Badger Meter - Earnings Call - Q4 2016

Transcript

Speaker 0

Good day, ladies and gentlemen, and welcome to the Badger Meter Q4 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 follow at that time. As a reminder, this conference call is being recorded. I would now like to introduce your host for today's conference, Mr.

Rick Johnson, Senior Vice President of Finance and Chief Financial Officer. Sir, you may begin.

Speaker 1

Thank you very much, Crystal. Good morning, everyone. Welcome to Badger Meter's fourth quarter conference call. I want to thank all of you for joining us. As usual, I will begin by stating that we will make a number of forward looking statements on our call today.

Certain statements contained in this presentation as well as other information provided from time to time by the company or its employees may contain forward looking statements that involve risks and uncertainties that could cause actual results to differ materially from those in these forward looking statements. Please see yesterday's earnings release for a list of words or expressions that identify such statements and the associated risk factors. Let me reiterate some of our guidelines. For competitive reasons, we do not comment on specific individual product line profitability other than in general terms, nor do we disclose components of cost of sales, for example, copper. More importantly, we continue our practice of not providing specific guidance on future earnings.

We believe specific guidance does not serve the long term interest of our shareholders. Now on to the results. Yesterday after the market closed, we released our fourth quarter and year end twenty sixteen results. I will comment on the fourth quarter results in a moment, but wanted to note that our sales, earnings and earnings per share for the full year 2016 were all records for the company, despite finishing the year with a slightly weaker fourth quarter than we anticipated. Fourth quarter sales were $93,100,000 a $2,700,000 decrease from $95,800,000 in the fourth quarter of last year.

We saw sales declines for both our municipal water products and flow instrumentation products. Municipal water products net sales represented 78% of sales for the most recent quarter compared to 77% in the fourth quarter last year. These sales declined nearly $1,100,000 or 1.5% from the fourth quarter last year. Included in last year's fourth quarter was approximately $1,700,000 of sales for The Middle East that did not occur this year. In addition, sales into Latin America, primarily Mexico, were down over $1,000,000 in this year's fourth quarter.

Therefore, the decline in municipal water was due primarily to lower foreign sales, which tend to be sporadic. Residential and commercial sales grew on a domestic basis, which is our primary market. Domestic residential sales grew 4% quarter over quarter, while domestic commercial sales grew 15.1%. Low instrumentation products represented 22% of our fourth quarter net sales versus 23% last year. These sales declined $1.6 or 7.2%.

For this category, the message is the same one that we've been saying all year. The weakness that affected oil and gas markets continues as well as general economic softness in the other markets we serve. Gross profit margin for the quarter was 36%, the same as last year. Higher brass costs in the quarter and the impact of foreign exchange were offset by lower warranty and obsolescence charges. Selling, engineering and administration expenses decreased 2.1% as we are now seeing the impacts of the flow instrumentation staff reductions we made in the summer.

We also saw reductions in sales promotions from last year when we were introducing new products. These reductions were somewhat offset by higher bonuses and employee incentives. We should also note that our expenses included approximately $770,000 or nearly $02 per share of a pretax non cash pension settlement charge. This amount was similar to what was incurred in the fourth quarter last year. Because of all this, earnings before income taxes declined approximately $350,000 or 3.8%.

For our income tax expense, the provision for income taxes as a percentage of earnings before taxes was 31.2% as compared to 40.6% in the 2015. We've been using a slightly higher estimate for most of the year and as we've explained before, there are a variety of assumptions made to arrive at the interim estimate. As it turned out, we estimated state taxes at a higher rate than actually occurred and as in the past, we adjusted the estimate in the fourth quarter. Percentage difference in the fourth quarter is usually magnified by lower earnings in the quarter. As a result, our income tax expense was less than the fourth quarter of last year, which resulted in net earnings actually increasing by approximately $630,000 or 11.5%.

Net earnings then for the quarter was $6,100,000 versus $5,500,000 for the same period last year. On a diluted earnings per share basis, this was $0.21 versus $0.19 last year. Let me recap the year as a whole. We saw sales increase over 4% to a record $393,800,000 This was due to strong domestic sales in our municipal water area offset somewhat by lower sales of products. Our gross margin as a percent of sales for the year was 38.2% versus 35.9% in 2015.

The higher volumes and their impact on capacity utilization and product mix as well as lower brass costs for the year as a whole all contributed to the higher gross margin. Selling, marketing and engineering expenses were higher for the year due to higher employee incentive costs, higher amortization charges and higher professional fees. Also included in the year was approximately $1,500,000 of pretax non cash pension settlement charges or more than $03 per share compared to only $800,000 in 2015. For the year, net earnings were $32,300,000 a nearly 25% increase over the $25,900,000 made in 2015. On a diluted earnings per share basis, earnings were $1.11 compared to $0.90 in 2015.

