Badger Meter - 10-K annual report

      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.     o

      Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” 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 December 31, 2005 was $266,779,622. For purposes of this calculation only, (i) shares of Common Stock are deemed to have a market value of $41.30 per share, the closing price of the Common Stock as reported on the American Stock Exchange on June 30, 2005, and (ii) each of the executive officers and directors is deemed to be an affiliate of the Company.

      As of February 10, 2006, there were 6,876,101 shares of Common Stock outstanding with a par value of $1 per share.

      Portions of the Company’s Proxy Statement for the 2006 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.

      Certain statements contained in this Form 10-K and accompanying 2005 Annual Report, 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.

      The Company is a leading marketer and manufacturer of products, and a provider of services, using flow measurement and control technologies serving markets worldwide. The Company was incorporated in 1905.

      The Company’s Internet address ishttp://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

      The Company is a leading marketer and manufacturer of products using flow measurement and control technologies developed both internally and with other technology companies. Its products are used to measure and control the flow of liquids in a variety of applications. The Company’s product lines fall into two general categories, utility and industrial. The utility category is comprised of two product lines, residential and commercial water meters (with various automatic meter reading (AMR) technology systems), which are generally sold to water utilities and constitute a majority of the Company’s sales. Industrial product line sales comprise the remainder of the Company’s sales and include automotive fluid meters and systems, small precision valves, electromagnetic meters, impeller flow meters and industrial process meters (all with related accessories and instrumentation).

      Residential and commercial water meters and related systems are classified as local (or manual) read meters or AMR products. Local read meters consist of a water meter and a register. With AMR meters, the register digitally encodes the mechanical reading and its radio frequency transmitter communicates the data to a computerized system that collects the data and sends it to specific utility computerized programs. Net sales and the corresponding net earnings depend on unit volume and mix of products, with the Company generally earning higher margins on AMR products. The Company sells AMR products of other companies as well as its own proprietary product, Orion^®, which has higher margins than the other AMR products. Orion^®is currently being sold as a walk-by/drive-by system, but also has the ability to connect with a variety of other technologies, such as power line carrier, broadband over power line, municipal WI-FI and radio frequency systems to allow for remote reading of the data. Net sales and the corresponding net earnings are therefore also dependent on the mix of AMR products between proprietary and non-proprietary products.

      There is a base level of annual business for utility products driven by replacement units and, to a lesser extent, housing starts. Sales above the base level depend on conversions to AMR away from manual read meters. The Company believes that conversion from local read meters to AMR products can accelerate replacements of meters and result in growth, because it is estimated that only 15-20% of the water meter market has been converted to AMR. Badger Meter’s strategy is to solve customers’ metering needs with its proprietary meter reading systems or other systems available through alliances within the marketplace.

      The industrial products generally serve niche markets and have in the past utilized technology derived from utility products to serve industrial uses. As these markets evolve, these products are becoming more specialized to meet industrial flow measurement and communication protocol requirements. Serving these markets allows the Company to expand its technologies into other areas of flow measurement and control, as well as 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; Rio Rico, Arizona; Nogales, Mexico and Brno, Czech Republic facilities. Products are also assembled in the Company’s Stuttgart, Germany and Nancy, France facilities.

      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.

      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 include Sensus Metering Systems, Inc., Neptune Technologies and AMCO Water Metering Systems for utility water meters. The primary competitor

      The dollar amounts of the Company’s total backlog of unshipped orders at December 31, 2005 and 2004 were $28.6 million and $24.1 million, respectively. The backlog is comprised of firm orders and signed contractual commitments, or portions of such commitments, that call for shipment within twelve months. Backlog can be significantly affected by the timing of orders for large utility projects.

      Raw materials used in the manufacture of the Company’s products include metal or alloys (such as bronze, 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 some 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.

      Expenditures for research and development activities relating to the development of new products, improvement of existing products and manufacturing process improvements were $5.3 million in 2005, compared to $4.6 million in 2004, and $6.1 million during 2003. Research and development activities are primarily sponsored by the Company. The Company also engages in some joint research and development with other companies.

      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.

