Q3 2022 Badger Meter Inc Earnings Call
Infrasonic meters Orion cellular radio endpoints and Beacon software as a service sales.
Utility water order rates and bid activity continue to be strong and as we noted last quarter. They have not moderated despite the slowing macroeconomic environment.
Even with the mid teen sales growth, we exited the quarter with a strong utility water backlog.
Sales for the flow instrumentation product line increased five 3% year over year led by double digit sales growth in water related markets such as HVAC.
The impact of the stronger U S. Dollar was most meaningful to this product line with constant currency growth of just over 9%.
Order trends remained steady with water related markets outperforming the array of industrial end markets served.
As we look to Q4, we expect the rate of growth to moderate on more difficult year over year comparisons. We also want to remind everyone that due to holidays. There are about 5% fewer shipping days sequentially in the fourth quarter and that the challenged operating environment persists.
Turning to margins as Ken noted, we were pleased with the operating earnings growth of 23% and operating margin improvement of 100 basis points year over year to 16, 1% from 15, 1% in the comparable quarter last year.
Gross profit as a percent of sales in the third quarter was 38, 9% in the middle of our normalized range.
While a favorable product mix trends continued the impact of persistent and widespread inflation across various material components logistics labor and other input costs remained challenging as we anticipated.
Input cost escalation on components that were previously in tight supply are now becoming more visible in our cost structure, such as certain electronic components and battery materials.
Copper pricing dynamics represents another example in.
In addition to the normal one quarter lag and margin realization are recycled brass input costs have not yet ease to the same extent as LMA quoted copper prices.
Given the acute and dynamic nature of the inflation challenges, we continue our pricing rigor integrating modifications in accordance with the value we deliver to customers. We remain committed to our normalized gross margin range and we remain confident in our overall margin resiliency of our business model.
SEC SEC SCA expenses in the third quarter were $33 7 million, an increase of approximately $2 $2 million year over year, due primarily to higher personnel costs research and development spend and travel.
As a percent of sales was 22, 7% a 200 basis point improvement from 24, 7% in the comparable prior year quarter.
As we have previously discussed the sales leverage inherent in our business model provides us with operating margin durability.
The income tax provision in the third quarter of 2022 was 25, 1% compared to 18, 3% in the comparable prior year quarter, which included a discrete tax benefit associated with equity compensation.
Consolidated EPS was a record 61 in the third quarter of 2022 up 13% from 54 in the prior year comparable quarter.
Year over year, EPS growth was 22%, excluding the 4% EPS discrete benefit in the prior period tax rate.
Free cash flow of $21 $9 million was $8 million higher than the prior year's $13 9 million due to higher earnings and working working capital timing between years.
Working capital as a percent of sales was 23, 8% at the end of the third quarter, which is consistent with the prior quarter end and down from $24. Five when was 24, 5% when we started the year.
On a year to date basis, our free cash flow conversion of net earnings is now right around 100% and we anticipate that we will meet or exceed our 100% plus goal as we finish out the year.
With that I'll turn the call back over to Ken.
Thanks, Bob turning to slide five I wanted to spend just a few minutes today on our industry, leading cellular communications technology.
You may recall back in early 2019, we announced the Columbia, South Carolina Ami wind, while we normally don't announce specific wins, we did announce this one for a couple of reasons.
First to highlight the commercial success of our then newly launched LTE cellular endpoint and second to reinforce that mechanical metering technology has been and will continue to be an important choice for utilities.
Last month, we celebrated the completion of that Columbia, Ami deployment, which you can watch on the city's Facebook page with the link on this slide.
The collaborative efforts of our team the city and other partners was evident in the demonstrated outcomes, including a reduction in truck rolls improved customer service rapid leak detection and as the city described it has changed the way we live as a utility.
We routinely speak about our nearly decade of expertise with cellular AMRI, including the flexibility resiliency and security of our infrastructure free solution.
But having a customer speak to how our solution is digitally transforming their operations to drive greater efficiency and sustainability through data insights truly validates our industry leading differentiated solution.
Turning to the current environment and outlook here on slide six in summary, we are confident in our competitive position and the underlying driver supporting our markets.
With continuing strong order rates and a robust backlog, we remain confident that our exceptional customer support and winning portfolio of digital solutions will provide sustainable growth.
Badger meter is uniquely positioned with a full line of smartwater offerings, including market, leading cellular communications water quality monitoring and Tailorable software to enable customers to monitor manage and support operational efficiencies and sustainability throughout the water distribution system.
We have differentiated our performance by mitigating the impacts of ongoing material cost increases supply chain disruptions and logistics availability in support of our customers.
As we discussed last quarter, our business model remains resilient, especially in times of potential economic softening.
A replacement driven demand secular ami drivers and growing proportion of stable SaaS revenue are supportive of durable multiyear growth against the backdrop of evolving economic conditions.
We have ample capacity to execute our capital allocation priorities, which includes the recently announced increase of our annual dividend as well as an attractive funnel of strategic growth investments I want to again, thank the badger meter team around the world for their efforts meeting the needs of our customers with that operator. Please open the line for questions.
As a reminder, if you'd like to ask a question today. Please press star followed by one on your telephone keypad now.
To ask a question. Please ensure your headsets fully kicked in in a muted locally.
One just telephone keypad.
And our first question today comes from Nathan Jones from Stifel.
Please go ahead your line is open.
Good morning, everyone.
Hi, Nathan.
I wanted to start off with the question around supply chain.
I think you're calling the disruptions you bit more sporadic now.
I'm just interested to hear kind of how much is that holding your production back like it would nice supply chain challenges and you <unk>.
<unk> to produce X.
Quarter, we at 90% of X, 80% of <unk>, 99% of X.
How much is that causing you a problem at the moment with just with throughput.
Yeah as you can imagine there is no easy answer to that question, because whether from quarter to quarter.
The disruption can be on one specific product line that wasn't an issue last quarter versus one thats in the backlog in and what I would what I would say as well.
We're very proud of our growth it.
It would be difficult to continue to grow mid teens to begin with so right. So we've got this great growth trajectory, we've got a strong backlog.
Overall supply chain is getting better it's easy for me to say our supply chain people are still fighting the battles but.
We're certainly as I said last quarter and the quarter before that we're in a better space now than we were before.
But it still has hampered some some growth for sure.
Okay I guess.
Second question.
Volume tends to be fairly.
For me eight years for the industry as a hall.
You guys have seen continued growth.
<unk> the second quarter of 2000.
Sequentially just about every quarter, it's continued to get revenue continue to go higher.
Can you talk about that.
The impact of may be impacted price to the extent that you're willing to disclose that as kind of a thing clearly that you or your average selling prices going up here youre more extensive product staying in the ones that are seeing high growth.
Yes, I'll go first and then I'm sure Bob will add in here, but.
We certainly are seeing growth in volumes Valley, if you break that into a couple of different things. We always talk about the fact that the meter portion of the business is replacement driven and those those those quantities are pretty static from year to year, They don't really increase or decrease.
We are absolutely seeing.
Really exciting volume growth when it comes to the cellular radios that we've talked about and then of course, the 100% attachment rate to software. So we're seeing really strong very durable software growth that comes.
Along with the Orion cellular growth, we're excited about the activity and the growth we've seen in the water quality acquisitions that we've done.
And year over year influence fermentation, we've done well also so I think from a volume point of view.
I think part of it has been that our portfolio is very strong and our execution is is differentiated so.
I'm not sure how far Bob wants to go on price, but volume has been a really strong driver here not just price I think and again when we think of price. Obviously, we do think about the technical reactions to price cost price cost dynamics, but largely we think of average sell price increase and so well, let's say in the metering portion of the portfolio at least on the Mccann.
<unk> side, there might not be unit growth. There is an average sell price from the conversion to.
Static metering and so that we can we've called that structural mix for a long time that structural mix as evident but as Ken alluded to it isn't just structural mix. It's also volume gains primarily in the category of products.
Do you, but do you guys. I mean, you have a competitor that had similar challenges than you have do you believe you are picking up market share here and do you believe that market share is sustainable or transient.
I would say on the Ami side.
Especially when we talk about the cellular leading solution and software, we absolutely are picking up market share and it's totally durable and and and locked in.
Okay. Thanks, very much for taking my questions.
Youre welcome.
The next question comes from Connor Lynagh from Morgan Stanley . Your line is open. Please go ahead.
Yes. Thanks.
I just wanted to put a bit of a finer point on some of the supply chain commentary it sounds like things got a little bit better, but I guess, what I'm trying to understand is.
A pretty strong sequential growth that you saw was that more a result of supply chain using was that more result of underlying demand increasing that's hard to answer but just high level. How do you think about that.
Yes, I would.
I could answer it both but I will say that that a portion of it has been in some of the product lines that were say a little more growth we've had better supply chain than we had in previous quarters I would say specific to the sequential step change from Q2 to Q3, it would be more in the category of supply.
And availability improvement than it is demand I think if you look longer term over the cycle right. The six quarter cycle. We keep talking about then it's more about demand step change improvement, obviously with intermittent supply chain throughout that period.
Okay got it and then just thinking through sort of incremental margins I mean, it would seem that you would you would generally be seeing a step up versus historical trend as supply chain continues to ease, but then again maybe.
Got a bit of positive mix, maybe thats, what youre alluding to there. So could you just help us think through the next few quarters here.
Is there any big deviation, we should think about how profitable that incremental revenue is going to be.
I would say historically, we've talked about incremental margins in that 20% to 25% range I don't think theres anything that changes that.
That would be kind of how I would how I would think about it.
And I'm, saying that on a short term basis not on a long term basis.
Yes, I think if you think just in terms of margin performance relative to that.
We're really focused on that normalized range, we've been really laser focused on that 38% to 40% range at least from a gross margin performance on a incremental margin perspective, we're talking about that 20% to 25% range.
Right right, Okay, and last one on supply chain just as.
As things.
We do continue to normalize.
Do you have a lot of working capital you want to pull out of the balance sheet or do you feel like it's the right place given where demand is.
Sure.
Yes, so I would.
Start by saying I'm, obviously really proud of the working capital performance that we've had here for several years.
In the past couple of quarters, certainly are showing that this year, we're still strong, but there's absolutely opportunity in inventory.
As and when the supply chain normalizes, we certainly have opportunity to take things out.
Yes, I would say again, if you if you look at our working capital journey over time.
Go back two three years ago, we were running working capital as a percent of sales in the high <unk> 'twenty 'twenty eight 'twenty, 9% high <unk>, we've obviously been able to stabilize that kind of mid to low twenty's right now we're running at 23, 8% I would say.
We're able to ever lap supply chain.
There's opportunities to improve that but I don't ever see that going 20% or below so.
It's consistent with our continuous improvement philosophy, the ability to continue to lever there is an opportunity right now as Ken alluded to its inventory that's.
On a broader scale inventory would be the target on a one quarter scale I would say would be the target we've got a slightly elevated level.
Relative to history that I think will will recover here in the fourth quarter.
Alright, Thats great color. Thank you very much I'll turn it back.
The next question comes from Andrew Buscaglia from Devin Bug Andrew Your line is open. Please go ahead.
Hey, good morning, guys.
Andrew.
So you talked a little bit about the dynamics around demand price volume and maybe some being being able to meet demand.
This quarter.
And generally like that that that mid teen growth I.
I think people are trying to gather how sustainable it is and obviously that's going to level out but.
I wanted to hear a little bit more about what maybe your customers are saying and what the.
Types of order then order activity Youre seeing there maybe.
Ill provide some insight into.
Yes, the sustainability above kind of above average growth rate for you guys.
And maybe comment on like what Youre seeing with the water infrastructure stimulus.
That will play into things over the next year.
Sure Yeah. So I'll go first and then.
Lots of add on.
He will do so, but yes first of all the <unk>.
Thing about the infrastructure Bill as we've talked about many times that can be helpful for us, but when you look at the macro drivers, particularly around Ami and in real time water quality monitoring.
The macro drivers are there for those businesses with or without infrastructure. So when we've been out at the <unk> trade show in June when we've been at Westpac here, most recently and we're talking with consultants and talking with customers.
The engineering pipeline the upfront planning is still very resilient our bid funnel is as strong as it's ever been throughout the cycle. Obviously, our order rates you can see very clearly are extremely strong as we continue to ship in.
Mid teens I think this year, we're up roughly 16% and.
And utility yet we keep booking more backlog. So so we're not hearing anything that looks like a slowdown.
In general the utility.
Utility World feels really strong.
Hmm.
Okay. So.
Yes, maybe.
I mean, the demand outlook.
It's positive.
In the near term.
Maybe Bob you talked about.
A lot a lot of nuances around the input cost.
So I'm getting about or something not yet.
Are you trying to say like I said Theres still room for improvement on that.
That side of thing yes.
You mentioned there.
Well I think if we just if youre generally speaking towards commodity pressures right within the prepared remarks, I think we're signaling is that while the whole world seemingly thinks inflations easing. It is still real and we're certainly seeing that on electronics and battery components and otherwise the other comment we specifically made related to copper.
So as everyone knows kind of copper at all time highs in the earlier part of this year leveled out over the balance of second and third quarter.
As we've typically signal that's about a one period lag until we realize that benefit in our margins. So there was not a whole pronounced effect to that in the third quarter. We would expect to start seeing that in the core in the fourth quarter. However.
I would just point out that whereas if you just look at copper as a commodity listed price change it's down 25% from highs are are purchased component is brass ingot, which is a recycled product, which hasn't seen that same level of price declines. So that's simply a signal that that benefits. The copper will be smaller than maybe if you just looked at it on a piece of paper.
And a reminder that of course, our exposure to copper here.
Is not what it used to be say five years ago now that we're selling a broader array of choice matters for products now that we're selling more radios and communications water quality software et cetera, our exposure is lighter, but it is still an influence on what we are.
And what we're expecting moving forward.
Okay that help unpack the prepared comments.
Yes very much.
Maybe it is not a lot.
Adding on that you guys have done a great job with gross margins and probably the top of it.
Period in recent history that you guys have made.
And then you've got some interesting acquisitions rolling through that are going to be higher margin. So let me come out on the other side of it.
Question here, but.
Why don't you hit me up or above the high end of that band.
Things normalize.
Of that 40% gross margin like why is that not.
Possible.
Well, so so I'm just going to add.
Andrew with everything Thats happening right now and just everything that we're seeing it's just hard to do.
Obviously, we have total confidence in our average sell price average margin uplift story, our software growing as a percent of business.
We absolutely have complete confidence in the fundamentals.
Improved margin its just right now with everything that we're seeing.
It's difficult to talk more than.
What we're going to see over the next quarter or two yes the difficulty.
Difficulty is predicting that point of when we're back to normal at the same time I would point out and I think this is clear in the results at least if you looked at the last three quarters, we've long been talking about the ability to leverage FCA as a percent of sales and that has played out in spades. The last three quarters, and we would expect that ability to exist moving forward. So it's not I don't.
Understand gross margin gets all the focus but when you look at op margin and EBITDA margin improvements, it's two levers and one is producing now and one has produced in the past and obviously, we're looking to get them hitting on both cylinders at the same time, but it's two levers it's not just one.
And adding to that a little bit so the ASC. The SBA leverage is going to be durable during that that we can do now in an inflationary environment and we will continue to do that.
When the inflationary period stops so.
Yes, okay.
Alright, Thanks again, Bob I appreciate it.
You bet.
The next question comes from Rob Mason with Baird. Please go ahead. Your line is open.
Yes, good morning.
My question was.
Good morning, Ken.
My question was around capacity expansions I know that was a topic that.
Bob I think you briefly broached last quarter that it was.
Maybe being considered in the future just given the strength of the order pipeline as you continue to see it.
I don't know if theres any update there.
That you can provide but I'm also just curious.
How long does it typically take badger to add capacity of the type that you might be contemplating in that scenario.
So a couple of quick reactions, yet last quarter, we did signal that we're thinking about capacity more and youre exactly right in large part that's been a function of our success not only the demand environment the bid funnel, but what we expect moving forward and quite frankly, our aspirations not just here at home in the North American market.
But certainly in the rest of world.
That comment was largely to signal a modestly higher level of capex not to necessarily signal.
The development of Greenfield spaces, or the creation of new facilities. So here's the fundamental answer to your question our maintenance Opex Capex Hasnt changed.
We will continue to invest in expanding capacity, but think of that as more throughput optimization, eliminating bottlenecks in production, whether that's testing capacity versus production capacity. So the comment is not necessarily about developing brand new greenfield space.
To your earlier question then the impact is relatively immediate with those investments. This isn't a two year three year four year journey. These are.
Inside existing four wall type improvements that simply come with a higher degree of Capex and where we've been running.
A specific example would be back Rob in 2020 when when.
When we had COVID-19 going on and people Werent working but we still had strong demand for our cellular offering or when we saw supply chain disruptions on the electronics and we couldnt deliver.
In the early stages of supply chain, we made an investment in 2022 to upgrade our cellular capacity.
By 50% at that time, and that's been a huge driver. So this is just one example of what we're talking about here is it.
It costs, a little bit, but we certainly have a handle of what we need to do and get really near term benefit from it.
Okay. Okay, that's very helpful.
Ken.
You mentioned earlier, just clearly the macro drivers around your business firmly in place and I think water conservation has always been a secular driver within that but.
But I am curious just specific to that particular area around conservation if youre seeing anything in your utility customers.
Where they are taking on a higher urgency around compliance.
If theres anything youre detecting in your bid conversations or even I guess regional demand patterns that would suggest that and then.
If that's the case.
How would.
How would you position badger relative to competitors in terms of ability to respond to that with your offering.
Yes, so so first off on the Ams side, we've traditionally talked about non revenue water and that obviously is a big driver for AMRI and our space. Now you also hear people refer to things such as unaccounted for water. So if you're in an area that's more water stressed.
You worry about losing at all whether youre getting paid or not right you've got to have it. So conservation is a big deal Ams helps with that.
Just in terms of whether it's ESG and how much youre doing in greenhouse gas emissions. If you look at the Columbia projects, we talked about in the website their truck rolls are reduced dramatically. So it saves on manpower's saves on driving driving all over the city to try to do things so our self.
Ams offering as well as our online water quality monitoring is square in the center of what people are trying to do within utilities for for conservation and we are again certainly the leader on the cellular side of Ami.
With a very long head start.
Is there.
Again, just around the urgency is there.
Distinction to be made there that.
Cellular could perhaps be deployed more more quickly to address that then.
Other networks other types of networks.
Yeah, absolutely so from a cellular point of view.
If you wanted to monitor the larger users in your city commercial we could ship your radios now and you could hook them up today and you could be monitoring them tomorrow.
Nobody is going to do that with a fixed network nobody's going to do that with any other option other than our cellular offerings. So so it's very quick and you can do specific things right away you can deploy a city. So much faster because you don't have to wait a year to build out a fixed network.
It's absolutely the most efficient way to get benefit from your Ams solution.
Barr Nunn.
Yes, okay. Okay very good thank you.
Youre welcome.
The next question comes from Tate Sullivan of Maxim Group. Your line is open. Please go ahead.
Hi, Thank you and good morning.
I think.
Starting on your comments on SG&A leverage I think in the past you talked about SG&A as a percent of revenue of about 25 26 and also I think you are hiring people based on your general presentation. On your website can you talk about I mean do you have a current a new target for SG&A leverage given are you indeed.
Okay.
Great.
Yes, so the 'twenty five 'twenty six comment was made I would argue 18 to 24 months ago Post acquisition. So just as we were doing the <unk> and <unk> acquisitions.
Signaled consistently our ability to lever that yes, youre exactly right.
To invest in the business. So this isn't a financial maneuvering to choke FCA to produce a result, we're still investing in people. We're investing in products. We're investing in R&D that is what has gotten us to where we are today. So while remaining steadfast in that investment we've simply been able to lever that sci, meaning gross sales at a at a rate faster.
So we ran the last three or four quarters in the.
2022, 23% range.
While we won't guide certainly.
I think what you've seen in the recent past as a relative degree of where we're at.
Great. Thanks, and also on the international markets, just if you can comment.
You pointed.
Pointed out potentially targeting UK and middle East with markets that combine both smart meter and industrial applications can you talk about what are the what country what types of infrastructure countries have when they have with smartwater and industrial applications.
What differentiates U K and the middle East.
In terms of expansion, yes, so, yes, so U K middle East and there's some other markets as well, but there are certainly markets in the world that have the same problems that we solve here.
In North America.
And they have characteristics, where theyre looking for the best technology at reasonable prices and those are the markets that that we find to be the best obviously for us to work in the UK being one of those really good strong market inverse easy to do business in.
Middle East also investing heavily in Smartwater and looking to do the best solutions.
There's certainly pockets of Europe that fall into that space. So we have definitely not changed our.
R R <unk>.
Desire to do more in international.
We're balancing that at the same time, though of taking advantage of being the leader and the best Smartwater market in the world already.
Okay, great. Thank you very much.
Sure.
As a reminder, if you'd like to ask a question that star followed by one on your telephone keypad.
<unk>.
Yeah.
As we have no further questions I'll hand back to Ken for concluding remarks.
Sure.
Great. Thank you operator, one final item dimension today, we published within the investors section of our website a supplement to last year's report by our board of directors addressing the topic of board diversity.
Supplement outlines the further progress Badger meter has made during the past year on our diversity journey.
Encourage you to read that report and please feel free to reach out to me with any questions or comments.
Thanks for joining our call today for your planning purposes. Our year end 2022 call is tentatively scheduled for January 27.
Be around all day to take any follow up questions you have and have a great day.
This concludes today's call. Thank you very much for your attendance you may now disconnect your lines.