Badger Meter - Earnings Call - Q2 2016

Transcript

Speaker 0

day, ladies and gentlemen, and welcome to the Badger Meter Second Quarter twenty sixteen Earnings Conference Call. At this time, all participants are in a listen only mode. Later, we will conduct a question and answer session and instructions will be given at that time. As a reminder, today's conference is being recorded. I'd now like to introduce your host for today's conference, Mr.

Rick Johnson, Senior Vice President of Finance and Chief Financial Officer. Sir, please go ahead.

Speaker 1

Thank you very much, Liz. Good morning, everyone, and welcome to Badger Meter's second quarter conference call. Thank all of you for joining us today. As usual, I will begin by stating that we will make a number of forward looking statements on our call today. Certain statements contained in this presentation as well as other information provided from time to time by the company or its employees may contain forward looking statements that involve risks and uncertainties that could cause actual results to differ materially from those in these forward looking statements.

Please see yesterday's earnings release for a list of words or expressions that identify such statements and the associated risk factors. Let me reiterate some of our guidelines. For competitive reasons, we do not comment on specific individual product line profitability other than in general terms, nor do we disclose components of cost of sales, for example, copper. More importantly, we continue our practice of not providing specific guidance on future earnings. We believe specific guidance does not serve the long term interest of our shareholders.

Now on to the results. Yesterday after the market closed, we released our second quarter twenty sixteen results. Sales for the 2016 were a record for any quarter, while earnings and earnings per share were second quarter records. Second quarter sales increased $4,900,000 or 5% to $103,800,000 compared to $98,900,000 in the second quarter of last year. The increase was due to higher sales of municipal water products, which increased 7.2%, offset somewhat by lower sales of flow instrumentation products, which declined 2.1%.

Let's talk about some of the details. Municipal water product sales represented 77.1% of sales in this quarter compared to 75.5% in the second quarter of last year. These sales increased $5,400,000 or 7.2% to $80,000,000 from $74,600,000 last year. The increase was a result of higher sales of both residential and commercial meters and related technologies. Overall residential sales increased 3.5% on higher volumes and modestly higher pricing, while commercial sales increased 29.1% due to higher volumes of products sold.

You may recall that in the first quarter, we said we believe the mild winter had caused certain utilities to order products in the first quarter that we would normally have received in the second quarter. We believe this is one of the reasons residential sales were up only 3.5% in the second quarter. Fluentrimentation products represented 22.9% of sales for the second quarter compared to 24.5% in the same period last year. Sales decreased to $23,800,000 in the second quarter from $24,300,000 last year. These sales continued to be impacted by the slow growth economy and overall general softness in the markets that Badger Meter serves.

Gross margin as a percent of sales was 37.9% in the second quarter compared to 35.5% in the second quarter of last year. The effect of higher product volumes on capacity utilization, modestly higher prices and lower material costs, particularly for brass castings, contributed to the higher percentage. Selling, engineering and administration expenses, what we refer to as SMIGA, increased $1,500,000 or 6.5% to $24,500,000 from $23,000,000 during the same period last year. This increase was due primarily to higher employee incentive costs and normal inflationary increases. Also included in the most recent quarter was approximately $700,000 of costs associated with the company's exploration of various options to enhance shareholder value, and Rich will have more to say about this in a moment, and amounts associated with an early retirement program offered to certain flow instrumentation employees.

Given the softness in our flow instrumentation business, the decision was made to offer the early retirement program to certain individuals as well as not filling open positions. These actions are expected to generate a savings of $1,300,000 annually going forward. The provision for income taxes as a percentage of earnings before taxes was 36% compared to 33.4% in the 2015. Last year's percentage of 33.4 was lower due to the settlement of a tax audit. When you adjust for that, the tax rates between quarters are comparable.

As a result of all this, net earnings for the second quarter were $9,400,000 or $0.65 per diluted share compared to $7,900,000 or $0.55 per diluted share in the second quarter of last year. There were no significant changes in our balance sheet. Inventories are a little higher due to the delay of certain shipments until later in the year. We continue to have good cash generation and have reduced our debt as a percentage of total capitalization to just under 18% at June 30. With that bit of background, I will now turn the call over to Rich Musson, Badger Meter's Chairman, President and CEO, who will have some additional comments.

