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spk29: Good morning, ladies and gentlemen, and welcome to the ITRON's fourth quarter 2022 earnings conference call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question-and-answer session. To ask a question during the session, you will need to press star 1-1 on your telephone. You will then hear an automatic message advising your hand is raised. Please note that today's conference is being recorded. I will now hand the conference over to your speaker host today, David Means, Director of Investor Relations. Please go ahead.
spk11: Thank you, operator.
spk15: Good morning, and welcome to ITRON's fourth quarter 2022 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, please let me remind you of our non-GAAP financial presentation and our safe harbor statement. Our earnings release and financial presentation include non-GAAP financial information that we believe enhances the overall understanding of our current and future performance. 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 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 and the comments made during this conference call and in the risk factors section of our Form 10-K and other reports and filings with the Securities and Exchange Commission. All company comments, estimates, 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, February 27, 2023, 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 turn the call over to our CEO, Tom Dietrich.
spk14: Thank you, David. Good morning and thank you for joining us. You will hear fourth quarter details from Joan coming up shortly, but here is a brief overview of the quarter. Revenue was $467 million. Adjusted EBITDA was $34 million. And non-GAAP earnings per share was 71 cents. Our fourth quarter financial results were a step in the right direction. The team executed well to convert and deliver additional components that were supplied late in the quarter, which unlocked revenue and EBITDA ahead of our expectations. Turning to slide five, for the third consecutive quarter, we achieved a new record level for total backlog, which reached $4.6 billion. Continued strong demand drove bookings in the fourth quarter to $898 million, or a 1.9 book-to-bill ratio. The full-year bookings were approximately $2.5 billion, which is a book-to-bill ratio of 1.4. Our key bookings in the fourth quarter continue to be driven by distributed intelligence, and analytics over our network technologies. Our network solutions and outcomes offerings continue to contribute over 90% of the total backlog. Hydro One received regulatory approval for their AMI 2.0 program, which is an important step in moving forward with deploying our Gen 5 REBA solution. This includes our distributed intelligence capabilities across their service territory in Ontario, Canada, to support grid reliability, resiliency, and consumer engagement initiatives. In the water vertical, the City of Detroit is upgrading to our water network, and ITRON will also provide managed services. CPS Energy extended our SAS contract by an additional 10 plus years, which strengthens our technology partnership in San Antonio, Texas, a fast-growing community that is now leveraging ITRON's network technology to deploy AMI and distribution automation across electricity and gas, as well as water in conjunction with a sister utility, SAWS. We are now excited to begin deployment of our Intellis gas solution, bringing market-leading safety functionality and increased edge intelligence to CPS Energy. Lastly, in Paris, France, CLS and ITRON entered a long-term strategic collaboration to provide Paris a citywide canopy network connecting more than 200,000 streets and traffic lights across the city. Coupled with deploying innovative breakthrough services, Paris will be able to cut public lighting energy by up to 30% beyond the impact of LEDs, resulting in massive energy savings and improvements in sustainability. Now turning to slide six, I would like to provide some operational updates and insights from around the business. We have a robust pipeline of opportunities ahead as our customers' needs are aligned with our technology portfolio and continued investments. While quarter to quarter bookings will vary, we anticipate the strong demand environment to continue. Seasonally, I note that first quarter bookings are typically lower than the fourth quarter. The current supply environment is showing improvement with choppy component deliveries in the near term, specifically for some analog and power semiconductors. We will continue to work aggressively to mitigate these constraints, including increasing inventory levels of selected components as it becomes available to improve supply chain security. Customer support remains strong, and we have not experienced nor expect any material cancellation of backlog. Looking forward, we expect improving supply availability across the year. We are watching the macro situation closely, including the timing of supplier capacity expansion, demand in the automotive industry, potential impacts from China reopening, and the overall inventory level across the full spectrum of the supply chain. The underlying improvement supply trend is positive, with some degree of volatility as the global supply chain rebalances. Input cost inflation rates have leveled out, but component costs remain elevated. Tactical pricing actions combined with the increased pricing flexibility in more recent contracts have improved margin on a portion of the backlog. Finally, I want to cover that we announced a plan to further streamline our global manufacturing operations and company overhead as we continue to execute our stated strategy. When complete, this plan will improve our operational and financial performance. I will now hand off to Joan to cover the fourth quarter results, 2023 outlook, and the details of our recently launched restructuring plan.
spk09: Thank you. As Tom mentioned, we received earlier than anticipated component supply late in the fourth quarter, allowing us to shift and recognize more revenue than expected. The additional component supply had been anticipated in Q1 of 23, so a portion of Q4's strong performance was a shift from Q1. I'll provide more color on our 2023 expectations, but first let me cover fourth quarter in fiscal year 2022 results. Please turn to slide seven for a summary of consolidated GAAP results. Fourth quarter revenue of 467 million decreased 4% versus last year and was flat in constant currency. Revenue declined year over year due to the sale of our CNI gas business and our device solution segment. This decline was offset by higher revenue in both our network solutions and outcomes segment. Gross margin for the quarter was 30.1%, 510 basis points higher than last year, primarily due to favorable mix, partially offset by elevated component costs. Gap net income of $22 million, or 49 cents per diluted share, compares with a net loss of $59 million, or $1.30 per share in the prior year. The improvement in the current period was due to higher GAAP operating income partially offset by a lower tax benefit. Regarding non-GAAP metrics on slide 8, non-GAAP operating income was $25 million. Adjusted EBITDA was $34 million. Non-GAAP net income for the quarter was $32 million or $0.71 per diluted share. Free cash flow was negative 18 million in Q4, driven by an increase in working capital, particularly inventory. We will continue to invest in critical components as they become available. Looking at revenue by business segment on slide nine, Device Solutions revenue was 100 million, a 42 million or 27% year-over-year decline on a constant currency basis. The decline was due to the sale of our CNI gas business, as well as continued product pruning. Network Solutions' revenue was $301 million, a $39 million or 15% increase in constant currency. The increase was driven by a ramp of new and existing deployments. Network Solutions benefited from the extra component supply received late in the fourth quarter. Revenue in the outcomes segment was $66 million, a $4 million or 7% increase in constant currency. The increase was due to higher software license and product sales, partially offset by the continuing decline in the EMEA prepay business. Lastly, foreign currency changes resulted in $19 million lower revenue versus the prior year. Moving to the non-GAAP year-over-year EPS bridge on slide 10, our Q4 non-GAAP EPS was 71 cents per diluted share, down 4 cents from the prior year. Net operating performance had a positive $0.48 per share impact due to the fall through of higher gross profit and lower operating expenses. A negative tax impact of $0.52 per share more than offset our positive operating performance. The negative year-over-year tax impact was due to a large tax benefit booked in Q4 of 2021. Turning to slides 11 through 13, I'll discuss Q4 results by business segment compared with the prior year. Device Solutions revenue was $100 million with gross margin of 11% and operating margin of 3%. Gross margin increased 230 basis points due to improving mix, partially offset by elevated component costs. Operating margin increased 40 basis points due to the fall through of the higher gross margin, partially offset by a higher percentage of operating expenses. Network Solutions revenue was $301 million with gross margin of 33%. Gross margin increased 260 basis points from the prior year due to favorable mix partially