Badger Meter - Earnings Call - Q1 2014

Transcript

Speaker 0

Good day, ladies and gentlemen, and welcome to the Quarter One twenty fourteen Badger Meeting Earnings Conference Call. My name is Carolyn, and I will be your operator for today. At this time, all participants are in listen only mode. Will conduct a question and answer session towards the end of the conference. As a reminder, the call is being recorded for replay purposes.

And now I'd like to turn the call over to Rick Johnson, Senior Vice President of Finance and CFO.

Speaker 1

Thank you very much, Carolyn. Good morning, everyone, and welcome to Badger Meter's first 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 made on the 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 interest of our shareholders.

Now on to the first quarter results. Yesterday after the market closed, we released our first quarter results. Sales were a record $83,500,000 as compared to $71,800,000 in the 2013. And I'll clarify that record is for our first quarter sales. This represents an increase of 11700000.016.3% over the same period last year.

This increase was driven by higher sales of municipal water products and flow instrumentation or industrial products. Let's look at each of these categories. Municipal water sales increased $10,900,000 or 23.3% to $57,700,000 in the 2014 from $46,800,000 in the 2013. These sales represented 69.1% of sales for the most recent three months. Sales of residential meters increased 17.6%, while sales of commercial meters increased 62.4% over the first quarter of last year.

The lion's share of this increase was due to increased volumes of products sold both with and without technology. We should also note that last year's first quarter was an unusually weak quarter, which we attributed in part to the winter weather. For some of us, this year's winter was not much better. In fact, it may be considered a little bit worse. However, the particular mix of customers that we have in any given quarter can also have an impact on our sales.

And so while weather probably did have an impact in certain parts of the country, much of the sales increase that we saw in the first quarter was due to customers in states that were not as impacted by weather. Flow instrumentation or industrial products represented 28.4% of twenty fourteen first quarter sales compared to 30.6% in the same period in 2013. These sales increased $1,700,000 or 7.7% to $23,700,000 from 22,000,000 the same period last year. This sales increase was due to higher volumes of products sold in most of this category's product line. Specialty products are a small part of our business as they represented 2.5% of first quarter sales.

These sales decreased $900,000 or 30% from the 2013. The decrease was due to lower sales of gas radios, offset by an increase in sales in the sales of concrete vibrators. Gross margin for the first quarter as a percent of sales was 34.7%, very close to the 34.9% that we saw last year. The slight decline was due to product mix. While municipal water sales were up in all categories, the increase was higher for manual or local read meters, which carry lower margins.

But the increased volume did help us with better capacity utilization within the plants. Selling, engineering and administration expenses for the three months increased $900,000 or 4.7% from the same period last year. Included in this year's expenses were charges totaling $1,700,000 or approximately $07 per diluted share related to due diligence and other transaction costs related to acquisition that ultimately was not pursued. Rich will have more to say about this in a moment. Excluding these charges, selling, engineering and administration expenses were down compared to last year due primarily to lower product development costs.

Costs. Last year, our development expenses were higher as we were investing in products that we have since released into the market.

Speaker 2

The effective tax rate for

Speaker 1

the quarter was 37.4% compared to 35% last year. Last year's first quarter effective tax rate included one time effects of tax law changes that were signed into law early in 2013. Without those changes, the tax rates would have been comparable between periods. As a result of all this, net earnings for the quarter were $4,600,000 or $0.32 per diluted share compared to $2,900,000 or $0.20 per diluted share for the same period in 2013. There were no significant changes in our financial condition.

In the first quarter, despite the increase in net earnings, we did not generate as much cash from operations as last year as the increase in earnings was more than offset by increasing receivables and inventories. We view this as a temporary situation and expect to continue to generate cash remainder of the year, which will be used in part to pay down debt. At March 31, debt as a percent of total capitalization was approximately 27%. I will now turn the call over to Rich Musson, Badger Meter's Chairman, President and CEO, who will have some additional comments. Rich?

Speaker 3

Thank you, Rick, and thank all of you for joining us today. Two months ago on our year end earnings call, I noted that the 2013 was weaker than normal due to unusual weather impacts throughout the quarter. But I indicated that we were optimistic about the 2014 since we were seeing sales and orders return to a more normal pattern. As Rick discussed, this held true through the first quarter, resulting in a very solid performance. One particular area of solid growth has been our E Series ultrasonic water meters.

