Badger Meter Inc. Q3 2009 Earnings Call Transcript

Oct.20.09 | About: Badger Meter, (BMI)

Badger Meter Inc. (NYSE:BMI)

Q3 2009 Earnings Call

October 20, 2009; 11:00 am ET

Executives

Rich Meeusen - Chief Executive Officer

Rick Johnson - Chief Financial Officer

Analysts

Steve Sanders - Stevens Inc.

John Quealy - Canaccord Adams

Carter Shoop - Deutsche Bank

Ryan Connors - Boenning & Scattergood

Eric Stine - Northland Securities

Rob Mason - Robert W. Baird

David Woodburn - ThinkEquity

Brian Rafn - Morgan Dempsey Capital

Gary Lenhoff - Ironwork Capital

Glenn Wortmann - Sidoti & Company

Scott Graham - Ladenburg Thalmann & Co

Brian Bechmen - Lyon Street Capital

Sig Bowman - Divisor Capital

Operator

Good day ladies and gentlemen, and welcome to the third quarter 2009 Badger Meter earnings conference call. My name is Mariso and I’ll be your operator for today. At this time all participants are in a listen-only mode. We will be facilitating a question-and-answer session at the end of the conference. (Operator Instructions).

I would now like to turn the presentation over to Mr. Rick Johnson, CFO. Please proceed.

Rick Johnson

Thank you very much Mariso, and good morning everyone. Welcome to Badger Meter’s third quarter conference call. I want to thank all of you for joining us. As usual, I will begin by stating that we will make a number of forward-looking statements on our call today.

Certain statements contained in this presentation as well as other information provided from time to time by the company, or its employees may contain forward-looking statements, that involve risk and uncertainties that could cause actual results to differ materially from those in these forward-looking statements. Please see yesterday’s earnings release for a list of words or expressions that identify such statements and the associated risk factors.

Let me reiterate some of our guidelines. For competitive reasons, we do not comment on specific individual product line profitability, other than in general terms, nor do we disclose components of cost of sales; for example, copper. More importantly, we continue our practice of not providing specific guidance on future earnings. We believe guidance does not serve the long-term interests of our shareholders.

Now, onto the results. Yesterday afternoon after the market close, we released our third quarter 2009 results. As you look at those results, you see that we’ve reintroduced the caption, discontinued operations, in the income statement.

The third quarter results include recognition of previously unrecognized tax benefits for certain deductions that were taken on prior tax returns related to the shutdown of the company’s front subsidiaries back in 2006. At the time the losses were incurred, there was uncertainty over whether the company would be able to sustain the deductions on the tax returns. The IRS has recently completed their audit and allowed those deductions.

As a result, the tax benefits associated with these, totaling nearly $7.4 million, were recognized as earnings from discontinued operations in the third quarter of this year. On a diluted basis, earnings per share from discontinued operations for the three months ended September 30 were $0.49.

Now, in addition, interest expense has been accruing on the potential liability, and with the completion of the audit, these amounts have also been reversed. Since the interest has been accruing as part of continuing operations since 2007, the reversal of interest expense is also shown as part of continuing operations. For the three months ended September 30, 2009, interest expense has a credit balance because it includes a reversal of nearly $1.2 million worth of interest expense.

On a net after tax basis, this equals approximately $0.05 per share. For the nine months ended September 30, 2009 interest expense as credit because it includes a net reversal of approximately $900,000. On a net after tax basis, this equals approximately $0.04 per share.

With that explanation behind us, let’s focus on the reminder of continuing operations. In the third quarter of 2009, we saw an 11.6% decline in sales over the third quarter of 2008 and yet we had record third quarter earnings and earnings per share.

The results for the third quarter was similar to those of the second quarter. The revenue decline was caused by lower sales volumes of our products. Total sales were $60.8 million, a decline of $8 million from $68.8 million last year. Utility sales declined $5.1 million or 9% from $56.9 million to $51.8 million this year.

Residential sales declined 7.7%, while commercial related sales declined 14.4%. Orion and Itron related sales declined 12.7% and 9.5% respectively compared to the third quarter of 2008. The Orion related products continued to outsell the Itron related products by a ratio of nearly 2:1 in the third quarter of 2009.

While current economic conditions may be contributing to this sales decline it is our belief that it’s more likely due to the delays associated with Federal Stimulus programs. We continue to hear stories of companies who are prepared to make a purchase from us, but not wanting to make a decision until they know for sure what the rules are for obtaining those funds.

In the quarter Chicago sales were $3.5 million compared to $4.4 million last year, while the sales are down from the same period last year, the project is still progressing. It is our understanding that decisions regarding the future phases of this project will more likely than not be deferred until 2010. Industrial sales for the quarter were $9 million, a decline of $2.9 million or 24% from sales of $11.9 million in the third quarter of 2008.

The product lines that make up the industrial area continue to struggle due to economic conditions. Gross margins increased in the third quarter, both on an actual dollar basis as well as the percentage basis. Margins for the third quarter were 39% compared to 34% in last year’s third quarter.

We continued to see a favorable impact from the reduction in commodity costs particularly copper, in addition continued focus on all aspects of the cost of manufacturing as well as favorable healthcare experience have improved the margins.

Our selling, engineering and administrative costs declined $1.2 million or 8.2% quarter three over quarter three, obviously with lower volumes we have certain lower expenses such as, incentives and other related costs. In addition, favorable healthcare and continued cost containment efforts have contributed to this reduction.

The effective tax rate for the quarter on continuing operations was 40.1%, which is an increase from prior quarters as we’ve now revised our estimates for the full year effective tax rate to 38.1%. The increase was necessitated by increases in state taxes and the mix of states served.

The result of all this is that earnings from continuing operations for the third quarter were nearly $7 million, a 19.5% increase over last year’s amount of $5.8 million. On a diluted basis, earnings per share from continuing operations were $0.47 compared to $0.39 last year.

There have been some changes in the balance sheet. One of the more significant changes is that we have made payments into our pension plan this year, totaling $10.1 million, resulting in a reduction in the long-term liability that is captioned Other Accrued Employee Benefits. We do not anticipate making any further payments in 2009, towards the pension plan.

The cash flow statement continues to reflect cash generated from operations, even after the pension payments I just mentioned. Even with these payments, we continued to reduce debt. At September 30, our debt as a percentage of total capitalization was less than 10%, and as I indicated in the second quarter conference call, the debt is now shown as current since the remaining maturities of long-term debt are due within one period, a one year period.

Finally, last week we renewed our line of credit with our primary bank, increasing it from $30 million to $35 million. It is in effect through October 2010.

With that, I’ll now turn the call over to our CEO and President Rich Meeusen, who will have additional comments. Rich.

Rich Meeusen

Thank you Rick. I also want to thank everybody for joining us here today. First let me say that in light of the weaker revenue numbers for the quarter, we are very pleased that we were able to generate record earnings, due to our continued focus on cost containment and pricing discipline.

As you all know, this has been a difficult year for the economy, and we have not been immune to the pressures that all the businesses are seeing. However, our strong market position, leading technologies and dedicated employees continue to drive good bottom line results.

Since Rick has just done a good job covering the numbers, let me cover a few other items. Yesterday, we also announced the signing of a contract to provide Orion Radios and Collectors to be installed on gas meters for Duke Energy, one of the nations largest energy companies.

This contract is exciting because it represents our first major win in a natural gas market. While we have provided Orion gas units to several smaller utilities, Duke’s decision to partner with Badger Meter demonstrates the adaptability of our Orion product to the natural gas industry.

We believe that we can build on this success to drive future sales in this market. An obvious question relates to the size of this contract. While the exact number of units and timeline can vary somewhat depending on Duke’s installation plans, we estimate that this contract represents potential revenues of up to $20 million which will probably be spread over a period of several years.

In the past, we’ve also cautioned you that in the AMR, AMI industry a contract is not a purchase order. We say this because we and other companies have occasionally seen customers cancel or curtail contracts before the end of their term. However, in this case we have been working with Duke for several years and have installed over 60,000 Orion units as part of a pilot project.

Duke has evaluated Orion and other products in a careful deliberate manner and we believe that this contract represents a major commitment by Duke to proceed with a full roll out of the system.

Let me now comment on the balance of the year. Although we do not give formal guidance, I will say that we expect to see some weakness in our revenues as the delay is caused by the stimulus funding continue.

On the other hand, if we do see allocation of the stimulus money or at least issuances of notices of funding decisions we would also expect to see some increase in our utility revenues. We believe that our industrial revenues will continue to be impacted by the slower economy in the near term.

As you know, last week we were once again named the Forbes Magazine’s list of the best 200 small companies. This is indeed an honor and recognition of our style of performance over the past one and five years.

Going forward in the long term, we continue to believe that we will benefit from the fundamental drivers of our business, water conservation driving a demand for meters and the need for operational efficiencies, driving a demand for AMR and AMI.

We are well positioned with both our Orion drive-by system and our Galaxy fixed network system in addition to our newly signed contract with Duke Energy, to continue to take advantage of these fundamental market drivers.

At this time we will welcome your questions.

Question-And-Answer Session

Operator

(Operator instructions) Your first question comes from Steve Sanders -Stevens Inc.

Steve Sanders -Stevens Inc

Good morning everyone. Just a follow up question on Duke, so the $20 million over several years, is that the full project that you have been on or do you think there is an incremental opportunity here within the next couple of years with Duke?

Rick Johnson

Well, that is the full price that we bid for Ohio. We have also been running pilot units in other areas of Duke service territory, and so there is more opportunity down the road if Duke decides to expand this type of application.

Steve Sanders - Stevens Inc

Will this be a drive-by system, or is this configured so that ultimately you can talk to an electric system?

Rick Johnson

This is not a drive-by system. The Orion Radios are being used as a short hop product to get over to a box provided by another vendor, which will then be brought back to the utility through some sort of back haul system.

Steve Sanders - Stevens Inc

Then Rich, I know this is a bit of a frustrating topic, but kind of a follow up on the anti-stimulus, I guess there’s several stages for the money to flow through from the EPA to the States to ultimately the communities and your customers. What’s your best guess at this point on when this at least turns to a neutral and potentially a positive? Should we think about early 2010 or what would you say on that?

Rich Meeusen

Yes, my best guess is early 2010. We have seen some states starting to release money, California has done some releases, the other seem to be slower and we are not seeing much out of them at this point, but if I had to guess and it is purely a guess, I would say early 2010.

Steve Sanders - Stevens Inc

Then two quick ones, maybe for Rick on copper, I think you commented this fourth quarter is going to see some of the same challenges that we have seen recently, we have also seen copper rally. So just wanted your kind of general commentary on how your copper pricing would look in the near term versus the past couple of quarters, whether you have changed your purchasing or hedging approach on that. Rick, can you give us the actual operating cash flow and CapEx numbers as well?

Rick Johnson

Sure, let me start with that one. The cash flow is cash provided from operations is $24.5 million and CapEx for the first nine months of the year is about $6 million. To copper, I’d phrase it this way, we had a big benefit from copper in the second quarter that benefit narrowed somewhat in the third quarter as copper continued to rise throughout the year. You can simply track copper year-over-year and realize that last year clearly in the fourth quarter copper was going down and this year it's not.

