Badger Meter - Earnings Call - Q3 2014
October 16, 2014
Transcript
Speaker 0
Thank you for joining us today. 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 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 third quarter results. Yesterday afternoon after the market closed, we released our third quarter twenty fourteen results.
We are very happy to report that we had record sales, earnings and diluted earnings per share for the third quarter. In fact, not only did these numbers break previous third quarter records, but they were the highest of any quarter in our history. Sales for the three months ended September 30 were $96,300,000 compared to $93,000,000 during the third quarter last year. The $3,300,000 or 3.5% increase was the net result of higher sales of municipal water and flow instrumentation products, offset slightly by lower specialty product sales. Let's look at each of these groups.
Municipal water sales increased $700,000 or 4% to $69,900,000 in the 2014 from $67,200,000 in the 2013. These sales represented 72.6% of total Badger Meter sales for the last three months compared to 72.2% in the same period last year. The increase in municipal water was due to higher sales of residential meters both with and without radio technology, offset by slightly lower sales of commercial meters and related technologies. Sales of residential meters increased 6.5% due primarily to higher volumes of products sold. Commercial meter sales decreased 5.6% over the same period in 2013.
However, it should be noted that in the 2013, commercial sales were up 33% over the same period in 2012. This is an example of the lumpiness we sometimes refer to and how our sales fall within particular quarters. Overall, our customers have continued their normal normal buying patterns. We are seeing efforts to sell products in other parts of the world and we continue to be favorably impacted by sales to customers of a former competitor. Particular Flow instrumentation products represented 24.3% of sales compared to 23.9% last year.
These sales increased $1,200,000 or 5.4% to $23,400,000 from twenty two point two million dollars in the same period last year. Most products within this group saw increases in total sales due to higher volumes and relatively consistent pricing. Specialty application products represented 3.1% of sales for the last three months compared to 3.9% in the same period last year. These sales declined $600,000 or 16.7% from Q3 to Q3 to $3,000,000 from $3,600,000 last year. The decrease was due to lower sales of gas radios, offset slightly by an increase in sales of concrete vibrators.
Gross margin as a percent of sales was 37.96% in the 2013. The increase was due in part to lower brass costs, favorable exchange rates on parts sourced from Europe and on lower costs associated with slow moving and obsolete inventory. Shifts in the product mix also contributed to the higher margin percentage. Selling, engineering and administration expenses for the last three months increased $1,300,000 or 6.8% over the 2013. The increase is due primarily to higher employee incentives due to better financial results to date, higher professional fees associated with an acquisition that was completed on October 1 and increased amortization expenses associated with recently installed software.
The effective tax rate for the quarter was 34.9% compared to 33.5% last year. The latest estimate of the effective tax rate for the year as a whole is 36.6% on all incremental dollars. The actual rate shown in the financial statements also includes some unique tax benefits that flow through the tax provision. I also want to note that the overall results include a non cash pension settlement charge of $680,000 or $03 per diluted share. As a result of all of this, net earnings for the quarter were $10,200,000 or $0.71 per diluted share compared to $9,000,000 or $0.63 per diluted share for the same period in 2013.
The balance sheet remains stable. We generated $28,200,000 of cash from operations during the nine months ended September 3034 compared to $28,700,000 in the same period in 2013. In the third quarter, we continued to reduce our overall debt. At September 30, debt as a percentage of total capitalization was under 23%. Rich will comment on this further, but on October 1, subsequent to the end of the quarter, we closed on our purchase of National Meter and Automation.
As a result, we will see higher debt balances in the fourth quarter. 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 1
Thank you, Rick, and thank all of you for joining us today. First, let me say that we're obviously very pleased with the strength of our business in the recent quarter. Our customers continue to see the value in our product offerings, especially our newest products, and we continue to manage the company for future growth and profitability. Let me provide a few specifics on those new products. We are seeing strong growth in our E Series Ultrasonic Residential Water introduced several years ago in stainless steel and most recently in a polymer version.
