Badger Meter Inc (BMI) 2011 Q4 法說會逐字稿

Good day ladies and gentlemen, and welcome to the quarter four 2011 Badger Meter earnings conference call.

My name is Robin and I will be your operator for today.

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

Later, we will conduct a question-and-answer session.

(Operator Instructions)

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

Rick Johnson, Senior Vice President, Finance and CFO.

Please proceed.

Thank you very much, Robin, and welcome to Badger Meter's fourth-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 fourth quarter results.

Yesterday afternoon, after the market closed we released our fourth quarter 2011 results.

In our last conference call, we predicted that concerns over municipal financing and slower housing starts would impact the fourth quarter.

Unfortunately, we were correct in that assessment and its effects on our fourth quarter results.

Sales for the fourth quarter were $60.7 million, versus $64.8 million in the same period in 2010.

This represents a $4.1 million, or 6.4% decrease.

This decrease is caused primarily by lower sales of residential water meters, and a decrease in sales of radials into the natural gas industry compared to the fourth quarter of 2010.

It is mitigated somewhat by the inclusion of remake sales in the fourth quarter this year, which were not part of the 2010 fourth quarter results.

Water applications represented 79.7% of sales for the fourth quarter, compared to 80.6% in the prior year.

Sales of water application products decreased nearly $3.9 million or 7.5%, to $48.4 million, compared to $52.3 million in 2010.

The decrease is due to lower volumes of meters sold, particularly Itron related products.

While ORION sales were down 4.3% in the fourth quarter compared to 2010, Itron sales were down nearly 49%.

In this most recent quarter, ORION-related products outsold Itron-related products by a ratio of over 3 to 1.

Sales of GALAXY fixed-network products were up over 40%.

We also saw declines in local or manual-read meters.

Commercial sales were relatively flat between years.

Specialty product sales represented 20.3% of sales in the most recent quarter, compared to 19.4% in the fourth quarter of 2010.

These sales declined approximately $200,000 or 1.6%, to $12.3 million from $12.5 million last year.

Included within this group are sales of radials into the natural gas market, and the decline in these sales is the primary reason for the specialty products decrease.

All other specialty products showed increases Q4 over Q4, as the economy continues to improve.

The fourth quarter of this year also included $0.8 million of remake sales, about $800,000.

Gross margin as a percent of sales was 31.9%, compared to 38% in the fourth quarter of last year.

The primary reason for the lower percentage is the lower volume of products sold and the related impact on absorbing our fixed costs.

This negative impact was offset somewhat by reduced copper prices and the price increase we put into place on January 1, 2011.

Selling, engineering, and administrative expenses -- we call it SMEGA -- increased nearly $2.4 million, or 15.8% over the same period last year.

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

But there are two significant charges that are included in this category that need to be pointed out.

First, as most of you know, we acquired Racine Federated just last week, on February 1.

However, the agreement was signed at the end of the year.

Most of the acquisition charges associated with this were expensed in 2011.

These amounts total almost $1 million, or about $0.04 a share on an after-tax basis.

As we go into 2012, we are not expecting significant additional acquisition costs.

Another significant expense occurred in the fourth quarter was a one-time non-cash charge for pension curtailment.

We recently signed a new five-year contract with our only union in Milwaukee, in which the union agreed to certain changes that give the Company flexibility in managing the Milwaukee plant in exchange for certain work guarantees that the Company made.

One of the changes the union agreed to was to move away from a defined benefit plan, or a defined contribution plan, similar to what the rest of the Company's US employees receive.

Because the defined benefit plan is frozen as of the end of the year, the Company incurred this non-cash one-time curtailment charge.

I should note that this so-called charge was already reflected on the Company's balance sheet as part of Other Comprehensive Income.

The agreement with the union simply triggered an accounting event where it needed to come out of that account and be recognized in the income statement.

The curtailment charge was nearly $1 million.

The portion that affected the income statement was approximately $0.03 per share.

Our provision for income taxes was 39.6% of pretax income.