Speaker 2

Rich?

Speaker 3

Thank you, Rick. And thank all of you for joining us today. In fairness, I should state that some of my comments to that none of my comments today were copied from any speech by Michelle Obama, although I did lift a few words from Lady Bird Johnson, So

Speaker 1

I'm not seeing that in the script.

Speaker 3

I know. It's gonna be this was a good quarter for Badger Meter with continued strong results on both the top and bottom lines. Our record sales continue to be driven by our flagship products. Our E Series ultrasonic water meters, our Orion cellular radios and our Beacon analytics software platform. For the second quarter compared to the same quarter in 2015, E Series unit sales were up 42% and Orion cellular units were up 35%.

Margins were strong, again aided by lower copper prices, although that benefit has been diminishing as copper prices have risen somewhat over the past sixty days and the relative benefit compared to the prior year's quarters has decreased. We expect to continue to see some benefit in the third quarter, but to a lesser extent than in the previous quarters. Although we are still confident about the balance of the year, we have seen some softening in order input over the past month, which could impact the third quarter. Due to the high demand for our BEACON software, we have recently encountered a bottleneck in developing the necessary interfaces between BEACON and the billing systems used by both current and potential customers. For each new BEACON application, it's necessary for us to map our database to the database in the customer's system.

Unfortunately, many of our customers do not have sufficient IT personnel internally to rapidly provide us with the necessary information, which has caused a slowdown in this process and a corresponding slowdown in new orders. We've assigned additional personnel to assist our customers in this process and expect to work through the backlog over the balance of the year. As Rick mentioned, we reduced our headcount in the flow instrumentation business, which will generate a $1,300,000 annual savings. This was necessary to address the downturn in that business. We were pleased that we were able to implement the headcount reduction without layoffs.

Instead, we were able to offer an early retirement program that achieved our desired results. Now let me address a matter that's been of concern to many people over the past two months. On May 4, we announced that the company was exploring on a preliminary basis various options to enhance shareholder value. We further stated that there could be no assurance that any action will be taken as a result of this exploration. We have made no additional comments since the May 4 announcement.

Badger Meter, like all public companies, periodically reviews options to enhance shareholder value. Such reviews are normally done on a confidential basis. Unfortunately, during this most recent process, certain media outlets became aware of the process resulting in the May 4 press release. At this time, we continue to explore our options and hope to have this process completed during the third quarter. I will again remind you that there can be no assurance that any actions will be taken as a result of this process.

We have no further comments on this process at this time. However, I do want to point out that throughout this process Badger Meter's team has remained focused on the fundamentals of our business. We have produced record sales and earnings for the 2016 with year to date earnings up 43% over last year at this time. These strong results validate our strategic approach to value creation and we believe that we will be able to continue to generate solid long term shareholder returns. With that, we'll be glad to take your questions.

Speaker 0

Our first question comes from the line of Ryan Connors with Boenning and Scattergood. Your line is now open.

Speaker 4

Great. Thanks for taking my question. Just wanted to ask you about this. You mentioned this issue of BEACON and the compatibility or mapping issues, Rich. Is there any precedent for that type of issue that you've been through in the past and, you know, kind of the range of outcomes and what could potentially go wrong as you try to work through that?

Speaker 3

Yeah, when we first offered ReadCenter, which would have been over ten years ago, which was a newer version of our interfacing software, we ran into some bottlenecks then too. We were able to get through them pretty quickly. The difference is that ten, fifteen years ago, the number of customers we had using automated meter reading or advanced metering analytics was much smaller. And so it was much easier for us to get through them. Also, when we introduced that, the demand didn't ramp up quite as quickly as it did this time.

So to give you some metrics around this, we have about 140 customers or potential customers in the backlog who want to install BEACON and want to start using our products. Normally, our normal backlog on something like this is about 50. Now 50 even sounds like a lot for a normal run rate, but you have to understand there's a lot of customers who are waiting for their vendor to get them the number get them the data so they can send it over to us. So there's always this this period of time delay from the time somebody says, wanna use Beacon until we can get the thing installed. But we're at about three times the normal run rate right now.

