U.S. Markets closed

Edited Transcript of BMI earnings conference call or presentation 17-Oct-19 3:00pm GMT

Q3 2019 Badger Meter Inc Earnings Call

Milwaukee Oct 23, 2019 (Thomson StreetEvents) -- Edited Transcript of Badger Meter Inc earnings conference call or presentation Thursday, October 17, 2019 at 3:00:00pm GMT

TEXT version of Transcript

================================================================================

Corporate Participants

================================================================================

* Karen Bauer

Badger Meter, Inc. - VP of IR, Corporate Strategy & Treasurer

* Kenneth C. Bockhorst

Badger Meter, Inc. - President, CEO & Director

* Robert A. Wrocklage

Badger Meter, Inc. - VP of Finance & CFO

================================================================================

Conference Call Participants

================================================================================

* Andrew Edouard Buscaglia

Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst

* Chip Moore

Canaccord Genuity Corp., Research Division - Senior Associate

* Nathan Hardie Jones

Stifel, Nicolaus & Company, Incorporated, Research Division - Analyst

* Richard A. Verdi

Coker & Palmer Investment Securities, Inc., Research Division - Senior Analyst of Water & MLP

* Richard Charles Eastman

Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst

* Tate H. Sullivan

Maxim Group LLC, Research Division - Senior VP & Senior Industrials Analyst

================================================================================

Presentation

--------------------------------------------------------------------------------

Operator [1]

--------------------------------------------------------------------------------

Thank you for standing by and welcome to the Third Quarter 2019 Badger Meter Earnings Conference Call. (Operator Instructions) Please note that today's call is being recorded. It is now my pleasure to turn the conference over to Karen Bauer, Vice President of Investor Relations, Strategy and Treasurer. Please go ahead.

--------------------------------------------------------------------------------

Karen Bauer, Badger Meter, Inc. - VP of IR, Corporate Strategy & Treasurer [2]

--------------------------------------------------------------------------------

Good morning, and welcome to the Badger Meter's Third Quarter 2019 Earnings Conference Call. On the call with me today are Ken Bockhorst, President and Chief Executive Officer; and Bob Wrocklage, Chief Financial Officer.

The earnings release and related slide presentation are available on our website. Quickly, I will cover the safe harbor, reminding you that any forward-looking statements made during this call are subject to various risks and uncertainties, the most important of which are outlined in our press release and SEC filings.

Finally, please note that on today's call, we will refer to certain non-GAAP financial metrics. Our press release and slides provide a reconciliation of the non-GAAP to GAAP financial metrics used.

With that, I'll turn the call over to Ken.

--------------------------------------------------------------------------------

Kenneth C. Bockhorst, Badger Meter, Inc. - President, CEO & Director [3]

--------------------------------------------------------------------------------

Thanks, Karen, and thanks for joining our third quarter earnings call today. We were pleased with the return to growth in the domestic utility market, with sales up 2% against the near record comparison last year. You may remember from last quarter's earnings call, we stated we expected to return to growth in the domestic market in the back half of the year. We did begin shipping the 3 and 4-inch E-Series commercial meters about midway through the quarter and 1 of the 2 larger municipal smart water wins began to ramp as well. This, combined with the solid municipal utility market backdrop, provided the return to growth in Q3.

I remain encouraged by customer feedback on the new technologies and the solid funnel of opportunities as we look forward. In addition, our gross profit leverage remains in the upper half of our normalized range. SEA spend was well managed and we were able to continue working capital initiatives and generate strong free cash flow again in the quarter.

Bob will walk you through the details of the quarter and after that, I'll come back and talk about a few key strategic items and our outlook.

--------------------------------------------------------------------------------

Robert A. Wrocklage, Badger Meter, Inc. - VP of Finance & CFO [4]

--------------------------------------------------------------------------------

Thanks, Ken, and good morning, everyone. Slide 4 gives you a snapshot of the financial results for the quarter compared to adjusted results in the prior year. Just as a reminder, the prior year amounts have been adjusted to exclude pension termination settlement and executive retirement charges for comparability. A reconciliation of these amounts is included in the appendix to the slide deck.

Starting with sales. Total sales for the third quarter were $108.6 million compared to $110.6 million in the same period last year, a decline of 2%. In municipal water, overall sales declined 3%.

Focusing on the domestic market, which obviously excludes our more uneven international revenues, we saw utility sales up approximately 2%. This quarter's domestic municipal water sales were the second-highest in our history and fell just short of the record second quarter of 2018. The increase was driven by continued adoption of smart metering solutions, including the newly launched large diameter, 3- and 4-inch E-Series commercial meters and ORION LTE-M cellular radio endpoints. Sales mix remained positive, with increased sales of Ultrasonic meters and meters with radios as well as increased BEACON service revenue year-over-year.

Flow instrumentation sales increased 1% year-over-year, with puts and takes across the broad array of industrial end markets served. Operating profit as a percent of sales was 15.1%, down 100 basis points from adjusted prior year results.

Taking a closer look at the drivers, gross margin for the quarter was 38.4%, once again, in the upper half of what we would call our normalized range of 36% to 40%.

In order of magnitude, favorable product mix was the primary driver, with the higher proportion of BEACON service revenues, Ultrasonic meters and meters with radios as well as favorable regional mix. We continue to experience favorable net pricing as brass input costs were lower year-over-year albeit at a more modest pace than the first half of the year.

During the quarter, we did record a discrete warranty provision associated with the sourced system integration module for a previously installed solution sold only outside of North America. Excluding this specific provision, our gross profit margins would have been modestly higher than the prior comparable quarter.

SEA expenses in the second quarter were $25.2 million, $0.9 million below the adjusted $26.1 million in the comparable period last year due primarily to lower incentive compensation and effective cost control measures. Our SEA leverage improved to 23.2% of sales from an adjusted 23.6% last year.

The income tax provision in the third quarter of 2019 was 22.1%, essentially in line with the prior year's 22.8% adjusted rate with the third quarter generally the lowest tax rate quarter of the year. Bottom line, adjusted EPS was $0.44 in the third quarter of 2019, a decline of 4% from the prior year's all-time record of $0.46 per share.

We again delivered a solid primary working capital performance, with third quarter working capital at 27% of trailing 12-month sales, down from 30.4% in the same period last year and on balance with the 26.9% at the end of our second quarter. Working capital management contributed to the 50% increase in third quarter free cash flow from $12.7 million a year ago to $19.1 million this year. On a year-to-date basis, our free cash flow to net earnings conversion is a very robust 159%.

With that, I'll turn the call back over to Ken.

--------------------------------------------------------------------------------

Kenneth C. Bockhorst, Badger Meter, Inc. - President, CEO & Director [5]

--------------------------------------------------------------------------------

Thanks, Bob. I want to take a minute to discuss one of the areas that frankly doesn't get a ton of attention from our investors, but it's of fundamental importance to us, and that's cash flow. These charts on Slide 5 display our free cash flow conversion, our ability to translate our earnings into actual cash flow and our primary working capital as a percent of sales trends. Bob just highlighted one of these, the nearly 160% free cash flow conversion for 2019 thus far.

One aspect of our broad, continuous improvement program has been focused on working capital management, and you can see the early results. Ongoing efforts to drive reductions in days inventory on hand, improvements in payment terms and tighter collection efforts span not just finance but purchasing operations and others and serve as a great example of our continuous improvement culture. We are in a net cash position. And so why is this important? Capital allocation is one of our most important jobs and our strong cash flow is supportive of our efforts to take a balanced approach by investing in Badger Meter's future growth, both organically and via acquisitions and meaningfully returning cash to shareholders as evidenced by the August 27th -- August announcement of our 27th consecutive year of increased dividends.

Finally, turning to Slide 6. As we move into the final quarter of the year, we see robust quote activity in the backlog supportive of our growth plans. The key project wins we highlighted earlier in the year are starting to ramp, demand for the 3- and 4-inch E-Series commercial meters has been strong and municipal spending trends are solid.

From a macro standpoint, while employment is still quite good, trade and other uncertainty appear to be taking a toll on consumer sentiment and overall industrial demand. For Badger Meter, we remain largely unaffected by those particular trends since we are predominantly a U.S.-centric replacement-driven business. We will continue to monitor the environment, but municipal spending trends remain a positive backdrop for our utility water business.

Execution on our strategic initiatives continues. We recently held a customer advisory council session, which is a process we use to gain insight on emerging customer trends and how our products and technology roadmap should evolve to meet those needs. Operational metrics and processes are being improved, including the addition of SIOP, or sales, inventory and operations planning capabilities. And finally, the active portion of the M&A pipeline includes some interesting technology opportunities.

In closing, I want to express my appreciation to all of our employees for their hard work and dedication. With that, operator, please open the line for questions.

================================================================================

Questions and Answers

--------------------------------------------------------------------------------

Operator [1]

--------------------------------------------------------------------------------

(Operator Instructions) Your first question comes from the line of Nathan Jones.

--------------------------------------------------------------------------------

Nathan Hardie Jones, Stifel, Nicolaus & Company, Incorporated, Research Division - Analyst [2]

--------------------------------------------------------------------------------

Maybe we could just start on the progress here around the new technologies that are coming into the market. I know we've -- it's nice to see you guys return to growth in the domestic market here against a pretty good comp. So maybe just a few questions around that. Can you tell me if there's more or less customers in pilot testing than there were 3 months ago? When does the pilot phase peak and customers begin to move more into the ordering phase out of this?

--------------------------------------------------------------------------------

Kenneth C. Bockhorst, Badger Meter, Inc. - President, CEO & Director [3]

--------------------------------------------------------------------------------

Yes. Sure, Nathan. I think I would characterize it rather than account of what's in pilot versus what moved into orders versus what moved into deferrals. It's probably easier to just think about this more as a phase in/phase out from the LTE-M (sic) [LTE] technology to the more robust LTE-M. And really, what we've seen is a return to normal, right? We're always going to have people piloting it. We're always going to have people doing different things, just the way we did before with the LTE technology. So what we've seen is a return to normal.

--------------------------------------------------------------------------------

Nathan Hardie Jones, Stifel, Nicolaus & Company, Incorporated, Research Division - Analyst [4]

--------------------------------------------------------------------------------

Okay. Maybe you could talk about then -- I mean you're only just ramping up the sales of LTE-M. When that radio is at kind of a full run rate, normal kind of mix, what percentage of sales, of radio sales, do you think will be LTE-M versus other technologies?

--------------------------------------------------------------------------------

Kenneth C. Bockhorst, Badger Meter, Inc. - President, CEO & Director [5]

--------------------------------------------------------------------------------

Yes. So similar to what I was just pointing out there. So the LTE radio has now been phased out, replaced by the LTE-M radio. So it isn't like we're still selling the LTE technology and the LTE-M, right? So if you think about technology, mobile reads are always good to be out there, and we like that. We continue to play in the mobile side. And as people make their decisions to go up to the full AMI systems, they'll be buying our LTE-M ORION Cellular.

--------------------------------------------------------------------------------

Nathan Hardie Jones, Stifel, Nicolaus & Company, Incorporated, Research Division - Analyst [6]

--------------------------------------------------------------------------------

Got it. That makes sense. Maybe just on the new 3- and 4-inch commercial meters, maybe talk a little bit about the initial traction you're seeing from those products in the market. What advantages do they generate for customers over the prior technology?

--------------------------------------------------------------------------------

Kenneth C. Bockhorst, Badger Meter, Inc. - President, CEO & Director [7]

--------------------------------------------------------------------------------

Yes. So from a technology point of view, it's really a nice enhancement for customers because it gives them the ability to sense for pressure, temperature, so it gives them more functionality. Also on these higher flow applications that are the larger meters, here's a case where the Ultrasonic does have an advantage with the no moving parts for wear, has better accuracy on low flow. And we've seen really strong customer support out of the gate. I think the thing to remember is the 3- and 4-inch is just part of a total product line. So I wouldn't think of the 3- and 4-inch as some huge stack bar of growth. It continues to improve our overall product line, and it was a really important product launch for us.

--------------------------------------------------------------------------------

Nathan Hardie Jones, Stifel, Nicolaus & Company, Incorporated, Research Division - Analyst [8]

--------------------------------------------------------------------------------

Okay. And then just one more on these warranty charge. Bob said gross margins would be up slightly without that, which implies there was about a $0.04 headwind to earnings in the quarter. It sounds like this is a third-party component that had issues. Are you confident that this is contained to the third quarter? Is it likely to see any others? And are there prospects for you to recover these damages from the supplier, given it sounds like just a part you were sourcing?

--------------------------------------------------------------------------------

Robert A. Wrocklage, Badger Meter, Inc. - VP of Finance & CFO [9]

--------------------------------------------------------------------------------

Yes. So from the standpoint of the technology, it's very much quarantined to specific regions. So from the standpoint of charges and future charges, we would expect minimal moving forward. As it relates to pursuing recovery at this point in time, that's not something that we're pursuing. So to think about it broadly, in our mind, it's a Q3 event and a Q3 event only.

--------------------------------------------------------------------------------

Nathan Hardie Jones, Stifel, Nicolaus & Company, Incorporated, Research Division - Analyst [10]

--------------------------------------------------------------------------------

Okay. So it's a 1x charge.

--------------------------------------------------------------------------------

Operator [11]

--------------------------------------------------------------------------------

Your next question comes from the line of Tate Sullivan.

--------------------------------------------------------------------------------

Tate H. Sullivan, Maxim Group LLC, Research Division - Senior VP & Senior Industrials Analyst [12]

--------------------------------------------------------------------------------

On the U.S. revenue increase, I mean you had a consistent streak of the U.S. revenue growth the last 4 -- 5 years, I think it's been around 6% a year. I mean can you talk about, I mean, with the positive muni backdrop you mentioned, I mean, any expectations for growth in your primary U.S. market?

--------------------------------------------------------------------------------

Kenneth C. Bockhorst, Badger Meter, Inc. - President, CEO & Director [13]

--------------------------------------------------------------------------------

Yes. So as we transitioned into this new release on the LTE-M, again, we're back -- we feel like we're back to normal in that phase in/phase out mode. You know of the 2 large ones that we announced in terms of projects relative to Columbia and Aurora. Columbia kicked off in Q3. Aurora will begin to kick off in Q4. We are seeing robust demand, in general, for what we're offering. So yes, I mean I feel like with how we felt coming out of Q2 and what we indicated on the last call, I feel like we've returned to what we expect.

--------------------------------------------------------------------------------

Robert A. Wrocklage, Badger Meter, Inc. - VP of Finance & CFO [14]

--------------------------------------------------------------------------------

And not pitching anything to a specific quarter, I think as we talk long-term growth rate and multiyear growth rate, I think we're still very confident in that low -- mid-single digit range for the utility portion of the business as we move forward. So no change in that sentiment, no change in that signaling as we talk, longer term.

--------------------------------------------------------------------------------

Tate H. Sullivan, Maxim Group LLC, Research Division - Senior VP & Senior Industrials Analyst [15]

--------------------------------------------------------------------------------

And then you mentioned the -- integrating the D-Flow technology into the 3- to 4-inch Ultrasonic. Are there other future D-Flow integration efforts? Or are you done integrating D-Flow on all your products?

--------------------------------------------------------------------------------

Kenneth C. Bockhorst, Badger Meter, Inc. - President, CEO & Director [16]

--------------------------------------------------------------------------------

No. That's one of the things that I'm actually excited about yet, is that we're going to continue to build out the larger sizes. So the 3 and 4 was just the first release. We'll start to move into the 6 and 8s and even larger, which will really help build out the full portfolio on the commercial side. And then we still have the opportunity in front of us to incorporate into the smaller residential meters and have a reasonable cost reduction that we'll be able to use, whether that's for taking more share and/or improving margins. So we have 2 really strong uses of the D-Flow technology still going forward.

--------------------------------------------------------------------------------

Robert A. Wrocklage, Badger Meter, Inc. - VP of Finance & CFO [17]

--------------------------------------------------------------------------------

I would think about the larger size being product line extension and expansion that opens us up to bids we didn't participate in previously. Then I would think of what Ken mentioned in terms of the integration of that into the residential metering as being a cost improvement that'll be used for combination of competitive global pricing as well as margin enhancement.

--------------------------------------------------------------------------------

Tate H. Sullivan, Maxim Group LLC, Research Division - Senior VP & Senior Industrials Analyst [18]

--------------------------------------------------------------------------------

Has that integration been on schedule? Has -- on the residential effort with D-flow, has that been consistent with your time line expectation on that since the acquisition?

--------------------------------------------------------------------------------

Kenneth C. Bockhorst, Badger Meter, Inc. - President, CEO & Director [19]

--------------------------------------------------------------------------------

Yes, Tate. So when it comes to implementing something that's going to reduce our cost, it's never fast enough in my point of view. But no, I mean we expected that we would've done it this year, later second half. We're looking more now first half next year.

--------------------------------------------------------------------------------

Operator [20]

--------------------------------------------------------------------------------

Your next question comes from the line of Chip Moore.

--------------------------------------------------------------------------------

Chip Moore, Canaccord Genuity Corp., Research Division - Senior Associate [21]

--------------------------------------------------------------------------------

I wanted to circle back to piloting activity. It sounds like things are normalizing a bit. But how are you thinking about any sort of elongation in the sales cycle? Is that really -- are we past that? And any seasonal considerations, I guess, as we enter into the harder time of year?

--------------------------------------------------------------------------------

Kenneth C. Bockhorst, Badger Meter, Inc. - President, CEO & Director [22]

--------------------------------------------------------------------------------

Yes. That's -- let me break that into a couple of parts. So first, again, reiterating on the LTE-M phase in/phase out of the LTE. We're feeling that's into a normalized phase. Again, we're always going to have people piloting. We're always going to have people ordering. So I don't think we're going to see more elongation there. The second part of the question, I forgot already. So what was that?

--------------------------------------------------------------------------------

Chip Moore, Canaccord Genuity Corp., Research Division - Senior Associate [23]

--------------------------------------------------------------------------------

Well, it sounds like no. But just in terms of elongation or piloting cycle, that it is a factor in terms of seasonality?

--------------------------------------------------------------------------------

Kenneth C. Bockhorst, Badger Meter, Inc. - President, CEO & Director [24]

--------------------------------------------------------------------------------

Yes, sorry. So seasonality. Seasonality can be interesting when it comes to weather impacts and some of the other things. But I think to think rolling forward here, now that we've got a couple of really large AMI integrations, the seasonality, I think, as we go through the next year, 2 years, 3 years, may not be as impactful as it had been in the past.

--------------------------------------------------------------------------------

Chip Moore, Canaccord Genuity Corp., Research Division - Senior Associate [25]

--------------------------------------------------------------------------------

Got it. And another one on SEA leverage, very strong. Any puts and takes there to take into account in sustainability as we look forward?

--------------------------------------------------------------------------------

Kenneth C. Bockhorst, Badger Meter, Inc. - President, CEO & Director [26]

--------------------------------------------------------------------------------

Yes. No, I think we've been pretty consistent in telling the story here on being able to leverage the SEA, particularly as we transition to higher average selling prices, larger AMI implementations. So I think we're feeling good about the SEA leverage, and I think it's progressing as we expected.

--------------------------------------------------------------------------------

Robert A. Wrocklage, Badger Meter, Inc. - VP of Finance & CFO [27]

--------------------------------------------------------------------------------

So I think just to reiterate, Ken mentioned, again, our ability to leverage SEA over time as a large part of our top line story is about average sale price increase. I will say the one thing that won't change and the thing that we will remain steadfast in is to continue to invest in the business organically to stay as a technology leader. So to the extent we find opportunities where we can accelerate new product development to keep us in a competitive advantage or to bump us to the top on a particular technology, we will not waver in that. So that's not meant to buffer or hedge the earlier comment. I still believe in the long-term prospects of SEA leverage, but there may be bumps along the way where we decide to put more into organic investment in that new product development.

--------------------------------------------------------------------------------

Chip Moore, Canaccord Genuity Corp., Research Division - Senior Associate [28]

--------------------------------------------------------------------------------

That's great. And maybe that's a good segue into one last one. You're in a pretty strong net cash position. How should we think about some of those organic investments, and then potentially any assets you're looking at?

--------------------------------------------------------------------------------

Kenneth C. Bockhorst, Badger Meter, Inc. - President, CEO & Director [29]

--------------------------------------------------------------------------------

Yes. So over the years, we've prided ourselves on the innovation that we brought to the market. So we will continue, first and foremost, to invest in R&D, as Bob just pointed out. We're proud of our 27-year history of increasing dividends year-over-year. That will continue to be a capital allocation priority for us. And then the third part is continuing to ready the organization with our organizational capability and improving our acquisition funnel and finding meaningful strategic acquisitions to improve the technologies and solutions we bring to our customers. So internal R&D, sticking with our dividend history and investing in M&A.

--------------------------------------------------------------------------------

Operator [30]

--------------------------------------------------------------------------------

Your next question comes from the line of Richard Eastman.

--------------------------------------------------------------------------------

Richard Charles Eastman, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [31]

--------------------------------------------------------------------------------

Just a question. I just want to get maybe your perspective here a little bit. We talked about the domestic business, the municipal business, water muni business being up plus 2% when we pull out the international impact of the comp. Could you just give us a sense of what the residential versus commercial did against that 2% domestic?

--------------------------------------------------------------------------------

Kenneth C. Bockhorst, Badger Meter, Inc. - President, CEO & Director [32]

--------------------------------------------------------------------------------

Yes. So the lion's share of the revenue is on the residential side. So the commercial doesn't really swing it that much, one way or the other, I guess. I don't have the specific number in front of me, but...

--------------------------------------------------------------------------------

Richard Charles Eastman, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [33]

--------------------------------------------------------------------------------

But just curious, I mean with the 3 and 4 introduced, that kind of would be more of a commercial product. I'm just curious if commercial was up 10% and residential was flat, just trying to get some sense of that.

--------------------------------------------------------------------------------

Kenneth C. Bockhorst, Badger Meter, Inc. - President, CEO & Director [34]

--------------------------------------------------------------------------------

No, it was really consistent with the normal quarters. So there wasn't spiking in commercial that would have covered for residential. It was very consistent.

--------------------------------------------------------------------------------

Richard Charles Eastman, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [35]

--------------------------------------------------------------------------------

And so when I look at that number, that 2% domestic muni water, what's your take on that number, that growth rate relative to what a market growth rate would have been in the third quarter?

--------------------------------------------------------------------------------

Kenneth C. Bockhorst, Badger Meter, Inc. - President, CEO & Director [36]

--------------------------------------------------------------------------------

Well, I would go back to the point that we expect for the long cycle to grow in the mid-single digits, mid 6% to 8%-ish. In fact, we were up 2% this quarter. We're proud of being up 2% this quarter. Last year, year-over-year, we were up 12%. So it was a really tough comp. And so we still think the market might have been above our 2%, but we're certainly not feeling bad about our 2%.

--------------------------------------------------------------------------------

Richard Charles Eastman, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [37]

--------------------------------------------------------------------------------

Okay, okay. And in the international business, I know the swing factor has mostly come from the Middle East. But I'm curious, with that business down, I think the comp was somewhere around $3 million to $4 million in the Mid East. But with that business down as much as it is, what is the run rate of the international business including Mid East? I mean if you look at the third quarter here, dollars times 4, just curious where that run rate is at.

--------------------------------------------------------------------------------

Kenneth C. Bockhorst, Badger Meter, Inc. - President, CEO & Director [38]

--------------------------------------------------------------------------------

Yes. So the interesting thing about the international markets compared to the U.S. is in the U.S., right, we have 50,000 municipalities that are, yes, that are generally doing replacements, and you have a lot of people doing a lot of different types of activities, some up, some down depending on where it's at. When you look across the world, you're looking at individual countries or cities that are implementing new systems. So the replacement business isn't there, right? So it tends -- it will tend to be more lumpy in the fact that it's more integrations that are large, and then they happen one year and they may or may not happen the next. So it'll continue to be uneven. It doesn't dampen our enthusiasm for what we're finding for utility -- water utility opportunities around the rest of the world. But I don't think you're going to see a consistent run rate from us over the next couple of years.

--------------------------------------------------------------------------------

Richard Charles Eastman, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [39]

--------------------------------------------------------------------------------

Well, but I'm just curious. When I look at -- maybe stated another way. If I look at utility sales in the quarter, around $84 million. And I'm just trying to figure out what percentage of that do you count as international? Because my understanding is international is -- I think it's Middle East, but isn't it also -- don't you throw Mexico in there? And -- I'm just curious what percentage of that is...

--------------------------------------------------------------------------------

Robert A. Wrocklage, Badger Meter, Inc. - VP of Finance & CFO [40]

--------------------------------------------------------------------------------

Internally, when we talk domestic, and when we're using the term domestic here today, it's basically an Americas number, whereas rest of world would encompass Middle East and other countries. But largely, our international presence, when you look across the entire book of business, has historically been more about flow instrumentation than it has utility. So it's a relatively -- it is a very small piece of that full utility number that you just mentioned.

--------------------------------------------------------------------------------

Richard Charles Eastman, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [41]

--------------------------------------------------------------------------------

So if my comp number is right, somewhere around, let's say, it's $3 million to $4 million, was the Middle East shipment last year. Does that -- in this quarter, does that $3 million to $4 million number go to 0? Isn't that (inaudible)?

--------------------------------------------------------------------------------

Robert A. Wrocklage, Badger Meter, Inc. - VP of Finance & CFO [42]

--------------------------------------------------------------------------------

No. It's Bob. It is fair -- I mean, again, we're kind of splitting hairs here. But with the Middle East number of $3 million to $4 million, our international number a year ago was modestly higher than that $3 million to $4 million. And in the current year, it's basically $1 million. So the largest part is that nonrecurrence, but it is very, very small numbers.

--------------------------------------------------------------------------------

Richard Charles Eastman, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [43]

--------------------------------------------------------------------------------

Okay. No, I understand, I'm just trying to get the order of magnitude. And then there was a reference, Ken, to the run rate around BEACON recurring revenue, subscription revenue. Is that number started to register on the scale at all? I'm sure it's a big growth rate. But I'm curious, order of magnitude, is it a few million bucks. Is it -- what kind of number has that grown to?

--------------------------------------------------------------------------------

Robert A. Wrocklage, Badger Meter, Inc. - VP of Finance & CFO [44]

--------------------------------------------------------------------------------

Yes. So generally, we've been running -- obviously, you're right, exactly. Because it's running from a small base, you're seeing larger percentage increase currently operating right around 3% of consolidated revenues being that kind of recurring base and obviously, we've talked openly about, with the adoption of and the migration to AMI systems and also the adoption of cellular as a preferred technology. Internally, we measure to wanting that to be 10% of utility based revenues over our 5-year strategic plan. So that's not a secret. But we're sitting currently at about 3% of total consolidated sales.

--------------------------------------------------------------------------------

Richard Charles Eastman, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [45]

--------------------------------------------------------------------------------

Of utility sales?

--------------------------------------------------------------------------------

Robert A. Wrocklage, Badger Meter, Inc. - VP of Finance & CFO [46]

--------------------------------------------------------------------------------

3% of consolidated.

--------------------------------------------------------------------------------

Richard Charles Eastman, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [47]

--------------------------------------------------------------------------------

Total, okay, okay.

--------------------------------------------------------------------------------

Robert A. Wrocklage, Badger Meter, Inc. - VP of Finance & CFO [48]

--------------------------------------------------------------------------------

Total.

--------------------------------------------------------------------------------

Richard Charles Eastman, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [49]

--------------------------------------------------------------------------------

Fair enough.

--------------------------------------------------------------------------------

Operator [50]

--------------------------------------------------------------------------------

Your next question comes from the line of Richard Verdi.

--------------------------------------------------------------------------------

Richard A. Verdi, Coker & Palmer Investment Securities, Inc., Research Division - Senior Analyst of Water & MLP [51]

--------------------------------------------------------------------------------

So basically, my company-level inquiries have been addressed, but I just have a couple of broad questions remaining. I kind of heard from a few clients, they feel the ORION LTE-M technology is somewhat inferior to other technologies. And so can you kind of address why the company feels choosing the ORION LTE-M technology was best and kind of compare it to your peer offerings?

--------------------------------------------------------------------------------

Kenneth C. Bockhorst, Badger Meter, Inc. - President, CEO & Director [52]

--------------------------------------------------------------------------------

Yes. So I'm certain that the people who express that to you aren't our customers. So because the benefits are many, right? So initially, there's 0 infrastructure investment required to be able to ramp up an AMI system. There's no time-based limit where you have to build out that system first. You can continue to improve at the rate of technology with cellular, which evolves faster than a fixed network. And specific natural disaster communication issues, if you have a problem with your fixed network getting damaged, cellular comes up faster. There's a different rate with which you can pay your subscription fee for the Software as a Service, which our customers really value. So I'd love to spend a lot more time with you to explain that in more detail, but it is in no way inferior to the other options.

--------------------------------------------------------------------------------

Operator [53]

--------------------------------------------------------------------------------

Your next question comes from the line of Andrew Buscaglia.

--------------------------------------------------------------------------------

Andrew Edouard Buscaglia, Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst [54]

--------------------------------------------------------------------------------

Can you guys talk a little bit more about -- I know you're saying, you had some commentary in the call that municipalities are showing interest. You're encouraged by their interest level. How much of this is related to new technologies, like 5G coming online? How much of it is a function of how they feel about the environment? I'm just trying to get inside the mind of what municipalities are thinking right now. I'm looking out to 2020, kind of what -- where do you get confidence that things will improve?

--------------------------------------------------------------------------------

Kenneth C. Bockhorst, Badger Meter, Inc. - President, CEO & Director [55]

--------------------------------------------------------------------------------

Yes. So I think the way that municipalities are looking at AMI adoption is that it's helping them solve a lot of their problems, right? So it's helping them be more efficient in how they're able to do their billing reads. It's making them more in tune with supply-demand within their system. It's helping them identify leaks and conserve water, which is really important in several parts of the country and the world. There's many benefits to an AMI solution that are driving customers that way. And then on top of that, generally, they're feeling pretty good about their ability to spend money. So I think it's a convergence of the technology really is solving problems for customers at a time when they can spend money to do it.

--------------------------------------------------------------------------------

Andrew Edouard Buscaglia, Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst [56]

--------------------------------------------------------------------------------

Okay. Okay. And then you made a point on the prepared remarks to talk about your cash flow. And it really has been building over the last year. What are your thoughts on maintaining or letting that continue to build just to fortify sort of your balance sheet? Or what are -- if you are spending it outside of M&A, what kind of R&D or what kind of stuff would you be spending on exactly?

--------------------------------------------------------------------------------

Kenneth C. Bockhorst, Badger Meter, Inc. - President, CEO & Director [57]

--------------------------------------------------------------------------------

Yes. So we can start from the R&D front, and one of the things that we will continue to do is build out our Ultrasonic large meter line to have the full line on the Ultrasonic side. Second piece that we'll continue to work on is building the rest of world meter portfolio that we need.

Third thing, there will continue to be evolutions in cellular technology. LTE-M was the last. NB-IoT is also coming. We are working on releasing in the early half of next year our flow limiting valve, which we're getting a lot of great feedback from our customers. So there's a lot of great R&D actions, and continuing to build out our Software as a Service platform. If you recall, we acquired Aquacue in 2013. We've got a great team of software engineers out in Silicon Valley, and we continue to develop new ways to help utilities be more efficient and real time with software. So we have a full plate of R&D activities that we're excited about.

And then on top of that, we're going to continue to look for really nice M&A tuck-in and technology extensions, like we've done before with D-Flow and that we've done really good work with and similar with Aquacue. So we have plenty of great things that I think we can continue to invest in at the appropriate rate that our customers are looking for.

--------------------------------------------------------------------------------

Andrew Edouard Buscaglia, Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst [58]

--------------------------------------------------------------------------------

Maybe just one last one. We talked a little bit about the international markets, and you guys focus on a lot of discussions around the Middle East. What about the U.K.? Can you talk a little bit about that market, if you see that as a good opportunity for you too?

--------------------------------------------------------------------------------

Kenneth C. Bockhorst, Badger Meter, Inc. - President, CEO & Director [59]

--------------------------------------------------------------------------------

Yes. So the U.K. is certainly interesting to us. It's a market with 15 utilities. There's a lot of growing, I think, need and discussions there around AMI-type solutions. The fact that we have and are continuing to build out our rest of world meter offering, I think that will be an opportunity for us rolling forward as well as building on Middle East, some pockets of Southeast Asia. I mean that's just one area that we think we can play, but yes I think you're right about that.

--------------------------------------------------------------------------------

Robert A. Wrocklage, Badger Meter, Inc. - VP of Finance & CFO [60]

--------------------------------------------------------------------------------

And certainly, the legislative and regulatory environment there is definitely driving toward more smart metering applications. And so yes, right overall. I think what we've done internally is obviously had to rally the resources, infrastructure and channel to support that market, which is very early stages for us.

--------------------------------------------------------------------------------

Operator [61]

--------------------------------------------------------------------------------

Your next question comes from the line of Nathan Jones.

--------------------------------------------------------------------------------

Nathan Hardie Jones, Stifel, Nicolaus & Company, Incorporated, Research Division - Analyst [62]

--------------------------------------------------------------------------------

Still despite highlighting it in your slide show, nobody is talking about cash flow. So I'll talk about cash flow. It looks like a lot of the improvement here has been in payables and receivables. You did have pretty high levels of both in 3Q '18. Can you talk about -- a little bit more about the kind of process improvement that you've made, terms and conditions, potentially, that you've made on both the payables and receivables side that's driven that primary working capital number down to that kind of 27% level?

--------------------------------------------------------------------------------

Robert A. Wrocklage, Badger Meter, Inc. - VP of Finance & CFO [63]

--------------------------------------------------------------------------------

I really just think it's a bit more focused than has historically existed, and that's not to throw anybody else under the bus. I think it's just, with new perspective, come new processes. And so I think it's a little bit of motherhood and apple pie on the receivables side. It's just staying closer to collection status, having more frequent touch points with customers, really identifying pockets of payer behavior that we could improve, one area being on the flow instrumentation line of business in Europe, just having a renewed focus on historic agreements and terms. So very much motherhood and apple pie as it relates to receivables. And I would say the same holds true from a payables standpoint. I think we've long prided ourselves on being a good payer, and we'll continue to do that. I would just rather be a good payer at 60 days than I would at 30 days. And so we've taken a targeted approach with our supply base to identify top 100, top 150 type suppliers and pursue at what I'll call advantageous terms discussions about extending our payment terms, which I think is clearly very common within manufacturing. Just an idea we're bringing to the table now. So -- but you're exactly right. Those are the 2 pockets of improvements, and that's a big part of what we've been able to do here in the last, really, 3 quarters of that focus, and that's been a tailwind for cash flow and it's certainly contributing to 159% free cash flow conversion to net earnings perspective that we just talked about.

--------------------------------------------------------------------------------

Kenneth C. Bockhorst, Badger Meter, Inc. - President, CEO & Director [64]

--------------------------------------------------------------------------------

And if I could add, Nathan. So we -- I mentioned also that we've kicked off a sales inventory and operations planning system. So we're really investing in trying to make sure that we optimize our inventory so we can continue to keep the service levels that we have. But we certainly think we can do better on the inventory side yet as well.

--------------------------------------------------------------------------------

Nathan Hardie Jones, Stifel, Nicolaus & Company, Incorporated, Research Division - Analyst [65]

--------------------------------------------------------------------------------

So that was going to be where I was going next. I mean I normally think of world-class primary working capital management being at about 20% of sales. I would imagine Badger Meter, given the type of business, given that short turnaround that you can have on some of these meters, would require a higher level of inventory than that. So I don't think 20% would probably be too low and your service levels would suffer at that point. But 27% probably still feels a little bit high as well. If you are operating optimally, where would you think that, that primary working capital number should be?

--------------------------------------------------------------------------------

Kenneth C. Bockhorst, Badger Meter, Inc. - President, CEO & Director [66]

--------------------------------------------------------------------------------

Well, first, let me tell you why you're right that we would generally have a higher number. So as we believe, we pride ourselves on the choice that we offer our customers. We have the full line of mechanical meters, whether that's in brass or polymer. We have the Ultrasonic. So we generally are going to carry more inventory to support our customers with choice. So that's one.

Two, as we ramp up the Columbias and the Auroras, there are going to be specific times where we're ramping up inventory to handle some of these large integrations where we've not received any revenue yet. So those are a couple of factors that are pretty large on it. I think we can continually improve as a percent of revenue over the next few years. What the end point is, I don't know. But I do expect to get better every year.

--------------------------------------------------------------------------------

Robert A. Wrocklage, Badger Meter, Inc. - VP of Finance & CFO [67]

--------------------------------------------------------------------------------

So rearview mirror, we've operated in the high 20s, sometimes even at 30%. We'll never -- I'll never give you a 22.6% as the ideal level. But what we will be committed to is that continuous improvement. It just so happens that in the last 3 quarters, we've been able to move that number down 200 basis points. And we're pleased with that progress, but we're going to keep growing to enhance that each year through to a little bit of motherhood and apple pie and some systematic implementation of SIOP and other things that will drive impact further.

--------------------------------------------------------------------------------

Nathan Hardie Jones, Stifel, Nicolaus & Company, Incorporated, Research Division - Analyst [68]

--------------------------------------------------------------------------------

Okay. So maybe inventory is a little bloated at the moment as well based on Columbia and Aurora ramping up, and that might last through, I guess, early next year kind of thing and we should maybe expect to see the inventory roll down a little bit after those... run rate?

--------------------------------------------------------------------------------

Robert A. Wrocklage, Badger Meter, Inc. - VP of Finance & CFO [69]

--------------------------------------------------------------------------------

We're focused on all 3 elements of primary working capital, Nathan. So...

--------------------------------------------------------------------------------

Kenneth C. Bockhorst, Badger Meter, Inc. - President, CEO & Director [70]

--------------------------------------------------------------------------------

Thrilled with 160% free cash flow conversion year-to-date.

--------------------------------------------------------------------------------

Nathan Hardie Jones, Stifel, Nicolaus & Company, Incorporated, Research Division - Analyst [71]

--------------------------------------------------------------------------------

You know what Wall Street's like. We all want more.

--------------------------------------------------------------------------------

Kenneth C. Bockhorst, Badger Meter, Inc. - President, CEO & Director [72]

--------------------------------------------------------------------------------

I just thought I'd remind you of -- I thought I'd come back to remind you of that for a while. But no, your points are valid, but I think the thing that you should recognize is Bob and I and the rest of the team here, we've spent the majority of our career working on maximizing our cash. And so that's one. Bob just talked about new processes and different things, it's something that's in our DNA and we'll continue to work to improve it.

--------------------------------------------------------------------------------

Operator [73]

--------------------------------------------------------------------------------

(Operator Instructions) Your next question comes from the line of Tate Sullivan.

--------------------------------------------------------------------------------

Tate H. Sullivan, Maxim Group LLC, Research Division - Senior VP & Senior Industrials Analyst [74]

--------------------------------------------------------------------------------

I think it will help. Just can you give a little more clarity on the warranty provision in the quarter? I mean just -- it's outside the U.S. Can you talk about what a system integration module is? And last -- sorry for the list of questions, when was the last time you took a warranty charge in the U.S., if you can disclose too, please.

--------------------------------------------------------------------------------

Kenneth C. Bockhorst, Badger Meter, Inc. - President, CEO & Director [75]

--------------------------------------------------------------------------------

Yes, so first, I would just say that this is definitely an outlier, as Bob said before. It's a part that goes into a system that unfortunately didn't work. We've moved on, and we don't expect it to repeat. And in terms of U.S., I mean, yes, I mean we generally don't disclose. There's nothing large enough to disclose. I think we -- I'm looking at Bob now, but...

--------------------------------------------------------------------------------

Robert A. Wrocklage, Badger Meter, Inc. - VP of Finance & CFO [76]

--------------------------------------------------------------------------------

Let me just come back to just modify one thing to what Ken just said in terms of we moved down. When he says that, when we've moved on, is we're still supporting our customer. We're going above and beyond to support that customer and make sure we can make right the performance of that system and the communications of that system. We're doing what's right and we're encouraged by the fact that even with that, our gross margin profile still landed at 38.4% in the quarter, still in the upper half of our normalized range. But then to your secondary question, of course, just like any other manufacturer, we have warranty provisions. It's just this tends to be an outlier versus our normal rate of accrual.

--------------------------------------------------------------------------------

Tate H. Sullivan, Maxim Group LLC, Research Division - Senior VP & Senior Industrials Analyst [77]

--------------------------------------------------------------------------------

Is it a unique system to the foreign client and country or...

--------------------------------------------------------------------------------

Kenneth C. Bockhorst, Badger Meter, Inc. - President, CEO & Director [78]

--------------------------------------------------------------------------------

Yes. It was a unique system to that foreign client. And we've come out with a new product and it's behind us.

--------------------------------------------------------------------------------

Tate H. Sullivan, Maxim Group LLC, Research Division - Senior VP & Senior Industrials Analyst [79]

--------------------------------------------------------------------------------

Okay. Great. And just on that guided -- I think you've guided before gross profit margin range -- or I don't want to say guidance because you don't put up of about 38% to 40%. But your comments, I mean, without the warranty charge, you get back up close to last year's gross profit level of 40% and then you have BEACON growing, which I imagine is higher-margin. I mean should we stay with that 38% to 40% expectation?

--------------------------------------------------------------------------------

Robert A. Wrocklage, Badger Meter, Inc. - VP of Finance & CFO [80]

--------------------------------------------------------------------------------

What we've talked about openly is a normalized range historically of 36% to 40%, with copper where it's at today and some of the margin enhancement initiatives that we're focused on. We've talked about being able to tighten that historic range. But I continue to reinforce with investors and others and the like, that we're still operating in primarily a North American oligopoly. And so the expectation that, that range or that tight range continues to move to the right, I'll always use, it's not a stairway to heaven. We're still competitively in the marketplace in a 4-player oligopoly here in North America. And while we're rational and we're all good competitors, to think that we can keep stringing together margin expansion into the 40%, 41%, 42% range is just not realistic, over time. So I would keep you laser-focused on the upper end, of the upper range of that range, if you will, particularly with where copper is today.

--------------------------------------------------------------------------------

Operator [81]

--------------------------------------------------------------------------------

There are no further questions at this time. I'll turn the call back over to the presenters.

--------------------------------------------------------------------------------

Karen Bauer, Badger Meter, Inc. - VP of IR, Corporate Strategy & Treasurer [82]

--------------------------------------------------------------------------------

Great. Well, thank you all for joining our call today. For your planning purposes, our fourth quarter and year-end 2019 call is tentatively scheduled for February 5. I'll be around all day to take any follow-up questions you may have. Have a great day.

--------------------------------------------------------------------------------

Operator [83]

--------------------------------------------------------------------------------

This concludes today's conference call. You may now disconnect.