Welcome to another Motley Fool conversation. I'm Andy Cross. Joining me today is the CEO of ITRON, Tom Deitrich. Tom, welcome to the Motley Fool. Great to have you here.
Andy, it's wonderful to be with you. Thanks.
We're excited to talk to you about your company. It's a $3 billion market cap leader in electric water utility grid intelligence. Now, Tom, I want you to start off with just kind of laying out for us ITRON's business, the advantages you have and what you're really trying to solve with a grid that I think all of us are just seeing more and more demands on the electricity and water usage from both consumers, businesses and governments around the world.
I think you captured the essence of what I'm about to say with your preamble there. But ITRON has been in the utility services and technology space since way back in 1977. So working with utilities all around the globe, we're fortunate enough to call about 8,000 utilities around the globe our customers today. And we participate in the electricity, gas and water space. So anything that is coming into your home or your flat, we probably have a position on it. Our largest market is clearly North America, where we're about 60 to 70 percent market share in both electricity and in gas in the communications networks. So all across the country and the globe, our products are used. What are we really thinking about and what are our customers up against? Those are really the two sides of the same coin from my point of view. We very much focus on how we can improve the efficiency, reliability, affordability of those services coming into your house.
The world is up against some really, really big challenges. And I put those challenges into three buckets. The first one being infrastructure related challenges. You referenced it higher and higher demand, AI data centers, reshoring and manufacturing, electrification of pretty much everything. We as consumers are using more and more energy. On the water side, water is a precious resource. And how can we do a much better job with that? On the electricity side, again, we have more and more renewables being integrated into the grid, which is great from a sustainability point of view. But now you've got variability in generation. If you had a coal plant, it produces the same amount all day every day. With wind and solar as an example, now you have some variability that you need to cope with. That infrastructure is under greater and greater attack physically and cybersecurity-wise. So what can we do to really meet that moment from a demand growth perspective and a reliability perspective from infrastructure?
Second bucket of challenges is the environmental piece of this. Doesn't matter where on the planet you are, floods, fires, storms, hurricanes, heat waves, cold waves, all of these things are clearly happening more and more frequently. And when those things happen in a particular area, it puts tremendous stress on those assets that are out in the field. When it wasn't designed to be 20 degrees Fahrenheit in Texas, something really strange happens to the grid here, where I live. Meanwhile, wildfires in California, flooding and hurricanes in the southeast, you name it, you've got it somewhere.
Third bucket of challenges then is the world of the consumer. We as consumers have been trained by using that little computer in your pocket to understand when you ordered your dinner from a delivery service, where it is and how much it's going to cost and what the drivers, previous customers thought about them and right up until the moment you can track it until it's outside your front door when you've got something good to eat in the evening. That real-time service capability is not the same experience you have, I would suspect, in dealing with your utility. You know what your light bill is going to cost at the end of the month when you pop open that envelope? That service imbalance creates a real opportunity for us. Those are the three big buckets of challenges we are working to solve for our customers and want to work really hard to make sure we can improve resiliency, reliability, and affordability for all.
Tom, talk a little bit about some of the actual solutions, the hardware, the software that you're offering. I want to talk about your business line units because they're interesting. The business has really evolved over the really since you became CEO and continues to evolve a lot more towards the software side. Just break it down. You have millions and millions of monitors out there. Just give us a sense of what someone physically, what does an ITRON solution look like?
Sure, happy to do so. I will use the segments that we report in from a Wall Street point of view as the basis for it. We have the device. That's something that is stuck on the side of your house. That meter in the backyard is most likely one of our products. That is something that takes a measurement, performs an action. Those are largely within our devices portfolio. The network's portfolio really is something that is capable of communicating all of the data that's produced by those devices in a secure and robust manner. Let's grab all that data and bring it back so that you can do something like billing determinants. How many kilowatt hours did you use the last month? Then you can figure out how to send Andy the bill at the end of the month. That software piece doing something interesting with the data is what happens in our outcomes segment.
