Richard Meeusen - Chairman, President & CEO Richard Johnson - SVP, Finance, CFO & Treasurer Kenneth Bockhorst - SVP & COO.

Nathan Jones - Stifel, Nicolaus & Company Richard Verdi - Atwater Thornton Tate Sullivan - Sidoti & Company Ryan Connors - Boenning and Scattergood Brian Rafn - Morgan Dempsey Capital Management Richard Eastman - Robert W. Baird & Co. Robert Chernow - RBC Jose Garza - G. Research.

Good day, ladies and gentlemen, and welcome to the Q1 2018 Badger Meter Earnings Conference Call. [Operator Instructions]. As a reminder, this conference call is being recorded for replay purposes. It is now my pleasure to hand the conference over to Mr. Rich Meeusen, Chairman, President and Chief Executive Officer. You may begin..

Thank you, Brian. Good morning, everybody, and welcome to Badger Meter's First Quarter Conference Call. Thank you for joining us. Yesterday, after the market closed, we released our first quarter results.

We are pleased that sales hit an all-time record for any quarter, helped by our sales of our BEACON enlace platform as well as sales stemming from our acquisitions of D-Flow and Carolina Meter.

That said, bottom line results did not meet our expectations, in part due to lower volumes caused by order delays that, while received in the quarter, could not be shipped in time to be recognized. That said, we do remain optimistic about the year ahead.

Ken Bockhorst, our COO, will talk about our new product developments and other initiatives that support that confidence. Moreover, future quarters will see the benefits of the January 1 price increases as they work their way through our order backlog, with some of the first quarter order delays spilling into the second quarter.

So with those brief comments, I'm going to turn the call over to Rick Johnson, our Senior VP and CFO, to go through the numbers.

Rick?.

Thanks, Rich. As usual, I'll 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 risks 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 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 let's discuss what happened in the first quarter. Sales in the first quarter increased $3.4 million or 3.4% to $105 million compared to $101.6 million during the same period in 2017.

Municipal water sales represented 76.7% of sales for this first quarter compared to 77.3% in the first quarter of last year. Municipal water sales increased $2 million or 2.6% to $80.5 million from $78.5 million in the first quarter of last year.

The sales increase was due to higher pricing on products ordered after January 1, higher sales to the Middle East and higher service revenues due to increases of the BEACON managed solution -- solutions, excuse me.

These positive impact, however, were somewhat offset by lower volumes of residential and commercial meters and radios than the first quarter of last year. As Rich mentioned, we attribute the decrease in lower domestic volumes to timing of orders as well as to a slower start at the beginning of the year.

We also believe weather played a role in the timing of orders, particularly in the northern regions. Flow Instrumentation products represented 23.3% of sales for the first 3 months of 2018 compared to 22.7% during the same period in 2017. These sales increased $1.4 million or 6% to $24.5 million from $23.1 million in the same period last year.

The increase is due to the continuing rebound of the oil and gas markets as well as strengthening of our distribution channels for the industrial markets we serve. Gross margin as a percent of sales was 35% in the first quarter compared to 38% in the first quarter of last year. The lower volumes of products sold had a significant impact on the margin.

Also contributing to the lower margin were higher brass costs and expenses associated with the shutdown of Badge Meter's Scottsdale, Arizona location. That project was completed by March 31, and all Scottsdale products are now being made at our Racine, Wisconsin facility.

Helping margins somewhat were price increases on products sold, although we have yet to see the full impact of those January 1 price increases. Selling, engineering and administration expenses for the first 3 months of this year increased $1.7 million or 6.7% to $26.8 million from $25.1 million in the first quarter of last year.

The primary reasons for this increase are normal inflation increases and the additional expenses associated with the acquisitions that we completed after the first quarter of last year, namely D-Flow and Carolina Meter.

Just a reminder that the primary reason for the D-Flow acquisition was not their book of business but their Ultrasonic expertise, the expenses at D-Flow are currently focused on developing the next-generation of E-series meters. Ken will comment on this in a moment.

The provision for income taxes as a percent of earnings before income taxes in the first quarter was 22.2% compared to 34.2% in the first quarter of last year. Almost all of the decrease was due to the lower federal tax rate, which went from 35% to 21%. This quarter also contains some nominal amounts of discrete credits to tax expense.

Net earnings then for the 3 months ended March 31 were $7.5 million or $0.26 per diluted share compared to $8.7 million or $0.30 per diluted share for the same period in 2017. Our balance sheet remains solid. Cash provided by operations declined to $6.8 million for the first 3 months of this year from $12.4 million last year.

Last year, we saw a drop in inventories from year-end until the end of the first quarter, which did not recur this year.

That fact, along with lower earnings, accounts for the lower amount of cash generated from operations Before me move on, I want to remind everyone again that we will be terminating our frozen pension plan this year and will be taking a onetime cash charge, which we estimated at year-end to be approximately $5 million.

At this point, we don't believe it will exceed that amount, and we are optimistic that the amount will be significantly less than that. Again, the exact amount of the transaction will not be known until employees finish making their new decisions on how they wish to receive what is due to them, which they are in the process of deciding now.

Also, a reminder that when the assets are distributed, there will be a onetime noncash charge for amounts already included as part of equity in the company's balance sheet. That number at December 31 was $17.6 million pretax. With that, I will now turn the call over to Ken Bockhorst, Badger Meter's Senior Vice President and Chief Operating Officer.

Ken?.

Yes, thanks, Rick. So in the quarter, we got off to a slow start in January as the incoming order rates were sluggish. We did see an uptick in February and then another increase in the order rate in March, which was positive.

But due to the timing, we were not able to convert as much into revenue as we would have liked, contributing to the disappointing bottom line results for the quarter. That said, we do remain optimistic about the second quarter in and for the full year 2018 for the following reasons.

First, we have a significant increase in backlog during the quarter due to increased order rate in March that I noted previously. A large project went into Middle East, which will ship in the second and third quarters.

Increased shipments for FIN, a joint venture between Balkan and Upinar, which utilizes our D-Flow ultrasonic technology into a smart water monitoring system for residential use, and continued strength in Flow Instrumentation orders.

And halfway into April, our order rates are above the average daily rate for the year, which also gives us some renewed optimism. Moreover, a number of impactful new product development initiatives are currently underway.

In the second quarter, we will increase our product offering for E-series commercial meters with D-Flow technology, which will allow us to bid on projects that we currently can't participate in. Also, we will release the next version of the E-series residential meters, which will be available at year-end.

These also incorporate our D-Flow technology, which will reduce our manufacturing costs. And for ORION Cellular, we will be ready with Cat-M chips, which are the next-generation chips for business-to-business cellular communication in the first quarter 2019, which will allow us to provide additional features as well as improve our cost position.

In short, we will increase our product offerings and reduce our costs as the year goes on. On April 2, we announced the acquisition of Innovative Metering Solutions, our fourth distributor acquisition. We are very pleased to add them to Badger Meter and complete our distributor rollout strategy.

We now have a significant portion of our sales through our company-owned model and look forward to continued success with our remaining independent distributors, who are and will continue to be good channel partners for Badger Meter.

With our distributor strategy complete, we will continue our process to identify larger acquisition targets that will build out our product and technology portfolio and increase our global footprint.

While it was a tough quarter, I am very optimistic about the future of Badger Meter, both for the short and the long term, and I'm glad to be part of the team. With that, Rick, Rich and I will be happy to take any questions..

[Operator Instructions]. And our first question will come from the line of Nathan Jones with Stifel..

Let's start on with some of the margin pressure there. A number of items that you guys called out that impacted gross margins in the quarter from higher brass cost, closing the facility in Scottsdale, lower volume.

Is there any way you can parse out in a little bit more detail what the impact of each of those main buckets was on the margins?.

Well, this is Rick. The margins were down about 300 basis points. And really, this is a rough cut, and this is how we're looking at it. Copper is probably about 100 of those basis points downward. The Scottsdale closure was about another 100 basis points.

The impact of the lower volumes on our capacity utilization was probably a couple of hundred basis points. So that's about 400. And then offsetting that somewhat were the price increases coming back by about 100 basis points. That's just -- that's the rough cut on the margin.

There's probably a thousand little things in there also, but those are the main ones that jump out..

No, I think that's very helpful. Could you then comment on -- you talked about realizing about 100 basis points of price there, but also that your rates in January 1, you still got backlog to ship from December that those prices were in at.

Now that we're probably going to get a full quarter and a second quarter of realizing those price increases, does that 100 go 200 basis points? Does it go to 300 basis points?.

This is Rich. I don't think it reaches 300, but it does go closer to the 200 mark. I'm hoping that we're going to pick up about 200 basis points when everything gets fully integrated through our order log..

Does that show up in 2Q? Or does it take until 3Q to hit the full run rate?.

More of it will show up in Q2. The full impact will be in Q3. But to be honest with you, as you start the second quarter, a lot of what's ordered for the second quarter came in, in the first quarter under the new prices. Yes, there's some lagging business yet from longer-term orders that came in last year, I just don't have it quantified right now..

But we don't do any contracts anymore that go more than a year without the price escalators in them. So really, by the end of the year, everything's in there, but I would say the vast majority of it is in there by the end of the second quarter..

And our next question will come from the line of Richard Eastman with RWB..

Just a couple of things I wanted to run by you.

In terms of D-Flow and Carolina third-party sales, what would be maybe the acquisition revenue contribution in Q1 year versus a year ago?.

I think D-Flow was probably -- it's over $1 million, $1 million to $1.1 million. Carolina Meter, probably $600,000. People are nodding their heads, yes, that's a good sign. So about $600,000. So we're getting that kind of impact. I think the BEACON revenue is up in excess of $1 million over last year's first quarter.

And then we had some sales for the Middle East that we didn't have in the first quarter of last year, and that's probably another $1 million right there..

Okay, okay.

And maybe you could just speak to -- well, let me ask you this, IMS, what would be the annual third-party revenue there? The piece that will flow through the revenue line versus the margin line?.

