UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934
for the quarterly period ended SEPTEMBER 30, 2006
BADGER METER, INC.
4545 W. BROWN DEER ROAD
MILWAUKEE, WISCONSIN 53223
(414) 355-0400
A Wisconsin Corporation
IRS Employer Identification No. 39-0143280
Commission File No. 1-6706
Indicate by check mark whether the Company (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the Company
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [X] No [ ]
Indicate by check mark whether the registrant is a large accelerated filer,
an accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act.
Large accelerated filer [ ] Accelerated filer [X] Non-accelerated filer [ ]
Indicate by check mark whether the registrant is a shell company (as
defined in Rule 12b-2 of the Exchange Act).
Yes [ ] No [X]
As of October 18, 2006, there were 14,098,558 shares of Common Stock
outstanding with a par value of $1 per share.
BADGER METER, INC.
QUARTERLY REPORT ON FORM 10-Q FOR PERIOD ENDED SEPTEMBER 30, 2006
INDEX
Page No.
--------
Part I. Financial Information:
Item 1 Financial Statements:
Consolidated Condensed Balance Sheets - -
September 30, 2006 and December 31, 2005 4
Consolidated Condensed Statements of Operations - -
Three and Nine Months Ended September 30, 2006 and 2005 5
Consolidated Condensed Statements of Cash Flows - -
Nine Months Ended September 30, 2006 and 2005 6
Notes to Unaudited Consolidated Condensed Financial
Statements 7
Item 2 Management's Discussion and Analysis of Financial
Condition and Results of Operations 13
Item 3 Quantitative and Qualitative Disclosures about Market
Risk 21
Item 4 Controls and Procedures 21
Part II. Other Information:
Item 6 Exhibits 21
Signatures 22
Exhibit Index 23
2
SPECIAL NOTE REGARDING FORWARD LOOKING STATEMENTS
Certain statements contained in this Form 10-Q, 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
could cause actual results to differ materially from those in the forward
looking statements. The words "anticipate," "believe," "estimate," "expect,"
"think," "should" and "objective" or similar expressions are intended to
identify forward looking statements. All such forward looking statements are
based on the Company's then current views and assumptions and involve risks and
uncertainties that include, among other things:
- the continued shift in the Company's business from lower cost, local
read meters toward more expensive, value-added automatic meter reading
(AMR) systems;
- the success or failure of newer Company products, including the
Orion(R) radio frequency mobile AMR system, the absolute digital
encoder (ADE(TM)) and the Galaxy(R) fixed network AMR system;
- changes in competitive pricing and bids in both the domestic and
foreign marketplaces, and particularly in continued intense price
competition on government bid contracts for lower cost, local read
meters;
- the actions (or lack thereof) of the Company's competitors;
- changes in the Company's relationships with its alliance partners,
primarily its alliance partners that provide AMR connectivity
solutions, and particularly those that sell products that do or may
compete with the Company's products;
- changes in the general health of the United States and foreign
economies, including housing starts in the United States and overall
industrial activity;
- increases in the cost and/or availability of needed raw materials and
parts, including recent increases in the cost of brass housings as a
result of increases in the commodity prices for copper and zinc at the
supplier level and resin as a result of increases in petroleum and
natural gas prices;
- the ability of the Company to shut down its French operations in an
orderly fashion and to maximize the value of the related assets;
- changes in foreign economic conditions, particularly currency
fluctuations between the United States dollar and the euro;
- the loss of certain single-source suppliers; and
- changes in laws and regulations, particularly laws dealing with the
use of lead (which can be used in the manufacture of certain meters
incorporating brass housings) and Federal Communications Commission
rules affecting the use and/or licensing of radio frequencies
necessary for AMR products.
All of these factors are beyond the Company's control to varying
degrees. Shareholders, potential investors and other readers are urged to
consider these factors carefully in evaluating the forward looking statements
and are cautioned not to place undue reliance on such forward looking
statements. The forward looking statements made in this document are made only
as of the date of this document and the Company assumes no obligation, and
disclaims any obligation, to update any such forward looking statements to
reflect subsequent events or circumstances.
3
PART I - FINANCIAL INFORMATION
ITEM 1 FINANCIAL STATEMENTS
BADGER METER, INC.
CONSOLIDATED CONDENSED BALANCE SHEETS
September 30, December 31,
2006 2005
------------- ------------
(Unaudited)
(In thousands)
ASSETS
Current assets:
Cash $ 4,281 $ 4,403
Receivables 41,317 30,450
Inventories:
Finished goods 10,395 11,875
Work in process 8,108 9,048
Raw materials 14,302 11,047
-------- --------
Total inventories 32,805 31,970
Prepaid expenses 2,595 2,309
Deferred income taxes 3,480 3,432
-------- --------
Total current assets 84,478 72,564
Property, plant and equipment, at cost 116,518 109,810
Less accumulated depreciation (70,343) (65,940)
-------- --------
Net property, plant and equipment 46,175 43,870
Intangible assets, at cost less accumulated amortization 942 1,026
Prepaid pension 16,370 17,726
Other assets 3,915 4,101
Goodwill 6,842 6,580
-------- --------
Total assets $158,722 $145,867
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Short-term debt $ 21,612 $ 8,847
Current portion of long-term debt 3,810 7,431
Payables 16,142 11,484
Accrued compensation and employee benefits 5,632 6,436
Warranty and after-sale costs 3,349 3,610
Income and other taxes 1,897 1,778
-------- --------
Total current liabilities 52,442 39,586
Other long term liabilities 576 634
Deferred income taxes 6,596 6,584
Accrued non-pension postretirement benefits 4,220 3,955
Other accrued employee benefits 6,246 6,332
Long-term debt 6,476 15,360
Commitments and contingencies
Shareholders' equity:
Common stock 20,494 20,112
Capital in excess of par value 15,529 13,320
Reinvested earnings 78,814 74,258
Accumulated other comprehensive income 790 1
Less: Employee benefit and nonvested stock (795) (1,357)
Treasury stock, at cost (32,666) (32,918)
-------- --------
Total shareholders' equity 82,166 73,416
-------- --------
Total liabilities and shareholders' equity $158,722 $145,867
======== ========
See accompanying notes to consolidated condensed financial statements.
4
BADGER METER, INC.
CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------- -------------------------
(Unaudited) (Unaudited)
(In thousands except share and per
share amounts)
2006 2005 2006 2005
----------- ----------- ----------- -----------
Net sales $ 62,980 $ 54,194 $ 186,421 $ 166,058
Cost of sales 46,679 35,540 128,413 107,965
----------- ----------- ----------- -----------
Gross margin 16,301 18,654 58,008 58,093
Selling, engineering and
administration 14,363 12,156 40,692 37,610
----------- ----------- ----------- -----------
Operating earnings 1,938 6,498 17,316 20,483
Interest expense 511 402 1,312 1,177
----------- ----------- ----------- -----------
Earnings before income taxes 1,427 6,096 16,004 19,306
Provision for income taxes 1,946 2,285 8,243 7,780
----------- ----------- ----------- -----------
Net earnings (loss) $ (519) $ 3,811 $ 7,761 $ 11,526
=========== =========== =========== ===========
Per share amounts:
Earnings (loss) per share:
Basic $ (.04) $ .28 $ .56 $ .86
Diluted $ (.04) $ .27 $ .55 $ .82
Dividends declared: $ .080 $ .075 $ .230 $ .215
Shares used in computation of
earnings (loss) per
share:
Basic 13,935,229 13,522,144 13,831,668 13,458,804
Impact of stock-based
compensation (a) -- 672,704 375,642 549,733
----------- ----------- ----------- -----------
Diluted 13,935,229 14,194,848 14,207,310 14,008,537
=========== =========== =========== ===========
(a) As a result of the loss recognized in the third quarter of 2006, the impact
of potential common shares related to stock-based compensation is
anti-dilutive and therefore excluded from the weighted average shares
outstanding used to calculate dilutive loss per share.