So we we what we've decided is we can't really it it is impacting the business a little bit. We can't really wait for the customers to go through their normal process. So we decided to increase the amount of hand holding we do to help them through that process. We've reassigned a few additional people over to that area so that we can focus on this. The bottom line here is I think we should get ourselves down to a normal backlog run rate by the end of the year, which means that, yeah, it may have some impact on the third quarter, but we should be able to catch up by the time we get to the end of the year.

Speaker 4

Okay. And when you say impact on the third quarter, you mean on that discrete piece of the business or you think that it'll be detectable for the consolidated numbers?

Speaker 3

Well, think I mean on that discrete piece of the business, but it could have it could slow down sales, you know, the Orion products where they want to use Beacon to interface with Orion. So and Orion is a big piece of our sales, so it could have some impact. It's a little early to say what the impact might be. All we know is that, you know, we we have customers out there that say, want to buy Orion Radios. I want to install Orion Radios, but I don't want to start doing that until I've got Beacon installed, mapped to my billing system, and I'm sure it will work fine.

And so that's kind of the first step in making those sales of the radios.

Speaker 4

Got it. And the other question I just had was regard to flow instrumentation. I mean, continued downward pressure on revenue in the quarter there. I mean, can you give us your latest in terms of the outlook and backlog, whatever metrics you look at? I mean, have things kind of stabilized?

Or are we looking at that being a continued drag over the balance of the year?

Speaker 3

Ryan, we're not using the word stabilized. We're using the word bottomed Okay. We we are believing that that the decrease we've seen over the last several years, you know, I don't believe our oil and gas can go much lower. And the overall economy in other areas has had a negative impact. We also had a couple customers that one of them brought a product in house instead of using us.

So that had an impact. So all of those things kind of pull together to make a perfect storm. But we are seeing this thing bottoming out now and we believe we're going be able to drive some growth coming in the next half of the year and into 'seventeen.

Speaker 4

Okay. That's great. Well, thanks for your time.

Speaker 3

Thank you.

Speaker 0

Our next question comes from the line of Richard Eastman with Robert W. Baird. Your line is now open.

Speaker 5

Yes. Good morning.

Speaker 4

Good morning.

Speaker 5

Maybe, Rich, could you just address for a minute or two, has there been a noted ramp in sales through American Water and that contract win when we progressed from 1Q into the second quarter here?

Speaker 3

Right. And the brief answer to that is no. What is happening with American Water is also what's happening with our Beacon customers. American Water has 15 subsidiaries serving 16 states. Their Tennessee subsidiary serves Georgia.

So there's 15 subsidiaries serving 16 states. And each of those subsidiaries is using a particular billing system that is provided by a relatively small provider. And so we are working with that provider to try and get that provider to to map their billing system to Beacon, but that provider doesn't have a lot of resources to work with us. Another option is to bypass that provider and try to go right to the SAP system that all of these entities are using, and we're also looking at that. So what I have to say to you is we have not seen the ramp up in American meter that we had hoped to see this year.

And in fact,

Speaker 1

For the second quarter we're higher in the second quarter than the first, but it is ramping up slowly. I mean, maybe there's about a million in the first quarter and about a million six in the second quarter.

Speaker 3

So based on that, you can see that it's not ramping up as fast as we had hoped, Okay? On the other hand, the good news is that our current strength in the first half of this year is not driven by the American meter business that we know is coming. It's I'm I'm sorry. American water business that we know is coming. That is that is being stretched out more.

So we we are not attributing the strength in the first half to that particular account, and we still have that upside potential.

Speaker 5

Okay. Understood. And then just a a quick question, for Rick. The the SMEGA expenses, you did identify maybe, the 700,000 that was, you know, involved in the review. The early retirement expenses, what was the maybe the total noise in the SMEGA expense that was recorded?

So we had the 700 plus the early retirement piece. I mean

Speaker 1

The 100 the 700 includes the early retirement.

Speaker 5

Oh, it does? Okay. So that that might be, you know, the onetime noise in the SMEGA expense that pumped it up a little bit.

