Badger Meter - Earnings Call - Q1 2018
April 18, 2018
Transcript
Speaker 0
Good day, ladies and gentlemen, and welcome to the Q1 twenty eighteen Badger Meter Earnings Conference Call. At this time, all participants are in a listen only mode. Following management's prepared remarks, we will host a question and answer session and our instructions will be given at that time. As a reminder, this conference call is being recorded for replay purposes. It is now my pleasure to hand the conference over to Mr.
Rich Musen, Chairman, President and Chief Executive Officer. You may begin.
Speaker 1
Thank you, Brian. Good morning, everybody, and welcome to Badger Meter's first quarter conference call. Thank you for joining us. Yesterday, after the market closed, we released our first quarter results. We are pleased that sales set an all time record for any quarter, helped by our sales of our Beacon analytics platform as well as sales stemming from our acquisitions of D Flow and Carolina Meter.
That said, bottom line results did not meet our expectations, in part due to lower volumes caused by order delays that, while received in the quarter, could not be shipped in time to be recognized. That said, we do remain optimistic about the year ahead. Ken Bockhorst, our COO, will talk about our new product developments and other initiatives that support that confidence. Moreover, future quarters will see the benefits of the January 1 price increases as they work their way through our order backlog, with some of the first quarter order delays spilling into the second quarter. So with those brief comments, I'm going to turn the call over to Rick Johnson, our Senior VP and CFO, to go through the numbers.
Rick?
Speaker 2
Thanks, Rich. As usual, I 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 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 let's discuss what happened in the first quarter. Sales in the first quarter increased $3,400,000 or 3.4% to $105,000,000 compared to $101,600,000 during the same period in 2017.
Municipal water sales represented 76.7% of sales for this first quarter compared to 77.3% of the first quarter of last year. Municipal water sales increased $2,000,000 or 2.6% to $80,500,000 from $78,500,000 in the first quarter of last year. The sales increase was due to higher pricing on products ordered after January 1, higher sales to The Middle East and higher service revenues due to increases of the Beacon managed solutions. These positive impacts, were somewhat offset by lower volumes of residential and commercial meters and radios than the first quarter of last year. As Rich mentioned, we attribute the decrease in lower domestic volumes to timing of orders as well as to a slower start at the beginning of the year.
We also believe weather played a role in the timing of orders, particularly in the northern regions. Flow instrumentation products represented 23.3% of sales for the first March 2018 compared to 22.7% during the same period in 2017. These sales increased $1,400,000 or 6% to $24,500,000 from $23,100,000 in the same period last year. The increase was due to the continuing rebound of the oil and gas markets as well as strengthening of our distribution channels for the industrial markets we serve. Gross margin as a percent of sales was 35% in the first quarter compared to 38 in the first quarter of last year.
The lower volumes of products sold had a significant impact on the margin. Also contributing to the lower margin were higher brass costs and expenses associated with the shutdown of Badger Meter's Scottsdale, Arizona location. That project was completed by March 31, and all Scottsdale products are now being made at our Racine, Wisconsin facility. Helping margins somewhat were price increases on products sold, although we have yet to see the full impact of those January 1 price increases. Selling, engineering and administration expenses for the first three months of this year increased $1,700,000 or 6.7% to $26,800,000 from $25,100,000 in the first quarter of last year.
The primary reasons for this increase are normal inflation increases and the additional expenses associated with the acquisitions that we completed after the first quarter of last year, namely D Flow and Carolina Meter. Just a reminder that the primary reason for the D Flow acquisition was not their book of business, but their ultrasonic expertise. The expenses of D Flow are currently focused on developing the next generation of E Series meters. Ken will comment on this in a moment. The provision for income taxes as a percent of earnings before income taxes in the first quarter was 22.2% compared to 34.2% in the first quarter of last year.
Almost all of the decrease was due to the lower federal tax rate, which went from 35% to 21%. This quarter also contains some nominal amounts of discrete credits to tax expense. Net earnings then for the three months ended March 31 was $7,500,000 or $0.26 per diluted share compared to $8,700,000 or $0.30 per diluted share for the same period in 2017. Our balance sheet remains solid. Cash provided by operations declined to $6,800,000 for the first three months of this year from $12,400,000 last year.
Last year, we saw a drop in inventories from year end until the end of the first quarter, which did not recur this year. That fact, along with lower earnings, accounts for the lower amount of cash generated from operations. Before we move on, I want to remind everyone again that we will be terminating our frozen pension plan this year and we'll be taking a onetime cash charge, which we estimated at year end to be approximately $5,000,000 At this point, we don't believe it will exceed that amount and we are optimistic that the amount will be significantly less than that. Again, the exact amount of the transaction will not be known until employees finish making their decisions on how they wish to receive what is due to them, which they are in the process of deciding now. Also a reminder that when the assets are distributed, there will be a onetime noncash charge for amounts already included as part of equity on the company's balance sheet.
That number at December 31 was $17,600,000 pretax. With that, I will now turn the call over to Ken Bockhorst, Badger Meter's Senior Vice President and Chief Operating Officer. Ken?