See accompanying notes to consolidated condensed financial statements.
5
BADGER METER, INC.
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
Nine Months Ended
September 30,
------------------
(Unaudited)
(In thousands)
2006 2005
-------- -------
Operating activities:
Net earnings $ 7,761 $11,526
Adjustments to reconcile net
earnings to net cash provided
by (used for) operations:
Depreciation 5,004 4,721
Amortization 235 147
Long-term asset impairment 1,288 --
Tax benefit on stock options -- 877
Deferred income taxes (32) (25)
Noncurrent employee benefits 3,204 2,666
Contributions to pension plan -- (2,000)
Changes in:
Receivables (10,455) (7,826)
Inventories (390) 1,802
Prepaid expenses (278) (513)
Current liabilities other than debt (55) 2,906
-------- -------
Total adjustments (1,479) 2,755
-------- -------
Net cash provided by operations 6,282 14,281
-------- -------
Investing activities:
Property, plant and equipment (7,941) (5,536)
Other - net (256) (293)
-------- -------
Net cash used for investing activities (8,197) (5,829)
-------- -------
Financing activities:
Net increase (decrease) in short-term debt 12,400 (7,917)
Issuance of long-term debt -- 10,000
Repayments of long-term debt (12,504) (6,891)
Dividends paid (3,206) (2,899)
Proceeds from exercise of stock options 2,326 1,288
Tax benefit on stock options 2,502 --
Treasury stock purchases -- (2,958)
Issuance of treasury stock 365 840
-------- -------
Net cash provided by (used for)
financing activities 1,883 (8,537)
-------- -------
Effect of exchange rate on cash (90) 330
-------- -------
Increase (decrease) in cash (122) 245
Cash - beginning of period 4,403 2,834
-------- -------
Cash - end of period $ 4,281 $ 3,079
======== =======
See accompanying notes to consolidated condensed financial statements.
6
BADGER METER, INC.
NOTES TO UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
NOTE 1 BASIS OF PRESENTATION
In the opinion of management, the accompanying unaudited consolidated condensed
financial statements of Badger Meter, Inc. (the "Company") contain all
adjustments (consisting only of normal recurring accruals except as otherwise
discussed) necessary to present fairly the Company's consolidated condensed
financial position at September 30, 2006, results of operations for the three-
and nine-month periods ended September 30, 2006 and 2005, and cash flows for the
nine-month periods ended September 30, 2006 and 2005. The results of operations
for any interim period are not necessarily indicative of the results to be
expected for the full year.
The preparation of financial statements in conformity with U.S. generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates.
On April 28, 2006, the Board of Directors declared a 2-for-1 stock split on the
Company's Common Stock effected in the form of a 100% stock dividend, payable on
June 15, 2006 to shareholders of record at the close of business on June 1,
2006. In this report, all the per share amounts and numbers of shares have been
restated to reflect this stock split. In addition, Common Stock and capital in
excess of par value have been adjusted to reflect this split for all periods
presented.
Certain other reclassifications have been made to the 2005 consolidated
condensed financial statements to conform to the 2006 presentation.
NOTE 2 ADDITIONAL BALANCE SHEET INFORMATION
The consolidated condensed balance sheet at December 31, 2005 was derived from
amounts included in the Company's Annual Report on Form 10-K for the year ended
December 31, 2005. Refer to the footnotes to the financial statements included
in that report for a description of the Company's accounting policies and for
additional details of the Company's financial condition. The details in those
notes have not changed except as discussed below and as a result of normal
adjustments in the interim.
GOODWILL Goodwill increased from $6.6 million at December 31, 2005 to $6.8
million at September 30, 2006 as a result of translation adjustments for
goodwill denominated in foreign currencies.
WARRANTY AND AFTER-SALE COSTS The Company estimates and records provisions for
warranties and other after-sale costs in the period the sale is reported.
After-sale costs represent a variety of activities outside of the written
warranty policy, such as investigation of unanticipated problems after the
customer has installed the product, or analysis of water quality issues. Changes
in the Company's warranty and after-sale costs reserve for the nine-month
periods ended September 30, 2006 and 2005 are as follows:
Balance at Net additions Balance
beginning charged to Costs at
(In thousands) of year earnings incurred September 30
---------- ------------- -------- ------------
2006 $3,610 $1,107 $(1,368) $3,349
2005 $3,817 $1,182 $(1,343) $3,656
STOCK-BASED COMPENSATION PLANS At September 30, 2006, the Company has two types
of stock-based employee compensation plans, which are described more fully in
Note 1 "Summary of Significant Accounting Policies" under the heading
"Stock-Based Compensation Plans" and Note 5 "Stock Option Plans" in the Notes to
Consolidated Financial Statements in Part II, Item 8 of the Company's 2005
Annual Report on Form 10-K.
The Company recognizes the cost of stock-based awards for all of its stock-based
compensation plans on a straight-line basis over the vesting period of the
awards. Total stock compensation expense recognized by the Company for the
three- and nine-month periods ended September 30, 2006 was $239,000 and
$750,000, respectively, compared to $79,000 and $185,000 for the same periods in
2005.
7
Stock Options:
The Company has six stock option plans which provide for the issuance of options
to key employees and directors of the Company. Each plan authorizes the issuance
of options to purchase up to an aggregate of 800,000 shares of Common Stock,
with vesting periods of up to ten years and maximum option terms of ten years.
As of September 30, 2006, options to purchase 547,776 shares remain available
for grant under three of these plans.
Prior to January 1, 2006, the Company accounted for stock compensation plans
under the recognition and measurement provisions of Accounting Principles Board
Opinion No. 25 (APB 25), "Accounting for Stock Issued to Employees," and related
Interpretations, as permitted by Financial Accounting Standards Board (FASB)
Statement No. 123 (SFAS 123), "Accounting for Stock-Based Compensation." No
stock-based employee compensation cost was recognized for stock option awards in
the Consolidated Statements of Operations for the periods prior to January 1,
2006 as all options granted under those plans had an exercise price equal to the
market value of the underlying Common Stock on the date of grant.
Effective January 1, 2006, the Company adopted the fair value recognition
provisions of FASB Statement No. 123(R) (SFAS 123(R)), "Share-Based Payment,"
using the modified-prospective-transition method. Under this transition method,
compensation cost recognized in the third quarter and first nine months of 2006
includes compensation costs for all share-based payments granted prior to, but
not yet vested as of January 1, 2006, based on the grant date fair value
estimated in accordance with the original provisions of SFAS 123 and
compensation cost for all share-based payments granted subsequent to January 1,
2006, based on the grant date fair value estimated in accordance with the
provisions of SFAS 123(R). The Company estimated the fair value of its option
awards granted prior to January 1, 2006 using the Black-Scholes option-pricing
formula, and continued to use this model. The Company records compensation
expense for stock options ratably over the stock option plans' vesting period.
Results for prior periods have not been restated.
As a result of adopting SFAS 123(R) on January 1, 2006, the Company's earnings
before income taxes and net loss for the three-month period ended September 30,
2006 were $30,000 lower and $14,000 higher, respectively, than if the Company
had continued to account for share-based compensation under APB 25. For the
nine-month period ended September 30, 2006, earnings before income taxes and net
earnings were $241,000 and $165,000 lower, respectively.
