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Executives

Richard A. Meeusen – Chairman, Chief Exec. Officer and President

Richard E. Johnson – Chief Financial Officer

Ronald H. Dix – Senior VP of Administration

Analysts

[Scott Newmanfol] – [Emerald Advisors]

[Richard Birdy] – [Servant & Company]

Richard Eastman – Robert Baird

Steve Sanders – Stephens, Inc

[Bryan Ram] – [Morgan Demps and Capital]

Ryan Connor – Boenning

John Quealy – Canaccord Adams

Badger Meter Inc. (BMI) Q3 2008 Earnings Call October 16, 2008 11:00 AM ET

Operator

Welcome to the Third quarter 2008 Badger Meter earnings conference call. (Operator Instructions) I would now like to turn the presentation over to your host for today's call, Rick Johnson, Senior Vice President of Finance and Chief Financial Officer.

Richard E. Johnson

As usual, I will begin my 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 risks and uncertainties that can cause actual results to differ materially from those in these forward-looking statements.

Please see our 2007 Form 10-K for a list of words or expressions that identify such statements and the associated risk factors. Also, I will give you my quarterly reminder about 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 will continue our practice of not providing specific guidance on future earnings. We believe guidance does not serve the long-term interest of our shareholders. And, if you'll [permit] me to editorialize a bit, I would suggest that our guidelines do serve us well.

We want to remind you that we manage this business for the long term. Because of the upheaval in the financial markets over the past several weeks, I've received calls from some analysts, shareholders and others, who suggested that the company abandon its guidelines and tell them something that would give them an indication of our results.

When reminded about the Fair Disclosure rules, I was even told by one person that all of the rules were out the window. I politely disagree and suggest that continuing to manage for the long term, despite these bumpy economic times, will best serve the interest of our shareholders, in the long term.

With that said, let's now turn to the third quarter results. Yesterday after the market closed, we released our third quarter of 2008 Results. Net sales for the third quarter were a third quarter record $68.8 million, a 9.6% increase over last year's third quarter sales of $62.8 million. The increase was driven by higher sales of the company's utility products, including ORION sales to Chicago, and higher prices offset somewhat by lower sales of its industrial products.

Looking at the breakdown of sales, residential and commercial water meter sales represented 82.7% of total sales for the third quarter, compared to 80.4% in the third quarter of 2007. These sales were $56.9 million, and increase of $6.4 million over last years amount of $50.5 million.

Sales to Chicago in the third quarter of this year were nearly $4.4 million, versus only $200,000 last year. Commercial meters, excuse me, commercial meters also saw a nearly $2 million increase. While sales of the ORION products, which include Chicago, were relatively flat, there was an increase in Itron-related sales of 39%.

Even though this is the third quarter in a row where we have seen increase in our Itron sales, we do need to point out that ORION sales, even in this quarter, outsell Itron products by a nearly 2 to1 margin.

We continue to believe that ORION is the primary driver of our AMR business, and that recent increases in Itron sales are just a function of current customer mix. For commercial meters, about 0.67 of the increase is coming from volume increases, while the balance is coming from price increases.

Industrial sales represented 17.3% of total sales for the third quarter of 2008, compared to about 19% for the same period last year. Sales were about $400,000 or 2.9% less than last year's level. Most of our industrial product lines have been affected by the economy, and they've seen declines in sales through the lower volume. But, one exception to this is our increased sales of valves, which saw a 22% increase in sales, in Q3 over Q3 of last year.

Well, gross margin dollars between this year's third quarter and last year's, increased due to our higher sales. The gross margin percentage declined to 34%, from 36.1% last year. The decline was due primarily to the product mix in the quarter. Like last quarter, we saw more Itron sales, which have a lower margin than our own proprietary products.

Also contributing to the decline is the lower mix of industrial products, which have higher margins. Increased sales volumes, higher prices, and favorable warranty experience did negate some of the product mix impact.

Selling, engineering and administrative costs for the third quarter are $1.3 million higher than last year, which [inaudible] have consulting costs associated with sales process enhancements and planned increase research and development costs.

In addition, we have intangible amortization expense for the recently acquired GALAXY technology. The effective tax rate for this quarter is 33.8% compared to 36.1% for the same period last year.

We have now revised our annual full-year estimate to be 36.7%, and as such, we have a slightly lower effect in the third quarter, as we catch up to that annual estimate. The annual estimate can vary, due to the effect of foreign exchange on our U.S. taxes.

As a result of all this, earnings from continuing operations for the third quarter of 2008 were $5.8 million, compared to $6 million last year. On a diluted earnings per share for continuing operations, were $0.39 for this quarter, compared to $0.41 in the third quarter of last year.

