Badger Meter Inc (BMI) 2007 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the fourth quarter year end Badger Meter's earnings conference call.

I'm Connie, and I'll be your coordinator for today.

At this time, all participants are in a listen-only mode.

We will be facilitating a question and answer session towards the end of this conference.

(OPERATOR INSTRUCTIONS) As a reminder, ladies and gentlemen, this conference is being recorded for replay purposes.

I would now like to turn the call over to your host for today, Mr.

Rich Meeusen, Chairman, President and CEO and Mr.

Rick Johnson, Senior Vice President - Finance.

Please proceed, gentlemen.

Hi, this is Rick Johnson, and thank you very much and welcome to this fourth quarter conference call.

I want to thank all of you for joining us this morning.

I will begin by stating that we will make a number of forward-looking statements on our call today.

Certain statements contained in this presentation, as well as other information provided from time to time by the company or its employees, may contain forward-looking statements that involve risk and uncertainties that could cause actual results to differ materially from those in these forward-looking statements.

Please see our 2006 Form 10-K for a list of words or expressions that identify such statements and the associated risk factors.

Again, I will reiterate certain of our guidelines.

For competitive reasons, we do not comment on specific individual line profitability nor do we disclose components of costs of sales.

For example, copper.

Most importantly, we will continue our practice of not providing specific guidance on future earnings.

We continue to believe guidance does not serve the long term interest of our shareholders.

Now on to the fourth quarter results.

Yesterday afternoon after the market closed we released our fourth quarter 2007 results.

We are pleased to report that sales from continuing operations for our fourth quarter record $57.2 million, a 4.9% increase over last year's fourth quarter sales of $52.7 million.

This increase was driven by increased sales of both AMR meters as well as local or manual read meters.

Before I give you more details on sales, let me make one comment on our French operations.

As you know, in the fall of 2006, we made the decision to completely shut down and liquidate our French operations.

I would like to report that the entire process was completed as of December 31st and that no additional charges are expected in the future.

Now let me give you a few details about our sales results.

Residential and commercial water meter sales represented 78.6% of total sales in the fourth quarter compared to 79.7% in the fourth quarter of 2006.

These sales increased nearly $3 million to $45 million compared to $42 million in the same period last year.

This was due to increased sales of ORION related products with revenues there up a 21.6%.

Also, higher sales of local read meters primarily driven by plastic meters and higher prices as a result of price increases instituted over the last two years.

Offsetting this lately will lower sales of commercial meters.

Industrial Products represented 21.4% of the total sales for the fourth quarter of 2007.

Those sales increased $1.5 million to $12.2 million compared to $10.7 million in the fourth quarter of 2006.

The increase was driven primarily by volume increases in most of the industrial product lines.

Gross margins for the quarter were 34.9% compared to 32.5% last year.

I will remind you that last year we were dealing with significant increases in metal costs, primarily copper, and the price increases we had put in to effect really had not yet taken hold.

The impacts of the price increases in both 2006 and 2007 have restored the margins on a number of product lines.

Selling, administrative, and engineering costs were 22.3% versus 23.6% last year.

The percentage decrease is more a reflection as actual increases increased due to normal inflationary increases.

Interest expense for quarter is $143,000 higher than in the fourth quarter of 2006.

Interest expense increased in the fourth quarter compared to the fourth quarter of 2006 due to interest charges related to the recorded reserves for 2006 federal tax refunds for our French operations.

While we believe we have the appropriate support for the positions taken on that return, the uncertainly necessitates these reserves continue to accrue interest until ultimate.

Our effective tax rate for the quarter for continuing operations was 39.3% compared to last year.

We generally use the fourth quarter to adjust to the annual effective tax rate which in this case was 37.3% compared to 48.5% last year.

We generally use the fourth quarter to adjust to the actual annual effective tax rate which in this case for 2007 was 37.3%

Earnings from continuing operations and for the fourth quarter were nearly $4.2 million compared to $2.3 million last year.

Like our sales results, this is also a record for Badger in the fourth quarter.

On a diluted basis, earnings per share for continuing operations was $0.28 compared to $0.16 in the same period in 2006.

Since this is the last quarter of the year, I'd also like to briefly comment on the year as a whole.

After a slow start in the first quarter, the Company has performed very well in the last three quarters.

As a result, sales earnings and earnings per share from continuing operations were all records.

For the year, the Company made nearly $18.4 million on sales of nearly $235 million in 2007 compared to $16.6 million on sales of nearly $230 million in 2006.

On a diluted basis, earnings per share from continuing operations were $1.26 compared to $1.15 last year.

Our balance sheet remains solid.

As a result of completing the liquidation of our French operations, you will no longer see assets or liabilities of discontinued operations.

After that, there have been no significant changes between years.

Cash is higher than what might be expected at year ends, simply as a result of timing of receipts.

Our debt as a percentage of total capitalization at year end has dropped to approximately 15%.

Looking at cash flow nearly, $24 million was generated from operations in 2007 compared to nearly $16.8 million there are in 2006.

We have mentioned we did receive a refund from the IRS earlier in 2007 of all the taxes paid in 2006 as a result of the tax position we took.

