 
 
 
Electricity
$
238,751

 
$
217,295

 
10%
 
 
Gas
124,211

 
139,256

 
(11)%
 
 
Water
114,630

 
141,039

 
(19)%
 
 
Total revenues
$
477,592

 
$
497,590

 
(4)%
 
 
 
 
 
Three Months Ended March 31,
 
2017
 
2016
 
Gross
Profit
 
Gross
Margin
 
Gross
Profit
 
Gross
Margin
Segment Gross Profit and Margin
(in thousands)
 
 
 
(in thousands)
 
 
Electricity
$
67,192

 
28.1%
 
$
64,586

 
29.7%
Gas
50,504

 
40.7%
 
48,577

 
34.9%
Water
39,529

 
34.5%
 
50,040

 
35.5%
Total gross profit and margin
$
157,225

 
32.9%
 
$
163,203

 
32.8%
 
 
 
Three Months Ended
March 31,
 
 
 
 
 
2017

2016
 
% Change
 
 
Segment Operating Expenses
(in thousands)
 
 
 
 
Electricity
$
50,330

 
$
53,954

 
(7)%
 
 
Gas
29,248

 
32,278

 
(9)%
 
 
Water
30,794

 
31,964

 
(4)%
 
 
Corporate unallocated
16,811

 
21,433

 
(22)%
 
 
Total operating expenses
$
127,183

 
$
139,629

 
(9)%
 
 
 
 
 
Three Months Ended March 31,
 
2017
 
2016
 
Operating
Income (Loss)
 
Operating
Margin
 
Operating
Income (Loss)
 
Operating
Margin
Segment Operating Income (Loss) and Operating Margin
(in thousands)
 
 
 
(in thousands)
 
 
Electricity
$
16,862

 
7.1%
 
$
10,632

 
4.9%
Gas
21,256

 
17.1%
 
16,299

 
11.7%
Water
8,735

 
7.6%
 
18,076

 
12.8%
Corporate unallocated
(16,811
)
 
 
 
(21,433
)
 
 
Total Company
$
30,042

 
6.3%
 
$
23,574

 
4.7%


31


Electricity

The effects of changes in foreign currency exchange rates and the constant currency changes in certain Electricity segment financial results were as follows:

 
 
 
 
Effect of Changes in Foreign Currency Exchange Rates
 
Constant Currency Change(1)
 
Total Change
 
 
Three Months Ended March 31,
 
 
 
 
 
2017
 
2016
 
 
 
 
 
(in thousands)
Electricity Segment
 
 
 
 
 
 
 
 
 
 
Revenues
$
238,751

 
$
217,295

 
$
(1,300
)
 
$
22,756

 
$
21,456

 
Gross profit
67,192

 
64,586

 
(1,041
)
 
3,647

 
2,606

 
Operating expenses
50,330

 
53,954

 
(336
)
 
(3,288
)
 
(3,624
)

(1) 
Constant currency change is a non-GAAP financial measure and represents the total change between periods excluding the effect of changes in foreign currency exchange rates.

Revenues - Three months ended March 31, 2017 vs. Three months ended March 31, 2016
Revenues increased $21.5 million, or 10%, for the three months ended March 31, 2017, compared with the same period in 2016. This increase was primarily driven by increased product revenues in our North America and Asia/Pacific regions.

For the three months ended March 31, 2017 and 2016, one customer represented 18% and 13%, respectively, of total Electricity segment revenues.

Gross Margin - Three months ended March 31, 2017 vs. Three months ended March 31, 2016
Gross margin was 28.1% for the three months ended March 31, 2017, compared with 29.7% for the same period in 2016. The 160 basis point decrease over the prior year was primarily the result of unfavorable product mix.

Operating Expenses - Three months ended March 31, 2017 vs. Three months ended March 31, 2016
Operating expenses decreased $3.6 million, or 7%, for the three months ended March 31, 2017, compared with the same period in 2016. Amortization of intangible assets, product development, restructuring, general and administrative, and sales and marketing expenses all decreased in the current period compared with the prior period.

Gas

The effects of changes in foreign currency exchange rates and the constant currency changes in certain Gas segment financial results were as follows:

 
 
 
 
 
 
Effect of Changes in Foreign Currency Exchange Rates
 
Constant Currency Change(1)
 
Total Change
 
 
Three Months Ended March 31,
 
 
 
 
 
2017
 
2016
 
 
 
 
 
(in thousands)
Gas Segment
 
 
 
 
 
 
 
 
 
 
Revenues
$
124,211

 
$
139,256

 
$
(1,394
)
 
$
(13,651
)
 
$
(15,045
)
 
Gross profit
50,504

 
48,577

 
(188
)
 
2,115

 
1,927

 
Operating expenses
29,248

 
32,278

 
(530
)
 
(2,500
)
 
(3,030
)

(1) 
Constant currency change is a non-GAAP financial measure and represents the total change between periods excluding the effect of changes in foreign currency exchange rates.