Our balance sheet remains solid. We generated over $55,000,000 of cash from operations, which was a record for us. We increased dividends for the twenty fourth consecutive year in 2016 and managed to reduce debt by over $33,000,000 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. Rich?

Speaker 2

Thanks, Rick, and thank all of you for joining us today. We were obviously very pleased with 2016 as we achieved record sales, operating income, net income and earnings per share. But this year should also be viewed in context with our long term financial success. Over the past five years, we've seen an average compound annual growth rate in sales of 8.4%, net income of 11% and EBITDA of 14.5%. This is especially impressive considering the pressures on our flow instrumentation business during this period with the drop in oil prices and considering the relatively slow growth in the overall economy over the past five years.

We have been able to overcome these challenges by not only offering our customers innovative flow technology, but also through strong internal cost controls. As we look ahead at 2017 and beyond, we see both challenges and opportunities. We are optimistic about the possibility of stronger economic growth in our North American markets as well as a possible rebound in our flow meter sales to the energy sector as oil prices recover and government regulations permit more energy production activity. We continue to see opportunities in The Middle East for our ultrasonic water meters. And of course, we expect to see continued North American growth in our newest water metering products, our E Series ultrasonic meters, our Orion cellular radios and our Beacon analytics software.

In addition to these opportunities, 2017 will also have some challenges. We buy significant amounts of brass each year for our meter bodies. In 2016, copper, which is a major component of brass, averaged about $2.2 per pound. However, in the fourth quarter of last year, copper prices jumped over $2.6 per pound and have remained in that range to date. This will put pressure on manufacturing costs if the price remains high throughout 2017.

However, since this also affects our competitors, we could see upward pricing movement in our industry during 2017 to offset this impact. Another major issue relates to possible government action on imports. At this time, there is no clarity on what is being proposed or any possible impact from future tariff changes. Therefore, it would be premature for us to speculate on such impacts. Let me assure you that we are watching this issue very closely and we will respond accordingly when actual decisions are made by the government.

That said, I do think it would be helpful for us to outline Badger Meter's current operations to help our shareholders better understand the potential for the tariff situation. Like most companies with international operations, Badger Meter imports various components into The United States and exports some of our products out of The United States. We have operations in The United States as well as Mexico and Europe. Meters manufactured in The United States are exported globally and a small number of meters manufactured in our European facilities are imported and sold into The U. S.

Markets. One of our largest facilities is in Nogales, Mexico. We've operated there for over forty years on a tariff free basis, initially under the Makiladora rules and later under the NAFTA rules. We ship meter castings and molded plastic components from The U. S.

To our Nogales facility on a regular basis. We also import radio boards and other components from Europe and Asia directly to our Nogales facility. The meters and radios are assembled and tested in Nogales and then returned to The U. S. For shipping to our customers.

Based on these logistics, potential tariffs on Mexican imports could have an impact on Badger Meter as could potential changes to NAFTA and the original Maquiladora rules. However, the actual amount of such impacts would depend on the treatment of not only meter imports from Mexico, but also the related exports of the meter components to Mexico. Badger Meter also has the capacity and capability to move some portion of manufacturing back into The U. S. Facilities if financially justified by any such tariffs.

Further, of our competitors in The U. S. Market import components or entire meters from Mexico and other countries and could also be affected by any possible tariffs. It should be noted that in addition to the tariff discussions, there are discussions around possible reductions in The U. S.

Corporate tax rate and the regulatory burdens, which could have a very favorable impact on Badger Meter. So with those comments, we'd be happy to take your questions.

Speaker 0

Thank you. And our first question comes from Richard Eastman from Robert Baird. Your line is open.

Speaker 3

Yes. Good morning, Rich and Rick.

Speaker 1

Good morning, Rich.

Speaker 3

Just a quick question around some of the new products within the municipal marketplace and just maybe traction around continued growth on the e meter side, just some of the new products. And then also, are you getting any traction with this E Meter with the integrated shutoff valve that you introduced back in the middle of the year?

Speaker 2

Yes. So let me try to address a couple of those We saw E Series growth in revenue of over 20% from last year to from 2015 to 2016. And we're continuing to see that kind of strength in the market. So the e series, which now does represent about 20% of our total meter sales, is is growing very well. On the Orion cellular, which is our other flagship product, again, we saw growth there of of well over 20%.

So it was pretty comparable. And amazingly, that also represents about 20% of our radio. So I know I'm giving you a lot of 20 percentages, but that's basically what it is. Okay. So so so we are you know?