When we sell something to a customer, oftentimes it is the outcome, meaning the top piece of what I talked about there, the network and the device to create a complete solution. What we sell, obviously, is basic meter-to-cache of services. I'll call that the baseline of the easiest problem that we solve, which is just automate the billing cycle, make it more accurate and make it work. But now when you have that device that's on the side of the house that can do lots and lots of different things, our current generation of devices is much akin to a smartphone. You can download different applications into it to do different services overall. You can now start to use that data to solve new and interesting problems.
You can coordinate charging. So if you do have a level two EV charger inside of your house, rapid charger, and you only have a 100 amp panel on the side of the house, you can spend $50,000 to get a new circuit to the house and a new panel, or you can coordinate when various things are happening. Hey, when I'm using the microwave and the air conditioner, I'm going to turn down the rate of charge and charge at a slower rate and live within my 100 amp budget on the side of the house, or maybe when the air conditioner stops running and we're done cooking dinner, we can turn up the rate of charge and charge the car a little bit faster. But it's a way you can use the power of software and coordinating devices to create new ways to save everybody money and provide more resilient reliable service. Perhaps a silly example, but that's really where the industry is going and how we can put all of the distributed energy resources, rooftop solar and EVs and batteries in people's garages to work.
We can make the grid more efficient by coordinating when certain things happen on the grid. We can make it more reliable because we can start to see when components in the network are starting to go bad. Hey, this transformer is starting to go bad. The way it used to work is the transformer would pop and you'd have an outage and the utility would roll a truck and they would fix it. Now you can start to see when it's going bad so you can proactively get a new transformer out on site. Instead of having a two day outage, maybe you have a four hour outage while you change the transformer and prevent a bigger issue, but improves the reliability and performance of the network by putting all this data to work. That's what we do in essence and you can propagate that simple mindset across what happens in the gas world. It's very safety oriented. What happens in the water world, which is how do we find leaks? 30% of all cleaned and pumped water is lost on the way to the consumer through leaks in the system. I can't think of another industry. Well, okay, maybe another legal industry where 30% of the product is lost on the way to the consumer, but yet it still powers on. We can do so much better by putting technology to work to solve these problems.
And as it pushes near 100 degrees here on the east coast, as you mentioned, just the challenges unfortunately that we're having with weather factors, maintaining the integrity of the grid. Would we know what a consumer, I guess maybe first of all, do you have a sense or can you break down the sense between the consumer and businesses or governments? I don't know if that's something that you do reveal. But would we know if ITRON is or one of our electric, our utilities is a client of ITRON?
Well, I mean, certainly, if you did enough digging in public records, I'm sure you could figure it out. Or if you even walked to the backyard, you could figure it out because you could find a logo there. But you know, by and large, what I would say is we're probably present somewhere. You know, seven out of the top 10 urban areas in the United States are ITRON clients today in terms of our network. And even if it isn't our network, there's a piece of software or another piece of hardware somewhere out there. In many ways, we're pretty pervasive. And in many ways, invisible. I'd like to be the umpire at the baseball game. At the end of the day, if everybody's talking about the play of the game, rather than the bad call the umpire made, you know, that's probably a pretty good day for the umpire. I'll take that role for ITRON in terms of just making everything work just a little bit better for all of us.
And all right, is this one question as I first started learning about your company, is why are utility companies just doing this all in house themselves? Like why even need someone like ITRON to come in and perform those tasks and offer those services?
Yeah, I would say that the networking effects and the scaling that you get is really an important part of this. Where I think it makes an easy example is a lot of the advanced services that I was talking about that's housed in our outcome segment, doing smart things with the data to make everything work better together. Utilities over the last couple of decades, to be honest, had built a lot of homegrown systems, cobbled something together because there wasn't another offering that was out there. But that's hard to maintain. And as the utility workforce is turning over, five or 600,000 utility workers are going to retire over the next five to 10 years. That brain drain from the utilities is a real issue that I think needs to be addressed systematically. And that's kind of what we are also trying to do within our resiliency solution segment, which I didn't touch on earlier, but we have an application that goes into the ruggedized iPad, if you will, that's out in the field. So when those utility workers, you see them out on the street in their hard hats, if you have a lot of gray beards like me that are out there, that they know what to look for in a safety kind of environment when they're trying to set up for a job to make sure everybody comes home safe in the evening. If you're new to the industry, maybe you don't. So why not put the power of AI to work to look for those hazards and make sure, again, that we keep all those workers safe out there? But that's another way we can bring new technology to help deal with a really important challenge that utilities are up against, which is that workforce transition.