Speaker 1

It is probably the onetime noise. Now, you know, there's a thousand other things that fluctuate through SMEGA. Health care is is a little bit better this year, those kind of things. But the reason we cited the 700 for the exploration of our options and the early retirement is because those are the one offs, so to speak.

Speaker 5

Okay. And then just last

Speaker 1

question That's

Speaker 5

about $03

Speaker 1

a share, I think, dollars 700,000.

Speaker 5

Yes. Okay. And then just the last question. On the utility side of the business, the commercial meter sales up 29%. How do you look at that number?

Is that an acceleration? Is that some catch up from the first quarter?

Speaker 1

Rick, that's just it's the lumpiness of the commercial meter business. And again, last year wasn't necessarily as strong. It was actually a little bit down. So, you know, it's not as big a piece, so you've got a smaller denominator to begin with. Yeah.

You know, residential is still what I call the bread and butter of municipal water sales, but it's nice that the commercial meters are there helping out. But it's just it's the pure lumpiness. There's nothing that we're citing. We don't make we don't call trends on one or two quarters.

Speaker 5

Sure. And would I be wrong to think that commercial meters, copper prices or brass prices down, your pricing gain here, modest pricing gain may have come from that? So all in all, the 29% growth rate on the commercial side would have been a positive two year gross margin.

Speaker 1

Yes, absolutely. Although I would say it's more volume based, but there are some higher prices in there.

Speaker 3

And on a comparative basis, the copper prices have an impact. Correct. And Rick, me throw a few numbers out to help help everybody with this copper impact that I referred to because because I I kind of I I I have these numbers stored in my gray matter, so I'll I'll share them. For the 2015, and you can look this up on the Internet. This is public information.

For the 2015, the average price of copper on the open market was about $2.75 a pound. For the second half, it had dropped to about $2.3 For the first half of this year, it averaged about $2.15. So for the first half of this year compared to the first half of last year, we had about a 60% per pound decrease. But now if it stays at $2.15, and actually it's gone up over $2.20 recently, but if it stays there, you're comparing to a $2.30 average in the second half. And that's what I the point I was trying to make.

I I don't I don't think quarter on quarter run rate is gonna be impacted dramatically because copper prices are still low. But when you're comparing to last year, high copper price in the first half of last year had an impact on us.

Speaker 5

I understand. Okay. Just last question, Thomas. In The Middle East, have we continued to gain traction in The Middle East on the e meter side? And how's what's the backlog look like there?

What does the trend line look there? And maybe just give us an update on on that initiative.

Speaker 3

The Middle East business is dominated by large product projects, primarily in The Emirates. So we continue to to, provide the the e series meters to Qatar or Qatar, however you wanna pronounce it. And and that's good business for us, and that continues to go. The other large project that we have been awarded is in Dubai. And that will be more of a second half type thing.

Speaker 1

That was the delay I referred to as to why inventory is a little bit higher at June 30. In our plan, we had some of those in the second quarter. It's being delayed to the third and the fourth. Right.

Speaker 5

Okay. Okay. And that's the same product? That's the e meter product?

Speaker 3

Correct. That's the same product.

Speaker 5

Very good. All right. Thank you.

Speaker 3

Welcome. Our

Speaker 0

next question comes from the line of John Quilley with Canaccord. Your line is now open.

Speaker 6

Hey, good morning, guys. First, I'd say on the marketplace stuff coming out of AWWA, looks like competition is catching up a little bit, Neptune with the cellular. I think Master Meter is trying to do some more deal stuff private label. Talk about the technology lead guys. I mean, Beacon came out of the gate hot and you're getting some growing pains here.

But just talk about the overall market. How do you think the portfolio is positioned as we sit here?

Speaker 3

John, I still think we have the strongest portfolio in the industry in North America. We knew that the others would try to come along. We have competitors who are trying to introduce electronic meters, but if you look carefully at what they're offering, they may have only one size. And in our industry, we know that you have to offer the full range of sizes to get any traction at all. So some of them may have rushed to market with one quick one that they private label out of China or something, and I think they're gonna have trouble gaining any traction.

The same thing on the cellular. There are people who are now running around saying, well, we have cellular too, but you have to look very carefully at that because some people are referring to a cellular backhaul. In other words, the water meter communicates with a collector up on a tower, and then they use cellular to send all that data from hundreds of water meters back to the utility. When we talk about cellular, we are talking about cellular from the water meter to the cell tower, and that there is no collector needed. There is no no proprietary collector needed up on the tower.

And so first off, be very careful what people are introducing when they talk about cellular. Secondly, cellular is much easier to do in above ground applications. So you see a lot of cellular in electric and gas because they're on the side of the house. The challenge with cellular is and in fact, you can try this out, John. Go down in the corner of your basement and see what kind of a signal you're getting on your cell phone.

Or better yet, take your cell phone out in your yard, lift the lid of your water meter pit, drop the cell phone down in the bottom of it, and see what put the lid back on and try to make a call to that cell phone.

Speaker 1

This is what Rich does on the weekends for fun,

Speaker 3

by way. Yes. This is how I I enjoy myself. So what I'm my point being that we that our cellular radio has been designed to deal with the very, very demanding environment of the of the water industry. And so a lot of people are rushing out saying, I have cellular.

Well, I could put a cellular on above on an above ground meter tomorrow with no problem whatsoever. It's those additional challenges of putting it under a pit lid, underwater, underground, and still being able to communicate for a decade without recharging. So that is really the challenge. And so when people say I have cellular, you really have to start questioning what they have.

Speaker 6

Okay, that's helpful. Two more for me. When you talk about a bit of the backlog and bottleneck on Beacon, and I just want to be clear, this is the Beacon to third party API that you need to build and you're trying to help people do it? Or is this Beacon to Orion that you're just trying to get hooked up?

Speaker 3

Beacon to Orion works fine. If people install Beacon and it's cloud software, so when they've got it on their system, it can read their meters and there is no challenge at all. But obviously, they want to take that BEACON data and then pass it into their billing system. Now the challenge here is there are 53,000 water utilities in The United States. There are thousands of billing systems that those water utilities are using.

Some of them are homegrown. Some of them are mom and pop shops. Some of them are larger companies. But in each case, you have to be able to take that BEACON data that has been brought into BEACON from the water meter and format it in a way that the buildings it can be passed on to the building system seamlessly. And that's where the challenge comes in because our people can certainly help the customer, but we need to know how their billing system works.

And very often, the customer is at the mercy of a third party vendor.

Speaker 1

Who doesn't want who doesn't wanna give up their code for us to do it for them.

Speaker 3

Yes. So they don't want us to do it for them, but they don't have the resources to do it themselves. So that's what we're really chasing. And we're chasing that on American Water too. So even some of the larger customers have systems that are challenging.

Speaker 6

Okay. And then the last one, back to the strategic review. Did the flow early retirements, did that come out of that process? Was it lingering in your mind watching the P and L? And when we hear strategic options, obviously, we all go towards sell.

But talk about could there just be an internal process realignment change in strategy that keeps you as a public company, I guess? Is this

Speaker 3

Well, and clearly, when we say that our board is reviewing strategic alternatives, that means all alternatives. And it's unfortunate that everybody immediately jumped right away to the idea of a sale, but that's what the market tends to do. This could include the sale of a portion of the business. This could include a major acquisition. It could include a lot of things.

I will remind you that about four or five years ago, we did a strategic review. Obviously, that didn't become public. The end result of that strategic review was that we bought, we're seen federated, and we also implemented a stock buyback program. These are the types of things that the board reviews. It's just a little unfortunate that this one became public matter.

And on your the other part of your question, no. The the issue of the headcount reduction in flow instrumentation was entirely driven by the loss of the oil and gas business, the downturn in that business and had nothing to do with strategic review. In fact, that plan was in place before we ever got into the strategic review.

Speaker 6

Okay. All right. Good luck, Thanks.

Speaker 5

Thank you.

Speaker 0

Our next question comes from the line of Richard Verdi with Ladenburg. Your line is now open.

Speaker 2

Hi, good morning guys and thank you for taking my call here. I just wanted to follow-up on one of the earlier caller's questions pertaining to the energy side of the business. Rich, you've said that you

Speaker 1

can you speak louder? We're having trouble hearing you.