offset by higher component costs. Operating margin of 23% increased 480 basis points due to the fall through of higher gross profit and lower operating expenses. Outcomes revenue was $66 million with gross margin of 46%. Gross margin increased 390 basis points due to very favorable solutions mix and improved operational efficiencies. Operating margin of 26% increased 130 basis points due to the fall through of the higher gross profit partially offset by higher R&D investment. Now to briefly recap full year 2022 results, please turn to slide 14. Revenue of approximately $1.8 billion was down 9% from 2021. On a constant currency basis, revenue is down 6%. And when further adjusted for the sale of our CNI gas business, revenue was down only 2%. The revenue decline was due to the component shortages, which limited our ability to fulfill customer demand. Gross margin was 29.1%, 20 basis points higher than 2021. Adjusted EBITDA was $95 million compared with $115 million in the prior year. Non-GAAP earnings per share was $1.13 per share versus $1.75 in 2021. Free cash flow was $5 million compared with $120 million in the prior year. The year-over-year decrease in free cash flow was due to higher working capital usage, higher variable compensation payments, and lower EBITDA, partially offset by lower capital expenditures. Turning to slide 15, I'll cover liquidity and debt at the end of the fourth quarter. Total debt remained flat at $460 million and net debt was $258 million. Net leverage was 2.7 times at the end of Q4. Cash and equivalents at the end of the fourth quarter were $202 million. Please turn to slide 16. I'd like to provide you some color on our 2023 expectations. We anticipate full year 2023 revenue to be in a range of 1.85 to 1.95 billion. We remain cautious to start the year as component supply continues to be constrained and somewhat unpredictable, including the nonlinear timing of deliveries within a quarter. But we do anticipate that the supply environment will improve gradually throughout the year. At the midpoint, the 2023 annual guidance is approximately 6% year-over-year growth. This is driven by growth in our networks and outcomes segments, partially offset by a continuing decline in our devices segment. We anticipate full-year non-GAAP EPS to be within a range of $0.70 to $1.10 per diluted share. At the midpoint of this guidance and normalizing the tax rate to 28% for both years, the year-over-year operational earnings growth is approximately 6%. This growth is somewhat muted due to an expected increase in variable compensation expense in 2023. The variable compensation costs in our 2022 results were not at the target payout, and we are planning to achieve targeted payout in 2023. Given our expected gradual improvement of supply throughout the year, earnings will be heavily skewed to the second half of the year. Other full-year guidance assumptions are a Euro to US dollar foreign currency exchange rate of 1.05, An average non-GAAP effective tax rate of approximately 28%. Average shares outstanding for the full year of approximately 45.7 million. Now, please turn to slide 17 for our first quarter outlook. Given the continued volatility in the component supply, I am also providing our view of Q1. We anticipate first quarter revenue to be in a range of $460 to $475 million, which at the midpoint is flat versus our Q4 performance. As I mentioned in my opening comments, the unexpected delivery of supply late in the fourth quarter was initially anticipated to be delivered and diverted to revenue in the first quarter. This supply shift is contributing to slightly lower revenue in Q1. We anticipate first quarter non-GAAP EPS to be within a range of 5 to 15 cents per diluted share. This is down sequentially from Q4 due to the very favorable product mix in Q4, an increase in variable compensation expense, and a much higher tax expense given Q4's rate was negative 30%. While we anticipate the full year 2023 tax rate to be approximately 28%, The quarterly rates will fluctuate based on the amount of earnings and any one-time true-ups. For the first quarter, we are expecting a one-time increase in tax expense of approximately $2 million. This is related to a required true-up as prior stock grants vest. Including the impact of this $2 million true-up, we expect the overall tax rate in Q1 to be in a range of 40% to 60%. In summary, the constrained and unpredictable nature of component supply continues to impact our results. However, signs of supply improvements started to appear in our fourth quarter. We are optimistic we will see improvement of supply availability throughout 2023. Please turn to slide 18 for details on the restructuring announcement we made this morning. Last week, our board of directors approved a new restructuring plan. This plan is a continuation of our asset life strategy and includes further actions to streamline our manufacturing operations as well as overall overhead in the company. We expect this project to cost between 40 and 45 million and generate annualized savings between 14 and 17 million. The project should be substantially complete by early 2025. Now I'll turn the call back to Tom.
spk11: Thank you, Joan.
spk14: I would like to close today by highlighting our expanding distributed intelligence offerings. To date, we have shipped approximately 5.8 million DI-capable endpoints and have approximately 7 million applications in operations today. Through partnerships, our proven and scalable DI platform will enable a new and innovative approach to improving grid resiliency and transforming the relationship between utilities and consumers. We recently announced a partnership with Smart Energy Water to transform the utility-consumer relationship to enable the management of distributed energy resources. This builds upon our partnership ecosystem that already includes our long-term collaboration with Microsoft to accelerate cloud adoption and the next generation of consumer and grid solutions for the utility and smart city industries. With partnerships, we will transform how end users view and manage their energy and how utilities meet the demands of a rapidly changing industry. Thank you, everyone, for joining today. Operator, please open the line for some questions.
spk29: Thank you. Ladies and gentlemen, to ask a question, you will need to press star 1-1 on your telephone and wait for your name to be announced. To withdraw your question, please press star 1-1 again. Please stand by while we compile the Q&A roster. Now, first question coming from the line of Noah Kay with Oppenheimer. Your line is open.
spk27: Good morning. Thanks for taking the questions. And, Tom, I want to pick up right where you left off with remarks around the expansion of the DI platform. Can you talk a little bit about the interest you've gotten from different players in the DI ecosystem following your announcement in January? Who are you seeing the demand for? coming most strongly from. And I think in that release, you mentioned the revenue opportunities around this would really start to manifest in 2024, but maybe give us a sense of what the revenue model might actually look like for some of these DI offerings.
spk14: Sure. Thanks, Mila. We see interest in DI applications from a broad swath of the industry. Certainly there are utilities that want to develop their own applications and then a host of ecosystem partners from large companies to small companies. that are interested. The applications that they are working on tend to be a mix of grid efficiency types of things as well as consumer engagement types of applications. It really depends on what problem they're trying to solve. Revenue model is largely a subscription kind of model where an application is used for a certain period of time and on a per usage basis or a per time basis. And the proportion of that revenue that accrues to ITRON is dependent on whether it's our application or whether it's a third party. If it's a third party, there's a hosting fee and think of it more of a usage fee. In our own applications, it's quite a bit higher in terms of the the revenue that we get. You're right in terms of the timing. Think of it as a case where networks are deployed, initial applications, an AMI or a DA use case is stabilized by the utility and then they start layering in incremental services. So it tends to to follow on in terms of deployments by maybe 18 months or so, and that's where you're starting to see the scalability now. I mentioned in our pre-recorded remarks that about 7 million applications running in the field today, sometimes one per endpoint, oftentimes multiple applications running in parallel in the endpoint, more like a smartphone kind of model in terms of how it's used.
spk27: Mm-hmm. Very helpful. I might leave it for others to pull on the thread of what that means for outcomes. I do want to ask just a couple clarifying questions around the outlook. It sounded like we had some revenue shift from 1Q23 into 4Q. So if I just add a little bit to 1Q, it really seems like the revenue outlook for the full year is annualizing what 1Q would have been with not much improvement. So just given your comments around expectations for the improving supply chain, I wonder if we could square that up a little bit. You know, how kind of conservative is the outlook in terms of the revenue run rate and what kind of level of increase are you assuming as we go throughout the year?
