UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

 

Form 10-K

 

Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

for the fiscal year ended December 31, 2007

 

BADGER METER, INC.

 

4545 W. Brown Deer Road

Milwaukee, Wisconsin 53223

(414) 355-0400

A Wisconsin Corporation

IRS Employer Identification No. 39-0143280

Commission File No. 1-6706

 

 

The Company has the following classes of securities registered pursuant to Section 12(b) of the Act:

 

 

The Company does not have any securities registered pursuant to Section 12(g) of the Act.

 

Indicate by check mark if the Company is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes o     No þ

 

Indicate by check mark if the Company is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act.  Yes o     No þ

 

Indicate by check mark whether the Company (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Company was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes þ     No o

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  þ

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer,” “non-accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o     No þ

 

The aggregate market value of the Common Stock held by non-affiliates of the Company as of June 29, 2007 was $381,497,933. For purposes of this calculation only, (i) shares of Common Stock are deemed to have a market value of $28.26 per share, the closing price of the Common Stock as reported on the American Stock Exchange on June 29, 2007, and (ii) each of the executive officers and directors is deemed to be an affiliate of the Company.

 

As of February 11, 2008, there were 14,516,799 shares of Common Stock outstanding with a par value of $1 per share.

 

Portions of the Company’s Proxy Statement for the 2008 Annual Meeting of Shareholders, which will be filed with the Securities and Exchange Commission under Regulation 14A within 120 days after the end of the registrant’s fiscal year, are incorporated by reference from the definitive Proxy Statement into Part III.

 

 

Special Note Regarding Forward Looking Statements

 

Certain statements contained in this Form 10-K, as well as other information provided from time to time by the Company or its employees, may contain forward looking statements that involve risks and uncertainties that could cause actual results to differ materially from those in the forward looking statements. The words “anticipate,” “believe,” “estimate,” “expect,” “think,” “should” and “objective” or similar expressions are intended to identify forward looking statements. All such forward looking statements are based on the Company’s then current views and assumptions and involve risks and uncertainties that include, among other things:

 

 

All of these factors are beyond the Company’s control to varying degrees. Shareholders, potential investors and other readers are urged to consider these factors carefully in evaluating the forward looking statements and are cautioned not to place undue reliance on such forward looking statements. The forward looking statements made in this document are made only as of the date of this document and the Company assumes no obligation, and disclaims any obligation, to update any such forward looking statements to reflect subsequent events or circumstances.

PART I

 

 

Badger Meter (“the Company”) is a leading manufacturer and marketer of products incorporating liquid flow measurement and control technologies serving markets worldwide. The Company was incorporated in 1905.

 

Available Information

 

The Company’s Internet address is http://www.badgermeter.com. The Company makes available free of charge (other than an investor’s own Internet access charges) through its Internet website its Annual Report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports, on the same day they are electronically filed with, or furnished to, the Securities and Exchange Commission. The Company is not including the information contained on or available through its website as a part of, or incorporating such information by reference into, this Annual Report on Form 10-K.

 

Markets and Products

 

The Company is a leading manufacturer and marketer of products incorporating liquid flow measurement and control technologies, developed both internally and in conjunction with other technology companies. Its products are used to measure and control the flow of liquids in a wide variety of applications. The Company’s product lines fall into two general categories, utility and industrial flow measurement. The utility category is comprised of two primary product lines — residential and commercial water meters that are used by water utilities as the basis for generating water and wastewater revenues. The market for these product lines is North America, primarily the United States, because these meters are designed and manufactured to conform to standards promulgated by the American Water Works Association. The utility flow measurement products constitute a majority of the Company’s sales.

 

Industrial product line sales comprise the remainder of the Company’s sales and include precision valves, electromagnetic inductive flow meters, impeller flow meters, and turbine and positive displacement industrial flow meters. Rounding out the industrial product line are automotive fluid meters for the measurement of various types of automotive fluids.

 

Residential and commercial water meters have generally been classified as either manually read meters or remotely read meters via radio technology. A meter that is manually read consists of the water meter and a register displaying the meter reading. Meters equipped with radio technology convert the mechanical measurement to a digital format which is then transmitted via radio frequency to a receiver that collects and formats the data appropriately for the utility’s billing computer. Drive-by systems are referred to as automatic meter reading (AMR) systems and have been the primary AMR technology deployed by water utilities over the past decade, providing cost effective and accurate billing data. In a drive-by AMR system, a vehicle equipped for meter reading purposes collects meter reading data.

 

Of growing interest to water utilities are fixed network advanced metering infrastructure (AMI) systems. These systems do not rely on a drive-by data collector, but rather incorporate a network of data collectors that are always active or listening to the radio transmission from the utility’s meters. Not only do fixed network systems eliminate the need for meter readers, but they have the ability to provide the utility with more frequent and diverse data at specified intervals.

 

The Company’s net sales and corresponding net earnings depend on unit volume and mix of products, with the Company generally earning higher margins on meters equipped with AMR or AMI technology. In addition to selling its proprietary AMR/AMI products including the Orion^® drive-by AMR technology and the Galaxy^® fixed network AMI system, the Company also remarkets the Itron^® drive-by AMR product under a license and distribution agreement. The Company’s proprietary AMR/AMI products generally result in higher margins than the non-proprietary AMR/AMI products that the Company remarkets.

 

One distinctive advantage of the Orion^® AMR technology is that while it is fundamentally a drive-by AMR system, the proprietary receiver technology of Orion^® has been licensed to other technology providers, including

those providing AMR/AMI products that communicate over power lines, broadband networks, municipal WiFi and proprietary radio frequency networks.

 

Utility meter and AMR/AMI product sales are generally derived from the water meter replacement requirements of customers, along with their plans for adoption and deployment of new technology. To a much lesser extent, housing starts also contribute to the base of new product sales. Over the last decade there has been a growing trend in the conversion to AMR/AMI from manually read water meters. This conversion rate is accelerating and contributing to an increased base of business available to meter and AMR/AMI producers. It is currently estimated that approximately 25-30% of water meters installed in the United States have been converted to AMR/AMI systems. Badger Meter’s strategy is to solve customers’ metering needs with its proprietary meter reading systems or other systems available through its alliance partners in the marketplace.

 

The industrial products generally serve a variety of niche flow measurement applications across a broad range of industries. Some of the flow measurement technologies now used industrially, such as positive displacement and turbine flow measurement, have been derived from utility meter technologies. Other technologies are very specific to industrial applications. In addition, a growing requirement is for industrial meters to be equipped with specialized communication protocols that control the entire flow measurement process. Serving both the utility and industrial flow measurement market enables the Company to use its wide variety of technology for specific flow measurement and control applications, as well as to utilize existing capacity and spread fixed costs over a larger sales base.

 

The Company’s products are primarily manufactured and assembled in the Company’s Milwaukee, Wisconsin; Tulsa, Oklahoma; Nogales, Mexico; and Brno, Czech Republic facilities. Products are also assembled in the Company’s Stuttgart, Germany facility.

