Ladies and gentlemen, welcome to the Quarter One 2015 Badger Meter Earnings Conference Call. My name is Laura, and I will be your operator for today. At this time, all participants are in listen-only mode. We will conduct a question-and-answer session towards the end of this conference. If at any time during the call you require assistance, please press star zero and an operator will be happy to assist you. As a reminder, this call is being recorded for replay purposes. I'd now like to turn the call over to Mr. Rick Johnson, Senior Vice President of Finance and Chief Financial Officer. Please proceed, sir.
Thank you very much, Laura. Good morning, everyone, and welcome to Badger Meter's first 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 first quarter results. Yesterday, after the market closed, we released our first quarter 2015 results. The first quarter proved a little tougher than we expected. Sales were approximately $100,000 higher than the first quarter of last year. This is the net result of higher sales of municipal water and specialty products and lower sales of flow instrumentation products. Let me review each of these sales categories. Municipal water represented 70% of sales in the first quarter of 2015, compared to 68.4% in the first quarter of 2014. These sales increased $1.4 million or 2.5% to $58.5 million in the first quarter of 2015 from $57.1 million in the first quarter of 2014.
Looking at the detail for municipal water, higher sales of residential products were offset by lower sales of commercial meters. Some of the increase in overall sales is attributable to the fact that we had incremental revenue of $3.9 million associated with National Meter and Automation, which we acquired last October. Most of that is attributable to residential sales. Total sales of residential meters and related technology increased 11%, primarily due to higher volumes of products sold with technology. Much of the increase was international, primarily Mexico in this particular quarter. Commercial meter sales decreased over 30% in this period compared to the same period in 2014 due to lower volumes of product sold. Remember that in the first period of 2014, commercial meter sales were up 62.4% over the first quarter of 2013. The first quarter sales in 2015 for commercial water meters returned to more normalized levels.
Flow instrumentation products represented 27.3% of sales for the first quarter of 2015, compared to 29.1% in the same period last year. These sales decreased $1.5 million, or 6.2%, to $22.8 million from $24.3 million in the same period last year. Most products within this group saw increases in total sales due to higher volumes and slightly lower pricing. However, while sales of products sold in euros increased compared to the first quarter of 2014, the strengthening US dollar had a negative impact when those sales were translated into US dollars. We estimate the impact of this foreign exchange on revenues to be approximately $1 million for the quarter. In addition, we had a significant decline in sales into the oil and gas market due to lower purchases by a major customer.
Specialty application products represented just 2.7% of sales for the last three months, compared to 2.5% in the same period last year. These sales increased $200,000, or 9.5%, in the first quarter, to $2.3 million from $2.1 million last year. We saw increases in sales of both gas radios and concrete vibrators. Again, this is not a significant component of the business, but we are seeing increases there. Gross margin as a percent of sales was 36% in the first quarter, compared to 34.7% in the first quarter of 2014. Much of this increase was due to the incremental revenue of National Meter. The increase was also due in part to lower overall costs resulting from favorable capacity utilization, less expensive raw materials, and favorable exchange rates on parts sourced from Europe.
These were offset somewhat by lower flow instrumentation prices, unfavorable exchange rate effects on sales and ultimately margins, and the product mix, where we had a smaller percentage of flow instrumentation sales, which carry higher margins. Selling, engineering, and administration expenses for the first quarter of 2015 increased $1.7 million or 8% to $23 million from $21.3 million in the same period last year. The first quarter of 2015 included $2.3 million of charges associated with National Meter. We also had higher software licensing fees and higher healthcare costs in this year's first quarter. What didn't recur this year were the charges totaling $1.7 million in the first quarter of 2014 for due diligence and other transaction costs related to a potential acquisition that ultimately was not pursued. The effective tax rate for the quarter was 37.2%, compared to 37.4% in the first quarter last year.
The first quarter of 2015 included a discrete charge of $77,000 associated with a federal tax audit. We are currently estimating the annual effective tax rate going forward at approximately 36.1%. As I said earlier, overall it was a tough quarter. Without National Meter, we would not have had the overall increase in municipal water, although residential sales still would've been up. However, the decline in commercial sales and the lower flow instrumentation sales contributed to lower earnings for the quarter. Earnings for the quarter then were $4.2 million, or $0.29 per diluted share, compared to $4.6 million or $0.32 per diluted share last year. Our balance sheet remains relatively unchanged from year-end. Debt as a percentage of total capitalization was 26% on March 31st. Cash generated from operations was $6.8 million, compared to only $600,000 for the first three months of 2014.