Additional -- you're talking incremental revenue? Probably a couple of million dollars annually..

That's it. Okay, okay.

And then maybe just for a second, could you just provide a little bit of color around, did the commercial meter piece grow in the quarter?.

No. The commercial was down significantly, probably about 1/3. But there was a large order in there last year from one particular customer that accounted for almost all of the decrease..

Well, okay, okay. And then you did comment about, again, the ORION Cellular product and the E-series product continuing to grow.

I'm a little -- I'm curious, when you look at the meter business and you look at your disk meters versus the E-series meters and compare the growth rates, or the decline in the case of disk meters, I'm just curious, how does that impact your capacity on the production side? So we're talking about the gross margin and the under capacity, under absorption there.

I mean, my impression is that the E-series meter's not cleaned up and absorb capacity in the Milwaukee facility.

But I'm curious, just from a manufacturing strategy perspective, has that impacted your under absorption, given the growth in the E-series?.

You mean the shift in mix from mechanical meters to electronic meters, how that's impacting our capacity utilization? I mean, there's no question, we are -- to some extent, with the growth of the E-series, we're cannibalizing some of our mechanical meters. Mechanical meters are partially made in Milwaukee and partially in Nogales.

The E-series are pretty much -- well, they're also split. We've got operations here that do them both, too. So there isn't a big difference between facilities.

But the E-series meters, they probably absorb a little bit less overhead because they're electronic and they go through the system a little faster, whereas mechanical meters require more -- a longer, more in-depth testing and -- to make sure that they're right.

But I don't think there's a -- Rick, I'm not sure where you're going with this because I don't think there's a huge impact on capacity utilization from one to the other. Generally, when we said that for the quarter, we had under absorbed our overhead. It really was, in total, the total metering products going through the system that had the impact..

Okay, fair enough. And then just one last question for Rick. Could you just talk a couple -- about a couple of the balance sheet items? I mean, you touched on inventory, but I'm surprised maybe a little bit that inventory did come down sequentially from the fourth quarter.

And then also just the AR build from the fourth quarter sequentially into the first quarter, at the end of the first quarter, AR is built at almost a 9% rate despite the sales were just up 3..

Yes. Your second question's easiest because there's the seasonality of the business. Receivables are always at their low point at the end of the year simply because of the way the fourth quarter sales actually come in, because December is one of the lowest months period.

Whereas in the first quarter, March is one of the stronger months, so it's up simply because of the timing of that. And in terms of the inventory, we talked about the timing of orders.

Well, on certain products, there's long lead times, okay? So we basically geared up for a higher anticipated sales than we actually had, hence the disappointment you're hearing in our voices today. And a lot of that will take care of itself as we get into the second quarter.

And so that's just a function of timing more than anything else at this point. Rick, last year, we had a very strong first quarter. I mean, we're doing a tough comp here also, by the way. But inventory then had dropped because we sold a lot of what we had planned to sell in the first quarter of last year..

And Rick, this is Rich. I'll also point out that, that inventory build to some extent in our minds is indicative of our expectation of a much -- of a stronger second quarter. We said we're optimistic about the second quarter. In the past, we have had times when we've had -- and you know our business is lumpy. We've talked about that repeatedly.

We've had times when we had a disappointing quarter, and we said on these calls, that we think it's going to continue into the next quarter, and it usually did. This time, we're seeing, we've had a bad quarter, we have a lumpiness in our businesses. We're not seeing a continue.

We have an expectation that we're going to have a stronger second quarter, and that inventory build is part of that because we have to be ready to ship all that..

And our next question will come from the line of Tate Sullivan with Sidoti..

First off, can we review some of your comments? I thought -- maybe I didn't hear this correctly.

Did you say that we're already halfway through the order rates from last year?.

No, no, I'm sorry..

At the end of March? Yes just..

What I was getting at there is that we ended the last couple of weeks of March with a really strong order rate primarily compared to the beginning of the year where we got off slow. And through the first half of April, that rate that we saw increasing at the end of March has continued.

So just alluding to the fact here that we're off to a really good start to this month, that's continued..

Okay. So the March rate continued into April. Okay. And to review your D-Flow comments, specifically, and I think you mentioned, I mean, the current -- you mentioned introducing a new series, the E-series.

But on the current E-series that you're selling, are you seeing lower costs because of D-Flow manufacturing costs already?.

No. So two things. It helps us in wo ways. And the first is, we talked a little bit earlier about our reduction in commercial meters. So there are some customers that are converting to the ultrasonic technology. So by finishing the D-Flow for the commercial meters, we'll be able to extend our product line here coming up in the next couple of quarters.

So we'll be able to participate in more bids on the commercial side. On the residential side, we will continue incorporating that technology into the residential meters in the second half of the year, which will be a pretty significant cost reduction for us that we'll see in 2019.

And so my comments were a little bit mixed there on my optimism for rebounding in revenue over the remainder of the year as well as improving our cost position for the longer term..

Okay.

And specifically, 2019 would be the target to reduce based on that shift costs?.

Correct. We'll begin to see the reduced costs on the residential meters in '19. Correct..

On residential, okay. And then is your -- maybe I missed this in your last acquisition amounts.

Is your distribution strategy complete now? And why is it complete?.

Yes. So we are complete now with the distributors that we wanted to acquire. So the majority of our revenue now is through our company-owned model. So we don't -- we still value the partners that we have in the other places, but we don't think it is worth it to acquire all of the distributors to find every region of the country.

We've got enough reach now with the distributors that we've acquired to go forward..

Okay. Okay, great.

And then my last is what else besides weather at the beginning of the year contributed to delay in orders? Was it customer -- funding uncertainty, or was it mainly weather?.

This is Rick. I wish I had a definitive answer for you. I mean, they had ice storms down south. They had the snow in the east. I mean, we just saw a decline. And then, as Ken said, as we got into February, it started picking up again. As we entered March, it got stronger.

Sometimes these things -- I mean, we can't use the word lumpy often enough, and I know people get tired of hearing that, but sometimes we don't know, and things have resumed. It just it is a function of timing..

Right. When our field sales force is telling us anecdotally that they're seeing delays because of weather impacts, one way we can look at that is by region of the country. And indeed, when we looked at the first quarter, our Western region exceeded our plan. But it was really the East and the northern part of the central that fell short.

And that would tend to support what our field people are telling us, that there was some weather impact that caused delays by these customers..

Okay. One more, Rich, can you comment on bigger picture. I mean, I've seen American Water Works do a series of transactions here.

Is there anything to look out in terms of changes in regulation or changes in your customer landscape that you see or can talk about for the rest of this year?.

No. I think American Water Works is continuing to move on opportunities.

Obviously, there are some states where acquiring a water utility is more favorable from a regulatory point of view than other states where the regulators would prefer that to not happen and, therefore, don't give the recovery rates, the return rates that you need to make those deals possible.

I think a lot of companies like American and the other ones that are out there are very smart in where they selectively play. But we don't see that changing our landscape.

I mean, even when we won the American contract and had an expectation that all of their properties would immediately convert over our meters, they operate with a mixed system, and they do not tell their subsidiaries, you must buy from Badger Meter. they say, you can. We've entered into a contract. It has given us some good return.

But it is -- it did not go wholesale. So in the same way that when American goes in and buys a water utility that may be supplied by one of our competitors, they don't immediately switch over to us. So that landscape of acquisitions does not have a big impact on our competitive landscape..

And our next question will come from the line of Ryan Connors with Boenning and Scattergood..

I wanted to kind of talk about the margin discussion from a bigger picture standpoint. And Rick, you mentioned the strong quarter a year ago, the tough comp. At that time, you talked about kind of a positive step change, a new normal where maybe copper wasn't as relevant as it's been in the past.

And you talked about things like the impact of new products and the recovery and the higher-margin Flow Instrumentation business and the addition of the distributors? It seems like most of those things have gone in your favor in the last year. Distributor's grown, flow Instrumentation's come back, new products have grown.

So can you just characterize for us whether you still believe that's the case, that there's a new normal here in terms of the normalized margin.

And if so, why those tailwinds weren't able to kind of at least offset what was happening on the raw material side?.

Right. Well, and this is Rich. Let me try to take a shot at that. I am still optimistic that we are going to continue to see this -- a higher margin level. And I believe this first quarter was very unusual.

Now copper, when copper went from $3.50 in the first quarter -- from $2.50, I'm sorry, $2.50 a pound in the first quarter of last year to over $3 now, that's a pretty big jump, and that did hit us for 100 basis points. But that didn't account for this 300 drop.

We know we took some charge in Scottsdale, and we understood we had that, but we had these order delays, and we are fairly volume-sensitive. A lot of our operation is a fixed-cost operation. It's hard to flex when you see those orders coming down and flex quickly and yet still remain positioned for stronger quarters to follow.

I think, Ryan, if we believe that this downturn in the first quarter was a trend and that we were going to see continued downturn in the coming quarters, we would have taken a lot of other hard actions in the first quarter that -- to rightsize the operation.

But when we have a lumpy down quarter like this, we have to very often just eat it in order to stay positioned for the future quarters. But as far as those margins go, we continue to see the shift to the electronic metering.

And once we finish the electronic large sizes, I think that's going to accelerate it even more, we continue to see the shift to BEACON and E-series. Those all carry higher margins. And I think -- so we're going to continue to see that moving over there.

And I do believe that there is fundamentally, not just the Badger Meter, but within our industry, an opportunity for some margin improvement over what we've seen -- over the next several years versus what we've seen for the last several years. So I have not changed my story on that..

Okay. Now a specific question and a subset of that. On Flow Instrumentation, so that's come back.

That -- has there been any shift in that market where that business or the composition of the recovery has changed the margin profile of Flow Instrumentation? Or is it still as good as it used to be?.

Yes, Ryan, this is Ken. So no, it's -- that has remained the same. So we still feel good about the rebound in that space and maintaining that strength..