 

The Company’s products are sold throughout the world through various distribution channels including direct sales representatives, distributors and independent sales representatives. There is a moderate seasonal impact on sales, primarily relating to higher sales of certain utility products during the spring and summer months. No single customer accounts for more than 10% of the Company’s sales.

 

Competition

 

There are competitors in each of the markets in which the Company sells its products, and the competition varies from moderate to intense. Major competitors for utility water meters include Sensus Metering Systems, Inc., Neptune Technologies and Elster Water Meter. The Company’s primary competitors for water utility AMR and AMI products are Itron, Inc., Neptune Technologies and Sensus Metering Systems, Inc. While the Company sells its own proprietary AMR/AMI systems (Orion^® and Galaxy^®), it is also a reseller of the Itron products. A number of the Company’s competitors in certain markets have greater financial resources than the Company. However, the Company believes it currently provides the leading technology in water meters and AMR/AMI systems for water utilities. As a result of significant research and development activities, the Company enjoys favorable patent positions for several of its products.

 

Backlog

 

The dollar amounts of the Company’s total backlog of unshipped orders at December 31, 2007 and 2006 were $38.7 million and $25.1 million, respectively. The backlog is comprised of firm orders and signed contractual commitments, or portions of such commitments, that call for shipment within 12 months. Backlog can be significantly affected by the timing of orders for large utility projects.

 

Raw Materials

 

Raw materials used in the manufacture of the Company’s products include metal or alloys (such as bronze, which uses copper as its main component, aluminum, stainless steel, cast iron, brass and stellite), plastic resins, glass, microprocessors and other electronic subassemblies and components. There are multiple sources for these raw materials, but the Company purchases most bronze castings and certain electronic subassemblies from single suppliers. The Company believes these items would be available from other sources, but that the loss of its current suppliers would result in higher cost of materials, delivery delays, short-term increases in inventory and higher

quality control costs in the short term. The Company carries business interruption insurance on key suppliers. World commodity markets may also affect prices.

 

Research and Development

 

Expenditures for research and development activities relating to the development of new products, improvement of existing products and manufacturing process improvements were $5.7 million in 2007 compared to $5.5 million in 2006 and $5.3 million during 2005. Research and development activities are primarily sponsored by the Company. The Company also engages in some joint research and development with other companies.

 

Intangible Assets

 

The Company owns or controls many patents, trademarks, trade names and license agreements in the United States and other countries that relate to its products and technologies. No single patent, trademark, trade name or license is material to the Company’s business as a whole.

 

Environmental Protection

 

The Company is subject to contingencies related to environmental laws and regulations. Currently, the Company is in the process of resolving matters relative to two landfill sites where it has been named as one of many potentially responsible parties. These sites are impacted by the Federal Comprehensive Environmental Response, Compensation and Liability Act and other environmental laws and regulations. At this time, the Company does not believe the ultimate resolution of these issues will have a material adverse effect on the Company’s financial position or results of operations, either from a cash flow perspective or on the financial statements as a whole. This belief is based on the Company’s assessment of its limited past involvement with these sites as well as the substantial involvement of other named third parties in these matters. However, due to the inherent uncertainties of such proceedings, the Company cannot predict the ultimate outcome of these matters. A future change in circumstances with respect to these specific matters or with respect to sites formerly or currently owned or operated by the Company, or with respect to off-site disposal locations used by the Company, could result in future costs to the Company and such amounts could be material. Expenditures during 2007, 2006 and 2005 for compliance with environmental control provisions and regulations were not material.

 

Employees

 

The Company and its subsidiaries employed 1,132 persons at December 31, 2007, 218 of whom are covered by a collective bargaining agreement with District 10 of the International Association of Machinists. The Company is currently operating under a four-year contract with the union, which expires October 31, 2008. The Company believes it has good relations with the union and all of its employees.

 

Foreign Operations and Export Sales

 

The Company has distributors and sales representatives throughout the world. Additionally, the Company has a sales, assembly and distribution facility near Stuttgart, Germany; sales and customer service offices in Mexico, Singapore and Slovakia; a manufacturing facility in Nogales, Mexico; and a manufacturing and sales facility in Brno, Czech Republic. The Company exports products from the United States that are manufactured in Milwaukee, Wisconsin and Tulsa, Oklahoma.

 

Information about the Company’s foreign operations and export sales is included in Note 10 “Industry Segment and Geographic Areas” in the Notes to Consolidated Financial Statements in Part II, Item 8 of this 2007 Annual Report on Form 10-K.

 

Financial Information about Industry Segments

 

The Company operates in one industry segment as a manufacturer and marketer of products incorporating liquid flow measurement and control technologies as described in Note 10 “Industry Segment and Geographic

Areas” in the Notes to Consolidated Financial Statements in Part II, Item 8 of this 2007 Annual Report on Form 10-K.

 

 

Shareholders, potential investors and other readers are urged to consider the significant business risks described below in addition to the other information set forth or incorporated by reference in this 2007 Annual Report on Form 10-K. If any of the events contemplated by the following risks actually occur, our financial condition or results of operations could be materially adversely affected. The following list of risk factors may not be exhaustive. We operate in a continually changing business, economic and geopolitical environment, and new risk factors may emerge from time to time. We can neither predict these new risk factors nor assess the impact, if any, on the business, or the extent to which any factor, or combination of factors, may cause the actual results of operations to differ materially.

 

Competitive pressures in the marketplace could decrease revenues and profits:

 

Competitive pressures in the marketplace for our products could adversely affect our competitive position, leading to a possible loss of market share or a decrease in prices, either of which could result in decreased revenues and profits. We operate in an environment where competition varies from moderate to intense and a number of our competitors have greater financial resources. Our competitors also include alliance partners that sell products that do or may compete with our products, particularly those that provide AMR or AMI connectivity solutions. The principal elements of competition for our most significant product lines, residential and commercial water meters for the utility market (with various AMR/AMI technology systems), are price, product technology, quality and service. The competitive environment is also affected by the movement toward AMR or AMI technologies away from manually read meters, the demand for replacement units and, to a lesser extent, the number of housing starts in the United States. For our industrial products, the competitive environment is affected by the general economic health of the industrial sectors in the United States and Europe.

 

Technological developments could harm future success:

 

We believe that our future success depends, in part, on our ability to develop technologically advanced products that meet or exceed appropriate industry standards. Although we believe that we currently have such advantages over our competitors, maintaining such advantages will require continued investment in research and development, sales and marketing. There can be no assurance that we will have sufficient resources to make such investments or that we will be able to make the technological advances necessary to maintain such competitive advantages. We are not currently aware of any emerging standards or new products that could render our existing products obsolete.