And the cash flow statement reflects the proceeds from the sale of our French assets, principally the building.

The most notable outflows in the casual statement are payments we have made on the second phase of our Mexican plant expansion, progress on which is continuing.

Construction of that plant should finish this year and we anticipate being in full production by year end.

With that, I'll now turn the call over to our CEO, Rich Meeusen, who will have additional comments.

Rich?

Thanks, Rick and I'd like to also thank all you for joining us today.

For those of you from Louisiana, Happy Mardi Gras and for those of you from the other 24 states, Happy Super Tuesday.

We are obviously pleased with the results for the quarter.

It's particularly good to follow the relatively weak first quarter we had with three record quarters.

In fact, 2007 exemplifies the fact that our business can somewhat be volatile on a quarter to quarter basis.

But our focus on long term results can generate good growth in both sales and earnings from year to year.

Our Chicago project is in full operation with weekly shipments of plastic meters and ORION radios and daily installations.

Although Chicago will have a favorable impact on 2008, revenues in the fourth quarter of 2007 were only about $1.2 million since shipments began in late November.

I am happy to report that all units are operating as expected and we have had no problems with this project.

For the first quarter of 2008 the first full quarter with the Chicago impact.

Although we don't provide forecasts or earnings guidance, I think it's important for me to make a few comments about our expectations for 2008 due to the current uncertainty in the U.S.

economic outlook.

If the U.S.

economy slows significantly and enters a recession we would expect to see some negative impact on our 2008 results.

However, at this time we are not seeing any major impact on the economic slowdown.

In fact we vetoed 2008 in a much stronger position than the start of 2007.

ORION orders and sales continue to be strong and our backlog is up significantly even without the favorable impact of the Chicago contract.

Although copper prices are higher now than one year ago, our margins are up due to the impact of our 2007 price increases and favorable mix.

Overall, we're optimistic about the first quarter of 2008.

A major reason for optimistic outlook is the significant market opportunity that we have with our ORION AMR product.

As most of you know in the late 1980s, Badger started selling the first water AMR product called TRACE.

As that product has come to the end of its life, we have replaced many of the TRACE units with ORION.

However, our customers still have over 800,000 TRACE units in their systems and that replacement opportunity alone represents approximately $100 million of potential business for Badger.

On top of that, we've sold over 2 million Orion units to over 1,000 customers.

Many of those customers who have chosen ORION as their AMR system have only just begun to install the product.

In fact, on average, ORION customers have only converted about 25% of metering systems leaving about 6.7 million more units to install.

We estimate that opportunity to be about $840 million.

Combined with the TRACE replacements, Badger is looking at almost a $1 billion opportunity for future Orion sales.

And this does not even consider sales to new ORION customers which we are signing up at a rate of one new customer per day.

We expect this opportunity will drive significant ORION sales over the next several years.

We are also seeing increased interest in our fixed-based GALAXY.

But before I talk about that, let me try to define some terms here.

There has been a lot of confusion over the terms AMR, which stands for automatic meter reading, and AMI which stands for advanced metering infrastructure.

In the electric industry, AMI often refers to two-way metering systems that enable the electric utility to gather significant load management data and even to control devices within the customer's premises.

Most of these features are not applicable to the water industry.

The November 2007 Chartwell AMR Report, which is a respected industry publication, stated that based on their survey water-only utilities defined AMI as the fixed network system with no reference to two-way metering.

Therefore, we have chosen to adopt the definitions being used by our customers and will refer to the drive-by systems like ORION as AMR and we will refer to fixed-based systems like GALAXY as AMI.

With that said, it should be noted that fixed-base systems had historically had a very slow acceptance rate among water utilities.

In fact, according to the most recent Scott Report fixed-based systems represent only 7% of all automated metering systems in water on a accumulative basis through 2006 as compared to 13% for electric residential customers and 32% for electric commercial customers.

As we move into 2008, we are now seeing a greater number of inquiries and formal ROPs for fixed-based AMI systems among our water customers.

That is why we are so excited that we have recently introduced the GALAXY pin unit which uses the same superior ceiling technology on our ORION product.

We believe that GALAXY is now the most competitive AMI product in the water industry.

Further more, it's our intention to continue to make significant investments in the GALAXY product line to take advantage of future market opportunities.

We are also starting to see strong market interest in our recently introduced low profile residential water meter.

I'll remind you that this meter exceeds the American water works association standards and has the same accuracy and long life as our standard meter but does own a smaller body that uses one-third less metal and allows our customers to install the meter in shallower pit boxes or tighter basement spaces.

Transitioning our customer base to this new meter will reduce our exposure to copper price fluctuations.

As Rick mentioned, we are continuing work on our new facility in Nogales, Mexico.

This 120,000-square foot facility will enable us to meet the growth requirements of our business and to ship certain manufacturing functions in the Mexico to achieve significant cost reductions.

The project is on track and on budget and expected to be completed in the third quarter of this year.

So with that let me conclude by repeating that we're very pleased with this record setting quarter and we remain optimistic about our long term opportunities.

At this time, we'll take any questions you may have.

