Badger Meter, Inc. (NYSE:BMI) Q4 2022 Earnings Call Transcript

Badger Meter, Inc. (NYSE:BMI) Q4 2022 Earnings Call Transcript January 27, 2023

Operator: Ladies and gentlemen, welcome to the Fourth Quarter 2022 Badger Meter Earnings Conference Call. As a reminder, today’s conference is being recorded. It is now my pleasure to turn the conference over to Karen Bauer, Vice President of Investor Relations, Corporate Strategy and Treasurer. Please go ahead, Ms. Bauer.

Karen Bauer: Good morning, and thank you all for joining the Badger Meter fourth quarter and full year 2022 earnings conference call. On the call with me today are Ken Bockhorst, Chairman, President and Chief Executive Officer; and Bob Wrocklage, Chief Financial Officer. The earnings release and related slide presentation are available on our website. Quickly, I will cover the safe harbor, reminding you that any forward-looking statements made during this call are subject to various risks and uncertainties, the most important of which are outlined in our press release and SEC filings. On today’s call, we will refer to certain non-GAAP financial metrics. Our earnings slides provide a reconciliation of the GAAP to non-GAAP financial metrics used. With that, I’ll turn the call over to Ken.

Kenneth Bockhorst: Thanks, Karen, and thank you for joining our fourth quarter earnings call. The Badger Meter team finished the year with another strong performance, delivering solid revenue growth while achieving yet another positive book-to-bill ratio. Despite persistent macro challenges with sustained inflation and sporadic component shortages throughout 2022, gross profit margins have consistently been within our tightened normalized range of 38% to 40% and we improved SEA expense leverage during the year. We generated robust cash flow in 2022 and utilize that growth capital to acquire Syrinix in early January 2023, adding to our comprehensive hardware enabled software offerings. I’ll talk more about Syrinix provide a recap for the full year and discuss our outlook later in the call. But for now, I’ll turn the call over to Bob to go through the details of the quarter.

Robert Wrocklage: Thanks, Ken, and good morning, everyone. Turning to Slide 4. Our total sales in the fourth quarter were $147.3 million, sequentially similar to last quarter’s record level, and 8.5% higher than the $135.7 million in the same period last year. On a constant currency basis, excluding the impact of the stronger U.S. dollar, sales increased 10%. Total utility water product line sales increased 9% year-over-year against a difficult prior year comparison. Broadly, we experienced continued strong order demand, ongoing price realization and growing adoption of our cellular AMI solution with higher Orion cellular endpoint and Beacon Software as a Service sales. Additionally, we saw increased sales of meters, including E-Series ultrasonic meters.

The strong demand environment resulted in another record utility water backlog exiting the year even with the strong top line sales performance. Sales for the flow instrumentation product line increased 8% year-over-year, led by solid growth in water related markets. The impact of the stronger U.S. dollar was most meaningful to this product line with constant currency growth of just over 10%. Order trends remained steady with water related applications outperforming the more general industrial end markets. While we are very excited about our growth expectations for both the near and long term, we do anticipate that the rate of quarterly sales growth in 2023 will moderate from 2022. Turning to margins. Gross profit as a percent of sales in the fourth quarter was 38.7%, consistent with the prior quarter and again, in the middle of our normalized range as anticipated.

While favorable structural mix trends continued, the impact of inflation across various input costs remained a stubborn headwind. Case in point, pick up any copper price graph, and you can see an example of the type of volatility and unpredictability inherent in the inflation challenges facing nearly all industries. After peaking around $4.90 a pound last spring, copper settled back into the $3.50 per pound range over the past six months or so. However, we now are back to over $4.25. While we can’t fully control these types of input costs, we are managing what is within our control, which includes continuing our value-based pricing rigor. We remain committed to our normalized gross margin range and are confident in the overall margin resiliency of our business model.

SEA expenses in the fourth quarter were $34.5 million, an increase of approximately $2.5 million year-over-year due primarily to higher personnel and incentive compensation costs, research and development spend and travel. As a percent of sales, SCA was 23.4%, a 20 basis point improvement from 23.6% in the comparable prior year quarter. Sequentially, SCA leverage did worsen 70 basis points as our robust cash flow in the fourth quarter resulted in higher incentive compensation accruals at year end. We expect SCA spend in dollars for 2023 to increase as a result of inflation and ongoing growth investments, yet we continue to endeavor to improve SEA leverage as a percent of sales as just one of the levers for future margin enhancement. The income tax provision in the fourth quarter of 2022 was 23.4% compared to 24.5% in the comparable prior year quarter.

Photo by RephiLe water on Unsplash

In summary, consolidated EPS was $0.60 in the fourth quarter of 2022 compared to $0.59 in the prior year comparable quarter. Working capital as a percent of sales was 22.2% at year-end compared to 23.8% at the end of Q3 and down from 24.5% when we started the year. While inventory has increased in response to supply chain complexities, the corresponding payables increase, coupled with receivables collection quality resulted in the net overall improvement. Fourth quarter free cash flow of $28.5 million was higher than the prior year’s $26.2 million, the result of our effective working capital management activities. For the full year, free cash flow was $76.6 million, and free cash flow conversion of net earnings was 115%. This represents the fifth consecutive year of greater than 100% conversion of net earnings.

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

Kenneth Bockhorst: Thanks, Bob. Turning to Slide 5. I want to spend a few minutes on our recently announced acquisition of Syrinix and how we believe it expands the value of our smart water solutions portfolio. Syrinix brings additional capabilities to our industry-leading offerings in the form of pressure (ph) monitoring hardware and software. Their patent protected and innovative time synchronized high-frequency pressure monitoring and acoustic leak detection complements the existing pressure monitoring capabilities available in our E-Series ultrasonic meters. Syrinix has a history of success with network monitoring installations across a variety of utilities, most notably in the U.S. and U.K. Of keen interest to Badger Meter is their radar software, which adds to the scope of real time and actionable data and analytics for utilities to improve their operations.

For example, time synchronized pressure data allows for proactive versus reactive strategies to address pipe burst and other leagues, saving precious time, money and water loss. Additionally, pressure and water quality sensors can work in tandem. For example, in situations where a cracked pipe is identified as a result of contaminant infiltration. In fact, Syrinix has worked closely with the ATI Water Quality team over the years. From a financial standpoint, this technology startup has seen steady growth, albeit from a very small base. Our acquired revenues are a few million dollars, and it will start up modestly dilutive to earnings, given the pre-profit position upon acquisition and future amortization of purchased intangibles. We believe over the long term, adding the Syrinix capabilities to our comprehensive and tailorable digital solutions will continue to competitively differentiate Badger Meter in the market.

Taking a look back at fiscal 2022 and the past several years overall here on Slide 6, we have distinguished our performance by executing our strategies exceptionally well in the face of a multitude of macro challenges. As noted in the release and outlined here, in 2022, we delivered 12% overall sales growth and 14% utility water product line growth, grew orders in backlog to new record levels, generated nearly $34 million in software revenues, grew operating profit 11% in the face of unprecedented inflation and delivered 115% free cash flow conversion of net earnings. Looking at just a few of the longer term accomplishments relative to our strategic growth goals. We’ve grown our utility water business at an accelerating rate over the last three years.

Increased software as a sales revenue at a 45% growth CAGR, reaching 6% of revenue in 2022, even with a sizable increase in product sales. We reduced our primary working capital as a percent of sales, freeing up capital by installing a focused continuous improvement mindset to working capital management, all of which enabled us to generate nearly $240 million in free cash flow over the past three years with an average free cash flow conversion of 137%. Of that cash, we deployed nearly $100 million inclusive of Syrinix, three strategic tuck-in acquisitions, adding water quality and pressure monitoring capabilities to our smart water solutions. We returned nearly 30% of that cash to shareholders in the form of dividends, achieving dividend aristocrat status with a track record of 30 years of consecutive annual dividend increases and we continue to invest in R&D and innovation to build on our leading portfolio of smart water solutions.

I couldn’t be more proud of the team’s achievements. Finally, turning to our outlook. I remain excited about the opportunities ahead. At a macro level, Badger Meter is uniquely positioned with a broad and expanding portfolio of smart water offerings. This includes our industry-leading cellular communications, real-time water quality and pressure monitoring as well as tailorable software to enable customers to be more efficient, resilient and sustainable with their water systems. Our replacement driven demand macro AMI adoption drivers and growing proportion of stable SaaS revenue are supportive of durable multiyear growth against an uncertain economic backdrop. We continue to remain constructive on the bid funnel and order rates with record orders in the fourth quarter and a record backlog, which bodes well for future sales growth.

I’m also encouraged by the current trajectory of supply chain easing. Coupled with some anticipated leveling off of input cost inflation and continued price realization, this should bode well for gradual gross improvement — gross margin improvement in 2023. Our cash flow generation and debt-free balance sheet provide us with ample capacity to execute our capital allocation priorities, including an attractive funnel of organic and inorganic strategic growth investments. I want to again thank the entire Badger Meter team for their tremendous efforts and accomplishments in 2022, and I look forward to executing on the many opportunities ahead. With that, operator, please open the line for questions.

See also 15 Most Undervalued NASDAQ Stocks and 12 Cheap Bank Stocks To Buy.

Q&A Session

Operator: Absolutely. Our first question comes from the line of Nathan Jones with Stifel. Your line is now open.

Nathan Jones: Good morning, everyone.

Kenneth Bockhorst: Nathan.

Nathan Jones: I do like that Slide 6. I think the chart there of working capital to sales coming down and especially the free cash flow conversion over the last couple of years with all these supply chain challenges are pretty impressive. Maybe you could talk about — a little bit more about the supply chain easing, what you’re seeing there, what you’re expecting to see there. No doubt all of this supply chain disruption has had a negative impact on the productivity within your facilities. Maybe talk a little bit about what that impact is being, what kind of margin expansion you might be able to see as you improve productivity with more reliable supply chains?

Kenneth Bockhorst: Yeah. Thanks, Nathan. Yeah. So supply chain, as we’ve talked about, I think, in the last couple of quarters, it continued to improve again. I wouldn’t say that we’re completely out of the woods yet across the entire industrial space, still seeing some challenges with electronics here and there. But for the most part, definitely in a better position than we’ve been and expect that to continue to improve. You’re right. The supply chain complexities certainly have added a lot of inefficiencies and other issues throughout our facilities, but we’ve handled it very well. And I expect to see some improvement there, but nothing that I think you can model as a huge improvement.

Robert Wrocklage: Yes. I think the takeaway, Nathan, should be exactly what within the — sorry, in the prepared remarks, which is with that supply chain easing continuing with the opportunity for greater efficiency, we’re still staying resolute in our normalized margin range, but we would expect a modest improvement in 2023 versus 2022.

Nathan Jones: And you talked about expectation some flattening inflation and some additional price reading through in 2023. Can you give us whatever color you’re prepared to on price cost in ’22? And then what your expectations are in ’23? Should price/cost be better in ’23 than it was ’22, was the same?

Robert Wrocklage: Yeah. So a lot of moving pieces there. As you know, when we talk about price cost, oftentimes, in addition to what people most traditionally think of, there’s always a mix or an average sell price dynamic that plays into that. That said, I think the way we would look at 2023 simply versus ’22 modestly better price/cost dynamics, 2023 versus 2022. We know we’ve had leading and lagging effects of price actions relative to cost. But that’s why we’re still staying resolute with that targeted comfort zone or margin profile of 38% to 40%.

Nathan Jones: Great. Thanks for taking my questions. I’ll pass it on.

Operator: Thank you, Mr. Jones. Our next question comes from the line of Thomas Johnson with Morgan Stanley. Your line is now open.