Good day, ladies and gentlemen, and welcome to the Q4 2017 Badger Meter Earnings Conference Call. At this time, all participants are in a listen only mode. [Operator Instructions] As a reminder, this conference call is being recorded. I would now like to turn the conference over to Rick Johnson, Senior Vice President of Finance and Chief Financial Officer. Sir, you may begin.

Thank you very much, Takia. Good morning, everyone. And welcome to Badger Meter's fourth quarter conference call. I want to thank all of you for joining us today. 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 specific guidance does not serve the long-term interest of our shareholders. Now on to the results. After the market closed yesterday, we released our fourth quarter and annual 2017 results. We are pleased that sales, net earnings and diluted earnings per share are records for the fourth quarter and the year as a whole, despite the softer utility market that impacted the entire industry. Let's review of some of the details. Sales in the fourth quarter increased 3.8% to $96.7 million from $93.1 million last year minutes. Municipal water sales were up 1.9% while flow instrumentation sales increased 10.7%. Municipal water sales represented 76.5% of the fourth quarter sales, coming in at $74 million. Within these sales, residential sales were up 5.4% while commercial sales were down 15.5%. The fourth quarter of 2016 included several…

Thank you, Rich. Thank all of you for joining us today. Before I start my comments, I would like to introduce our new Chief Operating Officer, Ken Bockhorst, who started with us in October. As COO Ken currently has responsibility for our North American sales, marketing, engineering and manufacturing functions. Since starting in October, Ken has been busy visiting our facilities, meeting with our customers and meeting some of our shareholders. I'll ask Ken to offer few comments on his background.

Thanks Rich. So these past few months, I've been a bit of a whirlwind. So I've been traveling to our facilities, meeting with our employees, customers and shareholders. And really getting to see first hand how our technologies deliver real-time data that improve our customers operations. It is clear to me that the caliber of our team, the sophistication of our products and operations and our strong financial position have us poised to continue growing organically, and we are strategically right through acquisition. While at Actuant where I was for six years prior to joining Badger Meter, I ran the company's energy segment. I was privileged to partner with over 1,500 employees working in 24 service centers in six manufacturing locations across the world. I spent a great deal of time outside the US, working to grow the business and overseeing an active M&A portfolio. And what I've learned throughout my career is that continuous improvement, product innovation, dedicated employees and meaningful customer relationships are really the backbone how to succeed in a competitive global marketplace. I am extremely pleased that that philosophy is shared by my new colleagues, which is one of the many reasons why I feel at home here already. If I haven't you met yet, I'm looking forward to doing so on the near future. And I am thrilled to be here and excited about our future. So on that I'll give you back to Rich.

Thanks Ken. As we stated in our press release when he joined us, Ken will be a key part of our future leadership planning here Badger Meter. We are fortunate to have an experienced executive like Ken as part of our team. You will certainly be hearing more from him in future quarters. Now let me turn my comments to the results. As Rick said, this was a strong quarter for us particularly with the stronger margins driven by the continued shift in mix to the higher margin products, both in our utility and flow instrumentation markets. We are pleased with the rebound in flow instrumentation particularly in the oil and gas metering markets. We are also benefiting from the continued market acceptance of the Orion cellular radios in the E-series ultrasonic meters. Our record breaking fourth quarter also capped off another record year in 2017, a year where sales cross the $400 million threshold for the first time. On a percentage basis sales increased 2.2% but our strong margins and cost control efforts combined to increase pretax income by 10%. As Rick explained, we generated record net income and record diluted earnings per share, so this was definitely a year for us to be proud off. The new tax law will benefit us in 2018 and beyond due its lower corporate tax rate. However, I'd like to mention one other cost that we incurred in 2017 that we expect to generate benefits in 2018 and beyond. As you know, we double down on our ultrasonic metering technology when we acquired D-Flow earlier in the year. We immediately refocused all of D-Flow's efforts to the task of integrating their technology into our E-series meters. We expect to see the benefit of that effort when we introduce our next version of the E-series meters in the second half of this year, both as a form of product improvement and cost reduction. However, until then we are absorbing the additional cost of the D-Flow acquisition through our current results. In fact during 2017, the net cost of the D-Flow operation was over $700,000 primarily due to intangible amortization related to the acquisition .We believe that this investment in the next generation E-series will yield significant benefits for the company in coming years. As we look at the year ahead, we have an other good reasons to be optimistic. We continue to see strength in utility markets, as well as select flow instrumentation markets. Although increase copper cost will continue to challenge margins for the entire industry, we believe that the price increases we instituted on January 1, combined with a continued shift in mix towards higher margin products will be able to offset this impact. Overall, we continue to be confident about the future of business and our ability to generate shareholder value for the long-term. With those comments, we will love to take your questions.

[Operator Instructions] Thank you. Our first question comes from the line of Richard Eastman from Baird. Your line is now open.

Good morning, Rick, Rich, Ken. Rich, could you perhaps maybe just kind of speak to the tone of business here as we track through January? I mean the first quarter can be notoriously plus or minus 10% relative to the fourth quarter, depending on weather and some other issues. But could you handicap the plus or the minus 10% given what you've seen in January? And just you know extremely early February.

Well, what I would say is that thus far we are seeing good order entry. So we are optimistic about having a solid quarter, but as far as handicapping what might happen in the next two months, it gets very difficult, you know the weather can play a big impact in the first quarter. Blizzard, snowstorms, things of that sort that cause our customers to redirect their efforts and refocus their efforts and maybe delay meter installations. So those things could impact us. We are continuing to see strength in oil and gas so that's good. But really beyond that I Rich, I really don't want try to predict what the first quarter going to look like.

And it's only February 6.

And it's only February 6.

I realize its February 6. Then I also wanted to just speak to, just on the gross margin, again, you delivered incremental gross margin dollars on lower sales and we are talking about a quarter-to-quarter. And I think your commentary was the price increase really was a January 1st event. You are looking forward to this kind of shift in the mix of business being favorable. So maybe is the set up here that we are kind of targeting a similar gross margin for all of 2018, given our pricing strategies and our expectations on mix. Can we hold that not necessarily quarter-over-quarter but can we hold that for full year, is that the target?

This is Rick. I'll start and then I know Rich will wait and speak -- who want to say something. But my reaction is you can't look in any individual quarter and determine a gross margin. If you look at this particular quarter, as I said, we sold more radios this quarter than we did in the fourth quarter of 2016. And we actually sold fewer brass meters, okay. At some point, we are going to be selling meters in there and that does factor into the mix. And so it's likely it's going to come down. And our business is always lumpy and so I don't read anything into a particular quarter in terms of gross margin. Having said that, the trend towards higher technology over the long term should slowly increase gross margins.

And I agree with what Rick said. If you look at the gross margins, we did over 40% in the fourth quarter, but we did 38.7% for the year. If I was looking at 2008, I'd be modeling closer 2018. Exactly there, wow. If we were looking at 2018 the margins are going to be lower. Right, if was looking at 2018 I would not expect to see margins 40% for the year. But they are still going to be strong. Part of the 40% was when we looked at the fourth quarter, a large number of sales of technology compared to other quarters because we also have quarters where we sell a lot of local read meters. Remember that still in the United States a lot of meters are simply read by people walking door-to-door. And those margins tend to be lower.

And remember, like I said commercial water meters sales were down, I don't know what I said 15% or something like that, okay. That's primarily brass type; I mean those are lower margin type products. When you put technology and commercial meters, technology is not as big a percentage of that because obviously there's increase of metal cost of those meters.

But I would say, Rick, I'm optimistic that we can maintain the margins that we saw in 2017. I mean I hope we can with the price increase offsetting some of the copper. I just don't think we can plan over 40% for the year.

Understood. The inventory build benefits you had at the gross margin line enough to note it. It was a pretty big step-up in inventory in the fourth quarter for some reason eventually?

The problem is the cost of goods sold in the fourth quarter is generally reflection of the third quarter cost, much the same as your first quarter is more a reflection of what you made in the fourth quarter just by virtue of the turns of the way the mechanics work, which is consistent with past because the fourth quarter is always one of our slower quarters of the year.

Also bear in mind that we bought another distributor in the fourth quarter. And with that comes some inventory.

Thank you. Our next question comes from the line of Chip Moore from Canaccord. Your line is now open.

Hey, good morning, guys. And congrats on new role, Ken. Maybe you could talk a little bit about pilot activity I guess given some of the new enhancements mechanism products that you can combined that with tax changes and some of the infrastructure chatters , is that got any change in the cadence of those pilots to move to projects?

I think we are seeing some stronger pilot activity recently than we saw may be throughout the year. There was anecdotally some slowdown in 2017 related all these talk about infrastructure bill that was coming out of DC. I think now that we've seen more about what the administration is talking about. The previous administration, the infrastructure bill was kind of a Santa Claus thing where they were just giving gifts out to the states and the cities. This one, they talk -- there's a lot of talk about very large $1.2 trillion, $1.5 trillion infrastructure bill but when you look at what they're proposing, it's a lot of matching funds. The administration is saying that they want to see the states and the cities match the funds, so the amount is not as large coming from the federal and will require a lot of matching funds and I think that's causes the municipalities to say or maybe this isn't the Christmas present that we were thinking was going to be. And now I think they're moving forward on projects that they might have delayed.

Got it, that's helpful. And maybe if you could drill down a bit more on D-Flow? Sound like the integrations going little ahead of plan but in terms of cost out or what that brings in the back half, maybe just provide a little more color on that.

Yes. Our plan right now is that we would have, we would start introducing the new version of the E-series in the larger sizes probably in Q3. And in the smaller sizes in Q4. So it will have some benefit to this year I would say modest impact. Right, but it's going to be coming in the second half. And it's going to take a while for those new products to get out to the marketplace.

I think our plan all along it was going to have more profound impact in 2019 and beyond than in 2018.

Correct.

Yes, fair. Then I guess just the last maybe on oil and gas industrial, obviously momentum is continuing there. Maybe you could talk a little bit an early traction on that international distribution deal and some of the markets? Thanks guys.

I am wondering why we are pausing, we are looking at each other going.

I think you are referring to our distribution agreement with the company called DNOW, right which not to be confused with D-Flow, two different businesses and DNOW is a larger distributor of oil and gas products. Ken, do you want to add anything on that?

Yes. We are starting to see some traction with them but I wouldn't say that we are on full-scale with them yet. In the past couple of months, we did a joint show with them in the Middle East, the Auto-Tech show, we are generally seeing a lot of the increase in oil and gas and the fact that the market is up and we've done a nice job organizing our team around it internally, but we still have certainly a lot more runway we can get DNOW.

Thank you. Our next question comes from the line of Nathan Jones with Stifel. Your line is now open.

Good morning, everyone. Just following up on E-Series rollout, can you talk about -- as you rollout the new E- series meter, how quickly did the old E-series meter go away and what kind of difference that has in terms of margins between the new one and the old one? As you talked about higher technology and low cost.

Right, well, our plan is to time the rollout and the inventory levels of the old one so that ideally would love to hit it perfect, and on a day we shipped the first new one, we shipped the last old one but that never really works out that way. We also have some customers who might want to try the new meters for a while before their comfortable switching over because it is going to be a different design. And that may cause customers to say, wait a minute, we really want to test this out. So we are optimistic about being able to get it out there pretty quickly because it will represent a margin enhancement for us. I think there's enough cost reduction there that we can remain competitive in the price, and yet get some enhanced margins off of it. We are not going to say how much. We are not giving out any numbers on it but we do think we are going to see some margin improvement on that.

Okay and then you talked about putting through price increases on January 1. Gross margin were little soft in 3Q with that price cost imbalance there. Did you push through any price increases during the fourth quarter or you held that up until January 1?

No, we held all those up till January 1.

So really the gross margin improvement here was all about mix rather than price cost and price cost is still to come?

Correct.

Thank you. Our next question comes from the line of Ryan Connors with Boenning and Scattergood. Your line is now open.

Great. Thanks for taking my question. I wanted to revisit this gross margin issue little bit. You're stressing mix and specifically the impact of new product, but Rick you mentioned also the radios were up, and I'm wondering about your re-sales of other OEM radios, whether there was an impact of any shift there? I know you used to disclose a metric on you know the multiple by which your own products were outselling retail and so forth. Any update there?

No. I mean really the mix of our product, the reason we stopped disclosing as we still are -- we are primarily selling our own radios and we continue to be and I tried reseller obviously but that's not that significant. There was no significant swing there whatsoever.

Okay. So it was purely just new products getting [Multiple Speakers]

Yes. But really I mean it' was just -- it happened to be the orders we got in this particular quarter. Again, this goes back to this lumpiness. WE got a lot of technology orders this particular quarter. There will be some quarter sometime where we will weigh towards a lot of manual read meters and our margins would be down and we say is that an indication that technology is not selling. Sometimes it's just a matter of how the orders come.

Got it.

And to give you some more details on that. Our Itron sales quarter, fourth quarter versus fourth quarter of the prior year were relatively flat. In fact, they were down a couple percentage points whereas our sales of our own radios were up significantly.

Got it, okay, so on the margin [Multiple Speakers]

Which is higher margin, it's obviously, it's higher margin when it's our own product.

Yes, got it. Also it seems like, I know you talked about not wanting to get to into forecasting based on the market outlook here, but it does seem like project push outs and delays is kind of recurring issue not only for yourself but industry wide. How reliant in your mind is the 2018 outlook on larger projects that could push to the right versus kind of more broad -- broad market upswing?

We have some projects, some larger projects planned in 2018. We are fairly confident that are going to come through in the US. I wouldn't say that represents a greater mix of larger projects from 2017. So I don't think where our 2018 is being predicated upon handful of very large projects, rather it's being predicated on a broader growth across the market. Then I will also throw out there that we are selective in the Middle East and we have some Middle East projects that are also in our plan for 2018, which have been delayed out of 2017, it could benefit us.

Got it, okay. Then last one for me is just on this acquisition Carolina Meter. Can just update on where this deal puts you in terms of your overall forward integration strategy? Where you stand in terms of when you're in there and any metrics you can share about it? What work in your business now is coming through, corporate owned, distribution?

Well, and as you may recall when we started down this path of acquiring some of our distribution, we were selling about 50% through distribution and 50% through our own direct sales force. We have now completed three distributor acquisitions; obviously they are three of our larger distributors. We do believe we have a couple more that we want to complete. So we think we might -- you might be seeing one of those two yes this in 2018. And I would say were down to probably below 20% of our sales are coming through distribution through non company owned distribution.

Part of that is we tacked down additional territory that wasn't assigned to distributor, to the ones we bought.

Right. But the fact that matter is as you probably got less than 20%, that's going through non company owned distribution.

Wow. I didn't realize that was that low.

The once we bought were all the largest.

Our next question comes from the line of Jose Garza with Gabelli and Company. Your line is now open.

Good morning, guys. And welcome Ken. Hey, Rick, just a quick just what was kind of the contributions from the acquisitions here in the fourth quarter? I guess D-Flow and then maybe some one Carolina Meter?

Yes. I can answer that right away. I can tell you that it was a bizarrely it was awash. And the reason I say it was a wash is there was a positive contribution of Carolina Meter, which was substantial but the D-Flow amortization offset that contribution. So when we're all done it was up within the $100, 00 plus or minus.

Okay. Rich I guess just in terms of -- I guess a little bit more positive sentiment on pilot programs. I mean would you characterize that against just across broader demand now that I guess some of this legislative portion that kind of worked themselves through?

I think we are seeing broader demand but I wouldn't say it's so much the legislative, yes; there was some delay last year, hesitation because of that. But when we're talking about pilot projects that are generally people who are testing out new technology. And that's driven more by the desire to see the new technology and see what's going on. So when you use the term pilot project, I think about somebody saying, look, I've been using either another company's technology or I've been manual meter reading. And now I want to go to something new and I'd like to test out cellular fixed network drive by and see what I want to try. And that's when they run a pilot project. When it comes to companies just delaying a project they may have already run the pilot. They were ready to pull the trigger and they delayed because of this infrastructure billing. So it's really two different things. Is that makes sense?

Yes. I mean I guess than I mean any kind of changing I guess just in terms of what you think is -- would you characterize this kind of continued softness? If I think back a few months, when we last had --

This is Rick. I mean when we talked about softness, I think part of it is we just finished the first year of a new administration. I think if you go back a year when we were looking at 2017, I think there were so many uncertainties as to what could be changing in this market? How could the money be allocated from the federal government? What about infrastructure? Right and I think there was -- I don't want to use the word hope because that's the wrong word, but there was anticipation of some kind of change within year. Now that we are a year into this, I think a lot of people are saying Washington has settled into the ways that are going to do business right, wrong or indifferent, okay. And we are just going to continue on with our plans because we don't see any fundamental changes coming that are going to impact our business. So I mean there's nothing that we can -- I mean a lot this anecdotal as Rich said, this past year, but a lot of the slowdown had to be --had to do with some of this uncertainty about what's going to happen, and how we are going to get this stuff funded. Now that we are a year into it, I think there's not a lot of anticipation of changes in 2018 for anything. I think we'll see some resumption.

Yes. So if --when we look at 2017, obviously we are not pleased with the 2% top line growth, that's not normal for our industry, it's not normal for our company. And we looked at 2017 and said yes anecdotally from our customers, there were some slowdowns, things were generally sluggish during the year. I think you heard that from some of our competitors too, at least who ones who tell the truth. When you look at 2018, we think, we believe we are going to see return to normal growth rates. We believe we are going to see the whole market growing again as it has in the past.

Thank you. Our next question comes from the line of Richard Eastman with Baird. Your line is now open.

All right. Sorry, hey, I am back. Just reference earlier in the call I think when you talked about residential meters are just a municipal side, was that it included revenue from D-Flow and Carolina? Could you just -- what is the number of quarterly contribution from those two acquisitions? Could be a million bucks or --

$2 million, about 2 million.

Okay and obviously Carolina was only in for part of it. So $2 million in the quarter from those acquisitions. And then a quick question. I just want to return to this inventory number for minute. I mean we went from the Q3 to Q4, step-up of $8 million of inventory. Was there any a pre buy ahead of price hike on the meter side or what accounts for that inventory?

A lot of this is -- I think it's a function of timing. We got our inventory in anticipation of first quarter, maybe compared to last year where it came in January. There's nothing that sticks out. It's just, in fact, I am writing the verbiage for the 10-K. Yes, they are little things. You buy Carolina and it goes up whatever and what not but the reality is I think it's just timing.

Yes. Have you been able to collect any feedback from the field or the channel relative to competitors, maybe announcing a price hike match or any sense of how competitors will respond to that?

As you know, we do have annual sales meeting in January. So we just came back from that a few weeks ago. And that's always a good way for us to gauge what's going on with the competitors out on the field. I think the general consensus of the of the sales force was that with brass prices going where they are, most of our competitors either have or will be following with some price increasing, they are going to have to. I mean I am sorry I said gas price, I meant bras prices. Did I say gas price?

I don' think so.

I am sorry. I heard gas, so that's okay. I think where copper prices went so right, so with brass prices going where they are, these are either before January we saw some competitors putting and trying to put a price increases. And I think the others will follow, that's been the historic norm. I don't anybody is going to be -- going to destroy pricing in our market. We are all pretty smart about what we can do out there. And I think I think we'll see that again.