spk09: Yeah, let me take a stab at that. So the outlook that we provided is based on our current expectations after discussions with suppliers in terms of when supply will Certainly, to the extent that the suppliers are able to exceed our current view, there is upside to the view. But right now, what we would say is that we expect gradual improvement through the year. And so, all things being normal, we would expect Q1 to be the low point and we would continue to grow through the year. The range is pretty wide, and as you say, if you take the kind of high end of the range, it's a different assumption than the low end of the range.
spk08: But I do think we will see somewhere around the midpoint or higher of revenue growth, which would be over 6%.
spk14: And the way to unpack that, if I had one additional point of color, is fourth quarter definitely demonstrated the upside potential in terms of being able to turn that revenue. We got components very late in the quarter, and the team really did an exceptional job of turning that. Customers are eager for the products and the technology that we provide. turn them as quickly as we can. We do think, as Joan mentioned, that there will be a view of improving supply over the year with variations and some volatility in terms of timing, certainly in the first half of the year.
spk26: Very helpful. I'll turn it over.
spk29: Thank you. One moment for our next question. Our next question, coming from the line-up, Jeff Osborne with Colin. Your line is open.
spk18: Yeah, good morning. Just a couple quick ones here. I was wondering, Joan, can you quantify what the semiconductor impact was for the quarter and the full year?
spk09: Yeah, I would say the fourth quarter was pretty similar to the prior quarters we experienced in 2022. So, you know, somewhere, call it 100 million or so a quarter, maybe slightly better than Q4. But exiting the year, we probably had about 400 million of revenue that was constrained because of the constraints.
spk18: Got it. And then on the restructuring, just a couple quick housekeeping there. The $14 to $17 million, is the majority of that savings on the cost of goods line?
spk06: Yes. I'd say 80% or so is on the cost of goods line.
spk18: Got it. And then what was the outsourced production mix, and then what do you anticipate that to be sort of post these actions?
spk14: We're probably running around 45%, maybe 50%. It varies a bit quarter to quarter, internal, external today. And I think this takes it up probably another 5% or so. So by the time we finish it off, meaningfully above 50% in terms of the amount of outsourced production.
spk18: Got it. And then my last one. Tom was just on the book-to-bill, obviously a great Q4. You implied that Q1 would be a bit softer seasonally. Do you anticipate it to be above one for the year, or how should we think about just the level of activity that you're quoting?
spk14: We do definitely think that the book-to-bill for the full year will be above one-to-one. The pipeline of opportunities remains very rich, very strong. based on needs from our customers for resiliency, reliability, as well as new technology applications, whether they be consumer side or EV and DERMS integration. So a rich set of opportunities, and we're bullish on what the year will bring in terms of bookings. That said, the only caution I would provide is it'll be a little bit lumpy quarter-to-quarter, just with normal seasonality as well as timing of individual contracts coming through.
spk19: Great. Thank you. That's all I have.
spk29: Thank you. One moment, please, for our next question. And our next question coming from the lineup. Chip Moore with EF Hutton Group. Your line is open.
spk16: Good morning. Hey, thanks for taking the question. Tom, I wanted to ask one on the regulatory environment. It seems like more and more states are looking at performance-based mechanisms to meet their goals. Is that something you're seeing with your customers for some of the more advanced solutions?
spk14: Indeed, the regulatory environment continues to understand the need for new technology and new models. The amount of states that allow some type of performance-based rates or capitalization is nearly 40 out of the 50 right now, and plenty of changes underneath each one of those along the way. So in general, the regulatory model is moving in the direction of enabling the technologies that we've been investing in.
spk16: Great to hear. And Joan, you talked about the weighting in the back half on the guidance. Can you give us any color on sort of mix and perhaps implications for cadence of margins for the year?
spk09: Yeah, I mean, I would say for the full year, we would look at margins being pretty similar to what they what they were in full year 22. So certainly as we get more supply, you get the benefit of more factory, even out the production and therefore less absorption issues. But we're also dealing sometimes with expedited freight things at that level. So for the full year, I would say 22 levels are pretty consistent. Those will start out slower in the first quarter and then grow through the year. So for the first quarter, I would say the gross margin would be similar to Q1 of last year.
spk16: Super helpful. And just more housekeeping, Joan, on the restructuring. Can you just remind us where we are on the prior programs, just to keep us abreast with the new program?
spk09: Yeah, the 2020 program is basically complete. And so we still are working on a 2021 program, which should be complete mostly maybe early next year. And those are all on track.
spk08: If anything, the payback's gotten a little bit higher because We just had a little bit less severance than we expected when we first initially booked the plan.
spk09: So those are going according to plan. And again, this one will be the savings should be complete by early 25. The cash out is really 24 to 26. So really no impact on cash for 23.
spk16: Got it. Okay. And sorry, one last one. It looked like there was an impairment charge on a software project. Any more there?
spk09: Yeah, we had a software project, a cloud-based project going on for really the last couple of years, and we continue to struggle with the vendor in terms of being able to deliver software that was bug-free and meet the functionality that we were expecting. So we made a determination in Q4 to basically exit that project, and what we ended up having to write off was capitalize both external cost as well as internal labor costs for a total of about $8.7 million.
spk08: Yeah.
spk16: Okay, I'll hop back in here. Thanks very much.
spk29: Thank you. And our next question coming from the line of Cassie Harrison with 5% on the line.
spk03: Good morning, and thanks for taking the questions. So you've previously indicated 2024 OPEX target of, I think, 22% to 23% of sales. 2022 came in at 26%, which is slightly up from 21. And so I'm just curious how you're thinking about the progression of OpEx for 23 and then where your confidence level is on the 2024 target. Yeah.
spk09: So we gave the 2024 targets in the fall of 21. And at that point, we did not expect the kind of supply constraints that we saw in 22 and continue to see in 23. So I would say While those are still our longer-term targets, I don't believe those targets will be met in 2024.
spk08: That said, the OPEX target of 22% to 23% is the longer-term target. It's just I think that's going to be pushed out a year or so as we work through the backlog and the things that have been delayed because of the supply component.
spk09: So still the right long-term targets. Do not expect it to be 2024. Helpful. Thank you.
spk03: And then for my follow-up, I just wanted to touch, just to ask a question on free cash flow. I think you generated just under $5 million in 2022. How are you thinking about free cash flow during 2023? And then to the extent that we do get some sort of, you know, recovering the supply chain environment and you unlock that, you know, $100 million per quarter network solutions revenue, you know, what are, you know, how do you think about use of potential free cash flow?
spk09: Yeah, so the cash flow was a positive $5 million for all of 22. It was actually negative in the fourth quarter to the tune of around $18 million. And a lot of that was continuing to invest in inventory. So we'll continue to, as components become available, invest to make sure we've got all the components necessary. My expectation for free cash flow for 2023 is negative for the full year, really for a couple of reasons. One is we have some large cash tax payments due in the second quarter Those relate to two things. One is settling from international tough tax audits that we had accrued but hadn't paid. But the bigger issue is the legislative change that happened with the 2017 tax reform, which essentially forced you to capitalize the R&D. We were expecting those laws to get overturned, as was everybody else, and they haven't yet. So the current tax law relative to the capitalization of R&D creates quite a bit larger cash tax payments. So as an example, just cash tax alone is going to be up something like $25 million year over year. In addition, we will continue to invest in working capital as we grow the business. So our guidance is to grow the business. And typically when that happens, you've got to grow the receivables. And as I mentioned, we'll continue to make sure we grow. So while it's negative for the full year, I expect it to turn in the second half. So expect Q1. And Q2 to be negative, Q1 also is the quarter where we will pay a discretionary bonus to the non-executive team. And Q2 is the large cash payments. By the time we get to Q3 and 4, where earnings are starting to improve versus the first half, I expect cash flow to be positive. But again, for the full year, something in the range of like minus 25 to minus 35 million.
spk00: Helpful. Thank you.
spk29: Thank you. And our next question, coming from the line of Ben Keller with Baird, Elon is now open.
spk28: Hey, good morning. Thanks, guys, and congrats on the bookings. Just quickly, maybe, Tom, just the environment for new projects and then maybe bookings this quarter explains it all, but there's been some reports of smaller utilities, more of a unique co-op of not being able to implement plans because of rising electricity prices. That's affected you guys at all. I'll have a couple of follow-ups.
spk13: Very good.
spk14: So the bookings environment or the pipeline of opportunities, maybe correctly stated, continues to be very robust. The need for investment in resiliency and reliability, whether you are a large or small utility, are there. The need to prepare your environment for growth in EVs and continued growth in things like rooftop solar means an awful lot of investment in the distribution grid. So we feel very bullish about what the future will bring for us in terms of demand from customers. That is something we hear directly from customers. The range of opportunities continues to expand. We launched a product called the Distributed Intelligence Network Interface Card really that allows us to put DEI into third-party types of devices like smart panels and others to again continue to broaden out the range of applications. On your point about smaller utilities delaying investments based on affordability and energy prices, I would say I've seen that on occasion, but it certainly hasn't been widespread. There are a broad range of municipalities and cities that are investing. And investor IOUs have been investing very aggressively in driving up the big bookings projects that you see in our backlog today. The work that's going on certainly is a multi-year and probably a multi-decade growth in terms of needs of the electricity grid and water systems. And that is good future growth for the company.
spk28: Thanks. And, you know, this portion of the backlog was signed, you know, before we got to the inflationary environment. And just how do we think about that backlog in pricing, how that impacts margin, or if you're able to reprice with customers going forward?
spk14: Sure. I can jump in on that one, and then perhaps, Jim, you want to add anything additional? Sure. work that we've been doing over the last year plus on changing contracts for new agreements to provide a little bit more flexibility around pricing specifically in the inflationary environment that has has gone well and i would say that that majority of new bookings are in a place where you've got a little bit better protection against inflation That said, we still have a fair amount of overhang of bookings prior to that change in our operations more than a year ago, and that work has sometimes been with us and sometimes we haven't been able to achieve a price increase. So I would say that in terms of backlog with inflation protected, we're above a third, but probably less than a half in terms of what the size of that is. But new projects, as they continue to roll through and as deliveries happen, it rolls off that stuff where we do have a margin pinch and gets us into a better zip code from a margin perspective.
spk28: Just maybe lastly, just could you remind us of the cadence of, especially on outcomes? I think I saw the service revenue tick up more, but just like on the trajectory of how things get implemented with service before it hits something else and then the different margin profile. Thank you, guys.
spk14: Sure. So a few stats on the outcomes side of things that I think are helpful. So roughly 75% of that revenue is recurring revenue. The majority of that is sort of staffs or service-based revenue, which has a meaningful higher margin, which is why outcomes tends to run material above in the gross margin line compared to networks or even devices. The timing of outcomes revenue is generally, let's call it 18 months after The network deployment in terms of timing, it changes a little bit project to project, but that's a good thumb of the year number to understand what the timing would be. And that revenue tends to come over a very long period of time. So I think 10-year SAS or managed service agreements, you get that revenue over a very long period of time.
spk29: Thank you, and our next question coming from the lineup, from Price with Raymond James. Your line is now open.
spk21: Hey, Pavel Molchanov here. Thanks for taking the question. Same question I asked a few months ago. In this kind of quasi-recessionary environment, is there any improvement in terms of multiples from an M&A perspective, as you look at private companies?
spk14: I think that valuations are certainly coming down. There's still a meaningful difference between, I would say, hardware valuations and software valuations, where software tends to be a bit higher. But, indeed, valuations are coming down a bit. Large-scale enterprise Software valuations still tend to be pretty rich compared to the traditional valuations that you've seen. But it comes down a little.
spk21: Okay. Can you get an update also on demand response business? I mean, it's obviously one slice of outcomes, but we get these extreme weather dynamics, which I would imagine – pushes up the appetite among ISOs for demand response.
spk14: Indeed, the demand response world continues to move along pretty nicely. And honestly, what I've seen is not only using that capability from a traditional demand response, let's shave the peak off and deal with a very high pressure kind of situation, using that capability much more as a normal course of practice to understand when to charge things like EVs and how to use rooftop solar much more effectively. So I think it's moving from a demand response peak shaving kind of situation to much more of a localized control for distributed energy resource management is where the industry tends to be heading, and a lot of the discussions we have with our customers encompass both of those use cases.
spk20: Understood. Thanks very much.
spk29: Thank you. And our next question coming from the lineup, Martin Muller with Johnson Price and Company. Your line is open.
spk17: Thank you for taking my question. I wanted to ask about the guidance. And I would have anticipated for the level of revenue that you're guiding to that the earnings per share would be higher. Could you maybe give us some help in terms of the magnitude for the variable comp that you talked about and also any help would be appreciated on the gross profit margin side?
spk09: Yeah, I think I answered the gross profit already. So from an annual perspective, you know, think at or slightly above the full year 2022 level. In terms of OPEX, I think you sort of talked about that one, which is we're going to continue to be a little bit higher if the revenue is not at the scale level. So for OPEX, you know, I think it's also in the percentages. similar to 2022, which would imply higher dollar objects between 22 and 23. And as I mentioned on the call, I think a lot of that is the variable comp. So really don't want to talk about exactly how much our variable comp is, but it was, you know, material, materially enough that, you know, we mentioned it. The other thing I would point to 2022 EPS versus 2023, we normalized it. for you in the discussion point. So the tax rate in overall 22 was 4%. The tax rate in 23 is 28%. And so we had a lot of favorable discreet, mostly linked to statute of limitations, expirations in 22. If you normalized for the same tax rate year to year, 2022 would have been 85 cents. The midpoint of our guidance is 90 cents, so roughly a 6%. And again, We've built the guidance based on our current view of supplier commitments, and to the extent they're better than that and more predictable, we'll be in a position to update the guidance in the August time frame.
spk23: Okay. That's helpful.
spk17: Then in terms of the record backlog here, can you break down maybe how much of that is outcomes and how much of that is network solutions?
spk09: Yeah, I mean, over 90% is networks and outcomes. It doesn't materially change much from quarter to quarter.
spk17: Okay. Thank you.
spk29: Thank you. And I will now turn the call back over to Mr. Tom Dietrich for any closing remarks.
spk13: Very good. Thank you all for joining us today. We look forward to updating you on our progress after Q1. Thanks, all.
spk29: Thank you. Thank you for your participation. You may now disconnect.