I do want to make some comments about our financial condition. Given the recent events in the markets, and the credit crisis that appears to be taking place, I [did] want to reassure our listeners that Badger Meter is in sound financial condition.

As you know, in the beginning of the third quarter, we took some of our short-term debt and replaced it with a two-year, $15 million term loan at a Fed interest rate of 5.04%. For our interim or daily purposes, we issue commercial paper, which is backed by our principal line of credit.

That line of credit was set to expire at the end of this month, on October 31. I am pleased to tell you that just this week, we renewed that line of credit for another full year. We also continue to issue commercial paper.

Just yesterday, we issued 57-day commercial paper at an all-in annual interest rate of 4.8%. This demonstrates to us that there is still demands in the market for this type of financing. If for some reason this demand would cease to exist, we would be able to finance our short-term [needs] from the line of credit itself. We do not see this as necessary, but it is there, should we need it.

Our total debt level, as a percentage of total capitalization, is approximately 23% at September 30. We also did not believe the credit worthiness of any of our existing or potential customers will be significantly influenced by the current events of the market. As such, we believe all of our receivables as shown, are realizable. With that, I will now turn this over to our President and CEO, Rich Meeusen.

Richard A. Meeusen

Thank you, Rick. I'd also like to thank all of you for joining us today. Given the difficult economic environment that exists today, we are pleased with our third quarter results, which include record sales and comparable earnings to last year's very strong third quarter.

Our net income did fall short of analysts' consensus. But, those estimates were developed three months ago, and much has happened in the economy since then. And, as I said, we were also up against a very strong comparable, since the third quarter of 2007 was a record quarter for the company.

The weakening in our industrial products was to be expected, since that portion of our business is very sensitive to the overall economy. In past quarters, we have repeatedly stated that our water segment has not always been immune to the impact of the general economy.

We said that a deep recession could eventually have a negative impact on our water meter and AMI sales. I believe we're beginning to see some impact of the general economic conditions on our water business. As I stated in the press release, at this time it's too early to tell if this will have a prolonged effect on us, or if this is just a temporary impact.

We also have composite sale wins in the short term. The significant drop in copper and oil prices should translate into lower costs for castings and plastic resin. Many of our electronic components, including the ORION radio boards, are sourced from Europe.

The stronger dollar should also reduce the cost of those components. Although pricing in our markets continue to be very competitive, we believe that we'll be able to maintain pricing and improve margins, as these stable cost factors take hold.

There are a few other favorable near-term impacts for our business. First, we are currently moving into our new facility in Nogales, Mexico, which will enable us to take advantage of production efficiencies.

Also, although interest rates have risen, our relatively low debt structure somewhat mitigates these impacts. These are all near-term factors, and I'll again remind you that our results can be somewhat volatile from quarter to quarter.

But, as we said in the past, our primary focus is on generating long-term results and long-term growth in shareholder value. We believe that our long-term strategies are still sound. Over 80% of our business is in the North American water market, which continues to represent our greatest opportunity.

Our leadership position in both metering and the AMI aspects of this market allows us to capitalize on these opportunities. We continue to invest in long-term R&D projects, to improve our ORION and GALAXY product offerings, as well as improving the basic meters themselves.

Badger Meter has a strong balance sheet. Our fiscally conservative approach has allowed us to increase our dividend 22% this year, while still maintaining a debt-to-capitalization ratio below 25%. We believe that we are well positioned to manage and even grow through these difficult economic times.

So, let me conclude by repeating that given the current economy, we are pleased with the results for the quarter, remain optimistic of our long-term opportunities. At this time, we'll take any questions you may have.

Question-and-Answer Session

Operator

(Operator Instructions) And, your first question comes from the line of John Quealy from Canaccord Adams. You may proceed.

John Quealy – Canaccord Adams

Hi, good morning, Rich and Rick, a couple questions. On the outlook, you did talk a little bit about water. Can you give us a little bit more detail? Was it manual read? Was it AMR? Was it commercial? What part, or is it broad-based that you're seeing on the water side, in the headwinds that you're getting?

Richard Meeusen

Oh, I think it's probably more of the AMR side, only because there's a – excuse me, I'm [death warmed] over today – only because those are generally longer lead times.

Unidentified Corporate Participant

But, you see Mark, it's not even so much delays, whether it's an announced delay. We're just seeing a longer sales cycle on some of these projects.

Richard A. Johnson

Yes, this is Rick. Let me make one thing clear about our reference to near-term projects. We have not seen any of the current projects that are in process being cancelled or pushed out. What we did start seeing, in September, anecdotally from the field sales [force], were that some of the projects that were in the pipelines that were coming in the near term, some of those cities – and it's not widespread, that's why we use the word, "some".

Some of those cities are starting to delay because of the current economy and just saying we're not sure what's going to happen. We don't see any projects going away. We're not aware of any projects that have been canceled. It's just some of the cities have said we're not ready to start yet. We want to see what's happening with the economy.

John Quealy – Canaccord Adams

And, then, in terms of the industrial side, obviously a lumpier business, a much easier correlation to make, with regard to your results this quarter. I would imagine that weakness should pervade or at least the headwinds should pervade in that side moving forward, as well.

Richard A. Meeusen

I think that depends upon the economy, but if we continue to have an economic slowdown in the industrial side of the business, in the industrial markets, that will impact our business. Now, the exception to that is [valve].

Our valve are – we have seen increased sales in valves. Our valve business is still strong. A lot of our valves are sold into the petrochemical industry, and that's where we're seeing a lot of strength.

John Quealy – Canaccord Adams

And, if I can ask you a follow-up to one of the comments you made about positioning Badger to even grow during difficult times. Can you give us some sort of flex or range of impacts, in terms of if this is the short-term pause, what that does to the business? Does it continue to grow on the top line, the bottom line, or is it a longer-term pervasive cycle? Can you give us an idea of how you look at the flex in the model, given those two scenarios?

Richard A. Meeusen

Well, I'm not sure if you're asking me to give short-term guidance. I won't do that, and I'm uncomfortable doing it. You know our position is that we believe our basic strategies are so strong that we continue to operate in a market that has strong, long-term fundamentals. The demand for water, the need for metering, the efficiencies caused by AMR or [inaudible] that could be created by AMR all of those factors are still driving our fundamentals. And we think we are still in a good position with the right products and we should over the long term be able to generate good results. I'd really can't comment on the near term.

John Quealy – Canaccord Adams

I should have asked it a different way. If you go back and look at water business sales over the past eight years, year on year they've generally held up and grown even in a couple different economic cycles. Is there anything about what you are hearing from your channel that would suggest differently, this time Rich?

Richard E. Johnson

We're not hearing anything differently and but I'll point out that looking over the last eight years, we have said in the past that when the economy hits a rough spot there has been some impact.

So when you say it's held up I think if you look back at 2000, 2001, particularly, you will see there was some decline in the market. There was some delaying of projects by cities. They certainly didn't cancel any thing; it was just a temporary delay.

So I wouldn't say that were immune to that. I would not say we've been immune to it over the last eight years. And we may see some impact now.

John Quealy – Canaccord Adams

Okay, my last question, the Itron agreement is coming up for renewal, can you give us an update on how that process is going to work, as we get into 09?

Richard E. Johnson

Yes, we've already started conversations with Itron, early indications from Itron are that they are very interested in renewing the contract and it's just a matter of working out the details.

John Quealy – Canaccord Adams

Okay, thanks guys.

Richard E. Johnson

Okay.

Operator

And your next question comes from the line of Richard Eastman from Robert Baird, you may proceed.

Richard EastmanRobert Baird

Yes, just a couple questions, Rich can you just talk to the commercial meters strength. Is that a function of some trailing projects or what's the visibility there, and why is that business remain so strong?

Richard E. Johnson

The commercial meter's very often go along with the residential meters on big projects, like we are selling commercial meters to Chicago, just as we are selling the residential meters.

However, there are a few cities that will source their commercial meters separately from residential meters. There are a lot of unmetered cities where the residential meters – where they don't have residential meters, that they will buy commercial meters.

I think we are seeing some good strong demand from cities that are upgrading their infrastructure on the commercial side. Especially cities that are selling water to other cities, that's where you see a lot of demand for the very large turbo meters. And that's really what's been driving it.

Richard EastmanRobert Baird

Okay, and then on the gross margin side. If we look at this 34% in a quarter understanding it's primarily mixed, is there any reason going forward – as we move forward over the next few quarters, certainly fourth quarter being seasonally weaker quarter, anyway.

Is there any ability on your part to move that margin higher, in a step function fashion if the mix doesn't change much?

Richard E. Johnson

I think there is Rick, because as I said, you have not yet seen in the margin the impact of the recent declines in copper prices or oil prices.

Richard EastmanRobert Baird

Okay.

Richard E. Johnson

And those two in particular and the stronger dollar all of those should translate into lower costs for us if they remain low. Right now anything that happens in the third quarter really ended up just in the inventory evaluation, and didn't get out into the field, because we are on a [inaudible] base.

So, we expect to see some favorable impact from that. Now of course, that could be offset by mix depending on what goes forward.

Richard EastmanRobert Baird

Yes, okay, and then can I also ask Rich, what's your conviction here that the pricing environment in this cycle, assume it stays – that the man stays weak here for whatever 12 months, your conviction that pricing –the pricing mentality won't revert back to what we've seen in the past, where we start to discount for volumes, - how do you have any conviction on that in this cycle?

Richard Meussen

I think that's a valid question. And we saw a ten year period in this industry where every year pricing went down. Now, that was driven by a combination of electronics getting cheaper and that happens on the AMR side. And just, very tough competition out in the marketplace.

The competition hasn't gone away and of course, the electronics do continue to get cheaper. But we were able to pass on some significant price increases over the last couple years, as the commodity prices went up, and as our competitors followed us on those price increases.

I believe that we have an opportunity going forward to hold onto some of those price increases even in light of lower commodity prices. But a lot of that is going to depend on upon the rational actions of our competitors.

So obviously, my conviction depends on whether or not the competitive environment remains reasonable.

Richard EastmanRobert Baird

And have the distributors – distributor network have they responded in short order to maybe the softening demand, I mean should we suspect that their work their inventory down a bit as we head into the fourth quarter. Maybe making this seasonal impact to the fourth quarter maybe a little bit more extreme.

Richard Meussen

I don't have any indication from the distributors of any plans to reduce inventory or any adjustments of that sort.

Richard Johnson

And this is Rick that a lot of the distributors a lot of what we make is what we call math customization. It's made for particular customers of the distributor. I mean they carry some stock inventory to help replenish but it's not where they you know, this is not like an automobile dealership where they've got cars on the lot.

So for the most part, that's never been an issue for us.

Richard EastmanRobert Baird

Okay and just one last question, we talk about some of the project delays or deferrals in the short term at least the longer selling cycle can we defer from that – that there should not be any disruption in Chicago shipments, is that very much on schedule?

Richard E. Johnson

Absolutely, right now Chicago is on schedule, it's moving forward as planned. The only delays that we get in Chicago are access delays, where sometimes it's hard to get into a house.

But frankly, we are very pleased with the sales levels and the progress we are making down there.

Richard EastmanRobert Baird

Okay, very good, thank you.

Richard E. Johnson

Sure, Rick.

Operator

Your next question comes from the line of Ryan Connors from Boenning you may precede

Ryan Connor - Boenning

Good morning, guys.

Richard E. Johnson

Good morning, Ryan.

Ryan Connor - Boenning

I just wanted to start off on drill down the issue of Itron resale's, for a couple minutes. I mean it’s the second kind of quarter in a row that you kind of seen that. And I know one of the things that we've heard, is apparently they've got sales people and so forth out there saying that they've really improved their [sealants] their technology, which historically has been a big selling point for Badger.

And that therefore, they've taken away competitive advantages, and I just wanted to get your thoughts or your comment on that. In particular, is that true, have they gained ground down there. And then, is that potentially any reason why in the short term there seeing a little bit more strength at least on the relative basis versus Orion sales?

Richard E Johnson

This is Rick, and I'll let Rich comment about the [sealant]. But I do want to – on the Itron sales. I mean, we have traced increases for the past several quarters, back to a handful of existing customers. No new Itron customers, just existing customers that are either accelerating projects or attempting to finish them.

So from a sales standpoint, were still confident that Orion is the dominant player in the industry. But what I will say and we did look into this, over the last few days. The indications from the field are that Itron has corrected some of the very significant problems they had with their [pit unit]. And that their new [pit] unit, the 60W that they have released is performing well in the field, and this is causing some customers that had already committed to Itron, or in the middle of Itron installation, put a hold on those installations until this problem was resolved.

It's now caused them to restart up their Itron program and we are seeing some of that impact. So yes' I would have to agree that Itron has improved their [pit] unit and it's performing well. Now that having been said I would not say that Itron is taking market share away from Badger Meter.

Because they've now fixed their problem, there's still a lot of concern out there and we believe that the Orion product, is still a superior product. But we sell, both Itron and Orion. There are customers who for various reasons have a preference for Itron, and we are certainly going to fill those customers' needs. And we are going to continue to move forward with Itron as a partner.

We think that the 60W product they have is a good product and it's going to work well for a lot of customers.

Ryan Connor – Boenning

OK that's great caller thanks for that Rich. And another thing on the AMI side how does – you talk about some project delays on some new AMR role out. How does AMI fit into this sort of macro situation, I mean, you know the capital investments is presumably higher and so you would think that the AMR may have re-impacted people would really try to back off of AMI's rollouts. I mean are you seeing that and is that impacting your outlook for Galaxy?

Richard A. Meeusen

I don’t think its impacting the outlook for Galaxy anymore than it is for Orion. In other words, when we talk about projects that were in the pipeline that are being delayed a little bit, I would apply that to both Galaxy and Orion, to both the drive by the AMR product and to the network of the AMI product.

The AMI has always had a longer sales cycle than AMR. There is a requirement to identify where you place the towers. There is a requirement to do propagation studies. It is a more complicated sale and it does require more time.

So we've always had a longer lead time but we have seen no projects that were in our pipeline get taken off the table, so we're still pretty confident that we're going to see a lot of network projects going forward.

Again as we said in the past, we believe in the water industry, drive-by will be the dominant technology for a long time to come. Its where all the city really wants is a read, drive-by is the most efficient way to get that but where cities are looking at for more features and more information, then AMI, the network technology, that [inaudible] represents makes a little more sense.

Ryan Connor - Boenning

Okay, just wanted to revisit the industrial side for a second. I know you do sell some product into the auto end market and obviously they’ve been enduring some tough times there. How big a factor was the automotive end market in applications in terms of the year-over-year, I guess, decline in revenue for industrial?

Richard E. Johnson

Well, for the quarter, automotive was down to low double digits, okay, driven primarily by volume and we've had volume declines in that business. For the year, it's actually, its down volume wise but it's only down maybe about three or four percent revenue wise year-to-date.

So it's really the quarter that took a hit for automotive.

Ryan Connor - Boenning

Okay, is that sort of the worse of the end markets in that industrial business? Or –

Richard E. Johnson

It's among them.

Richard A. Meeusen

Yes, and bear in mind that automotive represents about three or four percent of our sales.

Ryan Connor - Boenning

Right.

Richard A. Meeusen

So it is not a huge piece of our sales but it is one of the ones that has been hit the most.

Ryan Connor - Boenning

Okay, that’s great. Then just one final one, I guess for you [Rick], the tax rate looked a little bit lower in the quarter. Can you talk about your current assumption for '08?

Richard E. Johnson

Yes. Well, we think its going to be 36.7% for the year and every time we get to the end of a quarter we estimate what we think it is for the full year and we adjust to get to the year-to-date amount.

Since we had a higher estimate at the end of the second quarter, we did take – there was a little bit lower affected tax rate in the third quarter. It's our best estimate at this point in time.

Ryan Connor - Boenning

Okay, great. Well, that’s helpful. Thanks for your time, guys.

Unidentified Corporate Participant

Okay.

Operator

(Operator Instructions) Your next question comes from the line of [Bryan Ram] – [Morgan Demps and Capital].

[Bryan Ram] - [Morgan, Demps, and Capital]

A question for you on the commercial meter side, what is the sales cycle. Now if you look at the residential side, you guys have always said that the inaccuracies of the meter, it's about 15 year life cycle, about 6% replacement per year.

What's the kind of the metrics of the commercial meter cycle as far as life span and that?

Richard A. Meeusen

Right. Most of the commercial meters is – the commercial meters come with the same 20 year warranty as the residential meters. I think we see most of these change in all commercial meters a little slower than residential so residential maybe on average has a 15 year life, commercial might be 17 but it isn't very different.

I guess that’s kind of the metrics.

[Bryan Ram] - [Morgan Demps and Capital]

Okay. Okay. Relative to how you see installations, [Rich], do you see cities, and you had mentioned certainly cities that export water, would a city install a commercial or replace a commercial meter system first and then install residential. Is it offsetting? Is it – just a sense of whether its kind of pre or post the residential repair?

Richard E. Johnson

Well, I can't really say either one. I mean it…

Richard A. Meeusen

There is no standard answer.

Richard E. Johnson

There is no standard answer. It's all over the board, right.

[Bryan Ram] - [Morgan Demps and Capital]

Okay, okay. From a pricing standpoint, you guys mentioned certainly talking about the discounting. Is there more or less elasticity with the municipalities on the larger turbo meters versus if you get into a period of time where obviously your commodities feedback costs are coming down, is there more pressure? Is there a differentiation between your ability to hold prices in commercial versus residential?

Richard A. Meeusen

I don't think there is any difference, [Bryan]. I think they're both about the same.

[Bryan Ram] - [Morgan Demps and Capital]

Your sense of – you're talking about the normalize obsolescence on the residential side, with the delays, certainly budget issues, is there any possibility that you might see more migration to plastic meters?

Richard A. Meeusen

I'm not sure that the plastic meter would be that different going forward. The main reason why the cities are choosing the plastic meters is not across factor. It's more because they're lighter, easier to work with, and you don't have the vandalism issues with plastic meters that you have with the bronze meters.

I mean that’s why Chicago made those choices. If price sensitivity increases going forward we may see a move more toward to our LP meters which is the new meter that we introduced that uses about a third less copper than other meters.

So we may see an increase there but frankly, and if there is a drive to low lead, to a greater drive to low lead because the LP meters are all the low lead meters. But frankly, I don't see a movement to plastic just based on price alone.

[Bryan Ram] - [Morgan Demps and Capital]

You talked about the number of cities that were potentially delaying in the bid "cycle." Is there any size, geographic location, any specificity that you'd see, you know the eastern seaboard versus say the oil patch –

Richard A. Meeusen

No.

Ronald H. Dix

And they were all antidotal stories. I mean it's just – in the month of September we just kept getting this city is going to reduce their budget next year. I mean it’s a story here, a story there and by the way, that’s how we get a lot of market information.

[Bryan Ram] - [Morgan Demps and Capital]

Sure.

Ronald H. Dix

Is it indicative of a trend? I can't say for sure. That’s why we're hedging a little bit on the timing question.

Richard A. Meeusen

And it certainly, I don't want to give the impression that it was wide spread, it wasn’t. It was just a few cities that we heard about and we felt it was important to at least mention it in the press release so people were aware that – for three quarters, we've been seeing – we have not been seeing the impact of any economic slowdown.

We felt given the fact that we made those statements in the past, since we had some antidotal evidence, we owed it to the markets to at least make reference to it. So we really – let me add, we've been in tough economic times for a year, all right, and really what we've said is the story of water was outweighing the economic downfall. Now we're – in the past couple of weeks, we're in uncertain times.

How that plays out over the next even month or two is still yet to be determined.

[Bryan Ram] - [Morgan Demps and Capital]

From the standpoint of some of your feed specs, I know you don't talk about copper prices but if you look at oil and gas and relative to resident cost. You look at copper prices.

Can you give us a sense timing wise when those savings will start to flow through? Are we talking quarters, months, half a year?

Ronald H. Dix

Generally it takes a couple of months from the time we see a movement in our commodity prices until the time it turns into a cost of sales for us.

[Bryan Ram] - [Morgan Demps and Capital]

Okay. Okay. Anything on your value strength? Is there any thoughts, possibilities of adding more capacity? You mentioned I think the [Penzer] chemical values or is that just a niche business that’s you have a fancy there?

Ronald H. Dix

It’s a niche business and we have plenty of capacity.

[Bryan Ram] - [Morgan Demps and Capital]

Okay. Okay. You also mentioned too the start up on Nogales. Can you put a little more color relative to how many ships you're running, what's the status of operations there?

Richard A. Meeusen

Yes, we've – just for people who aren't familiar with it. We have a 60,000 square foot facility in Nogales that we lease. We have recently completed construction of a 120,000 square foot facility.

We are moving out of the 60 into the 120, into the new building so the lease cost will go away. The new building gives us much needed space as we've grown over the past year. It's gotten very tight there.

We are running three shifts down there. And also the additional space that we have down there gives us the opportunity in the future to shift more work down into the Nogales facility and that should help us reduce our costs.

[Bryan Ram] - [Morgan Demps and Capital]

Okay. One final one. [Inaudible] we get into a situation certainly here we've had virtually boundless long economic expansion since Ronald Regan was in the White House. If we get into a longer duration economic downturn here, not months, but longer certainly than a year, how does that impair your – you guys have always been a fairly high R&D spender, a new product prototyping, cycle time, efficiency.

How does that affect kind of the new product design?

Ronald H. Dix

Frankly I think it won't because even during past economic downturns, Badger Meter has continued to spend on R&D a fairly stable level. And frankly we maintain a very long-term outlook.

Our R&D projects are primarily related to products that won’t be introduced for another two or three years. So you know for us to cut R&D’s it has an impact down the road.

And we have no intention of doing that. Let me also say that you know I think Badger Meter is better situated to weather a long term economic downturn then a lot of other companies. The majority of our sales are replacement sales, both in meters and now in AMR.

And so we’re very confident that we’ve got a good base of business that will continue and Badger can continue to generate profits going forward. Also our balance sheet is very strong compared to other companies and so we’re not concerned about liquidity going forward. So given those two facts I would see no reason why we would cut back on R&D.

[Bryan Ram] - [Morgan Demps and Capital]

Okay good, good. Relative to again to the same scenario longer duration, if your bringing a look at your kind of your forward pipeline of new products is the adoption cycle tougher for municipalities with new state of the art technology and new product that you bring to the market in a recession versus an expansion?

Richard A. Meeusen:

I don’t know how I would even answer that. I’m not sure if it would be or if it wouldn’t be. I –

[Richard E. Johnson]

Depends on the customer, depends if their meter readers are unionized, and I mean just – there’s a lot of factors (Brian).

Operator

And your next question comes from the line of Steve Sanders – Stephens Incorporated. You may proceed.

Steve Sanders - Stephens Incorporated:

Good morning.

Unidentified Corporate Participant

Good morning.

Unidentified Corporate Participant

Morning.

Steve Sanders - Stephens Incorporated

Just had a follow-up. Rich I think last call you talked about 40% of water meters being at large, utilities 40% sort of midsize, and 20% small.

Richard A. Meeusen

That’s right.

Steve Sanders - Stephens Incorporated

So a couple of questions in prior downturns did you see the behavior of the large versus the medium and small to be notably different?

Richard A. Meeusen

No we didn’t. I think when we see a slowdown we see it across the board. So we don’t see a change in behavior between the size of the utility.

Steve Sanders - Stephens Incorporated

And given the credit market issues do you think this cycle at this point looks any different if in fact that turns out to be the case you know in other words does tightness in the credit markets have more of an impact on medium and small guys versus the large guys? Do you have a view on that?

Richard A. Meeusen

Well Steve if your asking me if this downturn is different from past downturns gee I would love to know the answer to that. Because I think everybody on Wall Street is asking that question right now.

I hear some people saying we’ve never seen this before and this is totally different. I’ve heard other people say well we’ve seen it before and it’s going to act like the last one. I really can’t answer I don’t know.

Steve Sanders - Stephens Incorporated

Ok, and I think you gave the answer I may have missed it. What’s the lag on copper and resin if we – as we see?

Richard A. Meeusen

Yes, it’s a couple months Steve, before it gets through the smelter. In the case of copper before it through the smelter, the foundry into our shop, turned into a meter, and shipped out the door.

Steve Sanders - Stephens Incorporated

Ok, and then on the Galaxy side you mentioned some traction. Can you provide a little bit more color there and maybe talk about what you’re seeing in gas versus water?

Richard A. Meeusen

Well let me comment on both of them. We are starting to see more Galaxy sales and we’re starting to see more Galaxy projects in the pipeline. So we’re pleased with that. We knew that this product would take a while to take off and our sales people are out there and we think we’ve got some good opportunities coming down the road.

As far as gas its pretty much the same story. Gas was an easy one for us because we didn’t have to make a big investment to convert ORION from being able to read water meters to being able to work on gas meters. It was a relatively low investment as compared to the Galaxy product.

But on the other hand we believe that there’s a huge potential for the gas only utilities that want a gas drive by solution. And ORION for gas is exactly that product and we think it can do very well. Again we’ve got a few projects in the pipeline that we’re chasing.

Steve Sanders - Stephens Incorporated

And then Rick did you give operating cash flow and cap ex data for the quarter end? If not could you?

Richard E. Johnson

Well we’re still generating cash from but he’s handing me the numbers now. But I think we generated – let me blow my nose here –

Richard A. Meeusen

Rick is getting a cold so you have to forgive him for a moment here.

Richard E. Johnson

And bad eyes.

Richard A. Meeusen

Yes and bad eyes.

Richard E. Johnson

We generated $17 million cash from operations in the first nine months that’s down a little bit from what it was for the first nine months of last year. That due in part to the fact that inventory grew.

Inventories grown for a couple reasons. One is in anticipation of this plant move, we did some buildup. We had some obvious there’s some higher cost in there. And now that Chicago’s fully operational we actually have some inventory already staged down there ready for installation which results in increase in inventory.

So really if we didn’t have that buildup in inventory we would probably even be generating more cash.

Steve Sanders - Stephens Incorporated

Ok. And CapEx?

Richard E. Johnson

And CapEx is about $10.5 million for the first nine months of which maybe $5.5 million of is it for the Mexican building.

Steve Sanders - Stephens Incorporated

Ok. Ok thanks very much.

Richard E. Johnson

Not a problem.

Operator

Your next question comes from the line of Richard Eastman- Robert Baird. You may

Richard Eastman-Robert Baird

Yes, just a quick question. Rich or Rick could you just talk to the net price capture in the quarter you know on the utility side of the business? I mean do you think it’s a point or two or three or?

Unidentified Corporate Participant

I think Rick it varies. I mean we obviously got more price capture with commercial meters simply because there’s more metal content.

Unidentified Corporate Participant

Okay, whereas maybe with and with local Rick because quite frankly that’s you know it’s a smaller dollar amount of a sale therefore metal is the higher component. Whereas maybe you know with the Itrons and the ORION it varies depending upon the customer.

Richard Eastman-Robert Baird

Okay. But you it’s a positive number though correct?

Unidentified Corporate Participant

Yes.

Richard Eastman-Robert Baird

Okay. And then just one other thought. Rick would you happen to have your operating expense in the quarter was it like $14.2 million the actual number?

Richard E. Johnson

Yes.

Richard Eastman-Robert Baird

Okay and then just one last comment.

Unidentified Corporate Participant

[inaudible] on the issue how’s that?

Richard Eastman-Robert Baird

That’s fine. One last comment much appreciated for getting rid of [mecca plus] when you did. That would be painful right now I suspect.

Unidentified Corporate Participant

Point taken.

Richard Eastman-Robert Baird

Thanks. See you.

Operator

And your next question comes from the line of [Richard Birdy] – [Servant & Company]. You may proceed.

[Richard Birdy-Servant & Company]

Most of my questions have already been answered I just have one quick housekeeping question. Can you give me an exact number for [intruse] expense for the quarter?

Richard Meussen

Rick is looking.

Richard Johnson

Not on this sheet. Stand by. In fact I’ll tell you is that the only question?

[Richard Birdy-Servant & Company]

Yes.

Richard E. Johnson

Why don’t we go on to the next question and I’ll announce it?

[Richard Birdy-Servant & Company]

All right. There you go.

Richard E. Johnson

We’ve got it. Here it is. $379,000.

Operator

Your next question comes from the line [Scott Newmanfol], – Emerald Advisors], you may proceed.

[Scott Newmanfol] – [Emerald Advisors]

Good morning thank you for taking my question.

Unidentified Corporate Participant

Good morning.

[Scott Newmanfol] – [Emerald Advisors]

Could you repeat the information [Rick] on the line of credit you said you were new to principal. What was the capacity there?

Richard E. Johnson

It’s $30 million line of credit. That’s our principal line of credit.

[Scott Newmanfol] – [Emerald Advisors]

Okay, thank you for that. And just one question one Nogales. You’re basically going to be doubling capacity and I think that [Rich] mentioned that you’re running three shifts full out so do you think that in the current climate you may be asked or inclined to lean on that facility a little bit more to get some cost improvements? And can you tell us what exactly it is that you’re making down there?

Richard Meussen

Sure. First off what we’re making down there is all of the registration and the radio board. And also all of our plastic meters are being made down there. Here in Milwaukee we still make the west side of the meter the bronze castings with the plastic inserts and the chambers and disks and all of that.

So it’s a lot of electronic assembly down there, it’s some plastic molding, but it’s a lot of assembly of parts and electronic assembly. Just so there’s no confusion we are not – when you say we’re running full out down there – we are only using probably right now about 80,000 of the 120,000 square feet.

So we have room – we have square feet to grow ok. And we are running three shifts but expansion down there is relatively easy for us since it’s primarily electronic assembly it’s not a lot of capital equipment.

It’s a lot of tables and it’s a lot of people but it’s not a lot of capital equipment. So we are very – it’s a facility that we can flex production very easily. We can either increase production or decrease production without incurring a lot of cost.

Unidentified Corporate Participant

When we talked about running three shifts it’s really plastic molding machines, which are just capital in nature and it’s just better to keep them running around the clock.

[Scott Newmanfol] – [Emerald Advisors]

Right.

Unidentified Corporate Participant

You get the most value that way.

Unidentified Corporate Participant

The highest value of production is coming off of the day shift. We have a few things going on at night just where we want to pick up some additional production.

[Scott Newmanfol] – [Emerald Advisors]

Do you got a resin cost advantage since petroleum is at least it’s my impression it’s a little bit less expensive in Mexico than it is in the United States. Is that helping you at all?

Unidentified Corporate Participant

No we sort our resin all through the U.S. And I’m not aware of any cheaper resin that can be bought in Mexico than in the U.S. I think it’s kind of a world price.

Operator

This concludes the question and answer portion of the call. I’d now like to turn it over to Rich Meussen for closing remarks.

Richard A. Meeusen

Yes I’d just like to say that you know given the economic condition – the economic situation that we’re in right now and seeing that a lot of other companies are struggling with liquidity and with significant sales and earning decreases, we’re very pleased with where the quarter came out and we still feel that all of our long term strategies are valid.

And that we believe that we can continue to grow the company and do well over the long term. Badger has always had some volatility in the short term but we believe we’re well positioned to take advantage of the market drivers. I also want to thank everybody for listening in today and we’ll talk to you next quarter.

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Source: Badger Meter Inc. Q3 2008 Earnings Call Transcript
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