When we look at it on a graph, we are generally talking about a two to four months like period before prices actually hit our cost of goods sold. So, right now this one I believe you said copper was 290 and in January of ’09 it was or December of ’08 it was a $1.20.

So, I mean it’s significantly higher and it’s sooner or later theses lines are going to cross there is probably a bit of benefit left for the fourth quarter but that nearly as much as the second or third.

Steve Sanders - Stevens Inc

You have not changed your purchasing or you’re hedging or anything like that?

Rich Meeusen

No, and we get asked that question a lot, and the reality is if a customer would have come to us when copper was $1.20 and say lock in my purchases at that price, we would turn to the customer and say lock in a firm delivery date, and to a customer there is not a customer that locks in delivery dates with us so that makes it hard to do that.

Operator

Your next question comes from John Quealy - Canaccord Adams.

John Quealy - Canaccord Adams

A couple of questions on the gross margin, year-on-year gross margin came in at 39% in Q3, last year it was about 34%. Over the 500 basis point movement, can you comment how much was priced, how much was copper or other initiatives to expand that margin or AMR mix?

Rick Johnson

Some of it clearly was volume in a negative sense. I mean with volume going down margins were affected negatively, and I think the commodity cost pretty much offset the volume plus. Frankly we didn’t really raise prices this year over last year, so I’m calling it pretty much of a loss, and other costs through.

We have taken a hard look at all the manufacturing cost, we are running very favorable in healthcare, and some of that does translate into the cost of goods sold. So, it’s the variety of things, but clearly commodity is the biggest one.

John Quealy - Canaccord Adams

On the SG&A line, you guys have done a nice job of tightening the belt obviously, you mentioned commissions not coming in with the lower revenue lines, so that helps if you will. Would you expect that trend to continue moving into ‘10 as long as revenue stays needed, or you are getting to the end of the cost savings on the SG&A lines?

Rich Meeusen

Well I think we have taken a lot of savings and we are operating in a little basis, I think more importantly the trick would be as revenue start to increase again, this is holding the line in those. Now some cost obviously will go up, incentives, commissions and the like, but we have taken, we talked, we had an early retirement program early in the year we took some of the costs out of the business, and so and it's our intention to try and keep those cost in line as we move forward.

John Quealy - Canaccord Adams

Final two questions, you folks are talking about moving the workforce around, I think maybe some Telsa physicians go to Milwaukee, so Milwaukee goes to Reynosa. How does that impact whether our cost of sales or SG&A intend at all.

Rick Johnson

Well first of all it’s written out Reynosa, it’s [Migalis], John.

John Quealy - Canaccord Adams

Sorry.

Rich Meeusen

That’s okay. Yes, we did talk recently and there were some articles in the local paper here about moving some jobs from Milwaukee down to Mexico, that’s a continuation of a strategy that we have been doing over the last 10 years. It’s part of the facility expansion that we made last year, and are now working to fill that facility.

So, this is kind of old news to the people around here, they understand what our plans were, and we are moving forward with that. We are also talking about moving, and that’s probably about 70 jobs that would move down there in the second half of 2010, which is about a third of our shop workforce here.

The jobs from Tesla to Milwaukee we are talking 20 to 25 jobs being moved and that’s more engineering, R&D, marketing things of that sort. All of this is part of just optimizing our facilities to get the best use out of each facility, and put the jobs where they make sense. We won’t be seeing any benefit of that till the second half of next year, because none of it would be done until then, and then we will see the full benefit in 2011.

John Quealy - Canaccord Adams

Lastly with regards to future expectations for gas wins, this Duke project was fairly certain for over a year and obviously we have gone through the regulatory process and other issues, but the sale cycles long. How do you handicap future wins in size moving forward for your team internally?

Rich Meeusen

You’re right, the sales cycle is very long, we have installed on the Duke project over 60,000 units of all part of pilot project over the last couple of years. So, it’s been a very long and a large pilot. We have other projects that we are in kind of recession with some we are installing pilots on also, but these are projects that take sometimes up to two or either three years before the decision is made.

Especially in a case like Duke, where we are working with several other partners and other technologies to put together the entire smart grid that we will talk to the meters and get the readings back. So sometimes we are partnering with the electric side of the business, sometimes we are partnering with other providers.

So, it is the long cycle, it’s hard for us to say that we think there is a 50% chance or 25% chance or a 75% chance on any particular project, but we do think the win of Duke does validate this product in the market place, and will dramatically improve our chances going forward to win other projects.

Operator

Your next question comes from Carter Shoop - Deutsche Bank.

Carter Shoop - Deutsche Bank

I wanted to follow up with the Duke commentary there, when you look at your pipeline for gas deals, are you bidding primarily with the Orion product portfolio or is it more of the Galaxy product that you are looking for opportunities and gas down the road that would be outside of the Duke contract and Duke potentials, elsewhere?

Rick Johnson

At this point, it’s entirely Orion, because we are either bidding it as a drive-by system or as a connectivity system to some of our other partner’s systems. So it is entirely Orion. That doesn’t mean we won’t offer Galaxy in the future and we are looking at that.

Carter Shoop - Deutsche Bank

That’s helpful, thanks. Shifting to gross margins again, the year-over-year commentary was very helpful. Can you talk a little bit about some of the quarter drivers gross margins, in particular how much of that was commodity versus restructuring benefits?

Rich Meeusen

Okay, the quarter over quarter, again, volumes stuff would have taken gross margins down, just simply because we didn’t have the volume that we had in Q3 of last year. Commodity more than made up for that and they actually helped improve the margin a little bit, but beyond that we don’t give it much color.

Healthcare is in there manufacturing costs, and that’s the same things I said before, those are the quarter over quarter comment.

Carter Shoop - Deutsche Bank

I am not sure I understood the question, but when you say quarter over quarter, you’re talking sequential quarters, or from year to year?

Rick Johnson

Sequentially obviously sales are down 10%, and so your healthcare margins is at 39% level. So, we are trying to understand what offset the significant lower fixed cost utilization?

Rich Meeusen

Well, it’s commodity. I mean, this year it’s been commodity, and our cost structure has been lower. We took some of the employees all over course.

Rick Johnson

But you are talking quarter three compared to quarter two of this year, right?

Rich Meeusen

That is correct.

Rick Johnson

Rick was answering on the basis of year over year. Yes, when you are talking about quarter three versus quarter two, you are right, the lower volume does add cost and where do we get the savings. It’s really been through maintaining pricing discipline and through other cost reductions, like we said we’ve been very fortunate in our healthcare costs and we’ve been able to drive down other costs out of the organization quarter over quarter.

Carter Shoop - Deutsche Bank

Did we shift any employees from Milwaukee down to [Migalis] in the first or second quarter that you saw benefits from in the third quarter or is it?

Rich Meeusen

Not really, not really.

Carter Shoop - Deutsche Bank

Could you remind us how you guys think about seasonality in the water utility business in the fourth quarter? I think it’s usually down on average here in the past three years about 8% or so. Is that how you think about seasonality if you are kind of stripped out the impact from the stimulus and everything else?

Rick Johnson

Well, up until last year, that’s how we thought about the fourth quarter and if you recall last year, we had unusually strong fourth quarter and it surprised even us. There’s always that seasonality in it, it sometimes has to do with where the mix of customers happens to be at that point in time, if you are starting to deal in it may be more of the Northern clients and things starts slowing down a little just because of installations and the like.

If we had to pick which quarter generally is the weakest quarter of the year, hands on I think we would all pick the fourth quarter, but as I said, last year we got surprised in the fourth quarter. So, that’s how we think about seasonality.

Where we are this year, because of the effective stimulus, you know, if the dollars were to start to flow suddenly we might see a sudden pick up near the end of the fourth quarter, right now we are guessing more likely that’s going to happen in the first quarter.

Carter Shoop - Deutsche Bank

Okay, that’s helpful. In regards to the Chicago contract, when do you envision the first stage of this being completed?

Rick Johnson

Well, I think, we have about a year to go on the contract and right now we anticipate finishing on time and being, we are on track to make that completion. More importantly is where does that contract go beyond that as we said, Chicago has indicated to us that, that decision likely is not going to come until next year.

Carter Shoop - Deutsche Bank

Two more quick ones, if I may. $10.1 million for payments incentive pension, what do you envision for 2010 in regards to payments for the pension?

Rick Johnson

Well, a lot of that depends upon what the assets do this year. The $10 million got us substantially funded in the plan and depending upon which voodoo actuarial methods you use or either we could be a 100% funded and in one deal, we could a little over 90% funds in another, but that doesn’t take into consideration the asset gains of this year.

Well, we reassess that as of January 1 of next year, it’s possible we’ll make no payments. I don’t anticipate making a substantial amount of payments as we did this year. We took advantage of the fact that we have the ability to do it this year, and as I said we are getting close to being fully funded.

Carter Shoop - Deutsche Bank

Okay, great last question. In regards to Duke, when do you expect to start volume shipments to that customer?

Rick Johnson

You know, right now our best guess is that we’ll probably see some products flowing out of here in the first quarter.

Operator

Your next question comes from Ryan Connors - Boenning & Scattergood.

Ryan Connors - Boenning & Scattergood

Yes, I wanted to talk a little bit about just the utility customer and market, and you talked a lot about the stimulus and so forth, but just in terms of customer budgets, we are now into a new budget year. Obviously, if there was any pressure on budget, it was downward, and just ex-stimulus if you will, do you get the sense that the money is there, absence stimulus dollars to fund metering programs, AMR programs etcetera at the level they had been prior to the downturn, or so let’s say the organic if you want to call it.

You feel like it’s there, or do feel like the markets under downward pressure, again ex-stimulus.

Rich Meeusen

Ryan, the way I kind of analyzed the market is based on some rough estimates that we did in a survey. About half of the cities in the United States, half of the water resources in the United States are operated as enterprise funds and the city, even if the city is having extreme budget pressure can’t just go in and grab that money, and about half of them the city can’t grab the money.

So right away that puts about 50% of the utilities in a situation like one utility manager of our large utility told me, he said I don’t care what happens to the city, I have got my money and they can’t touch it, I am going ahead with my meter program.

For the other half of the cities it’s kind of spotty, there are some cities especially in the cities that are heavily dependant on the automotive industry where we have seen them say, we are going to pull back on our metering program, because the politically it's just not the time to launch a new program, we are going to cut back.

Especially, where they were looking at installing AMR are doing a big technology roll out. Most cities recognize that when they build new house they have to have a meter, most cities recognize that when their meter gets to 15 to 16 years old they have to go and replace it. So I think our replacement business and some of that other business will continue even in those cities, but we can be affected on new technology rollouts.

When you come off right down to it that ends up being a fairly small piece of the market where they are impacted by the core economy, and the rest of the cities have the money, they are going to move forward. We don’t see a big impact there. So right now, if I had to guess, I would say we are seeing a bigger impact from stimulus than we are from general economic conditions.

Ryan Connors - Boenning & Scattergood

Thanks for that Rich, and then just sort of relying that discussion into Chicago. My understanding is that Chicago is one of the cities as you mentioned where the funds are commingled if you will, between the city and the water utility, correct me if I am wrong on that, but that’s my understanding.

Rich Meeusen

Correct, Chicago is treated as the department of the city.

Ryan Connors - Boenning & Scattergood

Right, so I am just trying to get an idea of how you look at that. Obviously as you mentioned you are on track to complete that project next year. So, do you worry at all about becoming a victim of your own success in the sense that in order to continue your growth trajectory into 2011 you’ve got to sort of replace if you will that business, I mean, and it's tough to see them continuing at the current run rate right through. So how do you look at that as an issue for the growth of the company in general, just Chicago and the twilight base now?

Rich Meeusen

Well, you are right. We had a similar situation in 2001 I believe when Philadelphia came to an end. Philadelphia was a very large project that ran for two years and when it came to an end we weren’t able to replace that business and we saw a decrease.

There is a risk of that scenario in 2011, however, when we look at things like Duke and some other large cities that are out there that are in our pipeline we are fairly optimistic about our ability to replace that business. There is also the fact that Chicago is interested in continuing, when we are done with Chicago it isn’t like Philadelphia where when we are done the entire city was metered.

In the case of Chicago when we are done with this project a third of Chicago will be metered. And they have a desire to meter the rest of the city. So we believe there is a strong likelihood of us getting follow on work at Chicago.

Ryan Connors - Boenning & Scattergood

Okay, that’s helpful. Thanks for the color. And just a quick housekeeping item. Rick could you repeat the Orion Itron sales year-over-year growth figures?

Rick Johnson

Orion and Itron, okay, Orion sales declined 12.7% Q3 over Q3 and Itron declined 9.5% Q3 over Q3. Is that what your looking for?

Ryan Connors - Boenning & Scattergood

Yes it is, thanks for all your help guys.

Operator

Your next question comes from Eric Stine- Northland Securities.

Eric Stine - Northland Securities

Good morning guys, thank you for taking my questions. First just on Orion Itron, just wondering if you could let us know were any of the Itron customers new deployments over those existing Itron customers?

Rick Johnson

Okay. We both just looked at each other. For the most part I would say substantially all of them were existing customers.

Eric Stine - Northland Securities

I do know of a couple of new ones.

Rich Meeusen

One or two new ones.

Rick Johnson

One or two new ones but all of the others were existing customers.

Eric Stine - Northland Securities

Okay. Very small numbers.

Rick Johnson

Right, yes.

Eric Stine - Northland Securities

Okay. I appreciate that color. Then maybe can we just turn to AMI, can you give us an idea of the progress you are making there and maybe what the revenue is for that in the quarter?

Rich Meeusen

We are looking at what our Galaxy sales were for the quarter. Three quarters of a million dollars for the quarter.

Rick Johnson

The galaxy product, the network products continue to be a slow ramp up, a lot of these projects take time and it is moving forward, we are happy with the pace. But it is a slow ramp up on these.

Eric Stine - Northland Securities

Isn’t that a function of just long sales cycles or the economic environment meaning a little bit more infrastructure cost is not something that municipalities are interested in right now?

Rick Johnson

No, I really think it’s a long sale cycle, and the other problem is it, it isn’t just a sales cycle, there is also a longer installation cycle, unlike drive-by where you can simply put the product in and be reading it the next day, with networks you have a lot more infrastructure that has to be installed.

Eric Stine - Northland Securities

Okay, that is helpful, maybe we can just, one last thing just touch on your port of quarter last year you alluded that that was unusually strong, and I believe it was due to some business out of Mexico, are there, I mean in part on that business, are there any opportunities that we should maybe think about in this fourth quarter?

Rich Meeusen

There are always opportunities in Mexico, last year fourth quarter, we basically received orders as late of December 15 and still managed to deliver by December 31, because what happens is that, it’s a very shot lead time from the time they cut the order to when they want the product.

Again, we would see some opportunities down there, we are taking some steps to build the inventory and to be ready for those potentials, but again it’s one of those, we joke it’s kind of like the lottery, you know we either get it right at the end or we don’t, if we don’t the inventory is still good it can be used elsewhere, but we are taking those steps to take advantage of that market.

Eric Stine - Northland Securities

I guess just one last question just on pricing, you have talked about, that you have been disciplined on the pricing side, do you have any concern as these stimulus project start to come on, that those are going to be more competitive and that there maybe some pricing pressure?

Rich Meeusen

I don’t think stimulus project in of themselves represent any kind of different pricing scenario than non stimulus projects. The utilities are taking the same approach that most of our bids and quotes and I don’t see a difference in how they are treated.

Operator

Your next question comes from Rob Mason - Robert W. Baird.

Rob Mason - Robert W. Baird

Yes, good morning, most of my question have been answered, but I did want to circle back. Earlier in the year we mentioned currency is possibly benefiting gross margin, that I’m going to assume that tail win has faded, you didn’t mentioned it but just could you clarify that?

Rick Johnson

Yes, it’s a good assumption, yes it has faded.

Rob Mason - Robert W. Baird

So, those will probably a headwind here in Q4?

Rick Johnson

That’s right.

Rob Mason - Robert W. Baird

You also mentioned inventory Rich, just given that expectation by Q1 there is perhaps some pent up demand, are you taking other steps or should we expect that in the fourth quarter to see that you are taking steps to build some inventory to address that?

Rick Johnson

Well, this is Rick, this is one of those unanswered questions internally, because when business does pick up, there is a pick up and resume as normal, however you define normal, or is there a lot of water building behind the stem and when it finally does start flowing it’s a minor flood, that’s kind of the question we ask almost daily, and we are getting a handle on it if you put a gun to our heads right now, it’s probably, two thirds of people are moving that are saying that it’s going to be business as normal, and there is a fraction that says that, it maybe, we may have a minor flood on here.

We are watching it carefully. We will take necessary steps to make sure that we can respond to customers on a timely basis. So, again it depends on timing, you may see a little build up on inventory because of that.

Rob Mason - Robert W. Baird

Okay, maybe one last housekeeping question. Do you have a number for how local read meters performed in the quarter?

Rich Meeusen

Local reads were actually up and volumes was up on those, they were up about 12%.

Rob Mason - Robert W. Baird

Okay, any sense what drove, that seems like a hot numbers from a volume standpoint?

Rich Meeusen

No, we are all shaking our heads around the table, nothing jumps out at us whether it was a big unusual order, local reads are it’s always a small piece of the sales anyway, so --.

Rick Johnson

And it tends to be very lumpy business.

Rob Mason - Robert W. Baird

Okay, but could there possibly be for some restocking activity in the channel?

Rich Meeusen

Not, really you are talking this morning about the fact that, most of our distributors during this downturn have thinned down their inventory quite a bit, and we don’t see them bringing it back up at this point, because they are just not confident that there is a lot of business coming in, in the next month or so.

So, we don’t see a lot of restocking activity out here, it could be some utilities that we are planning to move to AMR, we have now delayed that plan, and therefore are just continuing to buy the regular local read meters instead of AMR, if that’s possible?

Operator

Your next question comes from David Woodburn - ThinkEquity.

David Woodburn - ThinkEquity

Thanks for taking the questions, I guess following are using the phrase anti stimulus again. Are some of the project that you have seen been put on hold, are they likely to actually receive stimulus funding, or is it a case where there is another project that the water utility goes to receive funding for and they are just waiting to roll out their AMR or mere upgrade to see what the overall capital budget looks like, does that make sense?

Rick Johnson

Yes, it make sense, I think most of the delays that we are seeing are utilities that have applied for specific projects related to meter. You are asking also what we called a trickle down effect, to the extend that I have also applied for money for means or something, and I get that money, they are going to free up money for meters. We are not seeing as much of that. That is a hope for benefit somewhere down the line.

David Woodburn - ThinkEquity

And then for the stimulus project, are they justified more on the labor savings, the operational standpoint or the water saving aspect?

Rick Johnson

I think it’s a combination of both. There is a portion of the money that’s set aside for environmental reasons and obviously water conservation is one of those.

Operator

Your next question comes from Brian Rafn - Morgan Dempsey Capital.

Brian Rafn - Morgan Dempsey Capital

Can you get me a sense, Rich you talked a little bit about in some of the automotive OEM areas? Are you seeing across the United States any reduction in the installation or replacement for obsolescence, kind of your 6% every year, 15 or 16 years, are you seeing any core business deteriorating on just the normal obsolescent replacement?

Rich Meeusen

Another way to state your question, we see in the field kind of an average life for water meters about 15 years and we are seeing utilities stretching that out and saying, to save money let’s not replace for 18 years or 19 years, we are not seeing that. We have been asking that question we are not hearing about it all.

Brian Rafn - Morgan Dempsey Capital

Okay.

Rick Johnson

Having said that though, again go back to Rich’s anecdotal stores. To the extend it’s 15 years about half of my town just got laid off. I might delay it one year. And they might do it, but that's it. I mean nobody is looking at changing the overall cycles.

Brian Rafn - Morgan Dempsey Capital

Okay.

Rich Meeusen

We haven’t heard anything about that.

Brian Rafn - Morgan Dempsey Capital

All right, Rich you also talked about, you alluded to some national sales accounts at large cities in the pipeline. Can you look at after Chicago what’s kind of collectively across the US and the waterside, would there would be a half of dozen cities, would it be a dozen is it a one or two knock offs give me a sense as to what that universe is for you guys?

Rich Meeusen

It’s more about a half a dozen cities. I mean if you look at the 25 largest cities in America about half of them have either switched to some sort of automation or made a commitment and half of them have not. So, there is probably will be about a half out there that are talking about it, looking at it, that would be larger cities in the Chicago size. Obviously we are not going to name any specific cities.

Brian Rafn - Morgan Dempsey Capital

Okay, would those be looking at technology upgrade?. In other words when they go they are going with something that's not just a local or would they be going with something in AMR?

Rich Meeusen

Correct.

Brian Rafn - Morgan Dempsey Capital

Okay. Give me a sense, you guys increased your line of credit, you have talked about weakness on the industrial side. Any niche opportunities there, as far as M&A or looking at stuff that maybe trading at a low multiple EBITDA?

Rick Johnson

Yes, clearly over the last several years we have chased two or three acquisitions every year, and usually been outbid by private equity with a big bag of money who are willing to pay multiples of 12 or 14 times EBITDA. In all cases, we walked away and we didn't make acquisitions.

I think now, private equities had the big bag of money taken away from them and the multiples have come down to more reasonable levels. So we are interested in making small niche acquisitions. We’ve talked about this publicly in the past.

When we talk about acquisitions, we are talking about things in the $10 million to $40 million range, nothing huge, but we do believe we are in a better position now to look at those companies that have interesting unique flow measurement technologies that might bring some synergies to Badger, and we are also talking to companies and pursuing those.

Brian Rafn - Morgan Dempsey Capital

Okay, I missed your opening comments for the first minute or so. Anything on, you mentioned water mains, anything on the larger meters, and either the commercial utility side or was that just about flat for everything else?

Rick Johnson

We are checking here.

Rich Meeusen

Commercial sales declined about 14%. Last year was an unusually strong year for commercial sales. We had some large projects.

Brian Rafn - Morgan Dempsey Capital

Okay. Your movement of some R&D from Tulsa up to Milwaukee, there has been a lot of pluck with Milwaukee being kind of a vanguard of a National Research Center for water. Is that movement to expand or bring these people in R&D up to Milwaukee, is that designed to amp up the R&D for Badger Meter or is it tied into this kind of national water based here in Milwaukee, give me a sense or is it just a simple consolidation?

Rich Meeusen

Yes, it’s really on two sides. One is to consolidate our R&D in one location. We had to kind of split and we viewed Tulsa as a very good location for continuing to do manufacturing. So we want to keep our manufacturing there, but pull out some of the other functions, R&D marketing, customer support, things of that sort, but our choice to bring it to consolidate it in Milwaukee runs more to the vision for Milwaukee’s future as a water technology hub.

Milwaukee has over 120 water technology companies in this region, 5 of the 11 largest water technology companies in the world are located in this region or have major operations here.

So, given all of those reasons we do have a lot of confidence in the future of this region for R&D, for technology, we are going to have the talent in the region, and so that’s what we are looking at.

Brian Rafn - Morgan Dempsey Capital

Okay. Rick, property plan equipment budget for this year?

Rick Johnson

Well, as I said we have about $6 million of CapEx in that’s obviously down from where we were last year. It’s pretty much in line with depreciation and amortization, that’s probably where we will wind up for the year.

Brian Rafn - Morgan Dempsey Capital

Okay, and then on some of the healthcare savings. That I suppose is event driven specifically depending on surgical procedures or whatever.

Rick Johnson

I mean, like most companies we self-insure up to a certain amount and we just haven’t had some of the large ones that we’ve seen in the past.

Operator

Your next question comes from Gary Lenhoff - Ironwork Capital.

Gary Lenhoff - Ironwork Capital

Rick, it looks like your receivables picked up a bit in the quarter with the sales down so that your collection cycle extended by maybe nine or ten days, can you comment on that specifically whether you are having any specific bad debt issue?

Rick Johnson

Well, I am not having any specific bad debt issues per se. There is one large account that was a timing issue, we received funds in October already. The DSOs as we look they are up about five days.

I also think that we have about little less than a million dollars of taxes receivable buried in that number, just simply because after I made that pension payment I actually wanted being in a receivables position for my current year taxes. So you see some of that in there also. Not material enough to break out separately, but it does - it makes the numbers just look a little bit funny.

Operator

Your next question comes from Glenn Wortmann - Sidoti & Company.

Glenn Wortmann - Sidoti & Company

On the natural gas, aside from Duke, do you have ongoing pilot programs with other large utilities?

Rich Meeusen

We have ongoing pilot programs with a lot of different sites utilities, but I guess I don’t want to go into any specifically detail, because our agreement with those utilities is that we are not disclosing them. So, I’ll just say that, Yes, we do have ongoing pilot programs with a large number of different sites utilities.

Glenn Wortmann - Sidoti & Company

Okay, and then also I may have missed it, but I don’t know if you’ve provided us with a unit volume on the Duke contract or if you can?

Rick Johnson

The total volume, and it’s going to be totally up to Duke, as far as how broadly they apply this. But the total number of units in the territory that they are talking about right now is about 400,000 units, although we’ve done about 60,000 of them as pilot projects. So there are probably about 340,000 units left.

Before you take a $20 million contract and divide it by the number of units, you have to remember that there are a large number of collectors also in that area, so it’s both the radios and the collectors that make up the total contract.

Operator

Your next question comes from Scott Graham - Ladenburg Thalmann & Co

Scott Graham - Ladenburg Thalmann & Co

Hey, good morning. I am sorry, but before I seem to have disconnected myself.

Rich Meeusen

Okay, we have done that.

Scott Graham - Ladenburg Thalmann & Co

Yes, well, you know. So, the two questions I have for you is, I was just wondering if you could tell us, I am looking at the water numbers and kind of see a raise in comp -- the sales, and I know I don’t want to focus too much on one quarter, I know it’s a longer cycle business. But it actually does like the business deteriorated a little bit, because you had a deeper decline on an easier comparison, I shouldn’t be reading anything into that, should I?

Rich Meeusen

No, that’s an awful lot of granularity for a business that is relatively lumpy unfortunately.

Scott Graham - Ladenburg Thalmann & Co

Yes, right, that’s what I thought, okay. So, there maybe we can springboard from there into kind of how you saw, not necessarily sales but maybe order activity in the business as the quarter progressed, was September the most month of quotes, was -- how does that look?

Rich Meeusen

Well, again, that’s pretty lumpy, but I will say this. We have, since the beginning of the year, seen a fairly steady increase in the pipeline. We track our opportunities in various stages through the pipeline and we also value that pipeline and we have seen a pretty steady increase every month since the beginning of the year in the pipeline. That gives us some belief that there is a demand building up out there that’s being delayed, and I guess that’s all I can really say about it.

Scott Graham - Ladenburg Thalmann & Co

Okay. And you would consider that on the replacement side not necessarily even the stimulus side?

Rick Johnson

No, when I talk about out pipeline that is not really replacement pipeline, that’s projects and a lot of it is going to -- it’s technology projects, things of that sort. Our replacement business is kind of outside that pipeline that I am talking about.

Scott Graham - Ladenburg Thalmann & Co

That’s helpful, thank you. Now, as part of my trick of disconnecting, I missed a little bit of the discussion on what I thought was that you were starting to see some stimulus money’s flow through, a little bit, into your business. And my simple question is, you guys are the meters suggesting to me that when a stimulus moneys flow into water utility that’s not necessarily the first place that they are looking, but maybe that’s for my education. Could you kind of characterize how from a time standpoint where you guys are in the infrastructure water utility, spending cycle, if you will?

Rick Johnson

Well, let me, this is Rick. If you look at the electric, clearly we are not in the electric business, but in the electric all the stimulus money is coming from the Department of Energy and is generally flowing directly to investor owned electric utilities. So you are dealing with one layer of government.

On the water side it’s being administered by the Environmental Protection Agency, the EPA, and it starts with the EPA and then each individual of state goes to a state agency and from there it goes to the municipality. So your question is really, there are 50 answers to your question because it really depends on each state who divi’s out that money.

So, when you stepped away what we said is, we are starting to see some states, for instance California, where some of the money is starting to flow. There is a lot of states where the money haven’t started to flow yet, and so, to have one kind of one catch line that describes it is very difficult but because it’s kind of hit and miss right now.

Scott Graham - Ladenburg Thalmann & Co

I get that. The reason why I am asking the question is that I was presupposing that you guys would not be a first tier in the line up of beneficiaries for stimulus at all that you were a little bit later, and so, I was a little bit surprised to hear that you were already starting to see some moneys, and wondering if that was in fact stimulus or something that was in fact going through anyway.

Rick Johnson

If you look at some of the websites that are out there that attracts stimulus money and stimulus requests, you will see that there are requests from utilities for stimulus money directly for metering.

So, I wouldn’t say that we are at the end of the process or were ace or something like that behind mains and other things. It’s quite a mixture of what the utilities have requested and some of them have specifically requested metering as their primary use of stimulus funds.

Scott Graham - Ladenburg Thalmann & Co

That’s fair. I actually do track those websites and I didn’t see that much of that, but will go back and check that for sure. So, would it be fair to say that change in direction here in terms of the raw materials, if some of these bids start to maybe firm up a little bit more, is it possible that from a raw material standpoint you guys actually might be able to lock some stuff in here at this level of copper for a specific delivery or is that just not going to happen in your business?

Rick Johnson

This is Rick; I just don’t see it happening, because customers don’t lock in delivery dates. So I mean in order to lock in a price on something you got to lock in a delivery date but when you get it, which is generally ahead of when you want to ship it to a customer, and that just does not happen in this business, number one. Number two is I am not sure we would lock in at today’s price because we think copper is a bit high right now.

Rich Meeusen

I mean there are many pundits out there saying copper is going up as there are saying copper is going down. So we don’t know. Is copper low right now or is it high, your question would tend to imply that copper is at a bargain right now and it’s only going higher, I don’t know.

Operator

Your next question comes from [Brian Bechmen - Lyon Street Capital].

Brian Bechmen - Lyon Street Capital

Sort of getting rid of all the FX in copper. Can you just talk about where your gross margins were on a volume basis? I know you said that volume is down, how much did that affect gross margin?

Rick Johnson

Well, it’s significant and we told you what the revenues were down, okay, and so, again, we don’t get into real specifics about dollar amounts, but when we say commodity had a positive impact and obviously more than made up for the volume decline, beyond that we don’t give you much more color.

Operator

Your next question comes from [Sig Bowman - Divisor Capital].

Bowman - Divisor Capital

Good morning guys, thanks for taking the question. Just a question on this new contract, are you guys sole source on that contract?

Rick Johnson

Yes, we are. Now, there are other partners involved providing other aspects of the smart grid. But for the radios on the gas meters we are the sole source.

Sig Bowman - Divisor Capital

You are okay, and so is there maybe upside to the 400,000 unit number? I mean if Duke moves to other geographies as well?

Rick Johnson

Absolutely.

Sig Bowman - Divisor Capital

Okay, and I think, just want to check something that I recall. You guys previously said that gas projects would generally be lower margin than the corporate average, am I recalling that correctly?

Rick Johnson

Yes, generally the gas margins are a little bit tighter than the water side around the corporate average?

Sig Bowman - Divisor Capital

And that’s simply just because of the size of the contract?

Rick Johnson

Right, exactly.

Sig Bowman - Divisor Capital

Okay. But you guys aren’t passing through the cost of the gas meter, you are just selling directly just as the radio?

Rick Johnson

Right, we don’t sell the gas meters, we are simply providing the radios that go on to the gas meters.

Sig Bowman - Divisor Capital

Okay, but you are not doing an integration function either?

Rick Johnson

No. I mean any installation we don’t.

Sig Bowman - Divisor Capital

Got you. And then, I think previously you talked about the radios being sourced out of Europe, do I have that correct? Do you guys source those in Euros and so we are at some risk?

Rick Johnson

Yes, that’s correct. The Orion radios are sourced out of Europe and we buy them in Euros.

Sig Bowman - Divisor Capital

Obviously given your comments about copper heads and you are not going to go play with the FX market as well?

Rick Johnson

No, we are not doing that either.

Operator

At this time there is no further question sir.

Rich Meeusen

Well, then very good. We want to thank everybody for joining us. Obviously we are pleased with the quarter. We are still seeing the weakness on the top line, but we are optimistic about what the future holds for the company. So, once again, thank you for joining us.

Operator

Thank you for your participation in today’s conference. This concludes today’s presentation. You may now disconnect and have a great day.

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