Summary of Significant Accounting Policies

Profile

Badger Meter is an innovator in flow measurement, control and communication solutions, serving water utilities, municipalities, and commercial and industrial customers worldwide. The Company’s products measure water, oil, chemicals and other fluids, and are known for accuracy, long-lasting durability and for providing and communicating valuable and timely measurement data. The Company’s product lines fall into two categories: sales of water meters and related technologies to municipal water utilities (municipal water) and sales of meters to various industries for water and other fluids (flow instrumentation). The Company estimates that over 85% of its products are used in water applications when both categories are grouped together.

Municipal water, the largest category by sales volume, includes mechanical and ultrasonic (electronic) water meters and related technologies and services used by municipal water utilities as the basis for generating water and wastewater revenues. The key market for the Company’s municipal water meter products is North America, primarily the United States, because most of the Company's meters are designed and manufactured to conform to standards promulgated by the American Water Works Association. The majority of water meters sold by the Company continues to be mechanical in nature. In recent years, the Company has made inroads in selling ultrasonic water meters. The development of smaller diameter ultrasonic water meters combined with advanced radio technology now provides the Company with the opportunity to sell into other geographical markets, for example Europe, the Middle East and South America. In the municipal water category, sales of water meters and related technologies and services are also commonly referred to as residential or commercial water meter sales, the latter referring to larger sizes of water meters.

Flow instrumentation includes meters and valves sold worldwide to measure and control materials flowing through a pipe or pipeline including water, air, steam, oil, and other liquids and gases. These products are used in a variety of applications, primarily into the following industries: water/wastewater; heating, ventilating and air conditioning (HVAC); oil and gas; chemical and petrochemical; test and measurement; automotive aftermarket; and the concrete construction process. Furthermore, the Company’s flow instrumentation technologies are sold to original equipment manufacturers as the primary flow measurement device within a product or system.

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 collectability 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:



	Balance at beginning of year		Provision and reserve adjustments			Write-offs less recoveries			Balance at end of year
	(In thousands)
2017	$	425	$	285		$	(323	)	$	387
2016	$	477	$	2		$	(54	)	$	425
2015	$	811	$	(152	)	$	(182	)	$	477

Inventories

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



	Balance at beginning of year		Net additions charged to earnings		Disposals			Balance at end of year
	(In thousands)
2017	$	3,639	$	1,295	$	(1,053	)	$	3,881
2016	$	3,836	$	1,017	$	(1,214	)	$	3,639
2015	$	3,314	$	2,530	$	(2,008	)	$	3,836

Property, Plant and Equipment

Property, plant and equipment are stated at cost. Depreciation is provided over the estimated useful lives of the respective assets by the straight-line method. The estimated useful lives of assets are: for land improvements, 15 years; for buildings and improvements, 10 to 39 years; and for machinery and equipment, 3 to 20 years.

Capitalized Software and Hardware

Capitalized internal use software and hardware included in other assets in the Consolidated Balance Sheets were $6.0 million and $3.3 million at December 31, 2017 and 2016, respectively. These amounts are amortized on a straight-line basis over the estimated useful lives of the software and/or hardware, ranging from 1 to 5 years. Amortization expense recognized for the years ending December 31, 2017, 2016 and 2015 was $2.8 million, $3.1 million and $2.4 million, respectively.

Long-Lived Assets

Property, plant and equipment and identifiable intangible assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. If the sum of the expected undiscounted cash flows is less than the carrying value of the related asset or group of assets, a loss is recognized for the difference between the fair value and carrying value of the asset or group of assets. No adjustments were recorded as a result of these reviews during 2017, 2016 and 2015.

Intangible Assets

Intangible assets are amortized on a straight-line basis over their estimated useful lives, ranging from 5 to 20 years. The Company does not have any intangible assets deemed to have indefinite lives. Amortization expense recognized for 2017 was $6.8 million compared to $6.1 million in 2016 and 2015. Amortization expense expected to be recognized is $7.2 million in 2018, $6.9 million in 2019, $6.7 million in 2020, $6.6 million in 2021, $5.6 million in 2022 and $26.4 million thereafter. The carrying value and accumulated amortization by major class of intangible assets are as follows:



	December 31, 2017				December 31, 2016
	Gross carrying amount		Accumulated amortization		Gross carrying amount		Accumulated amortization
	(In thousands)
Technologies	$	47,647	$	21,882	$	47,657	$	18,970
Intellectual property	10,000		333		—		—
Non-compete agreements	2,322		1,923		2,112		1,670
Licenses	650		475		650		458
Customer lists	8,023		2,011		4,923		1,698
Customer relationships	21,620		9,649		20,790		7,416
Trade names	9,595		4,258		9,475		3,523
Total intangibles	$	99,857	$	40,531	$	85,607	$	33,735

Goodwill

Goodwill is tested for impairment annually during the fourth fiscal quarter or more frequently if an event indicates that the goodwill might be impaired. Potential impairment is identified by comparing the fair value of a reporting unit with its carrying value. No adjustments were recorded to goodwill as a result of these reviews during 2017, 2016 and 2015.