Prior to the adoption of SFAS 123(R), the Company presented all tax benefits of
deductions resulting from the exercise of stock options as operating cash flows
in the Consolidated Condensed Statements of Cash Flows. SFAS 123(R) requires the
cash flows resulting from the tax benefits of the tax deductions in excess of
the compensation cost recognized for those options (excess tax benefits) to be
classified as financing cash flows.
The following table illustrates the effects on net earnings and earnings per
share if the Company had applied the fair value recognition provisions of SFAS
123 to stock option plans during the three and nine months ended September 30,
2005. These pro forma calculations only include the effects of stock-based
compensation granted since January 1, 1995. The value of the options (net of
forfeitures) is amortized to expense on a straight-line basis over their vesting
periods.
Three months ended Nine months ended
(In thousands except per share amounts) September 30, 2005 September 30, 2005
------------------ ------------------
Net earnings, as reported $3,811 $11,526
Deduct: Incremental stock-based compensation
determined under fair value based method
for all awards since January 1, 1995, net
of related tax effects (78) (216)
------ -------
Pro forma net earnings $3,733 $11,310
====== =======
Earnings per share:
Basic, as reported $ .28 $ .86
Basic, pro forma $ .28 $ .84
Diluted, as reported $ .27 $ .82
Diluted, pro forma $ .26 $ .81
8
The following table summarizes the stock option transactions for the nine-month
periods ended September 30:
2006 2005
------------------ ------------------
Weighted Weighted
average average
exercise exercise
(In thousands except per share amounts) Options price Options price
------- -------- ------- --------
Options outstanding at January 1 1,290 $ 7.35 1,618 $ 7.01
Options granted 28 $31.41 45 $19.17
Options exercised (335) $ 6.94 (301) $ 7.19
Options forfeited/cancelled (2) $ 7.99 (38) $ 7.89
----- -----
Options outstanding at September 30 981 $ 8.17 1,324 $ 7.36
===== =====
Exercisable at September 30 669 $ 7.02 785 $ 7.08
===== =====
The following assumptions were used for options granted in the nine-month
periods ended September 30:
2006 2005
------ ------
Per share fair value of options granted during the period $11.62 $12.07
Risk-free interest rate 5% 4%
Dividend yield .96% 1.4%
Volatility factor 34% 30%
Weighted-average expected life (in years) 5.4 6.1
The following table summarizes the aggregate intrinsic value related to options
exercised, outstanding and exercisable as of and for the nine-month periods
ended September 30:
(In thousands) 2006 2005
------- -------
Exercised $ 7,076 $ 3,556
Outstanding $16,686 $19,260
Exercisable $12,113 $11,630
Stock options outstanding at September 30, 2006 are as follows (options in
thousands):
Weighted Weighted
average average
contractual exercise
Price Range life Options price
------------------- ----------- ------- --------
$3.70 - $ 5.75 2.9 312 $ 5.66
$6.03 - $ 7.13 5.9 377 $ 7.05
$7.50 - $31.42 4.6 292 $12.31
--- ---
Options outstanding 4.8 981 $ 8.17
=== ===
Options exercisable 4.0 669 $ 7.02
=== ===
As of September 30, 2006, the unrecognized compensation cost related to stock
options is approximately $610,000 ($396,000 on an after-tax basis) which will be
recognized over a weighted average period of 2.7 years.
Nonvested Stock:
Director Stock Grant Plan: Non-employee directors receive an annual award of
1,200 shares of Common Stock under the shareholder-approved 2002 Director Stock
Grant Plan. The Company records compensation expense for this plan ratably over
the annual service period beginning May 1. Director stock compensation expense
recognized by the Company for the three- and nine-month periods ended September
30, 2006 was $43,000 and $156,000, respectively, compared to $32,000 and
$106,000 of compensation expense recognized for the same periods in 2005. As of
September 30, 2006, the unrecognized compensation cost related to the nonvested
director stock award that is expected to be recognized over the remaining seven
months is estimated to be approximately $106,000 ($66,000 on an after-tax
basis).
Restricted Stock: On April 28, 2005, a restricted stock plan was approved which
provides for the issuance of nonvested Common Stock to certain eligible
employees. The Company records compensation expense for this plan ratably over
the vesting period. The plan authorizes the issuance of up to an aggregate of
100,000 shares of Common Stock, of which 31,000 shares were issued in the second
quarter of 2005 and 48,000 were issued in the second quarter of 2006. Nonvested
stock awards have a three-year cliff vesting period contingent on
9
employment. Nonvested stock compensation expense recognized by the Company for
the three- and nine-month periods ended September 30, 2006 was $166,000 and
$352,000, respectively, compared to $47,000 and $79,000 for the three- and
nine-month periods ended September 30, 2005.
The fair value of nonvested shares is determined based on the market price of
the Company's shares on the grant date.
Fair value
(In thousands except per share amounts) Shares per share
------ ----------
Nonvested at January 1 31 $18.33
Granted 48 $31.41
Vested (1) $18.33
Forfeited -- --
--- ------
Nonvested at September 30, 2006 78 $26.40
=== ======
As of September 30, 2006, there was $1.5 million ($960,000 on an after-tax
basis) of unrecognized compensation cost related to non-vested restricted stock
that is expected to be recognized over a weighted average period of 2.3 years.
NOTE 3 EMPLOYEE BENEFIT PLANS
The Company maintains a non-contributory defined benefit pension plan for its
domestic employees and a non-contributory postretirement plan that provides
medical benefits for certain domestic retirees and eligible dependents. The
following table sets forth the components of net periodic benefit cost for the
three months ended September 30, 2006 and 2005 based on a September 30
measurement date:
Other
Pension postretirement
benefits benefits
------------- --------------
(In thousands) 2006 2005 2006 2005
----- ----- ---- ----
Service cost $ 485 $ 457 $ 56 $ 44
Interest cost 595 625 122 125
Expected return on plan assets (918) (910) -- --
Amortization of prior service cost (28) (29) (9) (45)
Amortization of net loss 318 248 59 40
----- ----- ---- ----
Net periodic benefit cost $ 452 $ 391 $228 $164
===== ===== ==== ====
The following table sets forth the components of net periodic benefit cost for
the nine months ended September 30, 2006 and 2005 based on a September 30
measurement date:
Other
postretirement
Pension benefits benefits
----------------- --------------
(In thousands) 2006 2005 2006 2005
------- ------- ---- ------
Service cost $ 1,455 $ 1,371 $168 $ 132
Interest cost 1,785 1,875 365 375
Expected return on plan assets (2,754) (2,730) -- --
Amortization of prior service cost (84) (87) (27) (135)
Amortization of net loss 954 744 178 120
------- ------- ---- -----
Net periodic benefit cost $ 1,356 $ 1,173 $684 $ 492
======= ======= ==== =====
The Company did not make a contribution in 2006, because the return on assets as
of the annual measurement date of September 30, 2006 was sufficient.
The Company also disclosed in its financial statements for the year ended
December 31, 2005 that it estimated it would pay $1.0 million in other
postretirement benefits in 2006. As of September 30, 2006, $741,000 of such
benefits were paid. The Company continues to believe that its estimated payments
for the full year are reasonable. Note that the amount of benefits paid in
calendar year 2006 will not impact the expense for postretirement benefits for
the current year.
10
NOTE 4 GUARANTEES
The Company guarantees the debt of the Badger Meter Officers' Voting Trust
("BMOVT"), from which the BMOVT obtained loans from a bank on behalf of the
officers of the Company in order to purchase shares of the Company's Common
Stock. The officers' loan amounts are collateralized by the Company's shares
that were purchased with the loans' proceeds. There have been no loans made to
officers by the BMOVT since July 2002. The Company has guaranteed $0.5 million
and $1.1 million of the BMOVT's debt at September 30, 2006 and December 31,
2005, respectively. The current loan matures in April 2007, at which time it is
expected to be renewed. The fair market value of this guarantee at September 30,
2006 continues to be insignificant because the collateral value of the shares
exceeds the loan amount. It is the Company's intention to eliminate the BMOVT by
December 31, 2010, because it no longer fulfills its original purpose of
providing officers with loans to purchase Common Stock. The Company has no other
off-balance sheet arrangements.