Our water meter here in my house is in a bad location and it's difficult for the water company to access it. And just yesterday I saw them walking in my backyard looking for it and I came out there and I said, I have to take a picture of it for you, the water meter. And then he was, I said, I know there are now remote devices that they attach and it's all done with Wi-Fi and he's like, yep, just call the company and we can help set it up. But what I got thinking about is the changing dynamics of the workforce that is now becoming more and more technical. And of course, there's lots of conversations about the white collar workforce with AI. But so many jobs are becoming now really engineering. I know you have an engineering background or becoming very engineering focused that speaks, I think, to the types of solutions and products that ITRON is offering.
Indeed, indeed. Using that water example and building on top of it, just the automation in the water system is absolutely, that's probably one of the primary use cases and drivers. You don't have to know precisely where it is because the wireless communication will just pick it up and read the information and provide it. But you also now have a really interesting set of data. Instead of sending somebody into your backyard once a month to take the read, you can now do it every day or every hour or every five minutes if you like. And if you start to see a continuous leak, meaning just something continuing to run, you can proactively alert the homeowner, hey, I think you have a leak. Maybe you left the hose on in the backyard, which wouldn't be great, or maybe you've sprung a leak inside the house and your hardwood floors are about to need to be replaced. But being able to catch those things and automatically monitor what's going on is just a benefit out of the automation itself. So those communication modules, that device that you mentioned so that the fellow doesn't have to come in the backyard, that's probably our largest volume product here in the United States.
Will it eventually be controlled and monitored by the consumer or is it now where I have a dashboard of all my utilities and is it real time, can he monitor?
There are examples of that today. I would suspect that it won't be controlled by the user just because it is a utility asset and the user for billing and efficiency back into the network. But giving you real time insight into how you're using that service absolutely fits into that bucket three challenge that I was talking about earlier is helping you understand how you're using the commodity. So I'm fortunate enough to have a second property. And when I'm not at that property, I would love to know what's going on if I have a water leak. So I can bring it up on my phone and see what was my water usage in the last five minutes, last hour, last three days. And you can really watch these things happen in quasi real time. That consumer engagement I think is very, very important. If we ever want to get to a world where those consumer assets are used in a coordinated fashion, if you're going to allow the utility company to use that battery in your EV to provide that power back to the grid, because everybody's trying to keep rates down for everyone else, you have to have confidence it isn't going to be flat when you go to the garage in the morning. Do you have that level of trust in your utility today? I would say no, quite often that is the case. And what's the bridge to bridge that trust? It is helping the consumer understand in real time how they are using the service that way you can see it. You don't have to just blindly trust.
Just getting to a little bit more of the business side of ITRON, the network solution is by far the biggest and it's been the I think the highest and fastest growing part of your business out of, you know, maybe two and a half billion or roughly in annual revenue. The network solutions about one and a half of that just using kind of rough rough numbers. Just talk to us a little bit about the different business units and then just a little bit of the growth profile or lack of the growth profile as the business has evolved over the last five years.
Sure. So each of our business has a financial role to play in terms of the total model. So devices, what we've run very much for profitability and not necessarily for revenue growth. It's a lot of international markets where we will continue to work to get a good return and provide a good product but maybe they aren't the area that we would want to grow. That device's business was closer to 900 million dollars annually just a couple of years back. It's more like 400 to 450 today and that's just fine. Part of our margin progression story that you can see in the company level was to improve the overall company margin and financial return and exiting some of those markets and products that didn't make sense was an important part of it. So think about devices is there to generate profitability and that's the main metric we use.
Networks is a growth business for us. We want to make sure we can cover as many use cases as many locations around the globe as we can do so. But given the scale that we are at it's 1.6 billion per year and we're 60 to 70 percent market share we're kind of going to grow with the market itself which is a few percent per year in the utility space. So think of it as low or single digit kind of a growth on a compounded annual basis. Outcomes which is double digit growth year over year is the growth business doing more with the data. The more endpoints we have in the field the more target rich the environment is the more problems you can solve and that really is the growth vector. That business has been growing nicely for us double digit year after year and resiliency solutions ought to be, you know, teens to 20 percent growth for us at 70 percent gross margin so call that the icing on the cake and the fastest growing business in the years ahead. So that stack and that progression is how we are right in the business. If you watch over a long period of time okay our revenue was kind of flat for a couple of years as we had exited those hundreds of millions of dollars of business that didn't make a lot of sense for us and consolidated our factory footprint. We're getting to the really interesting part of the story now where that remedial work is now complete and we can focus on the growth story moving forward. Margins did exactly what we wanted to do and now revenues will start to do the same.
Will utility, will client subscribe or contribute to all four of the business units as part of a contract or a relationship with ITRON?
Indeed yes. Generally when we work with a customer, you know, we're present with our customers for decades at a time, right? When an asset goes in you want to use it over a long period of time and you want to make sure that it's agile and flexible so you can add software capability to it but have those things that are out in the field last a long time. Taste great, less filling, make sure that that just carries on and works for us. So in general our contracts with customers are multi-decade and they involve all four of those business units and if I have anything to say about it, it'll just continue to be so.
Are the contracts mostly based on volume size? How do you go about pricing the different solutions?
Yeah, it depends on the individual element inside of it. Clearly the hardware itself is a one-time sale, right? You sell it, they buy it, transactional sale, so be it. A lot of the software and services we do is it shows up as recurring revenue for us and it is subscription based or term license based with a renewal component. We finished up last quarter with about 414 million dollars in ARR, annual recurring revenue. That's up 28 percent year over year and we look to continue to enhance our business. The idea from a business model perspective is not at all to turn, you know, become a software company. We want to be a systems and enterprise company so think of it as iPhones and iTunes, right? If you want to have both ends of that and make sure a virtuous circle is available to solve more and new and interesting problems.
Is the sales process, maybe a little bit about the sales process, like just like your workforce going out there drumming up business. What is a typical kind of like sales cycle look like? All those kinds of things that get into it and then we'll get into a little bit more of the financials.
Sure, so selling process, you know, we have an account lead for a customer. As I said, we've been hanging around the industry now for four decades or so so everybody knows us and we know them. And so you've got an account lead that is working with a particular customer. The sell-in process for a new technology is probably a two-year effort. You're starting to look at, you know, what the customer needs. Remember utilities plan over a decade kind of time frame. I know, you know, it's really interesting these days to talk about AI data center growth and the industry just wasn't designed about need a gigawatt by Tuesday. That's just not how the industry from the utility side is working so we got some problems to solve there which we can get into but think of it as a two-year sell-in cycle then something is awarded then we would negotiate for a contract then it would receive regulatory approval and then we would register a booking and a big project lasts three four years with a customer. So it's kind of a long train, you know, to go work it through and do that deployment and once you're through the three or four year deployment phase for a big project then you're going to run it for the next decade or two so you get the recurring revenue that happens after that but that's the long chain of events and what the real sales cycle looks like for long cycle projects. There are clearly pieces that go faster than that but that's the big project.
Excellent, thank you. And I know the regulatory environment I imagine state-by-state area by area is different but just talk to us a little bit how does that evolve? Is it in general, has it worsened, has it gotten better? Is it more stringent as the demand for electricity and water and gas has increased?
Sure, so you nailed it. 50 states, 50 regulatory commissions that are all, you know, working hard to do their job for us as consumers and thank god that they are, right? So that structure exists for a perfectly good and rational reason. What I've seen from technology commissions is the market is clearly moving. Seven years ago the idea of doing something in a cloud just didn't make, you know, sense to folks. What, you know, we get, you know, the view of I want to pay the utility to recover on the capital that they spend so utilities were more or less incented to spend, you know, money and maybe they were starting to be pushed to spend money and doing things which are better done with something like a cloud service and take advantage of those economies of scale. The market is clearly moved and the regulators understand much better today and how that can work overall. Commissions are largely leaning into the idea of resiliency. What can we do to get ahead of things like wildfire risks? Should we be undergrounding, things of that sort? The regulatory environment I would say is constructive. Rate cases are absolutely being approved and they're being approved with a good rate of return. We're, I don't know, 9.8, 9.9 year to date in terms of greater return so it's happening. That said, the countermeasure is affordability is a real issue. So what we see in the environment, you know, maybe today over the last let's say four quarters or so is a mindset which is let's measure twice before we cut once. So rate cases are being approved when properly articulated but they're going to put you through your paces to make sure that everybody is optimizing the financials from the view of the rate payer, the utility, and that of course rolls through to our pricing structure overall.
The backlog right now that you have is about 4.4 billion. The book to bill ratio is around, you know, 0.81 somewhere in that line. Is book to bill the ratio not the best metric? Is it a metric that the industry kind of talks on but your business is moving on beyond that?
Yeah, it's, I mean, you've got exactly the right numbers so I don't think book to bill in any one quarter is particularly interesting, right? Why? Because when it goes into backlog it's only going to flow out the P&L over the next four years so if you're trying to use book to bill this quarter to say something about what my revenue is next quarter I can assure you you're not looking at something that's going to be a meaningful predictor of the future. Okay, yeah, book to bill over multiple quarters clearly has, you know, there's some validity to it but I would very much encourage folks to look at, you know, the total backlog as a predictor and is where is that going and then, you know, what mix of hardware and software do we actually have inside the business. The more we mix towards more of those software and services that kind of has a different rhythm and flow to it and it has more juice than the lemon meaning the margins are a bit higher on that piece of it so it tells you more about their future earnings growth and where we actually are. So total backlog is probably more meaningful than book to bill. Certainly in any one quarter book to bill is not particularly relevant.
Our co-founder and CEO and one of our lead advisors or investors Tom Gardner asked me this question last week in a conversation. If I had to pick metrics and ranked order between sales growth, gross profit growth and returns on invested capital, which one would I prefer to see kind of accelerate and improve? And I chose gross profit growth as I preferred and even before I kind of was thinking about your company but I think that is, that been the strength for ITRON? Sales are kind of, you know, in the flatish low single digits but the gross profit growth has really been the story.
Indeed, and I think that, you know, just gross margin in general and gross profit growth is a predictor of the quality and the value that you're adding for your customers. They're going to pay for something that creates real value for them and that's where it shows up. So the team has worked incredibly hard and done a lot to improve our gross margin. We're topping out at record gross margins here the last couple of quarters and that's where I really wanted to focus especially as we had to change the portfolio. You can't cut your way to greatness so revenue growth does matter and I would put that as, you know, sort of number two and I would expect you'd start to see that in our P&L over the years ahead but those are the metrics that I really really think about. We are a very capital efficient company so we only spend less than 1% of sales on capex. It's not capex heavy so ROIC is again, it's much more a gross margin, gross profit, earnings kind of view is the right way to value our company.
Yeah, but the return on capital has improved nicely over the last. Absolutely. So it does flow into that. I want to talk a little bit about some of the acquisitions you made because they happened, some meaningful ones in Urban and Locust View. Talk a little bit about those two big acquisitions, what they, why go external versus a kind of like why buy versus build, what they're bringing in and then just maybe acquisition strategy in general for ITRON over the next say five years.
Sure. So the two acquisitions that we've done in the last year, Urban and Locust View, let me unpack what they are for the moment. Locust View, a company that automates the construction management process for a utility. If you're going to go bury a bit of pipe as a gas utility, you've got to keep track of, you know, the materials that went into that and really importantly you have to keep track of where that pipe is located as a decade on, you know, you go find that in the field. This is not as easy as you would like so good GPS coordinates is wickedly important. The way it traditionally works in the utility space is the folks that are in the hard hats, you know, burying the pipe, they're writing down the numbers on a clipboard. The clipboard gets tossed on the front seat of the pickup truck and you hope six months from now it makes it back into the system of record as the project is completed. If we can do it on the spot so, you know, put it in an app in a mobile device out in the field, capture those GPS coordinates immediately, you now automated the entire process. You have an accurate location, you've got the material records and oh by the way the contractor who's in the field doing that burying, the guy on the backhoe is happy because he'll get paid faster because you won't pay them until you're sure it's been done. So it automates that entire cycle for construction management.
What does it bring to ITRON in a material sense is those GPS location coordinates are very very important because we can do something interesting with it. We have known for a decade what's inside of pipes and wires but not physically where they are located. So we can see electrically when trees are rubbing up against wires, it'll create a particular electrical signal. So we could say hey you got something happening over here but then the utility had to try to figure out how to match that electrical signal to the GPS signal. So if we've got that GPS data we can put those two things together and say roll truck, prune tree before the wind blows and you prevented an outage or a catastrophic fire or something of that sort. So combining those data sets creates new opportunities and new ways we can help our customer. So that's Locust View.
Urban is involved in worker safety and emergency preparedness and response. I talked about the need for worker safety and how that works a moment ago but emergency preparedness and response, storm response is really what that application is all about. If you can pre-position the crews before the hurricane comes ashore, they will be in the right spot to put the system back together again when the wind stops blowing. If you can use an AI model to understand storm track and where it's going to go and where your assets are and where the conditions of those assets, you can predict how many outages you're going to have, bringing the right number of crews from all across the country, create a marketplace to recruit those crews and get people to sign up and then pre-position them and when they're out in the field doing that hard work, figure out how to get them a bed and a hot meal in the evening. So automate that process as well and really help with that storm response and create a dashboard for the utility exec that's got to go in front of the camera in that storm response saying here's how many we fixed and here's how many there are but now you have real-time information about what that looks like. That's what Urban does and bringing that AI expertise and that model to be able to do that predictive management is what it was all about.
Overall the strategy is let's be with our customers every step of their asset journey from planning it to building it to operating it to protecting it and maintaining it. Let's automate that entire process and make sure that we can bring good services and technology to bear to be able to solve it. That's what those companies brought to us and the overall strategy of what we're trying to do.
You spend about, I try and spend 200 million-ish on research and development a year and it's about 10% of the sales. Just talk about the decision to look external to buy this capability versus actually just trying to build it internally yourself and the balance between those two internal external funding sources.
Yeah, make versus buy is, you know, it's a real trade-off that you would make. In these particular cases these companies had a ready-made platform. The really really hard part about breaking into the utility industry is creating something which is truly scalable just because of how utilities are unique to their own space. Everybody's got a different geography, everybody's got a different commission, everybody's got to live with the decisions they bake for decades and decades. So there is no one utility that looks like another. So creating a platform that you can scale across multiple utilities is not for the faint of heart. Many startups try to get into the space and they break into one utility and then they realize they have to fundamentally redesign their platform to get customer number two and three and four. And so, you know, finding something that brought new capabilities to us on day one, GPS coordinates and AI storm modeling was good and scalable platforms is why we pulled the trigger to do these acquisitions. But that notion of that resiliency platform all the way through the asset life is really what I'm driving to and that'll be sort of the next growth vector as we continue to just do more with the data on the operational side of things. So the engine of the company is great and financially sound and solid and how can we enhance growth is really what I was trying to do with these acquisitions.
What's the hardest thing about bringing in these acquisitions into the organization?