      The Company is subject to contingencies relative to compliance with federal, state and local provisions and regulations relating to the protection of the environment. Currently, the Company is in the process of resolving issues relative to two landfill sites. 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. Expenditures during 2005, 2004 and 2003 for compliance with environmental control provisions and regulations were not material and the Company does not anticipate any material future expenditures.

      The Company and its subsidiaries employed 1,052 persons at December 31, 2005, 215 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.

      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; a manufacturing and sales facility in Brno, Czech Republic; and a sales and assembly facility in Nancy, France. The Company exports products from the United States that are manufactured in Milwaukee, Wisconsin; Tulsa, Oklahoma; and Rio Rico, Arizona.

      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 2005 Annual Report on Form 10-K.

      The Company operates in one industry segment as a marketer and manufacturer of flow measurement and control products as described in Note 10 “Industry Segment and Geographic Areas” in the Notes to Consolidated Financial Statements in Part II, Item 8 of this 2005 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 2005 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 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. The principal elements of competition for our most significant product lines, residential and commercial water meters (with various automatic meter reading (AMR) technology systems) for the utility market, are price, product technology, quality and service. The competitive environment is also affected by the movement toward AMR technologies away from local (or manual) 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.

      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.

      We are affected by the availability and prices for raw materials, including metal or alloys (such as bronze, 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 hindering timely delivery 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.

      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. While we also serve several industrial markets to avoid a dependency on any one, a significant downturn in these markets could also cause a material adverse impact on sales and operating results.

      The terrorist attacks on September 11, 2001 and the resulting war on terrorism caused instability in world markets, which, we believe, temporarily impacted product purchases in the industry. 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.

      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, which could have a material adverse effect on revenues and 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 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.

      Since we sell products worldwide, we are subject to risks associated with doing business internationally. These risks include changes in foreign currency exchange rates, changes in a specific country 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. As a result of

      None.

      The principal facilities utilized by the Company at December 31, 2005 are listed below. Except as indicated, the Company owns all of 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 with 11,500 square feet in Neuffen, Germany. The Company is in the process of constructing an 8,500 square foot addition to the existing building. It expects to occupy this facility in early 2007 and vacate the above-mentioned leased German facility when the lease expires in June 2007. In addition, the Company purchased land in Nogales, Mexico in 2005 and is in the process of constructing a 40,000 square foot building to replace the Company’s Rio Rico, Arizona facility, and has sufficient land to expand in the future. Occupancy of this facility is expected in the third quarter of 2006. The Rio Rico, Arizona facility will ultimately be placed for sale.

      There are currently no material legal proceedings pending with respect to the Company. The more significant legal proceedings are discussed below.

      The Company is a defendant in numerous multi-party asbestos lawsuits pending in various states. These lawsuits assert claims alleging that certain industrial products were manufactured by the defendants and were the cause of injury and harm. The Company is vigorously defending itself against these alleged 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.

      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 2005 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, 2005.

      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 was elected as an officer.

      Mr. Meeusen was elected Chairman, President and Chief Executive Officer in April 2004. Mr. Meeusen served as President and Chief Executive Officer from April 2002 to April 2004, as President from November 2001 to April 2002, and as Executive Vice President — Administration from February 2001 to November 2001.

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

      Mr. Cieslak was elected Vice President — Operations in August 2005. Prior to joining the Company in August 2005, Mr. Cieslak served as Vice President and General Manager of Trombetta LLC for more than five years.

      Mr. Dix was elected Senior Vice President — Administration in February 2006, and had 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, and as Vice President — Human Resources from February 2001 to November 2001.

      Mr. Gras was elected Vice President — International Operations in November 2001. Prior to that date, Mr. Gras served as Vice President — Badger Meter Europe.

      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.

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

      Mr. Webb was elected Vice President — Sales, Marketing and Engineering in August 2005. Mr. Webb served as Vice President — Engineering from November 2001 to August 2005, and Vice President — Customer Solutions from April 2000 to November 2001.

      Mr. Zandron was elected Vice President — Business Development in November 2001. Prior to that date, Mr. Zandron served as Vice President — Utility.

      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 2005 Annual Report on Form 10-K.