The Company guarantees the outstanding debt of the Badger Meter Employee Savings
and Stock Ownership Plan ("ESSOP") that is recorded in long-term debt, offset by
a similar amount of unearned compensation that has been recorded as a reduction
of shareholders' equity. The loan amount is collateralized by shares of the
Company's Common Stock. A payment of $120,000 in the first quarter of 2006
reduced the loan from $0.9 million at December 31, 2005 to $0.8 million at
September 30, 2006.
NOTE 5 COMPREHENSIVE INCOME (LOSS)
Total comprehensive income (loss) of ($0.5) million and $3.6 million were
recognized for the three-month periods ended September 30, 2006 and 2005,
respectively. Foreign currency translation adjustments included in comprehensive
income (loss) for the three-month periods ended September 30, 2006 and 2005 were
a $27,000 gain and a ($0.2) million loss, respectively. Total comprehensive
income was $8.6 million and $9.7 million for the nine-month periods ended
September 30, 2006 and 2005, respectively. Foreign currency translation
adjustments included in comprehensive income for the nine-month periods ended
September 30, 2006 and 2005 were a $0.8 million gain and a ($1.8) million loss,
respectively.
NOTE 6 FRENCH OPERATIONS SHUTDOWN
Throughout 2006, the Company continued to evaluate strategic alternatives with
respect to its subsidiaries in Nancy, France, including potential restructuring,
sale or shutdown. In the third quarter of 2006, the Company began the process
under French law to obtain the required approvals to shut down the operations.
In the third quarter of 2006, the Company also recorded $3.7 million of
after-tax charges related to the anticipated shutdown of its French operations.
These charges included increased reserves for receivables and inventories
totaling $1.9 million, recording an impairment of long-lived assets of $1.3
million (primarily included in selling, engineering and administration in the
Consolidated Condensed Statement of Operations), and recognizing liabilities for
legally required severance costs of $0.5 million. The long-lived asset group
includes the intangible assets and fixed assets of the French operations. As a
result of the continued operating losses, the anticipated shutdown of the
Company's French operations, and the carrying amount of the long-lived asset
group exceeding the expected undiscounted future cash flows, the impairment
charge of $1.3 million was recognized for the difference between the carrying
value of the asset group and the fair value, based on an appraisal.
See Note 10 Subsequent Event for further discussion of action taken subsequent
to September 30, 2006 and anticipated future costs associated with the shutdown
of the Company's French operations.
NOTE 7 INCOME TAXES
The provision for income taxes differs from the amount that would be provided by
applying the statutory U.S. corporate income tax rate. The effective tax rate
for the third quarter of 2006 was 136.4% compared to 37.5% for the same period
in 2005, and 51.5% compared to 40.3% for the nine-month periods ended September
30, 2006 and 2005, respectively. The effective tax rates for the third quarter
and nine months ended September 30, 2006 were affected by the shutdown charges
recorded as a result of the anticipated shutdown of the Company's French
operations. Additionally, the effective tax rates were also higher than the
statutory rate due to the continuing operating losses from the French
operations. Consistent with prior periods, no tax benefit was taken for
French-related operating losses due to uncertainties surrounding the ultimate
realization of such benefits.
11
NOTE 8 CONTINGENCIES AND LITIGATION
In the normal course of business, the Company is named in legal proceedings from
time to time. There are currently no material legal proceedings pending with
respect to the Company. The more significant legal proceedings are as follows.
The Company is subject to contingencies relative to environmental laws and
regulations. Currently, the Company is in the process of resolving matters
relative to two landfill sites. Provision has been made for all known settlement
costs, which are not material.
The Company is also a defendant in numerous multi-party asbestos lawsuits
pending in various states. These lawsuits assert claims alleging that certain
industrial products were manufactured by the defendants and were the cause of
injury and harm. The Company is vigorously defending itself against these
claims. Although it is not possible to predict the ultimate outcome of these
matters, the Company does not believe the ultimate resolution of these issues
will have a material adverse effect on the Company's financial position or
results of operations, either from a cash flow perspective or on the financial
statements as a whole.
The Company has evaluated its worldwide operations to determine whether any
risks and uncertainties exist that could severely impact its operations in the
near term. The Company does not believe that there are any significant risks.
However, the Company relies on single suppliers for certain castings and
components in several of its product lines. Although alternate sources of supply
exist for these items, loss of certain suppliers could temporarily disrupt
operations in the short term. The Company attempts to mitigate these risks by
working closely with key suppliers, purchasing minimal amounts from alternative
suppliers and by purchasing business interruption insurance where appropriate.
The Company reevaluates its exposures on a periodic basis and makes adjustments
to reserves as appropriate.
NOTE 9 ACCOUNTING PRONOUNCEMENTS
In June 2006, the FASB issued Financial Interpretation No. 48, "Accounting for
Uncertainty in Income Taxes" (FIN 48), which clarifies the accounting for
uncertainty in income taxes recognized in a company's financial statements in
accordance with FASB Statement No. 109, "Accounting for Income Taxes." The
interpretation prescribes a recognition threshold and measurement attribute
criteria for the financial statement recognition and measurement of a tax
position taken or expected to be taken in a tax return. The interpretation also
provides guidance on derecognition, classification, interest and penalties,
accounting in interim periods, disclosure and transition. The Company is
required to adopt FIN 48 on January 1, 2007 and is currently evaluating the
impact that the adoption of FIN 48 will have on its consolidated financial
condition, results of operations and cash flows.
In September 2006, the FASB issued Statement No. 158, "Employers' Accounting for
Defined Benefit Pension and Other Postretirement Plans" (SFAS 158), which
requires the Company to recognize the overfunded or underfunded status of a
defined benefit postretirement plan as an asset or liability in the balance
sheet and to recognize changes in that funded status in the year in which the
changes occur through comprehensive income. Additionally, SFAS 158 requires the
Company to measure the funded status of a plan as of the date of its fiscal
year-end. The requirement to recognize the funded status of a defined benefit
postretirement plan and the related disclosure requirements are effective for
the Company as of December 31, 2006, while the requirement to measure the funded
status as of fiscal year-end is not effective for the Company until December 31,
2008. The company is currently evaluating the impact that the adoption of SFAS
158 will have on its consolidated financial position, results of operations and
cash flows.
NOTE 10 SUBSEQUENT EVENT
On October 16, 2006, the Board of Directors authorized management to shut down
the Company's French subsidiaries. French operations are expected to cease by
the end of fiscal 2006. The Company currently estimates that the shutdown of the
French subsidiaries will result in after-tax charges ranging from $6.0 million
to $8.0 million. In the third quarter of 2006, $3.7 million of after-tax charges
were recognized, with the remainder to be recognized as the operations wind
down, assets are liquidated and liabilities are settled. Upon substantial
completion of the shutdown, the results of operations will be eliminated from
the continuing operations of the Company and be presented as discontinued
operations.
12
ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
BUSINESS DESCRIPTION AND OVERVIEW
The Company is a leading marketer and manufacturer of products using
flow measurement and control technologies developed both internally and with
other technology companies. Its products are used to measure and control the
flow of liquids in a variety of applications. The Company's product lines fall
into two general categories, utility and industrial. The utility category is
comprised of two product lines, residential and commercial water meters (with
various automatic meter reading (AMR) technology systems), which are generally
sold to water utilities and constitute a majority of the Company's sales.
Industrial product line sales comprise the remainder of the Company's sales and
include automotive fluid meters and systems, small precision valves,
electromagnetic meters, impeller flow meters and industrial process meters (all
with related accessories and instrumentation).
Residential and commercial water meters and related systems are
classified as local (or manual) read meters or AMR products. Local read meters
consist of a water meter and a register. With AMR meters, the register digitally
encodes the mechanical reading and its radio frequency transmitter communicates
the data to a computerized system that collects the data and sends it to
specific utility computerized programs. Net sales and the corresponding net
earnings depend on unit volume and mix of products, with the Company generally
earning higher margins on residential AMR products (the impact of AMR on
commercial products is not as significant given the higher sales prices of
commercial meters). The Company sells AMR products of other companies as well as
its own proprietary product, Orion(R), which has higher margins than the other
AMR products. Net sales and the corresponding net earnings are therefore also
dependent on the mix of AMR products between proprietary and non-proprietary
products. Orion(R) is currently being sold as a walk-by/drive-by system, but
also has the ability to connect with a variety of other technologies, such as
power line carrier, broadband over power line, municipal WI-FI and radio
frequency systems to allow for remote reading of the data.
There is a base level of annual business for utility products driven
by replacement units and, to a lesser extent, housing starts. Sales above the
base level depend on conversions to AMR away from manual read meters. The
Company believes that conversion from local read meters to AMR products can
accelerate replacements of meters and result in growth, because it is estimated
that only 20-25% of the water meter market has been converted to AMR. Badger
Meter's strategy is to solve customers' metering needs with its proprietary
meter reading systems or other systems available through alliances within the
marketplace.
The industrial products generally serve niche markets and have in the
past utilized technology derived from utility products to serve industrial uses.
As these markets evolve, these products are becoming more specialized to meet
industrial flow measurement and communication protocol requirements. Serving
these markets allows the Company to expand its technologies into other areas of
flow measurement and control, as well as utilize existing capacity and spread
fixed costs over a larger sales base.
BUSINESS TRENDS
For several quarters, the Company has carefully evaluated strategic
alternatives for its subsidiaries in Nancy, France, including restructuring,
sale or shutdown. In the third quarter of 2006, the Company began the process
under French law to obtain the approvals to close the operation. On October 16,
2006, the decision was finalized and operations are expected to cease by the end
of 2006. The Company currently estimates that this will result in after-tax
charges ranging from $6.0 million to $8.0 million. In the third quarter of 2006,
$3.7 million of charges were recognized, with the remainder to be recognized as
the operations wind down, assets are liquidated and liabilities are settled.
As noted above, the Company sells AMR products of other companies as
well as its own proprietary product, Orion(R). The Company currently has a
distribution agreement under which it resells products produced by Itron, Inc.
Prior to the Company's introduction of its own proprietary Orion(R) products,
Itron(R) water utility related products were a significant contributor to the
Company's results. The Company's Orion(R) products directly compete with
Itron(R) water AMR products and, in recent years, many of the Company's
customers have selected Orion(R) products. As a result, the Company's annual
2005 sales of Itron(R) products decreased approximately 12%, while Orion(R)
sales doubled compared to 2004. This trend continued as sales of Itron(R)
products decreased approximately 6%, 13% and 17% in the first, second and third
quarters of 2006 respectively, while Orion(R) sales increased 43%, 20% and 63%
compared to the corresponding periods of 2005. The Company expects this trend to
continue, although it also believes that Itron(R) products will remain a
significant component of utility sales. Decreases in sales of Itron(R) products
have been offset by increases in sales of Orion(R) products, which produce a
higher gross margin than the Itron(R) products. As a result, the Company does
13
not expect this trend to have a material negative impact on the Company's
financial position or results of operations.
RESULTS OF OPERATIONS - THREE MONTHS ENDED SEPTEMBER 30, 2006
The net income for the quarter reflects approximately $3.7 million of
after-tax charges related to the planned disposal of the Company's French
operations. See the discussion above regarding the decision to shut down the
Company's French operations. These charges included increasing reserves for
receivables and inventories, recording an impairment of long-lived assets, and
recognizing liabilities for legally required severance costs. Additional charges
are anticipated in future periods as operations wind down and the actual
liquidation occurs.
The following tables reconcile consolidated condensed statements of
operations to similar data on a pro forma basis and is included to supplement
the consolidated condensed financial statements presented in accordance with
generally accepted accounting principles (GAAP). Management uses the net
earnings (loss) without shutdown charges for the its French operations or
without the French operating losses in its internal performance reporting.
Management believes that these non-GAAP financial measures are useful for
providing investors with additional insight into the Company's operating
performance because it eliminates from reported results the effects of the
charges associated with the French shutdown and the operating losses from the
French operations, both of which will be included in discontinued operations
once the liquidation process is completed. Therefore, these non-GAAP financial
measures enhance investors' overall understanding of the Company's ongoing
operations. Non-GAAP performance measures should be considered in addition to,
and not as a substitute for, results prepared in accordance with GAAP.
Pro Forma Consolidated Condensed Statements of Operations
Three Months Ended September 30, 2006
(Unaudited)
(In thousands except share and per share amounts)
Pro Forma
Pro Forma Without
French Without French
Operations' French French Shutdown &
Shutdown Shutdown Operating Operating
As Reported Charges Charges Losses Losses
----------- ----------- ----------- ----------- -----------
Net sales $ 62,980 $ -- $ 62,980 $ 2,781 $ 60,199
Cost of sales 46,679 (2,047) 44,632 2,324 42,308
----------- ----------- ----------- ----------- -----------
Gross margin 16,301 (2,047) 18,348 457 17,891
Selling, engineering and
administration 14,363 (2,094) 12,269 987 11,282
----------- ----------- ----------- ----------- -----------
Operating earnings 1,938 (4,141) 6,079 (530) 6,609
Interest expense 511 -- 511 52 459
----------- ----------- ----------- ----------- -----------
Earnings before income taxes 1,427 (4,141) 5,568 (582) 6,150
Provision for income taxes 1,946 (399) 2,345 -- 2,345
----------- ----------- ----------- ----------- -----------
Pro forma net earnings (loss) $ (519) $ (3,742) $ 3,223 $ (582) $ 3,805
=========== =========== =========== =========== ===========
Per share amounts:
As reported and pro forma earnings (loss)
per share:
Basic $ (.04) $ (.27) $ .23 $ (.04) $ .27
Diluted $ (.04) $ (.26) $ .22 $ (.04) $ .27
Shares used in computation of reported and
pro forma earnings (loss) per share:
Basic 13,935,229 13,935,229 13,935,229 13,935,229 13,935,229
=========== =========== =========== =========== ===========
Diluted 13,935,229(a) 14,356,475 14,356,475 14,356,475 14,356,475
=========== =========== =========== =========== ===========
(a) As a result of the loss recognized in the third quarter of 2006, the impact
of potential common shares related to stock-based compensation is
anti-dilutive and therefore excluded from the weighted average shares
outstanding used to calculate dilutive loss per share.
14
Pro Forma Consolidated Condensed Statements of Operations
Three Months Ended September 30, 2005
(Unaudited)
(In thousands except share and per share amounts)
Pro Forma
Pro Forma Without
French Without French
Operations' French French Shutdown &
Shutdown Shutdown Operating Operating
As Reported Charges Charges Losses Losses
----------- ----------- ----------- ----------- -----------
Net sales $ 54,194 $-- $ 54,194 $ 3,276 $ 50,918
Cost of sales 35,540 -- 35,540 2,908 32,632
----------- --- ----------- ----------- -----------
Gross margin 18,654 -- 18,654 368 18,286
Selling, engineering and
administration 12,156 -- 12,156 888 11,268
----------- --- ----------- ----------- -----------
Operating earnings 6,498 -- 6,498 (520) 7,018
Interest expense 402 -- 402 28 374
----------- --- ----------- ----------- -----------
Earnings before income taxes 6,096 -- 6,096 (548) 6,644
Provision for income taxes 2,285 -- 2,285 -- 2,285
----------- --- ----------- ----------- -----------
Pro forma net earnings (loss) $ 3,811 $-- $ 3,811 $ (548) $ 4,359
=========== === =========== =========== ===========
Per share amounts:
As reported and pro forma earnings (loss)
per share:
Basic $ .28 $-- $ .28 $ (.04) $ .32
Diluted $ .27 $-- $ .27 $ (.04) $ .31
Shares used in computation of reported and
pro forma earnings (loss) per share:
Basic 13,522,144 -- 13,552,144 13,552,144 13,552,144
=========== === =========== =========== ===========
Diluted 14,194,848 -- 14,194,848 14,194,848 14,194,848
=========== === =========== =========== ===========
Net sales for the three-month period ended September 30, 2006
increased $8.8 million, or 16.2%, over the same period in 2005. The overall
sales increase was driven by increased sales in both local read and AMR meters
as well as significant increases in commercial meters, all caused by volume
increases, and by higher industrial sales.
Residential and commercial water meter sales represented 78.4% of
total sales in the third quarter of 2006 compared to 75.2% in the third quarter
of 2005. These sales increased $8.6 million to $49.4 million compared to $40.8
million in the same period in 2005 due to increased sales of local (or manual)
read water meter units, units utilizing AMR technologies and commercial meters.
Most notable in the increase of AMR technologies was the increase in sales of
the Company's proprietary AMR product, Orion(R), which increased approximately
63% over the amount sold in the third quarter of 2005. The increase in Orion(R)
sales was somewhat offset by sales decreases in other AMR technologies,
particularly Itron(R).
Industrial sales were affected by economic conditions, domestically
and internationally, in each of the markets served by the various product lines.
In total, industrial products represented 21.6% of total sales for the three
months ended September 30, 2006 compared to 24.8% for the same period in 2005.
Industrial sales increased $0.2 million to $13.6 million in the third quarter of
2006 compared to $13.4 million in the third quarter of 2005. The increase in
sales was driven primarily by higher sales of electromagnetic meters, automotive
fluid meters and valves, offset somewhat by lower sales of automotive systems
sold by the Company's French subsidiary.
Gross margins in total for the third quarter of 2006 were 25.9%, which
includes the effects of the French shutdown charges. Without the Company's
French shutdown charges and operating results, the gross margins would have been
29.7% compared to 35.9% in the third quarter of 2005 on a pro forma basis. (See
the discussion above on non-GAAP financial measures.) The decrease in this pro
forma gross margin was due to the Company experiencing considerable cost
increases on purchased castings due to increased prices of raw material metals,
particularly copper, which is a main component in purchased brass castings. The
Company was unable to recoup all of these cost increases in the third quarter,
although price increases were implemented in August 2006 to recover a portion of
the increased cost of materials. It is the Company's belief that it will take
several quarters for the price increases to fully offset the increased costs.
Gross margins were also negatively
15
affected by the net impact of lower margins on automotive fluid meters and
related systems due to competition and to charges associated with the
development and introduction of a fixed-based technology product. These were
offset somewhat by higher residential meter margins due to the higher mix of AMR
products, particularly the Orion(R) product, which carries higher margins.
Selling, engineering and administration costs for the third quarter of
2006 increased 18.2% over the same period in 2005 due primarily to the shutdown
charges for the French operations. Without the Company's French shutdown and
operating charges, these expenses were essentially flat between periods on a pro
forma basis, reflecting continuing cost containment efforts, offset by normal
inflationary pressures. (See the discussion above on non-GAAP financial
measures.) In addition, the third quarter of 2006 includes $30,000 of additional
compensation expense due to expensing stock options to comply with SFAS 123(R),
"Share-Based Payment".
Interest expense for the third quarter of 2006 was $0.1 million higher
than the same period in the prior year primarily due to higher interest rates.
The effective tax rate for the third quarter of 2006 was 136.4% due to
the uncertainty of tax benefiting certain of the French shutdown charges,
compared to 37.5% for the third quarter of 2005. Without the Company's French
shutdown charges and operating charges, the effective tax rate would be 38.1%
compared to 34.4% in the third quarter of 2005. (See the discussion above on
non-GAAP financial measures.) The lower than anticipated rate on a pro forma
basis for the third quarter of 2005 was the result of adjustments made to the
annual estimated rate.
As a result of the above-mentioned items, there was a ($0.5) million
net loss for the third quarter of 2006. On a diluted earnings per share basis,
this equated to ($0.04) per share. Without the Company's French shutdown charges
and operating charges, pro forma net earnings for the third quarter of 2006 were
$3.8 million compared to net earnings in the third quarter of 2005 of $4.4
million, or $0.27 compared to $0.31, respectively, on a diluted earnings per
share basis. (See the discussion above on non-GAAP financial measures.)
16
RESULTS OF OPERATIONS - NINE MONTHS ENDED SEPTEMBER 30, 2006
The net income for the year-to-date results reflects approximately
$3.7 million of after-tax charges related to the planned shutdown of the
Company's French operations. See the discussion above regarding the decision to
shut down the Company's French operations. These charges included increasing
reserves for receivables and inventories, recording an impairment of long-lived
assets, and recognizing liabilities for legally required severance costs.
Additional charges are anticipated in future periods as operations wind down and
the actual liquidation occurs.
The following tables reconcile consolidated condensed statements of
operations to similar data on a pro forma basis and is included to supplement
the consolidated condensed financial statements presented in accordance with
generally accepted accounting principles (GAAP). Management uses the net
earnings (loss) without shutdown charges for the Company's French operations or
without the French operating losses in its internal performance reporting.
Management believes that these non-GAAP financial measures are useful for
providing investors with additional insight into the Company's operating
performance because it eliminates from reported results the effects of the
charges associated with the French shutdown and the operating losses from the
French operations, both of which will be included in discontinued operations
once the liquidation process is completed. Therefore, these non-GAAP financial
measures enhance investors' overall understanding of the Company's ongoing
operations. Non-GAAP performance measures should be considered in addition to,
and not as a substitute for, results prepared in accordance with GAAP.
Pro Forma Consolidated Condensed Statements of Operations
Nine Months Ended September 30, 2006
(Unaudited)
(In thousands except share and per share amounts)
Pro Forma
Pro Forma Without
French Without French
Operations' French French Shutdown &
As Shutdown Shutdown Operating Operating
Reported Charges Charges Losses Losses
----------- ----------- ----------- ----------- -----------
Net sales $ 186,421 $ -- $ 186,421 $ 9,393 $ 177,028
Cost of sales 128,413 (2,047) 126,366 8,846 117,520
----------- ----------- ----------- ----------- -----------
Gross margin 58,008 (2,047) 60,055 547 59,508
Selling, engineering and
administration 40,692 2,094 38,598 2,937 35,661
----------- ----------- ----------- ----------- -----------
Operating earnings 17,316 (4,141) 21,457 (2,390) 23,847
Interest expense 1,312 -- 1,312 146 1,166
----------- ----------- ----------- ----------- -----------
Earnings before income taxes 16,004 (4,141) 20,145 (2,536) 22,681
Provision for income taxes 8,243 (399) 8,642 (3) 8,645
----------- ----------- ----------- ----------- -----------
Pro forma net earnings (loss) $ 7,761 $ (3,742) $ 11,503 $ (2,533) $ 14,036
=========== =========== =========== =========== ===========
Per share amounts:
As reported and pro forma
earnings (loss) per
share:
Basic $ .56 $ (.27) $ .83 $ (.18) $ 1.01
Diluted $ .55 $ (.26) $ .81 $ (.18) $ .99
Shares used in computation of
reported and pro forma
earnings (loss) per share:
Basic 13,831,668 13,831,668 13,831,668 13,831,668 13,831,668
=========== =========== =========== =========== ===========
Diluted 14,207,310 14,207,310 14,207,310 14,207,310 14,207,310
=========== ========== =========== =========== ===========
17
Pro Forma Consolidated Condensed Statements of Operations
Nine Months Ended September 30, 2005
(Unaudited)
(In thousands except share and per share amounts)
Pro Forma
Pro Forma Without
French Without French
Operations' French French Shutdown &
As Shutdown Shutdown Operating Operating
Reported Charges Charges Losses Losses
----------- ----------- ----------- ----------- -----------
Net sales $ 166,058 $-- $ 166,058 $ 11,246 $ 154,812
Cost of sales 107,965 -- 107,965 9,268 98,697
----------- --- --------- ----------- -----------
Gross margin 58,093 -- 58,093 1,978 56,115
Selling, engineering and
administration 37,610 -- 37,610 2,825 34,785
----------- --- --------- ----------- -----------
Operating earnings 20,483 -- 20,483 (847) 21,330
Interest expense 1,177 -- 1,177 76 1,101
----------- --- --------- ----------- -----------
Earnings before income taxes 19,306 -- 19,306 (923) 20,229
Provision for income taxes 7,780 -- 7,780 23 7,757
----------- --- ----------- ----------- -----------
Pro forma net earnings (loss) $ 11,526 $-- $ 11,526 $ (946) $ 12,472
=========== === =========== =========== ===========
Per share amounts:
As reported and pro forma
earnings (loss) per
share:
Basic $ .86 $-- $ .86 $ (.07) $ .93
Diluted $ .82 $-- $ .82 $ (.07) $ .89
Shares used in computation of
reported and pro forma
earnings (loss) per share:
Basic 13,458,804 -- 13,458,804 13,458,804 13,458,804
=========== === =========== =========== ===========
Diluted 14,008,537 -- 14,008,537 14,008,537 14,008,537
=========== === =========== =========== ===========
Net sales for the nine-month period ended September 30, 2006 increased
$20.4 million, or 12.3%, over the same period in 2005. The overall sales
increase was driven by increased sales in both local read and AMR meters as well
as significant increases in commercial meters, all caused by volume increases.
Residential and commercial water meter sales represented 77.2% of
total sales for the first nine months of 2006 compared to 74.4% for the same
period in 2005. These sales increased $20.3 million to $143.9 million compared
to $123.6 million in the same period in 2005 due to increased sales of local (or
manual) read water meter units, units utilizing AMR technologies, and commercial
meters. Most notable in the increase of AMR technologies was the increase in
sales of the Company's proprietary AMR product, Orion(R), which increased 40.7%
over the amount sold in the first nine months of 2005. This was mitigated
somewhat by sales decreases in other AMR technologies, particularly Itron(R).
Industrial sales were affected by economic conditions, domestically
and internationally, in each of the markets served by the various product lines.
In total, industrial products represented 22.8% of total sales for the nine
months ended September 30, 2006 compared to 25.6% for the same period in 2005.
Industrial sales increased less than $0.1 million to $42.5 million for the first
nine months of 2006 compared to $42.4 million for the same period in 2005. Most
industrial product lines had modest increases, while the automotive systems
products sold by the Company's French subsidiary decreased.
Gross margins in total for the first nine months of 2006 were 31.1%,
which includes the effects of the Company's French shutdown charges. Without the
Company's French shutdown charges and operating results, the gross margins would
have been 33.6% compared to 36.2% for the same period in 2005 on a pro forma
basis. (See the discussion above on non-GAAP financial measures.) This decrease
in gross margin was due to the Company experiencing considerable cost increases
on purchased castings due to increased prices of raw material metals,
particularly copper, which is a main component in purchased brass castings. The
Company was unable to recoup all of these cost increases, although price
increases were implemented in the third quarter of 2006 to recover a portion of
the increased cost of materials. It is the Company's belief that it will take
several quarters for the price increases to fully offset the increased costs.
Gross margins were also negatively affected by the net impact of lower margins
on automotive fluid meters and related systems due to competition and to charges
associated with the development and introduction of a fixed-based technology
product. These were
18
offset somewhat by higher residential meter margins due to the higher mix of AMR
products, particularly the Orion(R) product, which carries higher margins.
Selling, engineering and administration costs for the nine months
ended September 30, 2006 increased 8.2% over the same period in 2005 due in part
to the shutdown charges for the French operations. Without the Company's French
shutdown and operating charges, these expenses would have increased $0.9
million, or 2.5%, as a result of higher sales levels and normal inflation,
offset somewhat by cost containment measures. (See the discussion above on
non-GAAP financial measures.) In addition, this nine-month period of 2006
includes $241,000 of additional compensation expense due to expensing stock
options to comply with SFAS 123(R), "Share-Based Payment".
Interest expense for the first nine months of 2006 was $0.1 million
higher than the same period in the prior year primarily due to higher interest
rates.
The effective tax rate for the nine months ended September 30, 2006
was 51.5% which is higher than normal due to the uncertainty of tax benefiting
certain of the French shutdown charges, compared to 40.3% for the same period in
2005. Without the Company's French shutdown charges and operating charges, the
pro forma effective tax rate would be 38.3% for both the nine months ended
September 30, 2006 and 2005. (See the discussion above on non-GAAP financial
measures.)
As a result of the above-mentioned items, net income for the nine
months ended September 30, 2006 was $7.8 million. On a diluted earnings per
share basis, this equated to $0.55 per share. Without the Company's French
shutdown and operating charges, pro forma net earnings for this period would
have been $14.0 million compared to $12.5 million for the same period in 2005.
(See the discussion above on non-GAAP financial measures.) On a pro forma
diluted earnings per share basis, the Company earned $0.99 for the nine months
ended September 30, 2006 compared to $0.89 for the same period in 2005.
LIQUIDITY AND CAPITAL RESOURCES
The main sources of liquidity for the Company typically are cash
provided by operations and borrowing capacity. For the first nine months of
2006, $6.3 million of cash was provided by operations, primarily as the net
result of increased earnings adjusted for depreciation and amortization, offset
by increased inventory and receivables.
The change in the receivables balance from $30.5 million at December
31, 2005 to $41.3 million at September 30, 2006 was primarily due to increased
sales and the timing of certain customer payments. Days' sales outstanding has
increased slightly, although the Company believes credit risk is consistent with
the prior year.
Inventories at September 30, 2006 have increased $0.8 million to $32.8
million from the December 31, 2005 balance of $32.0 million due primarily to
increased sales and higher material costs, particularly on brass castings,
offset by increased reserves resulting from the decision to shut down the
Company's French operations.
Net property, plant and equipment increased $2.3 million since
December 31, 2005. This is the net result of $7.9 million of capital
expenditures, $5.0 million of depreciation expense, the effects of currency
adjustments, and impairment charges related to the French operations.
Short-term debt and the current portion of long-term debt at September
30, 2006 increased $9.1 million to a combined $25.4 million versus a balance at
December 31, 2005 of $16.3 million. Long-term debt decreased to $6.5 million at
September 30, 2006 from $15.4 million at December 31, 2005. Overall, the
Company's total debt position has increased slightly due to changes in working
capital accounts. Total debt is 28.0% of total capitalization (debt and equity)
at September 30, 2006 compared to 30.1% at December 31, 2005. At September 30,
2006, none of the Company's debt carried financial covenants or required
collateral.
Payables increased to $16.1 million at September 30, 2006 from $11.5
million at December 31, 2005 primarily as a result of the timing of payments and
increased inventory levels. Accrued compensation and employee benefits decreased
$0.8 million since December 31, 2005 to $5.6 million due to the first quarter
2006 payments of short-term incentive amounts accrued at December 31, 2005,
offset somewhat by costs accrued for 2006 year-to-date expenses.
Common stock and capital in excess of par value increased from
December 31, 2005 due to new shares issued in connection with the exercise of
stock options. Employee benefit stock decreased as a result of a
19
payment made on the ESSOP loan during the first quarter of 2006, amortization of
nonvested stock expense and the adoption of SFAS 123(R), which required the
reclassification of amounts from employee benefit stock to capital in excess of
par value.
Badger Meter's financial condition remains strong. The Company
believes that its operating cash flows, available borrowing capacity, including
$31.9 million of unused credit lines, and its ability to raise additional
capital provide adequate resources to fund ongoing operating requirements,
future capital requirements and the development of new products.
OTHER MATTERS
There are currently no material legal proceedings pending with respect
to the Company. The more significant legal proceedings are as follows.
The Company is subject to contingencies relative to environmental laws
and regulations. Currently, the Company is in the process of resolving matters
relative to two landfill sites. Provision has been made for all known settlement
costs, which are not material.
The Company is also a defendant in numerous multi-party asbestos
lawsuits pending in various states. These lawsuits assert claims alleging that
certain industrial products were manufactured by the defendants and were the
cause of injury and harm. The Company is vigorously defending itself against
these claims. Although it is not possible to predict the ultimate outcome of
these matters, the Company does not believe the ultimate resolution of these
issues will have a material adverse effect on the Company's financial position
or results of operations, either from a cash flow perspective or on the
financial statements as a whole.
No other risks or uncertainties were identified that could have a
material impact on operations and no long-lived assets have become permanently
impaired in value.
ACCOUNTING PRONOUNCEMENTS
The Company began expensing the fair value of stock options on January
1, 2006 when it adopted SFAS 123(R), "Share-Based Payment". See Note 2 to the
Notes to Unaudited Consolidated Condensed Financial Statements in this Form 10-Q
for information regarding this accounting change.
In June 2006, the FASB issued Financial Interpretation No. 48,
"Accounting for Uncertainty in Income Taxes" (FIN 48), which clarifies the
accounting for uncertainty in income taxes recognized in a company's financial
statements in accordance with FASB Statement No. 109, "Accounting for Income
Taxes." The interpretation prescribes a recognition threshold and measurement
attribute criteria for the financial statement recognition and measurement of a
tax position taken or expected to be taken in a tax return. The interpretation
also provides guidance on derecognition, classification, interest and penalties,
accounting in interim periods, disclosure and transition. The Company is
required to adopt FIN 48 on January 1, 2007 and is currently evaluating the
impact that the adoption of FIN 48 will have on its consolidated financial
condition, results of operations and cash flows.
In September 2006, the FASB issued Statement No. 158, "Employers'
Accounting for Defined Benefit Pension and Other Postretirement Plans" (SFAS
158), which requires the Company to recognize the overfunded or underfunded
status of a defined benefit postretirement plan as an asset or liability in the
balance sheet and to recognize changes in that funded status in the year in
which the changes occur through comprehensive income. Additionally, SFAS 158
requires the Company to measure the funded status of a plan as of the date of
its fiscal year-end. The requirement to recognize the funded status of a defined
benefit postretirement plan and the related disclosure requirements are
effective for the Company as of December 31, 2006, while the requirement to
measure the funded status as of fiscal year-end is not effective for the Company
until December 31, 2008. The Company is currently evaluating the impact that the
adoption of SFAS 158 will have on its consolidated financial position, results
of operations and cash flows.
OFF-BALANCE SHEET ARRANGEMENTS AND CONTRACTUAL OBLIGATIONS
The Company's off-balance sheet arrangements and contractual
obligations are discussed in Part II, Item 7 "Management's Discussion and
Analysis of Financial Condition and Results of Operations" under the headings
"Off-Balance Sheet Arrangements" and "Contractual Obligations" in the Company's
Annual Report on Form 10-K for the year ended December 31, 2005, and have not
materially changed since that report was filed.
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ITEM 3 QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company's quantitative and qualitative disclosures about market
risk are included in Part II, Item 7 "Management's Discussion and Analysis of
Financial Condition and Results of Operations" under the heading "Market Risks"
in the Company's Annual Report on Form 10-K for the year ended December 31,
2005, and have not materially changed since that report was filed.
ITEM 4 CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
In accordance with Rule 13a-15(b) of the Securities Exchange Act of
1934 (the "Exchange Act"), the Company's management evaluated, with the
participation of the Company's Chairman, President and Chief Executive Officer
and the Company's Senior Vice President - Finance, Chief Financial Officer and
Treasurer, the effectiveness of the design and operation of the Company's
disclosure controls and procedures (as defined in Rule 13a-15(e) under the
Exchange Act) as of the end of the quarter ended September 30, 2006. Based upon
their evaluation of these disclosure controls and procedures, the Company's
Chairman, President and Chief Executive Officer and the Company's Senior Vice
President - Finance, Chief Financial Officer and Treasurer concluded that the
Company's disclosure controls and procedures were effective as of the end of the
quarter ended September 30, 2006 to ensure that material information relating to
the Company, including its consolidated subsidiaries, was made known to
management by others within those entities as appropriate to allow timely
decisions regarding disclosure, particularly during the period in which this
Quarterly Report on Form 10-Q was being prepared.
Changes in Internal Control over Financial Reporting
There was no change in the Company's internal control over financial
reporting that occurred during the quarter ended September 30, 2006, that has
materially affected, or is reasonably likely to materially affect, the Company's
internal control over financial reporting.
PART II - OTHER INFORMATION
ITEM 6 EXHIBITS
EXHIBIT NO. DESCRIPTION
----------- -----------
31.1 Certification by the Chief Executive Officer pursuant to Section
302 of the Sarbanes-Oxley Act of 2002.
31.2 Certification by the Chief Financial Officer pursuant to Section
302 of the Sarbanes-Oxley Act of 2002.
32 Certification of Periodic Financial Report by the Chief Executive
Officer and Chief Financial Officer pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
BADGER METER, INC.
Dated: October 31, 2006 By /s/ Richard A. Meeusen
-------------------------------------
Richard A. Meeusen
Chairman, President and Chief
Executive Officer
By /s/ Richard E. Johnson
-------------------------------------
Richard E. Johnson
Senior Vice President - Finance,
Chief Financial Officer and Treasurer
By /s/ Beverly L.P. Smiley
-------------------------------------
Beverly L.P. Smiley
Vice President - Controller
22
BADGER METER, INC.
QUARTERLY REPORT ON FORM 10-Q FOR PERIOD ENDED SEPTEMBER 30, 2006
EXHIBIT INDEX
EXHIBIT NO. DESCRIPTION
----------- -----------
31.1 Certification by the Chief Executive Officer pursuant to Section
302 of the Sarbanes-Oxley Act of 2002.
31.2 Certification by the Chief Financial Officer pursuant to Section
302 of the Sarbanes-Oxley Act of 2002.
32 Certification of Periodic Financial Report by the Chief Executive
Officer and Chief Financial Officer pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
23