Speaker 3
Yes. Thanks, Rick. So in the quarter, we got off to a slow start in January as the incoming order rates were sluggish. We did see an uptick in February and then another increase in the order rate in March,
Speaker 2
which is positive. But due to
Speaker 3
the timing, we were not able to convert as much into revenue as we would have liked contributing to the disappointing bottom line results for the quarter. That said, we do remain optimistic about the second quarter and for the full year 2018 for the following reasons. First, we had a significant increase in backlog during the quarter due to increased order rate in March that I noted previously. A large project went in The Middle East, which will ship in the second and third quarters, increased shipments for FIN, a joint venture between Belkin and Upendor, which utilizes our D Flow Ultrasonic technology into a smart water monitoring system for residential use and continued strength in flow instrumentation orders. And halfway into April, our order rates are above the average daily rate for the year, which also gives us some renewed optimism.
Moreover, a number of impactful new product development initiatives are currently underway. In the second quarter, we will increase our product offering for E Series commercial meters with D Flow technology, which will allow us to bid on projects that we currently can't participate in. Also, we will release the next version of the E Series residential meters, which will be available at year end. These also incorporate our D Flow technology, which will reduce our manufacturing costs. And for Orion Cellular, we will be ready with CAT M chips, which are the next generation chips for business to business cellular communication in the first quarter twenty nineteen, which will allow us to provide additional features as well as improve our cost position.
In short, we will increase our product offerings and reduce our costs as the year goes on. On April 2, we announced the acquisition of Innovative Metering Solutions, our fourth distributor acquisition. We are very pleased to add them to Badger Meter and complete our distributor roll up strategy. We now have a significant portion of our sales through our company owned model and look forward to continued success with our remaining independent distributors who are and will continue to be good channel partners for Badger Meter. With our distributor strategy complete, we will continue our process to identify larger acquisition targets that will build out our product and technology portfolio and increase our global footprint.
While it was a tough quarter, I am very optimistic about the future of Badger Meter both for the short and the long term and I'm glad to be part of the team. With that, Rick, Rich and I will be happy to take any questions.
Speaker 0
Thank you, sir.
Speaker 4
Let's start on with some of the margin pressure. There are a number of items that you guys called out that impacted gross margins in the quarter from higher brass costs, closing the facility in Scottsdale, lower volume. Is there any way you can pass out in a little bit more detail what the impact of each of those main buckets was on the margins?
Speaker 2
Well, this is Rick. The margins are down about 300 basis points. And really, this is a rough cut at it, but this is how we're looking at it. Copper was probably about 100 of those basis points downward. The Scottsdale closure was about another 100 basis points.
The impact of the lower volumes on our capacity utilization was probably a couple of 100 basis points. So that's about 400. And then offsetting that somewhat were the price increases coming back by about 100 basis points. That's just a that's the rough cut on the margin. Now there's probably 1,000 little things in there also, but those are the main ones that jump out.
Speaker 4
No. Think that's very helpful. Could you then comment on talked about realizing about 100 basis points of price there, but also that you raised in January 1, you've still got backlog to ship from December that those prices weren't in it. Now that we're probably going to get a full quarter in the second quarter of realizing those price increases, does that 100 go to 200 basis points? Does it go to 300 basis points?
Speaker 1
This is Rich. I don't think it reaches 300, but it does go closer to the 200 mark. I'm hoping that we're going to pick up about 200 basis points when everything gets fully integrated through our order log.
Speaker 4
Does that show up in 2Q? Or does it take until 3Q to hit the full run rate?
Speaker 2
More of it will show up in Q2. The full impact will be in Q3. But to be honest with you, as you start the second quarter, a lot of what's ordered for the second quarter came in, in the first quarter under the new prices. Yes, there's some lagging business yet from longer term orders that came in last year. I just don't have it quantified right now.
Speaker 1
But we don't do any contracts anymore that go more than a year without price escalators in them? Correct. So really, by the end of the year, everything's in there, but I would say the vast majority of it's in there by the end of the second quarter.
Speaker 4
Okay. That helps a lot. I'll pass it on and get back in queue.
Speaker 0
Thank you. And our next question will come from the line of Richard Eastman with RWB. Your line is now open.
Speaker 5
Yes. Good morning. Good Richard. Good morning. Just a couple of things I wanted to run by you.
In terms of D Flow and Carolina third party sales, what would be maybe the acquisition revenue contribution in Q1 here versus a year ago?
Speaker 2
I think was D probably it was over $1,000,000 1,000,000 to $1,100,000 Carolina meter probably 600 people are nodding their heads. Yes, that's a good sign. It's about $600,000 So we're getting that kind of impact. I think the Beacon revenue is up in excess of $1,000,000 over last year's first quarter. And then we had some sales to The Middle East that we didn't have in the first quarter of last year, and that's probably another $1,000,000 right there.
Speaker 5
Okay. And maybe you could just speak to well, let me ask you this. IMS is what would be the annual third party revenue there? The piece that will flow through the revenue line versus the margin line.
Speaker 2
Additional you're talking incremental revenue? Probably a couple of million dollars annually.
Speaker 5
That's it. Okay. Okay. And then maybe just for a second, could you just provide a little bit of color around did the commercial meter piece grow in the quarter?
Speaker 2
No. The commercial was down significantly, probably about onethree. But there was a large order in there last year for one particular customer that accounted for almost all of the decrease.
Speaker 5
Okay. And then you did comment about, again, the Orion cellular product and the E Series product continuing to grow. I'm a little I'm curious, when you look at the meter business and you look at your disc meters versus the E Series meters and compare the growth rates or the decline in the case of disc meters, I'm just curious, how does that impact your capacity on the production side? So we're talking about the gross margin and the undercapacity, under absorption there. I mean, my impression is that the E Series meter is not cleaned up and absorbed capacity in the Milwaukee facility.
But I'm curious just from a manufacturing strategy perspective, has that impacted your under absorption given the growth in the E Series?
Speaker 1
You mean the shift in mix from mechanical meters to electronic meters, how that's impacting our capacity utilization. I mean, there's no question we are to some extent with the growth of the E Series, we're cannibalizing some of our mechanical meters. Mechanical meters are partially made in Milwaukee and partially in Nogales. The E Series are pretty much well, they're also spread. We've got operations here that do them both too.
So there isn't a big difference between facilities. But the E Series meters, they probably absorb a little bit less overhead because they're electronic and they go through the system a little faster, whereas mechanical meters require more a longer and more in-depth testing and count to make sure that they're right. I don't think there's a huge Rick, I'm not sure where you're going
Speaker 3
with this because I don't think there's
Speaker 1
a huge impact on capacity utilization from one to the other. Generally, when we said that for the quarter, had under absorbed our overhead, it really was in total, the total metering products going through the system that had the impact. Correct.
Speaker 5
Okay. Fair enough. And then just one last question for Rick. Could you just talk a couple about a couple of the balance sheet items? I mean, you touched on inventory, but I'm surprised maybe a little bit that inventory didn't come down sequentially from the fourth quarter.
And then also just the AR build from the fourth quarter sequentially into the first quarter, at the end of the first quarter AR is built at almost a 9% rate despite the sales were just Yes. Up three
Speaker 2
Your second question is the easiest because the seasonality of the business. Receivables are always at their low point at the end of the year simply because of the way the fourth quarter sales actually come in because December is one of the lowest months period. Whereas in the first quarter, March is one of the stronger months. So it's up simply because of the timing of that. And in terms of the inventory, we talked about the timing of orders.
Well, on certain products, there's long lead times, okay? So we basically geared up for a higher anticipated sales than we actually had, hence the disappointment you're hearing in our voices today. And a lot of that will take care of itself as we get into the second quarter. And so that's just a function of timing more than anything else at this point. And the inventory year, we had a very strong first quarter.
I mean, we're doing a tough comp here also, by the way. But inventory then had dropped because we sold a lot of what we had planned to sell in the first quarter of last year.
Speaker 1
And Rick, this is Rich. I'll also point out that, that inventory build, to some extent, in our minds, is indicative of our expectation of a much of a stronger second quarter. We said we're optimistic about the second quarter. In the past, we have had times when we've had a and you know our business is lumpy. We've talked about that repeatedly.
We've had times when we had a disappointing quarter and we said on these calls that we think it's going to continue into the next quarter, and it usually did. This time, we're saying, we've had a bad quarter. We have a lumpiness in our business. We're not seeing it continue. We have an expectation that we're going to have a stronger second quarter, and that inventory build is part of that because we have to be ready to ship all that.
Speaker 5
Understood. Okay. All right. Thank you.
Speaker 0
Thank you. And our next question will come from the line of Tate Sullivan with Sidoti. Your line is now open.
Speaker 6
Hi. Thank you, everyone. First off, can we review some of your comments? I thought maybe I didn't hear this correctly. Is it did you say that we're already halfway through the order rates from last year?
Speaker 3
No. No. I'm sorry.
Speaker 6
March? So the edges.
Speaker 3
What I was getting at there is that we ended the last couple of weeks of March with a really strong order rate, primarily, compared to the beginning of the year where we got off slow. And through the first half of April, that rate that we saw increasing at the March has continued. So just alluding to the fact here that we're off to a really good start to this month that's continued.
Speaker 6
Okay. So the March rate continued into April.
Speaker 0
Then
Speaker 6
when you review your Deepflow comments specifically, and I think you you you mentioned I mean, the current you mentioned introducing new series, the e series. But on the current e series that you're selling, are you seeing lower costs because of dFlow manufacturers' costs already?
Speaker 3
No. So two things. It helps us in two ways. And the first is we talked a little bit earlier about our reduction in commercial meters. So there are some customers that are converting to the ultra sonic technology.
So by finishing the defo for the commercial meters, we'll be able to extend our product line here coming up in the next couple of quarters. So we'll be able to participate in more bids on the commercial side. On the residential side, we will continue incorporating that technology into the residential meters in the second half of the year, which will be a pretty significant cost reduction for us that see in 2019. So my comments were a little bit mixed there on my optimism for rebounding of revenue over the remainder of the year as well as improving our cost position for the longer term.
Speaker 6
Okay. And specifically, 2019 would be the target to reduce based on that shift costs?
Speaker 3
Correct. We'll begin to see the reduced cost on the residential meters in 2019, correct.
Speaker 6
On residential. Okay. And then is your maybe I missed this in your last acquisition amounts. Is your distribution strategy complete now? And why is it complete?
Speaker 3
Yes. So we are complete now with the distributors that we wanted to acquire. So the majority of our revenue now is through our company owned model. So we don't we still value the partners that we have in the other places, but we don't think it is worth it to acquire all of the distributors to find every region of the country. We've got enough reach now with the distributors that we've acquired to go forward.
