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BMI > SEC Filings for BMI > Form 10-K on 20-Feb-2014All Recent SEC Filings

Show all filings for BADGER METER INC

Form 10-K for BADGER METER INC


20-Feb-2014

Annual Report


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

BUSINESS DESCRIPTION AND OVERVIEW

An innovator in flow measurement and control products, the Company serves water utilities, municipalities, and commercial and industrial customers worldwide. Measuring water, oil, chemicals and other fluids, the Company's products are known for accuracy, long-lasting durability and for providing valuable and timely measurement data. 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 gas meter radios and concrete vibrators 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 mechanical and electronic (static) 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 most 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.

Additional information about the Company's business is described in Part 1, Item
1 "Business" under the heading "Market Overview, Products, Systems and Solutions" in this 2013 Annual Report on Form 10-K.

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. Similar to the electric utility industry a few years ago, the water utility industry is beginning to see the adoption of electronic (static) water meters. Electronic water metering has lower barriers to entry which could affect the competitive landscape in North America.

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.


There are approximately 53,000 water utilities in the United States and the Company estimates that less than 35% 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 its newer product offerings, including the recently introduced BEACON AMA system, 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 for 2013. The purchase price was $13.8 million in cash, including a small working capital adjustment. The Company merged Aquacue into Badger Meter, Inc. on December 31, 2013. This acquisition is further described in Note 3 "Acquisitions" in the accompanying Notes to Consolidated Financial Statements in Part II, Item 8 of this 2013 Annual Report on Form 10-K.

On January 31, 2012, the Company completed its acquisition of 100% of the outstanding common stock of Racine Federated, Inc. ("Racine Federated") of Racine, Wisconsin and its subsidiary Premier Control Technologies, Ltd. ("PCT") located in Thetford, England for approximately $57.3 million in cash, plus a working capital adjustment of $0.3 million. During the fourth quarter of 2012, the Company sold PCT for a nominal amount after the majority of its functions were absorbed by the Company's European subsidiary. The Company also merged Racine Federated into Badger Meter, Inc. on December 31, 2012. 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 3 "Acquisitions" in the accompanying Notes to Consolidated Financial Statements in Part II, Item 8 of this 2013 Annual Report on Form 10-K.

On January 26, 2011, the Company purchased Remag, AG ("Remag") of Bern, Switzerland for $4.9 million. Remag distributes a line of precision flow measurement products, some of which they manufacture, for the global industrial market. Their small turbine meters complement and expand the Company's existing line of industrial flow products. This acquisition is further described in Note
3 "Acquisitions" in the accompanying Notes to Consolidated Financial Statements in Part II, Item 8 of this 2013 Annual Report on Form 10-K.

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, and then in early 2014 launched its new BEACON AMA system as a managed solution 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 several years ago, 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

Net Sales

Net sales in 2013 increased $14.4 million, or 4.5%, to $334.1 million from $319.7 million in 2012. The overall increase was due primarily to higher sales of municipal water products as a result of higher volumes of units sold, offset somewhat by lower sales of industrial and specialty products.

Municipal water sales increased $17.9 million, or 8.4%, to $231.1 million in 2013 from $213.2 million in 2012. These sales represented 69.2% of total net sales in 2013 compared to 66.7% in 2012. The sales increase was due to higher sales of residential meters sold both with and without technology as well as higher commercial meter sales. Sales of residential meters and related technology increased 6.9% for the year due to higher volumes of product sold, slightly offset by lower average prices. Commercial water meter sales increased 15.2% in 2013 compared to 2012 due primarily to higher volumes of product sold. The Company believes the net overall increase for the year was a continuation of a return to normal buying patterns that began in 2012, although sales were negatively affected in early 2013 by a colder and snowier winter and the effects of Hurricane Sandy. In addition, part of the increase was due to additional sales to former customers of a competitor that ceased North American production of mechanical meters on June 30, 2013. The Company estimates sales to these customers were approximately $4.1 million in 2013.

Industrial flow products represented 27.3% of total net sales in 2013 compared to 29.0% in 2012. These sales decreased $1.6 million, or 1.7%, to $91.2 million from $92.8 million in 2012. Sales of products within this category were affected by general economic conditions which resulted in weaker orders.

Specialty products represented 3.5% of total net sales in 2013 compared to 4.3% in 2012. These sales decreased $1.9 million in 2013, or 13.9%, to $11.8 million from $13.7 million in 2012. The decline was caused by lower sales of radios into the natural gas market and lower sales of concrete vibrators.

International sales for municipal water meters and related technologies are generally made to customers in Canada and Mexico, which use similar mechanical technology and standards as customers in the U.S. International sales for industrial flow and specialty products are generally made throughout the world. In Europe, sales are made primarily in Euros. Other international sales are made in U.S. dollars or local currencies. International sales decreased 9.3% to $44.1 million in 2013 from $48.6 million in 2012 primarily due to the timing of large projects and general economic conditions.

Net sales in 2012 increased $56.8 million, or 21.6%, to $319.7 million from $262.9 million in 2011. The overall increase was due to the inclusion of Racine Federated's net sales for eleven months of the year and higher municipal water sales, offset somewhat by lower sales of radios to natural gas utilities. Racine Federated's sales for the eleven months ended December 31, 2012 were $41.3 million.

Municipal water sales increased $22.9 million, or 12.0%, to $213.2 million in 2012 from $190.3 million in 2011. These sales represented 66.7% of total net sales in 2012 compared to 72.4% in 2011. The sales increase was due to higher sales of residential meters sold with technology as well as higher commercial meter sales. Sales of meters with technology increased 11.6% for the year due to higher volumes of product sold. Sales of manually read residential meters were essentially flat between years. Commercial water meter sales increased 19.5% in 2012 compared to 2011 due to higher volumes of product sold. The Company believes the net overall increase for the year was due to normal buying patterns beginning to resume after a period where there were negative factors affecting market conditions. These factors included lingering concerns about municipal spending, which resulted in delayed buying decisions, and slower housing starts. In addition, the Company's introduction in 2011 of the next generation of the ORION product lengthened the sales cycle for water utilities as they evaluated this new technology. Weather may have also played a role as poor weather in the Midwest and Northeast had a negative impact on sales in early 2011 due to its effects on budget demands and installation rates, which did not recur in early 2012.

Industrial flow products represented 29.0% of total net sales in 2012 compared to 21.5% in 2011. These sales increased $36.2 million, or 64.0%, to $92.8 million from $56.6 million in 2011. As previously noted, Racine Federated was acquired on January 31, 2012 and Racine Federated's sales were included from that point forward. Within this product grouping, Racine Federated's sales were $32.6 million. The remainder of the increase was due to higher sales in most of the remaining industrial flow product lines.

Specialty products represented 4.3% of total net sales in 2012 compared to 6.1% in 2011. These sales decreased $2.3


million in 2012, or 14.4%, to $13.7 million from $16.0 million in 2011. Included in this product grouping was $8.7 million of sales from Racine Federated. Without these sales, specialty products would have shown a larger sales decrease due to lower sales of radios into the natural gas market. The 2011 sales included higher sales of radios to one particular natural gas customer that did not recur in 2012.

International sales for municipal water meters and related technologies are generally made to customers in Canada and Mexico, which use similar mechanical technology and standards as customers in the U.S. International sales for industrial flow and specialty products are generally made throughout the world. In Europe, sales are made primarily in Euros. Other international sales are made in U.S. dollars or local currencies. International sales increased 53.8% to $48.6 million in 2012 from $31.6 million in 2011 primarily due to the addition of Racine Federated's product lines.

Gross Margins

Gross margins as a percentage of sales were 35.0%, 38.2% and 34.2% for 2013, 2012 and 2011, respectively. The percentage decline in 2013 from the 2012 rate was due to a higher mix of municipal water sales compared to industrial flow sales which carry higher margins, lower prices charged to the former customers of a competitor that ceased North American production of water meters, higher obsolete inventory charges, higher costs of electronics due to foreign exchange effects, and higher costs of metal alloy as the shift to lead-free brass was completed.

The gross margin percentage increase in 2012 over the 2011 rate was due in part to the addition of Racine Federated's products, whose margins are generally a higher percentage than the Company's overall weighted margin percentage. Margins also increased due to lower costs for castings which fluctuate with the metals market, and higher sales volumes in general which increased overall factory utilization. Offsetting these factors was the impact of lower sales of radios to natural gas utilities.

Operating Expenses

Selling, engineering and administration expenses in 2013 were $0.1 million, or 0.1% higher than these expenses in 2012. The 2012 amounts included a $1.0 million charge related to the write down of the Company's investment in an emerging technology company. The 2013 amounts include intangible amortization charges associated with the Aquacue acquisition, charges associated with a legal issue and normal inflationary increases. Offsetting these increases were lower employee incentives and continuing cost control measures.

Selling, engineering and administration expenses in 2012 increased $15.5 million, or 24.9%, over these expenses in 2011. The increase was primarily attributable to the acquisition of Racine Federated and amortization of intangibles acquired, which were not included in the results for 2011. The remainder of the increase was due to higher employee incentives and normal inflationary increases, offset by continuing cost control measures. The 2012 amounts include a $1.0 million charge related to the write down of the Company's investment in an emerging technology company and a $1.1 million non-cash pension charge as a result of payouts from the pension plan occurring faster than the assumed rate.

Operating Earnings

Operating earnings in 2013 decreased $5.4 million, or 12.1%, to $39.1 million compared to $44.5 million in 2012. The decrease was the result of the lower gross margins resulting from the mix of sales, the lower prices charged to customers of a former competitor, higher obsolescence costs and higher alloy costs, all offset somewhat by the higher net sales.

Operating earnings in 2012 increased $17.0 million, or 61.8%, to $44.5 million compared to $27.5 million in 2011, as a net result of the higher sales of municipal water and industrial flow products, offset somewhat by higher selling, engineering and administration expenses. In addition, lower costs of certain raw materials also contributed to the increased operating earnings.

Interest Expense, Net

Interest expense, net was $1.1 million in 2013 compared to $1.0 million in 2012. The slight increase was due to higher average borrowings due in part to the Aquacue acquisition in April 2013.

Interest expense, net was $1.0 million in 2012 compared to $0.2 million in 2011. The increase was due primarily to higher borrowings in 2012 associated with the acquisition of Racine Federated and the Company's stock repurchase program.


Income Taxes

Income taxes as a percentage of earnings before income taxes were 35.2%, 35.5% and 29.9% for 2013, 2012 and 2011, respectively. The 2011 results include recognition of previously unrecognized tax benefits for certain deductions that were taken on prior tax returns. These benefits total approximately $1.3 million and were recognized in earnings in 2011 due to the realization that such benefits became more likely than not upon the conclusion of an IRS audit of the Company's 2009 Federal income tax return. Without these benefits, the provision for income taxes as a percentage of earnings before income taxes for 2011 would have been 34.8%. The variances in all three years presented are due to the changes in state taxes depending on each year's sales and the relationship of foreign and domestic income which are taxed at different rates.

Earnings and Diluted Earnings Per Share

Because of the decreased operating earnings, net earnings were $24.6 million in 2013 compared to $28.0 million in 2012. On a diluted basis, earnings per share were $1.70 in 2013 compared to $1.95 in 2012.

As a result of the increased operating earnings, offset somewhat by a higher effective tax rate, net earnings were $28.0 million in 2012 compared to $19.2 million in 2011. On a diluted basis, earnings per share were $1.95 in 2012 compared to $1.27 in 2011.

LIQUIDITY AND CAPITAL RESOURCES

The main sources of liquidity for the Company are cash from operations and borrowing capacity. In addition, depending on market conditions, the Company may access the capital markets to strengthen its capital position and to provide additional liquidity for general corporate purposes. Cash provided by operations in 2013 was $34.8 million compared to $34.8 million in 2012. The 2013 amount had lower earnings, an increase in receivables and a decrease in certain liabilities from 2012, while the 2012 amounts contained an increase in inventories and a pension payment that did not recur in 2013.

Receivables at December 31, 2013 were $50.1 million compared to $45.6 million at the end of 2012. The increase was due in part to higher sales in the fourth quarter of 2013 compared to the fourth quarter of 2012. The Company believes its net receivables balance is fully collectible.

Inventories at December 31, 2013 were $60.9 million and substantially unchanged from $61.0 million at December 31, 2012.

Property, plant and equipment increased as a net result of capital expenditures offset by depreciation expense. Capital expenditures totaled $14.3 million in 2013 compared to $8.2 million in 2012. These amounts vary due to the timing of capital expenditures. The Company believes it has adequate capacity to increase production levels with minimal additional capital expenditures.

Intangible assets decreased to $57.3 million at December 31, 2013 from $58.4 million at December 31, 2012. This is the net impact of a $3.9 million increase due to the acquisition of Aquacue, more than offset by normal amortization expense. Also, as a result of the Aquacue acquisition, goodwill increased to $44.7 million at December 31, 2013 compared to $35.9 million at December 31, 2012.

Due to higher than expected returns for the Company's pension assets, there was a prepaid pension amount of $4.3 million at December 31, 2013. At December 31, 2012, a pension liability of $4.2 million was included in other accrued employee benefits, which saw a reduction to $4.4 million at December 31, 2013 from $8.9 million at December 31, 2012.

Short-term debt increased from December 31, 2012 to December 31, 2013 as the Company borrowed funds for its acquisition of Aquacue. At the end of 2013, debt represented 26.3% of the Company's total capitalization. None of the debt is secured by the Company's assets.

Payables increased at December 31, 2013 to $18.6 million compared to $15.6 million at December 31, 2012. The 2012 amount included $4.6 million owed to the sellers of Racine Federated that was paid July 31, 2013. The 2013 amount includes $3.0 million owed to the sellers of Aquacue that will be paid in 2014. The remainder of the increase was due to the timing of purchases.

Accrued compensation and employee benefits decreased $2.5 million to $7.3 million at December 31, 2013 from $9.8 million at December 31, 2012 primarily due to lower accrued employee incentives.


The overall increase in total shareholders' equity from $171.2 million at December 31, 2012 to $196.6 million at December 31, 2013 was principally the result of net earnings, stock options exercised and a reduction in Accumulated Other Comprehensive Loss as a result of favorable actuarial gains, net of their tax effect, offset by dividends paid.

The Company's financial condition remains strong. In May 2012, the Company signed a new credit agreement that increased its principal line of credit from $90.0 million 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. While the facility is unsecured, 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 $47.8 million of unused credit lines available at December 31, 2013.

OFF-BALANCE SHEET ARRANGEMENTS

The Company had no off-balance sheet arrangements at December 31, 2013.

CONTRACTUAL OBLIGATIONS

In 2010, the Company restructured the outstanding debt of its Employee Savings and Stock Option Plan (the "ESSOP") by loaning the ESSOP $0.5 million to repay a loan to a third party and loaning the ESSOP an additional $1.0 million to purchase additional shares of the Company's Common Stock for future 401(k) savings plan matches under a program that will expire on December 31, 2020. Under this program, the Company agreed to pay the principal and interest on the new loan amount of $1.5 million. The receivable from the ESSOP and the related obligation were therefore netted to zero on the Company's Consolidated Balance Sheets at December 31, 2013 and 2012. The terms of the loan call for equal payments of principal with the final payment due on December 31, 2020. At December 31, 2013, $1.1 million of the loan balance remains.

The following table includes the Company's significant contractual obligations as of December 31, 2013. There are no material undisclosed guarantees.

                                                   Payments due by period
                                           Less than
                                Total        1 year       1-3 years      3-5 years      Beyond
                                                       (In thousands)
Short-term debt               $ 70,045    $    70,045    $         -    $         -    $     -
Operating leases                12,891          1,681          2,546          1,994      6,670
Total contractual obligations $ 82,936    $    71,726    $     2,546    $     1,994    $ 6,670

Other than items included in the preceding table, as of December 31, 2013, the Company had no additional material purchase obligations other than those created in the ordinary course of business related to inventory and property, plant and equipment, which generally have terms of less than 90 days. The Company also has long-term obligations related to its pension and postretirement plans which are discussed in detail in Note 7 "Employee Benefit Plans" in the Notes to Consolidated Financial Statements in Part II, Item 8 of this 2013 Annual Report on Form 10-K. As of the most recent actuarial measurement date, the Company is not required to make a minimum contribution for its pension plan for the 2014 calendar year. Postretirement medical claims are paid by the Company as they are submitted, and they are anticipated to be $0.5 million in 2014 based on actuarial estimates; however, these amounts can vary significantly from year to year because the Company is self-insured.

CRITICAL ACCOUNTING POLICIES AND USE OF ESTIMATES

The Company's accounting policies are more fully described in Note 1 "Summary of Significant Accounting Policies" in the Notes to Consolidated Financial Statements in Part II, Item 8 of this 2013 Annual Report on Form 10-K. As discussed in Note 1, the preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. The Company's more significant estimates relate primarily to the following judgmental reserves: allowance for doubtful accounts, reserve for obsolete inventories, warranty and after-sale costs reserve, and the healthcare reserve for claims incurred, but not reported. Each of these reserves is evaluated quarterly and is reviewed with the Company's . . .

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