And and, frankly, I think with the e series and the cellular representing about 20% of the meters and the radios respectively, we think there's a lot of of road map to go there. In other words, could it reach 50% in a few years? Yes, it probably could. You know, we're very optimistic about seeing it do that. So we think we're going to continue to see strength there.

Customers are more and more accepting these newer technologies. And especially as they've been in the field longer, they're more comfortable with them. So that's the positive story there. On the on the integrated shutoff valve, we've seen some sales, but not a very high volume. I I'm looking over at our VP of sales and marketing, Kim Stoll, here.

Speaker 3

Okay.

Speaker 2

Yeah. So so the volumes are not big yet, Rick, but it's just been introduced. A lot of customers are taking just a few and putting them on tests to see how they'll work. Also, we we have we have them integrated with some of our earlier versions of software. But as everybody knows, we and and everybody else in the market are working on the development of an LTE version of of our cellular product.

And that should be released sometime this year. And when that gets released, we will also have those controls integrated into that product, the ability to turn off the valve, turn on the valve, see the status of the valve. One of the things that makes our valve unique compared to other people's valves is that is that we can do a partial shutoff. There are other valves that are being introduced where the choice is to shut off the water completely or turn on the water completely. With Badger's technology, we the the the customer can choose to leave it 10% open, 20% open, which would just leave a trickle of water enough to flush a toilet, but only once every few hours.

So it would it would be it would be something that would encourage a customer to consider paying their bill. And so that's interesting. One other thing I'm gonna comment on, Rick, that you didn't ask about, but I had a feeling might be coming. There was some legal action around this product, and a lot of people thought that one of the competitors had sued Badger for patent infringement. The fact of the matter is Badger is the one that holds the patent.

What the customer did was they brought a legal action to try to get our patent invalidated. We've since reached the settlement where they have withdrawn that legal action, and they've agreed to a to compensate us for use of the patent. So that is no longer an issue. And there was a lot of confusion over that because the headline simply said Badger was being sued. Well, were well, and people thought that the competitor held the patent, but in reality Badger held the patent.

Speaker 3

And then Rich, just to kind of dovetail into Beacon, and can I ask if the what the book to bill there was? Are the orders still exceeding the sales? And how was the that integration IT bottleneck? How would you describe that currently or maybe at the end of the year here?

Speaker 2

Okay. That's a good question, Rick.

Speaker 3

Had a feeling somebody would bring One, that up because it

Speaker 2

four. Yeah, you get one every once in a while. I had a feeling somebody would bring that up because we did talk about that last time. And interestingly, last time, we had a backlog of about a 160 customers or so, and it was a problem. This we're now three months further down the road.

We threw the additional resources. We have addressed it. We now have a back we still have a backlog of 160, which is interesting. But we're clearing at a rate that that backlog only represents about three months. And that's not an unusual amount.

So basically, we've caught up on all the customers who were, let's say, past due, who wanted to adopt the BEACON system but had not been able to work with their billing providers to get us the information necessary to make the system work. And so we had a big backlog with those billing providers. We've cleared that. We cleared the whole backlog. We're shipping to those customers.

And we've had new customers come in requesting it. But I consider the current backlog to be the 160 backlog we have now to be very current, and we are addressing them very promptly. We're getting much better responsiveness from the billing vendors to get the customers onto this system. So that's the good thing.

Speaker 3

I understand. Let me just one more and then I'll step aside. How would you kind of assess and as we move into 'seventeen here, some of the bigger meter opportunities that are out there, I think we noticed, I think, yesterday afternoon that Itron won the automation piece of SAWS. And I I would hope maybe that we got some meter and some cellular content there. But how do you look at the bigger project flow here as we move into '17?

Any, you know, any movement better, worse year in '17?

Speaker 2

I I there are some large opportunities out there in '17 that were not there in '16, particularly on SAWS. SAWS had

Speaker 1

Which is?

Speaker 2

Oh, I'm sorry. SAWS is San Antonio water. Yep. And San Antonio has been a Badger customer for years on meters. We continue to sell the meters, and we think we'll continue to sell the meters in the future.

It it you know, we we know they're they're constantly trying different technologies, and so they may have chosen Itron for a portion of their city, and that's fine. But I'm pretty confident we'll continue to have them as a meter customer. Obviously, we know that Dade County water has been talked about for years as at some point doing something. They had a RF request for information on the street that we responded to, and there are a few other large ones that are out there this year. So so there are some big ones that are coming up in '17 that we didn't see in '16, which does represent more opportunity for us.

I wouldn't be surprised to see one or two of those break in '17.

Speaker 1

But for the benefit of everybody else, a big customer in water generally gets spread out over three, sometimes even five years. It's not the same impact it would have, for instance, if we were selling electric meters, where you have to have the elephants. And so I think that's an important distinction.