spk02: The conference will begin shortly. To raise and lower your hand during Q&A, you can dial star 1 1.
spk24: Thank you. Thank you. Thank you.
spk29: Good morning, ladies and gentlemen, and welcome to the ITRON's fourth quarter 2022 earnings conference call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question-and-answer session. To ask a question during the session, you will need to press star 1-1 on your telephone. You will then hear an automatic message advising your hand is raised. Please note that today's conference is being recorded. I will now hand the conference over to your speaker host today, David Means, Director of Investor Relations. Please go ahead.
spk11: Thank you, operator.
spk15: Good morning, and welcome to ITRON's fourth quarter 2022 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, please let me remind you of our non-GAAP financial presentation and our safe harbor statement. Our earnings release and financial presentation include non-GAAP financial information that we believe enhances the overall understanding of our current and future performance. 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 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 and the comments made during this conference call and in the risk factors section of our Form 10-K and other reports and filings with the Securities and Exchange Commission. All company comments, estimates, 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, February 27, 2023, 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 turn the call over to our CEO, Tom Dietrich.
spk14: Thank you, David. Good morning and thank you for joining us. You will hear fourth quarter details from Joan coming up shortly, but here is a brief overview of the quarter. Revenue was $467 million. Adjusted EBITDA was $34 million. And non-GAAP earnings per share was 71 cents. Our fourth quarter financial results were a step in the right direction. The team executed well to convert and deliver additional components that were supplied late in the quarter, which unlocked revenue and EBITDA ahead of our expectations. Turning to slide five, for the third consecutive quarter, we achieved a new record level for total backlog, which reached $4.6 billion. Continued strong demand drove bookings in the fourth quarter to $898 million, or a 1.9 book-to-bill ratio. The full-year bookings were approximately $2.5 billion, which is a book-to-bill ratio of 1.4. Our key bookings in the fourth quarter continue to be driven by distributed intelligence, and analytics over our network technologies. Our network solutions and outcomes offerings continue to contribute over 90% of the total backlog. Hydro One received regulatory approval for their AMI 2.0 program, which is an important step in moving forward with deploying our Gen 5 REBA solution. This includes our distributed intelligence capabilities across their service territory in Ontario, Canada, to support grid reliability, resiliency, and consumer engagement initiatives. In the water vertical, the City of Detroit is upgrading to our water network, and ITRON will also provide managed services. CPS Energy extended our SAS contract by an additional 10 plus years, which strengthens our technology partnership in San Antonio, Texas, a fast-growing community that is now leveraging ITRON's network technology to deploy AMI and distribution automation across electricity and gas, as well as water in conjunction with a sister utility, SAWS. We are now excited to begin deployment of our Intellis gas solution, bringing market-leading safety functionality and increased edge intelligence to CPS Energy. Lastly, in Paris, France, CLS and ITRON entered a long-term strategic collaboration to provide Paris a citywide canopy network connecting more than 200,000 streets and traffic lights across the city. Coupled with deploying innovative breakthrough services, Paris will be able to cut public lighting energy by up to 30% beyond the impact of LEDs, resulting in massive energy savings and improvements in sustainability. Now turning to slide six, I would like to provide some operational updates and insights from around the business. We have a robust pipeline of opportunities ahead as our customers' needs are aligned with our technology portfolio and continued investments. While quarter to quarter bookings will vary, we anticipate the strong demand environment to continue. Seasonally, I note that first quarter bookings are typically lower than the fourth quarter. The current supply environment is showing improvement with choppy component deliveries in the near term, specifically for some analog and power semiconductors. We will continue to work aggressively to mitigate these constraints, including increasing inventory levels of selected components as it becomes available to improve supply chain security. Customer support remains strong, and we have not experienced nor expect any material cancellation of backlog. Looking forward, we expect improving supply availability across the year. We are watching the macro situation closely, including the timing of supplier capacity expansion, demand in the automotive industry, potential impacts from China reopening, and the overall inventory level across the full spectrum of the supply chain. The underlying improvement supply trend is positive, with some degree of volatility as the global supply chain rebalances. Input cost inflation rates have leveled out, but component costs remain elevated. Tactical pricing actions combined with the increased pricing flexibility in more recent contracts have improved margin on a portion of the backlog. Finally, I want to cover that we announced a plan to further streamline our global manufacturing operations and company overhead as we continue to execute our stated strategy. When complete, this plan will improve our operational and financial performance. I will now hand off to Joan to cover the fourth quarter results, 2023 outlook, and the details of our recently launched restructuring plan.
spk09: Thank you. As Tom mentioned, we received earlier than anticipated component supply late in the fourth quarter, allowing us to shift and recognize more revenue than expected. The additional component supply had been anticipated in Q1 of 23, so a portion of Q4's strong performance was a shift from Q1. I'll provide more color on our 2023 expectations, but first let me cover fourth quarter and fiscal year 2022 results. Please turn to slide seven for a summary of consolidated GAAP results. Fourth quarter revenue of $467 million decreased 4% versus last year and was flat in constant currency. Revenue declined year over year due to the sale of our CNI gas business and our device solution segment. This decline was offset by higher revenue in both our network solutions and outcomes segment. Gross margin for the quarter was 30.1%, 510 basis points higher than last year, primarily due to favorable mix, partially offset by elevated component costs. Gap net income of $22 million, or 49 cents per diluted share, compares with a net loss of $59 million, or $1.30 per share in the prior year. The improvement in the current period was due to higher GAAP operating income partially offset by a lower tax benefit. Regarding non-GAAP metrics on slide 8, non-GAAP operating income was $25 million. Adjusted EBITDA was $34 million. Non-GAAP net income for the quarter was $32 million or $0.71 per diluted share. Free cash flow was negative 18 million in Q4, driven by an increase in working capital, particularly inventory. We will continue to invest in critical components as they become available. Looking at revenue by business segment on slide nine, Device Solutions revenue was 100 million, a 42 million or 27% year-over-year decline on a constant currency basis. The decline was due to the sale of our CNI gas business, as well as continued product pruning. Network Solutions revenue was 301 million, a 39 million or 15% increase in constant currency. The increase was driven by a ramp of new and existing deployments. Network Solutions benefited from the extra component supply received late in the fourth quarter. Revenue in the outcome segment was 66 million, a 4 million or 7% increase in constant currency. The increase was due to higher software license and product sales, partially offset by the continuing decline in the EMEA prepay business. Lastly, foreign currency changes resulted in 19 million lower revenue versus the prior year. Moving to the non-GAAP year-over-year EPS bridge on slide 10, our Q4 non-GAAP EPS was 71 cents per diluted share, down 4 cents from the prior year. Net operating performance had a positive $0.48 per share impact due to the fall through of higher gross profit and lower operating expenses. A negative tax impact of $0.52 per share more than offset our positive operating performance. The negative year-over-year tax impact was due to a large tax benefit booked in Q4 of 2021. Turning to slides 11 through 13, I'll discuss Q4 results by business segment compared with the prior year. Device Solutions revenue was $100 million with gross margin of 11% and operating margin of 3%. Gross margin increased 230 basis points due to improving mix, partially offset by elevated component costs. Operating margin increased 40 basis points due to the fall through of the higher gross margin, partially offset by a higher percentage of operating expenses. Network Solutions revenue was $301 million with gross margin of 33%. Gross margin increased 260 basis points