Revenues - Three months ended March 31, 2017 vs. Three months ended March 31, 2016
Revenues decreased $15.0 million, or 11%, for the three months ended March 31, 2017 compared with the same period in 2016. This was primarily due to decreases in product revenues in our North America and Europe, Middle East, and Africa (EMEA) regions due to the completion of significant projects in the prior year.


32


No single customer represented more than 10% of the Gas operating segment revenues for the three months ended March 31, 2017 and 2016.

Gross Margin - Three months ended March 31, 2017 vs. Three months ended March 31, 2016
Gross margin was 40.7% for the three months ended March 31, 2017, compared with 34.9% for the same period in 2016. The 580 basis point increase was related to favorable product mix in the current period.

Operating Expenses - Three months ended March 31, 2017 vs. Three months ended March 31, 2016
Operating expenses decreased $3.0 million, or 9%, for the three months ended March 31, 2017, compared with the same period in 2016. The decrease was primarily due to reduced product development costs.

Water

The effects of changes in foreign currency exchange rates and the constant currency changes in certain Water segment financial results were as follows:

 
 
 
 
Effect of Changes in Foreign Currency Exchange Rates
 
Constant Currency Change(1)
 
Total Change
 
 
Three Months Ended March 31,
 
 
 
 
 
2017
 
2016
 
 
 
 
 
(in thousands)
Water Segment
 
 
 
 
 
 
 
 
 
 
Revenues
$
114,630

 
$
141,039

 
$
(2,591
)
 
$
(23,818
)
 
$
(26,409
)
 
Gross profit
39,529

 
50,040

 
(1,047
)
 
(9,464
)
 
(10,511
)
 
Operating expenses
30,794

 
31,964

 
(319
)
 
(851
)
 
(1,170
)

(1) 
Constant currency change is a non-GAAP financial measure and represents the total change between periods excluding the effect of changes in foreign currency exchange rates.

Revenues - Three months ended March 31, 2017 vs. Three months ended March 31, 2016
Revenues decreased $26.4 million, or 19%, for the three months ended March 31, 2017, compared with the first quarter of 2016. This was primarily due to lower product revenues in North America and EMEA following the completion of significant projects in 2016.

No single customer represented more than 10% of the Water operating segment revenues for the three months ended March 31, 2017 and 2016.

Gross Margin - Three months ended March 31, 2017 vs. Three months ended March 31, 2016
During the first quarter of 2017 gross margin decreased to 34.5%, compared with 35.5% in 2016. The decrease in gross margin was driven by unfavorable product mix and lower volumes in EMEA and North America.

Operating Expenses - Three months ended March 31, 2017 vs. Three months ended March 31, 2016
Operating expenses for the three months ended March 31, 2017 decreased by $1.2 million, or 4%, compared with the first quarter of 2016. The decrease was primarily due to reduced product development costs, as well as lower amortization of intangible assets and general and administrative expenses.

Corporate unallocated

Corporate Unallocated Expenses - Three months ended March 31, 2017 vs. Three months ended March 31, 2016
Operating expenses not directly associated with an operating segment are classified as “Corporate unallocated.” These expenses decreased by $4.6 million, or 22%, for the three months ended March 31, 2017 compared with the same period in 2016. The decrease was primarily due to lower professional service fees associated with audit, accounting, and legal services as compared with the same period in 2016.

Bookings and Backlog of Orders

Bookings for a reported period represent customer contracts and purchase orders received during the period that have met certain conditions, such as regulatory and/or contractual approval. Total backlog represents committed but undelivered products and

33


services for contracts and purchase orders at period end. Twelve-month backlog represents the portion of total backlog that we estimate will be recognized as revenue over the next 12 months. Backlog is not a complete measure of our future revenues as we also receive significant book-and-ship orders. Bookings and backlog may fluctuate significantly due to the timing of large project awards. In addition, annual or multi-year contracts are subject to rescheduling and cancellation by customers due to the long-term nature of the contracts. Beginning total backlog, plus bookings, minus revenues, will not equal ending total backlog due to miscellaneous contract adjustments, fluctuations in foreign currency exchange rates, and other factors.