Not only did we start shipping these meters to our new customer in The Middle East during this quarter, but we also had strong domestic sales, resulting in total sales during the quarter of almost $4,000,000 for this relatively new product. With the recent introduction of additional sizes of these meters in both stainless steel and polymer, we believe that we will continue to see strong growth in this product line. In addition to meters, our recent introduction of the Orion Cellular Radio and the Beacon Advanced Metering Analytics System have been met with a great deal of enthusiasm by our sales force, our distributors and our customers. I'll remind you that this new system enables us to address hard to read metering locations through cellular technology, provides the utility with a powerful cloud based software analytics platform and enables our customers to provide timely consumption data to end consumers to encourage water conservation efforts. Sales are in the early stages with small numbers being shipped for customer evaluation and training purposes.

However, the performance in the field is excellent and sales inquiries are strong. And I'll go off script for a moment here, which makes everybody in the room extremely nervous and say that I just got off the phone about ten minutes ago with our VP of Business Development, Greg Gomez, who is in The Middle East right now with Horst Gras, our VP of International Operations. They are visiting the customers who are buying the E Series meters, but they were also demonstrating the Beacon Advanced Metering Analytics System. Greg indicated that several of the customers in The Middle East are very excited about Beacon's ability to allow the end consumer to see their water usage and to encourage those consumers to conserve because obviously in The Middle East, water conservation is a major focus. So he was very optimistic about our opportunities over there.

Finally, let me address the change the charge in this past quarter related to our acquisition activities. We worked very hard during the quarter on a potential acquisition and completed more than half of the due diligence work before we made the decision to not move forward with the acquisition. Anytime a company becomes involved in a potential acquisition, especially where significant due diligence costs are incurred, there is a risk that the management and the Board will feel compelled to complete the acquisition process regardless of what is uncovered in the due diligence process. I'm very proud of the fact that Badger Meter's management team and Board of Directors have maintained the discipline to walk away from a potential acquisition at any point in the due diligence process if we feel that the acquisition is not in the best interest of our shareholders. We will continue to pursue strategic acquisitions in the future and we will also continue to carefully vet those opportunities to ensure that they result in increased shareholder value.

With that, we'd be very glad to take your questions.

Speaker 0

Thank you. From Canaccord Genuity. Thank you.

Speaker 3

Hey, good morning guys. How are you? Good morning, John. Hey. So a couple of questions.

So thanks for the updates on several initiatives. But on Beacon, can you talk about domestically what you're seeing about order potential? I know I think at Distributech there was chatter that it's been

Speaker 4

out to about a dozen customers doing some testing.

Speaker 3

Yes. And I can give you a couple of data points on this. We've only had it out for a few weeks as you know. And obviously to make a sale, we're required to there's training involved and scheduling of training and everything else. But we have quoted over 60 Beacon systems already in just the last month or so that it's been out, which we view as a very positive sign.

Everything from small systems to very large systems, we've quoted. And also, we offered a starter kit because unlike our other systems, beauty of the Beacon system is that you can literally go out and put in one or two units and use them and it doesn't require you to put devices up on telephone poles. It doesn't interfere with any of your other meter reading operations. So we offered starter kits for a fee that included 10 units plus software and a training session, a webinar training session. And we have already received orders for over two dozen of those starter kits.

So we are very optimistic about what we're seeing. We feel that it's getting good market acceptance very early on. And part of that is because it is so easy to look at this. You can imagine if you order a new drive by system, putting 10 out there really doesn't test it. And a new fixed network system, you've got to put devices up on towers.

But this is a very easy system for utilities to get into and we think we're going to see a lot of utilities putting in small numbers, testing them for a few months and then following on with major orders. John, did I lose you? I might have lost you. You

Speaker 0

next question we have comes from the line of Richard Eastman.

Speaker 1

Yes. Good morning. Good morning, Rich. Rich, just wanted to double back for a minute on this E Series sales in the quarter this $4,000,000 Can you just give us a sense of how much of that is against that $6,000,000 order you had in the second half of the year? And maybe just with kind of the mindset of how much traction and what's realistic to assume for sales of that E Series meter in The U.

S. The next Can maybe 12 it move the needle?

Speaker 3

Yes, Rick. And hopefully, won't talk so much that I'll lose you like I

Speaker 1

did John. I mean, just put him to sleep, Rich.

Speaker 3

I don't know. He may have dozed off on us. John has dialed back in. So he must have lost the line and come back in again. So John, I apologize for whatever happened there.

Rick, in answer to question, yes, we did about 4,000,000 of E Series. About half of it was that major customer in The Middle East and about half of it was domestic applications. I think we're it's hard for me to say exactly a dollar amount we're to sell during the coming year. Obviously, have a budget and expectations. But I think we're going to see a very strong growth trajectory on this because a lot of customers have made the small purchases over the past year or so and have had them out there and testing them.

