Good day, ladies and gentlemen, and welcome to the Q3 2017 Badger Meter Earnings Conference Call. At this time, all participants are in listen only mode. Following management's prepared remarks, we will host a question answer session and our instructions will be given at that time. If during the conference you do require operator assistance, please press star then zero on your telephone keypad. As a reminder, this conference is being recorded for replay purposes. It is now my pleasure to hand the conference over to Mr. Rick Johnson, Senior Vice President of Finance and Chief Financial Officer. Sir, you may begin.
Thank you very much, Brian. Good morning, everyone. Welcome to Badger Meter's third quarter conference call. I want to thank all of you for joining us. As usual, I'll 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 risk 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. After the market closed yesterday, we released our third quarter 2017 results. While the bottom line did not match our expectations, sales were a record for any third quarter at just over $100 million. This is an increase of $3.7 million or 3.9% over last year's third quarter sales of $96.3 million. Let's talk about some of the details. Municipal water sales represented 74.7% of total third-quarter sales, compared to 77.4% in the third quarter last year. Municipal water sales increased three-tenths of 1% to $74.7 million in the third quarter from $74.5 million last year.
This is the net impact of higher commercial water meter sales and the inclusion of about $800,000 of sales from D-Flow, which we acquired earlier this year, offset somewhat by lower sales of residential meters and related technologies. Some of the decline in residential sales was due to lower international sales, particularly in the Middle East, where, as we've indicated in the past, sales tend to be sporadic. Flow instrumentation products represented 25.3% of total sales for the third quarter, compared to 22.6% last year. Sales increased $3.5 million, or 16.1%, to $25.3 million from $21.8 million last year. We saw significant increases across most of our product lines, including meters for the oil and gas market, valves, and magnetic meters. Gross profit as a percentage of sales was 37% in the third quarter, compared to 40.1% in the third quarter of 2016.
The primary driver for this decrease was higher brass and other costs compared to the same period last year, which contributed to the lower overall gross margin and lower earnings. Our selling, engineering, and administration expenses for the third quarter decreased slightly to $24.6 million from $24.7 million. You will recall that last year's third-quarter expenses included approximately $740,000 of a non-cash pension settlement charge that did not recur this year. This year's expenses do include costs associated with D-Flow. The provision for income taxes as a percentage of earnings before income taxes for the third quarter was 34.5%, compared to 36% in the third quarter of last year. The effective tax rate on an annual basis is now estimated to be 35.3% ± any minor discrete items.
Early in the year, we were using 35.5%, so the effective tax rate for the quarter is lower as we adjust year-to-date. As a result of the items I just mentioned, net earnings for the third quarter of 2017 were nearly $8 million, or $0.27 per diluted share, compared to $8.8 million or $0.30 per diluted share in the third quarter of 2016. Our financial condition remains strong. For the nine months ending September 30th, we generated $45.9 million in cash from operations, compared to $40.2 million in the same period in 2016. Debt as a percent of total capitalization stood at 14.1% on September 30th of 2017. With that bit of background, I will now turn the call over to Rich Meeusen, Badger Meter's Chairman, President, and CEO, who will have some additional comments. Rich?
Thank you, Rick, and thank all of you for joining us today. This was an interesting quarter for us with record sales but lower earnings, as Rick discussed. Although utility metering sales were relatively flat, we have seen an overall softening in the utility market over the past six months. When several of our competitors reported their second quarter results, they had significant decreases in sales. Therefore, we feel good that we've been able to hold our own position and most likely have seen an increase in our market share. In addition, we continue to see significant increases in our sales of our newer products, both the E-Series ultrasonic meters and the ORION Cellular radios. We are currently working to integrate the technology of our recent acquisition, D-Flow, into our ultrasonic meters and expect that that project will be completed later next year.
The introduction earlier this year of the LTE version of the ORION Cellular radio has driven a lot of interest in this leading-edge technology, resulting in many utilities initiating pilot tests, which we expect will further increase sales in 2018. We saw a significant rebound in our flow instrumentation business, driven both by the continued improvement in the oil and gas markets, as well as the impacts of sales channel reorganizations that we completed over the past year. A recently announced distribution agreement with DNOW L.P. for our global sales into the oil and gas industry did not have any significant impact on this quarter, but is expected to drive even more growth in future periods. Margins were softer than usual this quarter, primarily due to a significant impact from copper prices.
In the third quarter of last year, copper averaged $2.16 per pound, increased 35% over the past year to average $2.91 per pound during the third quarter. We purchased a substantial amount of brass for our meter manufacturing, which is primarily composed of copper. Since September 30th, copper prices have continued to increase to well over $3 per pound. Most commodity analysts believe this pricing level is not sustainable, and they expect to see price decreases going into 2018. We are prepared to announce price increases to offset higher material costs, as well as expected price increases in resin due to the impacts of Hurricane Harvey on resin producers in the Houston area. These increases will be announced in the fourth quarter, but will not have any impact until the first quarter of 2018.