from the prior year due to favorable mix partially offset by higher component costs. Operating margin of 23% increased 480 basis points due to the fall through of higher gross profit and lower operating expenses. Outcomes revenue was $66 million with gross margin of 46%. Gross margin increased 390 basis points due to very favorable solutions mix and improved operational efficiencies. Operating margin of 26% increased 130 basis points due to the fall through of the higher gross profit partially offset by higher R&D investment. Now to briefly recap full year 2022 results, please turn to slide 14. Revenue of approximately $1.8 billion was down 9% from 2021. On a constant currency basis, revenue was down 6%. And when further adjusted for the sale of our CNI gas business, revenue was down only 2%. The revenue decline was due to the component shortages, which limited our ability to fulfill customer demand. Gross margin was 29.1%, 20 basis points higher than 2021. Adjusted EBITDA was 95 million compared with 115 million in the prior year. Non-GAAP earnings per share was $1.13 per share versus $1.75 in 2021. Free cash flow was 5 million compared with 120 million in the prior year. The year-over-year decrease in free cash flow was due to higher working capital usage, higher variable compensation payments, and lower EBITDA, partially offset by lower capital expenditures. Turning to slide 15, I'll cover liquidity and debt at the end of the fourth quarter. Total debt remained flat at $460 million and net debt was $258 million. Net leverage was 2.7 times at the end of Q4. Cash and equivalents at the end of the fourth quarter were $202 million. Please turn to slide 16. I'd like to provide you some color on our 2023 expectations. We anticipate full year 2023 revenue to be in a range of $1.85 to $1.95 billion. We remain cautious to start the year as component supply continues to be constrained and somewhat unpredictable, including the nonlinear timing of deliveries within a quarter. But we do anticipate that the supply environment will improve gradually throughout the year. At the midpoint, the 2023 annual guidance is approximately 6% year-over-year growth. This is driven by growth in our networks and outcomes segments, partially offset by a continued decline in our devices segment. We anticipate full-year non-GAAP EPS to be within a range of $0.70 to $1.10 per diluted share. At the midpoint of this guidance and normalizing the tax rate to 28% for both years, the year-over-year operational earnings growth is approximately 6%. This growth is somewhat muted due to an expected increase in variable compensation expense in 2023. The variable compensation costs in our 2022 results were not at the target payout, and we are planning to achieve targeted payout in 2023. Given our expected gradual improvement of supply throughout the year, earnings will be heavily skewed to the second half of the year. Other full-year guidance assumptions are a Euro to US dollar foreign currency exchange rate of 1.05, An average non-GAAP effective tax rate of approximately 28%. Average shares outstanding for the full year of approximately 45.7 million. Now, please turn to slide 17 for our first quarter outlook. Given the continued volatility in the component supply, I am also providing our view of Q1. We anticipate first quarter revenue to be in a range of $460 to $475 million, which at the midpoint is flat versus our Q4 performance. As I mentioned in my opening comments, the unexpected delivery of supply late in the fourth quarter was initially anticipated to be delivered and converted to revenue in the first quarter. This supply shift is contributing to slightly lower revenue in Q1. We anticipate first quarter non-GAAP EPS to be within a range of 5 to 15 cents per diluted share. This is down sequentially from Q4 due to the very favorable product mix in Q4, an increase in variable compensation expense, and a much higher tax expense given Q4's rate was negative 30%. While we anticipate the full year 2023 tax rate to be approximately 28%, The quarterly rates will fluctuate based on the amount of earnings and any one-time true-ups. For the first quarter, we are expecting a one-time increase in tax expense of approximately $2 million. This is related to a required true-up as prior stock grants vest. Including the impact of this $2 million true-up, we expect the overall tax rate in Q1 to be in a range of 40% to 60%. In summary, the constrained and unpredictable nature of component supply continues to impact our results. However, signs of supply improvements started to appear in our fourth quarter. We are optimistic we will see improvement of supply availability throughout 2023. Please turn to slide 18 for details on the restructuring announcement we made this morning. Last week, our board of directors approved a new restructuring plan. This plan is a continuation of our asset life strategy and includes further actions to streamline our manufacturing operations as well as overall overhead in the company. We expect this project to cost between 40 and 45 million and generate annualized savings between 14 and 17 million. The project should be substantially complete by early 2025. Now I'll turn the call back to Tom.
spk11: Thank you, Joan.
spk14: I would like to close today by highlighting our expanding distributed intelligence offerings. To date, we have shipped approximately 5.8 million DI-capable endpoints and have approximately 7 million applications in operations today. Through partnerships, our proven and scalable DI platform will enable a new and innovative approach to improving grid resiliency and transforming the relationship between utilities and consumers. We recently announced a partnership with Smart Energy Water to transform the utility-consumer relationship to enable the management of distributed energy resources. This builds upon our partnership ecosystem that already includes our long-term collaboration with Microsoft to accelerate cloud adoption and the next generation of consumer and grid solutions for the utility and smart city industries. With partnerships, we will transform how end users view and manage their energy and how utilities meet the demands of a rapidly changing industry. Thank you, everyone, for joining today. Operator, please open the line for some questions.
spk29: Thank you. Ladies and gentlemen, to ask a question, you will need to press star 1-1 on your telephone and wait for your name to be announced. To withdraw your question, please press star 1-1 again. Please stand by while we compile the Q&A roster. Now, first question coming from the line of Noah Kay with Oppenheimer. Your line is open.
spk27: Good morning. Thanks for taking the questions. And, Tom, I want to pick up right where you left off with remarks around the expansion of the DI platform. Can you talk a little bit about the interest you've gotten from different players in the DI ecosystem following your announcement in January? Who are you seeing the demand for? coming most strongly from. And I think in that release, you mentioned the revenue opportunities around this would really start to manifest in 2024, but maybe give us a sense of what the revenue model might actually look like for some of these DI offerings.
spk14: Sure. Thanks, Mila. We see interest in DI applications from a broad swath of the industry. Certainly there are utilities that want to develop their own applications and then a host of ecosystem partners from large companies to small companies. that are interested. The applications that they are working on tend to be a mix of grid efficiency types of things as well as consumer engagement types of applications. It really depends on what problem they're trying to solve. Revenue model is largely a subscription kind of model where an application is used for a certain period of time and on a per-usage basis or a per-time basis. And the proportion of that revenue that accrues to ITRON is dependent on whether it's our application or whether it's a third party. If it's a third party, there's a hosting fee and think of it more of a usage fee. In our own applications, it's quite a bit higher in terms of the the revenue that we get. You're right in terms of the timing. Think of it as a case where networks are deployed, initial applications, an AMI or a DA use case is stabilized by the utility, and then they start layering in incremental services. So it tends to to follow on in terms of deployments by maybe 18 months or so, and that's where you're starting to see the scalability now. I mentioned in our pre-recorded remarks that about 7 million applications running in the field today, sometimes one per endpoint, oftentimes multiple applications running in parallel in the endpoint, more like a smartphone kind of model in terms of how it's used.
spk27: Very helpful. I might leave it for others to pull on the thread of what that means for outcomes. I do want to ask just a couple clarifying questions around the outlook. It sounded like we had some revenue shift from 1Q23 into 4Q. So if I just add a little bit to 1Q, it really seems like the revenue outlook for the full year is annualizing what 1Q would have been with not much improvement. So just given your comments around expectations for the improving supply chain, I wonder if we could square that up a little bit. You know, how kind of conservative is the outlook in terms of the revenue run rate and what kind of level of increase are you assuming as we go throughout the year?