We talked on our last conference call about the inventory buildup at our Mexican facility as we moved some product lines. Because of this, we did not see the significant increase in inventory values that we normally have as we gear up for the busier part of the year. We also saw no significant increases in receivables as we did in the prior year. 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. As Rick said, this was a tough quarter that followed a record-breaking year. The combination of the harsh weather in the upper Midwest and Northeast, the weaker euro, weakness in the oil and gas sector, and generally slower construction activity all combined to negatively impact our sales. On the other hand, margins improved as we benefited from the National Meter acquisition and lower copper prices. Unfortunately, these benefits were not sufficient to offset the headwinds. When I look at the coming quarters, I am optimistic. Although the weakness in the oil and gas sector is expected to continue to impact us, we also expect that most of these other factors will not. The weather effects should abate. Construction activity is expected to pick up. Lower copper prices should continue to benefit us.
Although the euro may remain weaker, it has little net effect on our business, as lower euro-based sales, when translated, are offset by lower euro-based purchases. Also, our new products are gaining market share, and we expect to see continued benefit from them as we move forward. Sales of our E-Series meters increased 47% in the first quarter of this year when compared to the first quarter of last year. Sales of our ORION SE meter-reading system increased 26%. Sales of our newest meter reading technology product, the BEACON Advanced Metering Analytics system, tripled sequentially from the fourth quarter of 2014 to the first quarter of this year. We introduced BEACON a little over a year ago, as many of you know, this product is unique because it is a managed system that includes cellular endpoints, making it both easy to install and very cost-effective.
During the first quarter, I spent time meeting with some of our salespeople, distributors, and BEACON customers. The reactions that I received were extremely encouraging, with many utilities making the decision this year to start a full BEACON implementation. I expect that we will continue to see strong growth in our BEACON sales. We have several R&D projects underway, with plans to introduce several new products at the American Water Works Association conference in Anaheim, California, in June. Before you ask me what those products are, I will tell you that our VP of Sales and Marketing, Kim Stoll, is sitting next to me, and she will stab me if I tell you, I cannot. We are also continuing to invest in the E-Series metering line, our ORION radio systems, and the BEACON software.
On the flow instrumentation side of our business, we also continue to develop and introduce new products that help our customers monitor and control their fluid resources. Over the past month, there has been a great deal of attention from the news media regarding the drought conditions in California. Although those conditions have existed for several years, the imbalance of California's water supply and demand is now reaching a point where significant attention and action is required by both governmental agencies and the general public. Governor Brown has declared a drought state of emergency and ordered state agencies to execute a statewide water conservation campaign targeting a 25% reduction in water usage. This situation, while tragic for the state, does represent an opportunity for Badger Meter. There are more than 235,000 homes and businesses in California that are not metered.
Those residents pay a flat rate for water regardless of the amount consumed. We know from experience that most homeowners will use 15%-20% less water if they have to pay for what they use. There are calls for accelerated meter installation programs in many California communities, Badger Meter is well-positioned to provide these meters. Further, our BEACON meter reading system includes a consumer portal that allows homeowners to monitor their daily and even hourly water consumption on their home computers or mobile devices. This software includes sophisticated tools that help encourage water conservation. We are in discussion with many California water utilities that have shown an interest in our BEACON system. In summary, let me say that while this was a disappointing quarter for our company, we're still confident in the basic drivers of our business, and we remain optimistic about the balance of the year.
With that, I'll open this up for questions.
Thank you. Ladies and gentlemen, if you wish to ask a question, please press star followed by one on your touchtone telephone. If your question has been answered or you wish to withdraw your question, press star followed by two. Please press star one to begin.
Okay. Your first question I have from Kevin Bennett from Sterne Agee. Please proceed.
Good morning.
Morning, Kevin.
Real quick on the oil and gas exposure in flow instrumentation. Can you guys just remind us about your exposure there? The oil and gas sales represent, well, I think about less than 5% of our total sales. Correct. It isn't a very large exposure. When you're comparing, especially a first quarter, which is typically our lowest quarter in total sales, when you're comparing a quarter-over-quarter, a significant swing can have an impact on us. Got you. That makes sense. Rick, for you, the $2.3 million of higher SG&A from National Meter, is that more of a one-time recurrence, or will we see that as this $23 million kind of the new run rate for SG&A going forward? Well, the two and a half million is the run rate for National Meter. Okay.