      Prior to December 1, 2005, the Company had undertaken stock repurchases from time to time to offset dilution created by shares issued for stock options and other corporate purposes, as well as to repurchase shares when market conditions were favorable. For the quarter ended December 31, 2005, the Company repurchased 9,293 shares of Common Stock for $365,700 based on an average price per share of $39.35. The purchase of Common Stock, prior to the discontinuation of this plan on November 30, 2005, was at the Company’s discretion, subject to prevailing financial and market conditions.

      The following chart discloses information regarding the shares of the Common Stock repurchased during the quarter ended December 31, 2005, all of which were purchased pursuant to the Board of Directors’ authorizations:

      The Company is a leading marketer and manufacturer of products using flow measurement and control technologies developed both internally and with other technology companies. Its products are used to measure and control the flow of liquids in a variety of applications. The Company’s product lines fall into two general categories, utility and industrial. The utility category is comprised of two product lines, residential and commercial water meters (with various automatic meter reading (AMR) technology systems), which are generally sold to water utilities and constitute a majority of the Company’s sales. Industrial product line sales comprise the remainder of the Company’s sales and include automotive fluid meters and systems, small precision valves, electromagnetic meters, impeller flow meters and industrial process meters (all with related accessories and instrumentation).

      Residential and commercial water meters and related systems are classified as local (or manual) read meters or AMR products. Local read meters consist of a water meter and a register. With AMR meters, the register digitally encodes the mechanical reading and its radio frequency transmitter communicates the data to a computerized system that collects the data and sends it to specific utility computerized programs. Net sales and the corresponding net earnings depend on unit volume and mix of products, with the Company generally earning higher margins on AMR products. The Company sells AMR products of other companies as well as its own proprietary product, Orion^®, which has higher margins than the other AMR products. Orion^®is currently being sold as a walk-by/drive-by system, but also has the ability to connect with a variety of other technologies, such as power line carrier, broadband over power line, municipal WI-FI and radio frequency systems to allow for remote reading of the data. Net sales and the corresponding net earnings are therefore also dependent on the mix of AMR products between proprietary and non-proprietary products.

      There is a base level of annual business for utility products driven by replacement units and, to a lesser extent, housing starts. Sales above the base level depend on conversions to AMR away from manual read meters. The Company believes that conversion from local read meters to AMR products can accelerate replacements of meters and result in growth, because it is estimated that only 15-20% of the water meter market has been converted to AMR. Badger Meter’s strategy is to solve customers’ metering needs with its proprietary meter reading systems or other systems available through alliances within the marketplace.

      The industrial products generally serve niche markets and have in the past utilized technology derived from utility products to serve industrial uses. As these markets evolve, these products are becoming more specialized to meet industrial flow measurement and communication protocol requirements. Serving these markets allows the Company to expand its technologies into other areas of flow measurement and control, as well as utilize existing capacity and spread fixed costs over a larger sales base.

      Badger Meter’s net sales of $216.7 million increased $11.6 million, or 5.7%, for 2005 compared to 2004. The increase was the net result of sales increases in most of the Company’s product lines, offset by declines in its automotive fluid meters and systems product lines as further discussed below.

      Residential and commercial water meter customers include independent distributors, large cities, private water companies and numerous smaller municipal water utilities. One group of the Company’s sales representatives focuses on distributors, another on large accounts (public and private), and a third group focuses on the remaining customers. Sales to customers are influenced by the movement toward AMR technologies, the lengthening of the sales cycle and the financial budget conditions of the various water utilities served.

      Residential and commercial water meter net sales represented 75.1% of total net sales in 2005 compared with 73.2% in 2004. These sales increased $12.6 million, or 8.4%, in 2005 to $162.7 million from

      Industrial sales are affected by economic conditions, domestically and internationally, in each of the markets served by the various product lines. The automotive fluid meters and related systems (sold through the Company’s French subsidiary) were negatively affected by the delay of new products, loss of a major customer and poor economic conditions in that market, which resulted in lower sales in 2005 versus 2004. All other industrial product lines showed sales increases in 2005 over 2004 levels. In total, the industrial products represented 24.9% of total net sales in 2005 compared to 26.8% in 2004. Industrial product sales decreased $0.9 million to $54.0 million in 2005 compared with $54.9 million in 2004, which is the net result of a $3.7 million decrease in automotive fluid meters and systems, offset by a $2.8 million increase in all other industrial product lines.

      International sales are comprised primarily of sales of small valves, electromagnetic meters and automotive fluid meters and systems in Europe, sales of 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 and other currencies. Most other international sales are made in U.S. dollars. The Company is able to partially hedge its euro exposure by holding euro-denominated debt. International sales decreased 7.3% to $31.6 million in 2005 from $34.1 million in 2004 due principally to lower European sales, offset slightly by the strengthening of the U.S. dollar versus the euro.

      Residential and commercial water meter net sales represented 73.2% of total net sales in 2004 compared with 72.3% in 2003. These sales increased $17.0 million in 2004 to $150.1 million from $133.1 million in 2003. Unit volume increased in meters utilizing AMR technologies offset by a slight decline in local (or manual) read meters. 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 2003 levels for the sales volumes of Orion^®, the Company’s proprietary AMR system introduced in 2002, which has higher margins than other AMR products.

      In total, the industrial products represented 26.8% of total net sales in 2004 compared with 27.7% in 2003. Industrial product sales increased $4.0 million to $54.9 million in 2004 compared with $50.8 million in 2003. All of the product lines showed growth over the 2003 levels, partially due to the effects of the strengthening euro.

      International sales increased 9.3% to $34.1 million in 2004 from $31.2 million in 2003 due principally to the effects of the strengthening euro. Without the effects from foreign exchange, sales increased 1.9% due to higher sales in Mexico, offset somewhat by lower European sales.

      Gross margins were 34.1%, 32.9% and 32.9% for 2005, 2004 and 2003, respectively. Gross margins increased between 2005 and 2004 due to the higher mix of AMR versus local read meters as well as a higher percentage of Orion^®AMR technology versus other non-proprietary AMR products, offset somewhat by higher metal prices. Gross margins were flat between 2004 and 2003 as a result of a higher mix of AMR sales and better plant capacity utilization, offset by increased obsolete inventory reserves and higher metal and resin commodity prices.

      Selling, engineering and administration costs increased 5.6% in 2005 over 2004 levels due to higher research and development costs, increased costs associated with higher sales, one-time expenses associated with the Company’s 100th anniversary celebration and normal inflationary pressures, offset somewhat by continuing cost control efforts. Selling, engineering and administration costs increased 1.9% in 2004 over 2003

      Interest expense was approximately the same in 2005 as in 2004. This was the net impact of lower debt levels offset by increasing interest rates and a new long-term loan replacing short-term debt. Interest expense decreased $130,000 in 2004 compared to 2003 due to higher cost long-term debt being replaced with lower cost short-term debt.

      Other expense (income), net in 2005 was income of $0.5 million versus an expense of $0.6 million in 2004. This was due primarily to the strengthening of the U.S. dollar against the euro resulting in exchange gains. Other expense (income), net in 2004 was an expense of $0.6 million versus income of $1.0 million in 2003. The 2004 amount included $0.4 million of foreign exchange loss compared to an exchange gain of $0.8 million in 2003. The 2004 exchange loss was due to the strengthening of the euro against the U.S. dollar and its effects on the Company’s foreign subsidiaries.

      Income taxes as a percentage of earnings before income taxes were 41.9%, 46.4% and 43.2% for 2005, 2004 and 2003, respectively. The decrease between 2005 and 2004 was due to increased domestic earnings which somewhat mitigated the increased valuation reserves for the operating losses of the Company’s French subsidiary (further discussed below), slightly lower state taxes and the estimated effects of the Section 199: Production Activities Deduction as permitted under the American Jobs Creation Act of 2004. The increase in 2004 from 2003 was primarily due to increased federal and state tax rates applied to the increased net earnings, and an increased valuation reserve on the operating losses of the Company’s French subsidiary.

      In 2005, 2004 and 2003, the valuation reserves were increased by $1.1 million, $1.2 million and $1.2 million, respectively, due to continued realization uncertainties for foreign net operating loss carryforwards in France. The increases in the reserves were recorded as additional tax expense, which significantly increased the Company’s effective rates over historic averages.

      At December 31, 2005, the Company had foreign net operating loss carryforwards at certain European subsidiaries totaling $9.8 million, of which $9.0 million related to the French subsidiary. The carryforwards have unlimited carryforward periods, which can be used to offset future taxable income at these locations.

      As a result of the above-mentioned items, net earnings were $13.3 million, $9.6 million and $7.6 million in 2005, 2004 and 2003, respectively. On a diluted basis, earnings per share were $1.89, $1.42 and $1.15, respectively, for the same periods.

      The main sources of liquidity for the Company are cash from operations and borrowing capacity. Cash provided by operations in 2005 was $18.4 million, an increase of $12.1 million, or 191.6%. The increase was the net result of increased net earnings, reduced inventory levels and the timing of payments of certain current liabilities, offset by increased receivables. Cash provided by operations in 2004 was $6.3 million, a decrease of $8.9 million, or 58.6%, compared to 2003. The decrease was the net result of a $2.0 million payment to the pension plan, increases in receivables and inventory levels, and reduced payables, offset somewhat by increased net earnings.

      Receivables increased 13.3% between December 31, 2004 and 2005 due primarily to higher fourth quarter sales, and an increase in the number of days sales outstanding, offset slightly by the effects of a stronger U.S. dollar. Inventories decreased 10.3% due primarily to reduced inventory levels at the Company’s

      Capital expenditures totaled $9.1 million in 2005, $5.6 million in 2004 and $5.2 million in 2003. These amounts vary due to the timing of capital expenditures. Included in capital expenditures for 2005 is approximately $1.0 million related to the purchase of a facility in Germany that will be remodeled for occupation in early 2007 and $3.0 million for land in Mexico for a new plant that is scheduled for completion in 2006. The Company expects to spend approximately $3.6 million on the construction of these new facilities in 2006 in addition to its normal level of capital expenditures. The Company believes capacity exists to increase production levels with minimal additional capital expenditures after the completion of these facilities.

      Prepaid pension increased $0.4 million at the end of 2005 compared to the same period in 2004. This was the result of pension expense of $1.6 million and a payment of $2.0 million during 2005. Assumptions for determining pension liability, expected return on assets and annual expense are reviewed and, if appropriate, adjusted annually. The impacts of hypothetical changes in certain assumptions are difficult to determine as economic factors can often impact multiple assumptions and inputs at the same time. The Company believes its current assumptions are reasonable. At December 31, 2005, the market value of the assets in the Company’s pension plan was $46.5 million compared to $45.7 million at December 31, 2004. Included in the Company’s December 31, 2005 prepaid pension balance was $18.9 million of unrecognized net actuarial losses compared to $18.6 million at the end of 2004.

      The amount of net goodwill recorded at December 31, 2005 and 2004 was $6.6 million and $7.1 million, respectively. The net decrease of $0.5 million was due to the strengthening of the U.S. dollar versus the euro.

      Short-term debt decreased $8.7 million in 2005 as the Company obtained a $10 million five-year term loan to replace short-term debt, offset by normal scheduled payments. The increase in payables between years is primarily the result of the timing of purchases. Accrued compensation and employee benefits increased $0.3 million due to increased incentive costs associated with improved sales and earnings levels. Income and other taxes increased $0.8 million as a result of the timing of tax payments.

      Total outstanding long-term debt (both the current and long-term portions) increased $2.6 million as a result of a new $10 million five-year term loan, offset by required payments. None of the Company’s debt carries financial covenants or is collateralized.

      Common Stock and capital in excess of par value both increased during 2005 due primarily to stock issued in connection with the exercise of stock options and treasury stock issuances. Employee benefit stock increased in 2005 due to a new restricted stock program approved by shareholders, offset by a $150,000 payment due to shares released as a result of payments made on the Badger Meter Employee Savings and Stock Ownership Plan (“ESSOP”) loan. Treasury stock increased due to shares repurchased during the year.

      Badger Meter’s financial condition remains strong. The Company believes that its operating cash flows, available borrowing capacity including $35.4 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 will convert short-term debt into long-term debt.

