Badger Meter Inc (BMI) 2011 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Q3 2011 Badger Meter, Inc.

earnings conference call.

My name is Shanae, and I will be your coordinator for today.

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

We will be facilitating a question-and-answer session towards the end of today's conference.

(Operator instructions).

As a reminder, this conference is being recorded for replay purposes.

I will now turn the presentation over to your host for today, Mr.

Rick Johnson, Senior Vice President of Finance and CFO.

Please proceed, sir.

Thank you very much, Shanae.

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 risk 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 onto the third quarter results -- yesterday afternoon after the market closed, we released our third quarter 2011 results.

Net sales for the three months ended September 30, 2011 were $69.7 million, a $6 million decrease from last year's all-time quarterly record of $75.7 million.

Like the second quarter, the decrease was due to lower sales of water application products offset in part by higher sales of specialty application products.

These results include approximately $900,000 of sales of our newly acquired Remag, whose sales are included as part of the specialty application product lines.

Water application products represented 81.6% of sales for the past three months compared to 83.7% in the same period last year.

Water application sales declined nearly $6.5 million in the third quarter to $56.9 million from $63.4 million during the same period last year.

The decline was due primarily to lower volumes of all water application products, including AMR and AMI, local reads and commercial meters.

Sales of ORION-related products decreased 6.5% while sales of the Itron-related products declined 44.2%.

You may recall that in 2010, sales of Itron products were up significantly due to sales of certain legacy accounts.

Commercial meter sales declined 5.2% and even manual residential meter sales were down 25.2%, although this has a much smaller base than the other product line sales.

While not as significant as our ORION sales, sales of our GALAXY products were up over 50%.

Overall, the concerns over municipal financing and spending continued into the third quarter and were certainly not helped at all by the European fiscal crisis, the debt ceiling talks and the recent volatility in the stock market.

Like many industries, ours functions better when there is stability in the financial markets.

And obviously, slower housing starts have also contributed to the lower sales.

Specialty application products represented 18.4% of sales for the three months ended December 30, 2011, compared to 16.3% for the same period last year.

These sales increased just $500,000 to $12.8 million from $12.3 million in the third quarter of last year.

As I indicated, this includes $900,000 of Remag sales.

On first glance, you might think that the core specialty application product sales were down.

With a few small exceptions, most specialty product lines showed good increases, including double-digit increases.

We have, however, seen a decrease in sales of radios into the natural gas market due almost entirely to the fact that sales under the Duke contract are beginning to taper off.

While we had $4 million of gas radio sales last year, we only had $2.8 million this year.

Let me remind everyone that we see these gas radio sales as incremental revenue; and, although we view this as having great potential, it is not part of our core business.

We do continue to market radios into the natural gas industry and believe there are further opportunities in the future.

Gross margins were impacted by the net overall sales decrease during the third quarter, as well as higher copper cost.

Gross margin as a percentage of sales was 32.7% compared to 36.9% in the third quarter of last year.

While copper prices have moderated, the lag factor is such that we won't see those impacts until the fourth quarter and into 2012.

The margin percentage was also affected by the lower volumes and their impact on absorbing our fixed cost.

Both the volume and copper effects were offset somewhat by increased prices that were put into effect earlier in the year as well as labor savings that we are now seeing at our Mexican facility.

Selling, engineering and administrative expenses -- we call those SMGA -- increased $300,000 or 1.9% over the same period last year.

Some of the increase was attributable to Remag being in the 2011 numbers.

Also, we are showing lower employee incentive cost due to the lower than anticipated profits for the year.

Certain one-time professional fees and consulting costs prevented our SMGA expenses from decreasing in line with the sales decline.

Our provision for income taxes was 14.8%.

I know this looks unusual compared to the 32.4% in the third quarter of last year.

However, this quarter does contain recognition of previously unrecognized tax benefits for certain deductions that we took on our 2009 tax return.

The benefits totaled nearly $1.5 million and were recognized in earnings this quarter as the IRS completed their audit of our 2009 tax return.

Had we not recognized these benefits, the provision for income taxes would have been approximately 33.1%, reflecting a reduction in our annual estimate of 34.8%.

As a result of all of this, net earnings from continuing operations were $6.9 million or $0.46 per diluted share compared to $9 million or $0.60 per diluted share for the same period in 2010.

A look at our balance sheet indicates that our financial condition remains sound.

We have paid down debt to the point where our cash on hand actually exceeds debt balances.

Cash generated from operations was nearly $26.3 million for the first nine months of the year compared with approximately $13.7 million last year.

The decline in earnings was more than offset by favorable working capital changes.

And one final point I would make before I turn it over to Rich is that we have just renewed our annual line of credit.

We increased the underlying amount from $50 million to $65 million.

This new line of credit will be in effect through October of 2012.

With that, I will turn it over to Rich Meeusen for his comments.

Rich?