spk09: Yeah, let me take a stab at that. So the outlook that we provided is based on our current expectations after discussions with suppliers in terms of when supply will will arrive certainly to the extent that the suppliers are able to exceed our current view there is upside to the view but right now what we would say is that we expect gradual improvement through the year and so all things being normal we would expect Q1 to be the low point and we would continue to grow through the year so the range is pretty wide and as you say if you take the kind of high end of the range it's a different assumption than the low end of the range but I do think we will see somewhere around the midpoint or higher of revenue growth, which would be over 6%.
spk14: And the way to unpack that, if I had one additional point of color, is fourth quarter definitely demonstrated the upside potential in terms of being able to turn that revenue. We got components very late in the quarter, and the team really did an exceptional job of turning that. Customers are eager for the products and the technology that we provide. determine as quickly as we can. We do think, as Joan mentioned, that there will be a view of improving supply over the year with variations and some volatility in terms of timing, certainly in the first half of the year.
spk26: Very helpful. I'll turn it over.
spk29: Thank you. One moment for our next question. Our next question, coming from the line-up, Good morning.
spk18: Just a couple quick ones here. I was wondering, Joan, can you quantify what the semiconductor impact was for the quarter and the full year?
spk09: Yeah, I would say the fourth quarter was pretty similar to the prior quarters we experienced in 2022. So, you know, somewhere, call it $100 million or so a quarter, maybe slightly better than Q4. But exiting the year, we probably had about $400 million of revenue that was constrained because of the constraints.
spk18: Got it. And then on the restructuring, just a couple quick housekeeping there. The $14 to $17 million, is the majority of that savings on the cost of goods line?
spk06: Yes. I'd say 80% or so is on the cost of goods line.
spk18: Got it. And then what was the outsourced production mix, and then what do you anticipate that to be sort of post these actions?
spk14: We're probably running around 45%, maybe 50%. It varies a bit quarter to quarter, internal, external today. And I think this takes it up probably another 5% or so. So by the time we finish it off, meaningfully above 50% in terms of the amount of outsourced production.
spk18: Got it. And then my last one. Tom was just on the book-to-bill, obviously a great Q4. You implied that Q1 would be a bit softer seasonally. Do you anticipate it to be above one for the year, or how should we think about just the level of activity that you're quoting?
spk14: We do definitely think that the book-to-bill for the full year will be above one-to-one. The pipeline of opportunities remains very rich, very strong. based on needs from our customers for resiliency, reliability, as well as new technology applications, whether they be consumer side or EV and DERMS integration. So rich set of opportunities and we're or bullish on what the year will bring in terms of bookings. That said, the only caution I would provide is it'll be a little bit lumpy quarter to quarter, just with normal seasonality, as well as timing of individual contracts coming through.
spk19: Great. Thank you. That's all I have.
spk29: Thank you. One moment, please, for our next question. And our next question coming from the lineup, Chip Moore with EF Hutton Group. Your line is open.
spk16: Morning. Hey, thanks for taking the question. Tom, I wanted to ask one on the regulatory environment. It seems like more and more states are looking at performance-based mechanisms to meet their goals. Is that something you're seeing with your customers for some of the more advanced solutions?
spk14: Indeed, the regulatory environment continues to understand the need for new technology and new models. The amount of states that allow some type of performance-based rates or capitalization is nearly 40 out of the 50 right now, and plenty of changes underneath each one of those along the way. So in general, the regulatory model is moving in the direction of enabling the technologies that we've been investing in.
spk16: Great to hear. And Joan, you talked about the weighting in the back half on the guidance. Can you give us any color on sort of mix and perhaps implications for cadence of margins for the year?
spk09: Yeah, I mean, I would say for the full year, we would look at margins being pretty similar to what they what they were in full year 22. So certainly as we get more supply, you get the benefit of more factory, even out the production, and therefore less absorption issues. But we're also dealing sometimes with expedited freight things at that level. So for the full year, I would say 22 levels are pretty consistent. Those will start out slower in the first quarter and then grow through the year. So for the first quarter, I would say the gross margin would be similar to Q1 of last year.
spk16: That's super helpful. And just more housekeeping, Joan, on the restructuring. Can you just remind us where we are on the prior programs, just to keep us abreast with the new program?
spk09: Yeah, the 2020 program is basically complete. And so we still are working on a 2021 program, which should be complete mostly maybe early next year.
spk08: And those are all on track. If anything, the payback's gotten a little bit higher because We just had a little bit less severance than we expected when we first initially booked the plan.
spk09: So those are going according to plan. And again, this one will be, the savings should be complete by early 25. The cash out is really 24 to 26. So really no impact on cash for 23.
spk16: Got it. Okay. And sorry, one last one. It looked like there was an impairment charge on a software project. Any more there?
spk09: Yeah, we had a software project, a cloud-based project going on for really the last couple of years, and we continue to struggle with the vendor in terms of being able to deliver software that was bug-free and meet the functionality that we were expecting. So we made a determination in Q4 to basically exit that project, and what we ended up having to write off was capitalize both external cost as well as internal labor costs for a total of about $8.7 million.
spk08: Yeah.
spk16: Okay, I'll hop back in here. Thanks very much.
spk29: Thank you. And our next question coming from the line of Cassie Harrison with 5% or Yolanda Selfin.
spk03: Hi, good morning, and thanks for taking the questions. So you've previously indicated 2024 OPEX target of, I think, 22 to 23% of sales. 2022 came in at 26%, which is slightly up from 21. And so I'm just curious how you're thinking about the progression of OpEx for 23 and then where your confidence level is on the 2024 target. Yeah.
spk09: So we gave the 2024 targets in the fall of 21. And at that point, we did not expect the kind of supply constraints that we saw in 22 and continue to see in 23. So I would say While those are still our longer-term targets, I don't believe those targets will be met in 2024. That said, the OPEX target of 22% to 23% is the longer-term target.
spk08: It's just I think that's going to be pushed out a year or so as we work through the backlog of the things that have been delayed because of the supply component.
spk09: So still the right long-term targets. Do not expect it to be 2024. Helpful. Thank you.
spk03: And then for my follow-up, I just wanted to touch, just to ask a question on free cash flow. I think you generated just under $5 million in 2022. How are you thinking about free cash flow during 2023? And then to the extent that we do get some sort of, you know, recovering the supply chain environment and you unlock that, you know, $100 million per quarter network solutions revenue, you know, what are, you know, how do you think about use of potential free cash flow?