Quarter Ended
 
Quarterly
Bookings
 
Ending
Total
Backlog
 
Ending
12-Month
Backlog
 
 
(in millions)
March 31, 2017
 
$
424

 
$
1,605

 
$
819

December 31, 2016
 
653

 
1,652

 
761

September 30, 2016
 
670

 
1,511

 
731

June 30, 2016
 
349

 
1,345

 
688

March 31, 2016
 
394

 
1,504

 
785


Information on bookings by our operating segments is as follows:

Quarter Ended
 
Total Bookings
 
Electricity
 
Gas
 
Water
 
 
(in millions)
March 31, 2017
 
$
424

 
$
174

 
$
125

 
$
125

December 31, 2016
 
653

 
387

 
141

 
125

September 30, 2016
 
670

 
372

 
176

 
122

June 30, 2016
 
349

 
109

 
114

 
126

March 31, 2016
 
394

 
145

 
137

 
112


Financial Condition

Cash Flow Information:

 
Three Months Ended March 31,
 
2017
 
2016
 
(in thousands)
Operating activities
$
63,257

 
$
33,805

Investing activities
(9,200
)
 
(8,233
)
Financing activities
(2,253
)
 
(25,035
)
Effect of exchange rates on cash and cash equivalents
2,559

 
1,060

Increase in cash and cash equivalents
$
54,363

 
$
1,597


Cash and cash equivalents was $187.9 million at March 31, 2017, compared with $133.6 million at December 31, 2016.

Operating activities
Cash provided by operating activities during the three months ended March 31, 2017 was $63.3 million compared with $33.8 million during the same period in 2016. The increase in cash provided was primarily due to changes in operating assets and liabilities. These adjustments include a $46.4 million increased source of cash related to timing of cash receipts. This was partially offset by a $14.5 million increased use of cash related to inventory caused by a modest buildup in North America and $11.1 million for higher variable compensation payments in 2017.

Investing activities
Cash used by investing activities during the three months ended March 31, 2017 was $1.0 million higher compared with the same period in 2016.


34


Financing activities
Net cash used by financing activities during the three months ended March 31, 2017 was $2.3 million, compared with $25.0 million for the same period in 2016. The decreased use of cash by financing activities is primarily a result of repaying $2.7 million of borrowings in the three months ended March 31, 2017, compared with $25.9 million during the same period in 2016.

Effect of exchange rates on cash and cash equivalents
The effect of exchange rates on the cash balances of currencies held in foreign denominations for the three months ended March 31, 2017 was an increase of $2.6 million, compared with an increase of $1.1 million for the same period in 2016.

Free cash flow (Non-GAAP)
To supplement our Consolidated Statements of Cash Flows presented on a GAAP basis, we use the non-GAAP measure of free cash flow to analyze cash flows generated from our operations. The presentation of non-GAAP free cash flow is not meant to be considered in isolation or as an alternative to net income as an indicator of our performance, or as an alternative to cash flows provided by operating activities as a measure of liquidity. We calculate free cash flows, using amounts from our Consolidated Statements of Cash Flows, as follows:

 
Three Months Ended March 31,
 
2017
 
2016
 
(in thousands)
Net cash provided by operating activities
$
63,257

 
$
33,805

Acquisitions of property, plant, and equipment
(9,122
)
 
(8,791
)
Free cash flow
$
54,135

 
$
25,014


Free cash flow increased primarily as a result of higher cash provided by operating activities. See the cash flow discussion of operating activities above.

Off-balance sheet arrangements:

We have no off-balance sheet financing agreements or guarantees as defined by Item 303 of Regulation S-K at March 31, 2017 and December 31, 2016 that we believe are reasonably likely to have a current or future effect on our financial condition, results of operations, or cash flows.

Liquidity and Capital Resources:

Our principal sources of liquidity are cash flows from operations, borrowings, and sales of common stock. Cash flows may fluctuate and are sensitive to many factors including changes in working capital and the timing and magnitude of capital expenditures and payments of debt. Working capital, which represents current assets less current liabilities, was $341.0 million at March 31, 2017, compared with $319.4 million at December 31, 2016.

Borrowings
Our credit facility consists of a $225 million U.S. dollar term loan and a multicurrency revolving line of credit (the revolver) with a principal amount of up to $500 million. The revolver also contains a $250 million letter of credit sub-facility and a $50 million swingline sub-facility (available for immediate cash needs at a higher interest rate). At March 31, 2017, $99.1 million was outstanding under the revolver, and $371.7 million was available for additional borrowings or standby letters of credit. At March 31, 2017, $29.2 million was utilized by outstanding standby letters of credit, resulting in $220.8 million available for additional letters of credit.

For further description of the term loan and the revolver under our 2015 credit facility, refer to Item 1: “Financial Statements, Note 6: Debt.”

For a description of our letters of credit and performance bonds, and the amounts available for additional borrowings or letters of credit under our lines of credit, including the revolver that is part of our credit facility, refer to Item 1: “Financial Statements, Note 11: Commitments and Contingencies.”

Restructuring
We expect pre-tax restructuring charges associated with the 2016 Projects of approximately $68 million, with expected annualized savings of approximately $40 million upon completion.