      The Company guarantees 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 are collateralized by the Company’s shares that were purchased with the loans’ proceeds. There have been no loans made to officers by the BMOVT since July 2002. The Company has guaranteed $1.1 million and $1.6 million of the BMOVT’s debt at December 31, 2005 and December 31, 2004, respectively. The current loan matures in April 2006, at which time it is expected to be renewed. The fair market value of this guarantee at December 31, 2005 continues to be insignificant because the collateral value of the shares exceeds the loan amount. It is the Company’s intention

      The Company guarantees the outstanding debt of the ESSOP that is recorded in long-term debt, offset by a similar amount of unearned compensation that has been recorded as a reduction of shareholders’ equity. The loan amount is collateralized by shares of the Company’s Common Stock. Payments of $150,000 and $220,000 in 2005 and 2004, respectively, reduced the loan to $915,000 at December 31, 2005. The terms of the loan allow variable payments of principal with the final principal and interest payment due on April 30, 2008.

      The following table includes the Company’s significant contractual obligations as of December 31, 2005. There are no undisclosed guarantees.

      Other than items included in the preceding table, as of December 31, 2005, 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 2005 Annual Report on Form 10-K. As of the most recent actuarial measurement date, no pension plan contributions are anticipated in 2006 and postretirement medical claims are paid as they are submitted. Postretirement medical claims are anticipated to be $972,000 in 2006 based on actuarial estimates; however, these amounts can vary significantly from year to year because the Company is self-insured.

      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 2005 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, allowance for obsolete inventories, warranty and after-sale costs reserve, and the health care reserve for 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 minimum and maximum amount of anticipated exposure for each account, and then selecting the most appropriate amount within the range based upon historical experience and various other considerations that are believed to be reasonable under the circum-

      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 reviewed in conjunction with applying historical write-off ratios to the remaining balances. The calculation for the allowance for 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 includes known potential problems on past sales as well as historical claims ratios for current sales 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, 2005 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 2006.

      The Company believes it is in compliance with the various environmental statutes and regulations to which the Company’s domestic and international operations are subject. Currently, the Company is in the process of resolving issues relative to two landfill sites. Provision has been made for all known settlement costs, which are not material.

      The Company is a defendant in numerous multi-party asbestos lawsuits pending in various states. These lawsuits assert claims alleging that certain industrial products were manufactured by the defendants and were the cause of injury and harm. The Company is vigorously defending itself against these alleged 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.

      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 systems for water utilities. A number of the Company’s competitors in certain markets have greater financial resources. 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, including housing starts in the United States and overall industrial activity. 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 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, 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, specifically European customers, as most other foreign sales are made in U.S. dollars. 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, 2005 and 2004, 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, 2005 was floating rate debt with market values approximating carrying value. Fixed rate debt was principally two U.S. dollar term loans with a 4.81% and a 5.59% interest rate and a euro dollar revolving term loan with a 3.79% 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, 2005, the effect of a 1% change in interest rates is approximately $88,000 before income taxes.

      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 2005 Annual Report on Form 10-K.

      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, 2005 using the criteria set forth inInternal 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, 2005, the Company’s internal control over financial reporting was effective based on those criteria.

      The Company’s auditors, Ernst & Young LLP, have issued an attestation report on management’s assessment of the Company’s internal control over financial reporting. That attestation report is set forth immediately following this report.

      We have audited management’s assessment, included in the accompanying Management’s Annual Report on Internal Control over Financial Reporting, that Badger Meter, Inc. (the “Company”) maintained effective internal control over financial reporting as of December 31, 2005, 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. 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 management’s assessment and 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, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, 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, management’s assessment that Badger Meter, Inc. maintained effective internal control over financial reporting as of December 31, 2005, is fairly stated, in all material respects, based on the COSO criteria. Also, in our opinion, Badger Meter, Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2005, 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. and subsidiaries as of December 31, 2005 and 2004, and the related consolidated statements of operations, shareholders’ equity and cash flows for each of the three years in the period ended December 31, 2005 and our report dated February 22, 2006, expressed an unqualified opinion thereon.

      We have audited the accompanying consolidated balance sheets of Badger Meter, Inc. and subsidiaries (the “Company”) as of December 31, 2005 and 2004, and the related consolidated statements of operations, shareholders’ equity and cash flows for each of the three years in the period ended December 31, 2005. 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. and subsidiaries at December 31, 2005 and 2004, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2005, in conformity with U.S. generally accepted accounting principles.

      We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of Badger Meter, Inc.’s internal control over financial reporting as of December 31, 2005, 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 22, 2006 expressed an unqualified opinion thereon.

      The Company is a leading marketer and manufacturer of products using flow measurement and control technologies developed both internally and with other technology companies. Its products are used to measure and control the flow of liquids in a variety of applications. The Company’s product lines fall into two general categories, utility and industrial. The utility category is comprised of two product lines, residential and commercial water meters (with various automatic meter reading (AMR) technology systems), which are generally sold to water utilities and constitute a majority of the Company’s sales. Industrial product line sales comprise the remainder of the Company’s sales and include automotive fluid meters and systems, small precision valves, electromagnetic meters, impeller flow meters and industrial process meters (all with related accessories and instrumentation).

      The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries.

      Receivables consist primarily of trade receivables. The Company does not require collateral 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, 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 are valued primarily at the lower of cost or market. Cost is determined using thefirst-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:

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

      Property, plant and equipment and identifiable intangible assets are reviewed for impairment, in accordance with Financial Accounting Standards Board (FASB) Statement No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” 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.

      Intangible assets are amortized on a straight-line basis over their estimated useful lives ranging from 5.5 to 10 years. The Company does not have any intangible assets deemed to have indefinite lives. Amortization expense expected to be recognized is $242,000 in 2006, $221,000 in 2007, $167,000 each in 2008 and 2009, and $146,000 in 2010. The carrying value and accumulated amortization by major class of intangible assets are as follows:

      During 2005 and 2004, the Company tested its goodwill balance for impairment in accordance with FASB Statement No. 142, “Goodwill and Other Intangible Assets,” and no adjustments were recorded to goodwill as a result of those reviews. The amount of goodwill recorded at December 31, 2005 and 2004 was $6.6 million and $7.1 million, respectively. The decrease was due to translation adjustments for goodwill denominated in foreign currencies.

      Revenues are generally recognized upon shipment of product, which corresponds with the transfer of title. The costs of shipping are 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

      The Company estimates and records provisions for warranties and other after-sale costs in the period in which the sale is recorded. 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:

      Research and development costs are charged to expense as incurred and amounted to $5.3 million, $4.6 million and $6.1 million in 2005, 2004 and 2003, respectively.

      Included in other expense (income), net are foreign currency gains and losses, which are recognized as incurred. The Company’s functional currency for all of its foreign subsidiaries is the U.S. dollar, with the exception of Badger Meter France (the French parent holding company of MecaPlus Equipements SAS (MPE)), MPE and Badger Meter Czech Republic, whose functional currency is the euro. A foreign currency gain of $478,000 was reported in 2005, primarily related to the strengthening of the U.S. dollar versus the euro, compared to a loss of $409,000 in 2004 and a gain of $781,000 in 2003 relating to the relationship of the U.S. dollar to the euro.

      The Company has six stock option plans that provide for the issuance of options to key employees and directors of the Company or for which issued options are still outstanding. Refer to Note 5 “Stock Option Plans” for a description of the plans.

      As allowed by FASB Statement No. 123 (SFAS 123), “Accounting for Stock-Based Compensation,” and Statement No. 148 (SFAS 148), “Accounting for Stock-Based Compensation — Transition and Disclosure,” the Company has elected to follow Accounting Principles Board Opinion No. 25 (APB 25), “Accounting for Stock Issued to Employees,” in accounting for its stock option plans. Under APB 25, the Company does not recognize compensation expense upon the issuance of its stock options because the option terms are fixed and the exercise price equals the market price of the underlying stock on the grant date. Pro forma information regarding net earnings and earnings per share required by SFAS 123 has been determined as if the Company had accounted for stock options granted since January 1, 1995 under the fair value method

      The weighted-average fair values of options granted in 2005, 2004 and 2003 were $12.07, $4.27 and $3.02 per share, respectively. The following table illustrates the effect on net earnings and earnings per share if the Company had applied the fair value recognition provisions of SFAS 123 to stock-based employee compensation. For awards granted before December 31, 2005, the Company’s policy is to recognize compensation cost over the explicit service period (up to the date of actual retirement) for stock-based awards subject to acceleration of vesting or continued vesting upon retirement. This policy will change upon the adoption of FASB Statement No. 123(R) (SFAS 123(R)), “Share-Based Payment,” on January 1, 2006 as the Company is required to apply the nonsubstantive vesting provisions of SFAS 123(R) for any awards granted subsequent to adoption. Refer to “Accounting Pronouncements” below for additional information on the effect of SFAS 123(R) on the Company. The following pro forma calculations only include the effects of options granted since January 1, 1995. As such, the impacts are not necessarily indicative of the effects on net earnings of future years.

      On April 29, 2005, a restricted stock plan was approved that provided for the issuance of non-vested Common Stock to certain eligible employees. The plan authorizes the issuance of shares up to an aggregate of 50,000 shares of Common Stock, of which a net of 15,500 were issued in the second quarter of 2005 with a fair value of $36.65 per share. The fair value of the non-vested shares was determined based on the market price of the Company’s shares on the date of grant. This stock award has a three-year cliff vesting period contingent on employment. Compensation expense related to this grant was $126,000 for the year ended December 31, 2005.

      Comprehensive income is comprised of net income and other comprehensive income, which includes foreign currency translation adjustments and minimum employee benefit liability adjustments. Total comprehensive income was $11.2 million and $10.4 million for 2005 and 2004, respectively. Components of accumulated other comprehensive income at December 31, are as follows:

      The $2,024,000 decrease in foreign currency translation adjustments was due primarily to the strengthening of the U.S. dollar versus the euro.

      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.

      Certain reclassifications have been made to the 2004 and 2003 consolidated financial statements and Notes to Consolidated Financial Statements to conform to the 2005 presentation.

      In December 2004, the FASB issued SFAS 123(R), which changed the accounting rules relating to equity compensation programs. On April 15, 2005, the Securities and Exchange Commission provided a phased-in implementation process for SFAS 123(R), which will be effective for the Company on January 1, 2006. Upon adoption, the Company will recognize expense in the financial statements at the time that an employee receives share-based awards, which includes stock options. As allowed by SFAS 123 and SFAS 148, the Company has elected to follow APB 25 in accounting for its stock option plans until the effective date of SFAS 123(R).

      Under APB 25’s intrinsic value method, no compensation cost for employee stock options is recognized. Accordingly, the adoption of SFAS 123(R)’s fair value method will have an impact on the Company’s results of operations, although it will not have a material impact on the overall financial position. The impact of adoption of SFAS 123(R) cannot be predicted at this time because it will depend on levels of share-based payments granted in the future. However, it is believed that had the Company adopted SFAS 123(R) in prior periods, the impact of that standard would have approximated the impact of SFAS 123 as described in the disclosure of pro forma net earnings and earnings per share in the discussion of “Stock Option Plans” above. SFAS 123(R) also requires the benefits of tax deductions in excess of recognized compensation cost to be reported as a financing cash flow, rather than as an operating cash flow as required under the current literature. This requirement will reduce net cash provided by operations and increase net financing cash flows in periods after adoption. While the Company cannot estimate what these amounts will be in the future (because they depend on, among other things, when employees exercise stock options), the amount of operating cash flows

      Prior to December 1, 2005, the Board of Directors had authorized the repurchase of up to 1,200,000 shares of Common Stock. The purchase of Common Stock, prior to the discontinuation of this plan on November 30, 2005, was at the Company’s discretion, subject to prevailing financial and market conditions.

      The Company has Common Stock, and also a Common Shares Rights Agreement, which grants certain rights to existing holders of Common Stock. Subject to certain conditions, the rights are redeemable by the Company and are exchangeable for shares of Common Stock. The rights have no voting power and expire on May 26, 2008.

      Common Stock shares that could potentially dilute basic earnings per share in the future totaled 4,000 and 199,000 in 2005 and 2003, respectively. Such amounts represent stock options whose exercise price was greater than the average stock price for the respective periods.

      In 2003, the Company sold its 15% interest in a Mexican company, Medidores Azteca, SA (Azteca) for the original cost of $75,000. During 2003, the Company sold $512,000 of product to Azteca.

      Short-term debt at December 31, 2005 and 2004 consisted of: