Ladies and gentlemen, welcome to the Badger Meter First Quarter 2021 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.

Good morning, and thank you for joining the Badger Meter First Quarter 2021 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, most importantly which are outlined in our press release and SEC filings. On today's call, we will refer to certain non-GAAP financial metrics. Our press release and slides provide a reconciliation of the GAAP to non-GAAP financial metrics used. Finally, during this call, we refer to core results for various financial metrics. For example, core utility water sales. Core, in this case, means the designated financial metric, excluding the impact of the recent s::can and ATI acquisitions. We believe this reference point is important for year-over-year comparability. With that, I'll turn the call over to Ken.

Thanks, Karen, and thank you for joining our first quarter earnings call. In summary, I'm pleased with our results for the quarter, delivering sales and EPS growth, margin expansion, and robust cash flow. Most exciting, we experienced record order rates for our Smart Water solutions across both lines of business as the underlying growth drivers for our Digital solutions based on customer demand. The well-publicized and widespread electronics supply shortages limited our conversion of these record orders into sales in the quarter, tempering core sales growth but resulting in a record high order backlog heading into the second quarter, which bodes well for the balance of the year. Our recent acquisitions delivered strong top line results, with net profitability muted as expected as a result of purchase accounting items. Overall, our acquisition integration activities are progressing as expected. I'll talk about the current environment and our outlook later in the call. But for now, let me turn the call over to Bob to go through the details of the quarter.

Thanks, Ken, and good morning, everyone. As you can see on Slide 4, total sales for the first quarter were $117.8 million compared to $108.5 million in the same period last year, an increase of 9%. In Utility water, overall sales increased 12%, reflecting the addition of the s::can and ATI acquisitions, which contributed approximately $10 million of sales in the quarter. Excluding acquisitions, core revenues in the utility water product line were essentially flat year-over-year despite record orders due to the intermittent electronic supply component shortages and logistics challenges that limited manufacturing output. Scarce capacity of electronics is a pervasive market issue impacting many industries and is not isolated to Badger Meter. We did experience growth in overall meter sales and BEACON Software as a Service revenue, and we benefited from strategic value-based pricing actions. As Ken noted, we ended the quarter with strong order momentum and a record backlog, which gives us confidence in our sales outlook moving forward. As expected, the flow instrumentation sales rate of change improved sequentially from down 10% last quarter to down 3% year-over-year, with the majority of end markets served experiencing recovering demand trends. We expect to return to overall growth moving forward as a result of improving demand conditions and easier comparisons. We are pleased with the operating profit improvement, delivering a 30 basis point increase in margins to 15.1% from 14.8% in the prior year. Gross margin for the quarter was 41.9%, up a healthy 200 basis points year-over-year. The core business delivered higher gross margins due to a positive sales mix, namely SaaS revenues, along with favorable pricing, which continued to offset the impact of higher brass costs in the quarter. Margins also benefited from a favorable acquisition mix. You may recall from last quarter, we described the water quality acquisitions of s::can and ATI as having higher than line average gross margins, combined with higher SaaS as a percent of sales and therefore, with a net EBITDA range for the combined businesses in the mid-teens. The positive acquisition mix benefit to gross margins was muted by the amortization of inventory fair value step-up in the quarter, but that's mostly behind us moving forward. Copper prices continued their upward trajectory after our last earnings call in late January when they were averaging approximately $3.60 a pound, to now near $4.20 a pound. This obviously increases the potential cost headwind for the year that we had estimated at $4 million to $5 million to closer to $7 million to $8 million on a year-over-year basis if it were to stay in that $4.20 range. We have executed well in implementing appropriate pricing mechanisms to offset this inflation as evidenced by our first quarter results and will continue to remain nimble in actively addressing inflation. Turning to SEA expenses, the first quarter spend of $31.6 million increased $4.3 million from the prior year. This includes a full quarter of SEA spending for both s::can and ATI, along with a higher level of acquired intangible asset amortization. Beyond the impact of acquisitions, higher personnel costs were more than offset by lower travel, trade show, and other ongoing pandemic impacted expenses. The decrease of which we will anniversary starting next quarter. The income tax provision in the first quarter of 2021 was 22.2%, slightly lower than the prior year's 25.6% rate. In summary, EPS was $0.47 in the first quarter of 2021, an increase of 15% from the prior year's EPS of $0.41. Working capital as a percent of sales was 24.3%, down from 25.5% at calendar year-end despite the addition of ATI, largely due to working capital initiatives in the quarter. Our free cash flow of $28.8 million was consistent with the prior year. In early January, we deployed $44 million net of cash acquired for ATI and currently have cash on the balance sheet of approximately $51 million. Along with the untapped revolver, we have significant financial flexibility to execute our growth strategies. With that, I'll turn the call back over to Ken.

Thanks, Bob. Turning to Slide 5. We don't provide guidance, but believe it is important to bring awareness to the increased level of unevenness we're likely going to see in our top line as this year unfolds. I want to spend just a minute highlighting comparative sales data to provide a clearer picture of the varied influences on the quarterly sales growth trend lines and discuss the optimism we have for our results for the remainder of the year and beyond. This chart depicts the quarterly sales growth rate of our core business in 2020 and into the first quarter of 2021. As you can see by the various call-out boxes, we had some specific dynamics in 2020 with COVID and now in the first quarter of 2021 that we need to be mindful of as we look ahead to the rest of the year comparisons. Namely, we will have an easier comp for our upcoming Q2 versus the 2020 COVID lockdowns combined with a portion of the record backlog converting to sales given the anticipation for some modest improvement in electronic supply. As we move into Q3, we'll have a difficult comparison based on the post-COVID lockdown order rate and manufacturing recovery last year. The bottom line to all of this is that we continue to have strong momentum and robust bid activity, order rates, and backlog consistent with our long-term outlook for mid-single-digit growth. From a top-line standpoint, the acquisitions are performing in line with their historic growth patterns, and our integration teams are working to begin putting the steps and processes in place to realize future growth synergies. Turning to our outlook. The underlying market drivers for smart water solutions remain intact. And in fact, as we've discussed, COVID has spotlighted the benefits of AMI for common utility challenges, such as remote work efficiencies and regular and automated consumer engagement tools. Water quality and security concerns are also driving accelerating interest in our real-time digital solutions. We saw evidence of that during the recent climate events in Texas and other Southern U.S. states, which experienced a debilitating deep freeze. We had a number of customers describe the real-life benefits of having our cellular AMI solution deployed, which remained in service due to the criticality of cellular networks. These utilities were able to obtain real-time mission-critical data, which helped identify potential main breaks, pipe freezes, and bursts, keeping a safe water supply available for their end consumers. Now surprisingly, one of the most common outlook questions we get from investors relates to the potential impact of the recent infrastructure proposal from the Biden administration. Specifically, the portion of the plan that calls for $56 billion of spending to upgrade and modernize America's drinking water, wastewater, and stormwater systems, and an additional $10 billion in part to invest in rural small water systems. As we have repeatedly stated, the underlying secular trends driving demand for our digital water solutions are already evident and growing. Stimulus investments could perhaps accelerate or add to those underlying drivers but are not necessary for us to realize our long-term growth plans. In fact, as we stated over the past couple of quarters, it's the widespread availability of vaccinations that is most relevant to near-term demand patterns. It's too early to tell if a potential pause in spending might occur as utilities wait and digest the implications of the stimulus proposals. Our view is that if a pause would occur, it would simply be a matter of timing and not a change to the long-term structural growth of our business. We will, as always, focus on the elements of our business within our control. Our teams have done an outstanding job managing value-based pricing initiatives, which have mitigated the significant increase in brass costs. Our sourcing and supply chain teams have their hands full actively managing the varied ramifications of the wide-ranging and universal electronic shortages, along with certain logistics bottlenecks, including those at West Coast ports. While these circumstances are not unique to Badger Meter, I am confident that we will be able to adequately support customers despite these many challenges. We will continue to manage working capital and drive cash flow in order to support our investments in both organic and acquisition-driven growth. Our focus remains on enhancing the product and software offerings serving water-related markets and applications globally. Finally, I want to provide an update on our ESG activities, notably establishing our first greenhouse gas intensity reduction target. This represents an important step on our ESG journey as we work to mitigate the impact we have on the environment and continue to be good stewards of the resources we use in our operations. The 15% intensity reduction goal by 2030 was developed through a strategic initiative to capture baseline greenhouse gas data globally and identify opportunities to reduce energy consumption and other level 1 and 2 emissions. We will set annual smart goals to monitor progress, and we'll report externally on our efforts in our biennial sustainability report. To close out our prepared remarks, I want to thank our teams around the globe for their consistent and dedicated efforts to serve our customers. With that, operator, please open the line for questions.

Your first question today comes from Nathan Jones with Stifel.

I'm going to start on gross margins. Obviously, a very strong year. I think we talked last quarter when they were about 42%, and you guys didn't think that was sustainable. Most of the inputs here of the higher-margin acquisitions would have already been factored into that. So I can only imagine that pricing was probably better than you had anticipated. Can you just give us a few comments on that gross margin level with another quarter under your belt, if you think this is sustainable? Did these acquisitions change the structural gross margin range that you guys have been talking about at 36% to 43% for years? Just any comments you've got on those?