Speaker 3

Okay, excellent. All right, thank you. I'll step aside here. Thank you.

Speaker 0

Thank you. Our next question comes from Chip Moore from Canaccord. Your line is open.

Speaker 4

Good morning. Hey, Rich and Rick, thanks. Maybe you can talk more broadly on competitive dynamics now with one of your competitors obviously under new ownership and some rumors of other businesses potentially being up for sale. Have you seen any changes? And then as it gets to the commodity headwind, how do you see that impacting any price increases?

Speaker 2

Yes. So the two big ones that have happened most recently were that Honeywell bought Elster. And and so so Elster Water, which is part of the larger Elster organization, is now under is now in the hands of Honeywell. And then most recently, Xylem, which for those of you who don't know, Xylem was the water spin off of ITT. Of ITT.

Xylem purchased Sensus,

Speaker 3

one of

Speaker 2

our other competitors from the Jordan company. In neither case did those acquisitions come with, in my opinion, major synergies. And what I mean by that is this was not like two water meter companies merging together where they could combine sales channels, they could combine manufacturing facilities, They could combine R and D. So in both cases, it was a change in ownership to somebody else who was very interested in getting into the water space, and I understand why it's a good space. Now let's look at each of those.

In the case of Ulster, Elster had previously pretty much pulled out of the North American market for water when it was owned by Melrose. And so, Honeywell does not really have a North American water presence for Elster, and we have not seen them upping that presence since that acquisition. Elster's water is primarily European and other areas of the world. They just haven't been in North America. On the on the census side, we haven't seen anything change there.

And I think it's still pretty new. I think Xylem is trying to figure out

Speaker 1

The deal just closed in November.

Speaker 2

Yeah. Rick says that Rick said the deal he thinks the deal just closed in November. So I think they're still trying to figure out what they've got and how they might integrate things and organize things. But Census remains a very strong competitor and a and a very strong company, and and it'll be interesting to see what they can do. But but also when when Xylem bought Census, they had projected some pretty significant cost savings from the integration, from synergies.

So it's going be interesting as to where they try to get those cost savings and what they try to cut to achieve that. We'll be watching that real closely.

Speaker 4

Okay, that's helpful. And then I guess on the flow instrumentation side, when you talk about maybe seeing some signs of recovery, is that anything you've seen so far in 'seventeen? Or is that more broader new administration? What's the thinking?

Speaker 2

Yes. I think that's a little bit broader. We're still this thing is still near the bottom. And especially you know, our our oil and gas business, which used to be a about a $12,000,000 business, and now it's down to less than 5. It's down around 4.

So we're looking more at what could happen with the administration as they open up more drilling, more fracking, more opportunities for energy production and a lot of our meters and products are used in those operations.

Speaker 4

Okay. And then just lastly, if I can, on M and A, maybe you can update on the pipeline and if you've seen any changes in what you're going after. Yes. We

Speaker 2

put a lot of our M and A activity last year on hold for the better part of the year while we were going through that review of strategic options that we've talked so much about. We've since reinvigorated that. We do have two of our distributors that we are in conversations with, and we hope to close this year if all goes well. So we are working on that. And we have some other acquisition opportunities that we're also currently pursuing that we hope to be able to make announcements on in the coming quarters.

Speaker 4

All right. Thanks.

Speaker 0

Thank you. Our next question comes from Ryan Connors from Boenning and Scattergood. Your line is open.

Speaker 5

Hi, good morning gentlemen. Good morning Ryan. I had a question regarding the bigger picture and kind of going back to Rick's question about kind of the large project outlook. I remember back when the last big federal stimulus package happened, you all talked a lot about how that actually ironically created some project delays leading up to and upon initial implementation of that, I guess because folks were waiting around to see whether they might be able to fund things cheaper and get access to some of that funding. There's been some talk about that maybe being the case today with the potential for a big infrastructure plan.

Can you give us your perspective on whether you're seeing any of that already or whether we will see any of that?

Speaker 1

This is Rick. First of all, I don't think we've seen any yet because honestly, no one has any idea what the actual plans are. What Ryan's referring to is back in the first quarter, I believe of 'nine, after Obama took office, there was an infrastructure big bill on the stimulus, and I believe $6,000,000,000 was allocated for water, of which 4,000,000,000 was wastewater, which is not a market we are are big in. But 2,000,000,000 was was just for fresh water. But the problem is it took them six months to write the rules.

And in those six months, we saw people just waiting to you know, on a $2,000,000 order, if they were gonna get a $200,000 credit on that, they waited to place the order. I think that risk exists, Ryan, but but to be honest with you, I think there's so many other bills ahead of of an infrastructure bill at this time. I'm not sure it's gonna have a profound impact on us in the near term because there's just nothing out there to point a finger at right now.

Speaker 2

The other question, Ryan, is if they do an infrastructure bill, how much ends up affecting water and wastewater. There there is obviously, there's a huge focus on roads and highways, which are the which is the visible in infrastructure. The invisible infrastructure, tends to get ignored. I'm, you know, I'm actually hopeful that money will be allocated to water and wastewater because our infrastructure is in such bad shape in The United States, and that would overall be good for the country. The question is, you know, will it, how much, and will it reach all the way down to the municipal level?

Speaker 1

Well, and in fact, back in o nine, when they said 2,000,000,000 for fresh water, they were very vague about what that meant. And in the end, while there was some money that actually went to metering, not a lot, okay, most of it went to mains and services where the money is really needed. Right. K? The truth of the matter is the meters are the cash register.

They're gonna always find the money to pay for those over time, and they've done that time and time again. But we still have 100 year old pipes in the ground that need replacing. So it depends again, the devil will be in the details if and when we ever see something.

Speaker 5

Got it. Okay. I also had a question regarding margins and the impact of copper. And just from a big picture standpoint, it feels like over the last number of years, margins have kind of step changed higher to a new baseline level. And I assume part of that is because your mix has shifted to more of the AMI, AMR over and less if you were traditional manual read meters.

So as we think about the potential impact of higher raw material cost environment, is there in fact a new higher band within which will fluctuate now? Or do you think we could actually revisit some of the low points you'd hit maybe seven, eight years ago?

Speaker 2

No. Ryan, the copper moving from $2.2 up to $2.6 have Short term. Short term could have an impact on our margins of less than 100 basis points. So yes, there is some impact from copper if we aren't able to offset that with pricing, which we've been able to do in the past. The more significant thing is that as our market has shifted to that 20% of newer products, the the e series and the cellular, those tend to carry a stronger margin.

And, and so that's really what's been driving it. And so I do think we're kind of at a at a new norm. It's moved up. Also, bear in mind that we've had a a headwind against the margin percent because flow instrumentation always had a higher margin. And so as we've seen flow instrumentation go down, that's created a downward pressure.

So if flow instrumentation comes back to a normal level, that will also help us. And then the other thing to bear in mind is as we buy our distribution, that contributes to margin. And that is not an insignificant contribution to margin to the margin percents too. And those are all permanent increases. So I think it is fair to say that there is a new normal on margin, and I do not expect that we would see some of the lower margins that we had seen in the past.

Speaker 5

Okay. That's good news. And then the other one was that for me was just you talked a little bit there about buying more distribution that being part of your M and A pipeline. Can you update us on I know that there had been some of the big national distributors notably Ferguson who had come in and been buying distribution for some of your competitors and so forth and that there was some element of what you're doing was offensive, but some of it was actually defensive in nature as well, wanting to keep your distribution maybe out of that kind of a system. So can you just update us, are they still active?

Or is there still roll up going on more broadly speaking in metering distribution or not?

Speaker 2

Well, we have seen Ferguson, particularly out west in California, they acquired a distributor out there of one of our competitors. And so they have been active out there. We have not seen them that active across the nation. It's really been more localized. And and so we haven't and and, frankly, post Ferguson, we have not seen a big change in how that former distributor that that distributor that was formerly independent, we haven't seen a big change in how they're operating.

So so I I don't think Ferguson has had the impact on our on our channels that at first we thought they might try to have. So that's good. On the pipeline that we have, the additional ones we're looking at, bear in mind, these are acquisitions that would be in the $10,000,000 range, okay, or even below. These are not real large acquisitions. But again, we just think that we think it makes sense to move to a model where we have better control over our distribution and we can assure a more consistent level of service to our customers as we move to these new technology products which do require more support.

Speaker 5

Got it. Well thanks for your time.

Speaker 0

Thank you. Our next question comes from Hassan Doza from Water Asset Management. Your line is open.

Speaker 6

Yes, hi, good morning gentlemen. On your follow-up on your Mexico manufacturing footprint, just wanted to understand this dynamic a little better. The first question I have is how much of your municipal water meters are manufactured today in the Nogales facility in Mexico?

Speaker 2

Right now, Hassan, all of our large meters are still produced in Milwaukee. Okay? And we do in The United States all of the castings and much of the precision plastic molding is all done in The United States. And the components are sent across the border into Nogales for the final assembly and test. We also do, we do some plastic molding in Mexico of the components for the mechanical registers, the gears and things.

So we do some of that. And we also do some some molding of our plastic water meters, of our of our polymer water meters. So Okay. Basically, pretty much all of the residential meters are touched by the Nogales facility. Okay?

And and the commercial arm.