Again, you got to back off some of the $1.7 million we had in there last year. The reality is, I think we had $2.5 million in the fourth quarter, $2.3 million in this quarter. Virtually all of their expenses are considered SG&A because they don't manufacture anything. Got you. There weren't any one-timers in that quarter? No. In the first quarter. Okay, thanks. Rick, last question from me, on BEACON and more specifically to California, can you elaborate on your comment about some utilities fully installing the platform? I know we've talked about the last few quarters about kind of the trial packages. Any more commentary around that would be great. We've got a list now about over 40 utilities that have made the commitment to BEACON.
They run everything from a small utility to a larger one, they average, I would say, about 7,000 or 8,000 services per utility. You're probably talking about somewhere between Well, now you want me to do the math for you? No. That we have where utilities have said, "Yes, we're interested." That doesn't mean they'll do them all this year. Right. They're going to do them over a period of time.
Got you. Okay. Thank you, guys. Okay.
Okay. Thank you for your question. Your next question comes from Richard Eastman from Robert W. Baird. Please go ahead. You're live in the call.
Yep. Thank you. Rick, was the National Meter revenue just under $4 million for the quarter? Was that on the light side, or is that just reflective of seasonality? Just curious how that, again, kind of flowed into the numbers here for the quarter.
I want to clarify, that was incremental revenue. Okay? That was not their total revenue. Their total revenue was in line with what we've seen in the past.
Okay.
That's the additional margin on the product that we normally would have sold to them in the past, plus some of the additional products they sell, as well as like their installation services.
Rick, let me just try to shed some light on this. Obviously, National Meter, on a standalone basis, has a much larger revenue that gets eliminated when we add the two companies together because they're reselling our products, right?
Yes.
The incremental revenue Rick is talking about is a combination of the markup they make on the products we sell them and on other products that they might sell.
The 3.9 is essentially the gross margin number contribution, correct?
No it's the sales contribution.
It is the sales contribution. Okay, it's the incremental sales contribution. Okay.
The incremental revenue. Their total sales for the quarter were actually about $9 million. All right?
Okay.
You have to eliminate what we sold them, which was about $5 million, and it left about four as incremental.
Okay.
Does that make sense to you?
Yep. Is there any reason to assume that that math changes a great deal here quarterly? Is there any seasonality in their business?
There is seasonality in that they are in the same business we are in. They tend to have a weaker first quarter, and a weaker fourth quarter, and their second and third are the stronger quarters.
Yep. Okay. Hey, then can I ask on the gross margin side of the business, given where copper prices are, and has there been any competitive pricing within the meter market relative to the competitors, some that maybe have a different cost component on copper?
No, we haven't seen it. Bear in mind that it's a little tricky because, first off, one competitor, Mueller, primarily sells plastic meters, so they really aren't even competing in the brass market. Obviously, Neptune only sells brass meters. They own their own foundry, so they really don't want the market to move to polymer meters. Sensus has moved more towards pushing their iPERL, which is a plastic meter. Really, the only major competitor we have in the brass area is Neptune, we have not seen pricing pressure yet.
Okay. Then, just one question on the industrial flow side of the business. Again, we did kind of, maybe we sized our oil and gas exposure at, say, $10 million-$12 million a year. If we do it that way, when you say it was down significantly, was it down 100%? I mean, it was.
No. Oh, no.
Okay. It was maybe a $1 or $2 million, you know, drag on the quarter year-over-year in terms of revenue?
Rick, it was a little over $1 million.
Right. Okay. All right. Again, that probably is going to be kind of a normal trend through the three quarters here.
We're obviously taking some actions to try and get whatever we can back, but the fact of the matter is, when our customers, when the whole market is down on activity, it's hard to jump around to it. It isn't like it's one customer you can jump to another.
Just on the municipal side, the water side, the commercial business, obviously the comp was out there for all to see. You had a massive 60% plus comp year-over-year. Again, given that the commercial stuff here is weather related, some defers on the construction side due to weather, one would assume that business comes back, as the weather clears here in second and third quarter. That's not a lost share. That's not lost business. It kind of sits in backlog until you get the thumbs up to ship.
It's not lost market share or anything like that. It's just that, we always refer to business being lumpy. It's the general lumpiness of it. Overall, the long-term commercial generally follows residential. When a city switches out, they not only switch out residential, they switch out their commercial meters also.
Yeah.
It's just more of a function of timing more than anything else at this point.
Okay. That business, just in general, should look something like, for the full year, should look something like non-res construction type of forecast, correct?
Yeah.
Something like that.
Right. Exactly. Yes. It should.
That's the trend. Okay. Thank you.
Okay. Thank you for your question. Your next question comes from Brian Dempsey from Morgan Dempsey Capital Management. Please proceed.
Yeah. Good morning, guys.
Morning, Brian.
Morning.
Going back, looking just at the weather, obviously Boston got 17 inches of snow. The Eastern Seaboard got killed with snow. Back to Midwest, back to 2014, we had Ice Station Zebra with all those polar vortexes. From a weather basis, can you look and maybe broadly, Rich, was weather about a push in both fairly difficult first quarters in 2014 and 2015?
No, I would say not, because the cold doesn't impact us as much as snow does. Ground cover on snow. When there is snow, it's difficult to find the pits, where the meters are, and so the utilities simply slow down sending their teams out, because it's just not an easy thing to do. Also, for the meters that are in basements, tracking snow in the basements, they don't want to do it. Snow has a bigger impact than cold. The first quarter of 2015 is more like the first quarter of 2013, which was a very heavy snow quarter.
In fact, if you remember, I remember distinctly sitting here a year ago talking about the fact that our customer mix weighted more west of the Mississippi last year at this time than normal.
Okay. Good. Yeah, I appreciate that. Given the drought conditions in California, some of which could be self-inflicted, are there any large national city, National Meter potential contracts? I'm thinking, and I don't know, Los Angeles, San Diego, Sacramento, San Francisco or any of the second-tier cities in California amongst the 235 that you talked about on meter?
The short answer is in California specifically, no. In New Mexico, we did get a contract with Santa Fe right now.
Right. We have a large contract in Santa Fe.
They have the same issues, by the way.
for BEACON, and it's because they have concerns about wanting to manage their water usage. I will say, though, in California, because the BEACON software was developed in California. At the time we bought that startup who was working on that software, they were basically using many of the California utilities, the large California utilities, as their beta sites for that software. We do have very strong relationships with those utilities, and we have a lot of interest from those utilities as to what this software could do for them, the entire system could do for them. We are moving forward in those discussions.
Okay. Then just one final one, guys. With the integration of National Meter as a distributor, you guys talked about having a lot of relationship with over the years, very much a legacy relationship. Are there any other maybe top-tier distributors that might be watching that integration and might now be at a point where they might be looking to follow in, or is that these things just one-off?
No. Brian, I think your first analysis was right. Once we did that, we did it very well, and we treated the sellers very fairly, other distributors expressed an interest, we are in conversations with other distributors. It's not really a one-off. It really is a strategy that we developed where we wanted to start with National Meter because it was our strongest, our largest distributor and had very good systems in place. Then look at whether or not we could roll up other distributors who might be interested in getting involved with us to where we could put them under the National Meter umbrella. We are in conversations, that is moving forward.
Okay, guys. Thanks a lot.
Thank you for your question. Again, ladies and gentlemen, if you wish to ask a question, press star one. Your next question comes from the line of Richard Verdi from Ladenburg. Please proceed.
Hi. Good morning, guys, thanks for taking my call. I did have to jump off the call here for a second, so forgive me if you've already addressed this, but I have a question surrounding copper. I know in the past you don't speak in depth or give in-depth details surrounding that issue. I do remember that a couple of years ago, Rick, you had mentioned that when there's a change in the price of copper, it takes about three to five months for that impact to be realized on the P&L. I'm wondering if that is a still accurate timeframe, and if so, at this point in time, are we closer to three months or five months?
No, our inventory as a whole turns about four times a year. Three months is still a reasonable assumption. If anything, it might actually turn a little bit less than that because.
Okay
The housings are the thing. We're hearing a noise, that's why we're pausing here. If anything, it might change a little bit less. Housings turn a little bit more than some of the other inventory.
Okay, thanks. That's great color. The other issue is with new construction build. I know there's been a lot of success with that in the past, we're also entering a time where it's been 10, 15 years, and meters need to be replaced. I'm just wondering if you'd give a little bit of color on how much of business Badger Meter is seeing that's new construction and how much is replacement. On top of that, if there is significant replacement, how much of that is the meter and how much is the radio?