35



As of March 31, 2017, $47.4 million was accrued for the restructuring projects, of which $31.0 million is expected to be paid over the next 12 months. We also expect to recognize approximately $17 million in future restructuring costs which will result in cash expenditures.

For further details regarding our restructuring activities, refer to Item 1: “Financial Statements, Note 12: Restructuring.”

Stock Repurchases
On February 23, 2017, Itron's Board of Directors authorized the Company to repurchase up to $50 million of our common stock over a 12-month period, beginning February 23, 2017. Any repurchases will be made in the open market or in privately negotiated transactions and in accordance with applicable securities laws. Repurchases are subject to the Company's alternative uses of capital as well as financial, market, and industry conditions. We repurchased no shares of common stock during the three months ended March 31, 2017.

Other Liquidity Considerations
We have tax credits and net operating loss carryforwards in various jurisdictions that are available to reduce cash taxes. However, utilization of tax credits and net operating losses are limited in certain jurisdictions. Based on current projections, we expect to pay, net of refunds, approximately $7 million in state taxes, $22 million in U.S federal taxes, and $13 million in local and foreign taxes during 2017. For a discussion of our tax provision and unrecognized tax benefits, see Item 1: “Financial Statements, Note 10: Income Taxes.”

At March 31, 2017, we are under examination by certain tax authorities for the 2000 to 2015 tax years. The material jurisdictions under examination include, among others, the United States, France, Germany, Italy, Brazil, and the United Kingdom. No material changes have occurred to previously disclosed assessments. We believe we have appropriately accrued for the expected outcome of all tax matters and do not currently anticipate that the ultimate resolution of these examinations will have a material adverse effect on our financial condition, future results of operations, or liquidity.

We have not provided for U.S. deferred taxes related to the cash in certain foreign subsidiaries because our investment is considered permanent in duration. As of March 31, 2017, there was $43.8 million of cash and short-term investments held by certain foreign subsidiaries in which we are permanently reinvested for tax purposes. If this cash were repatriated to fund U.S. operations, additional tax costs may be required. Tax is one of the many factors that we consider in the management of global cash. Included in the determination of the tax costs in repatriating foreign cash into the United States are the amount of earnings and profits in a particular jurisdiction, withholding taxes that would be imposed, and available foreign tax credits. Accordingly, the amount of taxes that we would need to accrue and pay to repatriate foreign cash could vary significantly.

In several of our consolidated international subsidiaries, we have joint venture partners, who are minority shareholders. Although these entities are not wholly-owned by Itron, Inc., we consolidate them because we have a greater than 50% ownership interest and/or because we exercise control over the operations. The noncontrolling interest balance in our Consolidated Balance Sheets represents the proportional share of the equity of the joint venture entities, which is attributable to the minority shareholders. At March 31, 2017, $21.7 million of our consolidated cash balance is held in our joint venture entities. As a result, the minority shareholders of these entities have rights to their proportional share of this cash balance, and there may be limitations on our ability to repatriate cash to the United States from these entities.

General Liquidity Overview
We expect to grow through a combination of internal new product development, licensing technology from and to others, distribution agreements, partnering arrangements, and acquisitions of technology or other companies. We expect these activities to be funded with existing cash, cash flow from operations, borrowings, or the sale of common stock or other securities. We believe existing sources of liquidity will be sufficient to fund our existing operations and obligations for the next 12 months and into the foreseeable future, but offer no assurances. Our liquidity could be affected by the stability of the electricity, gas, and water industries, competitive pressures, changes in estimated liabilities for product warranties and/or litigation, future business combinations, capital market fluctuations, international risks, and other factors described under “Risk Factors” within Item 1A of Part I of our Annual Report on Form 10-K for the fiscal year ended December 31, 2016, which was filed with the SEC on March 1, 2017, as well as “Quantitative and Qualitative Disclosures About Market Risk” within Item 3 of Part I included in this Quarterly Report on Form 10-Q.

Contingencies

Refer to Item 1: “Financial Statements, Note 11: Commitments and Contingencies.”


36


Critical Accounting Estimates and Policies

The preparation of our consolidated financial statements in conformity with GAAP requires us to make estimates and assumptions that affect amounts reported in the consolidated financial statements. Changes in these estimates and assumptions are considered reasonably possible and may have a material effect on our consolidated financial statements and thus actual results could differ from the amounts reported and disclosed herein. Our critical accounting policies that require the use of estimates and assumptions were discussed in detail in the 2016 Annual Report on Form 10-K and have not changed materially from that discussion.