Unit sales of these products doubled in this quarter compared to one year ago. The Orion SE radio, which provides simultaneous drive by and fixed network meter reading capability also continues to drive higher sales. And the Beacon Advanced Metering Analytics System with its cellular based radio introduced earlier this year continues to see strong market acceptance. We have sold over 150 starter kits and now have numerous utilities that have already committed to this newest technology offering. These three new products, E Series, Orion SE and the Beacon AMA system are all driving sales growth and strong margins for Badger Meter.
On the first day of this month, we were also very pleased to close on the purchase of National Meter and Automation, our largest distributor. We paid $20,700,000 for this company, which we estimate to be about EBITDA. Since a significant portion of National Meter's sales were from the resale of Badger Meter products, this acquisition is only expected to add to our consolidated revenues by approximately $15,000,000 annually. This represents National Meter sales of non Badger Meter products plus their markup on Badger Meter products. However, this acquisition will add significantly to both our gross margin and our bottom line.
More importantly, the acquisition will bring us closer to our customers and enable us to serve the market more efficiently. We're very pleased to have National Meter and Automation as part of the Badger Meter family. We continue to invest in our R and D efforts for meters, radios and software. We recently introduced the new iOn Water consumer app, which enables our utility customers that have implemented the Beacon AMA system to give their customers, the end water consumers, access to valuable information about their water usage. This free app is now available on home computers, iPads, iPhones and Androids.
Utilities in water stressed areas are particularly interested in providing this information to their customers to encourage conservation efforts. Looking forward, we feel that we are in a strong position to drive continued growth in both sales and earnings. Although the fourth quarter tends to be a weaker quarter due to the seasonality of our business and in October we're already seeing some of that weakness, we are optimistic about our long term prospects. With that, we'll take your questions.
Speaker 2
Thank And your first question is from Richard Eastman. Please go ahead.
Speaker 3
Good morning. Good morning, Rick. Good morning, Rick. Rich, could you just I just want to make sure I heard this right. On National Meter, you guys paid $20,700,000
Speaker 1
Correct.
Speaker 3
Okay. And could you just give us a sense of the kind of Badger maybe pass through revenue? We talk about $15,000,000 of being third party revenue, but Well, $15,000,000
Speaker 1
is third party revenue plus the markup But on our they were doing about 25,000,000 to $30,000,000 of Badger Meter products, which obviously doesn't double up on our sales. We're not counting that twice. But you can see that at $21,000,000 purchase price with seven times EBITDA, we're expecting to generate about $3,000,000 of additional EBITDA from this purchase in 2015 for sure.
Speaker 3
Okay. So $3,000,000 of EBITDA incremental from this purchase for all of next year?
Speaker 1
Right. To help you with your model, I'll also say that they add they will probably add about $6,000,000 to our sales engineering general and administrative costs. Okay. So that will fall in there. And the difference the plug number you're going to come after is improved margins.
Should get over 100 basis points on our margin.
Speaker 3
Excellent. Excellent. And then just could you just talk for a minute about the seasonality, just your last comment there? I mean typically your sales sequentially into the fourth quarter are down maybe 10%, 12%. So your comment about seeing that softness, you're really talking about that typical seasonal softness versus something that would be more year over year?
Speaker 1
I'm seeing the seasonal softness, but Rick I purposely made that comment about October because I'm October starting out a little softer than I have in the past in past October.
Speaker 3
Okay. So year over year it's a little
Speaker 0
bit It's a We thought we'd have a month ago.
Speaker 1
Right, right. I mean we've had now two great quarters in a row. And in fact even the first quarter if you adjust back the $07 for the acquisition, we've had three great quarters in a row here. And long term, don't see any issue in our business. But as you know, the utilities react to a lot of different things.
There's a lot of factors that come into play. Even the election can come into play on utility buying habits. We're just seeing some softness in our October order entry, which we're only halfway through October. It's possible that it's just timing.
Speaker 3
Yeah. And that's and so maybe the question is I mean from a you would talk about order patterns kind of return to normal. We would get some seasonality. Maybe we're a little bit softer than we'd like year over year in October. But there's nothing structurally because again revenue at the kind of municipal state level still seems to be kind of working higher.
There's nothing structural here that would suggest any caution in the buying pattern is there that I don't see?
