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BMI > SEC Filings for BMI > Form 10-Q on 26-Jul-2013All Recent SEC Filings

Show all filings for BADGER METER INC

Form 10-Q for BADGER METER INC


26-Jul-2013

Quarterly Report


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

Business Description and Overview

The core competency of the Company is flow measurement solutions. The Company is a leading innovator, manufacturer and marketer of flow measurement and control products, serving water and gas utilities, municipalities and industrial customers worldwide. Measuring a wide variety of liquids ranging from water and oil to lubricants in industrial processes, the Company's products are known for their high degree of accuracy, long-lasting durability and ability to provide valuable and timely measurement information to customers. The Company's product lines fall into three categories: sales of water meters and related technologies to municipal water utilities (municipal water), sales of meters to various industries for water and other fluids (industrial flow) and sales of concrete vibrators and gas meter radios to unique markets (specialty products). The Company estimates that over 75% of its products are used in water applications when all categories are grouped together.

Municipal water, the largest category by sales volume, includes water meters and related technologies and services used by water utilities as the basis for generating water and wastewater revenues. The key market for the Company's water meter products is North America, primarily the United States, because the meters are designed and manufactured to conform to standards promulgated by the American Water Works Association. Sales of water meters and related technologies and services are commonly referred to as residential or commercial water meter sales, the latter referring to larger sizes of meters.

Industrial flow includes products sold worldwide to measure and control materials flowing through a pipe or pipeline including water, air, steam, oil, and other liquids and gases. These meters and valves are used in a variety of applications, such as water/wastewater; heating, ventilating and air conditioning (HVAC); oil and gas; chemical and petrochemical; food and beverage; and pharmaceutical production.
Specialty products include sales of radio technology to natural gas utilities for installation on their gas meters, and concrete vibrators.

For municipal water, residential and commercial water meters are generally classified as either manually read meters or remotely read meters via radio technology. A manually read meter consists of a water meter and a register that gives a visual meter reading display. Meters equipped with radio transmitters (endpoints) use encoder registers to convert the measurement data from the meter into an encrypted digital format which is then transmitted via radio frequency to a receiver that collects and formats the data appropriately for water utility billing systems. Mobile systems, referred to as automatic meter reading (AMR) systems, have been the primary technology deployed by water utilities over the past two decades, providing accurate and cost-effective billing data. In an AMR system, a vehicle equipped for meter reading purposes, including a radio receiver, computer and reading software, collects the data from the utility's meters.


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Fixed network advanced metering infrastructure (AMI) systems continue to build interest among water utilities. These systems incorporate a network of permanent data collectors or gateway receivers that are always active or listening for the radio transmission from the utilities' meters. AMI systems eliminate the need for utility personnel to drive through service territories to collect meter reading data. These systems provide the utilities with more frequent and diverse data from the utilities' meters at specified intervals.

In 2011, the Company introduced what it believes will be the next generation of metering technology, advanced metering analytics (AMA), along with a host of automated utility management tools to facilitate the ability of water and gas utilities to increase their productivity and revenue, as well as proactively utilize their data. AMA is comprised of ReadCenter® Analytics software coupled with ORION® SE two-way fixed network or GALAXY® one-way fixed network technology, which is complemented by a family of highly accurate and reliable water meters.

The ORION SE system can operate as a mobile AMR system, a fixed network AMI system, or both. For example, a water or gas utility can begin deployment in mobile mode and migrate to a fixed network system. Also, if the system is operating in fixed network mode and the collector network goes down, the system will automatically revert to mobile mode, allowing the utility to continue collecting readings. Once the collector network is back up, it will automatically revert back to its fixed network mode. By using AMA, utilities will be able to proactively manage their day-to-day operations through powerful analytics-based software and a fixed network meter reading system.

The Company's net sales and corresponding net earnings depend on unit volume and product mix, with the Company generally earning higher margins on meters equipped with radio technology. In addition to selling its proprietary radio products, including the ORION radio technologies and GALAXY AMI/AMA system, the Company also remarkets the Itron® radio products under a license and distribution agreement with Itron. The Company's proprietary radio products generally result in higher margins than the remarketed, non-proprietary technology products. The Company also sells registers and endpoints separately to customers who wish to upgrade their existing meters in the field.

The proprietary ORION endpoint technology has been licensed to other technology providers on a non-exclusive basis, including those providing radio products that communicate over power lines, broadband networks, and proprietary radio frequency networks, allowing ORION a distinct advantage in the radio solutions market. In addition, the ORION universal gateway receiver transmits data over a variety of public wireless networks, which allows for strategic deployments, such as monitoring large commercial users.

Water meter replacement and the adoption and deployment of new technology comprise the majority of water meter product sales, including radio products. To a much lesser extent, housing starts also contribute to the new product sales base. Over the last decade, there has been a growing trend in the conversion from manually read water meters to radio technology. This conversion rate is accelerating and contributes to an increased water meter and radio solutions base of business. The Company estimates that less than 30 percent of water meters installed in the United States have been converted to a radio solutions technology. The Company's strategy is to fulfill customers' metering expectations and requirements with its proprietary meter reading systems or other systems available through its alliance partners in the marketplace.

Industrial flow and specialty products serve niche flow measurement and control applications across a broad industrial spectrum. Specialized communication protocols that control the entire flow measurement process drive these markets. The Company's specific flow measurement and control applications and technologies serve the flow measurement market through both customized and standard precision flow measurement technologies. Business Trends

Increasingly, the electric utility industry relies on AMI technology for two-way communication to monitor and control electrical devices at the customer's site. Although the Company does not sell products for electric market applications, the trend toward AMI affects the markets in which the Company does participate, particularly for those customers in the water utility market that are interested in more frequent and diverse data collection. Specifically, AMI and AMA technologies enable water utilities to capture readings from each meter at more frequent and variable intervals.

The Company sells its technology solutions to meet customer requirements. Since the technology products have comparable margins, any change in the mix between AMR, AMI or AMA is not expected to have a significant impact on the Company's net sales related to meter reading technology.


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There are approximately 53,000 water utilities in the United States and the Company estimates that less than 30 percent of them have converted to a radio solutions technology. Although there is growing interest in AMI and AMA communication by water utilities, the vast majority of utilities installing such technology continue to select AMR technologies for their applications. The Company's ORION technology has experienced rapid acceptance in the United States as an increasing number of water utilities have selected ORION as their AMR solution. The Company anticipates that even with growing interest in AMI and AMA, AMR will continue to be the primary product of choice for a number of years. For many water utilities, AMR technology is simply the most cost-effective solution available today. However, with the introduction of AMA, the Company believes it is well-positioned to meet customers' future needs.

Acquisitions

On April 1, 2013, the Company purchased Aquacue, Inc. ("Aquacue") of Los Gatos, California. The Aquacue acquisition provides the Company with intellectual property that complements and expands the Company's advanced metering analytics offerings by adding an integrated software platform that allows utility managers to monitor and control their water systems, while providing water management data to consumers. Sales of Aquacue products were immaterial during the three months ended June 30, 2013. The purchase price was approximately $14.0 million in cash, plus a small working capital adjustment. The purchase price includes a final $3.0 million payment of which half is due January 1, 2014 and half is due October 1, 2014. This acquisition is further described in Note 5 "Acquisitions" in the Notes to Unaudited Consolidated Condensed Financial Statements.

On January 31, 2012, the Company completed its acquisition of 100% of the outstanding common stock of Racine Federated, Inc. of Racine, Wisconsin and its subsidiary Premier Control Technologies, Ltd. located in Thetford, England for approximately $57.3 million in cash, plus an estimated working capital adjustment of $0.3 million. Racine Federated manufactures and markets flow meters for the water industry as well as various industrial metering and specialty products. These products complement and expand the Company's existing lines for the global flow measurement business. This acquisition is further described in Note 5 "Acquisitions" in the Notes to Unaudited Consolidated Condensed Financial Statements.

Revenue and Product Mix

Prior to the Company's introduction of its own proprietary radio products, for example ORION and GALAXY, Itron water utility-related products were a dominant radio products contributor to the Company's results. Itron products are sold under an agreement between the Company and Itron, Inc. that has been renewed multiple times and is in effect until early 2016. The Company's radio products directly compete with Itron water radio products. In recent years, many of the Company's customers have selected the Company's proprietary products over Itron products. While the Company's proprietary product sales are generally greater than those of the Itron licensed products, the Company expects that Itron products will remain a significant component of sales to water utilities. Continuing substantial sales in both product lines underscores the continued acceptance of radio technology by water utilities and affirms the Company's strategy of selling Itron products in addition to its own proprietary products.

As the industry continues to evolve, the Company has been vigilant in anticipating and exceeding customer expectations. In 2011, the Company introduced AMA as a hardware and software solution for water and gas utilities, which it believes will help maintain the Company's position as a market leader. The Company continues to seek opportunities for additional revenue enhancement. For instance, the Company is periodically asked to oversee and perform field installation of its products for certain customers. The Company assumes the role of general contractor, hiring installation subcontractors and supervising their work. The Company also supports its product and technology sales with the sale of extended service programs that provide additional services beyond the standard warranty. In recent years, the Company has sold ORION radio technology to natural gas utilities for installation on their gas meters. With the exception of a large sale of gas radios to one particular customer, the revenues from such products and services are not yet significant and the Company is uncertain of the potential growth achievable for such products and services in future periods.

Results of Operations - Three Months Ended June 30, 2013

The Company's net sales for the three months ended June 30, 2013 increased $6.3 million, or 7.7%, to $88.3 million compared to $82.0 million during the same period in 2012. The increase was the net result of higher sales of municipal water products and industrial flow products, offset somewhat by lower specialty product sales.

Municipal water sales increased $6.6 million, or 12.5%, to $59.6 million in the second quarter of 2013 from $53.0 million in the second quarter of 2012. These sales represented 67.5% of sales for the three months ended June 30, 2013. The


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increase was due to higher sales of residential meters both with and without radio technology as well as higher commercial meter sales. Sales of the residential meters increased 12.0% due primarily to higher volumes, offset somewhat by lower prices in certain products. Commercial meter sales increased 14.4% in this period over the same period in 2012 also due to higher volumes of products sold and slightly higher prices. The Company believes this overall sales increase in municipal water sales was due mainly to a return to normal buying patterns after weather affected purchases earlier in the calendar year.

Industrial flow products represented 28.9% of sales for the three months ended June 30, 2013 compared to 30.4% in the same period in 2012. These sales increased a net amount of $0.6 million, or 2.4%, to $25.5 million from $24.9 million in the same period last year. Sales were relatively flat for individual products within this group.

Specialty application products represented 3.6% of sales for the three months ended June 30, 2013. These sales decreased $0.9 million, or 21.8%, in the second quarter of 2013, to $3.2 million from $4.1 million during the same period in 2012. The decrease was due to lower sales of gas radios and concrete vibrators.

Gross margin as a percentage of sales was 33.8% in the second quarter of 2013 compared to 36.8% in the second quarter of 2012. The decline was due in part to a greater percentage of municipal water sales compared to industrial sales which carry higher margins, lower prices in certain product lines, and the lingering effects of selling higher cost products in the second quarter of 2013 due to lower plant utilization earlier in the year.

Selling, engineering and administration expenses for the three months ended June 30, 2013 increased $0.8 million, or 4.5%, over the same period in 2012. The increase was the net effect of higher intangible amortization charges associated with the Aquacue acquisition, charges associated with settlement of a legal issue and lower employee incentive charges. Also included in the quarter was a $0.7 million non-cash pension charge as a result of payouts from the pension plan occurring faster than the assumed rate. The remainder of the increase was due to normal inflationary increases, offset by continuing cost control measures.

Operating earnings for the second quarter of 2013 decreased $1.2 million, or 10.5%, to $10.2 million compared to $11.4 million in the same period in 2012 as a net result of the lower gross margins and higher selling, engineering and administration expenses.

Interest expense for the quarter ended June 30, 2013 increased slightly compared to the second quarter of 2012 due to higher average debt balances compared to the second quarter of 2012.

The provision for income taxes as a percentage of earnings before income taxes for the second quarter of 2013 was 36.1% compared to 33.1 % in the second quarter of 2012. The second quarter of 2012 included recognition of $0.4 million in reduced tax expense due to favorable state income tax audit outcomes for prior periods.

As a result of the above mentioned items, net earnings for the three months ended June 30, 2013 were $6.3 million, or $0.44 per diluted share, compared to $7.4 million, or $0.52 per diluted share, for the same period in 2012.

Results of Operations - Six Months Ended June 30, 2013

The Company's net sales for the six months ended June 30, 2013 increased $1.9 million, or 1.2%, to $160.1 million compared to $158.2 million during the same period in 2012. The increase was the net result of slightly higher sales of municipal water products and industrial flow products, as well as the inclusion of Racine Federated's products for the entire six-month period in 2013 versus only five months in 2012, offset somewhat by lower sales of specialty products.

Municipal water sales increased $1.0 million, or 1.0%, from $105.3 million in the first half of 2012 to $106.3 million in the first half of 2013. These sales represented 66.4% of sales for the six months ended June 30, 2013. The increase is the net impact of slower sales early in the year due to a colder and snowier winter and the lingering effects of Hurricane Sandy followed by a return to more normal buying patterns in the spring and early summer months. Generally, snow can slow or stop installations and delay the reordering of meters. The sales increase was due to higher sales of residential meters both with and without radio technology, which increased 1.3% on generally higher volumes. Commercial meter sales for the first half of 2013 were comparable to the same period in the prior year. Other factors that affected market conditions earlier in the year include municipal spending concerns that had been delaying ordering decisions, slower housing starts and the Company's introduction in early 2011 of the next generation of the ORION product that continues to cause water utilities to take time to evaluate this new technology.


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Industrial flow products represented 29.7% of sales for the six months ended June 30, 2013. These sales increased $1.1 million, or 2.4%, to $47.5 million from $46.4 million in the same period last year. As noted above, Racine Federated was acquired on January 31, 2012 and their sales were included from that point forward. As such, the first half of 2013 includes six months of those product sales versus only five months in the first half of 2012. Industrial sales on a comparable basis between years show declines due to a slight weakening of overall industrial orders.

Specialty application products represented 3.9% of sales for the six months ended June 30, 2013. These sales decreased $0.2 million in the first half of 2013, or 3.1%, to $6.3 million from $6.5 million during the same period in 2012. The decrease was due to lower sales of gas radios, offset by the inclusion of six months of sales of concrete vibrator products versus five months in 2012. On a comparable basis, concrete vibrator sales were down.

Gross margin as a percentage of sales was 34.3% in the first half of 2013 compared to 37.3% in the first half of 2012. The decline was the net effect of lower volumes of product produced and sold earlier in the year which negatively affected factory utilization, mix of product sold and lower prices in certain product lines.

Selling, engineering and administration expenses for the six months ended June 30, 2013 increased $2.5 million, or 6.6%, over the same period in 2012. The increase was due to having one more month of expenses in 2013 for certain Racine Federated costs as well as higher amortization of intangibles acquired for the additional month. In addition, software amortization costs associated with standardizing industrial product systems also increased. The 2013 amounts include intangible amortization charges associated with the Aquacue acquisition, charges associated with settlement of a legal issue and lower employee incentive charges. Also included in the 2013 amounts was a $0.7 million non-cash pension charge as a result of payouts from the pension plan occurring faster than the assumed rate. The remainder of the increase was due to normal inflationary increases, offset by continuing cost control measures.

Operating earnings for the first half of 2013 decreased $6.6 million, or 30.7%, to $14.9 million compared to $21.5 million in the same period in 2012 as a net result of the lower gross margins and the higher selling, engineering and administration expenses.

Interest expense for the six months ended June 30, 2013 increased slightly compared to the same period in 2012 due to higher average debt balances as compared to the first half of 2012.

The provision for income taxes as a percentage of earnings before income taxes for the first half of 2013 was 35.8% compared to 35.1 % in the first half of 2012. The 2013 effective tax rate included $0.1 million of 2012 research and development credits in the first quarter of 2013 as a result of tax legislation enacted at that time. The first half of 2012 included a $0.4 million decrease in tax expense due to recognition of favorable state income tax audit outcomes for prior periods.

As a result of the above mentioned items, net earnings for the six months ended June 30, 2013 were $9.2 million, or $0.64 per diluted share, compared to $13.7 million, or $0.94 per diluted share, for the same period in 2012.

Liquidity and Capital Resources

The main sources of liquidity for the Company are cash from operations and borrowing capacity. Cash provided by operations was $15.2 million for the first six months of 2013 compared to $14.1 million in the same period in 2012 due primarily to lower inventory balances, mitigated somewhat by lower earnings in the first half of 2013.

The receivables balance increased from $45.6 million at December 31, 2012 to $52.7 million at June 30, 2013. Generally, sales are lower in the fourth quarter resulting in lower receivable balances at year end. The Company believes its net receivables balance is fully collectible.

Inventories at June 30, 2013 decreased $7.4 million to $53.6 million at June 30, 2013 from $61.0 million at December 31, 2012 due to lower quantities of product.

Net property, plant and equipment at June 30, 2013 increased to $71.5 million from $70.5 million at December 31, 2012. This was the net effect of $5.5 million of normal capital expenditures, partially offset by depreciation expense.

Intangible assets increased to $61.4 million at June 30, 2013 from $58.4 million at December 31, 2012 of which $5.6 million was due to the preliminary valuation of the Aquacue acquisition mentioned above, offset by normal amortization expense. Goodwill increased $10.7 million to $46.6 million at June 30, 2013 from $35.9 million at December 31, 2012 due to the preliminary valuation of the Aquacue acquisition mentioned above.


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Short-term debt decreased from $66.7 million at December 31, 2012 to $66.2 million at June 30, 2013 as funds generated by operations were used to reduce outstanding balances.

Payables increased to $20.3 million at June 30, 2013 from $15.6 million at December 31, 2012 due primarily to the timing of purchases and payments. In addition, this account includes $4.6 million at June 30, 2013 and December 31, 2012 owed to the sellers of Racine Federated that is to be paid July 31, 2013, plus $1.5 million at June 30, 2013 owed to the sellers of Aquacue that is to be paid January 1, 2014.

Other long-term liabilities increased $1.6 million to $2.7 million at June 30, 2013 from $1.1 million at December 31, 2012 due primarily to the $1.5 million owed to the sellers of Aquacue that is to be paid October 1, 2014.

Accrued compensation and employee benefits decreased to $6.5 million at June 30, 2013 from $9.8 million at December 31, 2012. The decrease was due to the first quarter 2013 payment of employee incentives and benefits related to 2012 operations.

The overall increase in total shareholders' equity from $171.2 million at December 31, 2012 to $177.9 million at June 30, 2013 was the net effect of net earnings and stock options exercised, offset by dividends paid.

The Company's financial condition remains strong. In May 2012, the Company signed a new credit agreement which increased its principal line of credit to $125.0 million with its primary lender for a three year period. The line was reduced by $16.7 million in May, 2013 and will be reduced by a similar amount in May 2014. Included in the May 2012 credit agreement was a $5.0 million foreign currency revolving note that expired in May 2013, but was renewed to May 2015, the term of the principal line of credit. The entire facility is unsecured, but there are a number of financial covenants with which the Company is in compliance. The Company believes that its operating cash flows, available borrowing capacity, and its ability to raise capital provide adequate resources to fund ongoing operating requirements, future capital expenditures and the development of new products. The Company continues to take advantage of its local commercial paper market and carefully monitors the current borrowing market. The Company had $51.1 million of unused credit lines available at June 30, 2013.

Other Matters

In the normal course of business, the Company is named in legal proceedings. There are currently no material legal proceedings pending with respect to the Company. The more significant legal proceedings are discussed below.

The Company is subject to contingencies related to environmental laws and regulations. The Company is named as one of many potentially responsible parties in two landfill lawsuits. The landfill sites are impacted by the Federal Comprehensive Environmental Response, Compensation and Liability Act and other environmental laws and regulations. At this time, the Company does not believe the ultimate resolution of these matters will have a material adverse effect on the Company's financial position or results of operations, either from a cash flow perspective or on the financial statements as a whole. This belief is based on the Company's assessment of its limited past involvement with these landfill sites as well as the substantial involvement of and government focus on other named third parties with these landfill sites. However, due to the inherent uncertainties of such proceedings, the Company cannot predict the ultimate outcome of any of these matters. A future change in circumstances with respect to these specific matters or with respect to sites formerly or currently owned or operated by the Company, off-site disposal locations used by the Company, and property owned by third parties that is near such sites, could result in future costs to the Company and such amounts could be material. Expenditures for compliance with environmental control provisions and regulations during 2012 and the first half of 2013 were not material.

Like other companies in recent years, the Company is named as a defendant in numerous pending multi-claimant/multi-defendant lawsuits alleging personal injury as a result of exposure to asbestos, manufactured by third parties, and integrated into or sold with a very limited number of the Company's products. The Company is vigorously defending itself against these claims. Although it is . . .

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