This is Rich. That's a very, very difficult one, we've wrestled with that for years, the entire industry has. When we ship our meters to a utility, we never know whether they are going into new housing or whether they're being used as replacement. The utility has no methodology for reporting back, neither do our distributors. We've never been able to say this percent of our sales goes into new and this percent of our sales.
The same is true for commercial meters, too.
Right. It's the same thing with commercial, so it's really a hard thing. The only way you can kind of do it is to take a look at the, for example, the industry sells about 6 million meters a year. So you could say, well, there are 1 million new houses built, and therefore, say 80% of those have meters, and the other ones have private wells. You could somehow make a conclusion that some percentage, 20% or so, or 15% of the meters are going into new houses. It's that high level.
Okay. Okay, great. This has been very helpful. Thank you, guys. I'm going to jump back in the queue.
Okay, thank you. Your next question comes from Chip Moore from Canaccord. Please go ahead.
Hey. Thanks, folks. Just let me follow up a little bit more on your commentary about being a little more optimistic. Looking forward, maybe you could talk about cadence of orders, particularly March, April, and particularly where we've seen the snowpack melt.
By the way, Chip's in Boston. We assume the snow has melted there, right?
Yeah. I still have a little in my backyard.
Okay, we appreciate that, Chip, the weather report. Yeah. If you look at what happened to us in the first quarter of 2013, which was a very heavy snow quarter and had a big impact on our sales, we had a very weak first quarter. We followed that up with two record quarters. At this point, when we look at our order entry, our backlog, we see no reason to believe that we won't have some strong quarters coming forward. That's one of the things that makes us more confident about looking at the balance of 2015. Obviously, weather shouldn't be an impact. Weather really only hits us in the first quarter. We're going to continue to benefit from copper. The euro will probably remain weak, but it's pretty much a wash on us because of the purchases and the sales.
We know we're probably going to lose $1 million a quarter on the oil and gas. When we wash all those things together and we say, "Hey, construction should be improving, housing starts are continuing to improve," all of that, it says that we're pretty optimistic about the rest of the year.
Sure. That's fair. One more on California, obviously, great opportunity. As these utilities look to evaluate these new systems, is there potential for any sort of near-term delay on traditional replacement business, or how should we think about that?
We haven't historically seen that because if a utility is on a manual read system, they'll go ahead and replace their meters, and then when they go to an automation, they'll just pop the automation on top. Generally, a utility won't say, "Let's extend the lives of our meters because we haven't made a decision on automation." We don't see that happening.
Okay, thanks.
Okay, thank you for your question. Your next question comes from John Rosenberg from Loughlin Water Partners. Please proceed.
Yeah. Hi, good morning. Thank you for taking my question. This is a bit of a kind of a general question, but you mentioned California, which obviously represents an opportunity for Badger Meter. Are there any thoughts about perhaps trying to sell into Brazil? I know that COPASA does some business with Elster. Do any of your new products, perhaps, would that be an attractive market for you? If so, why or why not?
Yeah. This is Rich. Let me address that. It's generally not an attractive market. The first reason is that most of the Brazilian utilities use a velocity, a single-jet or multi-jet meter. That's not a type of meter that we make. It's not the type of meter that's used in North America. It's the type that's used in Europe, and a lot of those come out of China at a very low price. That's the first problem. The second problem with Brazil is that they have some pretty heavy tariffs for importing finished products. To be effective there, you have to have a partner. You're shipping in parts, and they're doing a significant amount of the final work on the meter.
We found that a key success factor on our meters is the control we exert over the final assembly and test of the meters, and outsourcing that to a third party is pretty risky. For all those reasons, we have not focused on Brazil as a target for our water meters. On the other hand, we sell a lot of our industrial meters down there, and we will continue to do so.
Okay. Thank you very much.
Sure.
Okay. Thank you for your question. I would now like to turn the call over to Rich Meeusen for closing remarks.
Well, I want to thank you all for joining us. This was a difficult quarter for us, but as Rick constantly likes to remind you, we are in a lumpy business. We have these quarters from time to time. History will show you that when we have a bad quarter driven by weather or other factors like that, we tend to bounce back. We're fairly confident that we can expect to see some good quarters coming forward. With that, I'll thank you again for your support and look forward to talking to you in the future. Thank you.
Okay. Thank you for your participation in today's conference, ladies and gentlemen. This does conclude the presentation. You may now disconnect. Good day.