Badger Meter Inc (BMI) 2010 Q3 法說會逐字稿

Good day ladies and gentlemen. Welcome to the third-quarter 2010 Badger Meter earnings conference call. My name is Katie, and I will be your coordinator for today.

At this time, all participants will be in a listen-only mode. We will be conducting a question-and-answer session towards the end of the conference. (Operator Instructions).

I would like to now hand the call over to Mr. Rick Johnson, Senior Vice President and CFO.

Thank you very much. Good morning everyone, and welcome to Badger Meter's third-quarter conference call. I want to thank all of you for joining us.

As usual, 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 risks and uncertainties that could cause actual results to differ materially from those in these forward-looking statements. Please see yesterday's earnings release for a list of words or expressions that identify such statements and the associated risk factors.

Let me reiterate some of our guidelines. For competitive reasons, we do not comment on specific individual product line profitability, other than in general terms, nor do we disclose components of cost of sales, for example copper. More importantly, we continue our practice of not providing specific guidance on future earnings. We believe specific guidance does not serve the long-term interests of our shareholders.

Now on to the third-quarter results. Yesterday afternoon, after the market closed, we released our third-quarter 2010 results. On our July conference call, we indicated that the strength we were seeing in the second quarter could continue into the third quarter now that the uncertainty over the US stimulus programs had been resolved. This turned out to be accurate, and we had a very strong third quarter with record sales of $75.7 million, an increase of $14.9 million or 24.5% from the $60.8 million that we had in the third quarter of 2009. The increase was due to higher sales in most of the Company's product lines. The addition of the Cox Flow measurement product line also contributes a small amount to the sales increase.

Water Applications represented 83.7% of sales for the third quarter compared to 89.4% last year. Sales of Water Application products increased $9 million, or 16.5%, to $63.6 million in the third quarter compared to $54.4 million in the third quarter last year. The increase was due to higher volumes of meters, both manual and also with AMR/AMI technology, and also due to higher prices.

Sales of our ORION technology products increased 18.4% during the third quarter while sales of Itron related products increased 25.5% over the same quarter last year. ORION continued to outsell Itron by a ratio of 1.8 to 1. Even sales of manually read meters increased by 10.6% in the third quarter. Sales of commercial water meters were relatively flat when compared to last year.

Specialty Application products represented 16.3% of sales in the third quarter compared to 10.6% last year. These sales increased nearly $5.9 million, or 92.2%, to $12.3 million from $6.4 million in the third quarter of last year. This increase does include the addition of Cox Flow Measurement. In addition, we've seen significant increases in the sales of radials into the natural gas industry. Finally, other product lines in this category did see double-digit increases over their 2009 levels, which were obviously very low last year due to weak economic conditions.

The gross margin as a percentage of sales was 36.9% in the third quarter, compared to 39% last year. The decline was due to the increased cost of metal castings, which fluctuate with the metals market, particularly copper, and higher costs associated with meeting certain made-in-America requirements for stimulus-related purchases. I will add that most of the stimulus-related purchases are behind us at the end of the third quarter.

The cost increases were offset somewhat by higher prices for the products, favorable currency exchange rates on foreign-source electronic components, product mix, and more effective plant utilization given the higher volumes of products sold.

Our selling, engineering and administrative expenses increased $1.5 million or 11.2% quarter-over-quarter. The increase was due to expenses associated with Cox Flow Measurement being included for the first time, higher incentive costs associated with the higher sales, and increased labor costs due to additional personnel as the Company strengthens its customer support functions.

Obviously, expenses are affected by normal inflationary increases, but we continue to have cost control measures in place.

In spite of the higher debt levels at the end of the quarter, interest expense continues to decline. You will recall last year that the interest expense included a reversal of $1.2 million associated with amounts we were accruing on a potential tax liability that were subsequently reversed. Without that adjustment last year, interest expense would show a decline due to lower average debt balances.

The effective income tax rate for the quarter was 32.4% compared to 40.1% last year. The reason for the decline this year is that, in the third quarter, we changed our estimate of the amount of state income taxes that we would pay, revising it downward. So we adjusted the year-to-date amount in the quarter.

In addition, we made a discreet entry to adjust differences between estimates previously used for 2009 and the actual tax return which was filed in the third quarter. Our current estimate of the annual effective tax rate is 36.7%. As a result of all of this, net earnings from continuing operations for the third quarter of 2010 were a record $9 million compared to $7 million in the third quarter of 2009. On a diluted basis, earnings per share from continuing operations was $0.60 compared to $0.47 for the same period last year.

There are several items of note on the balance sheet. Both receivables and inventories have increased due to the higher levels of sales. While we continue to monitor our receivables, we have not seen any indication of significant credit risk. Inventories have increased as we attempt to compensate for longer lead times on certain electrical components. It is our hope that this situation will be remediated in the coming months.

During this past quarter, we spent $8 million to purchase a license to manufacture and sell a key component of our Turbine Meter product line. Rich will talk more about this purchase in a few minutes.

We also made a $4.7 million contribution into our pension plan. While no contributions were required for 2010, we had the option to fully fund the pension plan under the current rules in place. Because we have the financial capacity to do so, we took advantage of this opportunity.

Because of the $8 million and the $4.7 million transactions, you'll note that we now have a higher short-term debt balance at the end of the third quarter. Even with this, our debt as a percentage of total capitalization is still less than 10% and our balance sheet is solid.

I would also like to inform you that just two weeks ago, our principle line of credit with our primary bank was increased from $35 million to $50 million effective at the end of this month. This is our annual renewal of our one year line of credit and gives us additional flexibility as we move into the future.

Cash generated from operations for the first nine months of 2010 totaled nearly $13.7 million, down from the $24.6 million was generated in the same period in 2009. Principal drivers for this reduction are the increases in Accounts Receivable and inventories to meet current business needs, offset somewhat by the higher earnings from continuing operations.

With that, I will now turn a call over to Rich Meeusen, who'll have some additional comments before we take your questions. Rich?

Thanks Rick. Thanks to all of you for joining us for today's call.

As Rick said, this was a very strong quarter and we're very pleased with these record results. At the end of the second quarter, we stated that we were saying the strong level of new orders continuing into the third quarter. As you can see, that strength continued throughout the quarter, resulting in record sales and profits for the third quarter.

Clearly, some of the sales in the second and third quarters of this year were catch-up sales from the fourth quarter of last year and the first quarter of this year when our business flow was interrupted by confusion over the government's pending stimulus program. But overall, we continue to see long-term strength in our water meter markets.

Meanwhile, our specialty products continue to experience the same rebound that many other companies are seeing as the economy slowly improves. While the increased sales of our gas ORION product have been driven by one large customer, Duke Energy, it's important to note that, since inception, we have installed gas ORION in approximately 60 other small municipal gas utilities across the United States. Cox added to our specialty product sales, as well as increases in our valves and other flowmeters.

Rick mentioned that we paid $8 million to purchase the license to manufacture and sell a key component of our Turbine Meter product line. For over 30 years, we have purchased a component for our turbine meters from a supplier in Europe. We had the opportunity to buy the North American rights to this technology and to manufacture these components ourselves. This will not only reduce our product costs going forward, but will also give us added flex ability in our supply chain.

While we do not give specific guidance, let me also make a few comments about the overall market. The past two quarters have been very strong as we caught up from the delays caused by the stimulus program. At this point, we believe that impact is behind us. We expect sales in the fourth quarter, which is typically our slowest period, to return to more normal patterns, accompanied by continued headwinds from commodity prices and the higher euro. As we move into 2011, we believe we will continue to see a good market -- good market growth and sales opportunities.

Regarding the recent increases in copper prices and the higher euro, we do expect to see some negative impact, but we will most likely implement a price increase on January 1, which will recover most if not all of the impact of these increases if these costs remain high.

During the quarter, we also increased our dividend by 17%, which was our 18th consecutive year of dividend increases. We also believe our strong balance sheet and cash flow being generated from operations will enable us to support these dividends while still allowing us to pursue strategic acquisitions. While we are pursuing small strategic acquisition candidates in both water and non-water flow measurement spaces, we are also being careful not to overpay for these companies. We believe we can continue to find high-quality companies like Cox that will bring significant synergies to Badger.

We are also continuing to move forward with the shift in certain manufacturing functions into our Mexican facility, which will provide us with a stable long-term source of high-quality and low-cost products. Most of this shift will be completed in the first quarter of 2011.

With that, we will be glad to take your questions.

(Operator Instructions). Carter Shoop, Deutsche Bank.

First question -- can you help us understand how much the acquisition contributed in the quarter, and also what Duke represented in the quarter?

We made a comment we wouldn't talk about specific product lines. In the second-quarter conference call, we said that sales were I'm going to guess about $1.4 million, and we saw something akin to that in the third quarter. It did have a positive impact on earnings but we are not going to disclose it.

Great. If the euro holds at current rates, can you discuss what the foreign-exchange headwind would be to margins in the December quarter, and if there's any hedges that are in place right now?

Either -- we generally don't hedge. Interestingly enough, even though the euro is hovering around $1.38, $1.39 right now, it surprised us. We're all thinking -- we remember the euro back at $1.20, and we think it's significant higher. But quarter-over-quarter, Q3 over Q3, actually we had a little but of a favorable effect because the euro was higher last year at this time. I don't recall what it was in the fourth quarter of last year, but it's an issue for us only from the standpoint that we remember it when it was just back at $1.20 six months ago.

This is Rich. We obviously buy our radio boards in euros, for those of you who don't realize that. So a stronger euro, weaker dollar, hurts us in that we have to pay more for our radio boards. We don't disclose exactly what that price is and what the impact is.

My cue card just held a sign that said the euro in the fourth quarter of last year was in the $1.40, $1.41, $1.42 range.

So it's not a big impact year-over-year, but an impact quarter-over-quarter.

Right.

That's helpful. Have you -- in regards to the stimulus, have you already seen the business slow down from kind of the post-stimulus benefit or is that something you're anticipated in the future?

No, we've already seen it. At its peak, orders that were funded at least partially with stimulus dollars I think we said represented about 15% of our backlog. We're well down under 5% now. So it has pretty much dropped off, and we're not really seeing that impact any more.

The last question -- can you comment on what you are seeing in regards to overall state budget spend and water budgets at the local state level, or at the muni co-op level and how that's impacting your business and how you think about that going forward?

First, it's important to realize that -- and this is based on some estimates that we've gotten from some outside people -- that about a third of the water utilities in the United States are operated as a department of the city and the municipality has the ability to tap the water utilities money. But about two-thirds are operated as enterprise funds, and the money is segregated. The city cannot simply reach in there and grab the money, no matter how bad the financial situation gets at the city.

So for the bulk of our customers, municipal budgets, tight municipal budgets, do not have an impact on us. The water revenue is kept separate, and it's used by the water meters and the city can't tap it.

But for about a third, there is an impact. Obviously, we work with our customers. Some customers view replacement of a water meter as a solution to a tight budget situation because they recognize that water meters are the cash register of the utility, and that water meters only run slower with time. By replacing the water meters, you get a revenue bump without a rate increase, and it can help a city budget situation. So there are a lot of different ways to deal with those situations. But it doesn't have nearly the impact that a lot of people would think it has.

That's helpful. Thank you very much.

John Quealy, Canaccord Genuity.

Good morning. Congratulations Rich and Rick. That was a good quarter. A couple questions -- first on -- I know you don't give guidance, but you had some language in the release about Q4 returning to typical normal seasonal patterns. The last two years, Q4 was the lowest dollar amount in revenues. I assume that's what you referring to in that release.

Yes. In fact, Q4 historically, if you look back even over a ten-year period, it's historically our lowest performing quarter, simply because it's also a function of the number of days, or the number of holidays for municipalities and the like. So it's generally been our weakest quarter.

Can you help us walk through the receivables? We talked last quarter about 45 net turns for certain distributors and there was no collection issues. AR was up 20% quarter-on-quarter Q2. Here we are up 6% on a 2% sales move. Can you just give us a little bit more granularity on what is going on there?

Not much more than what you talked about. I think it's more a function of the timing of the sales. But as we look, the past dues have not changed significantly. In our opinion, the credit exposure hasn't changed. We haven't really reserved that much more than the past. It's normally nominal value, so at this point in time, I'd say it's more a function of timing.

The other thing that has happened that is happening to us is more and more we're doing projects where we are installing networks. In a lot of those projects, the city has requirements that they will not either take title to product or they will not approve payment until the meters are communicating and the city has gone through and verified that communication. When you have projects like that, it does extend either the receivable terms or sometimes it extends the inventory that's on our books. So as the market goes more to networks, we're going to see a little more of this. We're going to see more and more situations where they want approval.

And I know I might add we generally do the billing at the end of the month.

Two more questions, more strategic. The first, on the competition, you've seen some new public competitors and rumors of some additional ones. Has that changed the characterization competition of the markets? That's my first question.

You're probably -- I'm assuming you're talking about Elster and their IPO recently.

There's a number of private companies, and Elster went public [since it] participates with a private company with public debt, so there's a couple out there. Obviously, divisions of other public companies like [Mueller] that participate. So I'm just wondering if that cycle, if you will, is having an impact on the industry itself.

We are not seeing any impact from that at all.

Then lastly, Rich, so the component sale that you bought of the $8 million license, if you would, you spent $20 million-odd on Israeli fix network stuff. Can you comment on should we expect more of these sort of technology asset tuck-ins or what is it on the platform that you want to get that you don't currently have in the coming sort of 18 to 24 months?

You're right. We're going to continue to look at those types of things. We may not always be doing acquisitions of companies. We may be doing acquisitions of technologies where we feel that they will fit in very well. The technology for the turbine meters was kind of a no-brainer for us because we've been using that technology for many years; we knew it. It was purely a mathematical calculation. What can we buy it for versus what is our annual savings going to be in present valuing that? It was a very compelling case to make the acquisition. So some of those are pretty easy.

There are other ones we're going to be looking at. There are other metering technologies that we don't have that I think could be very compelling. We're going to be also looking at those types of things. It may be the acquisition of a company, but it also may just be a technology acquisition.

Great, thanks.

Eric Stine, Northland Capital.

(technical difficulty) [quarter]. Just a couple of questions -- it sounds like you may not be willing to give the revenues from Duke in the quarter, but could you at least just give us your thoughts on where that stands? Should we think about that as a full rollout, and that revenues are more typical to what you saw in the first quarter rather than the second?

I'm not sure we disclosed it in the first or the second, other than it is up substantially. I would say it is rolling out on a level basis. But I think Rich commented in his comments, we are not just selling to Duke. We've actually, since inception, have probably sold -- is it 60 different municipalities for the small ones. So that radio technology is getting out there in the natural gas business.

Okay, that's helpful. Maybe just to clarify a previous question, just talking about the fourth-quarter commentary, were you trying to get across the thinking that the fourth quarter should be the lowest-revenue quarter of the year, or are you simply just saying directionally, given that the market is kind of normalized here, that it should be down versus the second and third?

Clearly, it should be down versus the second and third. Historically it's always been one of the lowest revenue quarters. As we say, we think we are going to more normal pattern. So I think, in a sense, we're trying to convey that, yes.

But understand too that we have an unusually weak first quarter.

Right, that's what I'm trying to get at. I mean those are two pretty large extremes.

(multiple speakers) what you're trying to ask us is will fourth quarter be weaker than the first quarter or not? We are not going to comment on that. That would be giving guidance, and we really aren't going to do that. (multiple speakers)

Fair enough. Last question just on the Itron ORION information you gave us, it sounds like Itron was pretty strong in the quarter. Were there any customers that made the switch, or were those just existing Itron customers?

They're existing Itron customers. We saw the same pattern last year, people trying to accelerate or it just happens to be the mix of a particular quarter that leans more towards Itron. We've really not sold any new customer an Itron product; that's generally ORION. There are a lot of legacy customers out there that still take the ORION product -- Itron product, I'm sorry.

Got it, thanks.

Richard Eastman, Robert W. Baird.

Good morning. Just Rick or Rich, could you talk a little bit about pricing and do you have a sense of what your price capture was in Q3 year-over-year?

Yes, we have a sense of it but we're probably not going to disclose it.

Are we starting to see any difference in buying patterns or quoting patterns, given the price increases that we've had over the last two years, given where copper is at? Is it nudging any of the marketplace towards either the plastic meter or the low-profile meter? Are you starting to see any difference there?

No, we are still doing I think about 15% of the meters we ship are still the plastic meters. I do think the plastic meters are a great value and they become a greater value as copper goes up, but we didn't see a big shift from one type of meter to the other the last time copper hit $4 a pound, and even with these price increases, we are not really seeing it now. Generally, most of the utilities have chosen a particular style meter, they like that meter, and they stick with it. And we don't see them jumping around based on price.

Okay. Then just another question -- I'm curious again on the receivables. Have we held -- the distributor incentives, payment incentives, have we held those all the way through the third quarter? Do we still -- have we lengthened them or held them?

In terms of the program about extend (multiple speakers)?

Payment terms, yes.

No, not really. But I'll go back in and as I've been thinking about this, the prime contracts where we do installations or certain customers won't accept title, those amounts generally get billed in the last week of the month. So you see those receivables sitting on the balance sheet, and it appears maybe they have been there a while. They may only be a week or two old. (multiple speakers) maybe then for the whole month. So we are dealing with a little bit about that, but again I just don't see any issues with receivables.

The distributor program we offered was earlier in the year. I think, in most cases, that's running out. I don't see a big change in that.

Given the increase in working capitals, given increase in working capital, especially on the receivable side but also on -- I guess maybe on inventory side, is there any opportunity here towards year-end, calendar year-end, to work those lower, or are we going to basically have (multiple speakers)?

Rick, I think there is. You're right Rick, there is because if you look historically, our working capital does go down towards the end of the year. December tends to be a weaker month. That lowers receivables. There is a slowdown in the installations because of the weather and the holiday season, and there is an opportunity to lower receivables and inventory at the end of the year. We would expect to see some decrease as we get towards the end of the year.

Okay. Then just a question on the Specialty Products segment of the business -- as we kind of think through the drivers here, the Cox business, the Duke and the gas shipments here, the core business is rebounding. What is maybe the gross margin? Has that responded as well for that whole segment? If you look year-over-year, is the gross margin in Specialty Products up a few hundred basis points, or what's the dynamic there?

The gross margin, as a general statement -- again, I won't comment specifically -- but as a general statement gross margins on the Specially Products are higher because they are more of a niche product industry. They can be -- even in certain of the real small ones, the gross profit percentage can be north of 50%.

We have seen some rebound, I won't talk about how much, but we have seen some rebound. Obviously, as the economy comes back and as our volumes of those specialty products go up, we see some improvement in the margin.

Okay. So if you just look at that year-over-year, that is positively accreting to the gross margin percentage.

By a small amount, right.

Can you just confirm -- we picked up a little bit. Fresno seemed to be at least -- you were kind of shipping into a pilot there. Has that business transitioned into kind of a steady-state shipping at this point?

Yes. Fresno is -- they're having regular meter installations, they have two companies doing installation day out there. As they install -- we're shipping the meters to the companies and they are installing them. So that project is in full swing now.

So okay. Last question -- anything on -- I know, on the Cleveland project, obviously the project manager was chosen there. First, were you competing for the meter portion of that? Secondly, any update?

Yes. The Cleveland project, they announced that they're choosing the Itron technology. As I understand, we came in second. That happens, and we understand that. That is a technology only; they have not chosen the meter. Cleveland has a large number of Badger meters installed. We are very optimistic we're going to have a good shot at the meter.

Is that -- is there any timing on that? They obviously have to choose the meter vendor here.

Cleveland issued RPs just recently, and I believe the due dates on those RPs are November. And they would probably start the project sometime next year.

Okay. Very good. Thank you.

Michael Cox, Piper Jaffray.

Good morning. Congratulations on a very nice quarter. My first question is on the Mexico manufacturing. Any update on where that stands today in terms of relocating or moving production down there?

Yes. We have all of the equipment installed down there. We have started up production. We would expect, by the end of the year, we will be getting about half of our small meter production out of Mexico.

Okay, that's helpful. (multiple speakers)

Right, end of first quarter of next year would be fully up to close to 100%.

Okay. Then another question on the Accounts Receivable. I know there are two distinct moving parts here, but on the payment terms side of this from earlier this year, do you feel that you've gained market share by having this extended payment term opportunity for distributors? If so, why not continue it, considering your balance sheet is as strong as it is?

Our honest answer is we probably didn't -- it probably didn't work as well as we had hoped. It was nice, but what happened is that it probably accelerated a few orders and actually created a few bottlenecks in the plant for orders that we normally would've gotten later. So I don't know that we would be repeating that at this point.

I think the other point thing was what we were trying to do was a lot of our distributors had really cut their inventory down to bare bones during the downturn. We wanted them to bring their inventories back up to normal levels, a lot of them coming through the fourth quarter of last year and the first quarter of this year when things slowed down were having some economic issues. So we said, look, we will give you a little bit of extended terms if you want to bring your inventory back up to normal levels.

We obviously benefit from the distributors having meters on the shelf. There are a lot of small utilities out there that just want to be able to swing by and pick up 5 meters, and we don't want to be in a situation where those meters aren't available. So we didn't do it to gain market share. It was just a matter of getting things restructured back to where they were before the downturn.

That's helpful. Thanks a lot.

Christopher Purtill, Janney Montgomery Scott.

Good morning guys. First, on pricing, is there any way for you to break out a rough percentage of the third-quarter water revenues that came through at the June 1 price increase level versus backlog that was pulled through at relatively lower pricing levels?

Again, internally we would do that but we would not publicly disclose that information.

Okay. On --

Again, just for everybody, I'll reiterate the fact that when a price increase went into affect on June 1, it can take 6 to 12 months to work its way completely into the system. So for instance, when we look at our results quarter-over-quarter, and we did not have a price increase, if you recall in 2009, but we are seeing impacts of price increases even that occurred from before that in some of the June 1. So it does take a while to work its way through the system and into the contracts.

Okay. Then on the Specialty business, can you characterize I guess the growth dynamics that you are seeing in that segment between gas applications and the industrial applications?

Well, when I say -- between Cox and the increase in the gas radios, that was a good chunk of the increase. The other product lines I'd say saw double digit increases, but you've got your member that, last year, some of those product lines went down 20% to 30%. Even if I'm coming back 15% to 20%, it's an improvement year-over-year. I'm probably not -- I'm still not back to where I want to be. That's about as much characterization as I'll give.

Okay. Lastly, based on some of the survey work we have done, you talked about municipal enterprise funds, people we have been talking to. It appears that those budgets are -- they are either being held flat or growing when you talk about the capital portion of the budget. Then there's a bigger focus on controlling the operating expense side of the budget, maybe trying to take some costs out there. So I'm curious if you are hearing anything from your sales force on this, and maybe if you're seeing municipalities trying to replace those operating expenses with more efficient capital expenditures.

I think your referring to moving more from manual read meters to automatic meter reading in order to reduce cost in utility? Is that what you're recurring to?

Yes, that's kind of the driver behind it, what that means for the manual business versus the AMR side.

That's been our fundamental argument for years, is that AMR is not only -- it's cost efficiency, it's better access, it's better information. We've said all along that the manual -- the business -- the number of meters leaving here with radios continues to grow. It is more than 50% right now. Customers still buy some manual read meters, but declines in the sales of manual read meters doesn't bother us if we are seeing a corresponding increase in meters sold with radios. We'd expect the trend that we would expect going forward over the long-term. Having said that, so the trend is upwards for radios with -- meters with radios. But having said that, it will be lumpy. There'll be certain quarters where the product mix may be more weighed heavily towards manual versus not. That's not necessarily indicative of a trend. But I would say the same fundamentals that have been out there for several years, in terms of the reasons to switch to AMR/AMI, are still there and we still [are doing them].

Right. I guess municipalities are maybe paying more attention to that benefit now, considering the financial states that they are in versus where they had been previously?

I'd like to believe that. It would only be anecdotal evidence we'd have, but we would like to believe that, if a utility is having financial difficulty, they'd recognize the cost benefit of upgrading the meters to some type of automation.

Great, thanks guys.

(Operator Instructions). Brian Rafn, Morgan Dempsey Capital.

Good morning guys. A question for you -- you guys talked on the 60 or so odd smaller gas utilities. Are those full installation rollouts, or are those beta tests, or what kind of numbers are you talking about? Tens of meters? Hundreds of meters?

I think we're talking -- some of those are betas. Some of those are complete projects, and we are talking about thousands of meters, a few thousands.

Mostly, they're what I would call the municipal-owned gas utilities.

Okay. How, from the standpoint of the stimulus money rolling in and starting to penetrate the municipal budgets, how has that affected maybe the markets for larger meters, the large utility meters, or things on big water mains and that?

Those two, the commercial water meters and the residential water meters, move hand-in-hand. When a utility is replacing meters, they have to have a certain number of large meters and a certain number of small meters. Really, market factors don't drive one segment versus the other. They really move hand-in-hand.

When you talk about volatility with the euro, have you guys done anything, or does that affect, or are you fairly inelastic to movements on the euro based upon stockpiling radio boards from [deals]?

We have not done any stockpiling. We have increased our radio board inventory, but we've done that more because of the long lead time that we're seeing on electronics. So we've had to increase our safety stock. We're hoping to see those lead times come down in the future, and it's going to allow us to bring down the inventory a little bit. But it's not in relation to the euro. We don't do it for that reason.

Are those lead times months or half a year, or quarters or what?

They were -- probably nine months ago, they were 16 weeks. At one point, they went up to 28 weeks.

28 weeks, okay.

The reality is we think -- we've talked to our purchasing folks. We think those lead times will continue for several more months in that length, so we are making purchasing decisions today for essentially next April. But then there is the hope that, somewhere towards February or March, that the lead times will start coming back to -- I'm going to put this in quotes, "whatever normal means any more". (multiple speakers) normal levels.

What is kind of -- give us a sense with the transition to Nogales. What is the size of kind of the labor force that you have down there?

We have over 600 employees in Nogales, all manufacturing. Here in Milwaukee, we have about 200 to 250 manufacturing (inaudible).

Incrementally, Rick, from here on, or Rich, are you looking for -- are you at your strategic plan, 200 to 600, or is it attrition from here on, or is there going to be, in the next three to five years, another major shift to Mexico?

First off, we've already announced that there's going to be a reduction from that 200 here as a result of the movement down to Mexico. We have not done that reduction yet; that will probably happen in the first quarter of next year. That could be as much as a third of the workforce; that could be about 70 jobs. So I would expect that sometime the middle of next year we are going to be down to about 130 production people here, and we'll have more down in Mexico. We'll have an increase down there.

Your question is, is that it then? Are we at that 130, and that's what we feel is right? We'll really have to evaluate what production we're going to have left here, what we're going to focus on. There are certain things we want to do here long-term, like large meters and things like that. But we really have to decide what the right size is for the workforce.

Yes, with all the focus, Rick, on -- or Rich on the whole Great Lakes and water technology and the University programs and that, is there an offset in your not maybe the labor force shifting to Mexico, but in more engineers, more higher value-added jobs here in Brown Deer?

Yes. As we have shifted work down to Mexico, it's been the shop flow work. We've actually been hiring here in Milwaukee. We've increased our workforce here. We brought about a dozen or more jobs from our Tulsa facility up here. Those were marketing, sales, engineering, R&D type jobs. We are also adding to our workforce here. So we do view the Milwaukee facility long-term as being very focused on sales, marketing, engineering, R&D as opposed to manufacturing.

Okay. Could you give us a sense, when you're looking at acquisitions, kind of the metrics, kind of the sales range, what you may be seeing in multiples of EBITDA going forward?

I would say we are -- the types of companies we are looking at are in the $5 million to $50 million range. That doesn't preclude us from doing something larger, but those are the ones that have been kind of coming across our radar. Cox was about a $7.5 million company, so -- and we would like to do some things larger than that. But that's kind of the sweet spot for us, in that range. In EBITDA multiples, it depends upon the profile of the company. You know what average EBITDA multiples are for industrial companies today, and it depends upon whether it's a turnaround situation or it's a growing company. All of that will affect the multiples.

Do you still have an interest in expanding, Rich, the industrial -- some of those industrial niche products that you have? You certainly closed the France operations but -- or are you strictly looking at water-related, water-integrated products?

No, we are looking at both water and other flow measurement. Now when you get into other flow measurement, you get into industrial water, which could be water used in silicon chip manufacturing, or water used in food processing. It can be a lot of other water metering. It's just not necessarily municipal water metering. But it could also be chemical metering and things of that sort when you get into the flow side.

As we are looking at kind of the US energy profile, is there any water meter valve installations in new nuclear plants, desalination plants, solar energy systems? Is there anything niche-wise that you see focused going forward that you guys might be able to apply that maybe in the past you haven't been really robust in?

This is Rick. We've always sold valves and meters into those kinds of applications. I will add that if it's nuclear, it's always on the non-reactor site. So we've been there. But those are the onesies twosies type thing. And so again, it fits into the niche businesses we have. But we will always watch that. We just came up with some application for oil rigs where we were working -- before the collapse of the oil industry off the Gulf, we were actually putting some of our products on platforms in the Gulf. So they are always looking for other things to take our existing full-blown measurement products into.

(multiple speakers)

Brian, I'm going to give you one more question because we've got other people queuing up here.

Any other national city deals going, any other cities looking at launching a major program?

I would say Cleveland is the biggest one that's out there. They've made a technology decision. They have not yet made a meter decision, so we're going to be obviously in there talking to them. I think we're in a pretty good position, but you never know what's going to happen. Beyond that, there isn't anything major going on.

Michael Coleman, Sterne Agee.

Good morning. You kind of touched on it just as you finished that question right there, Rich. But if you look at your sales cycle, it could be up to two years. If you were to kind of break it down into an early, mid, late kind of three buckets, could you kind of look at the industry and maybe provide some characterization of the activity level today in that kind of three buckets versus, say, six months ago, just in terms of an overall backdrop?

Yes. , Obviously I don't want to sit here and give you a list of cities we are chasing because my competitors would love me to do that. But what I would say is that we are still seeing pretty much the normal trends. When we look at our -- and we have a pipeline report that tells us how many projects we've got at stage I, stage III, stage V in the process. We are able to look at that and kind of monitor how the pipeline is full.

I would say the pipeline is as strong as it's been in the past. I don't see any big deterioration in any one stage or another. I don't see -- we are always mindful of the pig moving through the python and watching for some big, large projects that are coming through and are going to impact us. We don't see that. It's just a good normal, steady trend that we are seeing looking out into the future.

Thank you. The second question I had was -- I know most of your business is in North America, but you do have some in Mexico and Caribbean. I was wondering if you could comment on those businesses relative to what you are seeing in the States.

First, I don't mean to give you a geography lesson, but Mexico is in North America. But I know it -- I understand what your question is. We are a strong player in Mexico, and we do see some projects there. I'll say that -- the funny thing about Mexico and the unusual thing about Mexico is they tend to have a lot of large projects that get put into the fourth quarter each year. The projects sometimes ago and sometimes the projects don't go. Every year when we get to the fourth quarter, we are sitting here looking at some large Mexican projects, and they may or may not happen. Last year, they didn't happen. The year before that, they did happen. We are right back into the soup with Mexico again. There are some cities down there with some very large projects. We are being told that they're going to place some orders; we're going to see some purchase orders. But the problem in Mexico is you get the purchase order in the second week of December for delivery by year-end. So it really is a -- we call it the Mexican fire drill, and we really have to run through that. We are in that situation again. We have some large orders in Mexico that could come in this quarter. If they don't come in this quarter, they are going to come in next year. We're looking for those. But Mexico is heating up. I think there are a lot of opportunities down there that we are starting to look at. The same thing with the Caribbean, we're starting to see opportunities down there too.

Thank you.

John Quealy, Canaccord Genuity.

Just a quick follow-up -- with regards to the radio boards in euros, I assume that's still [Deal] in terms of manufacturing there. Can you switch up sourcing there to save some margin, or what's the relationship in terms of getting some margin out of that particular component?

We are still buying from Deal. We do have the rights to buy from other people. However, the fact is that the Deal production has been very efficient and the quality has just been incredible. We think the price is very reasonable, so we really don't see a reason to switch production somewhere else to try and lower the price. Clearly, we could go to Asia and try to get a cheaper price, but the quality of those boards has been so good, we just don't want to take any risks.

Can you give us your philosophy again on going to Europe in the water market? Obviously, there's a great macro emerging over there. Deal is a huge player, to your point, very quality-focused. Can you give us your philosophy about going to Europe in this space?

The problem in Europe is that, first off, they use velocity, primarily use velocity meters over there, and we don't have that technology. We use (inaudible) displacement here in North America, so we don't have a velocity meter to take to Europe. Also, there's a lot of water meter companies over there that are competing, and so it's very difficult. It's just as difficult for us to break into Europe as it is for Europe to break into North America.

The other thing about Europe that is different from North America is, in North America, you do not have a different water meter standard for Mexico, for US or Canada. Everybody uses the same lay lengths and the same thread widths and the same radio frequencies.

In Europe, you get into the different countries over there, and the lay lengths may be different; the thread widths may be different. You literally may have to make a different meter for France than what you make for Poland and you make for Spain. That gets very expensive and very difficult. So that's the main thing that has kept us from penetrating the European market. I think it has also kept the European market from penetrating here.

Thanks.

At this time, I am showing we have no further questions. I'd like to turn the call back over to management for closing remarks.

This is Rich. We were very pleased with the quarter. We thought things went very well. Fundamentally, we are looking at 2011, 2012, looking out at the future now, and seeing good strength in our markets. We still believe, with less than 30% of the water meters in North America converted to some sort of technology, we've got a huge opportunity to continue to grow that. The fundamentals are still there with our business on water shortages and the demand for metering, so all of those things we think are going to continue to drive our business. We are very optimistic about the future.

I want to thank everybody for joining us.

Ladies and gentlemen, thank you for your participation in today's conference call. You may now disconnect. Have a wonderful day.