And let me just add to that, Ryan. A lot of the rebound has been in the oil and gas products. But the margins in the oil and gas products are not that different than the margins in the rest of the Flow Instrumentation products. So there isn't a big shift in the overall margin there from that..

Got it, okay. And last one for me, Rich, I apologize if I missed it, but you talked about these project delays.

Can you just characterize the composition of that? Is it 1 or 2 or 3? Or is it more like 15 or 20? I mean, how many types of projects are we talking about, just rough magnitude?.

Yes, so Ryan, it may be more than I know for sure, but I know of at least 5 that have gone into play that they were not insignificant..

And they weren't all weather-related, okay? I'll add that there was one large utility, which I won't name, that got some bad press during the quarter, a Western utility. So weather wasn't affecting them. But they got some bad press for having installed meters improperly.

And of course, it was on the evening news and everything, that somebody got a huge bill because they put the wrong kind of register on a meter. This was not Badger doing it. This was the utility. They actually stopped ordering for the entire first quarter while they tried to deal with that and check their meters and things like that.

So what was normally a pretty good customer placing some very large, some over $1 million-type orders, they just went away for a quarter, and now they're coming back, they've got it behind them..

And our next question will come from the line of Brian Rafn with Morgan Dempsey..

The weather-related, I think we're beating this dead horse. And certainly, well all in northeastern and some of the Pennsylvania, New Yorkers is getting to 200 inches of snow, that's Colorado like. Are we right to assume on those projects that we have been delayed, that it's kind of a normal play out.

That it's just pent-up demand and maybe delayed and just pushed out from a time standpoint, not necessarily doubling up in any forward quarters?.

Yes. This is Rick. Yes, it's not a pig in the python where we'll double the sales in the second quarter, because basically, they didn't get out there to install them, they only have limited warehouse space. So everything just resumes and carries on as if -- and we just extend the time period. Generally speaking, that's how it operates in this industry..

Yes, yes.

On the BEACON analytics side, is the demand for still related to conservation and primarily a Western consumer versus, say, somebody in the Great Lakes? Or how is that BEACON analytics sold across the country?.

Right. This is Rich. It is no longer Western-related. And what you're referring to is when we first came out with BEACON, in particular, EyeOnWater. A lot of that was driven by the Western utilities who were under significant drought conditions saying, Boy, we really need something to help us better analyze our system, better manage.

And we'd like something that allows the homeowner to know when they're wasting water. So that's what drove the initial introduction of that product. Today, that project is being sold all across the United States. There is -- it is no longer kind of focused on a section or on a particular problem.

We're seeing BEACON and EyeOnWater -- BEACON utilities -- I'm sorry, utilities using BEACON and homeowners using EyeOnWater all across the United States, simply because it's a better system. It provides them better information. And frankly, I use EyeOnWater. I'd like to know what water consumption is going on in my house.

And I'd also like to know if I've got a leak, which, frankly, in January, my water, according to EyeOnWater, did not stop running in my house for about a week. I had a plumber come in, and he found that I had a running toilet, and he replaced the seals and it fixed the problem. That's the benefit of EyeOnWater.

So we're seeing even people in Milwaukee, like I am, using it extensively..

Okay. From kind of a -- Rich, from kind of a strategic sense, we always talk in the municipal side of our residential meters and new construction and obsolescence of that.

What do you see, say, on the next 2 to 5 years the commercial water meter side relative to kind of the bigger infrastructure talk and older water systems and sewage? Is there a viability from an infrastructure play on the commercial water meters or as the residentials are swapped off than the commercials are?.

Boy, I'd love to tell you that there is because it would sound really good coming for me. But here's the situation. The water utilities have tended, when they get under budget crunches, to slow down the replacement of mains. What they have not done is slow down the replacement of their commercial water meters.

And the reason is because the commercial water meter is the cash register. So a restaurant may go for a while with kind of a bad stove, but they won't go for a while with a cash register that's defective.

So the water utilities have stayed up on replacing those commercial meters, and I don't see a huge shift in that going forward as infrastructure spending comes in..

Okay. All right.

With the uptick in brass costs from the copper content, have you seen any moderation across utilities into plastic meters versus brass? Or is that a nonevent?.

No. This is Rick. I'd say brass is still the primary drivers for meters. It's probably -- 80% of the meters we make are probably made of brass. Plastic has gotten up from -- at one time, it was down about 10%. It's kind of leveled off at about 20% right now..

Got you. Got you. Let me ask you more strategic one, Rich. Trump's everyday Tweeting out something, whether it's PPP.

When he's talking about redrafting the NAFTA, does that at all -- is that a headwind or any negligible effect on Nogales?.

So I would say not anymore. Yes, well, let me address that. I mean, there have been so many proposals, that I'm not sure which ones to react to anymore.

If they revisit NAFTA, even before NAFTA, there was the maquiladora laws, and that's what -- the maquiladora rules were what we established our Nogales facility under, and a lot of automotive companies and other companies established on the maquiladora rules, and that's why we located within a few miles of the border.