37


Non-GAAP Measures

Our consolidated financial statements are prepared in accordance with GAAP, which we supplement with certain non-GAAP financial information. These non-GAAP measures should not be considered in isolation or as a substitute for the related GAAP measures, and other companies may define such measures differently. We encourage investors to review our financial statements and publicly-filed reports in their entirety and not to rely on any single financial measure. These non-GAAP measures exclude the impact of certain expenses that we do not believe are indicative of our core operating results. We use these non-GAAP financial measures for financial and operational decision making and/or as a means for determining executive compensation. These non-GAAP financial measures facilitate management's internal comparisons to our historical performance as well as comparisons to our competitors' operating results. Our executive compensation plans exclude non-cash charges related to amortization of intangibles and certain discrete cash and non-cash charges such as purchase accounting adjustments, restructuring charges or goodwill impairment charges. We believe that both management and investors benefit from referring to these non-GAAP financial measures in assessing our performance and when planning, forecasting and analyzing future periods. We believe these non-GAAP financial measures are useful to investors because they provide greater transparency with respect to key metrics used by management in its financial and operational decision making and because they are used by our institutional investors and the analyst community to analyze the health of our business.

Non-GAAP operating expenses and non-GAAP operating income – We define non-GAAP operating expenses as operating expenses excluding certain expenses related to the amortization of intangible assets, restructuring, acquisitions and goodwill impairment. We define non-GAAP operating income as operating income excluding the expenses related to the amortization of intangible assets, restructuring, acquisitions and goodwill impairment. We consider these non-GAAP financial measures to be useful metrics for management and investors because they exclude the effect of expenses that are related to previous acquisitions and restructuring projects. By excluding these expenses, we believe that it is easier for management and investors to compare our financial results over multiple periods and analyze trends in our operations. For example, in certain periods expenses related to amortization of intangible assets may decrease, which would improve GAAP operating margins, yet the improvement in GAAP operating margins due to this lower expense is not necessarily reflective of an improvement in our core business. There are some limitations related to the use of non-GAAP operating expenses and non-GAAP operating income versus operating expenses and operating income calculated in accordance with GAAP. We compensate for these limitations by providing specific information about the GAAP amounts excluded from non-GAAP operating expense and non-GAAP operating income and evaluating non-GAAP operating expense and non-GAAP operating income together with GAAP operating expense and GAAP operating income.

Non-GAAP net income and non-GAAP diluted EPS – We define non-GAAP net income as net income attributable to Itron, Inc. excluding the expenses associated with amortization of intangible assets, restructuring, acquisitions, goodwill impairment, amortization of debt placement fees, and the tax effect of excluding these expenses. We define non-GAAP diluted EPS as non-GAAP net income divided by the weighted average shares, on a diluted basis, outstanding during each period. We consider these financial measures to be useful metrics for management and investors for the same reasons that we use non-GAAP operating income. The same limitations described above regarding our use of non-GAAP operating income apply to our use of non-GAAP net income and non-GAAP diluted EPS. We compensate for these limitations by providing specific information regarding the GAAP amounts excluded from these non-GAAP measures and evaluating non-GAAP net income and non-GAAP diluted EPS together with GAAP net income attributable to Itron, Inc. and GAAP diluted EPS.

Adjusted EBITDA – We define adjusted EBITDA as net income (a) minus interest income, (b) plus interest expense, depreciation, amortization of intangible assets, restructuring, acquisition related expense, goodwill impairment and (c) excluding the tax expense or benefit. Management uses adjusted EBITDA as a performance measure for executive compensation. A limitation to using adjusted EBITDA is that it does not represent the total increase or decrease in the cash balance for the period and the measure includes some non-cash items and excludes other non-cash items. Additionally, the items that we exclude in our calculation of adjusted EBITDA may differ from the items that our peer companies exclude when they report their results. We compensate for these limitations by providing a reconciliation of this measure to GAAP net income.

Free cash flow – We define free cash flow as net cash provided by operating activities less cash used for acquisitions of property, plant and equipment. We believe free cash flow provides investors with a relevant measure of liquidity and a useful basis for assessing our ability to fund our operations and repay our debt. The same limitations described above regarding our use of adjusted EBITDA apply to our use of free cash flow. We compensate for these limitations by providing specific information regarding the GAAP amounts and reconciling to free cash flow.

Constant currency – We refer to the impact of foreign currency exchange rate fluctuations in our discussions of financial results, which references the differences between the foreign currency exchange rates used to translate operating results from local currencies into U.S. dollars for financial reporting purposes. We also use the term “constant currency,” which represents financial results adjusted to exclude changes in foreign currency exchange rates as compared with the rates in the comparable prior year

38


period. We calculate the constant currency change as the difference between the current period results and the comparable prior period’s results restated using current period foreign currency exchange rates.

Reconciliation of GAAP Measures to Non-GAAP Measures

The table below reconciles the non-GAAP financial measures of operating expenses, operating income, net income, diluted EPS, adjusted EBITDA, free cash flow, and operating income by segment with the most directly comparable GAAP financial measures.

TOTAL COMPANY RECONCILIATIONS
Three Months Ended March 31,
 
 
 
 
2017
 
2016
 
 
 
 
(in thousands, except per share data)
 
NON-GAAP OPERATING EXPENSES
 
 
 
 
 
GAAP operating expenses
$
127,183

 
$
139,629

 
 
 
Amortization of intangible assets
(4,549
)
 
(6,210
)
 
 
 
Restructuring
(3,052
)
 
(2,237
)
 
 
 
Acquisition-related expenses
(333
)
 
(3
)
 
 
Non-GAAP operating expenses
$
119,249


$
131,179

 
 
 
 
 
 
 
 
NON-GAAP OPERATING INCOME
 
 
 
 
 
GAAP operating income
$
30,042

 
$
23,574

 
 
 
Amortization of intangible assets
4,549

 
6,210

 
 
 
Restructuring
3,052

 
2,237

 
 
 
Acquisition-related expenses
333

 
3

 
 
Non-GAAP operating income
$
37,976


$
32,024

 
 
 
 
 
 
 
 
NON-GAAP NET INCOME & DILUTED EPS
 
 
 
 
 
GAAP net income attributable to Itron, Inc.
$
15,845

 
$
10,089

 
 
 
Amortization of intangible assets
4,549

 
6,210

 
 
 
Amortization of debt placement fees
241

 
247

 
 
 
Restructuring
3,052

 
2,237

 
 
 
Acquisition-related expenses
333

 
3

 
 
 
Income tax effect of non-GAAP adjustments(1)
(1,834
)
 
(1,955
)
 
 
Non-GAAP net income attributable to Itron, Inc.
$
22,186


$
16,831

 
 
 
 
 
 
 
 
 
Non-GAAP diluted EPS
$
0.57

 
$
0.44

 
 
 
 
 
 
 
 
 
Weighted average common shares outstanding - Diluted
39,215

 
38,376

 
 
 
 
 
 
 
 
ADJUSTED EBITDA
 
 
 
 
 
GAAP net income attributable to Itron, Inc.
$
15,845

 
$
10,089

 
 
 
Interest income
(269
)
 
(271
)
 
 
 
Interest expense
2,674

 
2,918

 
 
 
Income tax provision
9,047

 
8,626

 
 
 
Depreciation and amortization
14,378

 
16,674

 
 
 
Restructuring
3,052

 
2,237

 
 
 
Acquisition-related expenses
333

 
3

 
 
Adjusted EBITDA
$
45,060

 
$
40,276

 
 
 
 
 
 
 
 
FREE CASH FLOW
 
 
 
 
 
 
Net cash provided by operating activities
$
63,257

 
$
33,805

 
 
 
Acquisitions of property, plant, and equipment
(9,122
)
 
(8,791
)
 
 
Free Cash Flow
$
54,135

 
$
25,014


(1) 
The income tax effect of non-GAAP adjustments is calculated using the statutory tax rates for the relevant jurisdictions if no valuation allowance exists. If a valuation allowance exists, there is no tax impact to the non-GAAP adjustment.

39


SEGMENT RECONCILIATIONS
Three Months Ended March 31,
 
 
 
 
2017
 
2016
 
 
 
 
(in thousands)
 
NON-GAAP OPERATING INCOME - ELECTRICITY
 
 
 
 
 
Electricity - GAAP operating income
$
16,862

 
$
10,632

 
 
 
Amortization of intangible assets
2,362

 
3,250

 
 
 
Restructuring
(176
)
 
528

 
 
 
Acquisition-related expenses

 
3

 
 
Electricity - Non-GAAP operating income
$
19,048

 
$
14,413

 
 
 
 
 
 
 
 
NON-GAAP OPERATING INCOME - GAS
 
 
 
 
 
Gas - GAAP operating income
$
21,256

 
$
16,299

 
 
 
Amortization of intangible assets
1,277

 
1,619

 
 
 
Restructuring
1,084

 
1,264

 
 
Gas - Non-GAAP operating income
$
23,617

 
$
19,182

 
 
 
 
 
 
 
 
NON-GAAP OPERATING INCOME - WATER
 
 
 
 
 
Water - GAAP operating income
$
8,735

 
$
18,076

 
 
 
Amortization of intangible assets
910

 
1,341

 
 
 
Restructuring
1,018

 
(64
)
 
 
Water - Non-GAAP operating income
$
10,663

 
$
19,353

 
 
 
 
 
 
 
 
NON-GAAP OPERATING INCOME - CORPORATE UNALLOCATED
 
 
 
 
 
Corporate unallocated - GAAP operating loss
$
(16,811
)
 
$
(21,433
)
 
 
 
Restructuring
1,126

 
509

 
 
 
Acquisition-related expenses
333

 

 
 
Corporate unallocated - Non-GAAP operating loss
$
(15,352
)
 
$
(20,924
)

40


Item 3:    Quantitative and Qualitative Disclosures about Market Risk

In the normal course of business, we are exposed to interest rate and foreign currency exchange rate risks that could impact our financial position and results of operations. As part of our risk management strategy, we may use derivative financial instruments to hedge certain foreign currency and interest rate exposures. Our objective is to offset gains and losses resulting from these exposures with losses and gains on the derivative contracts used to hedge them, therefore reducing the impact of volatility on earnings or protecting the fair values of assets and liabilities. We use derivative contracts only to manage existing underlying exposures. Accordingly, we do not use derivative contracts for trading or speculative purposes.

Interest Rate Risk
We are exposed to interest rate risk through our variable rate debt instruments. In October 2015, we entered into an interest rate swap, which is effective from August 31, 2016 to June 23, 2020, and converts $214 million of our LIBOR-based debt from a floating LIBOR interest rate to a fixed interest rate of 1.42% (excluding the applicable margin on the debt). The notional balance will amortize to maturity at the same rate as required minimum payments on our term loan. At March 31, 2017, our LIBOR-based debt balance was $245.3 million.

In November 2015, we entered into three interest rate cap contracts with a total notional amount of $100 million at a cost of $1.7 million. The interest rate cap contracts expire on June 23, 2020 and were entered into in order to limit our interest rate exposure on $100 million of our variable LIBOR-based debt up to 2.00%. In the event LIBOR is higher than 2.00%, we will pay interest at the capped rate of 2.00% with respect to the $100 million notional amount of such agreements. The interest rate cap contracts do not include the effect of the applicable margin.

The table below provides information about our financial instruments that are sensitive to changes in interest rates and the scheduled minimum repayment of principal and the weighted average interest rates at March 31, 2017. Weighted average variable rates in the table are based on implied forward rates in the Reuters U.S. dollar yield curve as of March 31, 2017 and our estimated leverage ratio, which determines our additional interest rate margin at March 31, 2017.

 
2017
 
2018
 
2019
 
2020
 
2021
 
Total
 
Fair Value
 
(in thousands)
Variable Rate Debt
 
 
 
 
 
 
 
 
 
 
 
 
 
Principal: U.S. dollar term loan
$
11,250

 
$
19,688

 
$
22,500

 
$
151,875

 
$

 
$
205,313

 
$
202,913

Average interest rate
2.49
 %
 
2.95
%
 
3.27
%
 
3.40
%
 
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Principal: Multicurrency revolving line of credit
$

 
$

 
$

 
$
99,125

 
$

 
$
99,125

 
$
97,780

Average interest rate
1.75
 %
 
1.94
%
 
2.06
%
 
2.12
%
 
%
 


 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest rate swap on LIBOR-based debt
 
 
 
 
 
 
 
 
 
 
 
 
 
Average interest rate (pay)
1.42
 %
 
1.42
%
 
1.42
%
 
1.42
%
 
%
 
 
 
 
Average interest rate (receive)
1.24
 %
 
1.70
%
 
2.02
%
 
2.16
%
 
%
 
 
 
 
Net/Spread
(0.18
)%
 
0.28
%
 
0.60
%
 
0.74
%
 
%
 
 
 
 

Based on a sensitivity analysis as of March 31, 2017, we estimate that, if market interest rates average one percentage point higher in 2017 than in the table above, our financial results in 2017 would not be materially impacted.

We continually monitor and assess our interest rate risk and may institute additional interest rate swaps or other derivative instruments to manage such risk in the future.

Foreign Currency Exchange Rate Risk
We conduct business in a number of countries. As a result, approximately half of our revenues and operating expenses are denominated in foreign currencies, which expose our account balances to movements in foreign currency exchange rates that could have a material effect on our financial results. Our primary foreign currency exposure relates to non-U.S. dollar denominated transactions in our international subsidiary operations, the most significant of which is the euro. Revenues denominated in functional currencies other than the U.S. dollar were 47% of total revenues for the three months ended March 31, 2017 compared with 50% for the same respective period in 2016.

We are also exposed to foreign exchange risk when we enter into non-functional currency transactions, both intercompany and third party. At each period-end, non-functional currency monetary assets and liabilities are revalued with the change recognized

41


to other income and expense. We enter into monthly foreign exchange forward contracts, which are not designated for hedge accounting, with the intent to reduce earnings volatility associated with currency exposures. As of March 31, 2017, a total of 49 contracts were offsetting our exposures from the euro, Saudi Riyal, Indian Rupee, Chinese Yuan, Indonesian Rupiah, and various other currencies, with notional amounts ranging from $167,000 to $45.3 million. Based on a sensitivity analysis as of March 31, 2017, we estimate that, if foreign currency exchange rates average ten percentage points higher in 2017 for these financial instruments, our financial results in 2017 would not be materially impacted.