Speaker 1
That's absolutely correct. Not hearing anything from the field or And anything like
Speaker 3
with National Meter, again, we got kind of $15,000,000 of incremental third party revenue here to build into a model on an annual basis. I presume that their fourth quarter would be a little bit weaker seasonally as well? Correct.
Speaker 1
They will follow our seasonality.
Speaker 0
And because of the accounting rules and the write up of the inventory in the acquisition price, we don't expect to see much profit in the fourth quarter on the gross margin line.
Speaker 1
Right Rick. There won't be much that will hit the bottom line from National Meter because we have to write up all of their inventory in Sure. The
Speaker 3
And they wouldn't carry more than a quarter's worth
Speaker 1
Yeah. They've got like four turns a year. So anything we sell in the fourth quarter is going to be written up. It's going be a
Speaker 3
new Yes. Book written And just one last question sorry. But Orion SC, I'm just curious when you look at Orion SC sales relative to are you still selling any Orion product and also for that matter Galaxy? Or is most of the product now transitioned over to Orion SC?
Speaker 1
No. We are still selling a lot of Galaxy and a lot of the what we call Orion CE, is the classic endpoint. We're still selling a lot of that. In fact that's the majority of the sales. But we're on track to probably do about 100,000 Orion SE this year.
You're racking that up Units. Units. And you're racking that up against about 1,000,000 radios we sell each year. So, we're pleased with where it is. But as you know, we introduced this thing, basically about one years point ago, and a lot of utilities say, Send me 10, send me 20.
We'll see how it works and we'll place orders. I'm pleased that we're now selling tens of thousands a month, but we're not replacing all the Orion CEs with them.
Speaker 3
Yeah. I understand. Okay. Great. Thank you and very nice quarter.
Thank you.
Speaker 2
You. Your next question comes from Ryan Conniff. Please go ahead.
Speaker 4
Great. Thank you. I had a question guys on just if you could expand on the National Meter deal, particularly on kind of the strategic rationale behind the deal, Rich. I mean, I know typically you've not owned distributors in a big way. So does this indicate any kind of shift in channel strategy on your part?
Or was this more of just an opportunistic type situation?
Speaker 1
Yes. And it is a good question because historically, I've said that as a manufacturer, I'm a little uncomfortable owning a distributor and that it's difficult to operate that way. Well, first off, the opportunity came along on National Meter. National Meter is not only our largest distributor. They're kind of the gold standard of distributors industry.
They have done just an incredible job. They have great systems, great procedures, highly talented people. So this opportunity allowed us to start down kind of a new strategy path where we said, let's acquire National Meter. And we don't view this as a one off acquisition. We think the real opportunity with National Meter is that down the road as other territories become available distribution network or other distributors become available, we're going to look at them pretty aggressively as to whether we want to make some acquisitions or assign additional open territory to National Leader to allow them to grow and basically grow our own distribution network, if you will.
So, we're definitely going to look at this as a new strategy and a new opportunity going forward.
Speaker 4
Now, if I'm not mistaken, National Meter is largely kind of a Southwest part of the country. Is that correct?
Speaker 1
That's correct. They really have Colorado, Arizona and California. A little bit of other states, but that's basically what they've got.
Speaker 4
Okay. And that's one of the areas where Beacon has been, I think, most popular early on because of the water conservation management aspects of the system and that sort of thing.
Speaker 0
Does Absolutely. This
Speaker 1
I would probably throw Texas in there. The Texas utilities are also very interested in Beacon. But to tell you the truth, we've had interest all across The United States. We've got Eastern utilities that have picked it up and the starter kits have gone everywhere. But there's no question that this idea of ion water and allowing people to see what they're using to drive conservation, that's going to be a big selling point with the utilities in stressed water areas.
So that would focus California, Arizona, Texas, Nevada, areas like that.
Speaker 4
And you've talked about this technology double leap, Rich. I mean, as part of this the fact that you own distribution, does that enable you to better dictate how your channel partners are kind of pushing, how aggressively they're getting the word out and the message out and making a sale on some of the new technologies rather than being complacent selling some of the legacy stuff? Is that part of the rationale here or no?
Speaker 1
Well, I think there may be a little of that, but I wouldn't say that's the driving rationale because pretty much all of our distributors are sell primarily Badger products. So we've got a pretty close relationship with our all distributors now. But what this will do is bring us closer to our customers. It's going to let us get out into the field and spend more time with the customers. We're going to know more what the customers' needs are.