Speaker 2

Yes, sorry. Can you hear me better now?

Speaker 3

Yes. Yes.

Speaker 2

Okay. Sorry about that, guys. Yes, So I wanted to follow-up on the energy side of the business. Rich, you had said that it looks like things are bottoming here and that makes sense. It looks like rig count is starting to bottom out, net production is going to could be deficient later this year.

So I'm wondering if customer conversations are starting to heat up where we could see good strength in the second half in that business and into 'seventeen? Or are the favorable conversations with customers just not quite being seen yet?

Speaker 1

I'll give you some anecdotal evidence. The anecdotal evidence is while things are bottoming out, there's still there's great optimism out there for a lot of growth fast. Here, we're being handed a note now.

Speaker 2

Yes. Well,

Speaker 3

yeah. And and this is an important point too. Thank you. Greg Gomez, our our VP of flow instrumentation, just handed me a note that that that said my car lights are on. No.

I'm kidding. No. He hand me a note pointing out that first off, our third and fourth quarter comps are going to be easier compared to the prior year because we we had a stronger first half, and we really got weak in the second half. So now the comps become a little bit easier. But the other thing is when it comes to the energy sector, just the energy sector, and we were doing about a million dollars a month business in that sector.

It had dropped down to below a half a million dollars a month. So we lost a lot of it. And a lot of the meters there were being used on rigs. And and and so as the rig count starts coming back up again, that's gonna help us. The other thing is that a lot of the meters were we had a good piece of replacement business there.

And and when oil was very expensive and a meter would would have to be replaced, they would simply take it off, throw it in the garbage, and put a new one on to keep running the rigs. Now over the last several years, what we've seen them doing is taking them off and rebuilding them and putting them back on. So that that has impacted the business. As oil becomes more valuable, as the rigs become busier, we will probably see that replacement business pick up also.

Speaker 2

Okay, that's excellent color. Thank you for that. And just one last one for me. Kind of understand here there's a trend getting underway where the water utilities who are focused on implementing smart meters are I guess looking at joint forces with the electrics to share the same network infrastructure instead of implementing the new infrastructure to save on costs. I was wondering if you guys are seeing this trend and if so or if not, how a trend like this could impact Badger Meter.

Speaker 3

First, we aren't seeing the trend.

Speaker 1

At all.

Speaker 3

We've been told for twenty years that that trend might come, But they what what we have found in our industry is that, the water utilities view their data, their customer data, as very valuable proprietary data. And they don't like the idea of of working off of somebody else's system. So we were told twenty years ago that we had to worry about that trend, and that's why Badger Meter needed to move into the electric metering and the gas metering business. And, of course, we didn't do that. We chose to stay focused on the water business because that's what we were really good at.

And over the last twenty years, that has paid off very well for us. At this point, I have not heard about any water utilities.

Speaker 1

And there are a handful of municipalities that own their own electric and or gas distribution system where what you're saying is, by and large, you're really talking about investor owned electric and gas utilities versus municipal water utilities. And there is just a cultural difference there that it's hard for the municipal utilities to overcome. They're always not sure of an investor owned utility's motives in wanting to do something together,

Speaker 3

right?

Speaker 1

That's been around for decades.

Speaker 2

I see. That's great color. Thank you very much, guys. I appreciate it. I'll turn it back over.

Speaker 3

Thank you.

Speaker 0

I'm showing no further questions in queue at this time. I'd like to turn the call back to Rich Mewson for closing remarks.

Speaker 3

Thank you. Well, I want to thank everybody for joining us today. Obviously, we were pleased with this quarter. It was a good solid quarter. Have a lot of confidence about what we're going to see going forward and what our strategies can continue to generate.

As I said earlier, we do believe we have the strongest product portfolio, the best technology on the market. And Badger has been focused solely on water utilities for one hundred and ten years. It is our main focus on that side of our business. So it's allowed us to create a great deal of shareholder value and we expect to do that going forward. So with that, I'll thank everybody for joining us and have a good day.

Speaker 0

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program and you may now disconnect. Everyone have a great day.