Business context and reporting period
Badger Meter, Inc. designs and sells flow measurement, control and communication solutions, principally for municipal water utilities and industrial customers. This unaudited Form 10-Q covers the three and nine months ended September 30, 2017; comparisons are with the corresponding 2016 periods unless noted. Municipal water represented 74.7% of third-quarter sales and 76.2% of nine-month sales.
Financial results and liquidity
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Net sales | $100.0 million | $96.3 million | $305.8 million | $300.7 million |
| Gross margin | $37.0 million; 37.0% | $38.6 million; 40.1% | $116.7 million; 38.2% | $117.1 million; 38.9% |
| Operating earnings | $12.4 million | $13.9 million | $42.5 million | $41.7 million |
| Net earnings | $8.0 million | $8.8 million | $27.3 million | $26.2 million |
| Diluted EPS | $0.27 | $0.30 | $0.94 | $0.90 |
Third-quarter operating earnings were 12.4% of sales, versus 14.5% a year earlier; nine-month operating margins were approximately 13.9% in both years. Net margins were approximately 8.0% versus 9.1% in Q3 and 8.9% versus 8.7% year to date.
Cash from operations for the first nine months was $45.9 million, up from $40.2 million. Capital expenditures were $11.6 million; investing cash outflow was $29.9 million, including $18.4 million of acquisition payments, net of cash acquired and future payments. Cash increased to $13.4 million from $7.3 million at year-end 2016. At September 30, short-term debt was $45.0 million, versus $38.0 million at December 31, 2016. The company reported $88.2 million of unused credit lines and compliance with its financial covenants. Current assets were $163.3 million and current liabilities $92.5 million.
Material changes versus the prior comparable period
- Q3 sales rose 3.9%; flow-instrumentation sales increased 16.1% to $25.3 million, led by oil and gas demand and broader distribution. Municipal water sales were nearly flat at $74.7 million, with commercial meter gains and D-Flow sales partly offset by lower residential and international sales.
- For the first nine months, sales rose 1.7%. Municipal water sales increased 0.5% and flow instrumentation increased 5.8%.
- Q3 gross margin declined 3.1 percentage points, primarily from higher material costs, especially brass, and higher warranty, obsolescence and after-sale costs. Operating earnings fell 10.8% and net earnings fell 9.3%.
- Nine-month operating earnings increased 1.9% and net earnings increased 4.4%, despite lower gross margin, helped by lower selling, engineering and administration costs and a lower effective tax rate.
- The effective tax rate was 34.5% in Q3 versus 36.0%; year to date it was 34.8% versus 36.1%, including certain discrete credits in 2017.
Outlook, commentary, risks and unusual items
No specific earnings or revenue guidance is provided. Management said operating cash flows, borrowing capacity and access to capital should adequately fund operations, capital expenditures and product development. It noted that interim results may not indicate full-year results. The company estimates approximately 55% of U.S. water meters have converted to radio technology and sees opportunity in AMR, AMI, analytics and ultrasonic metering; it also noted that revenue from newer services and software offerings was not yet significant and future growth was uncertain.
On May 1, 2017, Badger Meter acquired D-Flow Technology AB for approximately $23.2 million in cash plus a working-capital adjustment. D-Flow added ultrasonic technology and a technology center; its products contributed approximately $1.5 million in sales through September 30. The purchase-price allocation remained preliminary. The acquisition contributed to higher goodwill, intangible assets and short-term debt.
Principal disclosed risks include brass and other input-cost volatility, competition and pricing, customer adoption and financing of utility purchases, product performance and development, reliance on certain suppliers and radio partners, foreign exchange, cybersecurity, and the execution and warranty risks of serving as a prime contractor. The company is named in two landfill matters and asbestos-related lawsuits; management does not expect these matters to have a material adverse effect, but acknowledges uncertain outcomes and potential future environmental costs. The company also relies on single suppliers for most brass castings and certain electronic subassemblies.
The 2016 comparison included a $0.7 million non-cash pension settlement charge in selling, engineering and administration that did not recur in 2017. The company reported no material subsequent events through filing and no material change in internal control over financial reporting. It planned to adopt the new revenue-recognition standard on January 1, 2018 using the modified retrospective method and had not identified an expected material financial-statement impact beyond expanded disclosures.
Important facts for investors to verify
- Whether elevated brass, warranty, obsolescence and after-sale costs persist and continue to pressure gross margins.
- How much sales growth reflects underlying demand versus D-Flow and shifts among municipal water, flow instrumentation and product categories.
- Final D-Flow purchase-price allocation, integration progress and realized contribution to earnings and cash flow.
- Cash conversion and working-capital trends, particularly receivables, and the use of short-term borrowing and available credit capacity.
- Developments in environmental and asbestos litigation, supplier concentration, and the effects of the revenue-standard adoption.