And yes, to some extent, it's going to allow us to focus sales efforts in areas where we feel that it's best for building shareholder value.
Speaker 4
Great. And then my last question just on the Beacon system. It's been a great story, obviously not material yet in terms of the numbers. I mean how soon out or how far out do you think it will be until that's really a needle moving part of the business? Is that a two year story, a five year story?
What do you think?
Speaker 1
I think one way to gauge that is to look at Orion SC. So we really introduced Orion SE in the second quarter of last year and we started selling thousands a month, which were primarily for people who were looking at starter packages and testing it, okay? Here we are a year later and we're selling tens of thousands a month, all right? I think we're going to see the same thing with Beacon. We released it pretty much in the second quarter of this year.
We sold over 150 starter packages where the utilities actually buy. They're making a commitment. The starter packages come with 10 radios and four free months of service. After four months, they have to decide whether they want to commit to this or not. And we are seeing a lot of utilities commit.
But I think it's going to be somewhere around the third quarter of next year when we're going to start seeing significant sales on this.
Speaker 4
Got it. That's very helpful. Thanks for your time.
Speaker 2
Thank you. And your next question comes from Chip Moore. Please go ahead.
Speaker 5
Hey, thanks. Wondering if we could touch on pricing environment a little here. Signed to some softness in October copper touching under $3 Presumably you've got a little cushion. Are you willing to compete a little more? And then what are you seeing from competitors there?
Speaker 0
I think we are competing a little bit. I didn't mention this in terms of the municipal water business because it was primarily volume driven the increase. We saw, I mean, just a smidgen of price decline and I mean less than 1%. That could have just been mix. So we really are not attributing that to anything.
But there is a little bit of there's heavy competition on price out there right now. We've used we've said forever built into our prices was $4 copper. You're right, copper is low right now, but we've used that to absorb other price increases over time. So we think we're properly priced for the market right now and we'll have to see what our competitors do.
Speaker 5
Okay. That's fair. And maybe you can bring us up to date on the Ulster business where we stand there?
Speaker 0
Well, I was going say the Ulster business we think it's now it's to the point where it's since it was our business last year, it's actually just being built into the normal results. But we feel we estimate that we've conservatively captured at least half of the Elster sales, the former Elster sales. We know there are customers out there that Elster had contracts with that basically stockpiled and we still haven't seen some orders from them. And so we're hoping that we still have some a little bit more potential in the future. But I'd say that's kind of built into our base now in 2014 going forward into 2015 and beyond.
Speaker 1
We're fairly confident that we got over 50% of the Ulster business. We also feel that that Ulster business is priced probably about 15% below market rates. What we were able to do on the renewals this year is I feel and this is just a gut feel from the renewals that I saw that we probably picked up a third of it this year. So we're maybe 10% below market rates on a package of all the customers and we'll pick we're going to try and pick up a third of it each year. We can't go in and say to a customer we're raising your rates 15% in one year.
They were used to these low prices from Elster. We got to get them back up to market, but it's going to take a few years to do it.
Speaker 5
Okay. That's helpful. And I guess just lastly on me back to Q4 trends. Language in the press release seems to suggest maybe Q1 levels or lower and then just triangulate that with the addition of National Meter. Thanks.
Speaker 0
Well, I mean Q4 I mean I always say Q4 is the weakest quarter of the year by far, okay? And Q1 can compete for Q4 for the bottom or can compete with Qs two and three. It all depends on how the year starts and the weather. We've had that conversation. But if I were a betting person, always say Q4 is the weakest.
There is seasonality. You're heading into winter, you're heading into the end of the year. Some utilities
Speaker 1
There's also a lot more holidays in Q4.
Speaker 0
Some utilities are a calendar year. We estimate maybe a third the utilities have calendar year ends, whether they have to spend money to get it done by the end of the year, which by the way has not been a problem in recent years, or whether they just wait till the New Year to start. All of those are factors, very hard to get a read on. I think all Rich was referring to is just as we start the first couple of weeks in October, we updated our forecast about a month ago and we're seeing a little softness even on that. In National Meter, I think the message there is don't expect anything great shakes in the fourth quarter where National Meter is specified amount of money in the bottom line just simply because we go through the opening entries and that inventory has to turn and we don't make a lot on that.