In future periods, we may use additional derivative contracts to protect against foreign currency exchange rate risks.

Item 4:    Controls and Procedures

Evaluation of disclosure controls and procedures

An evaluation was performed under the supervision and with the participation of our Company’s management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e)) under the Securities Exchange Act of 1934 as amended. Based on that evaluation, the Company’s management, including the Chief Executive Officer and Chief Financial Officer, concluded that as of March 31, 2017, the Company’s disclosure controls and procedures were effective to ensure the information required to be disclosed by an issuer in the reports that it files or submits under the Securities Exchange Act of 1934 is accumulated and communicated to our management, including our principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure. There are inherent limitations to the effectiveness of any system of disclosure controls and procedures, including the possibility of human error and the circumvention or overriding of the controls and procedures. Accordingly, even effective disclosure controls and procedures can only provide reasonable assurance of achieving their control objectives.

Changes in internal controls over financial reporting

In the ordinary course of business, we review our system of internal control over financial reporting and make changes to our applications and processes to improve such controls and increase efficiency, while ensuring that we maintain an effective internal control environment. Changes may include such activities as implementing new, more efficient applications and automating manual processes. We are currently upgrading our global enterprise resource software applications at certain of our locations outside of the United States. We will continue to upgrade our financial applications in stages, and we believe the related changes to processes and internal controls will allow us to be more efficient and further enhance our internal control over financial reporting.

Additionally, we have established a shared services center in Europe, and we are currently transitioning certain finance and accounting activities to the shared services center in a staged approach. The transition to shared services is ongoing, and we believe the related changes to processes and internal control will allow us to be more efficient and further enhance our internal control over financial reporting.

Except for these changes, there have been no other changes in our internal control over financial reporting during the three months ended March 31, 2017 that materially affected, or are reasonably likely to materially affect, internal control over financial reporting.

42


PART II: OTHER INFORMATION


Item 1:
Legal Proceedings
Refer to Item 1: “Financial Statements, Note 11: Commitments and Contingencies.”

Item 1A:
Risk Factors
There were no material changes to risk factors during the first quarter of 2017 from those previously disclosed in Item 1A: “Risk Factors” of Part I of our Annual Report on Form 10-K for the fiscal year ended December 31, 2016, which was filed with the SEC on March 1, 2017.

Item 2:
Unregistered Sales of Equity Securities and Use of Proceeds

(a) Not applicable.

(b) Not applicable.

(c) Not applicable.

Item 5:
Other Information

(a) No information was required to be disclosed in a report on Form 8-K during the first quarter of 2017 that was not reported.

(b) Not applicable.


43


Item 6:
Exhibits
 

 
 
 
Exhibit
Number
 
Description of Exhibits
 
 
10.1*
 
Form of Stock Option Grant Notice and Agreement for use in connection with both incentive and non-qualified stock options granted under Itron, Inc.'s Amended and Restated 2010 Stock Incentive Plan. (filed with this report)
 
 
 
10.2*
 
Form of Long-Term Performance RSU Award Notice and Agreement for U.S. Participants for use in connection with Itron, Inc.'s Amended and Restated 2010 Stock Incentive Plan. (filed with this report)
 
 
 
10.3*
 
Form of RSU Award Notice and Agreement for all Participants for use in connection with Itron, Inc.'s Amended and Restated 2010 Stock Incentive Plan. (filed with this report)
 
 
 
12.1
 
Computation of Ratio of Earnings to Fixed Charges. (filed with this report)
 
 
 
31.1
 
Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
 
 
31.2
 
Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
 
 
32.1
 
Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 
 
101.INS
 
XBRL Instance Document.
 
 
101.SCH
 
XBRL Taxonomy Extension Schema.
 
 
101.CAL
 
XBRL Taxonomy Extension Calculation Linkbase.
 
 
101.DEF
 
XBRL Taxonomy Extension Definition Linkbase.
 
 
 
101.LAB
 
XBRL Taxonomy Extension Label Linkbase.
 
 
101.PRE
 
XBRL Taxonomy Extension Presentation Linkbase.
 
 
 
*
 
Management contract or compensatory plan arrangement.

44


SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 
 
ITRON, INC.
 
 
 
 
May 3, 2017
 
By:
/s/ ROBERT H.A. FARROW
Date
 
 
Robert H.A. Farrow
 
 
 
Interim Chief Financial Officer

45