It should be noted that when copper prices have jumped in past years, our industry has generally been successful in passing along pricing to offset those increases. We see no reason to expect it to be different in the future. Overall, we continue to be confident about the future of our business and our ability to generate shareholder value on a long-term basis. With those comments, we'd like to take your questions.
Thank you, sir. Ladies and gentlemen, at this time, if you would like to ask a question over the phone, please press star and then one on your telephone keypad. If your questions have been answered or you wish to remove yourself from the queue, simply press the pound key. Once again, ladies and gentlemen, to ask a question over the phone, that is star and then one. Your first question will come from Nathan Jones with Stifel. Please proceed.
Morning, everyone.
Morning.
Rich, I wonder if you could give us a little more details on the planned price increases in the fourth quarter. Do you think they are going to cover all of the raw material increases? Do you think there will be a lag to that past the first quarter? Or just how should we think about that price cost dynamic for you guys over the next few quarters?
Yeah. What we will do is over the next 30 days, we will go through and queue up that increase. We need to give our distributors, and certain customers notice, at least 30 days notice, if not more. Over the next 30 days, we will go through and figure out which products, how much, and adjust our pricing sheets. All of that will be effective January 1. That is our target. Now, obviously, over the next 30 days, we are going to be watching the cost of copper, too. This morning it is at $3.17, it has jumped again on the London Exchange last night. A lot of that increase is being driven by news out of China. The problem we all have with China is we do not know how much copper they have in their stocks over there. They do not announce that. They are always the wild card.
What went up so quickly in the last few weeks could also go down just as quickly. We are going to be watching that and adjusting that increase for whatever happens with the price of copper. We are shooting at a moving target.
Yeah. The other thing, Nathan, is while we announce it, and we will announce it in the fourth quarter, we could get orders yet in under the old prices for delivery in the first quarter. To your point, there could be a bit of a lag where it really does not fully kick in until the second quarter.
Generally, in the past, we have announced a price increase, and obviously we have contracts. We don't do contracts for more than a year at a fixed price. If they go beyond a year, we've got a Producer Price Index adjustment in them. We have contracts that will be coming up for renewal every month over the next year. As they come up for renewal, we'll factor in those price increases. The ones that have PPI adjustments, we'll factor those in as soon as we can. Any new contracts will be let at new prices. Unfortunately, it does take a ramp-up. If we target an overall dollar amount that we're after to offset the impact of brass, it takes us a while to get there. On the positive side, we also gain on the downside.
If brass starts coming down again, it takes a while for that pricing to adjust down from competitive pressure, and so we gain on there. Just like when brass hit or when copper hit $4 a pound several years ago, and we went out and put in price increases to offset that, we expect this to follow along the same guidelines there. There may be some short-term negative impact, but we will get it in there.
Okay, it sounds like a couple quarters of margin headwind there. I understand that this is not the way it'll go, but if we assume that copper was flat from here, would you think that by, say, the second quarter of next year, that you would have recaptured all of that price cost differential?
That would be our goal, yes.
Okay. You did mention in the press release that there were some other expenses in there that also dragged down gross margin. Were they related to the acquisition or were they one time in nature? Any color you can give us on the size of that?
Yeah, this is Rick. I would think for the most part, they were one time in nature, and frankly, just higher than last year. You also got to remember our comp last year, the gross profit percentage was 40.1%. That's a little bit higher than normal. I mean, when we say higher costs, we mean higher than last year, just simply because of that factor.
Okay. Any color you can give us on the magnitude of that?
Most of the decrease in gross profit percentage was driven by the copper. Most of this other stuff was $100,000 here, $100,000 there, nothing of substance.
Except we did have a significant payment to a search firm for our new COO that we hired.
It's not in the margin.
No, it's not in the margin, but it's down in the SG&A cost. That was in there, too.
Got it. That's helpful. I'll pass it on. Thank you.
Thank you. Your next question will come from the line of Tate Sullivan with Sidoti. Please proceed.
Thanks. Can you follow up your comment on some softening in the markets? Historically, what's that due to? Is it due to multiple areas being done with their replacement cycle, replacing their older meters? What are the current factors in that softness?
What we're seeing right now is some of the larger projects that were in the queue are getting pushed out, delayed. It's always a question as to what causes this. We have to go out in the field and get anecdotal evidence. In some cases, it's all this talk out of D.C. about a possible infrastructure bill. People are saying, "Well, maybe there'll be some federal money that will help. We're going to delay a project." We're hearing some of that talk out in the field. Generally, we know our competitors are hearing it, too, because if you go back to the second quarter conference calls from the competitors who disclose the water portion of their business, there's three major ones out there that do that are public, they all said that they were down anywhere from 5%-13%.
When we saw that we were relatively flat, that's why I felt like we were probably gaining a little bit of share. There have been delays. I have no reason to believe any projects have been canceled. They'll still come. Question is, will we get them in the fourth quarter or the first quarter?
The other thing we're seeing, Tate, is if you recall at the end of the second quarter, we had just introduced effectively the LTE product. All right? What we're finding is, while there's very much interest in there, people are not buying thousands of them. They're buying 100 of them and putting them on tests. We're seeing a lot more pilots right now, which in a sense, in our mind, is just delaying sales. I do agree with Rich, there's nothing fundamental out there that suggests there's a reason for this. It's just kind of a bland year, and it's been a bland year through three quarters.
Okay, thanks. I thought you mentioned valves in your comments.
Yes.
Is that valves that go with meters in your industrial business, or what valve business do you have in your mind?
In our flow instrumentation side of our business, which is about 20%-25% of our business. Which by the way, was up 16% over last year, so it was a good increase.
I read that.
Yeah, I know you read that. I'm just repeating it.
No, I'm just-
Okay. Within that business, one piece of it is valves. We also do vortex meters. We also do turbine meters, Coriolis mass meters, mag meters. There's a lot of other ones in there, but one piece of it is valves. It is the one thing that is not directly flow measurement, but it's a good business for us. It's profitable, and we do link the valves up with meters sometimes to form a complete control loop. That business itself, our valve business is Thank you, John. It's being handed to me.
This quarter it was.
Our valve business is about $3.5 million a quarter. It's about $14 million a year.
Okay. Thank you. To follow up the copper comments and the brass, do your ultrasonic meters even use brass compared to the older meters?
Our E-Series ultrasonic meters are offered in both plastic and stainless steel. Okay?
Sure.
We will be converting them and offering them in brass. We initially came out with them in stainless steel because stainless steel was actually the same price as brass, and we felt that the market would be willing to pay a premium to have stainless steel, which is viewed as an even better material. What we found out is that the market really doesn't care whether it's brass or stainless steel, they just want metal. We started a project to develop in brass. If brass gets too expensive, then the stainless steel is a better option. Right now, they are offered only in stainless steel. You have to remember that all of our large meters are in brass, and those are the ones that take up a large quantity of brass.
Okay. Thank you very much.
Thank you. Our next question will come from the line of John Quigley with Canaccord. Please proceed.
Hey, good morning, folks. First question, Rich or Rick, can you break out mechanical versus AMR, AMI, and any third-party Itron color you can give us?
You're talking about meters without radios versus meters with radios, right?
Exactly. That's right. Thanks, Rich.
I'm just looking at this. That's a hard one to say.
Let me try and answer it this way. We have said all, basically, it's the same underlying meter either way, with or without the radio. We've been saying that we're shipping 60%-65% on average of the meters that we're shipping have radios. Okay? That varies quarter to quarter, depending upon the particular product mix. That's why I think Rich is kind of hesitating a little as to what's overall the detail. That number continues to grow. The install base out in the field is probably about 55% of-
Right
The meters out there have radios. If we keep having an input rate that's approaching, let's say 65%, that number will continue to grow. It's just a matter of how fast that's going to grow.
Okay. I'll do two more. Rich, would love your thoughts on Itron Silver Spring, pushes them more electricity, more IoT. What do you think that does to market share, name share in the U.S. radio AMR/AMI market for water, if anything?
Yeah. Silver Spring did not play heavily in water. They were really much more of an electric-focused company. Obviously Itron, the majority of their business is electric. That is where their big focus is. We focus only on water. We didn't see the purchase of Silver Spring as having a huge impact on the competitive market out there on the water side. I think it does have an impact on the electric side, we don't really see it as having a big impact on water.
Okay. Then last, the creation of the COO role and welcome. You guys have run a pretty great business over a number of years. Why now, Rich? What should we think about leadership transition if that's part of this? Thanks, guys.
Well, no, that's a good question. We do have Kenneth Bockhorst sitting here, who is our new COO, who has just, I believe it's his second day of work. Welcome, Ken. When I mentioned that we paid a lot of money for a search firm, it was the best money we ever spent. He agrees. We're excited to have Ken joining us. The fact of the matter is, I am 62 years old, and Rick is older, slightly older. We've recognized that over the next couple of years, we're going to have to have a shift in leadership here. The good thing is that the officer team that has driven this company for the past 10 years to where it is today is very stable and is here and is going to continue.
It's a younger team, younger meaning in their early 50s, we're going to have them around a while. Bringing in Ken, it helps us set up the transition for down the road. This has been something that the board of directors has been working on for the past several years. We ran a formal search. We were fortunate to get somebody of Ken's caliber in here. Now he will take on that COO role and hopefully be moving up as we go forward. But it'll give us plenty of time for overlap to make sure that he and other people are comfortable with this management team as we go forward. We will be bringing Ken out for investor meetings, all of the analysts, investors will have a chance to meet Ken and talk to him.
I think you're going to find out that his operating style, his vision, very much fits with Badger Meter. One of the things I think we're going to be looking for is getting a little more aggressive in M&A, that is one of Ken's strong points, that's going to help us, too. I hope that all helps.
It does. Thank you, guys. Good luck.
Thanks.
Thank you. Our next question will come from the line of Brian Raffin with Morgan Dempsey. Please proceed.
Morning, Rich. Good morning, Rick.
Morning, Brian.
You guys, I think, and correct me if I'm wrong, launched the ORION Cellular, the LTE, two-way in July, or it was in the second quarter. Is there any pent-up demand in delays on orders, or is there in subsequent quarters, or is it just going to kind of roll out with pilots?
just to clarify, Brian, we launched the ORION Cellular about three years ago as a 3G product.
Okay.
simply because the LTE networks weren't available for data yet. The LTE chips for data became available late last year. We immediately launched a project to move to the LTE platform. That new version with the LTE chips was released in April.
Okay.
I do believe we saw a little bit of a delay, people waiting for the LTE. I still think there is some pent-up demand because we're getting a lot of inquiries. We're doing a lot of pilot shipping of people who were waiting for the LTE, but they didn't come in as soon as the LTE was released and say, "Now give me 10,000." Instead, they said, "Give me 50 or 30, and we'll put them out there and try them for a few months and make sure they work okay before we commit to the larger volumes.
Got it.
I'm still convinced that this is going to be the technology of the future for our industry, because the whole idea of not having all that infrastructure makes so much sense that I think people are going to want to go this way.
Yeah, with some 51,000 water meter or water utilities. Are these test pilot programs in the hundreds of utility OEMs, or is it just dozens?
No, it's hundreds.
Okay.
It's hundreds.
Okay.
We believe it bodes well for future demand. I think we're going to continue to see that. I think we're going to continue to see our two fastest-growing products being the E-Series water meters, the ultrasonic water meters, especially once we finish integrating the D-Flow technology next year, which will make the product even more competitive with the mechanical meters. We're going to see that, and then on the radios, we're going to see cellular. Both of them, we have seen since introduction, strong double-digit growth every year, and I think we're going to continue to see that.
Got you. Yeah, Rich, with the question on mechanical versus AMR and AMI, I think in your presentation in August, you guys got an install base of about 58% meters with radios, and I think Rich's comment was the actual delivery now is more like 60%-65%. If I were to add on the BEACON Advanced Metering Analytics, you guys kind of being a leader in that. What might that be? Would that be still less than 1% or 2%? How fast is that add-on, that adjunct of technology being put on with the radios?
The BEACON is also coming on fast, and it's coming on fast in two ways. One is that when somebody buys cellular, okay, I'm looking for Kim to look at me to make sure I'm okay. My VP of Sales, I always like her to be staring at me when I'm saying this, so that if I say the wrong thing, she can frown. I think I'm right on this. The BEACON is sold with the cellular product and-
The network product.
Right. I'm saying first it's sold with all of the cellular, and some of our network customers, and even some of our drive-by customers, have said, "We want that BEACON analytics too." We've got it being sold across a much broader base than just the cellular. As cellular goes up, so does BEACON. We're also picking up these other customers too. I would say in a few years, we're going to be able to phase out some of our older, our legacy products, and focus much more on the BEACON as our main product. The nice thing too is that with the cellular, obviously we gather monthly fees. Okay. Even with the BEACON product, there are annual fees that we get from that.
As we've always said in the past, we are not driving towards Software as a Service as a company. It is becoming more and more of our revenue stream as we go forward.
Got you. I'll just ask one more, Rich. As I'm looking at your market share chart here in your presentation, North American Water, you guys are very quickly catching Neptune. Do you have any comment on that top-tier oligopoly, Neptune, Sensus, and Badger Meter, kind of where you might see that go over the next few years?
You guys always love me to talk about the competition. I won't disappoint. I'll make a few comments here. First off, the market share is very difficult in our industry because if you add up everybody's claimed market share, you get to about 120%. Not everybody is being honest on their market share. The analysts that do market share analysis, I don't think always get the facts right. What I would say is we have a-
Present company excluded, of course.
Present company excluded. I'm talking about the companies that sell the service of analyzing market share. I would say that Badger and Neptune both have a market share that is very close. We're probably the two top companies, as far as selling the meters in North America. Sensus is somewhere below us, and then down, you've got less than that at Mueller and Master Meter and some of these other smaller players in the marketplace. Neptune has been a little slow on new product introduction, but now they have announced a cellular product. They're three years behind us on that. They are coming out with cellular, and I'm kind of glad of that because it does confirm that cellular is a good product going in the future. We're not the only ones out there with it.
They've also announced an ultrasonic meter, they're going to be starting to sell that. Again, that validates our ultrasonic technology when the two leading companies in the marketplace are selling that technology. Sensus does not have cellular, has not chosen to go with cellular. They are still selling their fixed network called FlexNet, and they have chosen magnetic meter as their solid-state metering. I think there are issues with magnetic that will make ultrasonic more competitive in the future. Meanwhile, Mueller does not have either cellular or a solid-state meter. Basically, when you look at the competitive situation, that's where we are. We feel we're in the strongest competitive situation, having been in the ultrasonic metering business for seven years and the cellular business for three years, while our largest competitor is just starting this year on both of those.
I think that puts us in a very strong position.
Awesome. Thanks, appreciate it.
You're welcome.
Thank you. Our next question will come from the line of Richard Eastman with Robert W. Baird. Please proceed.
Yes, good morning. I wanted to ask.
Morning
a couple things. No, I'm just kidding. Rich, I just wanted to wake him up, actually. Just from a municipal standpoint, I think the reference was that the international business was lower. I think you specifically mentioned Middle East. If you look at the utility business, was the domestic residential business up low single digits, mid-single digits? How did the domestic business perform there?
This is Rick. The domestic municipal water business was essentially flat Q3 over Q3.
Okay. Does that include the commercial piece?
No, commercial.
Was commercial meters up?
Commercial was up.
Okay. Low singles, is that close enough?
Yeah. That's fine.
Okay. Just a question around late in the quarter, any hurricane impact more on the industry? I know in the Houston market, more so in the Florida market. I think your exposure in Florida is somewhat limited at Badger Meter. Was there any cramping up in the industry in terms of demand installed? What is your thought, Rich, on the impact there? When we had Hurricane Sandy, it kind of held up spend. Maybe just any thoughts there.
I do think there is some impact. Fortunately, we did not have a major project going on in Houston. We did not have a major project going on in Miami or anything like that. Nobody did. There was not a major project where somebody was selling $1 million a quarter in meters that got interrupted. In the case of Hurricane Sandy, it did. We had some large projects going on in that area, when that hurricane came through, it was a big impact. We do have regular meter sales to not only Houston, but the area around it. No question it got interrupted.
I would say it did not have a profound third quarter impact. If anything, we are still waiting to see if it is going to have an impact in the fourth quarter, likely that would rebound in the first quarter if it did happen.
Sure. The other impact of it, Rick, is, as I mentioned briefly, was resin. We do not buy our resin out of the Houston area, most of our resin suppliers get their feedstock out of the Houston refineries, there was an interruption there. We do not think we are going to have a supply issue, prices may take a temporary jump. We are going to factor that into our price increasing.
Just your reference on the large projects, is that large projects kind of stalling out a bit? Is that a domestic comment? Is that around large projects domestically, or is this, again, kind of international?
No, that was a domestic comment.
Okay, it is domestic. Okay.
Right. The opportunities we have in the Middle East are very spotty, very project-related, when one of the Emirates or somebody will decide to do a major project. That's more project-related.
Yeah. I was curious. The state of Illinois kind of mandated, I think this was during the third quarter, certainly earlier this year. They kind of mandated that municipalities have to ensure that they have no more than 10% unaccounted water by 2019.
Yes.
There was a project triggered there. Not to be too surgical here, but you guys have some exposure to Illinois. It's in the Midwest. Is that either a trend or is that at all impactful?
Well, there's a couple-
The states are starting to tighten up on this unaccounted for water.
Right. Clearly, everybody wants to tighten up on unaccounted for water. The question is, do they have the political will to do it? You may recall that we were metering Chicago. We got it one-third metered. People are surprised to hear the City of Chicago is not fully metered. About two-thirds of the people in Chicago pay a flat rate for their water. Therefore, you will never know if there's unaccounted water there.
Yeah.
They'll never be able to track it down. Under Mayor Daley, they had a metering program, and when Rahm Emanuel came in, he stopped the metering program, so two-thirds of Chicago still sits unmetered.
Okay.
Now, when they get a state mandate like that, obviously the first thing you would have to do is meter, if you're going to try to reduce unaccounted for water. You can't control what you can't measure. If they can't measure it, they don't even know what their percentage is.
Sure.
That's a problem. That would say that more of the Illinois municipalities should start metering. The question really is, Rick, what penalties were put in? It's very easy for the legislature to pass a law saying, "Let's hit this target by 2019," but if there's no penalties, it doesn't mean anything. The California-
I was just going to bring up California. California has a law on the books that by 2025, every home in California will have a water meter. As I say, look for big sales in 2024, because they didn't fund it. It was an unfunded mandate. It's those kind of issues that when you hear that stuff, it doesn't have an immediate impact on our business. Although, again, when I heard about Illinois, it can't hurt.
Sure.
Okay?
Yeah. No, that's fair. Yep. Fair enough. Hey, Rick, just one last question. When I look at both accounts receivables and inventories stepped up in the second quarter from the first, stepped up again in the third by about $3 million, AR kind of stepped up another $4.5 million. Just given where the sales number came in, can you just explain maybe why AR stepped up as well as inventories?
Yeah, it was simple. September was better than July and August. Okay? Our DSOs is up slightly, but there's really no significant collection issues. It's more a function of timing than anything else. Quite frankly, the same thing on inventory. There's really nothing that suggests that there's any issues one way or another. The other problem we have.
No change in terms or anything? Yeah.
No, we haven't changed any of the distributor terms.
Okay. All right. Thank you. Appreciate it.
Thank you. Our next question will come from the line of Hassan Dozo with WAM. Please proceed.
Good morning, guys. A couple of questions. Just a follow-up on the balance sheet. If you look at your accounts payable year-over-year, this is excluding a $4 million from the D-Flow acquisition, your payables went from $19 million to $23 million. This is excluding the $4 million D-Flow. That's a 20% increase while your sales are down year-over-year. I'm just curious, what's going on with the payable?
My first answer is I have no idea, but I'm not aware of any particular issues. Are you comparing us to December 31st?
No, I'm comparing you to third quarter of last year-over-year.
Oh. Third quarter of last year. It could be just a function of the days when we paid the bills.
Well, that's right. Very often, that's a function of what day of the week the month ends on, because bills are usually processed on the Fridays.
Yeah.
It's purely timing. It's nothing more than timing.
It's good cash timing.
I know you answered the question on receivables, but just to reiterate again, when I look at year-over-year, third quarter last year to third quarter this year, your receivables are up like 20%. Is there something underneath you're seeing on a more longer-term basis?
No. Frankly, is there a distributor, too, instead of paying us in 30 days, they're paying us in 45? Yes. We've got it, and there's some business issues at work here, but nothing that's of concern to us at this time.
Okay. My second question is, you referenced in the release that you're seeing some customers upgrade their system as they wait to adopt your cellular product. Can you give some color as to what type of upgrades, for example, a customer would need to make, and how much would it cost them for them to adopt your cellular product?
No, I think you misunderstood what I said. There is no requirement for a customer to upgrade their system in order to adopt our cellular product. If they adopt our cellular product, they also use the software, the BEACON software, that goes with it, just like if you were to buy a printer, you would probably use the printer driver that goes with it. The BEACON software, of course, comes with a lot of analytics and other capability, but that's a very easy software to put in. Very often, though, some of these customers have homegrown billing systems, and the BEACON software has to be mapped into their billing systems. That can get a little tricky, but generally, there's no system upgrade they have to do in order to use the cellular system.
Okay. Look, I'm taking this straight out of the release. It says several major municipal water projects slated for the third quarter are now expected in the future as customers upgrade their systems.
In other words, what we're saying is they plan to upgrade their system, instead of placing the order now, they, instead of buying, again, my example, instead of buying 1,000 meters, they bought 100 and put them on test pilot just to see how they work, and then eventually they'll make the purchasing decision sometime in the future. Hassan, the reference to upgrading the system- Upgrading the system from what they bought 15 years ago is not their IT system. It's upgrading their system of meter reading. Correct. We probably should've been clear about that. We're talking about their meter reading system, not their IT system.
Okay. Fair enough. Okay, guys. Thank you so much.
Okay.
Thank you. As a reminder, ladies and gentlemen, if you would like to ask a question over the phone, please press star and then one on your telephone keypad. Once again, to ask a question over the phone, that is star and then one. Our next question will come from the line of Jose Garza with Gabelli & Company. Please proceed.
Hey, good morning, guys.
Morning, Jose.
Hey, Rich. I guess just talking about the DNOW distribution, if you could just give more color. What does that mean for your existing oil and gas business and if there's any other additional partnerships you're looking for on the flow side, instrumentation side.
Yeah. The flow instrumentation business, we go to market primarily through distribution. When I said we reorganized our distribution channels, what we did was we started focusing on the end markets instead of the product. We've, in the past, may have had a distributor who specialized in turbine meters and a distributor who specialized in impeller meters. What we've done now is we've reorganized to where we have a distributor who perhaps specializes in breweries or a distributor who specializes in dairies or oil and gas. I'm sorry, I'm using the word distributor, I apologize. I just got a note. I should be using the word rep. These are reps, not distributors.
Okay.
These are primarily reps, okay? We have reps that now focus on various industries and specialize in those industries. That has helped us a lot because now a rep goes in and can sell any type of meter that is needed in that particular industry. That's a good thing. It was a big coup for us, we feel, to get DNOW, because we were going to the oil and gas market with a lot of smaller, more decentralized reps. DNOW is really a very large international. They're an international company that services oil and gas markets all around the world. Having an agreement with them where they are repping Badger's flow instrumentation products, I think is really going to open a lot more doors for us and help us get out there. That's what really DNOW does for us.
Yeah. Just remind me, is that an exclusive partnership?
That is outside of North America. It is exclusive outside of North America. Within North America, we have some other reps also.
Okay. For the rest of your business, in the flow instrumentation side, are there other opportunities that you guys are looking at that are similar to DNOW?
Yeah, we're always looking at opportunities to improve distribution channels. We have some distributors now that we've picked up over the last year that we really like, but there's always opportunities to find other ones that specialize in different areas, and we're going to be pursuing those.
Excellent. Thanks, guys.
Thank you. Our next question will come from the line of Brian Raffin with Morgan Dempsey. Please proceed.
Yeah, Rich, just maybe a five-year outlook relative to the larger municipal national sales accounts. Any big cities looking at projects that, not for you, but just for the industry that might be-
Right. There are some big cities out there that we've talked about in the past that keep saying they're going to be looking at doing a major project. They, from time to time, put out a request for information. They may form a committee to look into it. We're in those cities talking to them. Miami-Dade is probably one of the big classic elephants out there. They've not done anything, but they've run tests, they've run pilots. They're out there. Detroit is talking about doing something new, they're always a possibility. There are other cities in some of the major cities in Ohio are opportunities for us. Those are the ones that could still pop over the next several years that could be pretty big game changers.
It's important clearly from a sales and marketing side. I keep being told to put up my mic. I hope everybody can hear me. From a sales and marketing side, but also you got to remember that they don't have the same impact on the business, let's say, that they do in the electric industry. Usually when we get those, they're multi-year contracts, okay, and they get spread out. Even when we had Chicago now, what, six, seven years ago-
Right
It got spread out over three to five years. It had an impact. It is nice to have that steady order. You can also sell a lot of small cities the same amount of meters in a given year.
Also, people tend to forget that the size of a city can be deceiving. For example, a lot of people think Atlanta would be a huge customer, the city of Atlanta. City of Atlanta is only 300,000 people. It is not that big a city. However, the surrounding area is huge, the metro area. Well, when we are selling water meters, we are generally not selling to the metro area. We are selling to the municipality. So what some people think of as a large city is not necessarily one. The largest cities tend to be the ones in Texas like Houston and Dallas and some of those because they do not have that many people living in high-rises. It is spread out more, whereas other cities like Atlanta, you would be surprised that they are not as large as you would think.
That begets another question, Rich.
Go ahead.
As you've seen with police departments, fire departments, like you got up in the North Shore, Milwaukee, they got a whole fire department, not municipal, it's several municipalities. Do you see that urbanization with water developing, or is it strictly one city, one municipal utility?
We have not seen that developing. For decades, all I've heard about is the coming consolidation of water utilities, it has not happened. There has not been the consolidation. The reason people predicted it was because electric and gas, it tends to be consolidated. Also, sewage tended to be consolidated along the water basins. It just has not happened in water, we don't see anything driving it.
We'll see plenty of signs if it does come because they got to get the police departments, the fire departments, and the library systems done before water would ever happen.
Okay. All right. Just one final one. I always laugh at your comments with Chicago, the unaccountable being unmetered. It's like horses and carriages. If you look at the large municipal projects going forward, is it an install of meters for this kind of unmetered, unaccountable water, or is it primarily with big projects going to be just the conversion to radios and all?
Right. With the big projects, it's going to be primarily radio conversions. Most of the large cities are metered. Chicago is kind of an exception. There are also a lot of unmetered communities in the Central Valley of California, but they're smaller communities, too. When I'm talking about Detroits and Miamis, they're metered. We're talking about the opportunity to sell them radios. Very often with the radios come meter change outs.
Got you. Thanks. Appreciate it, guys.
Yep.
Thank you. Our next question will come from Richard Verde with Atwater Thornton. Please proceed.
Hi, good morning, guys. Thanks for taking my call here. Just a couple of quick questions, primarily pertaining to the President Trump attempt to lower the tax rate. I'm kind of wondering, how does Badger Meter believe the customers will react in terms of pricing? Do you think you guys will see some pressure, where the customers will want to reduce prices and see some of that tax benefit passed through?
I don't expect that. The reason I say that is unlike the electric industry, where there are 3,000 or 2,300 electric utilities in the U.S., and therefore, there are some very large utilities that have a lot of buying power. The water industry is very fragmented. There are 51,000 water utilities in the U.S. You don't have the large ones with a lot of buying power. We haven't seen that in the past. Generally, pricing pressure in our industry comes from internal rivalry. I'm kind of quoting Michael Porter's Porter's Five Forces. For all you MBAs out there. That's where you see the pricing pressure in our industry. If anything, it would be that we would all start competing more aggressively and driving prices down.
I think that's why when we do a price increase for something like brass, we can get it through. Generally, as brass prices come down, we don't go out and announce a huge price decrease. Instead, you just start seeing bids and quotes pushing pricing down over a period of time based on competitive pressures. That's what really happens in our industry.
That's great. Thank you for that color. Let's just say Badger Meter didn't see any pricing pressure, and the company recognized the full benefit of the tax cut. Valuations aren't really right for a buyback. Could you give us some color on maybe what you guys might do with that benefit? Could it be placed towards acquisitions or R&D, or what would be the early thinking?
First off, we would tend to benefit from that more so than some other companies. The reason I say that is if you look at our effective tax rate, it tends to be higher than other companies in our industry. Mainly because we have more of our operations solely in the U.S., and therefore we tend to pay the higher tax rate. Companies like Honeywell, which owns Sensus, I'm sorry, Xylem, which owns Sensus, I said that wrong, okay? Honeywell, which owns Elster. They have a large percentage of their operations outside the U.S., and therefore they have a lower tax rate, so the benefit isn't as great for them. Let me first point out that we would stand to benefit more significantly from some of the others.
What we would do is if we had additional resources, we would definitely want to deploy them and would want to deploy them probably in acquisitions. That would be our biggest opportunity. As I said, we have a desire to get a little more aggressive on acquisitions than we have in the past. I think the board wanted to be a little more settled on our succession plans going forward before they jumped in on something major. Now that we've got that better settled, I think you'll see us get a little more aggressive.
Excellent. Thank you. Then just the last question, kind of just an easy one here. I'm sorry if I missed it, but can you just tell me what the business looks like now in terms of new installation versus replacement?
That's always a very hard thing for anybody in our industry to answer. The reason is, if I ship 100 meters to the City of Chicago, I don't know how many of those meters are being put into new housing versus being used in replacement. Having said that, if our industry sells about 6 million meters in the U.S. a year, and that's probably a reasonable round number, okay? If there are 1,000,005 new housing starts in the U.S. every year, and let's say 80% of those new housing starts are on municipal water, 20% are on private wells. You could guess that of the 6 million, maybe a little over 1 million is going into new housing, and a little bit less than 5 million is going into replacement.
Perfect. Okay. Thank you very much.
Replacement is a much higher % in our industry.
Got it. Okay. Thank you, guys. I appreciate the time.
Thanks, Rich.
Thank you. Ladies and gentlemen, this concludes our question and answer session for today. Now it's my pleasure to hand the conference back over to Mr. Rich Meeusen, Chairman, President, and CEO, for some closing comments and remarks. Sir?
Yeah. Thank you, Brian. All I'll say is that, obviously we had a record year last year. We had two record quarters this year. The third quarter was a little disappointing. The stock price, I always say our stock price tends to overreact on good news and overreact on bad news. The stock price has dropped down to a level that we haven't seen well since July. Our stock price is back down to where it was in July. It had a significant run-up just in the last couple of months, and it's back down to the July levels. We still are very confident about where our business goes in the future. We tend not to focus a lot on the stock price and try to manage that. We tend to instead manage our business for the long term, and that's our focus.
We think we'll be able to offset this higher brass. We know we'll be able to offset this higher brass with price increases, which we are working on. There will be a temporary disruption. The long-term fundamentals of our business are still there. They're still strong, and we have a lot of confidence in our ability to continue to generate shareholder value. With that, I'll thank everybody for joining us. Thank you.
Ladies and gentlemen, thank you for your participation on today's conference. This does conclude the program, and we may all disconnect. Everybody, have a wonderful day.