But after that we're very confident.
Speaker 5
Great. Appreciate it guys.
Speaker 2
Thank you. And your next question comes from Glenn Wirthman. Please go ahead.
Speaker 4
Morning, Glenn. Good morning, guys.
Speaker 6
You explained the year over year gross margin improvement, but it was also up 150 basis points sequentially on essentially flat sales. Can you help us understand the move there?
Speaker 0
Well, I think I have a theory on that because our inventory turns four times a year. If you look at what we sold in the second quarter, a lot of that had to do with cost basically incurred in the first quarter when we didn't have as much volume. If you look at what we sold in the third quarter, a lot of that has to do with product basically produced in the second quarter when we were really basically cranking and we're more efficient. We have a lot of fixed costs. It's a fixed cost environment on a lot of the production costs.
And as we get the volume, we absorb it better and it helps drive down costs.
Speaker 6
Okay. And then just on the gross margin going forward, I mean 37.9% is towards the upper end of your range, but it sounds like you're going to get higher margins from the national sales, maybe some improved pricing from Elster. Any thoughts on where gross margin shakes out going forward?
Speaker 0
My answer is we always regress to a norm, okay? Because we start getting a little bit too high, eventually pricing then from the competition creeps back in and forces us to take some actions. You're right on all of those factors. They can all play a role, but we can go into a little bit of softness. And again, I point back to that cost environment, certain fixed costs and also the margin can decline a little bit.
Speaker 6
Sure. Okay. Thanks for taking my questions.
Speaker 2
Thank you. And your next question is from Brian Ruffin. Please go ahead.
Speaker 7
Good morning, guys.
Speaker 0
Good morning, Brian.
Speaker 1
Good morning, Brian.
Speaker 7
Give me a sense, Rich, how many when you look at your national wholesale distributors, what size universe of that is being the nationals maybe the gold standard, how many different distributors are we talking tens, hundreds?
Speaker 1
We have about 33 distributors that represent about 50% of our utility sales. The other 50% is done direct. And so National Meter represented was the largest of those 33 distributors.
Speaker 7
Okay. Okay. Does that at all does that create any encroachment with some of the other distributors maybe competitively looking at maybe adding competitive product to that given the fact if you're doing a little bit of a vertical integration?
Speaker 1
No. First off, all of our distributors under contract have exclusive territory, so they don't compete with each other. So we don't have that issue. We also, under our distributor contract have pretty tight control over what else our competitors can sell. So it's very I'm sorry, what else our distributors can sell.
I'd love to control what our competitors can sell, but I can't do that. We have pretty good control through the distribution contracts over what our distributors can sell. So, for example, most of our distributors sell meter pits, pit lids, connectors, things like that that are sold with the meter. So I don't see a problem with other distributors trying to encroach or bringing in other product lines. I don't think that's going to happen.
Speaker 7
Okay. Okay. A sense and you've talked Rich in the past maybe over the last year or so and you said that given what's going on with Ulster and Neptune some of the other competitors that for the first time since Jesus walked the earth there might be a shift in some of this legacy market share. Are you seeing any of that?
Speaker 1
Well, clearly, the decision by Elster to pull out of North America, which after one hundred years was the first time we've had a major shift like that, that was significant. And that was significant opportunity for us and I'm very proud of our team. We did a great job in being able to capitalize on that opportunity. And I was very pleased that Elster was willing to work with us on that to transfer over a lot of their accounts. So that was opportunity and that was great.
We've seen our other competitors. Some of them are owned by private equity and are for sale. Others are not. We've seen we hear a lot of rumors out there about who's going to buy what and what's going to happen out there. But from what I see now, it's pretty stable.
There is some market shift causing some competitors to have excess capacity and other competitors to not have much capacity. So that always impacts pricing and what's going on in the market too. But I would say the biggest thing was the Ulster change.
Speaker 7
Okay. All right. And then you talked a little bit about the Beacon Technology, the ion water. If you see this rollout, Rich, what is your sense of some of these starter kits? Do you see the consumer picking up on that and pulling some of that demand through?
Or do you see water utilities more in kind of the gospel discipleship you should have? How do you see that playing out over the next couple of
Speaker 1
I think we're a ways away from the consumer demanding ion water with utility. But what does happen is a utility in an area will decide to go with Beacon and will provide their consumers with this information. That word then starts spreading to the other utilities around them and the question starts being asked by common councils or people like that, utility boards, saying, well, what are we doing? Why aren't we using some of this latest technology? Why aren't we providing this?
In fact, in Texas, one utility said, we're going to be using Badger Meter's new Beacon system and providing this wonderful information to our consumers. And the intrepid reporter called, a neighboring utility and said, what are you doing? And I got a kick out of the neighboring utility's answer. They said, our consumers can see their water usage on a daily basis. All they have to do is call the water utility every day and we'll read it to them.
So that's kind of a different level of consumer engagement than what we're offering here. We're offering real time online information to the consumers. And I do think there's going to be pressure on utilities. I'm not sure if it's going to come from utilities, but it might come from the governance boards and the surrounding utilities.
Speaker 7
Yes. Okay. Okay. Given I think you talked a little bit about kind of your sense of business visibility. And in the past, you've talked about tax revenues and budgets and municipal water budgets.
Some of the nonsense going on whether it be IRST party and drones and NSA hacking and border issues and Ebola, are these things that are really tertiary and really not affecting your core business? Or are there potentially some of these political crisis that could have some impact?
Speaker 0
This is Rick. We talk about this all the time. I always go back to the 2003 when the newly formed Department of Homeland Security told all the water utilities to two three. Yes, that's why I can talk about it. It's ten years old.
Speaker 1
That's right.
Speaker 0
Patch of limitations expired. When the newly formed Department of Homeland Security told all water utilities to inspect their facilities because we were going to war in Iraq, okay, it had a huge impact on our sales in that first quarter, okay. So yes, I would say, we always talk about this municipal water utility they're government employees. They are impacted by what they see going on out there and sometimes these things give them pause. Because right now, we see the market kind of yesterday was on a roller coaster ride.
People see that and go, maybe I should hold off in making the decision about converting my sale in case this is the start of another 2008 again. So they are impacted there. Long term, they're not impacted because what happens is all of a sudden this will be old news two or three weeks from now, hopefully, And everything just resumes and it goes on as normal. And we see that day to day. Brian, we'll give you one more question because we've got people waiting in queue.
Speaker 7
Okay. One just on the comment on the Orion SE. At what point are there any benefits that the Galaxy system the fixed network provides that the Orion SE does not?
Speaker 1
No. Galaxy provides the reading. It's pretty much a one way system where it provides the reading back to the utility through a fixed network device on a water tower or on a dedicated tower. And when you look at the Beacon system, you're talking about using the cellular infrastructure and a two way system where the utility can communicate back to the meter.
Speaker 7
All right. Thanks guys. Thank
Speaker 4
you.
Speaker 2
And your next question comes from Hafand Ozan. Please go ahead.
Speaker 8
Hi. Good morning,
Speaker 1
Good morning, Hafand.
Speaker 8
A couple of questions. The first one is, when you talked about fourth quarter looking more like first quarter at a high level, I just want to make sure when we think about the base, you guys reported $0.32 in the first quarter of this year. So is that I know you don't give guidance, but is that the base we should think about when we think about the structure and shape of the fourth quarter?
Speaker 1
Well, first off, we didn't say the fourth quarter is going to look like the first quarter. One of the people asking a question said that, okay? And we didn't respond to it. Secondly, the first quarter was $0.32 but there was a $07 unusual item in there, which was acquisition cost for an acquisition we didn't complete. On a normalized basis, was a $0.39 quarter.
And thirdly, I'm not going to answer your question because we don't give guidance.
Speaker 8
Okay. The second question I had
Speaker 1
tried. No, that's okay, Hudson.
Speaker 0
We give you credit.
Speaker 8
The second question I had is you had about an 18% increase in inventory levels this quarter versus your sales up 3.5%. So would you mind giving a little bit more color as to the reason your inventory went up so much year over year?
Speaker 1
Sure. First off, we are building some strategic inventory in certain product lines, especially products that are made in our facilities overseas where we were seeing longer lead times, whether it's because of customs, homeland security or whatever, we've had to build up some strategic inventory there. Secondly, you're going to continue to see an inventory build between now and the end of the year, because in the fourth quarter and into the first quarter, because since those are slower months, we're going to be making some major production moves down in our Mexico facility. We've actually got two buildings down there and we're going to be moving some production from one building to the other just to optimize and give us capacity for future growth. And so during those moves, we want to have enough inventory built up to satisfy any customer demands.
So not only did you see a build now, you're going to see even more of a build between now and the end of the year. After that, I think in 2015, you're going to see start coming down again.
Speaker 8
Are you investing any incremental capital in this Mexican facility?
Speaker 1
First just part of the cost of moving the equipment between one facility and the other, which is just freeing up space. We're also expanding the parking lot, because we're bringing in more employees. It's all
Speaker 8
just growth related. Okay. And should there be any impact to your gross margins as you move around the Mexican facility during the fourth quarter?
Speaker 1
No. We don't expect it at all. Okay. The last question Go ahead. We're taking advantage of the fact that the fourth and the first quarters are very slow or slower than the second and third quarter.
So this is the time to do it, get everything optimized. It's just that the production of the E Series has grown faster than what we had originally planned. And so we need to put on an additional line and we just can't do that in the facility where we have the E Series. So it's going to be better to just move it up into our larger facility.
Speaker 8
Okay. And the last question on your working capital. I know as of the end of the second quarter you had a $9,000,000 negative drag on working capital because you also had the build in inventory. So maybe can you give us a little bit color as to your working capital and cash flow generation as of the end of the third quarter?
Speaker 0
Look, cash flow for the and cash flow when we disclosed this in the SEC filings, cash flow gets measured on a nine month basis. And I apologize, but I don't have the six months sitting here. But for the nine months, we generated $28,200,000 compared to $28,700,000 for the nine months ended 09/30/2013. Clearly, the increased earnings are a factor, but then the you're right, the inventory build kind of dragged that down a little bit to make it even between years.
Speaker 8
Thank you very much gentlemen. Appreciate it.
Speaker 2
Thank you. And your next question comes from Richard Eastman. Please go ahead.
Speaker 3
Richard. Just a quick follow-up Rich. In the utility business, municipal business, the two initiatives that you had in The Middle East and also just this international initiative to sell Orion Radios kind of through a reseller in Europe. Any traction there or ability to expand distribution or have you or customer base? Just what's the status of those two pieces of business?
Speaker 1
Well, couple of things. First off, we did win the Middle East contract about $6,000,000 We had some pretty heavy shipments in the second quarter, but not much in the third quarter. It's just the timing of how they take the product. We also completed a deal earlier this year with a company in Europe that is private labeling and reselling our Orion radio. And we are starting to see we are shipping to them.
We're seeing it's hundreds of thousands of dollars a quarter. It's not millions. So we're starting to see those shipments and we're still pursuing other deals. We did open an office a sales office in Dubai with three people. So it's a small sales office, but it's going to help us support those Middle East customers and also hopefully gain some more.
Speaker 3
Okay. And again, just incremental traction there, nothing of note. I mean, no second contract win and
Speaker 1
Right. It's going to be a lumpy thing because they tend to be pretty large sales. And so it's going to be lumpy.
Speaker 0
We're but there are potential customers in the pipeline. And again, a long sales cycle than Yes. Anything else
Speaker 3
I got you. Okay. Thank you.
Speaker 1
Okay.
Speaker 2
Thank you. I would now like to turn the call back over to Rich Miesen for closing remarks.
Speaker 1
Okay. Well, thank you. I obviously, we're very pleased with this quarter. We feel we've had we've racked up three pretty good quarters thus far this year. We're optimistic about where things can go.
We like the traction our new products are getting and we like the market and where the market is. So we feel we're well positioned. With that, I'll thank everybody for joining us.
Speaker 2
Thank you. And thank you for your participation in today's conference. That does conclude the presentation. You may now disconnect and have a good day.