So if they do away with NAFTA but leave the maquiladora rules still in place, we kind of fall back on that. If do away with both of them, then there's a question of, yes, what are the tariffs? How does this work? What would we have to pay? Badger still has the capability of bringing additional work back into the U.S.

in our other plants, so that could always happen. But we don't anticipate any of that happening. Our Nogales plant is very efficient. We like it.

And frankly, if we're going to be impacted by some sort of trade changes in tariffs and trade wars or something, there's a lot of other companies, a lot of bigger companies that are going to be hit first before us that are going to have a much bigger problem..

But just to be clear, though, the NAFTA was a concern when Trump first got into office. And it was a concern amongst our people down at the Nogales plant itself. I would say, since last summer, it's really not much of a concern because we talk a lot about things, but there's no action.

And I think people get that about what's going on in Washington right now..

No, I get that. I get that. You guys also mentioned on the -- I think it was the ORION Cellular, the Cat-M chips, and enhanced specifications, functionality, say, first quarter of 2019.

What do those Cat-M chips give you?.

So what's happening here, Ryan is that--.

Brian..

I'm sorry, Brian. I said Ryan. I'm sorry. Brian. What's happening, Brian, is that the cellular world is starting to split. And it's splitting between this LTE system, which is really designed for complex transmissions of data -- or I'm sorry, of conversations, of Internet pages, of things like that.

Meanwhile, machine-to-machine transmissions are very simple and very fast, in smaller packets and don't have the complexity of requirements. So what they're really doing with the Cat-M is kind of creating a fast lane, an express Lane on the highway for data that will allow it to fly down the highway much, much faster.

And by moving to these Cat-M chips, we and other people who are using cellular for our machine-to-machine communication will not only be able to improve our speed, we'll be able to use less energy in our transmissions, and we'll be able to add some additional functionality to our transmissions. So all of this is very good for us.

And of course, Moore's Law is still operating thing out there, and these next chips that are coming in are much cheaper than the last chips we're using. So that's also going to represent a pretty significant cost reduction for us..

Okay. Good, good, good. And then just from the standpoint of acquisitions. At one time, you were talking about the types of meters that you have. You control like 12 or 13 of the 16 different types. Now I think the last presentation, I saw you went down to 10.

Any meter technology that you don't have today that might add to the portfolio of meter technology? And then anything on the industrial products side that you might have a niche that you might have an interest in?.

Brian, this is Ken. So on Rich's slide of the 10 technologies, we currently have 8. There's one that we would be interested in adding to our portfolio, and that's the thermal mass.

But larger than that as well, we've begun an M&A process here where we're taking a good look at the universe of products and technologies that we could add to our portfolio and sell to the same customers that we already have, as well as finding some good opportunities to expand on our global footprint.

So we have -- still have a fantastic balance sheet, and I think we'll be able to find some pretty attractive opportunities out there to add to Badger..

I'll ask one more. Rick, any pressure -- everyone's talking about with the Trump tax plan, everybody's getting bonuses and hiring and salary wages. What are you guys seeing either in -- not maybe in retention of people, but availability of engineers looking to hire, pressure on SG&A, labor costs, maybe health care in there? What are your....

Sure. I'll take this last question then, Brian. First off, on the question of are we getting pressure from our people, that with the tax cut, they should all get some kind of bonus, obviously, the question was asked. We feel that we pay our people competitively. We pay them at market.

We have very little turnover in our facilities, which we tend to say that our compensation and our benefits taken as a package are very good. And we see no reason to adjust that. And frankly, I'm disappointed when a company says that because of lower taxes, we're going to increase everybody's pay.

I guess that they were saying that in the past, they were underpaying their people, and now, they're going to pay them fairly. In our case, we've been paying our people fairly, and we think that's right. I would also point out that in 1992, when Bill Clinton raised corporate income taxes, we didn't see anybody willing to cut their pay.

So I don't think my employees want their pay linked to the corporate tax rate. Having said that, the second part of your question is about recruiting. And we are in the same position as everybody else. Certain positions are hard to find in this economy. Engineers being one of them.

We're very aggressive on what we -- on finding the engineering talent that we need. But also, we are working closely with the universities and the technical schools to get interns in here, and that, in our opinion, helps us with recruiting down the road.

So we're taking the actions that we think we need to take, and we're pretty comfortable that we've got a really good workforce..

[Operator Instructions]. And our next question will come from the line of Richard Verdi with Atwater Thornton..

Just a quick question. So Q1 was the first full quarter under the agreement with Corix. And I guess, it's now about -- been about five months or so you've been with Corix.

So I was just wondering if you could give us a sense of if they really helped expand your Canadian presence and what that could really mean for Badger Meter Canadian penetration moving forward..

Yes. So we are optimistic about Corix's ability to expand our presence there. Unfortunately, we didn't get a real great opportunity to experience that in quarter 1 because Canada had some of the weather issues also. But it's early into the -- early into our relationship, and we definitely are positive on it..

What could it do for the opportunity, just broadly, for Badger Meter in Canada?.

Well, this is Rich. Badger's market share in Canada has been less than our market share in the United States, and that has been true for the decades that I've been here. And there've been a lot of reasons for that. There was a period of time when we did not want to sell in Canadian dollars. We found ways to deal with hedging and get around that.

For a while, one of our competitors had operations up there that helped them, that compared to no longer has the operations up there. So we're all pretty much on the same basis now. But what we found is that the Canadian utilities are very interested in some of these newer products, the ultrasonic meters and the cellular.

And that's giving us an opportunity up there where we didn't have one in the past. However, I don't think we had the strong channels that we needed, and Corix gives us that. Corix now gives us the strength in the channels, the foot in the door of a lot of these utilities.

So I think we can grow our market share up there to at least the percentage market share that we've got in the United States, and that could be pretty significant growth for us. That could be double-digit growth for us on our Canadian sales over the next several years..

That's great. I appreciate that. And then just another question on that front.

Since Corix was acquired by Deschenes, does that have any positive impact on the outlook? Or how about any negative issues?.

No. The same players are still there. And basically, that hasn't had any impact one way or the other. Corix is a good operation. We're really pleased with them. And I don't see any big changes..

And our next question will come from the line of Bob Chernow with RBC..

I'm curious on how your sales are going in the Middle East, and if you're using some of the sales techniques with the benefits, selling your product in the Middle East to other drought-ridden areas like Australia or California..

Bob, I think it's -- that's a very good question. And I often get the question, why the Middle East and not Sweden and England and other places like that? Well, first off, the Middle East -- in the Middle East, water is often more valuable than oil.

And so they take water conservation very seriously, and they have -- and they are willing to spend additional money for premium products that will perform very well.

So when -- Dubai in particular, Qatar and some other of the countries over there, started looking for how they could improve their systems, they did -- instead of just looking at the local companies, they did a global search of technology.

And that led them to Badger Meter and to our ultrasonic technology and to our cellular technology, and they really liked that. So we've had a lot of success there. As Ken mentioned, we did get a large order again just at the end of the first quarter, which is going to help us. And it continues to grow, and the excitement over there continues to grow.

I think our position in -- our original position in Qatar helped us get into Dubai, and now, Dubai is viewed as a leader over there. So being strong in Dubai is helping us get into other areas in the Middle East. So that's been very good.

Our selling technique over there, very often, one of the concerns they have is how the meters will stand up under very hot temperatures. That's a concern of theirs. And so our meters do very well in arid regions where there is hot temperatures.

That has always helped us out west, and we've used that as a selling point out west, and we used that selling point in the Middle East. The other thing is these meters maintain their accuracy over time.

That's the benefit of an electronic meter versus a mechanical meter, is that you don't lose accuracy with time, and you don't end up under billing customers. Obviously, in drought-ridden places like California, who suddenly don't quite believe that they're in a dry anymore. I think they believe their drought has ended.

But I'm not sure that will just last to the next dry spell. But clearly, the people out there understand that they need those more accurate meters.

So there is -- I think it's interesting you bring this up because there is a lot of similarity between how we sell in the Middle East and how we sell out west in those regions and the features of our products that sell well there. So yes, we do see that. That's a long answer to your question, Bob. I apologize. But yes, we do see it..

And our next question will come from the line of Jose Garza with Gabelli & Company..

Just a quick one, just putting that all together in terms of just the investments that you're making.

What's kind of your CapEx budget looking like for this year and things to just keep in mind relative to last year?.

Yes. Well, I think last year was about $15 million, and I see it in the same range for 2018. Maybe a smidge higher, but nothing down unusual..

For normal CapEx..

For normal CapEx..

Excluding acquisitions..

Correct. Excluding Acquisitions. I agree..

Okay.

And nothing from the new distribution investment that is worth noting there?.

No. And we'll disclose this in the 10-Q, but we paid $8.5 million, I think, for IMS in Florida. I mean, not that significant, so..

And our next question will come from the line of Nathan Jones with Stifel..

Just a comment that Ken made earlier that said the D-Flow technology incorporation opened up projects that you guys couldn't bid on before.

Can you talk about -- is this a meaningful increase in the addressable market that you're looking out from this kind of stuff? Or how meaningful that could be in terms of opening up markets or projects that you couldn't have bid on before?.

Yes. So in terms of quantifying, the problem that we had is we only had the smaller sizes, right? So as this -- it was fine when people were still buying the older technology. But as they shift, now we're adding on the 3-inch and the 4-inch, so we can participate in full projects.

So sometimes, we were just getting locked out because we didn't have the full line. In terms of significance, yes, I mean, it'll get us into more projects. Is it going to get us into multiple percentage points growth? No. But it will get us into some profitable projects we're getting shut out on today..

And I think we would continue to be shut out if we hadn't -- if we weren't....

Absolutely. That's correct. Yes, thanks. Thanks, Rick..

Got you. That makes sense. And then one of the other things you said, Ken, was that April order rates were above the daily order rates for the year. But you guys did say you got off to a slow start in January, February picked up, march picked up again.

So are the April order rates better than the March order rates, or in line with the March order rates?.

Yes. So they're better than the March order rates. And, yes, in line with what we saw the last couple of weeks of March, which was a significant ramp. So again, it's a relative small sample size, but it's one that I felt good enough to mention..

And then I've got one for Rich, more of a philosophical question. Looking back over the last decade, the company has kind of picked up 500 basis points on gross margin. But the SG&A expenses have picked up by a similar amount, and the SG&A expense has gone from roughly 20% to 25% of sales.

Can you talk about what's changed in the business model? Is this a result of needing more R&D, more engineers because they're higher technology products? Just the dynamics that are at play there and what you think is the right level of SG&A for the business..

Yes. And you're right about what has happened to SG&A. Now part of that is because when we buy a distributor, okay, the distributor sales force, almost all of their cost fall down in SG&A. And all of their benefit appears as incremental margin, basically. So you end up with a shift. We never bought any of our distributors over the last several years.

SG&A as a percent of sales would be much lower than it is. The other thing that's happened is we have made a pretty significant investment in patents, in technology and acquisitions, in D-Flow and everything else. A lot of those intangibles, the amortization of those intangibles are down in SG&A, and that's having an impact on us, too.

And then I'll point out just for this year that for the entire year this year, we are carrying an extra engineering load in the form of D-Flow to work on integrating all of these products, which we will not really see much benefit from until 2019. So that's having an impact on us, too, in the engineering area.

So all of those projects that are going on, all of these technologies staying on the leading edge, that is having an impact. I would like to believe that our SG&A can come down from that 25% over time, and I would rather see it in the low 20s, 21%, 22%, something like that, rather than up at 25%. And I think we can achieve that over time..

And our next question will come from the line of Tate Sullivan with Sidoti..

Got a quick follow-up.

Is it too early to talk about the dividends for this increase? And can you remind us of your dividend policy and how you look at balancing that with acquisitions?.

Yes, it's too early because, actually, the board decides, and if they do, it probably won't be until sometime later in summer. But we do -- historically, we've paid out in the 30%, trailing 30% of earnings, 30% to 35%. There's no reason to believe that, that won't continue, but obviously, we're not in a position to say anything at this time..

But I will say, even though we're not in a position to say....

But you'll say it anyway..

I will say that we have a very strong balance sheet. We generate a lot of cash in this organization and continue to do so. Our board has increased the dividend..

25 years ago..

Every year for the past 25 years, and I don't see any reason to believe that they're going to deviate from that type of policy..

Correct. But we haven't decided. We haven't even come up with a recommendation..

Right. Nothing has been decided yet. That's usually done at the August board meeting..

And our next question comes from the line of Brian Rafn with Morgan Dempsey..

Rich, just one follow-up.

If you look at where the municipal residential water meter is -- meters are from the standpoint of kind of end markets, what's kind of the mix between galaxy fixed network, ORION Cellular and then the old -- the drive-by or the read-only?.

Yes, I can answer that. From what we're selling right now, okay, we're selling about 50% drive-by and about 45% cellular right now. And then the remainder is a mixture of -- it's the old galaxy fixed network and [indiscernible]. Now that's when we sell something with a radio.

Obviously, there's also still a portion of what we sell that is mechanical read, where people are walking door-to-door reading water meters. That's what's going into the market..

That's what's going into the market. The market itself....

The market itself is about 60% convergence. So about 40% of the meters. And I'm talking about everybody, not my own customers. 40% of the water meters in the United States are being read by some kind of manual system, by somebody either walking door-to-door with a touch wand or just manually reading, versus some sort of automation..

Okay, okay. And then just from the standpoint of, say, the next couple of years, Rich, any major municipal residential programs, national sales-wise.

Any cities that you might highlight that might be looking to do something?.

Well, my reaction is even if we throw the city, we have no idea of the timing of it, okay? And generally speaking, the bigger the city, the longer the sales cycle. And in particular, I could think of one city that did 3 bids in 10 years and really never really bought anything. So we're always a little reluctant to do that.

And then even if you get that, sometimes it takes 3, 4, 5 years to complete that order. And I harken back to Houston, the one that actually publicly announced they were going to do the whole city in 2 years. It took them 5 years to buy those meters. And so that's why we're always a little reluctant to say anything..

Thank you. And I'm showing no further questions in the queue. So it'd be my pleasure to hand the conference back over to Mr. Rich Meeusen, Chairman, President and Chief Executive Officer, for some quick closing comments and remarks..

Great. Thank you, Brian. And I'll just conclude by repeating the L word again, which we seem to use a lot, that we are in a lumpy business where we occasionally have quarters like this, down quarters. But if you look at our history, we typically bounce back quickly. There is a fundamental, underlying strength to our market that helps us do that.

And we also have much to look forward to in the year ahead as far as new products and the developments we are working on. And we do remain confident in our business and believe that people continue to see strong orders in the future. We appreciate your time in today's call..

Ladies and gentlemen, thank you for your participation on today's conference. This does conclude our program and we may all disconnect. Everybody have a wonderful day..