Badger Meter, Inc. — Q3 2018 Form 10-Q
Reporting period: Three and nine months ended September 30, 2018. Unaudited consolidated results; comparisons are with the corresponding 2017 periods. Badger Meter supplies flow measurement, control and communication products, with municipal water products its largest business.
Financial performance
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Net sales | $110.6 million | $100.0 million | $329.3 million | $305.8 million |
| Gross margin | $43.9 million; 39.7% of sales | $37.0 million; 37.0% | $122.2 million; 37.1% | $116.7 million; 38.2% |
| Operating earnings | $15.7 million | $12.3 million | $42.1 million | $42.7 million |
| Earnings before taxes | $3.7 million | $12.2 million | $21.3 million | $41.9 million |
| Net earnings / diluted EPS | $2.9 million / $0.10 | $8.0 million / $0.27 | $16.6 million / $0.57 | $27.3 million / $0.94 |
| Operating cash flow | Not presented separately | Not presented separately | $39.9 million | $45.9 million |
- Sales and mix: Q3 sales grew 11%. Municipal water sales rose 16% to $86.5 million, supported by residential demand in North America and the Middle East, pricing, services and a richer mix of newer meters and radios. Flow instrumentation sales fell 5% to $24.1 million, partly because a large prior-year petrochemical order did not recur. For the first nine months, municipal water sales increased 9% to $255.0 million and flow instrumentation sales increased 2% to $74.3 million.
- Margins and expenses: Q3 gross margin improved on volume, pricing and mix. Nine-month gross margin declined as commodity cost increases exceeded pricing benefits. Q3 selling, engineering and administration expense rose 14% to $28.2 million; the increase included $2.1 million of CEO retirement-related award charges and higher incentive compensation. Nine-month expense rose 8% to $80.1 million.
- Taxes: The effective tax rate was 21.9% in Q3 and 22.2% for the first nine months, versus 34.5% and 34.8%, respectively, in 2017. The filing attributes the decrease primarily to the federal corporate tax rate reduction. Nine-month 2018 results included $6.0 million of discrete net tax benefits, including benefits related to pension contributions and termination costs and stock-based compensation.
- Cash flow and investment: Nine-month cash from operations was $39.9 million, down from $45.9 million. Investing used $15.3 million, including $7.2 million of capital expenditures and $8.0 million for acquisitions. Financing used $25.4 million, including $11.9 million of dividends, $4.5 million of treasury-stock repurchases and net debt reduction. Cash was $10.6 million at quarter-end, down from $11.2 million at December 31, 2017.
- Balance sheet and liquidity: Current assets were $170.9 million and current liabilities $77.9 million at September 30. Receivables were $70.0 million, up from $58.2 million at year-end; management cites higher late-quarter sales and normal seasonality. Inventories were $84.3 million, slightly below year-end. Short-term debt was $36.0 million, down from $44.6 million; the filing does not show a separate long-term debt balance. The company had $97.9 million of unused credit lines under its $125 million facility, which supports commercial paper of up to $70 million and includes a $5 million Euro line. The facility was extended to September 2021; Badger Meter said it was in compliance with its covenants.
Material changes, unusual items and outlook
- Pension plan termination: The company completed termination of its frozen defined-benefit pension plan in Q3. Settlement charges were $11.7 million in Q3 and $19.9 million for the first nine months. These costs were presented below operating earnings. Consequently, reported operating earnings benefited from the 2018 adoption of accounting guidance that moved most pension and postretirement costs out of operating expense: $11.8 million in Q3 and $19.8 million year to date. This presentation change is important when comparing operating earnings across periods.
- Acquisitions: Badger Meter acquired Florida distributor Innovative Metering Solutions in April for approximately $12.0 million of total consideration; its purchase-price allocation remained preliminary at quarter-end. The company also expected to pay $3.0 million of remaining contingent consideration for its 2017 D-Flow acquisition in Q4 2018.
- Revenue and other accounting: The company adopted Topic 606 on January 1, 2018; the transition reduced opening retained earnings by $0.1 million, and the effect on 2018 revenue was not material. It early-adopted ASU 2018-02, reclassifying $1.7 million from accumulated other comprehensive loss to retained earnings. The company expected adoption of the lease standard on January 1, 2019 to increase balance-sheet assets and liabilities for operating leases; the impact was still being evaluated.
- Other changes: The shareholder rights plan expired May 26, 2018 and was not renewed. Other long-term liabilities rose to $14.4 million, primarily because of increased deferred revenue related to BEACON AMA.
- Outlook: The filing provides no quantified earnings or revenue guidance. Management described its financial condition as strong and said operating cash flow, available borrowing capacity and access to capital were adequate for operations, capital spending and product development. It cited continued adoption of radio-enabled and advanced metering solutions as a business opportunity, while noting that flow-instrumentation demand varies across end markets.
- Risks and contingencies: Risks include competition and pricing, product and technology execution, municipal customers’ ability to fund purchases, commodity and component availability and costs, currency and trade-policy changes, supplier concentration, cybersecurity, and performance obligations on system projects. Environmental matters could result in future costs that may be material, although compliance spending in 2017 and the first three quarters of 2018 was not material. The company reported no material pending legal proceedings.
Important facts for investors to verify
- Separate underlying operating performance from pension settlement costs and the accounting reclassification that increased reported operating earnings.
- Track whether sales growth, gross-margin trends and commodity pricing develop as management described, particularly in municipal water and flow instrumentation.
- Assess receivables growth and operating cash conversion, including the effect of quarter-end sales timing and seasonality.
- Confirm the final purchase-price allocation for IMS and payment of the remaining D-Flow contingent consideration.
- Monitor use of the credit facility, covenant compliance and any material environmental or supplier-related developments.