Badger Meter, Inc. — Q3 2019 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2019. Unaudited consolidated results. Dollar amounts below are in millions unless otherwise noted.
Business context
Badger Meter supplies flow measurement, control and communications products and related services, primarily for water utilities and industrial markets. Municipal water is its largest sales category. The company is pursuing adoption of radio-enabled and ultrasonic meters, AMI systems and BEACON analytics software; over 85% of its products are used in water-related applications.
Financial performance
| Metric | Q3 2019 | Q3 2018 | Nine months 2019 | Nine months 2018 |
|---|---|---|---|---|
| Net sales | $108.6 | $110.6 | $317.1 | $329.3 |
| Gross margin | $41.7 | $43.9 | $122.4 | $122.2 |
| Gross margin rate | 38.3% | 39.7% | 38.6% | 37.1% |
| Operating earnings | $16.4 | $15.7 | $45.8 | $42.1 |
| Operating margin | 15.1% | 14.2% | 14.4% | 12.8% |
| Net earnings | $12.7 | $2.9 | $34.9 | $16.6 |
| Diluted EPS | $0.44 | $0.10 | $1.19 | $0.57 |
| Operating cash flow | Not provided for quarter | Not provided for quarter | $61.1 | $39.9 |
Q3 sales declined 1.8% year over year. Municipal water sales fell 2.6%, mainly because a prior-year Middle East order did not recur; domestic municipal water sales grew 1.9%. Flow instrumentation sales increased 1.0%. Q3 gross margin dollars decreased on lower volume and higher warranty costs, partly offset by mix, pricing and lower brass costs. Selling, engineering and administration expense fell to $25.2 million from $28.2 million.
For the first nine months, sales declined 3.7%; municipal water sales decreased 3.9% and flow instrumentation sales decreased about 3.1%. Management cited lower residential volumes, customer order deferrals while newer products underwent testing, softer industrial demand and unfavorable currency effects. Improved product mix, pricing, lower commodity costs and the absence of prior-year facility relocation charges supported the higher gross margin rate.
Net earnings comparisons benefited substantially from the nonrecurrence of 2018 pension termination settlement charges: $11.7 million in Q3 and $19.9 million for the nine-month period. Accordingly, the increase in reported net earnings does not solely reflect underlying operating improvement.
Cash, debt and liquidity
- Cash was $37.7 million at September 30, 2019, versus $13.1 million at December 31, 2018. Short-term debt was $4.4 million, down from $18.1 million; the company reported net cash of $33.4 million.
- Nine-month operating cash flow was $61.1 million, compared with $39.9 million in 2018, primarily due to working-capital management. Capital expenditures were $5.6 million versus $7.2 million.
- Primary working capital was $113.9 million, or 27.0% of trailing-twelve-month sales, versus $124.6 million, or 28.7%, at year-end 2018. Receivables declined; inventories rose modestly and payables increased, partly reflecting payment timing and extended terms.
- The company reported $128.2 million of unused credit lines and compliance with its financial covenants. Its credit facility includes a $125 million line supporting commercial paper and runs through September 2021.
- Dividends declared were $0.17 per share in Q3 and $0.47 per share year to date.
Material changes, outlook and risks
- A $1.7 million discrete warranty provision was recorded in Q3 for a sourced system integration module in a solution previously sold only outside North America. The warranty reserve increased to $6.8 million from $4.2 million at year-end 2018.
- Management highlighted growth in advanced technology products and SaaS revenue, while noting customer order deferrals, lower residential volumes and softer industrial demand. The filing provides no quantified earnings or sales guidance.
- Management described the financial condition as strong and believes operating cash flows, borrowing capacity and potential capital-market access are adequate for operating needs, capital expenditures and product development.
- Risks include competition and pricing, product performance and technology execution, municipal customers’ ability to fund purchases, economic and currency conditions, raw-material and supplier availability, cybersecurity, and obligations associated with installation contracts and subcontractors.
- The company relies on single suppliers for certain brass castings, resins and electronic subassemblies; replacement sources could increase costs or cause delays. Environmental matters could result in future costs that may be material, although related compliance expenditures to date were not material. No material legal proceedings or material subsequent events were reported.
- A further $2.0 million of contingent D-Flow acquisition payments was expected within 12 months and recorded in payables.
Important facts for investors to verify
- Whether deferred municipal orders and newer radio and meter launches convert into sales, and whether advanced-technology and SaaS mix continues to improve.
- The scope, costs and potential recurrence of the Q3 warranty issue, and the adequacy of the increased warranty reserve.
- Underlying earnings trends excluding the prior-year pension termination charge and other nonrecurring comparisons.
- Working-capital quality, cash conversion and the durability of lower debt and the net-cash position.
- Progress on D-Flow contingent payments and any developments in environmental, supplier, product-performance or cybersecurity exposures.