Speaker 6
Okay. Okay, great. And then my last is, what else besides weather at the beginning of the year contributed to delay in orders? Was it customer funding uncertainty? Or was it mainly weather?
Speaker 2
This is Rick. I wish I had a definitive answer for you. Mean, they had ice storms down south. They snow in the East. I mean, we just saw a decline.
And then as Ken said, as we got into February, started picking up again. As we had in March, it got stronger. Sometimes these things I mean, we can't use the word lumpy often enough, and I know people get tired of hearing that. But sometimes we don't know, and things have resumed. It's just it is a function of timing.
Speaker 1
But, you know, to when our field sales force is telling us anecdotally that they're seeing delays because of weather impacts, one way we can look at that is by region of the country. And indeed, when we look at the first quarter, our Western region exceeded our plan. But it was really the east and the northern part of the central that fell short. And that would tend to support what our field people are telling us that there was some weather impact that caused delays by these customers.
Speaker 6
Okay. And one more. Rich, can you comment bigger picture? I mean, I've seen American Waterworks do a series of transactions here. Is there anything to look out in terms of changes in regulation or changes in your customer landscape that you see or can talk about for the rest of this year?
Speaker 1
No. I think American Water Works is continuing to move on opportunities. There obviously, there are some states where acquiring a water utility is more favorable from a regulatory point of view than other states where the regulators would prefer that to not happen and therefore don't give the recovery rates, the return rates that you need to make those deals possible. I think a lot of companies like American and the other ones that are out there are very smart in where they selectively play. But we don't see that changing our landscape.
I mean, even when we won the American contract and had an expectation that all of their properties would immediately convert over to our meters, they operate with a mixed system and they do not tell their subsidiaries, you must buy from Badger Meter. They say, you can. We've entered into a contract. It has given us some good return, but it did not go wholesale. So in the same way that when American goes in and buys a water utility that may be supplied by one of our competitors, they don't immediately switch over to us.
So that landscape of acquisitions does not have a big impact on our competitive landscape.
Speaker 0
Okay. Thank you for that. Have a good rest of the day. Thank you.
Speaker 2
Thanks.
Speaker 0
Thank you. And our next question will come from the line of Ryan Connors with Boving and Scattergood. Your line is now open.
Speaker 7
Great. Thanks. Good morning. Good morning. Wanted to kind of talk about the margin discussion from a bigger picture standpoint.
And Rick, you mentioned the strong quarter a year ago, the tough comp. And at that time, you talked about kind of a positive step change, a new normal where maybe copper wasn't as relevant as it's been in the past. And you talked about things like the impact of new products and the recovery in the higher margin flow in the instrumentation business and the addition of the distributors. It seems like most of those things have gone in your favor in the last year. Distributors grown, Flow Instrumentation has come back, new products have grown.
So can you just characterize for us whether you still believe that's the case that there's a new normal here in terms of the normalized margin? And if so, why those tailwinds weren't able to kind of at least offset what was happening on the raw material side.
Speaker 1
Right. Well, and this is Rich. Let me try to take a shot at that. I am still optimistic that we are seeing we are going to continue to see this a higher margin level. And I believe this first quarter was very unusual.
Now copper, when copper went from $3.5 in the first quarter from $2.5 I'm sorry, 2.5 a pound in the first quarter of last year to over $3 now, that's a pretty big jump. And that did hit us for 100 basis points. But that didn't account for this 300 drop. We know we took some charge in Scottsdale, and we understood we had that. We also but we had these order delays and we are fairly volume sensitive.
A lot of our operation is a fixed cost operation. It's hard to flex when you see those orders coming down and flex quickly and yet still remain positioned for stronger quarters to follow. I think, Ryan, if we believed that this downturn in the first quarter was a trend and that we were going to see continued downturn in the coming quarters, we would have taken a lot of other hard actions in the first quarter to rightsize the operation. But when we have a lumpy down quarter like this, we have to very often just eat it in order to stay positioned for the future quarters. But as far as those margins go, we continue to see this shift to the electronic metering.
And once we finish the electronic large sizes, I think that's going to accelerate it even more. We continue to see the shift to Beacon and E Series. Those all carry higher margins. So we're going to continue to see that moving over there. And I do believe that there is fundamentally, not just a badger meter but within our industry, an opportunity for some margin improvement over what we've seen for over the next several years versus what we've seen for the last several years.
I have not changed my story on that.
Speaker 7
Now a specific question and a subset of that. On flow instrumentation, so that's come back. Has there been any shift in that market where that business or the composition of the recovery has changed the margin profile of flow instrumentation? Is it still as good as it used to be?
Speaker 3
Ryan, this is Ken. So no, it's that has remained the same. So we still feel good about rebound in that space and maintaining that strength.
Speaker 1
And let me just add to that, Ryan. A lot of the rebound has been in the oil and gas products, but the margins in the oil and gas products are not that different than the margins in the rest of the flow instrumentation products. So there isn't a big shift in the overall margin there from that.
Speaker 7
Got it. Okay. And last one for me, Rich. You apologize if I missed it, but you talk about these project delays. Can you just characterize the composition of that?
Is it one or two or three? Or is it more like 15 or 20? I mean how many types of projects are we talking about just just rough magnitude?
Speaker 3
Yeah. So, Ryan, I you know, it may be more than I know for sure, but I know of at least five that that have gone into the play that that they were not insignificant.