 

The inability to obtain adequate supplies of raw materials could decrease profit margins and negatively impact timely delivery to customers:

 

We are affected by the availability and prices for raw materials, including metal or alloys (such as bronze, which uses copper as its main component, aluminum, stainless steel, cast iron, brass and stellite), plastic resins, glass, microprocessors and other electronic subassemblies and components that are used in the manufacturing process. The inability to obtain adequate supplies of raw materials for our products at favorable prices could have a material adverse effect on our business, financial condition or results of operations by decreasing profit margins and by negatively impacting timely deliveries to customers. In the past, we have been able to offset increases in raw materials by increased sales prices, active materials management, product engineering programs and the diversity of materials used in the production processes. However, we cannot be certain that we will be able to accomplish this in the future. Since we do not control the actual production of these raw materials, there may be delays caused by interruption in the production of raw materials for reasons that are beyond our control. World commodity markets and inflation may also affect raw material prices.

A significant economic downturn could cause a material adverse impact on sales and operating results:

 

As a supplier of products primarily to water utilities, we may be adversely affected by general economic downturns that affect independent distributors, large city utilities, private water companies and numerous smaller municipal water utilities. These customers may delay capital projects, including non-critical maintenance and upgrades, during economic downturns or instability in world markets. While we also serve several industrial markets to avoid a dependency on any one market, a significant downturn in these markets could also cause a material adverse impact on sales and operating results. Therefore, any significant downturn in general economic conditions, as well as in our customers’ markets, could result in a reduction in demand for our products and services and could harm the business.

 

Failure to manufacture quality products could impact the ability to attract and retain customers, which could have a material adverse effect on our business:

 

If we fail to maintain and enforce quality control and testing procedures, our products will not meet the performance standards in the industry. Product quality and performance are a priority for us since our products are used in various industries where precise control of fluids is essential, and we believe we have a very good reputation for product quality. Substandard products would seriously harm our reputation, resulting in both a loss of current customers to competitors and damage to our ability to attract new customers. In addition, if any of our products proves to be defective, we may be required to participate in a recall involving such products. A successful claim brought against us with respect to a defective product in excess of available insurance coverage, if any, or a requirement to participate in a major product recall, could have a material adverse effect on our business, results of operations or financial condition.

 

Litigation against us could be costly, time consuming to defend and could adversely affect profitability:

 

From time to time, we are subject to legal proceedings and claims that arise in the ordinary course of business. We may also be subject to workers’ compensation claims, employment disputes, unfair labor practice charges, customer and supplier disputes, product liability claims and contractual disputes related to warranties arising out of the conduct of our business. Litigation may result in substantial costs and may divert management’s attention and resources, which could adversely affect our profitability or financial condition.

 

Changes in environmental or regulatory requirements could entail additional expenses that could decrease profitability:

 

We cannot predict the nature, scope or effect of future environmental or regulatory requirements to which our operations might be subject or the manner in which existing or future laws will be administered or interpreted. Compliance with such laws or regulations may entail additional expenses that could decrease profitability. We are subject to a variety of environmental laws, such as lead content in certain meters incorporating brass housings, and regulatory laws affecting the use and/or licensing of radio frequencies necessary for AMR/AMI products, as well as regulations related to customs and trade practices. Currently, the cost of complying with existing laws does not have a material effect on the business or financial position.

 

Risks related to foreign markets could decrease profitability:

 

Since we sell products worldwide as well as manufacture products in several countries, we are subject to risks associated with doing business internationally. These risks include changes in foreign currency exchange rates, changes in a specific country’s or region’s political or economic conditions, potentially negative consequences from changes in tax laws or regulatory requirements, differing labor regulations, and the difficulty of managing widespread operations.

 

Operational dependence on attracting and retaining skilled employees could negatively impact growth and decrease profitability:

 

The Company’s success depends on its continuing ability to identify, attract, develop and retain skilled personnel throughout the organization. Current and future compensation arrangements, including benefits, may not

be successful in attracting new employees or retaining existing employees, which may hinder the Company’s growth. In addition, the Company estimates liabilities and expenses for pensions and other postretirement benefits that require the use of assumptions relating to the rates used to discount the future estimated liability, rate of return on any assets and various assumptions related to the age and cost of the workforce. Actual results may differ from the estimates and have a material adverse effect on future results of operations or on the financial statements as a whole. Rising healthcare and retirement benefit costs in the United States may also add to the Company’s cost pressures and decrease profitability.

 

Risks to the Company’s reputation could adversely affect success:

 

The Company has a history of good corporate governance, including procedures and processes that existed prior to the enactment of the Sarbanes-Oxley Act of 2002, as well as related rules and regulations, board committee charters, and a Code of Business Conduct that defines how employees interact with various Company stakeholders and addresses issues such as confidentiality, conflict of interest and fair dealing. Failure to maintain this reputation could have a material adverse effect on the Company’s business and results of operations.

 

Failure to successfully integrate acquired businesses or products in the future could adversely affect the operations:

 

As part of our business strategy, we will continue to evaluate and may pursue selected business or product acquisition opportunities that we believe may provide us with certain operating and financial benefits. If we complete any such acquisitions, they may require integration into our existing business with respect to administrative, financial, sales and marketing, manufacturing and other functions to realize these anticipated benefits. If we are unable to successfully integrate a business or product acquisition, we may not realize the benefits identified in our due diligence process, and our financial results may be negatively impacted. Additionally, significant unexpected liabilities may arise after completion of an acquisition.

 

 

None.

 

 

The principal facilities utilized by the Company at December 31, 2007 are listed below. Except as indicated, the Company owns all such facilities in fee simple. The Company believes that its facilities are generally well maintained and have sufficient capacity for its current needs.

 

 

 

 

In 2005, the Company purchased land and an existing building in Neuffen, Germany, and subsequently constructed an addition that was completed in 2007. In June 2007, the Company vacated a leased facility to occupy this new facility. In addition, the Company purchased land in Nogales, Mexico in 2005 where a 41,300 square foot building was constructed in 2006. This new facility replaced the Company’s Rio Rico, Arizona facility, which was listed for sale at the end of 2007. In 2007, construction of a second facility with 120,000 square feet began on the

purchased land in Nogales, Mexico. This new facility will replace the Nogales, Mexico leased facility and the Company expects to occupy this new facility in 2008.

 

 

In the normal course of business, the Company is named in legal proceedings from time to time. There are currently no material legal proceedings pending with respect to the Company. The more significant legal proceedings are discussed below.

 

Like other companies in recent years, the Company has been named as a defendant in numerous multi-claimant/multi-defendant lawsuits alleging personal injury as a result of exposure to asbestos, manufactured by third parties, and integrated into a very limited number of the Company’s industrial products. The Company is vigorously defending itself against these claims. Although it is not possible to predict the ultimate outcome of these matters, the Company does not believe the ultimate resolution of these issues will have a material adverse effect on the Company’s financial position or results of operations, either from a cash flow perspective or on the financial statements as a whole. This belief is based in part on the fact that no claimant has demonstrated exposure to products manufactured or sold by the Company and a number of cases have been voluntarily dismissed.

 

The Company is subject to contingencies relative to the protection of the environment. Information about the Company’s compliance with environmental regulations is included in Part I, Item 1 of this 2007 Annual Report on Form 10-K under the heading “Environmental Protection.”

