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spk05: Good day, everyone, and welcome to the ITRON Incorporated Q2 2021 Earnings Conference Call. Today's conference is being recorded. For opening remarks, I'd like to turn the call over to Mr. Ken Gianella.
spk09: Please go ahead, sir.
spk01: Thank you, Operator. Good morning and welcome to ITRON's second quarter 2021 Earnings Conference Call. We issued a press release earlier today announcing our results. The press release includes replay information about today's call. A presentation to accompany our remarks on this call is also available through the webcast and on our corporate website under the Investor Relations tab. On the call today, we have Tom Dietrich, ITRON's President and Chief Executive Officer, and Joan Hooper, Senior Vice President and Chief Financial Officer. Following our prepared remarks, we will open the call to take questions using the process the operator described. Before I turn the call over to Tom, Let me remind you of our non-GAAP financial presentation and our safe harbor statement. Our earnings release and financial presentation include non-GAAP financial information that we believe enhances the overall understanding of our current and future performance. Reconciliations of differences between GAAP and non-GAAP financial measures are available in our earnings release and on our investor relations website. We will be making statements during this call that are forward-looking. These statements are based on our current expectations and assumptions that are subject to risks and uncertainties. Actual results could differ materially from these expectations because of factors that were presented in today's earnings release, in the comments made during this conference call, and in the risk factor section of our Form 10-K and other reports and filings with the Securities and Exchange Commission. In addition, due to the fluid nature of COVID-19 pandemic, Company estimates regarding the impact of COVID-19 on current or forward-looking statements are made in a good-faith attempt to provide appropriate insight to our current and future operating and financial environment. Materials discussed today, August 5, 2021, may materially change, and we do not undertake any duty to update any of our forward-looking statements. Now, please turn to page four in the presentation, and I'll turn the call over to our CEO, Tom Dietrich.
spk07: Thank you, Ken. Good morning, and thank you for joining us. You will hear details from Joan shortly, but to summarize our second quarter performance, revenue was $489 million, adjusted EBITDA was $36 million, non-GAAP earnings per share was 28 cents, and free cash flow was $64 million. Our operational results were below our expectations primarily due to component shortages that increased through the quarter. These constraints reduced revenue within the quarter by approximately $40 to $50 million. While our second quarter revenue level was disappointing, the demand outlook started to recover during the quarter as anticipated with numerous customer projects beginning to move forward again. Barring any negative impacts from COVID-19 resurgence, we expect the demand to continue to recover into the second half of the year and into 2022. This increased confidence is reflected in our latest bookings and backlogs numbers. Turning to slide five, for the third consecutive quarter, we saw very strong customer activity for our network solutions and outcome segments. We achieved a book-to-bill ratio of over 1.2 to 1, driven by bookings of approximately $596 million, allowing a new record total backlog of approximately $3.5 billion, and a 12-month backlog of approximately $1.4 billion. We are pleased with the continued increase in the 12-month backlog, but note it remains approximately $100 million below the view we had pre-pandemic. This quarter's bookings performance is highlighted by an agreement with National Grid to upgrade their gas communication solutions in New York and New England, an expansion of our AMI footprint in Asia Pacific with Singapore Power, a complete solution for AMI, grid operations, data management with Gainesville, Florida, and importantly, the continued expansion of our standing partnerships with Excel in Colorado and an extension of our SAS agreement with Con Ed in New York. We are encouraged by the bookings achieved over the past few quarters and see our demand rebounding across the customer base and the globe. However, we do anticipate component constraints to persist through the second half of the year and likely into 2022. Turning to slide six, I would like to have a brief discussion on the component constraints that impacted the quarter and the temporal effect that it is having on our operations and near-term outlook. For the past few quarters, we have been navigating through macroeconomic-driven supply challenges from supplier factory disruptions, logistics constraints, raw material and component shortages stemming from the pandemic. Up until the second quarter, we saw minimal impact from the component supply constraints as our mitigation efforts served us well. This includes the consumption of buffer inventory on key components, partnering with our customers to increase the visibility of their needs beyond our normal lead times, increasing our order coverage for key components, driving alternative sources, and targeting low value, low margin products for discontinuation. Entering the quarter, we saw elevated supply and cost pressures on steel, resins, logistics, and in particular, semiconductors. During the quarter, the revenue-related hotspots largely fell away on all except for semiconductors. In the semiconductor space, specifically for microcontrollers and matching analog components, we had significant and unexpected delays in delivery, coupled with limited delivery commitments. The components in focus here are, in general, commonly used industrial and automotive applications that are experiencing industry-wide allocations. These heavily constrained semiconductors were the primary driver for the unfulfilled demand within the quarter and predominantly impacted our network solution segment performance. Our team is continuing to aggressively mitigate constraints by working with the executive leadership teams at the handful of semiconductor suppliers associated with these bottlenecks to maximize our allocation and alternatives. We are also working with customers to align project schedules as the delayed demand is not lost but shifted into future periods. This situation remains fluid and is expected to continue to be volatile for ITRON and across multiple industries in the near term. With that, let me hand off to Joan to discuss our second quarter results.
spk06: Thank you, Tom. I will cover the second quarter results and then provide an update on our outlook for the full year. As Tom mentioned, our Q2 results were lower than expected, primarily due to component constraints. As anticipated, we saw customer demand begin to recover in the second quarter, but due to the part shortages and delayed deliveries, we were unable to fulfill a portion of that demand. Turning to slide seven, which is a summary of the Q2 consolidated gap results, Second quarter revenue of $489 million decreased 4% versus last year, or 7% in constant currency. The year-over-year decline was primarily due to component constraints limiting our ability to meet customer demand. We estimate that the component shortage negatively impacted Q2 revenue by approximately $40 to $50 million, with the largest impact being felt in the network solution segment. Gross margin for the quarter was 30.6%, 340 basis points higher than last year due to favorable product mix and lower manufacturing inefficiencies related to COVID-19. This was partially offset by higher supply chain costs. The gap net loss of $33 million or negative 73 cents per diluted share compared with a net loss of $63 million or negative $1.56 per diluted share in the prior year. The net loss in Q2 2021 was primarily due to changes concerning the 2020 divestiture in Latin America. Regarding non-GAAP metrics on slide eight, non-GAAP operating income was 27 million. Adjusted EBITDA was 36 million or 7.4% of revenue. Non-GAAP net income for the quarter was 13 million or 28 cents per diluted share. Looking at the revenue by business segment on slide 9, device solutions revenue was $163 million, a $24 million or 19% year-over-year increase on a constant currency basis. The increase was due to a favorable year-over-year compare with COVID-related factory closures impacting the prior year, partially offset by the impact of component constraints this year. Network solutions revenue was $265 million, a 63 million or 19% decline year-over-year in constant currency. The decrease was due to the impact of component constraints limiting our ability to meet customer demand, as well as the delayed timing of customer projects. Revenue in the outcomes segment was $61 million, a 4 million or 6% increase in constant currency from 2020. The increase was driven by higher managed and professional services. And lastly, foreign currency changes resulted in 16 million higher revenue versus the prior year. Moving to the non-GAAP year-over-year EPS bridge on slide 10, our Q2 non-GAAP EPS was 28 cents per diluted share, up 25 cents from the prior year. The drivers of the year-over-year improvement were net operating performance, which had a positive 3 cent per share impact versus Q2 of 2020. Improved operating performance was driven by better product mix and improved manufacturing efficiencies. This was partially offset by the negative impact related to component shortages. Lower interest expense resulted in a 4-cent increase in EPS year-over-year. A lower non-GAAP tax rate increased EPS by 22 cents versus Q2 of 2020. And finally, changes in foreign currency and a higher share count resulted in a 4-cent per share decrease year-over-year. Turning to slides 11 through 13, I'll discuss the Q2 results by business segment compared with the prior year. Device Solutions revenue was $163 million with gross margin of 19% and operating margin of 12%. Gross margin increased 940 basis points year-over-year, primarily due to reduced manufacturing inefficiencies related to COVID-19. Operating margin increased 13 points due to the higher gross margin and lower operating expenses. Network Solutions revenue was $265 million with gross margin of 36% and operating margin of 24%. Gross margin increased 280 basis points year-over-year due to favorable product mix and reduced manufacturing inefficiencies related to COVID-19. Operating margin increased 60 basis points year-over-year due to higher gross margin partially offset by higher operating expenses. Outcomes revenue was 61 million with gross margin of 38%. Gross margin increased 560 basis points year-over-year due to favorable solution mix, as well as cost efficiencies. Operating margin was 20%, 390 basis points higher than last year, with the gross profit improvement partially offset by higher investments. Turning to slide 14, I'll cover liquidity and debt. As discussed on our last call, we completed a convertible bond offering and an equity raise in the first quarter, which enabled us to accelerate our pay down of debt and, in turn, strengthen our balance sheet. While the transaction was complete in the first quarter, some of the delevering didn't occur until Q2, including the repayment of the 5% senior notes which with the call premium totaled $410 million. Free cash flow was 64 million in the second quarter versus a negative 10 million a year ago. The strong cash flow improvement was primarily driven by lower interest and CapEx and better working capital, some of which is timing. Cash and equivalents at the end of the second quarter were 207 million. Total gross debt was 491 million and net debt was 284 million at the end of the second quarter. Net leverage was 1.6 times at the end of Q2 2021, down from 3.8 times at the end of Q2 2020. Now turning to our full year 2021 outlook on slide 15. Our full year outlook for customer demand continues to show recovery from COVID-19 and is in line with our original guidance expectations, albeit at the low end of the range. However, as you just heard from Tom, we expect the component constraints that we experienced in Q2 will continue through the second half of the year. We estimate the component shortages will result in a lower revenue of approximately 150 to $200 million for the full year, including the 40 to 50 million we experienced in Q2. Factoring in these component constraints results in a revised full-year 2021 revenue range of $2.05 to $2.15 billion versus the $2.23 to $2.33 billion we provided in February. We expect to recover most of this delayed revenue beyond 2021 when the component supply chain recovers and allows us to fulfill this demand. The earnings will be negatively impacted by these component shortages given the fall through of lower revenue as well as higher supply chain related costs. Our estimate of this impact is a reduction of pre-tax income of approximately $65 to $95 million. This results in a non-GAAP EPS outlook of $1 to $1.50 per share versus previous guidance of $2.30 to $2.70 per share. This updated outlook assumes approximately 44.7 million average shares outstanding for the full year 2021. We are assuming a Euro to US dollar foreign exchange rate of 1.2 in the second half of the year, a full year non-GAAP effective tax rate between 32 and 34%, and full year interest expense of approximately 11 million. In summary, we were pleased to see customer demand begin to recover in Q2, and our second half demand outlook continues to reflect that recovery. Q2 was another strong quarter for new bookings, which signals future demand growth. However, due to the component constraints and the resulting negative impact it will have on our 2021 performance, our full-year outlook for revenue and earnings is now lower than the original guidance. The operational projects we have underway to reduce our fixed cost will continue as we navigate these near-term headwinds. and we remain confident in our long-term financial model targets. Now I'll turn the call back to Tom.
spk07: Thank you, Joan. We remain positive on the overall outlook for the company as we work through the near-term component constraints. With our strong balance sheet, record backlog, and increased strategic flexibility, we are in a great position to drive our business forward. We have grown our distributed intelligence capable endpoints to over 3 million cumulatively, delivering on our strategy to expand the footprint of our advanced multi-purpose, multi-application network. During the second quarter, we saw continued year-over-year growth in our outcome segment, demonstrating that once we install a network, we can then expand our value to our customers with our outcome solutions. We continue to execute on our asset light strategy, reducing our fixed costs and becoming nimbler in this dynamic environment. While these are just a few examples of the progress we have made so far in 2021, it is also why we remain positive on the efforts that will continue to create value as we execute our long-term strategy. Thank you for joining today. Operator, please open the line for some questions.
spk05: Thank you. If you would like to ask a question, please signal by pressing star 1 on your telephone keypad. If you're using a speakerphone, please make sure your mute function is turned off to allow your signal to reach our equipment. Again, press star 1 to ask a question.
spk09: And our first question today comes from Tommy Moll with Stevens. Thanks for taking my questions. Good morning. Can you hear me? We can now, Tommy. Yes, we can. Good morning.
spk12: Yeah. Tom, I wanted to start just if you could address in terms of the disruptions, has there been any major contract cancellation or does all this just push to the right? And then anecdotally, you know, last year you had pandemic related delays, now substantial component related delays. It feels like on the back end of this, this spring is going to be pretty well compressed and ready to pop, but are your customers growing? How impatient are your customers at this point?
spk07: Very good, Tommy. Good morning. Tom here. I would start by saying no contract cancellations at all. We have been pleased with the response of the customers in terms of working with us on the making sure that project schedules are aligned appropriately so that the demand that is unfulfilled in the second quarter and the stuff that we were thinking about for the back half of the year, that is rolling forward into future periods. So not lost, but delayed in time based on the nature of the contracts and the customer relationships we have. Clearly, customers are interested in improving the reliability and resiliency of their networks, which is the point of the investment and where our technology is really helping them shore up their business in that regard or doing the various automation projects that are out there. That's where we see desire on the part of the customers to implement those technologies as quick as possible. appropriate level of impatience, and we're very aligned on that from our standpoint. We very much want to fulfill those agreements as quickly as possible based on the supply of the components themselves. So that's how I would characterize it. Good customer relationships, and they remain strong. The demand is indeed pushed out into future periods.
spk12: And Tom, as a follow-up, any any impact from these component delays to your M&A appetite, and could you characterize the pipeline there and refresh us on what the priorities might be?
spk07: Sure. The current environment doesn't change our strategy nor our long-term financial model that we've talked about. Clearly, the pandemic has pushed it out a little bit, first demand and now supply, but all sort of related to the that the nature of the pandemic itself, no change in our financial model, no change in our desire to continue to grow our business organically and inorganically. On the organic front, our interest remains high in solutions that really will target where the market is going. So more resiliency, reliability, automation, cybersecurity, better ability to incorporate renewables and safety applications into the energy and water space that's out there. We certainly continue to look at that space actively. I would say most likely in the outcome space is where you would see us make an inorganic move.
spk09: Thank you, Tom. I'll turn it back. Thanks, Tommy.
spk05: And our next question will come from Jeff Osborne with Coward & Company.
spk04: Good morning. I had a couple on my end. I was wondering on the component side if using contract manufacturing would have mitigated some of these issues. I know you've got both your own facilities like in South Carolina, but also third parties. Are you finding that relative to auto, maybe you're having a tougher time procuring direct, but maybe your contract manufacturing is having less of an issue? I'm just curious if this changes your manufacturing footprint longer term.
spk07: No change in our manufacturing strategy whatsoever. The electronics components that are constrained today in the semiconductor space, specifically things like microcontrollers and all of the associated analog components that sit around it on the board itself, that is work we largely do in partnership with the contract manufacturers. We clearly are leveraging their spend power as well as our direct relationships with suppliers to maximize the supply. Certainly, that is an area where the components that are in play are largely very commonly used, and they are constrained across the chain itself. So I definitely believe that our relationships with contract manufacturing is helping us in this area. regard, but it certainly doesn't insulate us from the macroeconomic conditions that led to the shortage. Based on our business environment, though, the demand that we are not fulfilling in this quarter rolls forward, so it isn't lost. It's a timing issue for us.
spk04: Got it. Just a couple other quick ones. Is COVID coming back in Southeast Asia, in particular Malaysia, making the situation worse in the second half, or are you not as exposed to that region?
spk07: From a demand perspective or thinking about it from a revenue side, yeah, not an issue. That's where I was going. So not an issue on revenue. Certainly, it is something to consider on the supply side of things. We are not directly exposed in terms of where the hotspots are today from a manufacturing environment, but I do look through the chain. There are a lot of raw materials and raw components that come out of that part of the world that feed the broader ecosystem. So they are suppliers to semiconductor suppliers, as an example, that are often in that part of the world. And that is something that will need to be watched closely. All of that is absolutely considered in the guidance that we have provided.
spk04: Got it. Two other quick ones. You had some nice wins in the quarter. Can you just articulate what the RFP pipeline and quoting activity looks like for the second half? And then just another quick one, is the board have any outstanding capability on a buyback plan in place?
spk07: So, I'll take the first, and Joan can address the second. We definitely continue to see very strong interest on the part of our customers for the types of technology we provide. So, grid resiliency and reliability is high on everyone's mind. Safety in the gas space is important, and security and automation is very important in the water vertical. So each and every one of the verticals that we serve, the pipeline remains strong and we're very optimistic about where things stand. Bookings in the quarter, in second quarter, were very strong. We have another record total backlog in terms of where we are heading so that the future is bright and in terms of the need for our customers. The wins that we highlighted really revolve around those basic functions and technologies, and we're excited to provide it.
spk06: And on the question, there is no current board authorization for any stock buyback.
spk09: Got it. Thanks, Joe. And we'll hear next from Paul Costner with J.P.
spk05: Morgan.
spk11: Yeah, good morning. This is Mark Strauss. Thanks for taking our questions. Just to follow up on Jeff's question, just digging a little bit deeper there. To the extent that you're aware, do your direct competitors, are they using the same semiconductor components, potentially using different suppliers? It sounds like your booking activity remains pretty strong, but I'm just curious if you think there's a risk of some kind of near-term market share shifts here.
spk07: In terms of the supplier base, I don't know that I've got any insight that is significant in terms of supply base. I would say that, in general, the kind of components that are really constrained today are very commonly used across the industry in industrial and automotive applications. So I would suspect, given the consolidation in the semiconductor industry, we are probably all in discussions with the same sets of suppliers across the board. I don't see any particular share move. The long-term agreements that we have are certainly important to us in terms of the engagements we have, and when we contract with a customer for a long-term agreement, it usually takes a couple of years to implement the project, and then a long-term agreement SaaS and service agreement follows after. I don't detect any particular movement in terms of share across the board. We remain very strong in a number of the verticals that we play in, and we're pleased to work with the customers on that front.
spk11: Okay. Thanks, Tom. And then just a quick follow-up. Can you just talk about some of the, you know, give a bit more color on the mitigation efforts within the semiconductor specifically? Are you Are you looking to add additional suppliers? Are you locking into longer-term supply agreements? What can be done there near term?
spk07: I would say that the standard types of things that you mentioned are alive and well, and we work with the suppliers on every day. So, certainly exploring alternatives, whether they are another supplier or they are specification changes to common parts, that's something we have been working on. we'll continue to do so. We had undertaken a number of multi-sourcing efforts over the last couple of years, and those have indeed been a benefit. But again, given the current state of the macroeconomics, I think it's a wider set of shortages than any one particular supplier. Long-term agreements with suppliers to have firm forecasts and purchase orders out there is part of it, working closely with the customers to align on their longer-term demand outlook so that we can provide better information over a longer time horizon to the suppliers themselves is another. All of those are efforts that we will continue to work. In the short run, the most important part is maintaining the current continuity of supply and the allocations as components are really, really tight.
spk09: Got it. Thank you very much. And our next question today comes from Ben Callow with RW Baird.
spk00: Hey, Tom. Hey, Joe and Ken. Thanks for taking my question. Maybe could we talk about just the cadence of the shortage, you know, as you relate it to the auto industry? Just because I think that there was like last year, there wasn't as much shortage when autos were talking about it. And so was there a lag or am I just not remembering correctly? It's my first question. The second question is maybe just the differences on your business. You talked about the competitive environment, and I thank you for that. But just some of the differences where you see more headwinds. Is it the Europe exposure or the factory footprint there or both? And then the third question is just on costs. What kind of levers can you pull? um, you know, just because you said that the visibility that, you know, it's kind of could stretch into 2022. And so, uh, what are you doing on the cost front? Thank you very much.
spk07: Very good. So, uh, a number of things there. Let me see if I can't, uh, cover them all. So on the, the, the shortage side of things, uh, we started to see, uh, uh, lead time start to stretch out in, um, I'll, I'll say the late, uh, 2020, we, we reacted, uh, appropriately to that. And, uh, placed orders and actually came into the year with some good buffer inventory. During the first quarter and most of second, we consumed that buffer inventory. And sadly, we ended up with shortages really starting to materialize in the second half of Q2. And that is the position that we are in today. The shortage has obviously been well publicized and discussed in the broader press. It's hit and been present in a number of different industries. Otto clearly got a fair amount of discussion on it, given the nature of their manufacturing footprint. On our side of things, when it comes to the regional differences, the European market, while a bit behind North America in terms of the pace of the recovery on the demand side post-pandemic. It is up nicely year over year. You could use the devices business as a pretty good proxy where we were up 25 plus percent from second quarter last year to second quarter this year. So the demand on the European side is coming back significantly. nicely compared to 2020, albeit a little bit behind the pace of recovery in North America. Where the revenue shortfall and the unfulfilled demand really happened in Q2 and what we have baked into our guidance is really a bit more on the electronic side, which means that the networking business The networking business has very, very strong backlog. Network and outcomes relates to about three quarters plus of our total backlog. So we feel good about the trajectory of that business over time. We just got to be able to fulfill the demand and work with our customers to implement the projects. On the cost side of things, clearly we will continue to work aggressively and on mitigating the component supply. Getting that revenue back on the board is the best medicine for sure for us. We'll continue to be careful in terms of operating expenses. We will continue to work to make sure that our factories are operating as efficiently as they can given that the revenue constraints themselves. All of the projects for ongoing asset light work and the restructuring types of things that we announced back in 2020 continue on at pace with no change in our overall plans there. That will be part of the longer-term portfolio. We also, as a final point, use this current situation to continue to make the portfolio changes that we are have been working on for quite some time now as we phase out an end-of-life certain products that are lower margin for us overall. So that would be a quick snapshot or perhaps a lengthy snapshot of the overall game plan and how we go from here. So I hope I've hit all your points, Ben.
spk00: No, you got them all.
spk07: Thank you, Tom.
spk00: Very good. Thank you.
spk05: And we'll hear next from Pierce Hammond with Piper Sandler.
spk03: Yeah, thank you for taking my questions. Just to clarify, in the prepared remarks, were you saying that, like, the specialty steel and the resins and the shipping, those are getting better, but really from here it's more on the semiconductors? Just want to clarify that.
spk07: Correct. The exact context, just to repeat it again, on the revenue side, meaning where it is gating our shipments, it is down to semiconductors as the only material delay. On the other areas that we've seen hotspots earlier in the year, they are no longer gating us on the revenue side. We continue to work to monitor that, make sure that nothing pops up again, but that's not... a high concern for us today. That said, we do see cost pressures across the board. So the environment is definitely remaining under pressure from an overall cost across the board, meaning steel and resin and logistics as well as semiconductors. And that's something we work hard to mitigate through productivity means to make sure that it doesn't impact our bottom line.
spk03: Thank you for that. And then in the press release, you had said it would impact the second half of the year and then also impact into 22. So I'm just curious, how far do you expect this to kind of bleed into 22? Is it more first quarter or first half or longer than that?
spk07: Yeah, very difficult to put a fine point on it. Generally, given my experience on the semiconductor side as well as on the equipment side, These things tend to run a couple of quarters when they start to happen until things come back into balance again. We don't have great visibility as to what it would look like. We want to be forthcoming that it may not be done by the end of the year, but no specific guidance that we've placed for 2022 at this time.
spk03: And then, thank you, and then last one for me, the Biden infrastructure bill. I'm just curious, how do you see ITRON being a beneficiary if that bill gets passed?
spk07: As you know, the process continues on in D.C., the bipartisan process. package that's out there looks to be making its way through. It's working through a long series of amendments right now. If you look inside of that $1.1 approximate trillion package, there are provisions in there for energy, water, and for I'll call them grid EV-related electric vehicle types of preparedness provisions. There are a couple hundred million dollars approximately spread across those, a couple hundred billion, sorry, dollars spread across those various provisions. In particular, in the electricity space, there is funding for smart grid matching grants, which is very similar to the types of programs that happened back in the 08, 09 kind of timeframe, which reads directly on the types of products and services we do.
spk09: Thank you very much. And our next question comes from Noah K. with Oppenheimer.
spk10: Good morning. Thanks for taking the questions. You know, in the past, I think, when we've seen some guidance revisions, sometimes we've gotten a bridge from, you know, prior to the current. You do have a couple of assumptions you've given us on the guided slide, but I wonder if it would be possible to ask for, you know, something like a bridge just to help us understand the moving parts here include lower networks and that's a relatively high margin business. So understand it'll be margin dilutive. You have some other levers to potentially offset or mitigate. So just help us maybe understand how you think of some of the moving parts here within the revised guidance.
spk06: Yeah, let me take that. So if you look at the, if I think about the prior guidance to the new guidance, let me just take it at the midpoint just to make the math simple. So the midpoint of the revenue guidance is about $180 million down. As we discussed, it's really all supply chain component related constraints. So that range of $150 to $180 to $200, roughly $180 in between. The other comments I made in the script were that pre-tax income would be down in a range of $65 to $95 million. So call that kind of $80 million at the midpoint. So the flow through to income is quite high. much higher than our average gross margin in the company. And that's for really three reasons. One is the component impact is primarily in our networks solution segment. And so that, by definition, has higher gross margins than our overall company level. And it is some high margin business that is getting pushed out right now. So that's kind of number one. Two is, as Tom mentioned, there is cost pressure on components, freight, et cetera. So that is factored in. revised guidance as well. And then a third issue is there's factory overhead absorption issues. So all of those end up with a higher flow through to earnings from the revenue shortfall. And again, this shortfall we expect to recover in the future, but it is quite heavy fall through right now. So think that really the majority of the fall through that we provided in the EPS is margin related fall through. So if you looked at What we were expecting for the year when we started out, you know, it was basically to get back to gross margins at the pre-COVID-19 level, call it 30%. All of this probably costs us a point or so. So that's really what that is. Obviously, we continue to try to control OPEX as best we can. We really haven't resumed kind of travel and things like that across the company. So OPEX spending controls continue to be in place. But in general, most of this lowering of the EPS is margin related to the component shortage.
spk10: Joan, that's very helpful. I guess a question really around product design and ability to mitigate this in the future. You know, it's not a fair comparison, but in industries like auto, we've seen trucks and cars shipped with maybe reduced functionalities, but just using older chipsets to be able to still meet customer demand. I guess, can you help us understand why exactly there's not as much flexibility in this business in terms of specific components constraining the ability to make products? And is there a possibility to design for greater flexibility in the future? So it just feels like, you know, what you're using is typically kind of off-the-shelf, you know, components. And, you know, I think the ability to design in greater flexibility in the future would certainly help the company and reduce this kind of volatility.
spk07: I agree with your general premise and the current generation of products that we are – working with in terms of InDesign and the latest products that we've reduced, we do have a lot better control from a, I'll call it a platform kind of perspective, and the ability to mix and match and modify components from the start. That does give us a lot more agility and ability to weather these types of events. issue that we are struggling with tends to be over multiple generations of products, given the life cycle of the product itself. Older generations were not designed with that methodology and that thought process in mind. So we're into the journey to be able to operate with a different model from an R&D perspective We're only a few years into that journey, whereas a large number of our products and a bulk of our revenue is based on previous generations of products, which is where the lack of flexibility is driving some volatility into the results. Again, that is one area that we've been working on actively for several years now, and we will continue to do so, and it pays benefits in the future. The flip side of it is the long-term customer contracts that we do have, which means those multiple-year deployments and the long-term agreement, whereas the demand rolls forward rather than being canceled or lost, which is why we get it back going forward. So in a future sense, we have the best of both, which is why we've been working on it for the last couple of years.
spk10: Thanks so much for your help. I mean, I guess the follow-up would be, you know, maybe this is unrealistic to expect just given that a lot of these deployments need regulatory approval and some very specific specs. Why isn't it possible to just go to customers with a more modern, you know, better functioning product that you can make easier versus like the, you know, second and third generation, you know, legacy products and just, you know, we can make this so we can upgrade your system, you know, provide even more functionality. Is that just not possible or, you know, financially imprudent to do?
spk07: It is. It's, I would say, possible in certain cases. If you look at how we work with some of the customers that are on the latest generation of platform, we can continue to increase and mix between generations of products. So if I would take the... The Gen X network, as an example, we have customers that have a set of endpoints running Gen 3, Gen 4, and Gen 5 all in the same network at the same time. It allows the customer to have an increased level of functionality, and they can deploy it as they need in the area that's targeting that capability. That's absolutely the model that we continue to pursue. The utility space, though, at the same time, does absolutely... live on the notion of assets have to go and have to be amortized over a long period of time. And when you deploy something, you want to be able to get the benefit over a very, very long period of time. So how you design the product from the start, which is the latest generations of products, that's where you get that ability to pay as you go from a customer standpoint and add as you need. which is a very beneficial business model when it comes to managing ebbs and flows in terms of business and the macroeconomic environment. So I agree, and that's exactly the direction that we are heading.
spk10: Well, I appreciate that. And it does seem like you're bearing a disproportionate level of the risk around supply chain and your customers aren't. And so hopefully we can see that model continue to evolve.
spk09: I'll jump back in queue. And our next question will come from Graham Price with Raymond James.
spk02: Hey, good morning, and thanks for taking our questions. Just quickly on timing, I was wondering, do you expect the component shortage impact to be spread pretty evenly across the second half, or is that something where we should expect it to be weighted more towards one quarter of the other?
spk06: Yeah, I don't know that we've got specific timing. As Tom mentioned, it's really hard to predict. The situation is pretty fluid. I mean, hopefully we'll be talking in a quarter on the Q3 call to say we think the worst is behind us. But at this point, I don't really have any color for Q3 versus Q4.
spk02: Okay, got it. And then secondly, you've touched on it a bit already, but I was wondering if you could talk a little bit about how you see the revenue impact kind of broken down by segment, maybe between devices, network solutions, and outcomes. As you said, it looks like it's primarily network solutions, but just wanted a little color there.
spk06: Yeah, the vast majority is network solutions, which you would expect just given the higher-end technology, more use of electronics. So, the vast majority is networks. And then there is a you know, a fair amount that's in devices, very little outcomes. Other than outcomes, growth tends to follow networks. So, to the extent that our deployments are delayed, you won't see the same kind of growth that we would have normally expected with outcomes, but that will catch up as well as the, you know, as the demand shifts to the right. So, no material impact on outcomes, though.
spk02: Okay. Got it. Thank you very much.
spk05: And as a reminder, if you'd like to ask a question today, you may signal by pressing star 1 on your telephone keypad. And we'll go next to Thomas Johnson with Morgan Stanley.
spk08: Hi. Yeah. Thanks for taking my call today. Just kind of wanted to start off on the order front. Clearly, another strong quarter for orders. I know kind of with some of your competitors, they've seen customers start to pull orders forward. in hopes of kind of offsetting some of the longer lead times for components. So I was just wondering, what are you guys seeing on the customer side? There's some deceleration on a year-over-year basis here. So just any outlook for the second half of the year and order trends?
spk07: The backlog itself remains very, very strong. We see a strong pipeline of customer activities, and that's what is reflected in that $3.5 approximate billion of total backlog. On the order front, call it basic demand, as Joan commented in our prepared remarks, we see demand definitely continuing to improve as customers have increased desire to put the new technology in practice to solve the problems that are really putting pressure on their business. So I continue to expect that demand will continue to increase and the pipeline of opportunities beyond that remains very, very strong.
spk08: Great. Thank you. And then just a one question related to the backlog. So, obviously, the bulk of the revenue that's being pushed out is in the electronic component side of things, so network solutions. It's clearly margin accretive. So, I guess, as we're thinking about some of these projects getting pushed farther to the right due to that kind of component headwind issue, can you just maybe talk to us about your ability to pass through any price on that front and and possibly how you see the margin profile of the backlog evolving into 2022?
spk07: The best way to think about it is our business really has two types. There is a book-and-ship business or turns-based business, which is an area that we have a bit more ability to manage price positions. and pass that cost through in a more tactical sense. Clearly, there's a competitive environment out there, and we need to be competitive in the marketplace. But on that turns-based business, there's ability to work with price on an ongoing basis. On the longer-term contract side of things, which is largely in the backlog piece of it, that is pricing that we have agreed with customers on so that they can – work with their regulatory commissions to make sure the proper rate of return is present in the business case at the customer level. So their pricing flexibility on our side is very, very limited. That said, what is in that backlog is primarily networks and outcomes-based business, which is where our business is overall driving to and the area that we're keenly interested in growing, and that is accretive to the corporate gross margin.
spk09: Great, thanks. Very helpful. I'll turn it back now.
spk05: And this concludes our question and answer session. I'd like to turn the conference back to Mr. Tom Dietrich for any additional or closing remarks.
spk07: Thank you, Operator. We appreciate everyone joining today. As a reminder, in conjunction with ITRON Inspire, which is our large industry event that is held in October, we'll also be holding our 2021 Investor Day. That will be hosted both virtually and hopefully, if conditions permit, live. So please mark your calendars, and we look forward to seeing everyone there. Thank you for joining.
spk05: There will be an audio replay of today's conference available this afternoon. You can access the audio replay by dialing 1-888-203-1112 or 1-719-457-0820 with the passcode of 3115180 or go to the company's website, www.itron.com. And this concludes today's conference. You may now disconnect.
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