Speaker 1

It's it's more of an assembly operation down there because when you say manufacture, many of the parts are manufactured here sent down there to be assembled.

Speaker 2

Right. So it's that final assembly and test that is being done down there for all of the residential product. In the past, I'll remind you that when the government did do the stimulus program, they had a Buy America clause in there that the water utilities that were using stimulus money to buy water meters had to have those meters assembled and tested in The United States. We had plenty of floor space here. We simply moved those assembly and test operations back to The United States for that period of time to serve those customers.

That was probably about, I don't know, 15% of our volume during that period of time. So if the government came out with some kind of owners clauses, we could bring some production back if we had to. On the other hand, bringing the production back, there is a big difference in the labor cost between the two facilities, and we would have to take that into consideration. And obviously, if we did bring production back in The United States like most companies, we would automate. We would never do it the way we do it in Mexico, which is very manual.

When we were producing those when we were doing the final assembly and test of those meters in Milwaukee, that was a very highly automated process. We probably used one tenth of the labor that we used down in Mexico. So all of those things would have to be considered and would all depend upon what the government does, what action they take, and and how they treat not only imports in The United States, but the fact that we're importing components that were made in The United States and just sent down there for assembly. So, you know, how how the government would treat it would be very important.

Speaker 6

Understood. But at a at a very basic first blush economics, I mean, I look at your cost of goods sold and given now that almost, you know, 80% of your sales are municipal water meters, 77% as you said, And you have this footprint in Mexico where they have to be imported back into The US, fully assembled, etcetera. And if if we just run basic math, for example, like, you know, if there is a, say, 10 to 20% import tax on goods that are coming from Mexico to be sold in The US, it makes it pretty significant close to 20 to 30% hit, potential hit, at least in the short to medium terms to your earnings for a company like Badger Meter who has this border adjustability issue. So from a management perspective, you know, how are you thinking about mitigating that potential hit to earnings at least in the medium to short run? I would love to get your view because an import tax would be very detrimental at least initially to your bottom line.

Speaker 2

Well, you're you're I I think you're painting a hypothetical that would say that there would be a 20% tax on absolutely everything coming in The United States without any consideration for what is going from The United States back into into Mexico. Right. Okay? So you're talking about a one way 20% tax, which you're right would be very significant. However, if tax is on the value added in Mexico, that would be a very small number and would not be as significant to us.

Let's also bear in mind that even if NAFTA goes away, we operated before NAFTA ever existed under the Makilodora laws, which are still on the books. So the government would have to not only change NAFTA, but they would also have to go back and change the Maquiladora laws that preceded NAFTA. So that would be interesting.

Speaker 1

And then if you really want to deal with hypotheticals, they've also proposed that the corporate income tax rate go from 35% down to 15, which since most of our earnings are domestic, that'd be a huge benefit to us the other way, including the fact that we have deferred taxes on the books, which would have to be lower to that new tax rate. So I mean, we could deal with hypotheticals all day, and I think that's why Rich made the comment that we're aware of this stuff, but until some details come out, I'm comforted

Speaker 7

by

Speaker 1

the fact that Congress has to pass laws. I mean, is just not going be an edict, and this will take time. And so it is on our radar screen, but to deal in all the hypotheticals is just don't want to say pointless because we are watching it, but it's hard to plan until you know what the details are.

Speaker 2

Bear in mind that I have competitors who also produce in Mexico. They would be subject to the same thing. So the end result could be upward pressure on pricing. There are meters that come in from China in The United States. There are meters and meters and components, and there are meters and components that come in from Europe.

So, again, if your hypothetical is that there is an import tax from Mexico, but but all other imports are are duty free, you know, then that's one set of impacts. But if it's import tax on everything coming into The United States, obviously, we're all in the same boat, and that would result in significant upward pressure on pricing.

Speaker 6

Okay. Thanks for your thoughts. Appreciate it.

Speaker 0

Thank you. And our next question comes from Bob Chernow from RBC. Your line is open.

Speaker 8

Gentlemen, could you sort of give us an approach on how you're handling your debt? You've reduced your debt here quite a bit, but it appears as if you're going to be making other acquisitions. You don't have any long term debt. Have you considered that given the long term the low rates that we have today?

Speaker 2

Yeah. And Bob, let me before I turn it over to Rick to talk about that because he is the expert on it, let me just say that we recognize and we actually feel that debt is a problem for us, as in we don't have enough. You know, I think we're down to what is our debt to capitalization ratio.

Speaker 1

Less than 13%.

Speaker 2

It's less than 13%. We're at about a point five debt to EBITDA. So at that level, we would rather have a little more leverage on our balance sheet. That would make a little more sense to us. On the other hand, to borrow debt and do some sort of stock buyback, we're not comfortable taking liquidity out of the market on our stock.