Thank you, Rick, and thank all of you for joining us today.

Our third quarter results are disappointing but hardly a surprise, given the economic uncertainties that exist in the marketplace.

The same factors that we've been talking about since the first quarter -- [reducing] municipal budgets, a continued weakness in the housing market -- continue to plague not only our industry but the economy as a whole.

Add to that the political situation which creates more instability, and one understands why the third quarter was difficult for us.

Our markets tend to perform best in a stable environment, like Rick said, where municipalities know where their revenue is coming from.

That being said, however, we are still optimistic about our outlook for 2012 and beyond.

Our specialty product sales have rebounded.

Yes, sales of radios to the natural gas industry have slowed as the Duke contract is tapering off.

However, remember that we have always viewed that as incremental revenue and we are still optimistic that there are other opportunities in the future for this product.

Our new advanced metering analytics, AMA, product has now been completely launched.

To refresh your memory, this system consists of a new analytics-based software and our next generation ORION SE two-way radio which can function as either a drive-by or a fixed network system.

The radio can be switched between drive-by mode and fixed-network mode simply by transmitting a command to the meter, which gives our customers flexibility and true migration capability.

The software can then be customized to analyze the data and issue messages and work orders to a variety of people in the water utility.

This software was developed specifically with the water utilities in mind and will help them improve their operations, increase customer satisfaction and enhance revenue.

The feedback for this product continues to be very positive.

We also continue to receive very favorable response on our E series meter.

While it still won't be certified by the American Water Works Association for another 2.5 years -- remember, it takes five years of in-field use for a new metering technology to be certified -- we are very optimistic about this product and are currently selling it in limited quantities to customers that want to try it out.

With state-of-the-art software and the highest quality meters, we believe we have the products to meet the market's needs.

And let's talk about that market.

Nothing has fundamentally changed in our business.

Water meters still need to be replaced and adding technology to those meters can help reduce operating cost for a water utility.

Eventually, the uncertainties of our current marketplace will give way to resumed buying patterns and we believe that we are well positioned to do well when that occurs.

We will continue to look for acquisition candidates.

Our two latest acquisitions, Cox and Remag, continue to perform very well for us.

The balance sheet, with increased cash generated by operations and, as Rick mentioned, our recently increased borrowing capacity, is well-positioned to absorb additional acquisitions.

Finally, we continue to have a long-term mind set, and as such we have not cut back on research and development.

We are constantly working to improve and enhance our products so that we will remain the leading manufacturer of flow measurement devices.

With that, we will take your questions.

(Operator instructions) John Quealy, Canaccord Adams.

Thanks, good morning, it's Chip Moore for John.

I guess, first, I was wondering if you could talk about how much is remaining on the Duke project.

I know last quarter, we were talking about kind of being sort of in the middle, and it sounds like it's ramping down a little bit more quickly.

When is the bulk of that complete?

And then, does that make it a little tougher to grow the specialty business in 2012?

That's a good question.

When we initially announced that Duke order, we said sales could be up to $20 million.

Sales cumulatively since inception of the contract through September 30 are now north of $22 million, and we are continuing to sell.

I'm hesitant to speak for Duke at a period they continue to buy under that existing contract, but the bulk of the sales are behind us.

Now, that doesn't mean that there can't be additional orders to them, but obviously that is up to them, if they decide to expand the project.

And let me also comment -- this is Rich -- that obviously Duke has a much larger territory than just what they have rolled this system out into.

So there is an opportunity for follow-on work with Duke that we are in discussions with.

There are also other large gas utilities and gas and electric utilities in the United States that we have bids into that could be as large as Duke, as the Duke project.

So we are pursuing other ones.

I don't want to name specific ones, but we are pursuing other ones and we do have bids out.

Okay, that's helpful.

And maybe just sticking with the specialty business, can you talk sort of about the organic growth rate you think is sustainable there?

Is there anything that gives you better or different visibility versus the metering business?

Well, I think in the specialty products, and let's separate gas from the rest of the specialty products because gas is really project-based and we are going to occasionally hit a Duke or another one, and we hope we hit another elephant, but those are hit and miss.

When it comes to all of our other specialty products, they really are used in industrial processes.

So most of those are dependent upon the overall strength of the economy.

As the economy improves, they will improve.

Now, this quarter they were very strong.

But remember, last year they were much weaker.

So they have come back quite a bit over the last two years as they have been down.

Two years ago, they were down about 30%.

We had double-digit increases last year.

We are seeing double-digit increases this year.

We are getting back to those -- you know, to the organic type growth from this point forward, so to speak.

And if that's some kind of bellwether for the economy that companies buy meters to expand their processes, that means that they're going to be doing more in the future, yes, I guess you could read it that way.

But we do tend to follow the economy on those types of products.

Okay, and then if we move over to water, are you seeing any competitors get a little more aggressive on price, just given the lengthening muni cycle out there?