And thus far, these things are testing very well. They are performing exactly as we had told our customers they would perform. The beauty of the E Series meter, for those of you who aren't familiar, is that it's an ultrasonic meter. It's solid state, meaning it has no moving parts. So it does not wear out and lose its accuracy like a mechanical meter does.

And also because there's no moving parts, any grit or anything that might get in the water is less likely to damage the meter. So it's a very good it's a very well performing meter and we do think it's going to have a strong growth trajectory during over the next four quarters as we go forward.

Speaker 1

And this is Rick. And if I just can add to the extent we sell it domestically, it's selling to customers who normally would have purchased mechanical meters and are moving to solid state meters. So there is Yes, I understand. And again, I know from commentary you've made in the past, the ASP purchase price on this is higher. Is the margin better on your than your typical brass local read meter?

Speaker 3

Yeah. I think it's a little bit better.

Speaker 1

Okay. All right. So there's no trade off. Could you just maybe address the gross margin here? Again, just continues to be maybe a little bit disappointing and maybe sluggish relative to some of the variables that go into that number namely volumes.

And I would have thought we'd have seen some improved performance, especially sequentially. I mean, did $2,500,000 more sales and our gross margin actually declined a few $50,000 So just I mean, what's your patience level there, your timing there? How should we start to model that going forward here?

Speaker 3

Rick, I'm going to let Rick Johnson answer that question, but I want to go back to one thing so there's no confusion. On your question on E Series margins and I said margins are a little bit better, I'm talking about margin percentages. So obviously, if you've got a higher selling price, margin dollars are even better. So there's no confusion there.

Speaker 1

And I'll try and give you a little color. Again, you go back to last year was a difficult quarter for us. We know that. And so even just looking you're talking sequentially, I'm talking Q1 over Q1. There are some additional warranty charges in there that do impact margin, maybe point 5% here and there in this current quarter.

There's some FX charges in there. We continue to buy our radio boards out of Europe. There's the increased cost. If you remember last year, were still selling about half the brass was standard brass and the other half was bialloy. We're now at 100% bialloy.

And yes, we did increase the prices to cover for some of that. But there are in terms of the cost, those costs of the bialloy eys a little bit higher. But Rick, it's the same issue. Clearly, volume helped the margin dollars, okay? When we got to the end to a certain extent, there is some pricing pressure out there that squeezed a little bit and it's a particular mix of customers we have.

So right now, we're not reading anything in particular in this. Your question as to how to model it going forward, we continue to push to get into that 36%, 37% gross margin range. I made the comment in my comments that there was a little bit heavier mix of local read meters in this particular quarter. And so that impacted it. So I mean, I'm literally looking at like a dozen items that can impact margin.

None of them other than volume pumping it up, none of them really jump out at me as a major factor, but taken as a combined set, it did have that little dampening effect on the margin. But that's again, if we just there's so many variables that go in there. I think we understand the variables. But just with volume going forward, can incremental gross margin it seems to me it should be 40% or 50%. Now again, I'm thinking incremental as in quarter to quarter.

Speaker 3

Well, I'm confused by the question Rick, so let me make sure. You're saying you think the gross margin itself ought to be 40% to 50%? Or are you saying the gross margin on

Speaker 1

I'm saying the incremental gross margin. So incremental dollar of sales, the gross margin on that should be north of 40%.

Speaker 3

Yes. And you're right because once you're adding work to a factory that has capacity, there is an additional gross margin that you gain. And so you're absolutely right. When we add an extra $1,000,000 of sales into a factory that has excess capacity, we could pick up a margin north of 40% with no problem whatsoever. And we understand that.

And that's one of the reasons why we went aggressively after some of Elster's low margin business because we knew even though that margin was low, we could put it into our factory. And our factory is running at about most of our plants are running at about 70%, 75% capacity. So we could easily put it in there without adding equipment and pick up a higher margin than what Ulster had.

Speaker 2

Okay. But again

Speaker 3

But Rick there are so many other factors.

Speaker 1

I understand. I can double back to you. It's just I'm just looking fourth quarter to first quarter. And again, you had a decremental on higher sales. Now I know Rich or Rick you're kind of addressing year over year and I understand that.

But it's still a bit surprising that from the fourth quarter to the first quarter with $2,500,000 more of sales, gross margin went down by $50,000 So that's what I was trying to reconcile. But just one other question I can double back. But can I just ask these due diligence charge this due diligence charge in the quarter, can I just ask you approximately some range of revenue in the acquisition that you were looking at? How big was that?

Speaker 3

Yes. And we talked a lot about this and figured we'd get a lot of questions on the size of the acquisition on whether it was domestic or foreign and whether it was in our industrial area or water meter area. And we decided that we would tell you it's bigger than a breadbox, but we're not going to play 20 questions. And because we really don't want to narrow it down. It was I would say it was a significant acquisition that we were chasing because obviously the due diligence dollars in my opinion became significant, but that's all we're really saying.

Speaker 1

And we've actually signed a confidentiality agreement, so we are not going to say anything more. Well, there was a piece of business that transacted in Mexico. But it was quite small. And I'm going to just kind of presume that's not what you were looking at.

Speaker 3

This was a significant opportunity.

Speaker 1

Okay. Okay. Thank you.

Speaker 0

Thank you. Next question we have John Quelley from Canaccord Genuity back in the call.

Speaker 3

John, you must have dozed off on us. Yes. You're the one caller I don't doze off on. There's always the risk that you say something. So I don't doze off.

Anyway, sorry about that. So my follow-up on that question on Beacon was, is this not cannibalizing the existing drive by platform at all? Or just help us frame it because it seems like a good solution and it seems like it's getting decent traction at least initially. John, what I would say is obviously it is going to cannibalize some drive by in fixed network. But I view this as a really positive thing.

The most recent estimate by IMS is that in The U. S. Or in North America, about 43% of the meters now have radios on them. So we still have a long way to go. And one the major issues in getting utilities, those other 60% of the utilities to switch from manual meter reading where somebody walks door to door to some sort of automation is the fact that we have been offering, we and all of our competitors have been offering drive by or fixed networks as alternatives.

And both of those have limitations. The problem with most fixed networks is that you always city boundaries are not a perfect circle. If they were, life would be so much easier for us. You always have houses out in those hard to read areas. And so you're talking about a lot of infrastructure to get coverage.

And even the best fixed network system, you're still going to have some meters that won't report. It's very difficult. We've all struggled with this. But with a cellular system, pretty much every house that is on a municipal water system has cellular service. Obviously there are houses in the North Woods of Wisconsin that don't have cellular service but they also aren't on a municipal water system.

So we feel that this is a solution that is really going to help. And then the second thing that this does, overlook the value of the conservation tool here. A lot of the water utilities are now going through what the electric utilities went through in the '80s, which is they are being pressured to find ways to help customers conserve. And with a tool like this, when your cell phone can tell you exactly how much water you're using, can warn you that there's a likely leak, that's a very powerful tool. So I I'm think hoping that what Beacon really does is rather than cannibalize a lot of our existing sales, it's going to move a lot of those 60% of the utilities off the dime where they've been sitting back and waiting for compelling reason to go to automation.

And this I believe is the reason. Okay. And then just two more questions. First, so we talked about this concept of an Lster drag as you I guess, make whole get overhead absorption on your side and keep those customers' prices under previous agreements with Elster. When generally does the bulk of that run off so it's no longer a drag, if you will?

I think we're going to well, there's several factors here. One is those contracts that we took over since June 30 mostly run through 2014. A few of them might run into early twenty fifteen. I'm looking at Kim Stoll, our VP of Sales here to see if she'll nod at that statement. There are a few that go into early twenty fifteen, but most of them run off through 2014.

Now when they run off, we will go aggressively to try and get some price relief. When Will we successfully get prices on all those contracts back up to what our averages are? Probably not. We may achieve it on some. I don't think we'll achieve it on all.

So those L store customers who got very used to paying a submarket price for their meters, they're going to be hard to convince and it's going to take time to convince them over time to move on. We'll have a first shot at it when their contract ends or we'll go after it.

Speaker 1

Let me enhance that. We've already had conversations with most of those customers and prepared them for the fact that we cannot sell at those prices going forward. And for the most part, while not exactly receptive, I think most of those customers understand that because they understand Elster is no longer around.

Speaker 3

But on the other hand, can you go in and convince the customer that on the renewal they should have a 20% price increase? Probably not. On the other hand, could you get a 10% price increase? Yes, you could probably do that. So it may take a couple of rounds for us to get those up to where we want.

I don't want you to think John that those customers are going to jump on renewal. Yes. No. So this leads to my last question. So copper took a pretty good digger here at the end of the recent past in whenever you got forty five, sixty day inventory turns and things like that.

Rich Rick I think mentioned a little bit of price pressure in and around there. So all else equal, we should still see some ability to grow the gross margin. If you're getting some goodness on copper, maybe you give a little bit on price. But I can't imagine that you're going to be much more negatively impacted on price or is that not a fair assumption? No, think it's a very fair assumption.

First off, takes about sixty days or ninety days, they're telling me ninety days, for a copper price increase or decrease to move through our system because it's first seen at the smelter, then it's seen at the foundry and then it has to move through our inventory and out to the customer. So it's about ninety days. So you're right, copper did take a drop. And if it stays down, we're going to see some benefit of that coming through. The other thing that's happening is that when you compare to a year ago, and I know we keep talking a year ago, guys like to compare sequential quarters.

But a year ago, the benefit of lower copper was offset by the fact that there was a mix of cheaper copper, the 81 brass, which we no longer have now. As we move through this year, that year over year comparison goes away because by about the middle of last year, there was no more of the 81 brass and it was all bialloy. So you're absolutely right though. We are anticipating some margin tailwinds from the fact that copper has recently dropped.

Speaker 1

And I'm a cynic. I mean, the price increases come within ninety days. Decreases are like gasoline prices when oil goes down. It just takes a little bit longer. And so we've been really pressuring the foundry to give us those decreases.

Speaker 3

Yes. Rick tends to believe the worst in everybody. He assumes that when prices go up, immediately pass them on to us and we have to squeeze to get some extent A hint of truth. To some degree, he may be right. All right, guys.

Thank you.

Speaker 1

You bet.

Speaker 0

Thank you. The next question we have comes from the line of Ryan Connors from Janney Montgomery Scott. Please go ahead.

Speaker 2

Great. Thank you. I have a few questions guys. I guess first off just more of a housekeeping type question then a couple of bigger picture items. First off just you discussed the gross margin in pretty good detail there.

But just can you kind of give us an outlook for the SG and A line? I know there's been a number of moving parts there with the R and D rolling off, but maybe variable comp heading up in this charge. So what's kind of the outlook for the trajectory we should look for there in the moving pieces?

Speaker 3

Yes. Ryan, what I'll tell you is that our engineering costs, which are a major part of our sales, what Rick calls SMIGA, sales, marketing, engineering, G and A, our engineering costs have historically run less than 5% of our sales. They've been anywhere from the 4.5% to 4.8%. Last year, we consciously allowed them to go over 5%. It was what I euphemistically referred to as the surge.

We did that in order to get Beacon to market. We felt we had a very compelling product that would generate great shareholder value. So we put a surge into engineering. We spent the additional money and we got that to market very quickly. As I told my engineering guys, when the surge is over, it's time to bring the troops home.

And so in 2014, we believe that our engineering expenditures should drop below the 5% level. And we should be able to gain from that. We should have something up there. Our other SG and A costs, I think you're going to see them maybe a little bit higher with inflation. Also the fact that we didn't pay any bonuses last year because at Badger Meter, if earnings don't go up, we don't pay bonuses.

So that is this year, if earnings are higher, we will be factoring some bonuses. You'll see that impact. But beyond that and absent unusual onetime events like the $1,700,000 on acquisition. Absent that, you should not see much of a rise in SG and A.

Speaker 1

And I think, Victor, the only thing is we always are watching their non cash charges and it's this it's pension accounting and you saw that last year I think in the second and third quarters. And simply from the fact that we froze the pension plan a couple of years ago, we're more likely to have some of those charges later in the year depending upon the payoffs from the plan. It's some convoluted thing, but it's always a non cash charge. In fact, the balance sheet is properly stated. This is the thing we always talk about.

We just pull it out of equity, run it through the income statement and back in. So likely you might see those later on in the year.

Speaker 2

Okay. That's great stuff. So the bigger picture, so first off just to follow on the BEACON and the Orion SC discussion. You've mentioned several times Rich about conservation being a key selling point and the ability to help drive a conservation program. That seems to be a recurring theme in the customer testimonials that we've listened to.

You mentioned Greg reporting that back from The Middle East in real time. So to what extent does that make that somewhat of a niche solution that's more applicable to The Middle East than to parts of the Southwest in The United States and so forth and kind of limit the addressable market there because it seems like that is a big talking point for that product.

Speaker 3

And Ryan, I think to some extent, and I know you're very familiar with water industry as I am. I think to some extent you might be underestimating the significance of the new focus that we're seeing on water conservation, not only around the world, but all across The United States. Milwaukee, where we are today, is in the world's largest water basin. We have over 20% of the world's fresh water right outside our back door here in the form of the Great Lakes. And yet even here, people are saying we need to conserve because there's also energy nexus.

Even if you have plenty of water, you're using a lot of energy to move and clean that water. And so people in, I'm finding people in all communities, people located on rivers and lakes are focused on water conservation. And to the extent that Beacon can help their community achieve water conservation goals, I think we're going to see that happening all across The United States and all around the world. So I don't view it as a niche play. But then I would also remind you that Beacon itself is more than just about water conservation.

To us, that was an additional feature we were able to provide. Once that information is up in the cloud and through a cellular system, getting it back down to iPads and iPhones was a very easy thing and that's a nice thing to provide. But really Beacon offers so many tools for the utility to analyze their water usage and to identify where potential leaks are and to deal with management, all of those wonderful things that they'll be able to do with Beacon, it goes far beyond just conservation. It also goes to allowing the utility to focus on what they do best, which is managing their utility. And that's really a key factor also.

So I don't want you to think conservation is the only selling point. I think it's a selling point that we're hearing a lot of interest in. Maybe we've been underestimated how interested people would be based on Greg's comments from The Middle East. But there is a lot more there than meets the eye.

Speaker 2

Okay. And then one more just kind of revisiting a topic that was a hot topic last year. I haven't been hearing as much about it, but just the state of the municipal customer base and the municipal end market in general, I mean, you're posting some pretty strong numbers and growth in that end market, which many people are still saying is in trouble given pension issues and so forth. I mean, you read that as a recovery in that end market? Is there something else going on there?

Speaker 3

No. And Ryan, I know that you do a lot of research into the health of the municipalities. And in fact, I rely on some of it because it's pretty good, surprisingly good.

Speaker 2

Couldn't leave with

Speaker 3

an open compliment like that, Ryan. I had but the fact is I also think what we're seeing is that the municipalities can cut back on water meter replacement for a while. But at some point, they have to go back to it. So you have a bad winter, maybe the municipal budget gets used up filling potholes and salting roads. And so they decide for six months we're just going to cut back on water meter replacements.

At some point, those meters are getting old. They're becoming inaccurate. They lose their accuracy with time. Revenue is being lost and the utility has to go back to it. So remember that the water meter is the cash register of the water utility.

And as Rick Johnson, our CFO, loves to say, even a restaurant going out of business keeps an accurate cash register by the door. So no matter how difficult a city's pension obligations are or other budgetary constraints are, they want to have accurate cash registers and at some point they will start that replacement. I think that's what we're seeing. I think we're seeing them come up and say, we've got to get back into these replacement programs.

Speaker 1

And Ryan, one other comment on the first quarter sales. One of the things that we're kind of getting anecdotally is that we introduced Beacon in the first quarter. In fact, we introduced it at our sales meeting in January. Now granted, training didn't take place till mid March on it, all right? But we have a lot of people saying they just paused for a while, okay?

So to have record sales for any first quarter despite the fact that if we had not introduced Beacon, maybe sales would have been higher. Now we can't guarantee that, but we have had Anador instances where cities are just thinking about it. The lack of infrastructure associated with this is very attractive and some people also.

Speaker 2

Great. Well, that's great stuff as always. Thanks guys.

Speaker 3

Thank you.

Speaker 0

Thank you. The next question we have comes from the line of Glenn Wortman from Sidoti and Company. Please go ahead.

Speaker 2

Yeah. Good morning,

Speaker 4

Good morning, Glenn.

Speaker 2

I'm glad I can if this had come up on past conference calls, but with the introduction of E Series meter and it holds the accuracy longer, I mean, do you think that would lengthen the replacement cycle if these meters really catch on?

Speaker 3

No, Glenn. The reason I say no is because in our industry meters are warranted for twenty years. Batteries generally last twenty years. And the average replacement is about fifteen. There are some utilities that will replace earlier than the twenty years and some that go the full twenty years.

So we run an average of about 15. I don't see accuracy stretching that out much. It certainly can't go beyond twenty because by then batteries die and the product has to be replaced. If anything, there are some utilities that maybe stretch a little bit beyond the 20%. And I think once they go to electronic metering, the 20 becomes kind of a hard wall for them.

Speaker 2

Okay. All right. And then just to ask the acquisition question a little bit differently, can you maybe just comment on what types of businesses you might be interested in going forward?

Speaker 3

Yes. We still there are really two distinct buckets of acquisitions that we see as potentials. One are smaller strategic acquisitions, primarily in the one third of our business that is flow instrumentation or what we were always calling industrial metering. And acquisitions like we've made in the past with Cox and REMAG and companies like that. Those are smaller acquisitions.

We're not looking at any large companies there. We're talking maybe south of $10,000,000 maybe as high as $20,000,000 something like but not huge acquisitions. But the second thing we have to do as a company is keep ourselves up open to major opportunities that if something significant came along that we would have an opportunity to jump on it. We have a very healthy balance sheet. We have a very good stock price, so very good currency in our stock.

And we think we have a strong team here that could absorb a major acquisition. When it comes to water meter companies, there aren't small ones. I mean, they're all pretty much significant players. And we have to remain open to opportunities that come along those lines.

Speaker 2

Okay. Thanks for taking my questions.

Speaker 0

Thank you for that question. The next question we have comes from the line of Hassan Doza from Water Asset. Please go ahead.

Speaker 4

Hi, good morning gentlemen. Just follow-up on the two questions. First on earnings growth. If I look at the company in the last two years, obviously, last year was an earnings down year versus the year before. And if I look at this year's first quarter point results of $39 adding back the charges, it's still down from your first quarter twenty twelve, which was a normal quarter versus the first quarter of last year.

So the reason I wanted to kind of get your thoughts is that how do you think about Badger beginning to grow earnings again in their organic business? Or do you think that at this point you really need a transformational acquisition to grow earnings? Because the last couple of years we really haven't seen Badger grow earnings. So I just wanted to get your thoughts on that dynamic of finally seeing earnings growth coming out of Badger Meter.

Speaker 3

Well, okay. So 2012 was a year of very good And you're right, the 2012 was a strong quarter. I'll also point out that the winter in that 2012 was one of the mildest winters we've had in years. Snow cover was 20% below normal, whereas last year was about 15% above normal and this year it was about 9% above normal.

So that has a significant impact. So 2012 was a very strong year of earnings growth. 2013, our earnings growth slowed down and dropped in that year. So I don't think it's several years of lower earnings. It's really we've had one year.

I think in 2014, we're optimistic and we believe earnings. Have some very strong tailwinds, some very strong new products. We have copper prices very favorable. Yes, we've had some pricing pressures. But I do think I think we can deliver in 2014 a very good year.

I wouldn't read much into the fact that the first quarter was not as was $0.39 and perhaps the Street was expecting $0.42 In my opinion, that's within the noise level of our business. We always say we run a lumpy business. Quarters are very hard to predict. And a $02 miss, I don't read a lot into it. Maybe you do, but I don't think it's that big a deal.

Speaker 2

In fact, the $0 is

Speaker 3

only about 100

Speaker 1

and No. Thousand

Speaker 4

wasn't really focusing on the $02 I was really looking at kind of the quarter to quarter earnings growth looking at 2012 as a more normal year. But the bigger picture question to add to your comment Rich is, do you feel the business as it is right now you need an acquisition to really have visible earnings growth the volatility. That that's kind of my second part of the question.

Speaker 3

Right. And my direct answer to that is I don't feel we need an acquisition to drive earnings growth. What we need is some strong new products to put into the pipeline. And what we need is our competitors to cooperate, if you will, or to help us by having difficulty in their own business. And to be real blunt with you, I think we're at a perfect position right now because whereas in the past, it's taken us anywhere from three to five years to introduce a significant new product.

In the last twelve months, we've introduced two. We introduced Orion SC a year ago and now we've introduced Beacon, both very strong products. And we now have two of the industry leading technologies on the market. But the other thing that's happened is our competitors have made strategic decisions to narrow their product offerings. They are either getting out of mechanical meters and only offering electronic meters or they are getting out of metal meters and only offering polymer meters.

Badger Meter is the only company in North America that is still offering a full suite of electronic, mechanical, metal and polymer meters. So we feel that in our legacy markets, in our North American markets, we have the two perfect situations, very compelling new products. At the same time, our competitors are reducing their offerings. And then when you add on to that, that we now for the first time have significant opportunities to take our products globally because we have a meter and a radio that works in foreign markets. That too could drive significant growth for us.

That's why we're so optimistic and we're not factoring in acquisitions as a major growth driver.

Speaker 4

And my last question on the gross margin. And just to understand, when you are as you're absorbing the LCR customers, you said most of the absorption will happen during 2014, meaning you're picking up these underpriced contracts mostly during 2014?

Speaker 3

No, I don't think you got that right. Most of the pickups happened in the last nine months from June 30 to the end of the first quarter. We've picked up, we believe, over 50% of Elster's customer base in that period of time. What I said in 2014 is most of the contracts that we took over will be renewed in 2014 where we will have price improvement opportunities.

Speaker 4

Got it. Okay. Thanks for clarifying it. Appreciate it. Thank you.

Speaker 3

No problem.

Speaker 0

Thank you. The next question we have comes from the line of Rich Eastman from Robert W. Baird.

Speaker 1

Yes. Sorry, Frank. Hey, Rich, from that very last comment, can we assume that in this first quarter that maybe your Elster sales were around $2,500,000

Speaker 3

No, you can't.

Speaker 1

Okay. But we got half.

Speaker 3

Right, right.

Speaker 1

And the $20,000,000 annualized.

Speaker 3

Right. But what you financial guys love to do is draw straight lines.

Speaker 1

Yes. That's what we do.

Speaker 3

Yes. That's what you do. And you remember you're With

Speaker 1

all the information and all the data points that we collect, we have to draw straight lines.

Speaker 3

Yes. Yes. So what you really need to do is put away your ruler and get out a protractor. Too

Speaker 1

much caffeinated coffee this morning apparently. So it's not 2,500,000.0 It's somewhat it must be less than that.

Speaker 3

Yes. Rick, I know where your math is going because Elsa was doing about $20,000,000 a year in sales in the in North America in their Water business. They pulled out of that. They mostly pulled out of that. We feel we've taken over 50%.

That would be about 10,000,000 year. And you divide that by four and you get $2,500,000 Of course, as you've now learned is our business is lumpy. The first and fourth quarters tend to be weaker quarters and the second and third tend to be stronger. Whereas I do believe we'll have about $10,000,000 in sales this year, I don't believe it will come in at $2,500,000 every quarter for the next four quarters. So the first quarter was south of $2,500,000 The fourth quarter will be south of 2,500,000.0 The third and fourth will be north.

Speaker 1

Yeah. Okay. And just as we talk about price pressure and we've kind of mentioned this in the trailing quarters as well. And it just it strikes me that Elster is out of the market, which I guess you could include their pricing as price pressure, but we knew that's been out there. I can't Neptune doesn't cut prices, I don't I'm

Speaker 3

not sure. I wouldn't agree with that statement. Neptune has a capacity They a They own their own foundry, Rick, and they are more vertically integrated. So when they lose volume, it really hurts them a lot more. And I believe that companies that have capacity issues tend to get a lot more aggressive in pricing, especially when so much of their business is a fixed cost.

We don't own our own foundry. So when our sales go down, we don't carry all that overhead.

Speaker 1

So their loss share to Hersey could matter or not yes to Hersey or Mueller could matter.

Speaker 3

Mueller. So yes Mueller free And water so we have been seeing price some price pressure coming out of the Neptune area where we haven't historically seen it.

Speaker 1

And then so is any of this the price pressure coming from non U. S. Vendors trying to gain a little bit of share here on land?

Speaker 3

No, not at all.

Speaker 1

No. Okay.

Speaker 3

Rick, it and I don't want people to get the wrong impression here. Badger Meter feels we have an opportunity to take our meters and radios internationally. On the other hand, I'm not going to open offices in Berlin and Paris and start knocking on doors. That makes no sense for us because brand and channels still matter in our industry to a great extent. And so just as it's hard for those international firms to get into North America because they don't have the brand and they don't have the channels and the companies that are here are all over 100 years old, we've all been selling for a long time, we will run into the same problems over there.

However, we do have partners. We have companies that will private label our products and are private labeling our products. And then we have regional opportunities such as The Middle East where they are very open to buying American products.

Speaker 1

Yes. I just wanted to check the box that what's not occurring is foreign vendors trying to gain a foothold in share in The U. S. With price?

Speaker 3

No. We are not seeing that. Okay.

Speaker 1

Okay. And just one last question. Rick, on the receivables and inventory that stepped up. Is there any message there? Anybody trying to get ahead of price increases?

Are you guys building to did you build anything on the inventory side in the first quarter for delivery later in the year? No. Mean, general receivables are always low at year end, so they're higher now because we had obviously record sales in the first quarter. On the inventory side, again, the end of the fourth quarter, it's increased since then. We're going into our busy time.

The second and third quarters, we've got long lead times on certain products. And to a certain extent, while we did well, we're buying inventory according to a plan. Frankly, we're

Speaker 3

a little short of our own plan.

Speaker 1

Yes. No, that's okay. I just there wasn't any terms given on the distribution side relative to price increase coming up? No. No.

Very good. Thank you again.

Speaker 0

Thank you for that question. We have no further questions at this time. It

Speaker 3

doesn't appear we have additional questions. So why don't we wrap it up? And I'll just say that I'll reiterate that we are optimistic about 2014. We think the first quarter was not a record breaking earnings quarter, but it was a good quarter. And that we believe 2014 can be a strong year.

We're particularly impressed with the customer reception to the new BEACON offering and to the growth in sales that we're seeing in the E Series meters. Those are two very strong areas. We also think we have continued growth coming in our industrial flow areas as the economy improves and we see more industrial capacity added where a lot of our sales are made. So with that, I'll thank you again for joining us.

Speaker 0

Thank you, ladies and gentlemen. That concludes your conference call for today.

Speaker 3

You

Speaker 0

may now disconnect.