Goodwill was $67.4 million and $49.3 million at December 31, 2017 and 2016, respectively. The increases resulted from the asset purchase of Carolina Meter & Supply of Wilmington, North Carolina in 2017 and the acquisition of D-Flow Technology AB of Luleå, Sweden in 2017. These acquisitions are further described in Note 3 “Acquisitions.”

Revenue Recognition

Revenues are generally recognized upon shipment of product, which corresponds with the transfer of title. The costs of shipping are generally billed to the customer upon shipment and are included in cost of sales. A small portion of the Company's sales includes shipments of products combined with services, such as meters sold with installation. The product and installation components of these multiple deliverable arrangements are considered separate units of accounting. The value of these separate units of accounting is determined based on their relative fair values determined on a stand-alone basis. Revenue is generally recognized when the last element of the multiple deliverable is delivered, which corresponds with installation and acceptance by the customer. The Company also sells a small number of extended support service agreements on certain products for the period subsequent to the normal support service provided with the original product sale. Revenue is recognized over the service agreement period, which is generally one year. In 2014, the Company began offering software as a service with its BEACON AMA product and revenue for this service is recognized on a monthly basis as the service is performed.

Warranty and After-Sale Costs

The Company estimates and records provisions for warranties and other after-sale costs in the period in which the sale is recorded, based on a lag factor and historical warranty claim experience. After-sale costs represent a variety of activities outside of the written warranty policy, such as investigation of unanticipated problems after the customer has installed the product, or analysis of water quality issues. Changes in the Company's warranty and after-sale costs reserve are as follows:



	Balance at beginning of year		Net additions charged to earnings		Adjustments to pre-existing warranties			Costs incurred			Balance at end of year
	(In thousands)
2017	$	2,779	$	4,520	$	(439	)	$	(3,493	)	$	3,367
2016	$	3,133	$	3,559	$	(554	)	$	(3,359	)	$	2,779
2015	$	1,739	$	1,559	$	1,278		$	(1,443	)	$	3,133

Research and Development

Research and development costs are charged to expense as incurred and amounted to $10.6 million in 2017, 2016 and 2015.

Stock-Based Compensation Plans

As of December 31, 2017, the Company has an Omnibus Incentive Plan under which 1,400,000 shares are reserved for restricted stock and stock option grants for employees as well as stock grants for directors as described in Note 5 “Stock Compensation.” The plan was originally approved in 2011 and replaced all prior stock-based plans except for shares and options previously issued under those plans.

The Company recognizes the cost of stock-based awards in net earnings for all of its stock-based compensation plans on a straight-line basis over the service period of the awards. The Company estimates the fair value of its option awards using the Black-Scholes option-pricing formula, and records compensation expense for stock options ratably over the stock option grant's vesting period. The Company values restricted stock and stock grants for directors on the closing price of the Company's stock on the day the grant was awarded. Total stock compensation expense recognized by the Company was $1.8 million for 2017, $1.6 million for 2016 and $1.5 million for 2015.

Healthcare

The Company estimates and records provisions for healthcare claims incurred but not reported, based on medical cost trend analysis, reviews of subsequent payments made and estimates of unbilled amounts.

Accumulated Other Comprehensive Loss

Components of accumulated other comprehensive loss at December 31, 2017 are as follows:



	Pension and postretirement benefits			Foreign currency			Total
				(In thousands)
Balance at beginning of period	$	(10,495	)	$	(1,140	)	$	(11,635	)
Other comprehensive income before reclassifications	—			1,844			1,844
Amounts reclassified from accumulated other comprehensive loss, net of tax of $0.3 million	(1,102		)	—			(1,102		)
Net current period other comprehensive (loss) income, net	(1,102		)	1,844			742
Accumulated other comprehensive (loss) income	$	(11,597	)	$	704		$	(10,893	)

Details of reclassifications out of accumulated other comprehensive loss during 2017 are as follows:



	Amount reclassified from accumulated other comprehensive loss
	(In thousands)
Amortization of employee benefit plan items:
Prior service cost (1)	$	(25	)
Settlement expense (1)	641
Actuarial loss (1)	(2,010		)
Total before tax	(1,394		)
Income tax impact	292
Amount reclassified out of accumulated other comprehensive loss	$	(1,102	)


(1)	These accumulated other comprehensive loss components are included in the computation of benefit plan costs in Note 7 “Employee Benefit Plans.”

Components of accumulated other comprehensive loss at December 31, 2016 are as follows:



	Pension and postretirement benefits			Foreign currency			Total
	(In thousands)
Balance at beginning of period	$	(11,968	)	$	(812	)	$	(12,780	)
Other comprehensive income before reclassifications	—			(328		)	(328		)
Amounts reclassified from accumulated other comprehensive loss, net of tax of $(1.0) million	1,473			—			1,473
Net current period other comprehensive income (loss), net	1,473			(328		)	1,145
Accumulated other comprehensive loss	$	(10,495	)	$	(1,140	)	$	(11,635	)

Details of reclassifications out of accumulated other comprehensive loss during 2016 are as follows:



	Amount reclassified from accumulated other comprehensive loss
	(In thousands)
Amortization of employee benefit plan items:
Prior service cost (1)	$	(25	)
Settlement expense (1)	1,510
Actuarial loss (1)	1,007
Total before tax	2,492
Income tax impact	(1,019		)
Amount reclassified out of accumulated other comprehensive loss	$	1,473


(1)	These accumulated other comprehensive loss components are included in the computation of benefit plan costs in Note 7 “Employee Benefit Plans.”

Use of Estimates

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. Actual results could differ from those estimates.

Fair Value Measurements of Financial Instruments

The carrying amounts of cash, receivables and payables in the financial statements approximate their fair values due to the short-term nature of these financial instruments. Short-term debt is comprised of notes payable drawn against the Company's lines of credit and commercial paper. Because of its short-term nature, the carrying amount of the short-term debt also approximates fair value. Included in other assets are insurance policies on various individuals who were associated with the Company. The carrying amounts of these insurance policies approximate their fair value.

Subsequent Events

The Company evaluates subsequent events at the date of the balance sheet as well as conditions that arise after the balance sheet date but before the financial statements are issued. The effects of conditions that existed at the balance sheet date are recognized in the financial statements. Events and conditions arising after the balance sheet date but before the financial statements are issued are evaluated to determine if disclosure is required to keep the financial statements from being misleading. To the extent such events and conditions exist, if any, disclosures are made regarding the nature of events and the estimated financial effects for those events and conditions. For purposes of preparing the accompanying consolidated financial statements and the notes to these financial statements, the Company evaluated subsequent events through the date the accompanying financial statements were issued.

New Pronouncements

In February 2018, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2018-02 "Income Statement - Reporting Comprehensive Income (Topic 220)." Under existing U.S. generally accepted accounting principles, the effects of changes in tax rates and laws on deferred tax balances are recorded as a component of income tax expense in the period in which the law was enacted. When deferred tax balances related to items originally recorded in accumulated other comprehensive income are adjusted, certain tax effects become stranded in accumulated other comprehensive income. The amendments in ASU 2018-02 allow a reclassification from accumulated other comprehensive income to retained earnings for stranded tax effects resulting from the Tax Cuts and Jobs Act of 2017. The amendments in this ASU also require certain disclosures about stranded tax effects. The guidance is effective for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years. Early adoption in any period is permitted. The Company’s provisional adjustments recorded in 2017 to account for the impact of the Tax Cuts and Jobs Act resulted in stranded tax effects. The Company is currently evaluating the timing and impact of adopting ASU 2018-02.

In May 2017, the FASB issued ASU 2017-09 “Compensation - Stock Compensation (Topic 718),” which clarifies when a change to terms or conditions of a share-based payment award must be accounted for as a modification. The new guidance requires modification accounting if the vesting condition, fair value or the award classification is not the same both before and after a change to the terms and conditions of the award. The new guidance is effective on a prospective basis beginning on January 1, 2018 and early adoption is permitted. The Company does not expect the adoption of this standard to have an impact on its consolidated financial statements as it is not the Company’s practice to change the terms or conditions of share-based payment awards after they are granted.

In March 2017, the FASB issued ASU 2017-07 “Compensation - Retirement Benefits (Topic 715),” which changes the presentation of defined benefit and post-retirement benefit plan expense on the income statement by requiring separation between operating and non-operating expense. Under the ASU, the service cost of net periodic benefit expense is an operating expense that will be reported with similar compensation costs. The non-operating components, which include all other components of net periodic benefit expense, are reported outside of operating income. The ASU also stipulates that only the service cost component of pension and postretirement benefit costs is eligible for capitalization. The ASU is effective for the Company beginning on January 1, 2018. Application is retrospective for the presentation of the components of these benefit costs and prospective for the capitalization of service costs. The Company's net periodic benefit cost components are disclosed in Note 3 "Employee Benefit Plans."

In January 2017, the FASB issued ASU 2017-04 "Intangibles - Goodwill and Other (Topic 350)." The update requires a single-step quantitative test to measure potential impairment based on the excess of a reporting unit's carrying amount over its fair value. A qualitative assessment can still be completed first for an entity to determine if a quantitative impairment test is necessary. The ASU is effective for fiscal year 2021 and is to be adopted on a prospective basis. Early adoption is permitted for interim or annual goodwill impairment tests performed on testing dates after January 1, 2017. The Company anticipates that the adoption of this standard will have no impact on its consolidated financial statements.

In February 2016, the FASB issued ASU 2016-02 "Leases (Topic 842)," which requires lessees to record most leases on their balance sheets. Lessees initially recognize a lease liability (measured at the present value of the lease payments over the lease term) and a right-of-use ("ROU") asset (measured at the lease liability amount, adjusted for lease prepayments, lease incentives received and the lessee's initial direct costs). Lessees can make an accounting policy election not to recognize ROU assets and lease liabilities for leases with a lease term of 12 months or less as long as the leases do not include options to purchase the underlying assets that the lessee is reasonably certain to exercise. For lessors, the guidance modifies the classification criteria and the accounting for sales-type and direct financing leases. The ASU is effective for the Company beginning on January 1, 2019 and early adoption is permitted. The standard requires the use of a modified retrospective approach for leases that exist or are entered into after the beginning of the earliest comparative period in the financial statements. Full retrospective application is prohibited. The Company is continuing to evaluate the impact that the adoption of this guidance will have on its financial condition, results of operations and the presentation of its consolidated financial statements.

In July 2015, the FASB issued ASU 2015-11 "Inventory (Topic 330)," which requires entities to measure inventories at the lower of cost or net realizable value ("NRV"). This simplifies the evaluation from the current method of lower of cost or market, where market is based on one of three measures (i.e. replacement cost, net realizable value, or net realizable value less a normal profit margin). The ASU does not apply to inventories measured under the last-in, first-out method or the retail inventory method, and defines NRV as the "estimated selling price in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation." The ASU was adopted on a prospective basis by the Company on January 1, 2017. The adoption of this ASU did not have an impact on the Company's financial condition or results of operations.

In May 2014, the FASB issued ASU 2014-09 “Revenue from Contracts with Customers (Topic 606).” This ASU provides a single principles-based, five-step model to be applied to all contracts with customers. The five steps are to identify the contract(s) with the customer, to identify the performance obligations in the contract, to determine the transaction price, to allocate the transaction price to the performance obligations in the contract and to recognize revenue when each performance obligation is satisfied. Revenue will be recognized when promised goods or services are transferred to the customer in an amount that reflects the consideration expected in exchange for those goods or services. In addition, the standard requires disclosure of the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. During 2016, the FASB issued additional ASU’s which enhanced the originally issued guidance. These ASU’s encompassed narrow scope improvements and practical expedients along with providing further clarification on the accounting for intellectual property licenses, principal versus agent considerations and identifying performance obligations.

In 2017, the Company addressed all significant areas of impact for ASU 2014-09 and finalized the documentation of formal policies in anticipation of adopting the standard on January 1, 2018. The adoption of this ASU will not have a significant impact on the Company’s consolidated financial position, results of operations, equity or cash flows as of the adoption date beyond the additional required disclosure. The Company has identified a subset of contracts with customers where services are provided that are both uniquely beneficial and separately identifiable from product sales and thus are considered separate performance obligations under the new guidance. Each of these individual service activities has been documented in scenario development and processes have been established to recognize revenue for each unique performance obligation in accordance with the guidance, when effective.

The guidance permits two methods of adoption: retrospectively to each prior reporting period presented (full retrospective method), or retrospectively with the cumulative effect of initially applying the guidance recognized at the date of initial application (modified retrospective method). In 2018, the Company anticipates adopting the new revenue standard using the modified retrospective method by recognizing the cumulative effect of applying the new revenue standard as an adjustment of less than $0.5 million in the opening balance of retained earnings. The transition adjustment will primarily be related to the deferral of revenue for a subset of the Company's service contracts. In 2018, the Company will also include the disclosures required by ASU 2014-09 in all reporting periods. Comparative information will not be restated and will continue to be reported under the accounting standards in effect for the period presented.