Rich, can I ask you, if I look over the last call three years or so, some of the fourth quarter seasonality has kind of dissipated from the business. I meant if you go back four, five, six years ago, we typically see fourth quarter where sales would, the sales would high single digits if not double digit sequentially. In the last three quarters, we really haven't seen that, last three years excuse me. And I am curious is it a mix of business? Is it international sales? What in your opinion kind of accounts for that like a seasonality that we've seen over the last few years?

I think you're absolutely right that we are seeing some changes in that seasonality, especially when you see a weak third quarter followed by strong fourth quarter. I mean normally our second and third quarters were strongest. And our first and fourth were weakest. And we didn't see that last. Last year started to see some unusual things. The first thing, I'll say is that historically and going back 10-20 years, Badger Meter had been strongest or had the largest market shares in the upper Midwest and the Northeast. And we were not as strong in the South and the West. I think that is changed. We are starting to gain a lot of market share in the South and the West. And so I think our market share is moving more into --call in the sunshine states, where they are disaffected by that winter weather, the fourth and the first quarter. So I think that's part of it. I also think that a lot of our customers have figured out that they can continue to change all meters in it around that winter period without disrupting things too badly and so that helps.

And I also if we get the growth rates that we really anticipate in this industry, you probably would see more of that in the second and third quarter, and we haven't seen it for the past couple years simply because the markets been kind of limping along a little bit. So I think if we -- we've always talk about long-term, that we want to try and grow the top line in the high single digits. And we are not necessarily seeing that in the most recent years. But that strengthen in this business is always been the second and third quarters. So we'll see that return.

So maybe the anomaly is really more around Q3 not seeing the strength versus Q4 where the decline is less.

I just throw that out as another possibility.

Yes, right, understand. No, I understand mathematically. Okay, all right, well thanks again guys. Appreciate it. Thank you.

Thank you. Next we have a follow up from the line of Nathan Jones of Stifel. Your line is now open.

Just following up on the pricing question, what -- do you guys see any kind of risk from small or maybe private competitors on the lower technology side? Potentially using some of the tax savings as a means to go off the market share by perhaps not raising prices or perhaps discounting prices?

One of the benefits that we have Nathan in this industry is that we are somewhat an oligopoly. There are really five major companies in North America selling water meters. We always have some small companies out there that are trying to come in. But the problem is that you're fighting against companies that of 100 year brand and that have extensive market channels. There are -- remember, that there are about 50,000 water utilities in the United States and it's very hard to develop channels into a market that's that spread out. Also water utilities tend to be very conservative and want to deal with a larger company. So I'm more concerned about what my large competitors might do than what the small startups might do. And one of the thing, factors that I like is that compared to some of our large competitors, we are more focused in North America and the tax rate cut is going to help us more than a company that is more international. And so we sit in a stronger position from that point of view. So we are going to watch, we are going to watch what our competitors do. If pricing becomes an issue, we are going to have to try and respond. But I rather do is find ways to offset that through efficiencies, reduce cost if we can as that goes forward. But it is a concern we'll have to watch for it.

Thank you. I am showing no further questions in queue at this time. I'd like to turn the conference back over to Rich Meeusen, Chairman, President and Chief Executive Officer for closing remarks.

Thank you. And I want to thank everybody for joining us today. We were very pleased with the quarter certainly with about 45% increase in pretax earnings. And for the year, when we look back on the year, yes, top line only grew about 2%, but we had a 10% increase in pretax earnings on the operating line. So we're very pleased with that, so overall a great quarter. We look at 2018. We are excited about how it looks and what our opportunities are out there. We are excited about having Ken Bockhorst on the team now. And we will be looking for -- we are optimistic about a good year. So, again, thank you everybody for joining us.

Ladies and gentlemen, thank you for your participation in today's conference. This concludes today's program. You may now disconnect. Everyone have a great day.