So we do think that making some strategic acquisitions to help get the debt back up over the next several years makes a lot of sense, and we would like to try to do that. Now I'll turn it over to Rick to speak specifically about the debt levels we have.

Speaker 1

Well, I did mention we generated over $55,000,000 of cash from operations. Last year, we managed to pay down the debt. And even the types of acquisitions we've been talking about for this year, we probably can fund those out of working capital. And so Bob, to your question is every time we do one of these deals, we basically update our cash forecast looking out. And even hypothetically, I do some type of a $20,000,000 deal this summer and you look out, we'll still be out of debt in two to three years.

And so, you know, if you look at what the what the the daily LIBOR rate is that we pay plus plus a fee, you know, all in right now, my borrowing costs, I believe, are about 1.5, 1.6, somewhere in that neighborhood. Pretax. Pretax. And so, you know, if you're talking about a term loan right now, yeah, I could get a loan for three or 4%. But if I'm gonna have it paid in a couple years, it's it's it's just better to stay short term.

Now if we do a deal and it says we're gonna, you know, we're gonna be in debt for that three, four, five year period, the banks have already talked to us. They're prepared to term it out. You know, we they're all lined up to do it for us. It's just that, you know, when we decide to do it, they're ready for us, and we continue to have those conversations. We also maintain regular contact with three insurance companies with the State of Wisconsin Investment Board.

Everybody would like to help, you know, give us money. So I don't think once once we decide to do something, I don't see it as a problem.

Speaker 2

And and, you know, we we do, like most people, I hate to say this, but I'm gonna say it again. We do think interest rates will be going up.

Speaker 5

I've been saying that

Speaker 2

for so long. But we do think interest rates will be going up. But right now, with a 200 to 300 basis point difference between our short term borrowing and what we could lock in long term on, long term being three or four years, it just doesn't make sense to do it because I don't see the interest rates coming up that fast that much. So we are much more comfortable with our low level of debt, keeping it all short term and pursuing some acquisitions. If we do end up with enough acquisitions to justify terming out some debt, we would do that, Bob.

Speaker 8

Thank you.

Speaker 0

Thank you. And we do have a follow-up from Richard Eastman from Robert Baird. Your line is open.

Speaker 3

Thank you. Thanks for having me back. Not that you had a choice, but thank you anyway. Hey,

Speaker 1

At least you acknowledge we didn't have a choice.

Speaker 2

Yeah, didn't have a choice. That was nice of you.

Speaker 3

Hey, just could you update us, Rich, on the American Water kind of contract? I presume since we caught up on Beacon there, some of that goes to American Water. But does that contract in year two, does it ramp towards a $20,000,000 a year kind of run rate in revenue or does it ramp from here? We

Speaker 2

did spend $20.16 getting an American meter, you have to remember, has I used to know the number. I think it's 16 or 20 subsidiaries. So there's an American Meter of Ohio. There's an American Meter of Kentucky. So they've got all these different subsidiaries, and they do operate with some level of autonomy.

So when American Meter entered into the contract with them, the various managers and the subsidiaries were given an opportunity to look at our product and decide how to integrate it. The key to this thing was getting our was I saying American meter? I apologize. It was American Water.

Speaker 3

I was wondering if Water.

Speaker 2

Yes, people are holding up signs that I'm misspeaking. I meant to say, Rick, American Water. But but our the key to this thing was getting American Water's primary billing vendor to work with us to integrate into Beacon. We that that has been done for the most part now. We are able to go out and do a very smooth interface with all of these subsidiaries.

We did about $5,000,000 with American water subsidiaries, with all the different American water subsidiaries last year. And that was less than what we had hoped to do. We thought we could be closer to maybe eight or even 10 on the upside. But it was a slower ramp up than we thought. We do think there's good potential in 2017 to increase that, and we think we're going to continue to see it increase as we've now gotten past these interface issues with their billing vendor.

Fathom is the name of their billing vendor. Gotten past that and we're feeling pretty comfortable.

Speaker 3

And then just a question. In the press release, when you talk about the early part of 'seventeen, I think you I'm just looking for the quote here. But you talk about being off to a good start. And I'm curious, you have a monster comp in the 2016. And I'm curious, is a good start year over year?

Or is it a good start coming out of 2016 and off the fourth quarter?

Speaker 2

Well, I do believe the first quarter is going be better than the fourth quarter, okay? And we do have a strong backlog, and all of that looks good. The question of whether or not we're going to beat the first quarter of last year, as we've said in the past, at any date, we have about a month or one months point of or less than 1.5 We have about five weeks of orders in our backlog. So it's very hard for us to sit here now and even talk about March. I've got January pretty much in the bank.