 

 

No matters were submitted to a vote of the Company’s shareholders during the quarter ended December 31, 2007.

 

Executive Officers of the Company

 

The following table sets forth certain information regarding the executive officers of the Company.

 

 

There are no family relationships between any of the executive officers. All of the officers are elected annually at the first meeting of the Board of Directors held after each annual meeting of the shareholders. Each officer holds office until his successor has been elected or until his death, resignation or removal. There is no arrangement or understanding between any executive officer and any other person pursuant to which he or she was elected as an officer.

 

Mr. Meeusen was elected Chairman, President and Chief Executive Officer in April 2004. From April 2002 to April 2004, Mr. Meeusen served as President and Chief Executive Officer.

 

Mr. Dix was elected Senior Vice President — Administration in February 2006, and served as Senior Vice President — Administration and Secretary from February 2005 to February 2006. Mr. Dix served as Senior Vice

President — Administration/Human Resources from May 2003 to February 2005 and Secretary from August 2003 to February 2005. Mr. Dix served as Vice President — Administration and Human Resources from November 2001 to May 2003.

 

Mr. Johnson was elected Senior Vice President — Finance, Chief Financial Officer and Treasurer in May 2003. Mr. Johnson served as Vice President — Finance, Chief Financial Officer and Treasurer from February 2001 to May 2003.

 

Mr. Bergum was elected Vice President — General Counsel and Secretary in February 2006, and served as General Counsel from September 2003 to February 2006. Prior to joining the Company, Mr. Bergum served as Corporate Counsel at Onyx Waste Services, Inc. from March 2003 to September 2003, and as Vice President and Assistant General Counsel at Fortis Insurance Company prior to March 2003.

 

Mr. Gomez was elected Vice President — Engineering in February 2008. Mr. Gomez served as Director of Engineering from July 2007 to February 2008 and served as Manager — Mechanical Engineering from January 2006 to July 2007. Prior to January 2006, Mr. Gomez served as Manager — Research and Development.

 

Mr. Gras has served as Vice President — International Operations for more than five years.

 

Mr. Serdynski was elected Vice President — Manufacturing in February 2008. Mr. Serdynski served as Director of Manufacturing Operations from April 2005 to February 2008 and served as Director of Manufacturing — Milwaukee from February 2004 to April 2005. Prior to February 2004, Mr. Serdynski served as General Plant Manager — Residential.

 

Ms. Smiley has served as Vice President — Controller for more than five years.

 

Mr. Webb was elected Vice President — Sales and Marketing in February 2008. Mr. Webb served as Vice President — Sales, Marketing and Engineering from August 2005 to February 2008 and served as Vice President — Engineering from November 2001 to August 2005.

 

Mr. Zandron has served as Vice President — Business Development for more than five years.

PART II

 

 

Information required by this Item is set forth in Note 11 “Unaudited: Quarterly Results of Operations, Common Stock Price and Dividends” in the Notes to Consolidated Financial Statements in Part II, Item 8 of this 2007 Annual Report on Form 10-K.

 

The following information in Item 5 of this Annual Report on Form 10-K is not deemed to be “soliciting material” or to be “filed” with the SEC or subject to Regulation 14A or 14C under the Securities Exchange Act of 1934 or to the liabilities of Section 18 of the Securities Exchange Act of 1934, and will not be deemed to be incorporated by reference into any filing under the Securities Act of 1933 or the Securities Exchange Act of 1934, except to the extent we specifically incorporate it by reference into such a filing.

 

The following graph compares on a cumulative basis the yearly percentage change since January 1, 2003 in (a) the total shareholder return on the Common Stock with (b) the total return on the American Stock Exchange Corporate Index and (c) the total return of a peer group made up of 11 companies in similar industries and with similar market capitalization as selected by an independent consulting firm. The graph assumes $100 invested on December 31, 2002. It further assumes the reinvestment of dividends. The returns of each component company in the peer group have also been weighted based on such company’s relative market capitalization.

 

Comparison of Five-Year Cumulative Total Return of Company,
Peer Group and Broad Market

 

 

 

 

BADGER METER, INC.

 

Ten Year Summary of Selected Consolidated Financial Data

 

 

 

 

 

Book value equals total shareholders’ equity at year-end divided by the number of common shares outstanding.

 

Working capital equals total current assets less total current liabilities.

 

Current ratio equals total current assets divided by total current liabilities.

 

Debt as a percent of total debt and equity equals total debt (the sum of short-term debt, current portion of long-term debt and long-term debt) divided by the sum of total debt and total shareholders’ equity at year-end. The debt of the discontinued French operations is included in this calculation for 2002 through 2007, the years of ownership, although there was no debt at the end of 2007 related to the French operations.

 

Return on shareholders’ equity equals earnings from continuing operations divided by total shareholders’ equity at year-end.

 

Price/earnings ratio equals the closing stock price for common stock divided by diluted earnings per share from continuing operations.

 

 

BUSINESS DESCRIPTION AND OVERVIEW

 

The Company is a leading manufacturer and marketer of products incorporating liquid flow measurement and control technologies, developed both internally and in conjunction with other technology companies. Its products are used to measure and control the flow of liquids in a wide variety of applications. The Company’s product lines fall into two general categories, utility and industrial flow measurement. The utility category is comprised of two primary product lines — residential and commercial water meters that are used by water utilities as the basis for generating water and wastewater revenues. The market for these product lines is North America, primarily the United States, because these meters are designed and manufactured to conform to standards promulgated by the American Water Works Association. The utility flow measurement products constitute a majority of the Company’s sales.

 

Industrial product line sales comprise the remainder of the Company’s sales and include precision valves, electromagnetic inductive flow meters, impeller flow meters, and turbine and positive displacement industrial flow meters. Rounding out the industrial product line are automotive fluid meters for the measurement of various types of automotive fluids.

 

Residential and commercial water meters have generally been classified as either manual read meters or remotely read meters via radio technology. A meter that is manually read consists of the water meter and a register displaying the meter reading. Meters equipped with radio technology convert the mechanical measurement to a digital format which is then transmitted via radio frequency to a receiver that collects and formats the data appropriately for the utility’s billing computer. Drive-by systems are referred to as automatic meter reading (AMR) systems and have been the primary AMR technology deployed by water utilities over the past decade, providing cost effective and accurate billing data. In a drive-by AMR system, a vehicle equipped for meter reading purposes collects meter reading data.

 

Of growing interest to water utilities are fixed network advanced metering infrastructure (AMI) systems. These systems do not rely on a drive-by data collector, but rather incorporate a network of data collectors that are always active or listening to the radio transmission from the utility’s meters. Not only do fixed network systems eliminate the need for meter readers, but they have the ability to provide the utility with more frequent and diverse data at specified intervals. The Company’s response to these market requirements will be detailed further in the Business Trends section.

 

The Company’s net sales and corresponding net earnings depend on unit volume and mix of products, with the Company generally earning higher margins on meters equipped with AMR or AMI technology. In addition to selling its proprietary AMR/AMI products including the Orion^® drive-by AMR technology and the Galaxy^® fixed network AMI system, the Company also remarkets the Itron^® drive-by AMR product under a license and

distribution agreement. The Company’s proprietary AMR/AMI products generally result in higher margins than the non-proprietary AMR/AMI products that the Company remarkets.

 

One distinctive advantage of the Orion^® AMR technology is that while it is fundamentally a drive-by AMR system, the proprietary receiver technology of Orion^® has been licensed to other technology providers, including those providing AMR/AMI products that communicate over power lines, broadband networks, municipal WiFi and proprietary radio frequency networks.

 

Utility meter and AMR/AMI product sales are generally derived from the water meter replacement requirements of customers, along with their plans for adoption and deployment of new technology. To a much lesser extent, housing starts also contribute to the base of new product sales. Over the last decade there has been a growing trend in the conversion to AMR/AMI from manually read water meters. This conversion rate is accelerating and contributing to an increased base of business available to meter and AMR/AMI producers. It is currently estimated that approximately 25-30% of water meters installed in the United States have been converted to AMR/AMI systems. Badger Meter’s strategy is to solve customers’ metering needs with its proprietary meter reading systems or other systems available through its alliance partners in the marketplace.

 

The industrial products generally serve a variety of niche flow measurement applications across a broad range of industries. Some of the flow measurement technologies, such as positive displacement and turbine flow measurement, now used industrially have been derived from utility meter technologies. Other technologies are very specific to industrial applications. In addition, a growing requirement is for industrial meters to be equipped with specialized communication protocols that control the entire flow measurement process. Serving both the utility and industrial flow measurement market enables the Company to use its wide variety of technology for specific flow measurement and control applications, as well as to utilize existing capacity and spread fixed costs over a larger sales base.

 

Business Trends

 

AMI is the growing standard of technology deployment in the electric industry. AMI provides an electric utility with two-way communication to monitor and control electrical devices at the customer’s site. AMI deployments are always fixed network technologies. Although the Company does not participate in the electric market, the trend toward AMI is now affecting the water and gas utility AMR market as well. Specifically, in the water industry, fixed network AMI enables the water utility to capture interval readings from each meter on a daily basis. While two-way communication is extremely limited in water fixed network AMI, utilities are contemplating how two-way networks could benefit them. As noted above, the Company markets the Orion^® drive-by AMR product line as well as the Galaxy^® fixed network AMI product line. The Company is positioned to sell either product as this trend continues. Since both products have comparable margins, any acceleration or slowdown in this trend is not expected to have a significant impact on the Company.

 

Although there is growing interest in fixed network communication by water utilities, the vast majority of utilities currently installing AMR/AMI are selecting drive-by AMR technologies for their applications. The Company’s Orion^® technology has experienced rapid acceptance in the United States. By the end of 2007, more than 1,000 water utilities had selected Orion^® as their AMR solution of choice. There are approximately 53,000 water utilities in the United States and the Company estimates that less than 30% of them have converted to an AMR technology. It is anticipated that even with growing interest in fixed network AMI, drive-by AMR will continue to be the primary product of choice by water utilities for a number of years. Drive-by AMR technology is simply the lowest cost form of AMR currently available to water utilities.

 

Prior to the Company’s introduction of its own proprietary Orion^® products, Itron^® water utility-related products were a significant contributor to the Company’s results. Itron^® products are sold under an agreement between the Company and Itron, Inc. that expires in early 2009 and the Company is currently discussing with Itron an extension of the agreement. The Company’s Orion^® products directly compete with Itron^® water AMR products and, in recent years, many of the Company’s customers have selected Orion^® products. In 2007, Orion^® sales increased 24.8% while Itron^® licensed product sales decreased 21.7% compared to 2006. The Company expects this trend to continue, although it also believes that Itron^® licensed products will remain a significant component of utility sales. To date, decreases in sales of Itron^® licensed products have been offset by increases in sales of Orion^®

products, which produce a higher gross margin than Itron^® licensed products. As a result, the Company does not expect this trend to have a material negative impact on the Company’s financial position or results of operations.

 

During 2006, the Company carefully evaluated strategic alternatives for its subsidiaries in Nancy, France, including restructuring, sale or shutdown. In the third quarter of 2006, the Company began the process under French law to obtain the requisite governmental and regulatory approvals to close the operation. On October 16, 2006, the decision was finalized. From that date through 2007, all assets and liabilities were liquidated resulting in total after tax charges of $7.3 million, of which $5.4 million of charges, net of the income tax benefit, were recognized in 2006. All results associated with the Company’s French operations have been removed from continuing operations and are presented as results of discontinued operations. See Note 3 “Discontinued Operations” in the Notes to Consolidated Financial Statements in Part II, Item 8 of this 2007 Annual Report on Form 10-K. All remaining comments in this section relate to continuing operations.

 

RESULTS OF OPERATIONS

 

Net Sales

 

Badger Meter’s net sales of $234.8 million increased $5.1 million, or 2.2%, for 2007 compared to 2006. The increase was the result of sales increases in industrial products, while utility sales were approximately the same between years, as further explained below.

 

Residential and commercial water meter net sales represented 79.2% of total net sales in 2007 compared with 80.9% in 2006. These sales of $185.9 million increased just $20,000 in 2007 compared to 2006. Overall volume declines in bronze manual read meters, meters with Itron^® licensed technology and commercial meters were offset by volume increases in plastic meters and in meters with the Company’s Orion^® AMR technology. In 2007, sales of Orion^® products increased nearly 25%, due mostly to volume increases. By contrast, sales of Itron^® related products declined nearly 22% due to lower volumes.

 

Industrial sales are affected by economic conditions, domestically and internationally, in each of the markets served by the various product lines. Industrial product net sales increased 11.5% in 2007 over 2006 levels. In total, the sales of industrial products represented 20.8% of total net sales in 2007 compared to 19.1% in 2006. Industrial product net sales increased $5.0 million to $48.9 million in 2007 compared with $43.9 million in 2006 driven primarily by higher sales of automotive fluid products, precision valves and other industrial products.

 

International sales are comprised primarily of sales of small valves, electromagnetic meters and automotive fluid meters in Europe, sales of electromagnetic meters with water meters and related technologies in Latin America, and sales of valves and other metering products throughout the world. In Europe, sales are made primarily in euros. Other international sales are made in U.S. dollars or local currencies. International sales increased 28.8% to $27.3 million in 2007 from $21.2 million in 2006 due principally to higher sales of industrial products in Europe. Foreign exchange effects also contributed to the sales increase, notably the strengthening of the euro against the U.S. dollar.

 

Badger Meter’s net sales of $229.8 million increased $26.1 million, or 12.8%, for 2006 compared to 2005. The increase was the net result of sales increases in most of the Company’s product lines driven primarily by increased volumes of product sold.

 

Residential and commercial water meter net sales represented 80.9% of total net sales in 2006 compared with 79.9% in 2005. These sales increased $23.2 million, or 14.3%, in 2006 to $185.9 million from $162.7 million in 2005. Unit volume increased in residential and commercial manual read water meters as well as meters utilizing AMR technologies. AMR technologies carry a higher price, which also contributed to the increase in net sales. In addition, net sales increased in part due to a significant increase over 2005 levels for the sales volumes of Orion^®, the Company’s proprietary AMR system, which has higher margins than other AMR products.

 

Industrial product net sales increased 7.1% in 2006 over 2005 levels. In total, the industrial products represented 19.1% of total net sales in 2006 compared to 20.1% in 2005. Industrial product net sales increased $2.9 million, or 7.1% to $43.9 million in 2006 compared with $41.0 million in 2005 driven primarily by higher sales of automotive fluid and electromagnetic meters.

International sales increased 14.0% to $21.2 million in 2006 from $18.6 million in 2005 due principally to higher sales of industrial products in Europe.

 

Gross Margins

 

Gross margins were 34.7%, 33.4% and 36.1% for 2007, 2006 and 2005, respectively. Gross margins increased between 2007 and 2006 as a result of increases in AMR volumes driven by sales of Orion^® products as well as price increases put into effect to recover higher cost of materials, particularly copper, the main component of the brass housings used to make meters. Gross margins decreased between 2006 and 2005 due to higher cost of materials, particularly copper. This was mitigated somewhat by the higher mix of AMR versus manual read meters, a higher percentage of Orion^® AMR technology versus other non-proprietary AMR products, and price increases initiated in mid-2006 and continuing through 2007.

 

Operating Expenses

 

Selling, engineering and administration costs increased 6.1% in 2007 compared to 2006 and were the net result of higher legal fees associated with successfully completed litigation, increased reserves for uncollectible receivables, increased product development costs and normal inflationary pressures offset by continued cost controls. Selling, engineering and administration costs increased 3.4% in 2006 over 2005 levels due to normal inflationary increases and increased costs associated with higher sales.

 

Interest Expense

 

Interest expense was approximately the same between 2007 and 2006. Interest expense was approximately $0.2 million less in 2006 than in 2005 due primarily to lower overall debt balances.

 

Income Taxes

 

Income taxes as a percentage of earnings from continuing operations before income taxes were 37.3%, 39.7% and 37.0% for 2007, 2006 and 2005, respectively. The decrease in the effective tax rate between 2007 and 2006 was due to an increase in the Federal income tax deduction available to manufacturers for qualified production activities (Section 199 Deduction) and the settlement of certain state tax audits. The increase in the effective tax rate between 2006 and 2005 resulted from the Company’s inability to claim the Section 199 Deduction due to the tax positions taken related to the Company’s French operations.

 

Earnings and Earnings Per Share from Continuing Operations

 

As a result of the above-mentioned items, earnings from continuing operations were $18.4 million, $16.6 million and $16.2 million in 2007, 2006 and 2005, respectively. On a diluted basis, earnings per share from continuing operations were $1.26, $1.15 and $1.15, respectively, for the same periods.

 

LIQUIDITY AND CAPITAL RESOURCES

 

The main sources of liquidity for the Company are cash from operations and borrowing capacity. Cash provided by operations in 2007 was $28.3 million versus $16.8 million in 2006. The increase in cash provided by operations between years was due principally to improved earnings. Cash provided by operations in 2006 was $16.8 million versus $18.4 million in 2005. The decline was due principally to lower earnings. The increase in cash at December 31, 2007 over the balance at December 31, 2006 is a function of the timing of receipts near the end of 2007.

 

Receivables increased 4.7% between December 31, 2007 and 2006 due primarily to higher fourth quarter sales. Inventories increased 2.4% due to higher raw material costs and the timing of inventory purchases.

 

Prepaid expenses and other current assets increased $0.3 million between December 31, 2007 and 2006 primarily due to increases in prepaid service contracts. The December 31, 2007 and 2006 balances also include $0.7 million of remaining book value related to the Rio Rico, Arizona facility that is listed for sale.

Capital expenditures totaled $16.0 million in 2007, $11.1 million in 2006 and $9.1 million in 2005. These amounts vary due to the timing of capital expenditures. Included in capital expenditures for 2007 is approximately $8.0 million related to the construction of a second facility in Mexico compared to $6.2 million of construction in 2006 for new facilities in Mexico and Germany. The Company expects to spend approximately $1.8 million in 2008 to complete construction of the second facility in Mexico. The Company believes capacity exists to increase production levels with minimal additional capital expenditures after the completion of this facility.

 

Other assets increased to $4.9 million at December 31, 2007 from $4.2 million at December 31, 2006. This increase is due to the purchase of additional manufacturing software to enhance the business systems.

 

Short-term debt decreased $4.2 million in 2007 and total outstanding long-term debt (both the current and long-term portions) decreased $2.0 million. These reductions of debt were due to cash generated from operations. None of the Company’s debt carries financial covenants or is secured.

 

The $0.8 million increase in payables between years is primarily the result of the timing of purchases. Warranty and after-sale costs decreased to $1.9 million at December 31, 2007 from $3.0 million at December 31, 2006 due to fewer warranty costs due to improved manufacturing processes for products introduced in recent years.

 

Income and other taxes increased to $8.4 million at December 31, 2007 from $0.6 million at December 31, 2006. At December 31, 2006, the Company recorded its net federal income tax position (refundable income tax net of the related reserves for unrecognized tax benefits) as a receivable. In 2007, the Company received payment of the refundable tax amounts and reclassified the reserve for unrecognized tax benefits to the income and other taxes liability in the Consolidated Balance Sheet.

 

The accrued non-pension postretirement liability declined $0.8 million to $6.1 million at December 31, 2007 from $6.9 million at December 31, 2006. The decline is principally due to changes in the funded status of the Company’s post-employment benefit plans.

 

Common Stock and capital in excess of par value both increased during 2007 due primarily to the exercise of stock options, stock compensation expense and the tax benefit on stock options. Treasury stock decreased due to shares issued in connection the Company’s dividend reinvestment program.

 

Accumulated other comprehensive income decreased by $2.9 million primarily due to changes in the funded status of the Company’s pension plan and other post-employment benefits.

 

Badger Meter’s financial condition remains strong. The Company believes that its operating cash flows, available borrowing capacity including $37.9 million of unused credit lines, and its ability to raise capital provide adequate resources to fund ongoing operating requirements, future capital expenditures and development of new products. The Company continues to take advantage of its local commercial paper market and from time to time may convert short-term debt into long-term debt.

 

OFF-BALANCE SHEET ARRANGEMENTS

 

The Company had no off-balance sheet arrangements at December 31, 2007. Prior to that date, the Company guaranteed the debt of the Badger Meter Officers’ Voting Trust (“BMOVT”), from which the BMOVT obtained loans from a bank on behalf of the officers of the Company in order to purchase shares of the Company’s Common Stock. The officers’ loan amounts were secured by the Company’s shares that were purchased with the loan proceeds. The entire outstanding loan balance was repaid at December 31, 2007 and the BMOVT was dissolved because it no longer fulfilled its original purpose of providing officers with loans to purchase Common Stock.

 

CONTRACTUAL OBLIGATIONS

 

The Company guarantees the outstanding debt of the ESSOP that is recorded in short-term debt, offset by a similar amount of unearned compensation that has been recorded as a reduction of shareholders’ equity. The loan amount is secured by shares of the Company’s Common Stock. Payments of $62,000 and $171,000 in 2007 and 2006, respectively, reduced the loan to $682,000 at December 31, 2007. The terms of the loan allow variable payments of principal with the final principal and interest payment due on April 30, 2008, at which time it is expected to be renewed.

The following table includes the Company’s significant contractual obligations as of December 31, 2007. There are no undisclosed guarantees.

 

 

Other than items included in the preceding table, as of December 31, 2007, the Company had no additional material purchase obligations other than those created in the ordinary course of business related to inventory and property, plant and equipment, which generally have terms of less than 90 days. The Company also has long-term obligations related to its pension and postretirement plans which are discussed in detail in Note 7 “Employee Benefit Plans” in the Notes to Consolidated Financial Statements in Part II, Item 8 of this 2007 Annual Report on Form 10-K. As of the most recent actuarial measurement date, no pension plan contributions are anticipated in 2008 and postretirement medical claims are paid as they are submitted. Postretirement medical claims are anticipated to be $612,000 in 2008 based on actuarial estimates; however, these amounts can vary significantly from year to year because the Company is self-insured.

 

CRITICAL ACCOUNTING POLICIES AND USE OF ESTIMATES

 

The Company’s accounting policies are more fully described in Note 1 “Summary of Significant Accounting Policies” in the Notes to Consolidated Financial Statements in Part II, Item 8 of this 2007 Annual Report on Form 10-K. As discussed in Note 1, the preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. The Company’s more significant estimates relate primarily to several judgmental reserves: allowance for doubtful accounts, reserve for obsolete inventories, warranty and after-sale costs reserve, and the health care reserve for claims incurred, as well as claims incurred but not reported. Each of these judgmental reserves is evaluated quarterly and is reviewed with the Company’s Disclosure Committee and the Audit and Compliance Committee of the Board of Directors. The basis for the reserve amounts is determined by analyzing the anticipated exposure for each account, and then selecting the most likely amount based upon historical experience and various other considerations that are believed to be reasonable under the circumstances. This method has been used for all years in the presented financials and has been used consistently throughout each year. Actual results may differ from these estimates under different assumptions or conditions.

 

The criteria used for calculating each of the reserve amounts varies by type of reserve. For the allowance for doubtful accounts reserve, significant past due balances are individually reviewed for collectibility, while the balance of accounts are reviewed in conjunction with applying historical write-off ratios. The calculation for the obsolete inventories reserve is determined by analyzing the relationship between the age and quantity of items on hand versus estimated usage to determine if excess quantities exist. The calculation for warranty and after-sale costs reserve uses criteria that include known potential problems on past sales as well as historical claim experience and current warranty trends. The health care reserve for claims incurred, but not reported is determined by using medical cost trend analyses, reviewing subsequent payments made and estimating unbilled amounts. The changes in the balances of these reserves at December 31, 2007 compared to the prior year were due to normal business conditions and are not deemed to be significant. While the Company continually tries to improve its estimates, no significant changes in the underlying processes are expected in 2008.

 

The Company also uses estimates in three other significant areas. Estimates are used in developing pension and other postretirement obligations and costs. The actuarial valuation of benefit obligations and net periodic benefit

costs rely on key assumptions including discount rates, long-term expected return on plan assets, future compensation and healthcare cost trend rates. Another area where estimates are used is in calculating stock-based compensation costs. The total cost of the Company’s share-based awards is equal to the grant date fair value per award multiplied by the number of awards granted, adjusted for forfeitures. Forfeitures are initially estimated based on historical Company information and subsequently updated over the life of the awards to ultimately reflect actual forfeitures, which could have an impact on the amount of stock compensation cost recognized from period to period. The third area employing estimates is income taxes. In calculating the provision for income taxes on an interim basis, the Company uses an estimate of the annual effective tax rate based upon the facts and circumstances known at each interim period. On a quarterly basis, the actual effective tax rate is adjusted as appropriate based upon the actual results as compared to those forecasted at the beginning of the fiscal year. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The Company evaluates and updates all of these assumptions annually. Actual results may differ from these estimates.

 

OTHER MATTERS

 

The Company is subject to contingencies related to environmental laws and regulations. Currently, the Company is in the process of resolving matters relative to two landfill sites where it has been named as one of many potentially responsible parties. These sites are impacted by the Federal Comprehensive Environmental Response, Compensation and Liability Act and other environmental laws and regulations. At this time, the Company does not believe the ultimate resolution of these issues will have a material adverse effect on the Company’s financial position or results of operations, either from a cash flow perspective or on the financial statements as a whole. This belief is based on the Company’s assessment of its limited past involvement with these sites as well as the substantial involvement of other named third parties in these matters. However, due to the inherent uncertainties of such proceedings, the Company cannot predict the ultimate outcome of these matters. A future change in circumstances with respect to these specific matters or with respect to sites formerly or currently owned or operated by the Company, or with respect to off-site disposal locations used by the Company, could result in future costs to the Company and such amounts could be material. Expenditures during 2007, 2006 and 2005 for compliance with environmental control provisions and regulations were not material.

 

Like other companies in recent years, the Company has been named as a defendant in numerous multi-claimant/multi-defendant lawsuits alleging personal injury as a result of exposure to asbestos, manufactured by third parties, and integrated into a very limited number of the Company’s industrial products. The Company is vigorously defending itself against these claims. Although it is not possible to predict the ultimate outcome of these matters, the Company does not believe the ultimate resolution of these issues will have a material adverse effect on the Company’s financial position or results of operations, either from a cash flow perspective or on the financial statements as a whole. This belief is based in part on the fact that no claimant has demonstrated exposure to products manufactured or sold by the Company and that a number of cases have been voluntarily dismissed.

 

MARKET RISKS

 

In the ordinary course of business, the Company is exposed to various market risks. The Company operates in an environment where competition varies from moderate to intense. The Company believes it currently provides the leading technology in water meters and AMR/AMI systems for water utilities. A number of the Company’s competitors in certain markets have greater financial resources. Competitors also include alliance partners that sell products that do or may compete with our products, particularly those that provide AMR/AMI connectivity solutions. In addition, the market’s level of acceptance of the Company’s newer products may have a significant effect on the Company’s results of operations. As a result of significant research and development activities, the Company enjoys favorable patent positions for several of its products.

