Badger Meter Inc

NYSE:BMI

Earnings Call Analysis

Robust Q3 Performance Sets Ground for Growth

Badger Meter reported a milestone, with third quarter sales soaring 26% to $186.2 million compared to the previous year, driven by robust demand for their digital smart water solutions, advancing their record to an impressive $186.2 million. Total utility water product sales surged by 31%, and flow instrumentation saw a 2% increase, reflecting strong manufacturing output due to better supply chain conditions. Gross margins rose to 39.1%, with earnings per share (EPS) jumping an astonishing 44% to $0.88. Free cash flow improved to $28.4 million, and projections show a robust sales growth outlook, underpinning a strong foundation for profitable expansion into 2024.

Record-Setting Performance amidst Robust Demand

Badger Meter showcased strong operational competence by delivering another record-setting quarter. The company saw growth in sales, operating profit, and EPS as compared to the previous year, underscoring a healthy demand for its digital smart water solutions. Improvements in supply chain dynamics have played a crucial role in enabling this consistent performance.

Sales Soar with Strategic Product Mix

The company's sales surged by 26% to $186.2 million for the third quarter, a significant increase from $148 million last year. This growth builds upon a trend of substantial year-over-year increases, with sales now 60% above pre-pandemic levels in 2019. This represents a compounded annual growth rate of approximately 13%. The utility water products line, which encompasses a suite of smart water solutions, experienced a 31% growth. This included increased demand for cellular Automatic Meter Infrastructure (AMI), E-Series Ultrasonic meters, and software services. Additionally, water quality and pressure monitoring sales also contributed to the top-line expansion. The company's flow instrumentation product line saw a more moderate growth of 2%. Gross profit margin edged up marginally from 38.9% to 39.1%, while operating margins saw a more notable increase from 16.1% to 16.9%, driven by a healthy product mix and efficient execution.

Beyond Meters: A Strategy for Diversified Growth

Although 'meter' is part of the company's name, Badger Meter's growth strategy extends well beyond metering hardware. The company is targeting macro challenges like labor shortages, infrastructure aging, water conservation, and climate change which demand investment in water systems. With an estimated $20 billion global market for its digital water solutions, Badger Meter boasts a broad and customizable product portfolio that promises ample room for growth and expansion both domestically and in select international markets. Further growth is expected from both organic developments and disciplined M&A activities, positioning the company to maintain its value creation trajectory into the remainder of the year and into 2024.

Anticipating Impact from Global Events

Badger Meter is cautiously observing global events, such as conflicts in the Middle East, which could impact its operations and partnerships in the region. Nonetheless, the company's strong order and bid activity coupled with its repertoire of water-related hardware and communication offerings suggest a positive outlook for sustaining future growth.

Stable Pricing in a Complex Economic Landscape

Despite the ongoing challenges of inflation and rising interest rates affecting many industries, Badger Meter has managed to maintain stable pricing dynamics. This is attributed to the company's strategic decision three years prior to adopt a value creation and pricing model, which continues to serve it well in a turbulent economic environment.

Long-Term Growth Expectations

The company's growth prospects are assessed on a 5- to 10-year strategic cycle. It seeks to achieve high single-digit compounded annual growth rates over the long term, despite the likelihood of uneven annual results. While sustaining double-digit growth year-over-year is recognized as challenging, the company values the positive trajectory established over the strategic cycle and remains committed to this growth philosophy.

Book-to-Bill Ratio Indicates Steady Growth

Badger Meter reported that their book-to-bill ratio, an indicator of order backlog versus billings, was slightly above 1 in the third quarter. This implies that the company received slightly more orders than it could invoice during the period, which is a positive sign of the company's order flow and ability to fulfill demand.

Earnings Call Transcript 2023-Q3

[Operator]

Ladies and gentlemen, welcome to the Third Quarter 2023 Badger Meter Earnings Conference Call. [Operator Instructions] 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.

[Karen Bauer, executive]

Good morning, and thank you for joining the Badger Meter Third Quarter 2023 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, executive]

Thanks, Karen, and thank you for joining our third quarter earnings call. The Badger Meter team delivered another record quarter with continued strong sales, operating profit and EPS growth year-over-year. Demand for our differentiated and tailorable digital smart water solutions remains robust and improving supply chain dynamics allowed us to make modest headway into the elevated backlog.

I want to thank all of our employees for their focused efforts in serving our customers. I'll provide an update on the macro environment and market outlook later in the call. For now, I'll turn it over to Bob to go through the details of the quarter.

[Robert Wrocklage, executive]

Thanks, Ken, and good morning, everyone. Turning to Slide 4. Our total sales in the third quarter reached yet another record at $186.2 million, an increase of 26% compared to $148 million in the same period last year. This increase was on top of 15% year-over-year growth in Q3 last year and 13% in the prior year.

To put our multiyear organic sales trend line into perspective, third quarter 2023 sales are more than 60% above pre-COVID-19 -- 2019 levels, which equates to about 13% compounded annual growth on an organic basis. Total utility water product line sales increased 31% year-over-year with broad-based growth across the portfolio of utility smart water solution offerings.

Continued robust order demand and normalization of supply chain conditions resulted in strong manufacturing output. Similar to last quarter, we delivered on meaningfully higher cellular AMI demand, including ORION cellular endpoints, E-Series ultrasonic meters and BEACON Software as a Service revenues.

Additionally, water quality and pressure monitoring sales contributed to the top line growth. Sales for the flow instrumentation product line increased 2% year-over-year with solid demand in water-related markets, partially offset by modestly lower sales associated with deemphasized general industrial applications.

Turning to margins. Solid execution at both the gross margin and [ SEA ] lines contributed to the 80 basis point increase in operating margins in the quarter, reaching 16.9% versus 16.1% last year. Gross profit dollars increased to $15.2 million year-over-year and as a percent of sales increased 20 basis points to 39.1% versus 38.9% last year with higher volumes and favorable product mix contributing to the improvement.

We were pleased with overall gross margins again in the upper half of our normalized range. SEA expenses in the third quarter were $41.3 million, an increase of $7.6 million year-over-year, which included higher personnel-related costs such as headcount, salaries and variable compensation as well as R&D expenses.

The addition of Syrinix with its related intangible asset amortization also contributed to the dollar increase. Despite the higher spend levels to support growth, SEA as a percent of sales declined 50 basis points to 22.2% from 22.7% in the comparable prior year quarter.

While operating income grew 31%, we increased EPS an exceptional 44% to $0.88 in the third quarter compared to $0.61 in the prior year quarter. The delta includes the benefit from interest income earned on our increasing cash balance. And in addition, the quarter's 20.3% income tax rate benefited from discrete equity compensation transactions occurring in the quarter.

We continue to expect our normalized effective income tax rate to be plus or minus 25%. Working capital as a percent of sales was 22.7% compared sequentially to 23.4% last quarter end. While overall working capital, including inventory, has increased in total dollars to support growth, we did see an improvement in inventory as a percent of sales and continue to expect modest inventory reductions as we move forward.

Free cash flow of $28.4 million improved from a year ago, primarily on higher earnings. We remain on track for 100% plus free cash flow conversion of net earnings for the full year.

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

[Kenneth Bockhorst, executive]

Thanks, Bob. Turning to Slide 5. As Bob mentioned earlier, we've delivered meaningful growth over the past several years, leveraging our expanding portfolio of digital water -- digital smart water solutions to solve our customers' evolving water challenges. While the word meter is a part of the Badger Meter name and remains a prominent element of our offering, the growth that we've had and will continue to deliver goes far beyond the meter.

As the macro challenges of labor shortages, aging infrastructure, water conservation and climate events continue to drive much needed investment into critical water systems, Badger Meter's broad portfolio of customizable solutions, spanning metering, sensors, instruments, communication, software and support offerings is uniquely positioned to serve the evolving needs of our utility and other customers.

The total available market globally is valued at approximately $20 billion, giving Badger Meter ample opportunity to continue to grow and expand these offerings in the U.S. and other select regional markets [indiscernible] disciplined M&A investments.

We've demonstrated our ability to capitalize on these growth opportunities and we remain well positioned to further build on our track record of value creation. Looking ahead, we have a constructive outlook for the remainder of the year and see a solid foundation for profitable growth in 2024. We -- as noted in the release, as we close out 2023, we continue to expect solid year-over-year sales growth, taking into account the fewer operating days in the fourth quarter with U.S. holidays.

As supply chain dynamics improved, we've been able to begin improving lead times. These improving dynamics have also aided manufacturing efficiencies, benefiting the gradual margin expansion we've consistently discussed. One additional item to note, we're monitoring the evolving conflict in the Middle East and its potential impact related to partners in the region. Awards, orders and bid funnel activity remains strong, supported by the well-understood macro drivers facing the water industry. The replacement-driven underlying demand activity as well as our ability to leverage our water-related hardware and communication offerings to accelerate software and data analytics across the water ecosystem position us well for future growth. With that, operator, please open the line for questions.

[Operator]

[Operator Instructions] Our first question today comes from Rob Mason from [indiscernible].

[Kenneth Bockhorst, executive]

[Audio gap] I don't think about it in past too. I just think about this. These are things that times and eat that down a bit. I would feel happy about that. Overall, we're extremely excited about order rates. So that optimism has not changed on that time.

[Robert Mason, analyst]

Understood. [Audio Gap] Headwinds that had been out there in commodity costs as well have settled down, just give us maybe a framework for what you're seeing, either on list prices or in particular, just how the RFP and bidding.

[Kenneth Bockhorst, executive]

[Audio Gap] change from what we've talked about in the other quarters. While some things are moderating inflation is still real. There are parts of the economy that's still certainly aren't great as we talked about inflation and interest rates and others, [indiscernible] then for us throughout a difficult operating environment, but largely [Audio Gap]

[Robert Mason, analyst]

[Audio Gap] Which is certainly appreciate it. I did notice in the slide that was back in January, that was at $50 million to $60 million range. Can you just speak to what the dynamic is pushing that up, whether that's all price? Or does that include some blended mix between mechanical and e-meters or just [Audio Gap]

[Robert Wrocklage, executive]

[Audio Gap] numbers current, but there's probably a bit of price increase that's occurred over multiple time frames between those being updated [Audio Gap] being included in that. So I think if that's your specific question, that reflects kind of whatever was in the market at that point in time.

[Robert Mason, analyst]

[Audio Gap] A quick one on the fewer selling days in 4Q. Should we be expecting a sequential decline in 4Q revenue?

[Robert Wrocklage, executive]

Yes. So we don't give guidance, but I think you're walking away with an obvious takeaway, which is with fewer working days, likelihood that that's a potential. That's, I think, effectively what we're saying.

[Unknown Analyst]

All right. Okay. Fair enough. And then shifting gears, could you talk about strategic investments and how we should think about that driving revenue growth?

[Kenneth Bockhorst, executive]

Yes. So I think if you just look at our history in totality, the strategic investments are what have brought us to the point that we're at, whether that was being first in our market with ultrasonic meters or first in our market with cellular radios or bringing the water quality portfolio and developing our own software.

In many cases, it's continuing to invest in keeping and advancing our lead in cellular, keeping or advancing our lead in Software as a Service, our software offering continuing to integrate water quality and Syrinix into the broader portfolio on cross-selling. So the long answer is yes. The short answer is yes.

I mean we continue to follow our capital allocation priorities of number one, R&D investment and priding ourselves and keeping our innovation leader status, increasing dividends annually in line with earnings and disciplined M&A. So that hasn't changed. That's the same as it back.

[Robert Wrocklage, executive]

I think I just -- I'd augment kind of that first capital allocation priority of organic investment in the business. Everyone always thinks of innovation as being R&D, but we equally think of innovation in the space of operational efficiency and capacity expansion. And so we've been investing over the last several years to be able to drive higher capacity and output, which, of course, allows us to then deliver on those higher order rates and higher growth numbers that you're asking about.

So it's equal parts -- I don't know the equal parts, but it's contributory from innovation as well as operational efficiency focus and capital investment to support capacity.

[Operator]

The next question comes from Andrew Krill from Deutsche Bank.

[Andrew Krill, analyst]

I ask first just sales have been very strong for several quarters in a row. And I think you're on track for strong double-digit growth in 2023, and that's on top of basically double-digit growth on prior 2 years. So I am just wondering, is the kind of historical like mid- to high single-digit growth rate for this industry. Is that -- do you think it's structurally moved higher? Or should we expect to kind of go back towards that range again?

[Kenneth Bockhorst, executive]

Yes. So if you went -- if you rewound a couple of years ago, we used to refer to it as mid-single digits. So we have changed into that high single-digit mode. And as you know, we don't provide guidance in the quarter or the annual basis. Things can tend to be uneven at times, but for the most part, through the strategic cycle, we're really comfortable thinking in the high single-digit range year-over-year.

[Robert Wrocklage, executive]

And so when we say high single digit over the strategic cycle, we're talking 5 or 10-year cycle. So to get a compounded annual growth rate of high single digits, there may be years that are up 15%, 16% and there may be years that are only up 5%. So we're simply talking about that kind of trend line over a CAGR style.

So I do think, again, we don't guide obviously. But I think the ability to sustain double-digit growth even in this market, it's not doable, repeatable every year annually over that strategic cycle.

[Andrew Krill, analyst]

Makes sense. And just next, just on like capital allocation, any update on how you're thinking about your approach there just as your cash balance continues to grow and maybe an update on like the deal pipeline or anything you're looking at?

[Kenneth Bockhorst, executive]

Sure. Yes. So the deal pipeline remains strong. We have as we've always maintained over the last several years, a really healthy target-rich environment of companies that are in this water quality space, we'd be certainly interested in building that out more software side, anything that has global footprints in the select regional markets that we're looking at, similar to what [Audio Gap] where value does get driven within our industry, and that's -- [Audio Gap] opportunities in M&A?

[Andrew Krill, analyst]

[Audio Gap] an update on that for the third quarter?

[Kenneth Bockhorst, executive]

Well, yes, so as I talked about with that improving lead time situation, we had a really strong order period that we're really proud of. We just had an exceptionally strong shipment period that was slightly better. and I do mean slightly.

[Operator]

[Operator Instructions] The next question comes from Tate Sullivan from Maxim Group.

[Tate Sullivan, analyst]

A couple of things, I mean, impressive expense control. I mean your revenue growth exceeded my expectations that expenses were under. Can you just talk about maybe the composition in selling and administration expenses? I mean is R&D at higher levels than historically to enter more water quality [Audio Gap]

[Robert Wrocklage, executive]

Yes. I certainly won't dissect the $41 million of SEA, but I think the way to think about that, Tate, is exactly what we've been saying for the last 4 years is that SEA leverage because of our -- I'm going to say a term I hate to say, growth algorithm because of our growth algorithm, we believe, while still being an innovator and doing the things that you talked about, R&D, integrating new businesses that we've acquired, et cetera, we can still do all those great things but grow SEA at a rate slower than sales, and that creates automatic SEA leverage.

I mean we're not more than 3 years removed from a time when we were running at 25%, 26% SEA as a percent of sales. And we just closed the quarter at 22.2%. And I think for the full year, we're in that kind of high 22% range.

So the story of SEA leverage is real improvement over the last 3 years, and we believe to continue that while being steadfast and being invested in organic investment as our capital allocation priority number one. We continue to gain that leverage as a point of operating and EBITDA margin expansion. So there's nothing unique in the third quarter. It's more the continuation of that trend that we've been talking about over the last 3 years.

[Tate Sullivan, analyst]

Great. And then the addressable market slide, thank you for including it. I mean -- and I want to understand the meter market part of that, I mean I would -- if it's fair to categorize mostly the replacement market, how much of the $20 billion -- remaining $20 billion market, I mean, I thought maybe you're creating, so to speak, I mean, are you creating some of the real-time water quality markets and the software markets? Are you replacing existing solutions? Can you talk more about got the pie chart in there.

[Kenneth Bockhorst, executive]

Yes. What's exciting to us, and I know sometimes the acquisitions that we've done can appear small, but given our brand name, our 118-year history, things we've done in the water market, when we add these companies like ATi, s::can and Syrinix, it opens up these much larger markets to us. And as we continue to integrate and develop software, it opens up these other markets to us.

We do tend to enjoy and look for niche opportunities within these spaces. We're not looking to follow some of the giants in some of these spaces that have established markets that are more difficult to get into, we're, for example, in water quality. [ Hach ] is a really strong, great business and there's -- but there's room for several other technologies and everyone to be successful in a wonderfully large growth market Welcome.

[Operator]

[Operator Instructions] As we have no further questions, I'll hand the call back to Karen Bauer for any concluding remarks.

[Karen Bauer, executive]

Thank you, operator. Thanks, everyone, for joining our call today. For your planning purposes, our year-end call is tentatively scheduled for January 26, 2024. I'll be around all day to take any follow-up questions you have. Have a great day.

[Operator]

This concludes today's call. Thank you very much for your attendance. You may now disconnect your lines.