I can look at the backlog and say I've got a good shot at February, but March is just a total unknown to us, and it's going to depend on a lot of factors. So I don't want to sit here and say that when I see a good start, I'm confident that we're to beat the first quarter of last year. I can't really give you that. But obviously, I think the first quarter is right now shaping up to be a good first quarter.

Speaker 3

Okay. Okay, that helps me. That helps me with some guidelines there. All right. Thank you again.

Speaker 2

Not a problem, Rick.

Speaker 0

Thank you. And our next question comes from Brian Raffin from Morgan Dempsey Capital. Your line is open.

Speaker 7

Good morning, guys. This is Ryan Hamilton in for Brian.

Speaker 2

Hi, Ryan.

Speaker 7

I've got a question. Oftentimes, this time of year, you often talk about the impact of snowfall and weather in some of your markets. Could you any comments on what you're seeing in that regard?

Speaker 2

Yes. I mean, this year so far, we're seeing a very normal year. There was a year a while back when the snow cover in The United States went way south and lasted much longer and did have an impact on us.

Speaker 1

And and the particular mix of customers that we had that quarter were in that area.

Speaker 5

Correct.

Speaker 1

Because we've had other winters that were very snowy, but our customer mix tended to skew to the West where it wasn't as big an impact. So it is a combination. The year we the year that it really impacted us, we had a lot of customers East Of The Mississippi in that quarter, and we had a tremendous amount of snowfall.

Speaker 2

Right. So what I would say so far about the weather patterns and the weather impact on our sales, and we just had a big meeting with all our salespeople a couple weeks ago and and and spoke to them, they're they're not seeing anything significant. It's it's pretty much a normal pattern. But as you know, in The United States, that could change at any time. We we could see major blizzards.

But right now, things are looking pretty good. And because of that, I think a lot of our competitors are placing orders because they intend to start up the northern competitors.

Speaker 1

Our customers

Speaker 2

are starting to place orders because they're anticipating a normal start up to their meter replacement programs, and therefore, they're getting the product in. So we are not seeing a negative impact there.

Speaker 7

Right on. I remember that quarter from the past. I remember which one you're talking about. I guess one last thing and the rest of my questions have been answered. Could you kind of just refresh us on your hedging strategies?

Speaker 1

Well, we this is Rick. We really don't have hedging strategies per se other than the most natural hedges when your prices are going up, you try and pass them on to the customer. The reality is if I wanted to if copper came down suddenly and I wanted to lock in prices or a cut more importantly, a customer said, I'd like to lock in prices, we'd ask that customer for firm delivery dates. And there's not a municipal customer we have that is willing to give us firm delivery dates. Hence, hedges are really not possible in the business because generally, you got to pick a date.

But what happens is the power in this industry really lies with the competitors. We all use the same components. We always say it's like jet fuel in the airline industry. We all use it. So when these brass costs go up, okay, we'll see it in the form of competition from our competitors.

Speaker 2

And let me also say that, again, I'm just going to go back to something we've talked about in the past for those who aren't familiar with it. We cannot enter into a hedge that the accounting profession would give us hedge accounting treatment for. And and the reason is because we can't get a perfect hedge or even close to a perfect hedge. We don't buy copper. We buy brass.

And we don't even buy the raw materials of brass. We our brass is made out of scrap. And so we're really out in the scrap market buying scrap brass. And I mean, literally, candlesticks and old car radiators and church bells and all those things are being melted down to make our water meters. So in that light, copper simply becomes a surrogate for what direction brass scrap might go.

And it does there is a good correlation there. There's a strong correlation

Speaker 1

there. But

Speaker 2

there's not about a 90% correlation, but it's not strong enough for the accounting profession to allow us to use hedge accounting. So if we were to enter into a hedge, we would have to mark that to market every month and that would cause even more volatility.

Speaker 7

Good discussion. Thanks, guys.

Speaker 2

Great. Thank you.

Speaker 0

Thank you. And I'm showing no further questions from our phone lines. I would now like to turn the conference back over to Rich Musson for any closing remarks.

Speaker 2

Well, want to thank you for spending the time with us today. Again, when we look out at 2017, Badger is extremely well situated with our leading edge products. And so we feel good about what those can do. And the market is strong. We don't see a major change in the market.

Obviously, have some uncertainties with what the government's going to do, but I think every company faces those uncertainties. And we will deal with them as they come along. But those could be good for us, those could be bad for us, and we'll figure out how to deal with them. But overall, we felt 2016 being a record year on so many levels was just great. We're very proud of our team here, and we know we're very confident about what we can do in 2017 and continue to see positive results for the business.

So with that, I'll thank you for joining us.

Speaker 0

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program. You may now disconnect. Everyone have a wonderful day.