While this appears to be high, it is really just a mechanical arithmetic issue due to the much lower pre-tax income in the quarter.

For the year, the effective tax rate was 29.9%.

As we told you in the last conference call, the third quarter did contain recognition of previously unrecognized tax benefits for certain deductions that we took on our 2009 tax return.

These benefits totaled nearly $1.5 million and were recognized in earnings in the third quarter.

Had that not happened, the effective tax rate for the year would have been about 34.5%, compared to 35.5% for 2010.

As a result of all of this, net earnings from continuing operations were about $1.2 million, or $0.08 per diluted share in the fourth quarter, compared to $6.3 million, or $0.42 per diluted share for the same period in 2010.

For the year as a whole, our sales were down about $13.7 million or 5%, to $262.9 million.

A year ago we commented that while we thought a recovery in our business was under way, there will be continuing headwinds associated with what we perceived as high copper prices.

While those copper prices have come down a little, we did not realize the market would be so profoundly affected by events of the past year.

Poor weather early in the year, debt ceiling talks in Washington in summer, the continuing European fiscal crisis, and the volatility in the stock market, all contributed to great uncertainty over municipal financing.

Combined with lower housing starts, it appears as if the industry took pause in 2011 to assess the impact of all of this as it moves forward.

One of the reasons we cited for our first quarter results last year was the winter weather that had plagued much of the Midwest, Northeast, and even parts of the Deep South.

I'm almost hesitant to say this, but so far this winter, at least in these parts, it has been relatively mild, which certainly can't hurt business as we move into 2012.

Just a quick comment about our financial condition.

At year end, our balance sheet remained solid.

Our debt as a percentage of total capitalization is now less than 1%, although that changed last week when we executed the purchase of Racine Federated.

For those of you who are curious, we have financed the Racine Federated purchase using our existing line of credit.

We are in the process of assessing cash flows for the next several years, and will determine whether or not we turn that into some type of term loan and restore the line of credit.

Just a note though, that our term loan likely would not be longer than two or three years, as we believe we will continue to generate cash from operations.

Finally, let me mention the stock repurchase plan that was announced in November.

We will begin this plan shortly.

Prior to today, we have been in blackouts due to the Racine acquisition and the regular year-end reporting period.

It is our intention to repurchase up to $30 million of Badger Meter common stock on the open market or in privately-negotiated transactions over a two-year period, depending on market conditions.

With that, I'll turn it over to Rich who will add his comments.

Rich?

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

Obviously, we were very disappointed with both the fourth quarter results and the entire year of 2011.

Even without the two unusual Q4 charges mentioned by Rick, the earnings in the fourth quarter were much lower than we had expected.

Correspondingly, our channel checks indicate that the entire municipal water meter industry was sluggish throughout 2011.

As such, we believe that we did not lose any significant market share during this downturn.

One positive aspect of 2011 was the significant increase in our non-utility flow products, such as magnetic meters, turbine meters, and valves.

This occurred both domestically and internationally.

These products continue to grow as the economy improves and as customers upgrade their production facilities.

In particular, Cox Flow Measurement, which we acquired in 2010, has seen significant growth in their turbine and oval gear meter sales for the agriculture and petrochemical markets.

We expect to see this growth continue in 2012.

While we do not give formal guidance, I do think it is appropriate for me to make a few comments about 2012.

As we noted in the press release, we have seen some strength returning to our municipal utility market as we move into 2012.

January has seen an increase in both orders and margins, certainly as compared to Q4 of last year, but also as compared to Q1 of last year.

In fact, our January sales were up about 20% over January of last year.

Although one month is not necessarily indicative of the quarter's results, we are optimistic about 2012.

Copper prices are also favorable compared to last year at this time.

As you know, copper is a major input cost for us.

In the first quarter of last year, copper reached $4.50 a pound.

This year it has stayed well below the $4.00 mark.

If it stays low, we expect that these copper prices will help us as we move into 2012.

Even though 2011 was a difficult year for sales, we continued our commitment to maintaining our technology leadership by investing over $8 million in R&D during the year.

This is a record level of R&D spending, which will enable us to bring new products to the market, and will benefit future years.

We also completed the purchase of Racine Federated as of February 1.

We expect this $57 million acquisition to be accretive for 2012.

However, due to purchase accounting rules related to inventory write-up, we will probably not see any significant benefits until the second quarter.

Racine Federated is a well-run company with a strong product line primarily consisting of industrial flow meters, with about $43 million in sales in 2011.

About 40% of Racine's sales are flow meters for various water applications, including waste water, processed water and HVAC systems.

Another 40% of sales are flow meters for non-water applications, such as chemicals, food processing, petrochemical, et cetera.

The remaining 20% are sales of products for the concrete industry, which, not surprisingly has been depressed lately, but is now seeing some growth.

From a technology point of view, the Racine acquisition now gives Badger Meter a much broader offering of flow meters.

For the first time we can offer our customers variable area meters, vortex meters, and differential pressure meters, to name just a few.

We will also be able to combine our sales channels to market Badger Meter's products to Racine's customer base.

While our total sales in water metering, both utility and industrial, remain over 70% with this acquisition, we have reduced our exposure to the US water utility market.

On a pro forma basis, Badger Meter sales would shift from about 72% utility water metering products, to 62% with the addition of Racine Federated.

Further, we see significant growth opportunities in the $5 billion global flow metering market for the future.

With that, Robin, you can turn this over for questions, thank you.

(Operator Instructions)

Our first call comes from the line of John Quealy of Canaccord.

Good morning -- it is Chip Moore for John.

I was wondering if you could -- on the charges for the acquisition and the defined contribution plan switch there, is that all allocated to SG&A?

And on a go forward basis, what are the benefits of that pension switch?

The charges for the acquisition all aren't in SMEGA costs, yes.

The changes are that we get rid of the volatility.

In recent years, to the surprise of no one, the return on our assets has not been that significant or has not been that great.

It's actually been losses.

The idea is that we are seeing significant volatility in pension costs as a result.

We'd like to stabilize it, moving to a defined contribution, where you set the percentage of what you're going to set aside for each employee each year allows us to accurately forecast our costs.

And frankly, there is actuarial risks that has existed historically with pensions.

We'll never get rid of that completely until this plan really actually dies at some point in the future.

But, it does save us going forward from adding new participants to that plan.

I'm not sure you answered the first part of the question.

You mentioned that the acquisition costs were all included in sales, marketing and engineering G&A line, but the pension cost--

The pension curtailment cost -- most of it is included in the SMEGA line.

A portion of it gets allocated to costs of goods sold, so there is a small piece of it probably still sitting in inventory.

But the lion's share of it hit the P&L in the fourth quarter.

Okay, that is helpful.

And then with the increased bookings with some higher margins, so far here in the new year -- can you talk a little bit more about what is driving that, whether it is mix or volume?

Obviously, with copper down by 15% should help in Q4, should help in Q1 and even a lower euro.

Maybe if you could give a little more color there.

Yes.

It's a little early yet.

We have not finished closing all of the details on January, so it is hard for me to comment a lot on where that mix is coming from.

But it does seem to be more mix that is driving a stronger margin than what we saw a year ago.

Our backlog is also up about 12% at the end of January versus one year ago.

And that, too, is a positive sign that we are looking at.

The fact that January sales were 20% higher, the backlog is up 12%, we are seeing the stronger margins -- all of those are starting to drive us to be a little more confident about 2012 as we move into it.

Perfect.

And on the competitive environment -- are you still seeing a lot of competition on price, or anything there this quarter?

I don't think there has been much of a change to the competitive environment.

Basically saying that it is still highly competitive out there, and pricing is very difficult, as it has been over the past year.

I think with the housing being softer, Badger Meter and all of our competitors have some excess capacity, and we are all out there aggressively trying to fill it.

And lastly, in terms of your appetite for M&A, particularly in light of that buyback, what are your thoughts there?

This is Rick.

I still think we have sufficient room to borrow for the right acquisition.

We would find a way.

Quite frankly, when we're sitting here trying to determine if we continue financing this on a short-term basis for two or three years, or actually decide to put some long-term money out there, if we found the right acquisition, I'd have no doubt that we would be able to structure something longer-term and to be able to finance that.

So the financing is not the key; the key is finding the right fit at the right price.

Right now all of Badger's debt is basically without collateral and without any significant covenants.

So, if we wanted to start putting up collateral and accept some covenants, we could certainly garner more funds if we needed them to make an acquisition.

If we had a significant enough acquisition, we could always look at going to the equity markets.

But, right now, we think we can continue to look at good acquisitions that are out there in the coming year, and finance them with debt.

Thank you for all the color.

Carter Shoop of KeyBanc

Thank you for taking my questions.

First, can we dive into the sales growth you have seen so far in January?

I appreciate that the quarter is not officially closed yet, but can you at least give us some color in regards to there being a couple large orders in there, or sales in there?

Or is it pretty broad-based?

No.

There are not large orders in there.

That is a broad-based increase.

We do not have one big city driving that, or one big order.

Okay, great.

And in regards to tax rate assumptions for the first quarter of 2012 and into the full year, what are you looking at now?

If I were building a model I might use about 35%.

The truth of the matter is, it varies year-by-year depending upon what states we sell into, and then how much income is foreign, because some of our foreign income is not necessarily (inaudible) some of it is taxed at lower rates.

But we're at 34.5% this year, without that one-time credit; we have 35.5% in 2010.

35% is probably a good starting point.

And I'm not sure if I missed this, but CapEx for 4Q 2011, and then expectations for 2012?

CapEx for the year as a whole was probably about $5.3 million.

For the year as a whole.

I do not have it for the particular quarter, because I do not have third-quarter cash flow sitting in front of me.

But that compares to about $9 million, $8 million last year.

What we have said, historically, is that CapEx moving forward over rolling three- to five-year periods should not exceed depreciation and amortization.

A couple years we're over; this past year we were under.

And then last question -- you mentioned that you did not see a significant shift in market share in 2011.

Would you be willing to comment on where you believe your market share is in 2011, and how that compares to where you were in 2010?

I don't want to particularly comment on specific numbers.

We get our information from the Scott Report and from a report called Proprietary publishing, which gives us our percentages.

We have run in the high-20s% to 30% market share over the last several years, and we have not seen that change much.

However, I will say that all of those reports are through September 30.

Obviously, nobody has kicked out a December 31 report at this time; it's way too early; it takes a while for those to come out.

But through September 30 we did not see any significant change.

Great, thank you very much.

Richard Eastman of Robert W.

Baird.

Yes, good morning.

Could you, Rich, talk a little bit to the order growth?

Is the order growth that you mentioned here in January -- how is that influenced by ORION FC with the AMA?

Have you seen an uptick in orders there since releasing the third quarter?

I would not say we have seen a big uptick.

This product, like most new products in the utility side of our business, take a while to gain customer acceptance.

We have a lot of customers that have ordered starter kits where they put 10, 20, or even 100 units out in the field to see how they perform; and we saw a lot of that during 2011.

I would not say that we are seeing any big jump in it at this point, but we are still optimistic about it going forward.

I have to remind you, when we first introduced ORION, ten or more years ago, it too took a few years to gain acceptance, because customers are very leery of new technology and they want to take a while to test them out.

So, no, I would not say it was a big uptick as a result of that.

Okay.

And then, also, your Itron sales being down virtually 50% -- is this basically just adjusting for the lumpiness from last year, still?

Yes.

Last year, we had some unique large orders to certain customers, and we're trying to fulfill those.

Because you recall, last year we were telling it was up for that same reason.

Yes.

Okay.

And just a question on the specialty side of the business -- Duke having run off here, have there been any large gas projects enter the bidding pipeline here that you could comment on?

What is the tone on potential gas sales?

First off, we are selling gas products to about sixty-some gas utilities during the course of 2011.

Obviously, Duke is the lion's share of that.

Duke was the strongest, was the largest of those.

So, there were a lot of smaller gas utilities that were buying the product, and they like it and it is working well.

We do have another large Duke-sized opportunity that we are looking at and is moving forward.

We are not ready to comment on it at this time.

It has not been formally awarded, so we have not made any kind of announcement.

We do have one that is moving further along, and then there are other ones out there that are just in the very early discussion stages.

Are you implying that you have been chosen on this larger one, or is it still in the bid process?

No, it is still in the bid process.

I am saying it is out there, and we are in the bidding process on that.

And can I flip back for one second to the water side?

Can you comment -- did Cleveland start to ship?

The reason I'm asking is, as we go into 2012, I know that is just meters -- but can we expect better absorption with the volume out of Cleveland?

In the fourth quarter, there were some sales to Cleveland, but not under that recent award.

We really haven't started shipping under the most recent one that was awarded.

It was a very small amount, maybe a couple hundred thousand dollars or whatever, in the fourth quarter with regards to that.

It is not kicking off necessarily in the first quarter, and as with any customer, we are kind of reluctant to talk about exactly when purchase orders are going to come in.

There is no reason to believe it won't start sometime this year.

I just don't want to comment on the specifics without the customer's kind of blessing off on that.

The information I have right now is that the award on Cleveland is about an $8 million award.

Correct, yes.

Our best sense of it right now is that it might start sometime in the summer.

But, again that is up to the customer as to when they start doing something.

But Rick is right -- we have always been shipping to Cleveland, and we have always had sales to Cleveland, and we continue to.

The award just has not started yet -- the larger one.

Okay, I got that.

Just one last question -- your response to the CapEx question for 2012, can I just back up?

Do you have an estimate for 2012's D&A, which would then obviously be inclusive of RFI?

D&A?

Are you talking genetics?

Depreciation and amortization.

Is that what you're saying?

Yes.

D and A -- I heard DNA, I'm sorry.

Rich is an accountant and didn't get it.

Off the top of my head, I do not have one combined, but our depreciation and amortization combined is -- holding up fingers -- $8 million a year.

Yes, I would think there would be a step up on -- probably on the amortization -- well, both -- with RFI.

The reason I'm asking is, you do not expect your CapEx to exceed D&A, but I would think it would be, your CapEx would be below $8 million, wouldn't it?

Correct.

Let's correct that.

We do not expect it to exceed historical D&A.

At this point, one major project is, with the settlement of our union contract, we're now looking at the Milwaukee facility in ways to optimize production in the Milwaukee facility.

So there might be some spending there in 2012, maybe to the tune of a few million.

But we really cannot think of anything else that is major at this point that we need to do.

Thank you.

Hasan Doza of Water Asset Management.

Good morning guys.

I wanted to get some color about capacity equalization.

Would you guys talk about the capacity utilization of your factories during Q3 and Q4, and how did they compare to levels versus a year ago?

It was lower.

I'm not trying to be flip with that.

Historically, we make about 1.5 million meters a year, and we know that the volume was down this past year.

It was probably down in the magnitude of the 20%- to 25%-type scenario.

On the fixed cost -- more so in the third and fourth quarter, because Qs 1 and 2 were a little bit better.

And then we really saw the softening near the end of the year.

In our mind, that is what drove the gross profit percentage significantly lower, is that volume impact against those fixed costs.

As far as our capacity utilization, we have the ability -- we have all of the equipment and the ability to do well over 2 million units per year without a significant increase in CapEx spending.

So, if you want to do some kind of capacity utilization -- prior to the housing crash, we were at about 1.5 million units a year, and we are down to about 1.2 million now with the housing crash.

We could easily go over 2 million.

So, you can do the math.

Okay, thank you.

(Operator Instructions)

Steve Sanders of Stephens Inc.

Good morning, guys.

I just want to see if we could get a little more color on the Racine deal.

First -- Rick, how are you going to report that across your two segments?

First of all, we only have one segment, but we have a couple of different product lines.

I think we are still finishing discussions, but I think what we're going to do is, we're going to wind up talking about water applications in terms of water metering applications and other water applications.

And then we'll probably talk about specialty in terms of an industrial flow type flow -- and then what I call pure specialty, which is radios into the gas industry, these concrete vibrators that are sold by Racine and maybe we'll throw in the valve business in there, or something like that.

So we are still toying with that.

But again, just to clarify, we will report on sales probably in those categories.

And, Steve, I want to clarify what Rick said, because I think he misspoke without realizing it.

We have talked in past about water and specialty.

That is how we broke it apart.

We are really talking about the possibly of maybe going to four groupings, talking about utility water metering and non-utility water metering.

Rick said water metering and other water.

We're talking about utility water metering and non-utility water metering; and then industrial flow metering in the specialty products.

Those are the four categories we are thinking about moving to, but we are still talking about that.

And any additional color on the potential sales synergies?

You mean between Racine and Badger?

Yes.

We have started the process of looking at all of the reps.

And Racine primarily sells to reps and so does Badger, on the industrial side of the business.

We have started the process of going down the list and looking at all of the reps and deciding where we have strength in what areas, and how to best optimize that.

There are certain reps that will gain product lines.

If Racine has a particularly strong rep in a certain area, we will give them Badger product lines to add to that.

Likewise, if Badger has a strong rep, we will look at adding the Racine product lines.

But in these industrial markets, you're really talking about a lot of market segments that you have to get involved with.

Like you may have a rep who specializes in petrochemical, and another rep who specializes in pharmaceutical, and then another one that specializes in food processing.

So we really have to go through the process of determining where we have strength and how best to go to market.

We think there are significant opportunities here, because you can argue about how many different ways there are to measure flow; and physics people and engineers love to talk about this.

But when I look at it, I say there is roughly sixteen ways to measure flow.

Badger historically has had seven; Racine has had seven; we've only got two that are in overlap, and we sell them into different industries.

So when you combine, we now have, instead of having seven of the sixteen ways, we now have twelve of the sixteen ways.

We are getting much closer to being able to offer every possible way there is to measure flow.

I think for some of these reps that is going to be a huge opportunity for them.

And as we think about the supply chain and the manufacturing, how do we treat Racine?

Is it stand-alone for now, or are there opportunities to shift some production for them like you have done with your other businesses?

What are you thinking at this point?

At this point, we do not see a plan to shift production out of Racine.

In fact, the Racine facility has empty space, and one of the things that was attractive to us was the opportunity to add some production into Racine.

So we will be looking at that and looking at optimizing it.

So that is a positive thing.

On the supply chain, we will be going aggressively and looking at whether or not we can combine our purchasing capabilities and things of that sort, in order to drive some more synergies.

And last question -- how should we think again on Racine about the margin profile relative to Badger's historical?

I know there has been quite a bit of volatility there.

But what --

Generally Racine carries a higher margin than Badger's historical margin, which is true of Badger's industrial products, too.

The industrial products, overall, it's a little more capital-intensive, it's a little lower volume, more specialized in engineered products.

So Badger's industrial products carry a higher margin than our corporate average, and Racine also carries that higher margin.

What do you baseline as the corporate average?

Because we have seen high teens and we've seen --

I would say the mid- to high 30s% is corporate average.

And I'm talking about gross margin.

I'm not talking about operating margin.

I'm talking about gross margin.

Got it.

Thank you.

There are no more questions at this time.

I would now like to turn the call back over to Rich Meeusen for closing remarks.

I would like to thank everybody for talking to us today.

Obviously, 2011 was not strong, but as we look at 2012, we see all of our fundamentals are still there.

We see January as coming out of the chute with a strong month.

We like what we see in the backlog at this point.

All of those things tend to make us believe that 2011, especially the second half of 2011, was a bit of an aberration, and to what is otherwise a very good long-term growth story.

So we are optimistic about 2012, and we will be working hard to turn in some good results for that year.

With that, I will thank you.

Thank you very much.

This concludes today's conference.

Thank you for your participation.

You may now disconnect and have a great day.