 

The Company’s ability to generate operating income and to increase profitability depends somewhat on the general health of the United States and foreign economies, the overall industrial activity, and to a lesser extent, housing starts in the United States. In addition, changes in governmental laws and regulations, particularly laws dealing with the use of lead or rules affecting the use and/or licensing of radio frequencies necessary for AMR/AMI

products may impact the results of operations. These factors are largely beyond the Company’s control and depend on the economic condition and regulatory environment of the geographic region of the Company’s operations.

 

The Company has evaluated its worldwide operations to determine if any risks and uncertainties exist that could severely impact its operations in the near term. The Company does not believe that there are any significant near-term risks. However, the Company does rely on single suppliers for certain castings and components in several of its product lines. Although alternate sources of supply exist for these items, loss of certain suppliers could temporarily disrupt operations in the short term. The Company attempts to mitigate these risks by working closely with key suppliers, purchasing minimal amounts from alternative suppliers and by purchasing business interruption insurance where appropriate.

 

Raw materials used in the manufacture of the Company’s products include metal or alloys (such as bronze, which uses copper as its main component, aluminum, stainless steel, cast iron, brass and stellite), plastic resins, glass, microprocessors and other electronic subassemblies and components. The price and availability of raw materials is influenced by economic and industry conditions, including supply and demand factors that are difficult to anticipate and cannot be controlled by the Company. Commodity risk is managed by keeping abreast of economic conditions and locking in purchase prices for quantities that correspond to the Company’s forecasted usage.

 

The Company’s foreign currency risk relates to the sales of products to foreign customers. The Company uses lines of credit with U.S. and European banks to offset currency exposure related to European receivables and other monetary assets. As of December 31, 2007 and 2006, the Company’s foreign currency net monetary assets were substantially offset by comparable debt resulting in no material exposure to the results of operations.

 

The Company typically does not hold or issue derivative instruments and has a policy specifically prohibiting the use of such instruments for trading purposes.

 

The Company’s short-term debt on December 31, 2007 was floating rate debt with market values approximating carrying value. Fixed rate debt was principally a U.S. dollar term loan with a 5.59% interest rate and a euro dollar revolving term loan with a 5.91% interest rate. For the short-term floating rate debt, future annual interest costs will fluctuate based upon short-term interest rates. For the short-term debt on hand on December 31, 2007, the effect of a 1% change in interest rates is approximately $108,000.

 

 

Information required by this Item is set forth in Part II, Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations” under the heading “Market Risks” in this 2007 Annual Report on Form 10-K.

 

BADGER METER, INC.

 

Management’s Annual Report on Internal Control over Financial Reporting

 

The Company’s management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) under the Securities Exchange Act of 1934. The Company’s internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. generally accepted accounting principles.

 

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

 

The Company’s management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2007 using the criteria set forth in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this assessment, the Company’s management believes that, as of December 31, 2007, the Company’s internal control over financial reporting was effective based on those criteria.

 

Ernst & Young LLP, an independent registered public accounting firm, has audited the Consolidated Financial Statements included in this Annual Report on Form 10-K and, as part of its audit, has issued an attestation report, included herein, on the effectiveness of the Company’s internal control over financial reporting.

BADGER METER, INC.

 

Report of Independent Registered Public Accounting Firm

 

The Board of Directors and Shareholders of Badger Meter, Inc.

 

We have audited Badger Meter, Inc.’s (the “Company”) internal control over financial reporting as of December 31, 2007, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). Badger Meter, Inc.’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on the effectiveness of the Company’s internal control over financial reporting based on our audit.

 

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

 

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

 

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

 

In our opinion, Badger Meter, Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2007, based on the COSO criteria.

 

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Badger Meter, Inc. as of December 31, 2007 and 2006, and the related consolidated statements of operations, shareholders’ equity and cash flows for each of the three years in the period ended December 31, 2007 and our report dated February 21, 2008, expressed an unqualified opinion thereon.

 

 

Milwaukee, Wisconsin
February 21, 2008

BADGER METER, INC.

 

Report of Independent Registered Public Accounting Firm

 

The Board of Directors and Shareholders of Badger Meter, Inc.

 

We have audited the accompanying consolidated balance sheets of Badger Meter, Inc. (the “Company”) as of December 31, 2007 and 2006, and the related consolidated statements of operations, shareholders’ equity and cash flows for each of the three years in the period ended December 31, 2007. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

 

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

 

In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Badger Meter, Inc. at December 31, 2007 and 2006, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2007, in conformity with U.S. generally accepted accounting principles.

 

As discussed in Note 1 to the Consolidated Financial Statements, on January 1, 2006, the Company changed its method of accounting for share-based awards and on December 31, 2006, the Company changed its method of accounting for defined benefit pension and postretirement healthcare plans.

 

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Badger Meter, Inc.’s internal control over financial reporting as of December 31, 2007, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 21, 2008 expressed an unqualified opinion thereon.

 

 

Milwaukee, Wisconsin
February 21, 2008

BADGER METER, INC.

 

Consolidated Balance Sheets

 

 

See accompanying notes.

BADGER METER, INC.

 

Consolidated Statements of Operations

 

 

See accompanying notes.

BADGER METER, INC.

 

Consolidated Statements of Cash Flows

 

 

See accompanying notes.

BADGER METER, INC.

 

Consolidated Statements of Shareholders’ Equity

 

 

See accompanying notes.

BADGER METER, INC.

 

Notes to Consolidated Financial Statements
December 31, 2007, 2006 and 2005

 

 

Profile

 

The Company is a leading manufacturer and marketer of products incorporating liquid flow measurement and control technologies, developed both internally and in conjunction with other technology companies. Its products are used to measure and control the flow of liquids in a wide variety of applications. The Company’s product lines fall into two general categories, utility and industrial flow measurement. The utility category is comprised of two primary product lines — residential and commercial water meters that are used by water utilities as the basis for generating water and wastewater revenues. The market for these product lines is North America, primarily the United States, because these meters are designed and manufactured to conform to standards promulgated by the American Water Works Association. The utility flow measurement products constitute a majority of the Company’s sales.

 

Industrial product line sales comprise the remainder of the Company’s sales and include precision valves, electromagnetic inductive flow meters, impeller flow meters, and turbine and positive displacement industrial flow meters. Rounding out the industrial product line are automotive fluid meters for the measurement of various types of automotive fluids.

 

Consolidation

 

The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All intercompany transactions have been eliminated in consolidation.

 

Receivables

 

Receivables consist primarily of trade receivables. The Company does not require collateral or other security and evaluates the collectibility of its receivables based on a number of factors. An allowance for doubtful accounts is recorded for significant past due receivable balances based on a review of the past due items and the customer’s ability and likelihood to pay, as well as applying a historical write-off ratio to the remaining balances. Changes in the Company’s allowance for doubtful accounts are as follows:

 

 

Inventories

 

Inventories are valued primarily at the lower of cost or market. Cost is determined using the first-in, first-out method. Market is determined based on the net realizable value. The Company estimates and records provisions for obsolete inventories. Changes to the Company’s obsolete inventories reserve are as follows: