Behind the Business: 3 Questions for Badger Meter

Shareholders don't just own stocks. We invest in businesses. Every share we buy purchases a stake in a company -- a sliver of a living, breathing enterprise run by a management team that ultimately determines the fate of the money we invest.

That's why The Motley Fool regularly contacts public companies and executives on our community's behalf, asking them the questions that shareholders would find relevant. Because while quantitative measures are important, it's also crucial for investors to assess the less tangible aspects of the businesses they own (or are thinking of owning).

We recently surveyed select companies to gain insights into their business. Today we highlight Badger Meter (NYSE:BMI):

Here are Badger Meter's answers to our email query about the business:

What steps have you taken to navigate your business through the economic turmoil of the past 12 months?
As a result of our core philosophy to manage for the long term, Badger Meter entered the recession in a strong financial position. This has enabled us not only to weather the economic storm, but to continue investing in new product development and expanded sales and marketing initiatives to drive our future growth. At the end of 2008, our debt to total capitalization ratio was under 20%. Our strong cash flow enabled us to increase the dividend for the 16th consecutive year and fund $13 million in capital expenditures for the year. We made further progress in 2009, reducing our debt to total capitalization ratio to under 10% as of September 30, 2009. We renewed our line of credit with our primary bank and increased it from $30 million to $35 million. Cash flow has continued to be strong, funding the 2009 dividend increase and capital expenditures of $6.0 million for the first three quarters of the year.

The economic crisis has affected both of our markets, utility and industrial. Approximately 85% of our business is water meters and automatic meter reading (AMR) and advanced metering infrastructure (AMI) technology sold to municipalities. Since the announcement that stimulus funds will be available for infrastructure projects, many of our customers have delayed purchasing decisions while waiting to see if they will receive federal stimulus dollars for infrastructure improvements. This has slowed our top line. The remaining 15% of our business is a variety of metering technologies for markets including industrial processes, concrete, HVAC, and wastewater. These markets have all been affected by the slowing economy.

While sales are down, we have continued to achieve double-digit increases in earnings, with record earnings from continuing operations in the third quarter of 2009. The decrease in the price of copper, which is used in our meter castings, has helped our margins. We are also benefiting from ongoing cost control measures that generated an 8.2% reduction in SG&A in the third quarter, and a 4.1% reduction for the year-to-date.

In 2007, we completed construction of a new facility in Nogales, Mexico, and moved production from a leased facility in Nogales into the new facility. We also closed and sold a facility that we owned in Rio Rico, Arizona, and moved that molding function into our Nogales facility. Recently, we announced plans to move additional production from Milwaukee to Nogales and to consolidate product management, engineering, marketing, and customer service positions currently at our Tulsa, Oklahoma, facility into our Milwaukee operations. These initiatives will further reduce operating expenses and make us a stronger competitor.

Our solid financial position has enabled us to continue to develop new products, even during these recessionary times. Last year, we introduced a new residential meter housing that uses less copper and should also benefit our margins in the year ahead.

Recently we adapted our highly successful ORION radio-frequency water meter AMR system for the gas meter market. This led to a sizable contract in the third quarter with Duke Energy (NYSE:DUK), which we believe could be the beginning of a new growth market for Badger Meter.

Another factor that has enabled us to weather the economic storm is our strategy to develop metering systems that interface with the leading communications networks in the market. The ORION radio-frequency automatic meter reading system and GALAXY fixed-network meter reading technology are our two proprietary meter reading systems. Our meters equipped with data transmitters also interface with leading meter reading technologies offered by other companies, including mobile, fixed-base, power-line carrier, Wi-Fi and virtually every other available means of sending the signal from the meter to the utility for billing.

This strategy enables us to sell our products to utilities of all types and sizes and regardless of the meter reading system they select. In addition, more than two-thirds of our water meter sales are for replacements of older meters, providing a solid base for our overall sales growth. And frequently during a replacement program, utilities upgrade to some type of AMR/AMI system, which provides additional revenues above and beyond the meter itself.

What are the top two or three metrics to which your business pays the closest attention?
The price of copper is the main metric as it is used in our meter housings. We have begun to sell more plastic meter housings, which provide the same warranty as our traditional meters. We have also designed a new casting that uses less copper to address the rising copper prices.

Another, longer-term metric is the adoption rate for AMR. The American Water Works Association estimates there are approximately 102 million residential buildings in the U.S. Of these, 67% are metered, 13% are not metered (i.e., charge a flat fee) and 20% are on wells. Of the approximately 68 million homes that are metered, less than 30% have been converted to advanced meter reading technologies, an indicator of the growth potential of this market.

In addition, there is the 13% of homes that do not even have meters to begin with. This amounts to an estimated 13 million residences in the U.S. that at some point could be metered -- another potential growth opportunity. Some very large cities are still not metered, such as New York and Chicago. In 2007, Badger Meter won a three-year, $39.8 million contract to provide our ORION AMR units as part of Chicago's first major water metering project.

Now that the first decade of the new century is drawing to a close, we'd like to take a moment to reflect on what lies ahead. What excites you most about your business?
The shortage of fresh water in the U.S. is a driver for our business, as an increasing number of Americans retire and move to warmer, more arid regions of the country, and cities such as Atlanta, which haven't had water problems in the past, begin to experience shortages. History shows that when water usage is measured and consumers are billed for what they use, consumption invariably goes down. We are the U.S. leader in providing AMR technology. In addition to the benefits of our proprietary ORION and GALAXY products, we have the best-in-class AMR package for meters located in pit settings, where our unique sealing process protects the electronics from the harsh environments in the pits. About two-thirds of U.S. residential water meters are located in pit settings.

Along with accurately measuring water usage, utilities also want more data to help them better manage their system and operate it more efficiently. Product features in our metering systems include leak detection and data profiling, which help to save enormous volumes of wasted water and provide information on how much water a customer is using. These two key features also promote water conservation.

Water is our most precious global resource. Oil can be replaced with ethanol, gas, electricity, and other forms of power, but there is no replacement for fresh, clean water. As more and more people recognize there is a finite amount of water in the world and that we must conserve and preserve it, the opportunities for Badger Meter will continue to grow. We believe we are well-positioned to capture an even larger market share than we currently have because of the quality of our products, our service, and our adaptability to the unique needs of municipalities.

Badger Meter is rated four stars (out of a possible five) by our Motley Fool CAPS community. Do agree with our community's bullish assessment? Click here to rate the stock and cast your opinion.