Speaker 1
And they weren't all weather related. Okay? I'll add that there was one large utility, which I won't name, that got some bad press during the quarter, a western utility, so weather wasn't affecting them. But they got some bad press for having installed meters improperly. And of course, it was on the evening news and everything that somebody got a huge bill because they put the wrong kind of register on a meter.
This was not Badger doing it. This was the utility. They actually stopped ordering for for the entire first quarter while they tried to deal with that, go out and check their meters and things like that. So what was normally a pretty good customer placing some very large some some over $1,000,000 type orders, they just went away for a quarter and now they're coming back. They've got it behind them.
Speaker 0
And our next question will come from the line of Brian Raffitt with Morgan Dempsey. Line is now open. Good morning, guys.
Speaker 2
Good morning, Brian. How are you?
Speaker 8
Yeah. Good. The weather related, I think we're beating this dead horse. And certainly, with all the nor'easters and some of the Pennsylvania and New York areas getting up to 200 inches of snow, that's Colorado like. Is are we to assume on those projects that we have been delayed that that it's kind of a normal play out that it's just pent up demand and maybe delayed, and just pushed out from a time standpoint, not necessarily doubling up in any forward quarters?
Speaker 2
Yes. This is Rick. Yes. It's not a pig in a python where we'll double the sales in the second quarter because basically, they didn't get out there to install them. They only have limited warehouse space.
So everything just resumes and carries on as if we just extend the time period. Generally speaking, that's how it operates in this industry.
Speaker 8
Yes. Yes. On the Beacon Analytics side, is the demand for still related to conservation and primarily a western consumer versus, say, somebody in the Great Lakes? Or or how is that Beacon Analytics, you know, sold across the country?
Speaker 1
Right. And and this is Rich. It is no longer Western related. And what you're referring to is when we first came out with Beacon, in particular, Ion Water, a lot of that was driven by the western utilities who were under significant drought conditions saying, Boy, we really need something to help us better analyze our system, better manage, and we'd like something that allows the homeowner to know when they're wasting water. So that's what drove the initial introduction of that product.
Today, that product is being sold all across The United States. It is no longer kind of focused on a section or on a particular problem. We're seeing IonWar Beacon utilities u I'm sorry. Utilities using Beacon and homeowners using ION water all across The United States simply because it's a better system. It it provides them better information.
And, frankly, I I use ION water. I like to know what water consumption is going on in my house. And I also like to know if I've got a a leak, which, frankly, in January, my water, according to ION water, did not stop running in my house for about a week. I had a plumber come in, and he found that I had a running toilet. And he replaced the seals, it fixed the problem.
That's the benefit of ION Water. So we're seeing even people in Milwaukee, like I am, using it extensively.
Speaker 8
Okay. From a kind of a Rich, from kind of a strategic sense, we always talk in the municipal side about residential meters and new construction and obsolescence and that. What do you see, say, on the next two to five years, the commercial water meter side relative to kind of the bigger infrastructure talk and older water systems and sewage? Is there a viability from an infrastructure play on the commercial water meters or as the residentials are swapped out than the commercials are?
Speaker 1
Boy, I'd love to tell you that there is because it would sound really good coming from me. But here's the situation. The water utilities have tended, when they get under budget crunches, to slow down the replacement of mains. What they have not done is slow down the replacement of their commercial water meters. And the reason is because the commercial water meter is the cash register.
So so a restaurant may go for a while with kind of a bad stove, but they won't go for a while with a cash register that's defective. So the water utilities have stayed up on replacing those commercial meters, and I don't see a huge shift in that going forward as infrastructure spending comes in.
Speaker 8
Okay. Alright. With the uptick in brass costs from the copper content, have you seen any moderation across utilities into plastic meters versus brass? Or is that a non event?
Speaker 2
No. This is Rick. I'd say brass is still the primary driver for meters. It's probably 80% of the meters we make are probably made of brass. Plastic has gotten up from at one time, was down about 10%.
It's kind of leveled off at about 20% right now.
Speaker 8
Got you. Got you. Let me ask you more of a strategic one, Rich. Trump's every day tweeting out something with his PPP. When he's talking about redrafting the NAFTA, does that at all is that a headwind or any negligible effect on Magalis?
Speaker 2
So so I would say not anymore.
Speaker 1
Well, let yeah. Let me address that. I mean, there have been so so many so many proposals that I'm I'm not sure which ones to react to anymore. If they revisit NAFTA, even before NAFTA, there was the Mequiladora laws, and that that's what the Michiladora rules were what we established our Nogales facility under, and a lot of automotive companies and other companies established under the Michiladora rules, and that's why we located within a few miles of the border. So if they if they do away with NAFTA but leave the Miquiladora rules still in place, we kinda fall back on that.
If they do away with both of them, then there's a question of, yeah, what are the tariffs? How does this work? What would we have to pay? Badger still has the capability of bringing additional work back to back into The US in in our other plants, so that could always happen, but we don't anticipate any of that happening. Our Nogales plant is very efficient.
We like it. And frankly, if we're going to be impacted by some sort of trade changes in tariffs and trade wars or something, there's a lot of other companies, a lot of bigger companies that are going to be hit first before us that are gonna have a much bigger problem. But but just
Speaker 2
to just to be clear, though, the NAFTA was a concern when Trump first got into office, and it was a concern amongst our people down at the at the Nogales plant itself. I would say since last summer, it's really not much of a concern because we talk a lot about things, but there's no action. And I think people get that about about what's going on in Washington right now.
Speaker 8
No. I get that. I get that. You guys also mentioned on the I think it was the Orion cellular, the CAD M chips and and and enhanced, you know, specifications, functionality, say, 2019. What do those CAD M chips give you?
Speaker 1
So what what's happening here, Ryan, is that Brian. Brian. I'm sorry. I said Ryan. I'm sorry.
Brian. What's happening, Brian, is that the the the cellular world is starting to split. And it's splitting between the this LTE system, which is really designed for complex transmissions of data or or I'm sorry, of of conversations, of Internet pages, of things like that. Meanwhile, machine to machine transmissions are very simple and very fast and smaller packets and don't have the complexity of requirements. So what they're really doing with the CAD M is kinda creating a fast lane, an express lane on highway for data that will allow it to fly down the highway much, much faster.
And by moving to these CAD M chips, we and other people who are using cellular for machine to machine communication will not only be able to improve our speed, we'll be able to use less energy in our transmissions, and we'll be able to add some additional functionality to our transmissions. So all of this is very good for us. And of course, Moore's Law is still operating out there, and these next chips that are coming in are much cheaper than the last chips we were using. So that's also going to represent a pretty significant cost reduction for us.
Speaker 8
Okay. Good, good, good. And then just from the standpoint of acquisitions, at one time, were talking about the types of meters that you have. You were you control like 12 or 13 of the 16 different types. Now I think the last presentation I saw, you went down to 10.
Any any meter technology that you don't have today that might add to the portfolio of meter technology? And then anything on the industrial product side that you might have a niche that you might have an interest in?
Speaker 3
Brian, this is Ken. So on Rich's slide of the 10 technologies, we currently have eight. There's one that we would be interested in adding to our portfolio, and that's the thermal mass. But larger than that as well, we've begun an M and A process here where we're taking a good look at the universe of products and technologies that we could add to our portfolio and sell to the same customers that we'd already have as well as finding some good opportunities to expand on our global footprint. So we have still have a fantastic balance sheet, and I think we'll be able to find some pretty attractive opportunities out there to add to Badger.
Speaker 8
I'll ask one more. Rick, any pressure, you know, everyone's talking about with the the Trump tax plan, everybody's getting bonuses and, you know, hiring and salary wages. What are you guys seeing either in, not maybe in retention of people, but availability of engineers looking to hire, pressure on SG and A, labor costs, maybe health care in there? What are your
Speaker 1
Sure. I'll this last question then, Brian. First off, on the question of are we getting pressure from our people that with the tax cut, they should all get some kind of bonus? Obviously, the question was asked. We feel that we pay our people competitively.
We pay them at market. We have very little turnover in our facilities, which would tend to say that our compensation and our benefits taken as a package are very good. And we see no reason to adjust that. Frankly, I'm disappointed when a company says that because of lower taxes, we're going to increase everybody's pay. I guess they were saying that in the past they were underpaying their people, and now they're going to pay them fairly.
In our case, we've been paying our people fairly, and we think that's right. I would also point out that in 1992, when Bill Clinton raised corporate income taxes, we didn't see anybody willing to cut their pay. So I don't think my employees want their pay linked to the corporate tax rate. Having said that, the second part of your question is about recruiting, and, we are in the same position as everybody else. Certain positions are hard to find in this economy.
Engineers being one of them. We're we're very aggressive on on what we on on finding the engineering talent that we need. But also, we are working closely with the universities and and and the technical schools to to get interns in here. And and that that, in our opinion, helps us with recruiting down down the road. So we're taking the actions that we think we need to take, and we're we're pretty comfortable that we've got a really good workforce.
Speaker 8
Alright, guys. We'll see you at the annual meeting. Take care.
Speaker 2
Thank you.
Speaker 0
Thank you. And our next question will come from the line of Richard Verdi with Atwater Thornton. Your line is now open.
Speaker 9
Hi, good morning and thank you for taking my call here. Just a quick question. So Q1 was the first full quarter under the agreement with CorEx. I guess it's now about been about five months or so you've been with CorEx. So was just wondering if you could give us a sense of if they really helped expand your Canadian presence and what that could really mean for Badger Meter Canadian penetration moving forward?
Speaker 3
Yes. So we are optimistic about CorEx's ability to expand our presence there. Unfortunately, we didn't get a real great opportunity to experience that in quarter one because Canada had some of the weather issues also. But it's early into the early into our relationship, and we definitely are positive on it.
Speaker 9
What what what type what could it do for the opportunity, just broadly for Badger Meter in Canada?
Speaker 1
Well, this is Rich. Badger's market share in Canada has been less than our market share in The United States, and that has been true for the decades that I've been here. And there have been a lot of reasons for that. There was a period of time when we did not want to sell in Canadian dollars. We found ways to deal with hedging and get around that.
For a while, one of our competitors had operations up there that helped them. That competitor no longer has the operations up there. So we're all pretty much on the same basis now. But what we found is that the Canadian utilities are very interested in some of these newer products, ultrasonic meters and the cellular. And that's giving us an opportunity up there where we didn't have one in the past.
However, I don't think we had the strong channels that we needed, and CorEx gives us that. CorEx now gives us the strength in the channels, the foot in the door of a lot of these utilities. So I think we can grow our market share up there to at least the percentage market share that we've got in The United States, and that could be pretty significant growth for us. That could be double digit growth for us on our Canadian sales over the next several years.
Speaker 9
That's great. Thank you, Rich. I appreciate that. And then just another question on
Speaker 7
that front. Since
Speaker 9
Quirks was acquired by Decheen, has that had any sort of positive impact on the outlook? Or how about on any negative issues at all?
Speaker 1
No. The same players are still there. And basically, that hasn't had any impact one way or the other. CorEx is a good operation. We're really pleased with them, and I don't see any big changes.
Speaker 0
Thank you. And our next question will come from the line of Bob Chernow with RBC. Your line is now open.
Speaker 2
Thank you. I'm curious on how your sales are going in The Middle East and if you're using some of the sales techniques or the benefits of selling your product in The Middle East to other drought ridden areas like Australia or California? Well, Bob, I I think it's it's a that's
Speaker 1
a very good question. You know? And I often get the question, why why The Middle East and not, you know, Sweden and and England and other places like that? Well, first off, The Middle East in The Middle East, water is often more valuable than than oil. And so they take water conservation very seriously, and they have and they are willing to spend additional money for premium products that will perform very well.
So when Dubai, in particular, Qatar and some other of the countries over there started looking for how they could improve their systems, They did instead of just looking at the local companies, they did a global search of technology. And that led them to Badger Meter and to our ultrasonic technology and to our cellular technology, and they really liked that. So we've had a lot of success there. As Ken mentioned, we did get a large order again just at the end of the first quarter, which is going to help us. And it continues to grow and the excitement over there continues to grow.
I think our position in our original position in Qatar helped us get into Dubai, and now Dubai is viewed as a leader over there. So being strong in Dubai is helping us get into other areas in The Middle East. So that's been very good. Our selling technique over there, often, one of the concerns they have is how the meters will stand up under very hot temperatures. That's a concern of theirs.
And so our meters do very well in regions where there is hot temperatures. That has always helped us out West, and we've used that as a selling point out West, and we use that selling point in The Middle East. The other thing is that these meters maintain their accuracy over time. That's the benefit of an electronic meter versus a mechanical meter is that you don't lose accuracy with time and you don't end up underbilling customers. Obviously, in drought ridden places like California who suddenly don't quite believe that they're in a drought anymore.
I think they believe their drought has ended, but I'm not sure. I'm that will just last till the next dry spell. But clearly, the people out there understand that they need those more accurate meters. So there is a I I think it's interesting you bring this up because there is a lot of similarity between how we sell in The Middle East and how we sell out West in those regions and the the the features of our products that sell well there. So yes, we do see that.
That's a long answer to your question, Bob. I apologize. But yes, we do see it.
Speaker 2
Thank you. Thank
Speaker 0
you. And our next question will come from the line of Jose Garza with Gabelli and Company. Your line is now open.
Speaker 2
Hey, good morning guys. Hi Jose. Hi Jose.
Speaker 9
Hey, just a quick one, just putting it all together in terms of just the investments that you're making. What's kind of your CapEx budget looking like for this year and then things to just keep in mind relative to last year?
Speaker 2
Yes. Well, I think last year was about $15,000,000 and I see it in that same range for 2018. Maybe a smidge higher, but nothing that unusual. For normal CapEx,
Speaker 1
excluding acquisitions. Correct,
Speaker 2
excluding I agree.
Speaker 9
Okay. And nothing from this new distribution investment that is worth noting there?
Speaker 2
No. Mean and we'll disclose this in the '10 Q, but we paid $8,500,000 I think for IMS in Florida. I mean, not that significant.
Speaker 0
Our next question will come from the line of Nathan Jones with Stifel.
Speaker 4
Just a comment that Ken made earlier that said the Deepflow Technology Incorporation opens up projects that you guys couldn't bid on before. Can you talk about is this a meaningful increase in the addressable market that you're looking at from this kind of stuff? Or how meaningful that could be in terms of opening up markets or projects that you couldn't have bid on before?
Speaker 3
Yes. So in terms of quantifying, the problem that we had is we only had the smaller sizes, right? So as this tech it was fine when people were still buying the older technology. But as they shift, now we're adding on the three inches and the four inches, so we can participate in full projects. So sometimes we were just getting locked out because we didn't have the full line.
In terms of significance, yes, I mean, it will get us into more projects. Is it going to get us into multiple percentage points growth? No. But it will get us into some profitable projects we're getting shut out on today.
Speaker 2
And I think we would continue to be shut out if we had if we weren't
Speaker 3
That's correct. Yes. Thanks, Greg.
Speaker 4
Got you. That makes sense. And then one of the other things you said, Ken, was that April order rates were above the average daily order rates for the year. But you guys did say you got off to a slow start January, February picked up, March picked up again. So are the April order rates better than the March order rates or in line with the March order rates?
Speaker 3
So they're better than the March order rates and, yeah, in line with what we saw the last couple of weeks of March, which was a significant ramp. So, again, it's a relative small sample size, but it's one that I felt good enough to mention.
Speaker 4
And then I've got one for Rich, a more of a philosophical question. Looking back over the last decade, the company has kind of picked up 500 basis points on gross margin, but the SG and A expenses have picked up by a similar amount. And the SG and A expense has gone from roughly 20% to 25% of sales. Can you talk about what's changed in the business model? Is this a result of needing more R and D, more engineers because they're higher technology products?
Just the dynamics that are at play there and what you think is the right level of SG and A for the business?
Speaker 1
Yes. And you're right about what what has happened to s g and a. Now part of that is because when we buy a distributor, okay, the the the distributor sales force, almost all of their costs fall down in s g and a, And all of their benefit appears as incremental margin, basically. So you end up with a shift. We never bought any of our distributors over the last several years.
SG and A as a percent of sales would be much lower than it is. The other thing that's happened is we have made a pretty significant investment in patents, in technology, in acquisitions, in D Flow and everything else. A lot of those intangibles, the amortization of those intangibles are down in SG and A, and that's having an impact on us too. And then I'll point out just for this year that for the entire year this year, we are carrying an extra engineering load in the form of dFlow to work on integrating all of these products, which we will not really see much benefit from until 2019. So that's having an impact on us too in the engineering area.
So all of those projects that are going on, all of these technologies staying on the leading edge, that is having an impact. I would like to believe that our SG and A can come down from that 25% over time. And I would rather see it in the low 20s, 21%, 22%, something like that, rather than up at 25%. And I think we can achieve that over time.
Speaker 4
That's very helpful. Thanks a lot. Thank
Speaker 0
you. And our next question will come from the line of Tate Sullivan with Sidoti. Your line is now open. Mr. Sullivan, your line is now open if you have a follow-up question.
Sorry about that. Guys, a quick follow-up.
Speaker 7
Is it too early to talk
Speaker 0
about the dividend for this increase?
Speaker 6
And can you remind us of your dividend policy and how you look at balancing that with acquisitions?
Speaker 2
Yes, it's too early because actually the Board decides. And if they do, it probably wouldn't be until sometime later in summer. But we do historically, we've paid out in the 30% trailing 30% of earnings, 30% to 35%. There's no reason to believe that, that won't continue, but obviously, we're not in
Speaker 1
a position to say anything at this time. But I will say, even though we're not in a position to say
Speaker 3
But you'll say it anyway.
Speaker 1
I will say that we have a very strong balance sheet. We generate a lot of cash in this organization and continue to do so. Our Board has increased the dividend every year for the past twenty five years, and I don't see any reason to believe that they're going to deviate from that type of policy. Right.
Speaker 2
But we haven't decided we haven't even come up with a recommendation.
Speaker 1
Right. Nothing has been decided yet. That's usually done at the August Board meeting. Correct. Right.
Speaker 0
Okay. Thank you.
Speaker 1
Okay. Thank
Speaker 0
you. And our next question comes from line of Brian Rafin with Morgan Dempsey. Your line is now open.
Speaker 8
Yes, Rich, just one follow-up. If you look at where the municipal residential water meters are from the standpoint of of kinda end markets, what's kinda the mix between, you know, Galaxy fixed network, Orion cellular, and
Speaker 4
then the old you know,
Speaker 8
the drive by or the read only?
Speaker 1
Yeah. I can answer that. Right from what we're selling right now, okay, we're selling about about 50% drive by and about fifth about 45% cellular right now. And then the remainder is a mixture of it it's the old Galaxy FiX network and and that kind thing. Now that's on that's when we sell something with a radio.
Obviously, there's also still a portion of what we sell that is mechanical read, where people are walking door to door reading water meters.
Speaker 2
And that's what's going into the market. The market itself, the The
Speaker 1
market point of itself is about 60% converted. About 40% of the meters, and I'm talking about everybody, not my own customers, 40% of the water meters in The United States are being read by some kind of manual system, by somebody either walking door to door with a touch wand or or just manually reading versus some sort of automation.
Speaker 8
Okay. Okay. And then just from the standpoint of, say, the next couple of years, Rich, any major, you know, municipal residential programs, national sales wise, any cities that you might highlight that, you know, might be, you know, looking on looking to to do something?
Speaker 2
Well, my my reaction is even if we throw out a city, we have no idea of the timing of it. Right. Right. Okay. And the and generally speaking, the bigger the city, the longer the sales cycle.
And and in particular, I can think of one city that did three bids in ten years and really never bought anything. So we're always a little reluctant to do that. And then even if you get that, sometimes it takes three, four, five years to to complete that order. And I hearken back to Houston o one that actually publicly announced they were gonna do the whole city in two years. It took them five years to buy those meters.
And so that's why we're always a little reluctant to say anything.
Speaker 1
And
Speaker 0
I'm showing no further questions in the queue. So it would be my pleasure to hand the conference back over to Mr. Rich Musen, Chairman, President and Chief Executive Officer, for some quick closing comments and remarks.
Speaker 1
Great. Thank you, Brian. And I'll just conclude by repeating the L word again, which we seem to use a lot, that we are in a lumpy business where we occasionally have quarters like this, down quarters. But if you look at our history, we typically bounce back quickly. There is a fundamental underlying strength to our market that helps us do that.
And we also have much to look forward to in the year ahead as far as new products and the developments we're working on. And we do remain confident in our business and believe that we will continue to see strong quarters in the future. We appreciate your time on today's call.
Speaker 0
Ladies and gentlemen, thank you for your participation on today's conference. This does conclude our program, and we may all disconnect. Everybody, have a wonderful day.