(OPERATOR INSTRUCTIONS) And the first question comes from the line of Rick Eastman from Robert Baird.

Please proceed.

Just a couple of questions.

Rick, when you kind of weighed out the growth rates here, you said the utility business increased at what about?

Does it look like about 7% for the quarter?

Does that sound about right?

I'm looking here.

Okay.

And maybe just a question for Rich.

As we go into '08 as we move into '08 here, should we still be assuming that Chicago ships more or less on a straight line basis, $13 million a year?

Is that still the best projection at this point?

Yes, your first question here is about 7%.

Your second question about the - - right now that is the best estimate, the straight line.

Okay.

It just started so there's nothing to suggest anything else at this point.

Can your just give us a feel for the pricing strategy will be here across the utility and the industrial business as we've entered '08 given your forecast on copper prices?

How are you going to approach the year from a pricing standpoint?

We have for the last two years done our price adjustments in the middle of summer.

The June, July time frame.

We will be looking at that again this summer.

It will depend upon where not just copper is but oil prices because that affects our plastics, it affects fuel, transportation.

So we'll be looking where all our costs are this summer and making a decision on pricing at that time.

And in the meantime, margins, gross margins, should be reasonably stable at this level.

Yes.

Okay, thank you.

The next question comes from the line of John Quealy from Canaccord Adams.

Please proceed.

Hey, guys.

Congrats on a great year and quarter here.

A couple of questions.

One, just some of the things that you were saying, Rich.

In terms of the opportunity on the replacement cycle and you may have said this, what time frame are we looking at here?

Are we looking for 7, 8 years for a round out of a billion dollars of the replacement of an existing Badger AMR product or how do we catch on that?

Well, John, this is where I've done the calculations of the numerator for you by telling you what the opportunity is and you want me to give you the denominator.

It's how many years it will be over.

I'm a little uncomfortable doing that.

I think we've seen customers do everything from a replacement cycle of a couple years to doing it over 15 years as their normal product wears out.

So frankly, I would be purely guessing as to whether those customers are going to change on all their TRACE product or finish installing the ORION product over the next five years, 10 years, I don't know.

But it's probably in that range just given history.

But I really don't know where it falls.

Okay, let me ask you in a different way.

In terms of your current base AMR and manual read business, is it mostly obsolescence or depreciation which causes people to swap out systems wholesale?

It's more obsolescence.

It's more a desire to swing over to a new technology.

Okay.

And then the other comment you made and that was interesting on the signing of one new ORION customer per day if I heard that correctly.

That's correct.

How does that compare to prior periods, Rich?

I can't imagine that from a higher end.

Yes.

That's accelerated.

If you think about it, we've been selling Orion for about five years, and we have a thousand customers.

So on average over the - - since we started, we've signed up about 200 customers a year.

We're now up to close to 400 customers a year.

I read that piece.

Got you.

And two other questions.

One, on the same distribution channel, clearly one of your competitive strengths in your gaining share there it appears, any major new initiatives or changes in how that functionality is working?

Or any more investment there?

Or is it sort of giving you a good enough return on capital that you're fine?

We're pretty pleased with our sales channels are working.

We go with a mixture of distribution and the direct sales force and it's served us very well for the past hundred years and we don't see any changes we're going to make there.

Yes.

Last thing, maybe Rick.

So SG&A, I know you had a small sort of 1 to 2.6 inflationary movement on SG&A.

How are you looking for next year broadly speaking?

Any major sort of corporate or overhead items pressing on you guys on that line.

Short answer is no.

Okay.

Thanks, guys.

Nothing anticipated.

Nothing anticipated at this point.

Thanks again.

Okay.

The next call?

And the next question comes from the line of [Bob Chorney] from RBC named Roger.

Please proceed.

Very good quarter.

I was especially pleased, Rick, in the fact that industrial products were up about 14%.

I know this is a small part of your business but it's an area in which you've improved over the last couple of years.

I was wondering if you might comment on the foreign portion of your business, specifically South America and Central America.

How is progress in that area?

I'll take a stab.

This is Rick.

I'll take a stab.

The answer is for the most part, since 80% is water meters, it's an up and down business.

Occasionally, we'll get a project in South America that's funded with U.S - - has U.S.

aid and just positive displacement of meters.

For the most part, it's not the technology that's used there.

So, I say, it's kind of hit and miss.

We are always attempting.

We are trying to make an industrial cyber, trying to make in roads in their.

It's hard to find the right channels in there.

We're trying to work through distributors now.

But, I seen sales that have been up and down, sort of hit and miss.

No real progress.

But that's still about 10% of our sales or international overall.

Okay.

Thank you.

And the next question comes from the line of Ryan Connors from Boenning & Scattergood.

Please proceed.

Good morning, Ryan.

A couple of questions.

Except, I'll cross over, Ryan.

It's Boenning and Scattergood.

Yes, it's Boenning and Scattergood.

It's very difficult pronunciation.

First off, just on kind of a macro talk a little bit more about that.

I know that in particular there seems to be a lot of concern all these issues with municipal on and so forth and that that may have some impact on municipality's ability or willingness to spend on infrastructure and water being one area of that.

I just want to hear a comment on whether you've seen evidence of that or expect to see that and what your thinking is on that heading into '08.

Ryan, I'll agree with you.

It could have some impact down the road if things become more difficult than they are.

We are not seeing any effect at this time.

It's true that most of our customers fund their meter replacement programs out of ongoing revenue from their rate structure.

And they don't go out and bond.

Sometimes when you get a very large project that they want to do quickly, changing out to an AMR or AMI [inaudible] they will go out and bond.

And if the city bonding becomes a more difficult issue as the economy weakens, that could have some impact.

But we're just not seeing it at this point.

That leads to the question in particular on Chicago.

Any reason to believe there could be an impact there?

None whatsoever.

The funding is all set up and we are being told it is moving ahead exactly as planned.

Okay kind of in a spectacular vein, it's feeding someone of a dead horse 'cause you've been I know you've addressed it many times in the past.

In terms of the housing market we really did see a dramatic drop off even from already low levels in December in terms of new housing starts..

And I know it does not appear to obviously have had an impact on you.

But I know some of your units are going in new homes.

If you could just update us on your Latest thinking on how the housing market impacts your business?

Some does go into new homes.

Not as much as a lot of people would think.

Because of many homes are built in areas where they don't have meters, they have wells.

The meters get installed when city sewer and city water eventually is extended to those areas, often much later.

So new housing starts don't have a direct correlation on our sales.

I've addressed that in the past.

Cities do collect connection fees from new housings as suburbs go up in places like that.

Sometimes those connection fees are used to fund meter replacements.

So we've seen some cities that might say they would slow down because of a slow down in connection fees being collected.

Also, I've often said that if the economic conditions in a city get really bad where they're seeing the major employment layoff, they're seeing unemployment increase, cities might rethink doing a major project at that time.

Just politically, it might not be the right time to launch major project.

That's why I made the comment that if 2008 weakens and we enter some kind of recession, it could have an impact.

Right now coming into 2008, we're just not seeing it.

We're seeing an extremely strong tail wind with the company.

And the orders are coming in strong and we're just not seeing any slowdown.

Okay.

And then one last one.

You mentioned the AMI opportunity AKA fixed network.

Starting to be some traction there.

That's great news.

And your referenced the penetration rate.

How fast do you think that takes place?

Does that 7% grow 1% per year or is it a faster uptake than that?

Curious how fast the water sector sort of moves toward that type of technology.

And understand I'm just giving you my opinion, I do think it could be faster than that.

We saw an acceptance of ORION that came very quickly.

And even the acceptance of AMR back in the early '90s when it was introduced had a pretty steep curve as people started adopting it.

So I think we're getting through this introductory phase of fixed networks where you had a lot of early adopters and now we're getting into the phase where it's becoming more common.

We're seeing a lot of our piece, a lot of activity.

We have won a few more accounts that we're excited about.

And I just think the time is coming for that.

It's been a while, fixed networks have been all fair report the last 5 to 10 years and it's been a very slow acceptance but I think it could accelerate rapidly.

Okay.

That's helpful.

Thanks a lot, guys.

Thanks, Rick.

And again, ladies and gentlemen, to ask a question, that is star one.

And the next question comes from the line of Patrick Morgan from Texas Securities.

Please proceed.

Good morning and congratulations on the solid results.

Thank you.

A follow-up on the galaxy product that you have.

In general for a decent sized job, what would the price premium be for a GALAXY system over a mobile system?

Is it somewhere in the range of 20% or so maybe?

Well, I'd rather not talk specifically about GALAXY pricing.

But what I will say is what we see in general in the market place, the cost of an AMI system a fixed network system versus drive-by system whether it be galaxy or any competitor systems, I would say you're probably looking at a 10 to 25% premium because it may not be the end points, the cost of the radios on the meters.

But when you add on the equipment on the poll poles, that's where the costs can start to escalate.

That cost is going to depend on the topography of the system, how many end points your need to achieve the penetration, whether the city has existing poles to put the devices on, or whether you have to install poles.

All of that can change the formula.

Okay.

Fair enough.

And I guess the utilities business case for fixed network, they would be able to get 10% to 25% premium.

Apply savings from eliminating the route trucks and what have you.

I wouldn't agree with you, Patrick.

The fact is if a utility simply wants a read, there will - - I don't think there will ever be a cheaper system, or right now, there is no cheaper system than a drive-by system.

The drive-by systems per getting a read are incredibly efficient.

The reason utilities go to fixed networks is when they're looking for more than just a read.

When they want interval data, they want hourly data, they want daily data or when they want improved customer service.

When a customer comes into the utility with a complaint about their water bill and they can immediately go to the computer and read that water meter, while the customer is standing there.

Those are the types of intangibles that utility looks for when they adopt a fixed network system.

And that becomes much more important.

We are also seeing more interest in what we call hybrid systems where a city will say, "You know, I want a drive-by system for the majority of my city, but I have an industrial park which represents my large user and there I want to have networks so that I can give them hourly information on their water usage.

Or for hard to read areas like gated communities, military bases or airports where even getting in with a truck to drive around and read the meters is difficult.

A lot of utilities are opting to put fixed networks in there.

So we really believe that we're going to see more fixed networks on their own.

We're also going to see more demands for fixed networks through hybrid systems and in both cases, we systems we think GALAXY is a perfect fit.

And then last question, with respect to GALAXY, any from a technology or a functional perspective.

Any comments you can make sort of versus the competitive offerings from ITRON and [HEXOGRAM]?

Well, all I'll say at this point is that the difficulty with fixed networks is the pit environment.

Because you're trying to broadcast quite a distance from an object that's underground and that makes it more difficult.

And the pit environment is a harsh environment.

We have finally gotten the GALAXY radio into the ORION package and we're very pleased with that because an ORION package is such a bullet-proofed package.

We are excited about that.

So we think we've got the superior pit product for networks.

Beyond that, we are always enhancing it.

We have several more projects in the works to further improve GALAXY and we'll be coming out with those as the year goes on, but I really don'ta want to go in detail..

Okay.

Very good.

Thank you.

And the next question comes from the line of Rick Eastman from Robert Baird.

Please proceed.

Just wanted to circle back for a second.

On the local read business, you had commented that that business did increase in the quarter.

Was the increased volume driven or was it all price?

This is Rick.

It's actually both both.

We had some unique orders from Mexico, plastic meters and increased volume as a result of that and for the brass, the local read brass, we're getting more price simply to cover the increased metal cost.

Okay.

And how would you define when you look at your local read business as a stand alone.

How much of that business is now or in the quarter was plastic?

Our people are looking right now.

And, Rick, let me comment on the plastic.

The plastic meter business, especially when we're selling in Mexico can be a little lumpy.

Because they'll have large projects that they'll throw in from time to time.

And we did have some large projects in the fourth quarter that we had.

The reason quite honestly, Mexico likes plastic meters is because they're less susceptible to vandalism.

People have been stealing a lot of the brass meters and turning them in for the scrap.

The other thing a lot of our customers liked the plastic meters is their lighter and they don't have the worker comp claims from the lifting of the meters and the meter boxes.

An the answer to your question is probably of the local read business in the fourth quarter and probably 30%, 33% of it was plastic.

Wow.

Okay.

That's good then.

But again, Rick, it was unique orders that we got from Mexico.

And, Rick, I haven't checked yet at year end, but through the third quarter, we were running at about 15% plastic meters.

So the fourth quarter was - - did have a bump in it for plastic because of those Mexico orders.

however, that 15% was up from the previous year where we were running about 8% plastic meter.

Our engineers don't like us calling them plastic meters.

They say we should called them engineered polymers but we won't be kidding anybody.

They're plastic meters.

Sounds more real.

And they're very very good the plastic meters just for the record.

And again is we go forward, Chicago's plastic.

They lightweight, Chicago loves the plastic meters.

They like them because they're lightweight, easier to install, exact same warranty as our brass meters.

Exact same life, exact same accuracy.

They perform just as well as the brass meters.

They're lighter and they're not susceptible to vandalism because people don't steal them.

Do they have a similar price point?

Yes, they do.

It's pretty close.

It might be a little bit less than the brass meters.

But then with the brass meters at the end of life, you have some scrap value.

No.

These were not.

Okay, let me ask -- are the plastic meters going out to Mexico?

Are they AMR equipped?

These were not, just local read meters.

This is local read meters.

And then a question I have on the industrial meter side of the business.

How much of that 14% increase and for that matter I think my math suggests maybe that business was up 12% for the full year.

How much of that was currency?

That's a good question.

Probably about half of the industrial sales and total are overseas, okay.

I don't have a number of the - - [ Overlapping Speakers ]

Probable about half the sales and total are overseas, okay.

I don't have the number.

The obviously, the dollar did wicken against the Euro on.

A chunk of it.

Maybe a third of the increase was FX.

That's just an estimate.

It's a guess.

Okay.

But I'm getting a yes nodded at me.

Okay.

What's the CapEx plan here for '08 right now?

We'll be polishing off Nogales by the third quarter.

Yes.

We're just guessing.

We say normally CapEx equals depreciation: We'll probably spend another $6, $7 to finish the Mexican project on top of that, that's our estimate right now.

So it moved you up in the teams like $13 or something?

No, I don't think it would be that high.

That $13 million, Nogales estimate, that's put between years, is that right?

Yes.

I see a total for about $8 million.

Okay.

That's our estimate right now.

Okay.

Thank you.

Okay.

And again, ladies and gentlemen, press star one to ask a question.

Star one to ask a question.

And the next question comes from the line of Brian Rafn from Morgan Dempsey Capital.

Please proceed.

Good morning, guys.

Good morning, Brian.

Rich, and you talk about what your installed bases is on GALAXY systems?

I think you talked about 2 million ORION?

Can you comment on that?

We've only had about a half a dozen GALAXY installations at this point.

So the number of installed units is maybe in the 10,000ths somewhere around there.

And because over the last five years we've been doing a lot of beta testing, improving the product and getting it in the position we wanted.

We did not want to aggressively market it in pit environments until we had the pit package correct.

Because we've seen a lot of our competitors have problems with their pit packages where water intrudes.

So debt about 60% of the market is the pits.

Okay.

So we really focused on the northern states where the meters would go in the basements and so we've really got only about half a dozen customers at this point.

Is the accelerating adoption rate of GALAXY is it a function of the learning curve or is it on your part an acceleration of the marketing and the tutorial?

Can you give us some sense over this?

Right.

I would say there are a lot - - the reason I'm very optimistic about GALAXY is I think there are two things happening at the same time.

We have got the product now to the point where we feel it's the best product that's in the market.

And that it's a superior product.

We can go out there.

We can really market it with a lot of confidence.

At the same time, the market itself is changing and starting to accept fixed networks in general more readily.

For a while the market wasn't sure whether they wanted fixed markets what it's for and now they should have a better understanding of them.

So I would say both of those are converging and that's what's giving me a lot of confidence about the product.

Okay.

You guys are always talked about over-engineering your brass meters and with an adoption cycle where you have an obsolete cycle of roughly 15 years and 6% to 7% of the infield installation turning over.

You talked kind a bit of the margin about political pressures and not wanting to adopt something if the economy heads south.

Is the robustness of your meters 20 years, 25?

How long could you spend energy for that?

We give a main case guarantee of 20 years.

That's pretty much the industry standard, okay.

On AMR, lives tend to be a little bit shorter because batteries, we guarantee batteries in the 15- to 20-year range.

Generally, it's 20 years.

The issue isn't so much how long can a utility wait?

We know there are utilities with 30-year-old meters out there.

So they can wait a long time.

The issue that as the meters get older, they tend to lose accuracy.

And this is a fact of all meters.

All meters lose accuracy with time.

And so a system where the average meter is 15 years old.

They may only be collecting 85% of the money for the water they're pumping.

And that becomes an issue.

So very often meter changeout programs are designed to keep the meters newer so that they're more accurate.

It's more fairness within the system.

And they collect for the water they pump.

And you just can't swap out the recorder.

You have to just swap out the whole meter.

It's all integrated.

You can take the register off the meter and the radio.

And swap it out.

But it's the meter that wears and loses its accuracy.

Generally, the attitude is if they're going out to the site and incur the cost of going to the site to make the change out, they're also going to put in a new meter.

That's what Chicago is doing.

Chicago has 162,000 meters and they're going to swap out and even though some of those are fairly new, they're going to swap out half of them.

They're going to swap out the oldest half because they want that accuracy improvement.

I got you.

You also, Rich, talked about 2 million installed base on ORION and another used the number 6.7 million.

Now, is that 2 million to be added to the 6 to give 8.7 on infield or is it part of the 6, 7 replacing the obsolescence of the 2 million already.

Give me a census to where you think that 'cause you used the number, I think, 840 million which should be about 100, 2500, $3 at year end.

And the 2 million would be added.

If we take all of the customers that have started to install ORION and we add up how many service connections they have, we get to 8.7 million.

I got you.

So 2 million have already been done, that's why, say, about 25% done it leads to about 6.7 million yet to do.

If 25% are done, you guys have talked in the past that actually the infield installation for the new installation per year, is it still running about 50%?

About 50% of the meters we shipped have radios on them.

Okay, okay.

You also talked, Rich, about the delta change in the new customers per year going from 200 to about 400.

Of the early adopters that got in or got in big, are you seeing any change in the average side of orders?

It's all over the spectrum.

It really is.

Okay.

The expansion on the 120,000-square foot at Nogales at Phase 2 when that's done your guys are assembling registers down there I think.

We are doing two things down there.

We do all of our register and radio electronic work down there and we also mold plastic for the plastic meters down there.

Okay.

How -- when that comes online versus Arizona how does that change your capacity across the country?

Well, first off, what we intend to do is when that comes online, we have a 60,000-square foot building down there now that we lease.

We will move the assembly operation out of that 60,000-square foot building and into the new one.

That leaves us about half the building empty if you will.

Allows us for future growth.

Generally, for register and radio assembly, it's a very manual process.

That's why we have it down in Mexico.

It doesn't require a lot of capital equipment.

It just requires for staffing and there seems to be plenty of that in Mexico.

As far as the meters themselves, we probably have the capacity about 1.6 million meters a year.

We probably have the capacity to go up to 2.5 million without a lot of capital investment here.

Okay, okay.

That makes sense.

You guys talked about the Chicago installation.

Somebody asked whether cold weather or snow would impair the installation.

We've got rocked here in southeast, the Wisconsin and Chicago with snow.

Has that affected you installation in December or/and going into January?

No, it has not slowed us at all.

The one thing people from Wisconsin and Illinois have learned is to work in the snow.

So it has not slowed it down at all.

Okay.

One question for you, Rick.

Anything on SG&A inflation, what are seeing on labor and wage rates?

Nothing significant.

Normal inflationary increases is as well we're projecting.

Health care costs?

That's all netted in with the average.

But we're self-insured so that's always a variable.

Right, right.

Okay, okay.

What's on a cumulative basis was you guys have talked not about just a price increase on copper but an all in resource diesel, oil and gas and that?

What cumulatively were the price change in the June, July period in '06 and '07?

We don't disclose them.

Okay, okay.

And your comment on '08 was you're going to be selective about the choices.

Is there pressure to do that in '08?

Pressure to increase or decrease?

What are you asking?

Yes.

Or at this point as we make the turn, January, February, does the delta change in cost look like an '08 price increase is inevitable or it's too early to tell?

I would say given where we are on copper and oil right now, we don't see any major pressure to do a big price increase, but we'll see where it plays out over the next six months.

What's been kind of - - I think you guys mentioned that the utility side was a little softer.

Give us the kind of commercial utility water market you talked about the residential.

What's that for?

You're talking about the commercial meters, the commercial water meters, that side of the business.

Not the industrial.

The commercial water meters were down a little bit but that's just lumpy.

That's timing.

It will fluctuate up and down depending upon timing of some large orders to the cities.

It wasn't anything I made that's feel like there was softness for the euro or there was any major concern.

Okay.

Rick, tax rate for '08?

Probably similar to '07 at this point.

There's nothing to say.

Again, Brian, that varies by whatever states we sell in and obviously, I don't know that now.

But right now I'd use the '07 rate.

Finally, with the acceptance and the certainly the design in getting AMR and the popularity of that, is there any pressure from [DOEG] and availability of radios?

From availability of radios?

You mean, from Deal Corporations?

Yes.

From Deal sourcing.

No.

Deal is a - - we buy our - - for those who don't understand what Brian is asking, we buy our ORION radios.

We source from a company in Europe called Deal.

And Deal is a very large company.

They make armament systems and they have a huge amount of capacity for making boards.

We don't see any problem.

And the fact that we get all of those boards from any board house so we could also- -if there was a capacity issue we could buy them here in the U.S.

if we had to.

Okay.

One, funny.

You guys talked in the past and for my edification about trying to take $2 or $3 of cost out of getting a low end economy 20, 22, 32-dollar meter.

Is that the pit meter, the plastic meter?

Or is that still another design yet to come?

No, Brian.

That's the LP meter.

That's this lower copper LP meter where we've taken some cost out of it by removing about a third of the metal.

Okay, got you.

Super job, guys.

Thanks.

Thank you.

And the next question comes from the line of Steve Sanders from Stephen, Inc.

Please proceed.

Good morning.

Good morning, Steve.

Just a follow-up.

Can you talk a little bit about the sales cycle on the AMI side and for you, do you view the growing interest in AMI as more incremental or competitive with you AMR business?

I think the sales cycle on AMI is the same if not a bit longer than sales cycle on AMR because there has to be a lot of decisions made about locations of devices on towers or on municipal buildings.

There's a lot of topography work that has to be done.

So we do see it as being both a little bit longer, I would say.

Clearly AMI will take some AMR.

There are a lot of cities that say, I want to go to a technology.

It's either going to be drive-by or it's going to be fixed network and I have to make a decision.

So I think to that extent, yes, there will be some cities that do that.

On the other hand, I think there are cities that have said, I haven't made an automation decision because I really don't think a drive-by system will service my entire city and will give me everything I need.

Now, that they have that option of putting in a hybrid system with AMI, that may move them along.

So I think we are going to get some kick from that.

Okay.

And then you talked quite a bit about pricing.

Can you talk on the meter side?

Can you talk specifically about what your seeing in the market in terms of pricing on the AMR, AMI side?

I think, generally, in the market we're seeing pricing remain pretty stable.

You know, there was a time a few years ago when there was a disruptive technology that came in -- I shouldn't say technology -- a company that came from England with a very cheap product that they were selling.

It caused a lot of price pressure on the technology side.

Fortunately for us, the product started failing in mass across United States, the company filed a bankruptcy.

And so I think people realized that buying the cheapest product isn't necessarily the right answer.

So that probably benefited the whole market because we're all able to maintain our higher prices for better products.

I don't think price is the only consideration on the higher end.

It's a key factor but it's not the only on.

Whereas, on the local read of the manual read meter, it's 90% of the decision.

There are other factors when you get to the high end.

Okay.

And then, Rich, on the gas AMR side, what kind of potential do you see there for Badger over the next couple of years?

We're excited about it.

We now have and have released - - we were demonstrating the product.

We have the ORION radios for all of the major gas meters in the United States.

The thing about gas though is unlike water, there are 53,000 water utilities in the United States and there are only about 1,500 or so gas utilities in the United States.

So with gas when you make one sale, it's usually a big one.

So the question is when will we make a big sale?

We have had some.

We have had some success with a couple of gas utilities where we have shipped tens of thousands of units and we are in the process of talking to some others.

They were pretty excited about it that it could have a big opportunity.

But for me to guess as to how fast, it's going to ramp up.

It's kind of an all or nothing type thing.

And that makes it difficult.

Let me also remind you that we are only selling ORION radios.

We don't make or sell the gas meters.

We sell the radios to fit on existing gas meters.

Right, right.

Okay.

Thank you very much.

Good quarter.

Thanks, Steve.

And the next question comes from the line of John Quealy Canaccord Adams.

Please proceed.

Rich, just one last follow up for me.

Last call, you talked a little bit about MNA activity.

Can you give us an update in your thoughts as we go through '08?

Yes, John.

We are definitely still interested in looking at some - - at the right acquisitions.

We did chase some acquisitions in 2007.

We did not succeed on any of them.

There were two in particular pretty important ones that we felt we could get.

I don't say major in size.

They were all in the let's say $40 to $80 million sales range.

But we felt they would be nice additions to our product portfolio.

In both cases we backed away because we felt the price was too high and we don't want to overpay.

And there are people around offering 14-time, even in multiples still surprises me and I just don't think that's appropriate.

So we backed away on some of those.

But we are still aggressive.

We are still actively looking.

Having a 15% debt to capitalization ratio bothers me a little bit.

And we think that there are some acquisitions we could make that would provide some nice synergies for our product lines.

Did those acquisitions that you chased down, did it give you any head wind on the earnings or was it just minimized impact on the OpEx?

It would have been accretive with debt.

Oh, it would have been accretive with debts.

But I'm sorry, insurgently any fees or anything like that actually.

Oh, no.

No, no.

We did not.

No, we did not incur any significant fees at all.

They would have been accretive if we would have gotten them at the price we wanted,right?

Don't let show then it would have been accretive.

We would have paid what the ultimate winner did pay.

Yes.

Thanks a lot.

Thanks.

And the final question comes from the line of Brandon Olson from [Vancouver].

Please proceed.

Hey, guys.

Two questions.

The first one, what was the average price increase in your units from Q4 of last year to Q4 of this year?

We don't disclose particular details about price increases.

The prices are up.

Prices were up random.

We don't like to disclose specifically what the price impacts because we know from the list that we're looking at a lot of our competitors are listening.

Okay.

Yes.

I was trying to figure out growth in units versus growth in price there.

When you guys talk about the billion-dollar replacement opportunity, whether that's $150 million a year or something potential to you guys over a 7-year time frame, how much revenues do you guys get right now per year on stuff that's replaced versus stuff that's sort of green field new meters going in?

Well, about 2/3 of what we ship is replacement.

But that doesn't translate to 2/3 of our revenues.

Because a lot of the replacement is meter only.

Local read meters and not radios.

So I would say right now replacement is maybe 40% of our sales revenues and 60% comes from people transitioning to AMI or new customers.

Okay.

So replacement is like $100 million but you think there's an opportunity for $150 million.

There's a potential delta increase of $50 million in your revenues and you can execute on replacement opportunity.

Is that a fair characterization?

I didn't come up with the 150 million-dollar number.

You did.

Okay.

Okay.

A billion over how many years.

(inaudible)

He also picked the denominator.

You picked the denominator.

I do appreciate you not asking me to give you that.

You can do the math anyway you want.

But there is an opportunity out there.

Okay.

Alright.

Thanks, guys, congratulations.

Thank you, Brandon.

And the next question comes from the line of Brian Rafn from Morgan Dempsey Capital.

Please proceed.

Just a follow-up.

Rich, with all of the talk about infrastructure and the EPA came out with a big number a couple of years.

You were saying over 500 billion in water infrastructure and the highway bill being passed, do you see any acceleration in the penetration?

You guys always talked about 60 million, ramped to 60 million or 64 million meters being on.

Do you see any penetration beyond that kind of 50%?

What do you mean?

In actual houses being metered, you talked about the rural and soon going out to the rural.

Do you see any delta change in that process or it's also like population growth?

No, we do.

We estimate that there's about 12 or 13 million homes in the United States that have municipal service -- municipal water service to them.

Not wells, they have a municipality providing them water who are paying a flat fee.

And we are seeing more and more of those looking into metering and recognizing that they have to go metered.

[Central Bell of...]

Chicago is an example.

There is 340,000 billions in Chicago.

They are paying a flat fee that will eventually be metered.

[Central Bell of California].

A lot of pressure for it in the southwest and now we're starting to see pressure in the southeast.

Droughts are terrible things for most people but not for us.

They do tend to help us.

Okay.

Anything from the standpoint on the national account sales?

Yes, but this big cities I know they're lumpy.

They come along.

Are you seeing more big city projects being put into play even though they might be five, six, seven, eight.

Or is it just no transparency.

We're not seeing a lot of transparency.

And then you talked about new customers decisions.

If you looked at AMR customers and GALAXY customers, can you make a comment on new customers that Badger gets versus leakage and loss of customers on a net-net basis?

Is your retention better than maybe competitors?

Or as you gain one, you lose one overall?

I think we have extremely high retention but I also think our largest competitor, now named the Neptune.

I think Neptune also has high retention.

So I don't necessary - - sometimes we steal one of theirs.

They steal one of ours We're kind of like Coke and Pepsi from that point of view.

I think some of the other companies in the market place have lost customers to both of us.

Okay.

Thanks, guys.

Okay.

There's no further questions.

I would like to turn the presentation back over to your host, Mr.

Rich Meeusen.

Thank you, and again, I'd like to thank everybody for joining us and we look forward to talking with you at the next quarter.

Thank you.

This concludes the presentation for today, ladies and gentlemen.

You may now disconnect.

Have a wonderful week.