Yes, we are.

I think we are starting to see that, especially on some of the bids and quotes that are out there.

Everybody is seeing this slowdown, so everybody has got some extra capacity.

And when that happens, pricing gets a little more competitive.

And I think we're going to continue to see that, at least through the end of the year as this slowdown continues.

And then have you thought about anything to try and help stimulate channel demand, whether it's longer terms or favorable financing, anything like that that you're contemplating?

This is Rick.

Generally we don't do financing, since utilities can generally borrow at rates cheaper than we can with their tax exempt status.

It's hard to sell into channels because basically what we sell is custom made for each customer.

It's like selling a Dell computer; they all look alike, but there's variances all over the place.

And so we have found it difficult to forward sales.

And generally, even into our distribution network, they like to have customers that are going to buy that.

Since it's custom-made and all that, we have very limited opportunity to do that.

Okay.

Just lastly, on Cleveland, when should we be looking for that to start up?

A good question.

I thought that was going to be starting up in the fourth quarter, but I would have to check it.

Yes; I'm getting a signal here that we can expect shipments to be starting in the fourth quarter.

Okay, thanks a lot, that's very helpful.

Chip, I want to make one other comment, just to follow up on this.

When you asked the question about financing, it's my opinion that this slowdown is more about confidence than it is about access to money.

It's a consumer confidence type thing where the utilities are just concerned about what is going to happen in the future.

This isn't a matter that if we suddenly came in and said, well, we can help you do financing -- that's not what they're looking for.

They want to know that the state revolving funds won't be driving up, that the federal government and the state government won't be cutting back on support for water initiatives.

Those are the types of things they're looking for.

And in this environment, they're just not sure what's going to happen.

There's just a lack of confidence among our customers to be willing to jump into any major projects at this point in time.

And even if you look several years ago when we did offer financing -- I agree with Rich, by the way.

But when we did offer financing, we had an outside third party that we would link our customers to.

That generated few, if any sales.

Most people -- I agree; they are not looking for the financing aspect of this.

Okay, that's helpful, thanks a lot.

Richard Eastman, Robert W.

Baird.

Rick, could you just go back to that math on Duke for a minute?

You talked about cumulative being at $22 million.

Coming out of the June quarter, we talked about being halfway done, and in this quarter we did $2 million -- You know, ish.

Well, if we said that, then we probably weren't there because we didn't have the numbers in front of us at the time.

But we are now north of $22 million cumulatively since inception.

I mean, I'm talking about '09, '10 and '11.

Okay, but are you talking about that against -- when you booked that project, I think we were talking about Duke being something on the neighborhood of maybe $17 million.

No, we said up to $20 million.

That's right; we said up to $20 million.

We said up to $20 million.

Oh, up to $20 million.

We've already did $22 million.

So essentially, going forward this drops pretty close to zero, then?

Well, it depends.

They surprised us by going beyond the $20 million.

Yes, okay, all right.

And so that's the $22 million, and we are still making shipments.

So I don't know where this goes and I don't know how far Duke will extend this product into their service territory.

Okay, all right.

Really, this is one of those things where we are hesitant to comment on what a specific customer is going to do.

You know, it's their call.

Okay, all right.

I think we were trying to track that number on a quarterly basis to Duke over the last, say, eight quarters.

And I guess I'm surprised we are at north of $22 million cumulative because I thought we were at like half that number.

I would have to go back and look, but I don't recall us saying we were at half at the second quarter.

But -- you may be right, but I would have to look.

Okay.

And then, Rich, this ORION SE with the AMA now available, the software product, is this just going out as a package, or are we trying to basically sell -- go to market with ORION SE?

And is AMA an option, add-on?

Well, there are various forms of AMA.

There's a light version, an advanced version.

Obviously, you need the software to make the radios work.

To be able to read the radios and to be able to do any billing at all, you need the software.

As to how many of the features -- and there are many, many advanced features in this software -- as to how many of the features you want, you can pay up for those.

It's just like buying any other software where you can buy a premium version versus a basic version.

Okay, but we do need AMA to be able to remotely trigger the read option on the ORION SE?

Right.

You at least need the basic software program to be able to read the meters.

Okay, and that basic software as well as some maybe 2.0 or 3.0 is now available in commercial volumes?

Correct.

Okay, and then just one last question I wanted to dig into.

On the gross margin, when we look sequentially from the kind of disappointing level that we came in here at the third quarter, is there any reason to assume we make progress on the gross margin?

Is there any mix?

Volumes typically are lower in the fourth quarter.

Pricing is still rolling in, copper probably coming down a little bit, but it's still on a lagged basis.

And now we have got some price competitiveness.

So any confidence that you have that gross margins bounce meaningfully sequentially?

This is Rick.

That's probably the question of the week around here right now; that's what we are looking at.

For the most part, it was -- copper is out there; it had an impact.

For the most part, pricing almost got most of the copper impact back.

But the big one for us was the volume, and it shocked us as to the extent of the effect on the margin percentage.

We even went back and started digging into whether -- did we dig into finished goods versus the finished components, versus work in process and all that?

I think it's just a function of the significantly lower volume this quarter.

I think -- you asked about fourth quarter because you're going into a quarter that generally is the least busy of the year.

I think that kind of is factored into the plan for the year as we spread cost over the year and over the volumes.

I don't know that, if we have normal fourth-quarter type volumes, if you will see that type of impact.

But it is -- it was a surprise to us also.

Yes.

And so that's the best I can give you.

I don't know if you have any additional comments.

No; that's -- you are right.

Is the piece of the business, that 20% that's kind of special industrial -- I think you have talked in the past that as volumes return there and we are seeing growth there now, that gross margins there can bounce north of 40%.

Oh, yes.

Correct.

The product lines -- are we there?

Are we -- for that 20% of the business, would you estimate that we are north of 40%?

Yes.

Yes?

Okay.

Great.

Well, thank you.

Stephen Sanders, Stephens Inc.

I just wanted to follow up on the gross margin.

So I think you said that price offset most of the copper issues and so it was really the capacity utilization.

So how do we think about that in the fourth quarter?

In other words, it doesn't sound like your visibility on a significant recovery is that good right now.

So that's going to continue to be an issue in the fourth quarter?

Go ahead; you can try it this time.

That's pretty much the same question that I think Ric Eastman just asked, which is -- what kind of visibility do we have into margins in the fourth quarter?

If the fourth quarter is also a low-volume quarter, which it historically is, will we also see weaker margins?

As Rick said, we kind of spread our costs a little differently, anticipating the weaker fourth-quarter because we obviously have fewer workdays.

We have holidays and vacations and all that, so some of those costs are accrued.

So that might mitigate some of the factor, but I would still expect that if the volumes are weak in the fourth quarter, it could have a negative impact on our margins.

And I will say one other thing.

Again, I don't know if we've mentioned it, but there is in the margin also an FX effect that negatively impacted us because we source our radios out of Europe.

And, despite the fact that the euro has been bouncing around, it still costs us more than it did last year in the third quarter.

Right, okay, thanks.

And then, Rick, how do you feel about overall inventory levels and the mix of finished goods?

Well, again, finished goods is a misnomer in our business.

And just -- I'll take the time.

It's really finished components.

It's not like it's a finished meter on the shelf waiting to be shipped.

So make sure we understand that.

It's kind of like Dell computer -- they're finished goods probably are all the keyboards sitting in one rack and all the CPUs sitting in another.

It's too high.

I'm a CFO; I'm paid to say that.

But the reality is, because --

No; you're paid to lower it.

(Laughter) thank you very much.

But it's too high.

We have talked to our manufacturing people.

But because of the significance of trying to respond to customers and trying to give every competitive advantage that we can, given the fact that the cost of money is significantly low and we are virtually out of debt, we have allowed inventory levels to stay high so that we can meet the demand.

I have talked to our manufacturing people.

They are well aware of the fact that in an era of rising interest rates, if we ever have that, all right, that's one of the first places I am going to look for cash, and I think that's understood in the Company.

Okay.

And then, Rich, you mentioned the macro issues and the negative impact that they are having on the water business.

But it sounds like you are still pretty optimistic about the specialty business, ex-gas.

And so I'm just curious; do you feel like you're in end markets or geographies in specialty outside gas that are a little more insulated from some of these issues?

Well, we are, because we are very much -- our specialty products run very much to niche markets.

For example, we -- when it comes to using magnetic meters to measure concrete flow in the United States, we pretty much own that market.

When it comes to oil meters in quick lube garages, we pretty much own that market.

So there are a lot of little niche markets that we are very involved in -- valves on oil drilling platforms, meters that go in drone predators.

So, because of those niche markets, we are not so open to the broader economy.

It's just how each of those niche markets performs.

And that strategy has played well for us because we have been able to dominate those markets.

Okay, okay, very good, thank you.

Eric Stine, Northland.

Thanks for taking the questions.

Just to clarify, did you mentioned how much Duke revenues you had in this quarter?

I'm just trying to get at kind of what a base specialty business run rate is for the quarter.

What we said was that the sales of all gas meters was $4 million in the third quarter of 2010 and $2.8 million in the most recent quarter.

And we said it's primarily -- it's all -- I don't want to say it's all Duke.

There are other small customers in there, but the bulk of it is Duke.

Okay.

Both last year and this year.

Got it.

And in the past, you have talked about the progress that you have made with gas customers outside of Duke.

I think the last quarter, you said that you had shipped -- I can't remember if it was 30-plus or 50-plus gas utilities -- just wondering how that has trended.

And then, just as far as the potential work that you are pursuing, if you could kind of share how that falls out between small, medium and large opportunities.

Well, first off, the number of gas customers we've got has been fairly flat.

Yes, it's around 50.

And -- but a lot of them are very small, perhaps municipal gas that want to use our system for water and gas, and they are putting it in.

Duke is clearly the big one there.

As far as other opportunities and how they might fall out, we're talking about very large utilities, the size of Duke.

There are utilities across the United States, mostly electric/gas combinations, that have large gas properties.

And the reason Badger has an opportunity to play there is, much like Duke, they are looking at a technology for reading their electric meters that depends upon the power coming through the electric meter to drive it.

And since they don't have that power on the gas meter, they have to find some other way to get that reading off the gas meter.

Most of those companies that they are dealing with have alliances with Badger where we provide that gas meter or even the water meter reading, if that's what they want.

So it's through these alliance partnerships that we make our deals with these large, large players that are out there.

And it's those alliance partners who are out there bidding on these contracts, and if they get the contract, then they bring Badger long as the gas solution or as the water solution.

Okay, that's helpful.

And then just wondering lastly if you could just clarify -- you did in your prepared remarks talk about being positive on the gross margin going forward.

Is that sequentially versus this quarter or kind of versus more historical rates, because those two things have a very different read-through?

Sure.

Well, first of all, I don't think we said we were optimistic, we were positive on the gross margins going forward.

But let me make some -- I think we said we were positive more about 2012; we were optimistic about 2012.

Let me first explain why I'm optimistic about 2012, since nobody has asked the question to this point, surprisingly, and that is that we've seen this pattern before.

We have seen this pattern three times before where the utilities were thrown into a state of confusion and we lost customer confidence in the marketplace.

And the three times we saw it were right after 9/11, we saw it again right after Desert Storm started, and we saw it most recently when the government announced the possibility of a stimulus program for water.

And all three times, the water utilities in the United States dramatically slowed their buying.

And those slowdowns -- if you go back and look at all three of those periods, and the most recent one being the stimulus one -- you will find that those slowdowns lasted for two quarters.

The stimulus-related slowdown lasted for the fourth quarter of '09 and the first quarter of '10.

And, following those two quarters of slowdown, we saw a very strong rebound in our business because the utilities can only defer buying water meters for a certain period of time, and then they've got to start replacing them again.

They've got to start putting them in again.

And so if this pattern follows the pattern that we've seen in the past, we could see two quarters of slowdown, and that would be the third quarter of this year and the fourth quarter of this year.

And if it follows the pattern we've seen in the past, we could see a much stronger 2012 when all of this comes back.

And obviously, if that drives higher sales, it's going to drive stronger margins for us, because we are very much a fixed cost operation in many ways.

Also, the fact that copper has come off of its highs -- if it remains lower like it has been for the past month or so, if it remains at that level through the end of the year, we could see a very significant benefit starting in the first quarter from that also on margins.

So those are the real reasons why I'm optimistic about 2012.

Okay, that's very helpful.

And just to have a point-counterpoint here, the other thing is we used to head into what was an election year somewhat optimistic that we would see improving economic conditions.

This concern over muni financing and all that -- you'd think the dust would settle because everybody wants to make sure they get reelected.

The flip side of Rich's discussion, and it's something that we are taking seriously here because we manage this for the long-term -- and I agree with everything Rich said.

But we are also taking -- we're doing some contingency planning that says, what if 2012, because it's an election year and everybody is going into the far left and the far right and there is no more middle anymore -- what happens if this lingers for a while?

What steps do we have to take to maintain our financial results?

So just to make it clear, we are looking at both sides of this and doing appropriate planning.

Okay, thank you very much.

Craig Irwin, Wedbush Securities.

Hi, this is David Giesecke in for Craig.

I was hoping you could talk a little bit further about the gas side and what you're seeing in the market.

Are you seeing the same sentiment that you are seeing on the water side, or could you talk to that a little bit, please?

Yes.

I guess I would say we are not seeing as much of it on the gas side.

I don't think the gas and the electric companies have the level of concern that the municipalities have.

The municipalities -- when I talk to them, they are worried about funding of state revolving funds, they're worried about how much of the state money is going to come down to the municipality.

You've got some municipalities where the water department is operated as an enterprise fund and they are insulated from the city's problems, but that doesn't necessarily insulate them from cutbacks in the revolving funds or federal funding for their programs.

Other ones are obviously department of the city and are concerned about the city's overall financial health and where the city is going to make cuts.

So on the water side, I think there's much more concern about what the government is doing.

On the gas and electric side, I don't think you see as much concern about what the government is up to.

Great, thank you.

Carter Shoop, KeyBanc.

First question, on gross margins, when you look at it on a quarter-over-quarter basis, so relative to 2Q '11, can you try to break down the biggest impacts there?

Obviously, lower fixed cost absorption is a big part of that.

Were there any one-time-related items in the third quarter of 2011 that we didn't see in 2Q '11?

Also FX impacts, any mix shift -- is the margins higher in the gas business than on the water business?

Can you kind of give us a little bit more granularity on that decline?

I'll give you just a little.

For the most part, there's probably a little bit more FX impact in the Q3 over Q2.

But in terms of one-time things, the first thing I looked for, there was nothing.

But it's primarily -- it's the volume, it's the copper, it's the FX.

There's really nothing that unique.

I thought so, too; I said, did we take any unusual write-offs, bad inventory, whatever?

No.

And then on the SG&A line, you alluded to some one-time related costs.

Could you tell us or quantify those for us and how they compare to 2Q '11?

Q2 2011?

I'm not sure I can do that off the top of my head, because generally we do Q3 over Q3 and likewise.

But we had some professional fees and consulting costs in terms of long-range planning and stuff that were in there and other things like that, nothing -- not one of them that jumps out and says this is a huge number.

But, for the most part, because we are managing this for the long-term, we kept doing business and it impacted the line.

And so, when normally you would expect to see there are variable costs in our SMGA costs, and so you expect to see -- with a sales decline, you would have expected to see it go down more.

You didn't see that because we continue to run this business for the long-term and we are incurring certain of those expenses.

Okay, last question -- on the M&A side, can you talk about your outlook for acquisitions?

What does the pipeline look like today?

Is it mostly small to medium size acquisitions that you guys have been doing in the past year and a half, or are you guys entertaining some larger deals?

We are looking at some larger deals.

We've always said that we would look at deals that -- it's great to make a $5 million or a $10 million acquisition.

The problem is, it takes as much management time and as much cost to do a $5 million as a $50 million, so we would much rather do a larger deal.

We have looked at other deals and walked away, either because we felt they were too pricey or because they didn't come with strong enough management, which is one of the criteria that we want.

We are currently looking at some additional deals that are larger, larger in the range of, say, $50 million that we think are real positive and we may be able to move forward on.

Great, and then how willing are you to diversify away from the core business here, which is primarily the water meters?

Obviously, we are doing that a little bit with the other applications.

When you think about those larger deals, is it more continuing along the water metering space, possibly diversifying outside the US, or is it more diversifying away from the core business of water meters?

Well, we consider ourselves to be in the flow measurement business.

So the acquisitions we are looking at are in flow measurement.

Now, generally, if you buy a company that makes flow meters, maybe 25% or a half or 75% of the business is measuring water.

So we don't necessarily look for a company that is purely in the water business; we look for a good, solid company that's in flow measurement that has good technologies.

That flow measurement may be partially used in industrial and it may be partially used in water.

But that's what we're looking at.

So we don't see ourselves going far afield from what we are doing now.

Actually, one more question, if I may.

Just your candid view on potential consolidation in the water metering space in the US market?

Anyone's guess, but I would be curious to hear how you think the market plays out in the next couple of years.

Well, there are only five companies that make up over 90% of the market --

North America.

In North America.

I mean, we're talking North America.

So if you're looking at those companies, Neptune is part of Roper.

I don't see that moving anywhere.

Elster just went public.

Sensus -- we don't know what's going to happen there; they've talked about doing a deal or going public or doing something.

I think the private equity firm that holds them now would like to do something, so there's likely something to happen there.

But there isn't a big opportunity for consolidation when there's just a handful of players in this industry.

That's helpful, thank you.

Glenn Wortman, Sidoti.

Just looking at the sequential drop in specialty applications sales -- was that all reduced sales to Duke?

Yes.

Probably, yes.

That was the gas.

Okay.

And I know this was asked before, but -- so do you think that the shift in product mix affected the gross margins at all sequentially, or was it more just a volume issue?

No; I don't think so because, for the most part, the radios into the gas industry, while having good margins, were not -- that's not one of those specialty applications that's north of 40% because it's more assembly type work.

We don't need as high a margin on that.

So no, I don't think that was a big impact on the margins.

Okay, all right, thank you very much.

(Operator instructions) Jeff Matthews, Ram Partners.

I have two questions.

One is very short-term and the other one is longer-term.

The short-term one is, I'm not clear why the issues in Europe were cited as a factor in the quarter.

That's number one.

That's a good question.

I got asked the same question when I wrote the script.

What's the answer?

Let me answer that one for you real quick.

Frankly, I think it was just Mr.

Johnson waxing poetic about the world's ills.

It was a little bit -- what it was is -- my philosophy is that our customers, which are generally municipalities, act in the same way any retail stock customer would at a brokerage firm.

Okay?

And so when you see the debt crisis and the impact on the financial markets, the European crisis and the impact on the financial market and just the volatility in general, and they see all that, that uncertainty, it's like what you read in the paper about the average guy and his 401(k) who is afraid to open the envelope.

My point is that our customers kind of go into paralysis when they see all of that.

I get it.

So it's just part of the whole --

Well, that's all I was trying to say.

It was a very indirect reference.

I got it, okay.

And then the longer-term -- (multiple speakers) forget the quarter and the next quarter and the next month and all that and what happens with Duke and everything.

But looking out a few years, and ex-ing out any potential major acquisitions you might do, what roughly would the business look like, assuming we get back to some normalcy in the country?

And I'm just thinking in terms of -- generally in terms of revenue where you were in the past, generally in terms of margins versus where you were in the past.

That's what I'm looking for.

And I think that what -- if you take away all the uncertainty and all the stuff that's happening out there, our business over the long-term -- when we look at it we say, look, the water metering business, given the number of unmetered homes in America that have to be metered, given some normal growth rate in housing, okay, beyond where we are right now, which is almost a subsidence level, given some normal growth rate in housing and given a return of confidence in the water utilities, this should be a low double-digit growth rate business.

This should be a 10% to 15% top-line business.

And I'm talking about the total market, not just Badger -- on the water meter side.

On the specialty side, probably lower than that -- the specialty meters are going to tend to move with the economy.

They're going to go down when the economy goes down; they're going to go up when the economy goes up.

But maybe you make mid- to high-single digits growth rate on that side of the business.

And margins -- I think we ought to be -- on a normal circumstance, if copper wasn't volatile, if we weren't dealing with all these volume issues, this ought to be a 35% percent to 40% margin business.

That's -- in the long-term, when we look at this business, that's our opinion.

And we think it will get back to all of those terms as the economy settles down and as things go back to normal.

Okay.

And roughly, what does it cost to run that kind of business?

Does it cost you 15% of sales to run that business or 10% of sales?

You are asking, what, at the --

I'm looking -- I'm wondering -- what's a normalized operating margin down the road?

On operating earnings?

Well, I'll answer this -- because we don't give numbers generally.

But if you look at our selling and administrative and engineering costs and all that -- and again, we have never disclosed what's fixed versus what's variable, but there is a component in there that's fixed which we believe we can leverage that up.

I mean certain things will go up percentage-wise with increased sales, like commissions and the like, but other costs are fixed.

And so you should see -- to the extent we can grow that top line by what Rich was talking about, we should be able to grow the bottom line a little bit more.

(multiple speakers) beyond that you don't get much detail from us.

No, I guess where I'm getting at is, when I look at the last few years, operating margins on an annual basis have been in the 15%-16% range, but there were a few years before that where they were below double digits.

And I'm just wondering, where do you settle in versus that?

Is there something unusual about the systems (multiple speakers) [operating margin] --

No, I think this business ought to be able to generate margins in the 15% to 20% range over the long-term.

Okay, all right, that's --

We have carried excess capacity for years at the industry -- I'm not just talking about us.

The whole industry has carried excess capacity for years.

If our capacity utilization jumped even by 10 points, went from, say, 65% to 75%, it could have some pretty significant impact on the bottom line.

Understood.

And then, just to follow up on the gross margin side, is the move to Mexico on the production side -- would that have a -- would the thought there -- does that have a significant impact on gross margin, or not?

Well, it's having a positive impact.

Against the volume, it doesn't look that significant, but it's enough to register on our list of things when we do the analysis of the gross margin dollars.

Got it, okay.

Large enough that it shows up.

And I think the impact is going to continue to improve.

Obviously, there's a learning curve down in Mexico as we shifted things down there, and we are seeing their efficiency improve every quarter.

Got it.

And what has been the biggest surprise, positive or negative, out of that move?

Well, I think the positive surprise has been that we haven't seen any hiccups with the customers.

Obviously, when you make a move like that internally, you're going to have some issues.

But we've had no issues with the customers.

So they have been able to keep shipments on time and keep everything -- the quality up and everything else through what was a fairly tricky and complex move.

Yes, thanks very much.

Bob Chernow, RBC.

Gentlemen, could you perhaps describe the significant benefits of your new products in the water meter area?

We have not had a lot of discussion on that.

Sure, and Bob, here's how this new ORION SE, I think, performs better than what you see among our competition.

Many of our competition, many of the other companies offer a two-way radio.

What the problem is, when you start asking the water utilities, what do you want a two-way radio for?

They don't really have any very good answers.

On the electric side, it's much simpler.

We want to be able to turn off water heaters or turn down refrigerators or adjust thermostats.

We want to do peak shaving.

So on the electric side, two-way makes a lot of sense.

On water we are not going to shut off anybody's toilet.

It just doesn't make any sense.

So the water utilities have been kind of stymied as -- they all say we want two-way, but as a supplier we couldn't get past, well, why do you want it?

But everybody started offering two-way.

We went out and did focus studies with the customer groups, both our customers and non-customers, and really explored what is it they really want, what could they really use.

What we did is we came out with a two-way radio that offers a true transition from a drive-by mode to a fixed-network mode.

Now, when a radio is in a drive-by mode, it's broadcasting every 4 seconds a few hundred feet to reach a car going down the street.

When it's in fixed network mode, it's broadcasting maybe six or eight times a day, maybe a mile, to reach a device up on a tower.

But what -- a lot of the utilities say, well, we are not ready to put up towers yet.

We want to buy a product, read it drive by.

But maybe a year later, maybe two years later we'll want to put up towers and we'll start reading that way.

We want to know that we aren't going to have to go out and change out all this product.

And what we said is, okay, put in our system as a drive-by mode, and when you put a tower, you go out, you drive down the street broadcasting a signal and the meters will all switch from drive-by to fixed-network automatically.

Even better than that, if that tower goes down for some reason -- it gets hit by lightning, a wind storm knocks it down -- and that meter doesn't hear that tower responding anymore, it will go back into drive-by mode.

This is called drive-by back up.

Nobody else has this sort of thing.

And in most of our competitors, if they want to switch between drive-by and fixed network, they have to go up to meter and reprogram it, and gaining access is difficult.

With ours, we are using that two-way radio as the perfect tool for switching back and forth.

And then going beyond that, Bob, is the software.

You know, water utilities do not have a large staff like the electric and gas utilities to analyze data and to do their load management.

And you can imagine that if you have water meters that are broadcasting every 3 or 4 hours and you've got a city with 100,000 water meters, that's millions of pieces of data that are coming into the water utility.

The water utility is just not equipped to sit there and go through that.

Our system says you don't have to.

You can define a group of customers and a condition to look for and what to do when that condition is found.

So for example, if your largest water user in town suddenly starts drawing water at a rate 30% less than what they have used over the past year, a flag gets sent to the head of the water utility saying, hey, our water sales are dropping significantly.

You might want to find out why.

If a customer has a leak, a flag might be sent to the meter reader telling him to check out the leak.

So there are -- so this type of system automates the analysis, and that's what our customers have said they want.

They don't have a team of analysts to go through the data.

They want it to be completely automated, and we want the action to be automated.

Our action can be to send a text message, to send an e-mail, to print a work order.

We can communicate with the employees of that water utility in a myriad of ways.

We think this is a real game changer.

We think, between the ORION SE radio, the two-way radio and the AMA software, we have a major game changer in the marketplace because this was designed not for the electric companies and ported over to water, and it wasn't designed for the gas companies and ported over to water.

This was designed with the water utilities in mind, and it meets exactly their needs.

Not that I feel passionately about it, Bob (laughter).

Can I ask another question on this?

Sure.

There has been a lot of focus on other things.

In fact, no one even has asked the copper question, which I am always looking forward to.

But for this product, I think you said in the last session orders were held up because people were looking for it going out.

Can this -- maybe I misunderstood when you were talking about the other product taking basically five years or so before it would be approved.

Does this product have to be approved?

No.

The other product is the E series meter.

Okay.

And in my opinion it's just as exciting because it is a solid-state water meter with no moving parts.

But when you come out with a completely new technology that's nothing like anything that's been seen on the market before, some utilities will buy it before it's certified.

But the American Water Works says, before we certify a whole new metering technology, we really want to see it in the field for five years.

We have utilities that are buying it, saying give us 50, give us 100; we will put them out there, we will see how they work.

But others will say, well, we'll wait until AWWA certifies it.

And we are in the same boat as our competitors on this; you just have to go through this process.

But that's on a new meter.

When it comes to the ORION SE radio and the software, that doesn't apply.

So we don't have the AWWA standards to deal with on those.

In fact, the ORION SE radio works on our meters now, and it eventually will work with the E series meter.

Right.

It does work with the E series now.

It does work with the E series meter, I'm saying.

So that's the technology component.

Right.

So there's no comparable five-year wait on the radio and software, Bob.

Right, thank you.

I would now like to turn the call over to Mr.

Richard Meeusen for closing remarks.

Thank you, and let me reiterate that, although we were disappointed with this quarter and we don't expect to see a quick turnaround, because the fourth quarter tends to be a weaker quarter for us, I am optimistic about next year.

And the reason I'm optimistic is because, when I look at the past and I see this condition happening in the past, it has usually been a two-quarter confusion.

Now, I could be wrong about that, but if I'm right, if it follows past patterns, we could see strength coming back in 2012.

I think between the products we have in the marketplace, I think between the -- and when you consider that water is becoming a bigger issue, it's becoming more scarce, the utilities know that they have to meter it, they have to get people to conserve, metering is the best way to get people to conserve -- all of those factors will continue to drive our business.

So, in the long-term we are still very optimistic about the business.

And with that, I will thank you.

Thank you for your participation in today's conference.

This concludes the presentation.

You may now disconnect.

Have a great day.