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Badger Meter Inc (NYSE:BMI)
Q3 2019 Earnings Call
Oct 17, 2019, 11:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Ladies and gentlemen, thank you for standing by and welcome to the Third Quarter 2019 Badger Meter Earnings Conference Call. [Operator Instructions] Please note that today's call is being recorded.

It is now my pleasure to turn the conference over to Karen Bauer, Vice President of Investor Relations, Strategy and Treasurer. Please go ahead.

Karen Bauer -- Vice President, Investor Relations, Strategy & Treasurer

Good morning, and welcome to the Badger Meter's third quarter 2019 earnings conference call. On the call with me today are Ken Bockhorst, President and Chief Executive Officer; and Bob Wrocklage, Chief Financial Officer. The earnings release and related slide presentation are available on our website. Quickly, I'll cover the Safe Harbor, reminding you that any forward-looking statements made during this call are subject to various risks and uncertainties, the most important of which are outlined in our press release and SEC filings. Finally, please note that on today's call, we will refer to certain non-GAAP financial metrics, our press release and slides provide a reconciliation of the non-GAAP to GAAP financial metrics used.

With that, I'll turn the call over to Ken.

Kenneth C. Bockhorst -- President And Chief Executive Officer

Thanks, Karen, and thanks for joining our third quarter earnings call today. We were pleased with the return to growth in the domestic utility market, with sales up 2% against a near-record comparison last year. You may remember from last quarter's earnings call, we stated we expected to return to growth in the domestic market in the back half of the year. We did begin shipping the three- and four-inch E-Series commercial meters about midway through the quarter, and one of the two larger municipal smart water wins began to ramp as well. This combined with the solid municipal utility market backdrop provided the return to growth in Q3.

I remain encouraged by customer feedback on the new technologies and the solid funnel of opportunities as we look forward. In addition, our gross profit leverage remains in the upper half of our normalized range. SEA spend was well managed and we were able to continue working capital initiatives and generate strong free cash flow again in the quarter.

Bob will walk you through the details of the quarter, and after that, I'll come back and talk about a few key strategic items and our outlook.

Robert A. Wrocklage -- Vice President, Chief Financial Officer

Thanks, Ken, and good morning, everyone. Slide 4 gives you a snapshot of the financial results for the quarter compared to adjusted results in the prior year. Just as a reminder, the prior year amounts have been adjusted to exclude pension termination settlement and executive retirement charges for comparability. A reconciliation of these amounts is included in the appendix to the slide deck.

Starting with sales, total sales for the third quarter were $108.6 million compared to $110.6 million in the same period last year, a decline of 2%. In municipal water, overall sales declined 3%. Focusing on the domestic market, which obviously excludes our more uneven international revenues, we saw utility sales up approximately 2%. This quarter's domestic municipal water sales were the second highest in our history and fell just short of the record second quarter of 2018. The increase was driven by continued adoption of smart metering solutions, including the newly launched large diameter three- and four-inch E-Series commercial meters and ORION LTE-M cellular radio endpoints.

Sales mix remained positive with increased sales of ultrasonic meters and meters with radios as well as increased BEACON service revenue year-over-year. Flow instrumentation sales increased 1% year-over-year with puts and takes across the broad array of industrial end-markets served. Operating profit as a percent of sales was 15.1%, down 100 basis points from adjusted prior year results. Taking a closer look at the drivers, gross margin for the quarter was 38.4%, once again, in the upper half of what we would call our normalized range of 36% to 40%.

In order of magnitude, favorable product mix was the primary driver, with the higher proportion of BEACON service revenues, ultrasonic meters and meters with radios as well as favorable regional mix. We continued to experience favorable net pricing as brass input costs were lower year-over-year, albeit at a more modest pace than the first half of the year.

During the quarter, we did record a discrete warranty provision associated with the sourced system integration module for a previously installed solution sold only outside of North America. Excluding this specific provision, our gross profit margins would have been modestly higher than the prior comparable quarter. SEA expenses in the second quarter were $25.2 million, $0.9 million below the adjusted $26.1 million in the comparable period last year, due primarily to lower incentive compensation and effective cost control measures. Our SEA leverage improved to 23.2% of sales from an adjusted 23.6% last year.

The income tax provision in the third quarter of 2019 was 22.1%, essentially in line with the prior year's 22.8% adjusted rate, with the third quarter generally the lowest tax rate quarter of the year. Bottom line, adjusted EPS was $0.44 in the third quarter of 2019, a decline of 4% from the prior year's all-time record of $0.46 per share. We again delivered a solid primary working capital performance, with third quarter working capital at 27% of trailing 12-month sales, down from 30.4% in the same period last year and on balance with the 26.9% at the end of our second quarter. Working capital management contributed to the 50% increase in the third quarter free cash flow from $12.7 million a year ago to $19.1 million this year. On a year-to-date basis, our free cash flow to net earnings conversion is a very robust 159%.

With that, I'll turn the call back over to Ken.

Kenneth C. Bockhorst -- President And Chief Executive Officer

Yeah, thanks, Bob. I want to take a minute to discuss one of the areas that frankly doesn't get a ton of attention from our investors, but it's a fundamental importance to us and that's cash flow. These charts on Slide 5 display our free cash flow conversion, our ability to translate our earnings into actual cash flow and our primary working capital as a percent of sales trends. Bob just highlighted one of these, the nearly 160% free cash flow conversion for 2019 thus far.

One aspect of our broad continuous improvement program has been focused on working capital management and you can see the early results. Ongoing efforts to drive reductions in days inventory on hand, improvements in payment terms and tighter collection efforts span not just finance but purchasing, operations and others and serve as a great example of our continuous improvement culture.

We are in a net cash position and so why is this important? Capital allocation is one of our most important jobs and our strong cash flow is supportive of our efforts to take a balanced approach by investing in Badger Meter's future growth both organically and via acquisitions and meaningfully returning cash to shareholders, as evidenced by the August announcement of our 27th consecutive year of increased dividends.

Finally, turning to Slide 6, as we move into the final quarter of the year, we see robust quote activity and a backlog supportive of our growth plans. The key project wins we highlighted earlier in the year are starting to ramp, demand for the three- and four-inch E-Series commercial meters has been strong and municipal spending trends are solid. From a macro standpoint, while employment is still quite good, trade and other uncertainty appear to be taking a toll on consumer sentiment and overall industrial demand. For Badger Meter, we remain largely unaffected by those particular trends, since we are predominantly a U.S.-centric replacement driven business. We will continue to monitor the environment, but municipal spending trends remain a positive backdrop for our utility water business.

Execution on our strategic initiatives continues. We recently held a Customer Advisory Council session, which is a process we use to gain insight on emerging customer trends and how our products and technology roadmap should evolve to meet those needs. Operational metrics and processes are being improved, including the addition of SIOP or sales, inventory and operations planning capabilities. And finally, the active portion of the M&A pipeline includes some interesting technology opportunities.

In closing, I want to express my appreciation to all of our employees for their hard work and dedication. With that, operator, please open the line for questions.

Questions and Answers:

Operator

[Operator Instructions] Your first question comes from the line of Nathan Jones. Your line is open.

Nathan Jones -- Stifel Nicolaus -- Analyst

Good morning, everyone.

Kenneth C. Bockhorst -- President And Chief Executive Officer

Good morning, Nathan.

Robert A. Wrocklage -- Vice President, Chief Financial Officer

Nathan.

Nathan Jones -- Stifel Nicolaus -- Analyst

Maybe we could just start on the progress here around the new technologies that are coming into the market. I know it's nice to see you guys return to growth in the domestic market here against a pretty good comp. So maybe just a few questions around that, can you tell me if there is more or less customers in pilot testing than there were three months ago? When does the pilot phase take and customers begin to move more into the ordering phase out of this?

Kenneth C. Bockhorst -- President And Chief Executive Officer

Yeah. Sure, Nathan, I think I would characterize it rather than account of what's in pilot versus what moved into orders versus what moved into deferrals. It's probably easier to just think about this more as a phase-in, phase-out from the LTE-M technology to the more robust LTE-M. And really what we've seen is a return to normal, right, we're always going to have people piloting it, we're always going to have people doing different things just the way we did before with the LTE technology. So what we've seen is a return to normal.

Nathan Jones -- Stifel Nicolaus -- Analyst

Okay. Maybe you could talk about then, I mean, you're only just ramping up the sales of LTE-M. When that radio is at kind of a full run rate normal kind of mix, what percentage of sales -- of radio sales do you think will be LTE-M versus other technologies?

Kenneth C. Bockhorst -- President And Chief Executive Officer

Yeah, so similar to what I was just pointing out there. So the LTE radio has now been phased out replaced by the LTE-M radio. So it isn't like we're still selling the LTE technology and the LTE-M, right. So if you think about technology, mobile reads are always going to be out there and we like that, we continue to play on the mobile side. And as people make their decisions to go off to the full AMI systems, they'll be buying our LTE-M ORION Cellular.

Nathan Jones -- Stifel Nicolaus -- Analyst

Got it. That makes sense. Maybe just on the new three- and four-inch commercial meters, maybe talk a little bit about the initial traction you're seeing from those products in the market. What advantages do they generate for customers over the prior technology?

Kenneth C. Bockhorst -- President And Chief Executive Officer

Yeah, so from a technology point of view, it's really a nice enhancement for customers because it gives them the ability to sense for pressure, temperature, so it gives them more functionality. Also on these higher flow applications that are the larger meters, here's a case where the ultrasonic does have an advantage with the no moving parts for where has better accuracy on low-flow and we've seen really strong customer support out of the gate. I think the thing to remember is the three- and four-inch is just part of a total product line. So I wouldn't think of the three- and four-inch as some huge stack bar of growth. It continues to improve our overall product line and was a really important product launch for us.

Nathan Jones -- Stifel Nicolaus -- Analyst

Okay. And then just one more on these warranty charge, Bob said gross margin to be up slightly without that, which implies it was about a $0.04 headwind to earnings in the quarter. It sounds like this is a third-party component that had issues? Are you confident that this is contained to the third quarter? Is it likely to see any others? And are there prospects for you to recover these damages from the supply, given, it sounds like just a part you were sourcing?

Robert A. Wrocklage -- Vice President, Chief Financial Officer

Yeah, so from the standpoint of the technology, it's very much quarantined to specific region. So from the standpoint of charges and future charges, we would expect minimal moving forward. As it relates to pursuing recovery at this point in time, that's not something that that we're pursuing, so to think about it broadly, in our mind, it's a Q3 event and a Q3 event only.

Nathan Jones -- Stifel Nicolaus -- Analyst

Okay. So it's a 1x charge. Thanks, I'll pass it on.

Robert A. Wrocklage -- Vice President, Chief Financial Officer

All right. Thanks.

Operator

Your next question comes from the line of Tate Sullivan. Your line is open.

Tate Sullivan -- Maxim Group -- Analyst

Hi, thank you. On the U.S. revenue increase, I mean, you had a consistent streak of the U.S. revenue growth for last four or five years, I think it's been around 6% of the year, I mean, can you talk about, I mean, with the positive muni backlog -- backdrop you mentioned, I mean any expectations for growth in your primary U.S. market?

Kenneth C. Bockhorst -- President And Chief Executive Officer

Yeah. So as we transitioned into this new release on the LTE-M again we're back -- we feel like we're back to normal on that phase-in, phase-out mode. You know of the two large ones that we announced in terms of projects relative to Columbia and Aurora. Columbia kicked off in Q3, Aurora will begin to kick off in Q4. We are seeing robust demand in general for what we're offering, so yeah, I mean I feel like with how we felt coming out of Q2 and what we indicated on the last call, I feel like we've returned to what we expect.

Robert A. Wrocklage -- Vice President, Chief Financial Officer

And not pitching anything to a specific quarter. I think as we talk long-term growth rate -- multi-year growth rate, I think we're still very confident in that low -- mid-single digit range for the utility portion of the business as we move forward. So no change in that sentiment, no change in that signaling as we talk longer term.

Tate Sullivan -- Maxim Group -- Analyst

Great, thank you. And then you mentioned integrating the D-Flow technology into the three- to four-inch ultrasonic. Are there other future D-Flow integration efforts or are you done integrating D-Flow on all your products?

Kenneth C. Bockhorst -- President And Chief Executive Officer

No, that's one of the things that I'm actually excited about yet is that we're going to continue to build out the larger sizes. So the three and four was just the first release, we'll start to move into the six and eights and even larger, which will really help build out the full portfolio on the commercial side. And then we still have the opportunity in front of us to incorporate into the smaller residential meters and have a reasonable cost reduction that we'll be able to use whether that's for taking more share and/or improving margin. So we have two really strong uses of the D-Flow technology still going forward.

Robert A. Wrocklage -- Vice President, Chief Financial Officer

Yeah, so Tate, I would think about the larger size being product line extension and expansion that opens us up to bids we didn't participate in previously, that I would think of what Ken mentioned in terms of the integration of that into the residential metering as being a cost improvement that'll be used for combination of competitive global pricing as well as margin enhancement.

Tate Sullivan -- Maxim Group -- Analyst

Has that integration been on schedule -- has on the residential effort with D-Flow? Has that been consistent with your timeline expectation on that since the acquisition?

Kenneth C. Bockhorst -- President And Chief Executive Officer

Yeah, Tate. So when it comes to implementing something that's going to reduce our cost, it's never fast enough in my point of view, but no I mean, we expected that we would have done it this year, later second half, it's -- we're looking more now first half next year.

Tate Sullivan -- Maxim Group -- Analyst

First half, OK. Thank you. Thank you, have a good day.

Kenneth C. Bockhorst -- President And Chief Executive Officer

Sure. Thanks.

Operator

Your next question comes from the line of Chip Moore. Your line is open.

Chip Moore -- Canaccord Genuity -- Analyst

Good morning. Hey, guys.

Kenneth C. Bockhorst -- President And Chief Executive Officer

Hi, Chip.

Chip Moore -- Canaccord Genuity -- Analyst

Wanted to circle back to piloting activity, it sounds like things are normalizing a bit, but how are you thinking about any sort of elongation in the sales cycle, is that really -- are we past that and any seasonal considerations I guess as we enter into the harder time of the year?

Kenneth C. Bockhorst -- President And Chief Executive Officer

Yes, that's -- let me break that into a couple of parts. So first again reiterating on the LTE-M phase-in, phase-out of the LTE, we're feeling that's into a normalized phase, again, we're always going to have people piloting, we're always going to have people ordering, so I don't think we're going to see more elongation there. The second part of the question, I forgot already. So what was that?

Chip Moore -- Canaccord Genuity -- Analyst

All right. It sounds like no but just in terms of elongation or piloting cycle that you think is a factor in terms of seasonality?

Kenneth C. Bockhorst -- President And Chief Executive Officer

Yes, so right, seasonality. Seasonality can be interesting when it comes to weather impacts and some of the other things, but I think to think rolling forward here now that we've got a couple of really large AMI integrations. The seasonality, I think, as we go through the next year, two years, three years may not be as impactful as it had been in the past.

Chip Moore -- Canaccord Genuity -- Analyst

Got it. And another one on SEA leverage very strong. Any puts and takes there to take into account and sustainability as we look forward?

Kenneth C. Bockhorst -- President And Chief Executive Officer

I think we've been pretty consistent in telling the story here on being able to leverage the SEA particularly as we transition to higher average selling prices, larger AMI implementation. So I think we're feeling good about the SEA leverage and I think it's progressing as we expected.

Robert A. Wrocklage -- Vice President, Chief Financial Officer

So I think just to reiterate that Ken mentioned again our ability to leverage SEA over time as a large part of our top line story is about average sell price increase. I will say the one thing that won't change and the thing that we will remain steadfast in is to continue to invest in the business organically to stay as a technology leader. So to the extent we find opportunities where we can accelerate new product development to keep us in a competitive advantage or to bump us to the top on our particular technology, we will not waiver in that. So that's not meant to buffer or hedge the earlier comment, I still believe in the long-term prospects of SEA leverage but there may be bumps along the way where we decide to put more into organic investment in new product development.

Chip Moore -- Canaccord Genuity -- Analyst

That's great. And maybe that's a good segue into one last one, you're in a pretty strong net cash position. How should we think about some of those organic investments and then potentially any assets you're looking at? Thanks.

Kenneth C. Bockhorst -- President And Chief Executive Officer

Yeah, so over the years, we prided ourselves on the innovation that we've brought to the market so we will continue first and foremost to invest in R&D, as Bob just pointed out. We're proud of our 27-year history of increasing dividends year-over-year, that will continue to be a capital allocation priority for us. And then the third part is continuing to ready the organization with our organizational capability and improving our acquisition funnel and finding meaningful strategic acquisitions to improve the technologies and solutions we bring to our customers. So internal R&D sticking with our dividend history and investing in M&A.

Chip Moore -- Canaccord Genuity -- Analyst

All right. Thank you.

Kenneth C. Bockhorst -- President And Chief Executive Officer

Thanks.

Operator

Your next question comes from the line of Richard Eastman. Your line is open.

Richard Eastman -- Robert W. Baird -- Analyst

Yes, good morning, Ken.

Kenneth C. Bockhorst -- President And Chief Executive Officer

Hi, Rich.

Robert A. Wrocklage -- Vice President, Chief Financial Officer

Good morning, Rich.

Richard Eastman -- Robert W. Baird -- Analyst

Good morning, Bob. Hey just a question -- I just want to get maybe your perspective here a little bit, we talked about the domestic business, municipal business, water meter business being up plus 2% when we pull out the international impact of the comp. Could you just give us a sense of what the residential versus commercial did against that 2% domestic?

Kenneth C. Bockhorst -- President And Chief Executive Officer

Yeah, so the lion share of the revenue was on the residential side, so the commercial doesn't really swing at that much one way or the other, I guess. I don't have the specific number in front of me. But--

Richard Eastman -- Robert W. Baird -- Analyst

But I was just curious, I mean, with the three and four introduced that kind of would be more of a commercial product. So I'm just curious if commercial was up 10% and residential was flat or just -- I'm trying to get some sense of that.

Kenneth C. Bockhorst -- President And Chief Executive Officer

It was really consistent with the normal quarter. So there wasn't spike in commercial that would have covered for residential, very consistent.

Richard Eastman -- Robert W. Baird -- Analyst

And so when I look at the number, that 2% domestic muni water. What's your take on that number -- that growth rate relative to what a market growth rate would have been in the third quarter?

Kenneth C. Bockhorst -- President And Chief Executive Officer

Well, I would go back to the point that we expect for the long cycle to grow in the mid-single digits, mid 6% to 8%-ish. Fact is we were up 2% this quarter. We're proud of being up 2% this quarter. Last year, year-over-year, we were up 12%. So it was a really tough comp. And so we still think the market might have been above our 2% but we're certainly not feeling bad about our 2%.

Richard Eastman -- Robert W. Baird -- Analyst

Okay. And in the International business, I know the swing factor has mostly come from the Middle East, but I'm curious with that business down I think the comp was somewhere around $3 million to $4 million in the Mid-East. But with that business down as much as it is, what is the run rate of the International business, including Mid-East. I mean if you look at the third quarter here dollars times four, just curious where that run rate is at?

Kenneth C. Bockhorst -- President And Chief Executive Officer

Yeah, so the interesting thing about the international markets compared to the U.S. is in the U.S. right we have 50,000 municipalities that are generally doing replacements and you have a lot of people doing a lot of different types of activities, some up, some down depending on where it's at. When you look across the world, you're looking at individual countries or cities that are implementing new systems. So the replacement business isn't there, right. So it tends -- it will tend to be more lumpy and the fact that it's more integrations that are large and then they happen one year and they may or may not happen the next or. So it'll continue to be uneven, it doesn't dampen our enthusiasm for what we're finding for utility -- water utility opportunities around the rest of the world. But I don't think you're going to see a consistent run rate from us over the couple of -- next couple of years, right.

Richard Eastman -- Robert W. Baird -- Analyst

Well, but I'm just curious, when I look at, I mean, maybe stated another way, if I look at utility sales in the quarter around $84 million. And I'm just trying to figure out what percentage of that do you count as International because I -- my understanding is International is, I think it's Middle East, but isn't it also -- don't you throw Mexico in there and -- I'm just curious what percentage of that is?

Kenneth C. Bockhorst -- President And Chief Executive Officer

So internally when we talk domestic and when we're using the term domestic here today, it's basically in America's number, whereas rest of world would encompass Middle East and other countries. But largely our International presence when you look across the entire book of business has historically been more about flow instrumentation than it has utility. So it's a relatively -- it is a very small piece of that full utility number that you just mentioned.

Richard Eastman -- Robert W. Baird -- Analyst

So if my comp number is right somewhere around, let's say, it's $3 million to $4 million was the Middle East shipment last year. Does that -- in this quarter, does that $3 million to $4 million number go to zero?

Kenneth C. Bockhorst -- President And Chief Executive Officer

No.

Richard Eastman -- Robert W. Baird -- Analyst

Is it that flatty [Phonetic]?

Kenneth C. Bockhorst -- President And Chief Executive Officer

No, I would say, I mean it is -- I mean, again, what we're kind of splitting hairs here but with the Middle East number of $3 million to $4 million, our International number a year ago was modestly higher than that $3 million to $4 million, and in the current year, it's basically $1 million. So the largest part is that non-recurrence, but it is very, very small numbers.

Richard Eastman -- Robert W. Baird -- Analyst

Okay. No, I understand -- I was just trying to get order of magnitude. And then there was a reference, Ken, to the run rate around BEACON recurring revenue -- subscription revenue. Is that number started to register on the scale at all? I'm sure it's a big growth rate, but I'm curious -- order of magnitude is at a few million bucks, is it -- what kind of number has that grown to?

Kenneth C. Bockhorst -- President And Chief Executive Officer

Yeah, so generally we've been running -- obviously, you're right exactly, because it's running from a small base, we're seeing larger percentage increase currently operating right around 3% of consolidated revenues being that kind of recurring base and obviously we've talked openly about with the adoption of -- and the migration to AMI systems, and also the adoption of Cellular as a preferred technology internally we measure to -- wanting that to be 10% of utility-based revenues over our five-year strategic plan. So that's not a secret but we're sitting currently at about 3% of total consolidated sales.

Richard Eastman -- Robert W. Baird -- Analyst

Of utility sales?

Kenneth C. Bockhorst -- President And Chief Executive Officer

3% of consolidated.

Richard Eastman -- Robert W. Baird -- Analyst

Total. Okay.

Kenneth C. Bockhorst -- President And Chief Executive Officer

Total.

Richard Eastman -- Robert W. Baird -- Analyst

Okay, fair enough. Yes, I got it. Okay, great, thank you very much.

Robert A. Wrocklage -- Vice President, Chief Financial Officer

Yes. You're welcome.

Operator

Your next question comes from the line of Richard Verdi. Your line is open.

Richard Verdi -- Coker & Palmer -- Analyst

Hi, thank you for taking my call. So basically my company level increase have been addressed, but I just have a couple of broad questions remaining. I kind of heard from a few clients, they feel the ORION LTE-M technology is somewhat inferior to other technologies and so can you kind of address why the company feels choosing the ORION LTE-M technology was best and kind of compare it to your peer offerings?

Kenneth C. Bockhorst -- President And Chief Executive Officer

Yeah, so I'm certain that the people who express that to you aren't our customers, because the benefits are many, right. So initially there is zero infrastructure investment required to be able to ramp-up in AMI system. There is no time-based limit where you have to build out that system first. You can continue to improve at the rate of technology with Cellular which evolves faster than a fixed network and so specific natural disaster communication issues if you have a problem with your fixed network getting damaged, Cellular comes up faster. There is a different rate at -- with which you can pay your subscription fee for the software-as-a-service, which our customers really value. So I'd love to spend a lot more time with you to explain that in more detail, but it is in no way inferior to the other option.

Richard Verdi -- Coker & Palmer -- Analyst

Okay. Okay, great. You kind of answered my second question there. I'm going to jump out. Thank you very much for the time.

Kenneth C. Bockhorst -- President And Chief Executive Officer

Yeah. You're welcome.

Operator

Your next question comes from the line of Andrew Buscaglia. Your line is open.

Andrew Buscaglia -- Berenberg Capital Markets -- Analyst

Yes.

Kenneth C. Bockhorst -- President And Chief Executive Officer

Hey, Andrew. That was close right.

Andrew Buscaglia -- Berenberg Capital Markets -- Analyst

That was a new one. Can you guys talk a little bit more about you're seeing -- you had some commentary in the call that municipalities are showing interest, you're encouraged by their interest level. How much of this is related to new technologies like 5G coming online? How much of it is a function of how they feel about the environment? I'm just trying to get inside the mind of what municipalities are thinking right now and looking out into 2020 kind of what -- where you get confidence that things will improve?

Kenneth C. Bockhorst -- President And Chief Executive Officer

Yeah. So I think the way that municipalities are looking at AMI adoption is that it's helping them solve a lot of their problems, right. So it's helping them be more efficient in how they're able to do their billing reads. It's making them more in tuned with supply/demand within their system. It's helping them identify leaks in conserved water, which is really important in several parts of the country and the world. There is many benefits to an AMI solution that are driving customers that way, and then on top of that, generally, they're feeling pretty good about their ability to spend money. So I think it's a convergence of -- the technology really is solving problems for customers at a time when they can spend money to do it.

Andrew Buscaglia -- Berenberg Capital Markets -- Analyst

Okay, I see. And then you made a point on the prepared remarks, talk about your cash flow and it really has been building over the last year. What are your thoughts of maintaining or letting that continue to build just to fortify sort of your balance sheet? Or what are you -- if you are spending it, I said at M&A, what kind of R&D or what kind of stuff would you be spending on exactly?

Kenneth C. Bockhorst -- President And Chief Executive Officer

Yeah, so we're going to start from the R&D front, and one of the things that we will continue to do is build out our ultrasonic large meter line to have the full line on the ultrasonic side. Second piece that we'll continue to work on is building the rest of world meter portfolio that we need. Third thing there will continue to be evolutions in Cellular technology, LTE-M was last and BIOT is also coming. We are working on releasing in the early half of next year our flow limiting valve, which we're getting a lot of great feedback from our customers. So there's a lot of great R&D actions and continuing to build out our software-as-a-service platform. If you recall, we acquired Aquacue in 2013. We've got a great team of software engineers out in Silicon Valley and we continue to develop new ways to help utilities be more efficient in real-time with software. So we have a full plate of R&D activities that we're excited about. And then on top of that, we're going to continue to look for really nice M&A tuck-in and technology extensions like we've done before with D-Flow and that we've done really good work within similar with Aquacue. So we have plenty of great things that I think we can continue to invest in at the appropriate rate that our customers are looking for.

Andrew Buscaglia -- Berenberg Capital Markets -- Analyst

Got it. Maybe just one last one. We talk a little bit about the International markets and you guys focused on a lot of discussions around the Middle East. What about the UK? Can you talk a little bit about that market, if you see that as a good opportunity for you too?

Kenneth C. Bockhorst -- President And Chief Executive Officer

Yeah. So the UK is certainly interesting to us. It's a market with 15 utilities there's a lot of growing I think need and discussions there around AMI type solutions. The fact that we have and are continuing to build out our rest of world meter offering, I think that will be an opportunity for us rolling forward as well as building on Middle East some pockets of Southeast Asia. I mean that's just one area that we think we can play, but yeah, I think you're right about that.

Robert A. Wrocklage -- Vice President, Chief Financial Officer

And certainly the legislative and regulatory environment, there is definitely driving toward more smart metering applications. And so yeah ripe overall, I think what we've done internally is obviously had to rally the resources infrastructure and channel to support that market, which is very early stages for us.

Andrew Buscaglia -- Berenberg Capital Markets -- Analyst

Okay, got it. All right, thanks guys.

Kenneth C. Bockhorst -- President And Chief Executive Officer

Thank you.

Operator

Your next question comes from the line of Nathan Jones. Your line is open.

Nathan Jones -- Stifel Nicolaus -- Analyst

Good morning, again.

Kenneth C. Bockhorst -- President And Chief Executive Officer

Welcome back.

Nathan Jones -- Stifel Nicolaus -- Analyst

Still despite highlighting it in your slide show, nobody is talking about cash flow. So I'll talk about cash flow, it looks like a lot of the improvement here has been in payables and receivables you did have pretty high levels of both in 3Q '18. Can you talk about a little bit more about the kind of process improvement that you've made, terms and conditions potentially that you've made on both the payables and receivables side, that's driven that that primary working capital number down to that kind of 27% level?

Kenneth C. Bockhorst -- President And Chief Executive Officer

Yeah, I really just think it's a bit more focus than has historically existed, and that's not to throw anybody else under the bus, I think it's just with new perspective cum new processes. And so I think it's a little bit of motherhood in apple pie on the receivable side, it's just staying closer to collections, that is having more frequent touch points with customers really identifying pockets of payer behavior that we could improve one area being on the flow instrumentation line of business in Europe just having a renewed focus on historic agreements in term.

So very much motherhood in apple pie as it relates to receivables, and I would say, the same holds true from a payables standpoint, I think we've long prided ourselves on being a good payer and we'll continue to do that. I would just rather be a good payer at 60-days than I would at 30-days. And so we've taken a targeted approach with our supply base to identify top 100, top 150 type suppliers and pursue at what I'll call advantageous terms discussions about extending our payment terms, which I think is clearly very common within manufacturing just an idea we're bringing to the table now. So but you're exactly right those are the two pockets of improvement and that's a big part of what we've been able to do here in the last, really three quarters of that focus and that's been a tailwind for cash flow and is certainly contributing to the 159% free cash flow conversion on net earnings perspective that we just talked about.

Robert A. Wrocklage -- Vice President, Chief Financial Officer

And if I could add, Nathan. So we -- I mentioned also that we've kicked off a sales inventory and operations planning system, so we're really investing and trying to make sure that we optimize our inventory, so we can continue to keep the service levels that we have, but we certainly think we can do better on the inventory side yet as well.

Nathan Jones -- Stifel Nicolaus -- Analyst

So that was going to be where I was going next, I mean, I normally think of world-class primary working capital management being at about 20% of sales. I would imagine Badger Meter given the type of business, given that short turnaround that you can have on some of these meters would require a higher level of inventory than that, so I don't think--

Kenneth C. Bockhorst -- President And Chief Executive Officer

Yeah.

Nathan Jones -- Stifel Nicolaus -- Analyst

20% would probably be too low and your service levels would suffer at that point. But 27% probably still feels a little bit high as well. If you were operating optimally where would you think that that primary working capital number should be?

Kenneth C. Bockhorst -- President And Chief Executive Officer

Well, first let me tell you why you're right that we would generally have a higher number. So as we believe we pride ourselves on the choice that we offer our customers, we have the full line of mechanical meters and whether that's in brass or polymer, we have the ultrasonic. So we generally are going to carry more inventory to support our customers with choice, so that's one. Two, as we ramp up the Columbias and the Auroras, there are going to be specific times where we're ramping up inventory to handle some of these large integrations where we've not received any revenue yet. So those are a couple of factors that are pretty large on it. I think we can continually improve as a percent of revenue over the next few years, what the endpoint is? I don't know. But I do expect to get better every year.

Robert A. Wrocklage -- Vice President, Chief Financial Officer

Yeah, I would say, rearview mirror, with rearview mirror, we've operated in the high 20%s, sometimes even at 30%. We'll never -- I'll never give you a 22.6% is the ideal level but what we will be committed to is that continuous improvement and just so happens that in the last three quarters, we've been able to move that number down 200 basis points and we're pleased with that progress, but we're going to keep growing to enhance that each year through a little bit of motherhood in apple pie, and then some systematic implementation of SIOP and other things that'll drive impact further.

Nathan Jones -- Stifel Nicolaus -- Analyst

Okay. So maybe inventory is a little bloated at the moment as well based on Columbia and Aurora ramping up and that might last through I guess early next year kind of thing and we should maybe expect to see the inventory roll-down a little bit after those -- run rate?

Kenneth C. Bockhorst -- President And Chief Executive Officer

Focused on all three elements of primary working capital, Nathan. So--

Robert A. Wrocklage -- Vice President, Chief Financial Officer

I'm thrilled with 160% free cash flow conversion year-to-date.

Nathan Jones -- Stifel Nicolaus -- Analyst

No, you know what Wall Street like, we want more.

Kenneth C. Bockhorst -- President And Chief Executive Officer

I just thought I'd remind you of -- just thought I'd come back to remind you that for a while, but no, your points are valid, but I think the thing that you should recognize, as Bob and I and the rest of the team here, we've spent the majority of our career working on maximizing our cash. And so that's one Bob, just talked about new processes and different things, it's something that's in our DNA and we'll continue to work to improve it.

Nathan Jones -- Stifel Nicolaus -- Analyst

Okay, perfect. I'll leave it there. Thanks.

Kenneth C. Bockhorst -- President And Chief Executive Officer

Sure.

Operator

[Operator Instructions] Your next question comes from the line of Tate Sullivan. Your line is open.

Tate Sullivan -- Maxim Group -- Analyst

Thank you for the follow-up. And I think just can you give a little more clarity on the warranty provision in the quarter and I mean just it's outside the U.S., can you talk about what a system integration module is and last, sorry for the list of questions last, when was the last time you took a warranty charge in the U.S., if you can disclose too, please?

Kenneth C. Bockhorst -- President And Chief Executive Officer

Yeah. So first, I would just say that this is definitely an outlier, as Bob mentioned before, it's a part that goes into a system that unfortunately didn't work, we moved on, and we don't expect it to repeat. And in terms of U.S. I mean yeah, I mean we generally don't disclose there's nothing large enough to disclose and I think -- I'm looking at Bob now but--

Robert A. Wrocklage -- Vice President, Chief Financial Officer

Let me just come back to just modify one thing what Ken just said in terms of, we moved out when he says that when we moved on is, we're still supporting our customer, we're going above and beyond to support that customer and make sure we can make right the performance of that system and the communications of that system. So we're doing what's right and we're encouraged by the fact that even with that, our gross margin profile still landed at 38.4% in the quarter, still in the upper half of our normalized range.

But then to your secondary question, of course, just like any other manufacturer, we have warranty provisions, it just tends to be an outlier versus our normal rate of accrual.

Tate Sullivan -- Maxim Group -- Analyst

Is it a unique system to the foreign client and country or?

Robert A. Wrocklage -- Vice President, Chief Financial Officer

Yeah.

Kenneth C. Bockhorst -- President And Chief Executive Officer

Yes, it was a unique system to that foreign client and we've come out with a new product and its behind us.

Tate Sullivan -- Maxim Group -- Analyst

Okay, great. And just on that guided -- I think you've guided before gross profit margin range or I don't want to say guidance because you don't put of about 38% to 40% but your comments I mean without the warranty charge you get back up close to last year's gross profit margin level of 40% and then you have BEACON growing, which I imagine it's higher margin I mean, should we just stay with that 38% to 40% expected?

Kenneth C. Bockhorst -- President And Chief Executive Officer

So what we've talked about openly is a normalized range historically of 36% to 40% with copper, where it's at today and some of the margin enhancement initiatives that we're focused on. We've talked about being able to tighten that historic range, but I continue to reinforce with investors and others that alike that we're still operating in primarily in North American oligopoly and so the expectation that that range or that tight range continues to move to the right, I'll always used, it's not a stairway to heaven, we're still competitively in the marketplace in a four player oligopoly here in North America and while we're rational and we're all good competitors, so to think that we can keep stringing together margin expansion into the 40%, 41%, 42% range is just not realistic over time. So I would keep you laser-focused on the upper end or the upper range of that range, if you will, particularly with where copper is today.

Tate Sullivan -- Maxim Group -- Analyst

Okay. Thank you for that.

Kenneth C. Bockhorst -- President And Chief Executive Officer

Thanks.

Operator

There are no further questions at this time, I turn the call back over to the presenters.

Karen Bauer -- Vice President, Investor Relations, Strategy & Treasurer

Great. Well thank you all for joining our call today. For your planning purposes, our fourth quarter and year-end 2019 call is tentatively scheduled for February 5th. I'll be around all day to take any follow-up questions you may have. Have a great day.

Operator

[Operator Closing Remarks]

Duration: 42 minutes

Call participants:

Karen Bauer -- Vice President, Investor Relations, Strategy & Treasurer

Kenneth C. Bockhorst -- President And Chief Executive Officer

Robert A. Wrocklage -- Vice President, Chief Financial Officer

Nathan Jones -- Stifel Nicolaus -- Analyst

Tate Sullivan -- Maxim Group -- Analyst

Chip Moore -- Canaccord Genuity -- Analyst

Richard Eastman -- Robert W. Baird -- Analyst

Richard Verdi -- Coker & Palmer -- Analyst

Andrew Buscaglia -- Berenberg Capital Markets -- Analyst

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