spk09: Yeah, so the cash flow was a positive 5 million for all 22. It was actually negative in the fourth quarter to the tune of around 18 million. And a lot of that was continuing to invest in inventory. So we'll continue to, as components become available, invest to make sure we've got all the components necessary. My expectation for free cash flow for 2023 is negative for the full year, really for a couple of reasons. One is we have some large cash tax payments due in the second quarter. Those relate to two things. One is settling from international tough tax audits that we had accrued but hadn't paid. But the bigger issue is the legislative change that happened with the 2017 tax reform, which essentially forced you to capitalize the R&D. We were expecting those laws to get overturned, as was everybody else, and they haven't yet. So the current tax law relative to the capitalization of R&D creates quite a bit larger cash tax payments. So as an example, just cash tax alone is going to be up something like $25 million year over year. In addition, we will continue to invest in working capital as we grow the business. So our guidance is to grow the business. And typically when that happens, you've got to grow some receivables. And as I mentioned, we'll continue to make sure we grow. So while it's negative for the full year, I expect it to turn in the second half. So expect Q1. And Q2 to be negative, Q1 also is the quarter where we will pay a discretionary bonus to the non-executive team. And Q2 is the large cash payments. By the time we get to Q3 and 4, where earnings are starting to improve versus the first half, I expect cash flow to be positive. But again, for the full year, something in the range of like minus 25 to minus 35 million.
spk00: Helpful. Thank you.
spk29: Thank you. And our next question coming from the line of Ben Keller with Baird, Elon is now open.
spk28: Hey, good morning. Thanks, guys, and congrats on the bookings. Just quickly, maybe, Tom, just the environment for new projects and maybe bookings this quarter explains it all, but, you know, there's been some reports of smaller utilities, more beauty co-op of, you know, not being able to implement new because of the rise in electricity prices. That's affected you guys at all. I'll have a couple of follow-ups.
spk14: Very good. So the bookings environment or the pipeline of opportunities, maybe correctly stated, continues to be very robust. The need for investment in resiliency and reliability, whether you are a large or small utility, are there. The need to prepare your environment for growth in EVs and continued growth and things like rooftop solar means an awful lot of investment in the distribution grid. So we feel very bullish about what the future will bring for us in terms of demand from customers and That is something we hear directly from customers. The range of opportunities continues to expand. We launched a product called the Distributed Intelligence Network Interface Card really that allows us to put DEI into third-party types of devices like smart panels and others to again continue to broaden out the range of applications. On your point about smaller utilities delaying investments based on affordability and energy prices, I would say I've seen that on occasion, but it certainly hasn't been widespread. There are a broad range of municipalities and cities that are investing And investor IOUs have been investing very aggressively in driving up the big bookings projects that you see in our backlog today. The work that's going on certainly is a multi-year and probably a multi-decade growth in terms of needs of the electricity grid and water systems. And that is good future growth for the company.
spk28: Thanks. This portion of the backlog was signed before we got to the inflationary environment, and just how do we think about that backlog in pricing, how that impacts margin, or if you're able to reprice with customers going forward?
spk14: Sure. I can jump in on that one, and then perhaps, Joe, you want to add anything additional. work that we've been doing over the last year plus on changing contracts for new agreements to provide a little bit more flexibility around pricing specifically in the inflationary environment that has has gone well and i would say that that majority of new bookings are in a place where you've got a little bit better protection against inflation That said, we still have a fair amount of overhang of bookings prior to that change in our operations more than a year ago. And that work has sometimes been with us and sometimes we haven't been able to achieve a price increase. So I would say that in terms of backlog with inflation protected, we're above a third, but probably less than a half in terms of what the size of that is. But new projects, as they continue to roll through and as deliveries happen, it rolls off that stuff where we do have a margin pinch and gets us into a better zip code from a margin perspective.
spk28: Just maybe lastly, just could you remind us of the cadence of, especially on outcomes? I think I saw the service revenue tick up more, but just like on the trajectory of how things get implemented with service before it hits something else and then the different margin profile. Thank you, guys.
spk14: Sure. So a few stats on the outcomes side of things that I think are helpful. So roughly 75% of that revenue is recurring revenue. The majority of that is sort of staffs or service-based revenue, which has a meaningful higher margin, which is why outcomes tends to run material above in the gross margin line compared to networks or even devices. The timing of outcomes revenue is generally, let's call it 18 months after The network deployment in terms of timing, it changes a little bit project to project, but that's a good thumb of the year number to understand what the timing would be. And that revenue tends to come over a very long period of time. So I think 10-year SAS or managed service agreements, you get that revenue over a very long period of time.
spk29: Thank you, and our next question coming from the lineup, from Price with Raymond James. Your line is now open.
spk21: Hey, Pavel Molchanov here. Thanks for taking the question. Same question I asked a few months ago. In this kind of quasi-recessionary environment, is there any improvement in terms of multiples from an M&A perspective as you look at private companies?
spk14: I think that valuations are certainly coming down. There's still a meaningful difference between, I would say, hardware valuations and software valuations, where software tends to be a bit higher. But, indeed, valuations are coming down a bit. Large-scale enterprise software evaluations still tend to be pretty rich compared to the traditional valuations that you've seen. But it comes down a little.
spk21: Okay. Can you get an update also on demand response business? I mean, you know, it's obviously one slice of outcomes, but, you know, we get these extreme weather dynamics, which, you know, I would imagine is pushes up the appetite among ISOs for demand response.
spk14: Indeed, the demand response world continues to move along pretty nicely. And honestly, what I've seen is not only using that capability from a traditional demand response, let's shave the peak off and deal with a very high pressure kind of situation, using that capability much more as a normal course of practice to understand when to charge things like EVs and how to use rooftop solar much more effectively. So I think it's moving from a demand response peak shaving kind of situation to much more of a localized control for distributed energy resource management is where the industry tends to be heading, and a lot of the discussions we have with our customers encompass both of those use cases.
spk20: Understood. Thanks very much.
spk29: Thank you. And our next question coming from the lineup, Martin Muller with Johnson Price and Company. Your line is open.
spk17: Thank you for taking my question. I wanted to ask about the guidance. And I would have anticipated for the level of revenue that you're guiding to that the earnings per share would be higher. Could you maybe give us some help in terms of the magnitude for the variable comp that you talked about and also any help would be appreciated on the gross profit margin side?
spk09: Yeah, I think I answered the gross profit already. So from an annual perspective, you know, think at or slightly above the full year 2022 level. In terms of OPEX, I think you sort of talked about that one, which is we're going to continue to be a little bit higher if the revenue is not at the scale level. So for OPEX, you know, I think it's also in the percentages. similar to 2022, which would imply higher dollar objects between 22 and 23. And as I mentioned on the call, I think a lot of that is the variable comp. So really don't want to talk about exactly how much our variable comp is, but it was, you know, material or materially enough that, you know, we mentioned it. The other thing I would point to 2022 EPS versus 2023, we normalized it. for you in the discussion point. So the tax rate in overall 22 was 4%. The tax rate in 23 is 28%. And so we had a lot of favorable discreet, mostly linked to statute of limitations, expirations in 22. If you normalized for the same tax rate year to year, 2022 would have been 85 cents. The midpoint of our guidance is 90 cents, so roughly a 6%. And again, We've built the guidance based on our current view of supplier commitments, and to the extent they're better than that and more predictable, we'll be in a position to update the guidance in the August time frame.
spk23: Okay. That's helpful.
spk17: Then in terms of the record backlog here, can you break down maybe how much of that is outcomes and how much of that is network solutions?
spk09: Yeah, I mean, over 90% is networks and outcomes. It doesn't materially change much from quarter to quarter. Okay.
spk17: Thank you.
spk29: Thank you. And I will now turn the call back over to Mr. Tom Dietrich for any closing remarks.
spk13: Very good. Thank you all for joining us today. We look forward to updating you on our progress after Q1. Thanks, all.
spk29: Thank you. Thank you for your participation. You may now disconnect.
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