Yes. Nathan, I'll go first and then I'll turn it over to Bob. But we're obviously very pleased with the performance of the business this quarter and frankly, in the fourth quarter as well. The work that our team has done around value-based pricing, which for us is not a project. It's not an initiative. This is a change in how we do business and how we assess the value we provide for our customers and what that value is worth. So we feel great about the pricing program that we've started. We've talked many times about the structural changes that we have in more BEACON revenue and structural mix changes that are favorable. Bob can talk a little bit more about the acquisitions. But in general, from an execution point of view, I just wanted to get out there that I'm really proud of the work everyone's done here to manage all the inputs to have us in a really good price/cost position.

Yes. I don't have much to add to that, Nathan. We're very excited about the margin performance from the last two quarters. As a cautious company, we prefer to see more wins before we consider it a solid accomplishment. This is something to monitor closely. I don't think we're ready to announce a shift in that area. However, when looking at the last eight to ten quarters of performance, we have definitely remained within a tighter range. While the mix of acquisitions can influence this to an extent, I don't think we're prepared to make any significant adjustments just yet.

Okay. Fair enough. Then maybe just a follow-up on the supply chain. Obviously, the electronic supply chain has been big news around the investment community. So we know it's not something that's restricted to Badger. Can you talk about how much that impacted the quarter? Like was there a meaningful amount of revenue that you had to defer out of the quarter because of those restrictions and your ability to produce where you want to? And just how you see that going, what your suppliers are telling you on that?

Yes, we don't provide guidance, but we think it's important to mention the supply chain challenges we're experiencing. Our team has been performing exceptionally well for many years, not just in recent quarters. We anticipate some improvement as we move into Q2 and throughout the year. We acknowledge that this is a global issue and there isn't a quick resolution. While we may not see an immediate turnaround in Q2, we are optimistic about future improvements. We're particularly excited about the increase in our backlog, which is why we maintain a positive outlook. It’s about navigating these supply chain challenges that many in the industry are also facing.

Yes, I would expect that you had a number of different supply chain issues, such as freight. Is there a figure that you believe was postponed from Q1 that you could have shipped in the quarter if those supply chain challenges hadn't existed?

Yes. We're probably not going to frame that out for you because from quarter to quarter, backlog can change, just I would guide in a way that this change has been higher than others we've had.

Your next question comes from the line of Conor Lunagh with Morgan Stanley.

I was wondering if we could just stay on margins for a second here because there were just a couple of things you specifically called out in the press release. So there was the fair value step-up of the acquired inventory and then the brass input cost. And basically, what I'm wondering is as we move into the second quarter here, do either of those trends significantly favor your margins or against your margins? Basically, if we strip those out or thought about where we're going to be in the back half of 2021, how should we think about the underlying trend?

Sure, let me break it down. You might be referring to the second half of 2021 compared to 2022. You pointed out two main factors. First, the inventory step-up is mostly behind us now, which means the impact of that initial inventory increase is essentially finished for both s::can and ATI. This headwind will no longer affect us going forward. Second, regarding copper and pricing dynamics, it's a changing situation. For instance, in just the first quarter, we saw the input cost rise from $3.60 to $4.20, with a notable increase in April following a more favorable change in March. We continue to emphasize our pricing strategy, seeking to capitalize on the opportunity and the market's willingness to accept price increases in the current environment. We will persist in this approach, aiming to offset most of the cost pressures we face. I don’t anticipate any dramatic changes as we progress. While there may be some variations from quarter to quarter, I believe we have this situation well managed, as reflected in our first quarter results.

Thank you. I appreciate it. My other question is about free cash flow. I know you prefer to take a conservative approach, but you've also been successful in extracting a significant amount of cash from working capital. Can we expect more of that in the future? How much more do you think you can achieve in that area? Additionally, considering the acquired revenues and the ongoing transition to SaaS revenues, how do you foresee the free cash conversion for the business evolving in comparison to your historical performance?

Yes, I know some may find this amusing, but after the past two years, as we approach the end of the year, I feel we've extracted all possible value, and I don't anticipate maintaining that level of conversion moving forward. I mentioned this in the fourth quarter. Yet, here we are with the first quarter showing over 200 percent conversion. It's worth noting that if you examine the free cash flow conversion in 2020, we started similarly, with nearly the same free cash flow in the first quarter of last year, which then decreased throughout the year. Ultimately, we achieved a relatively healthy conversion rate of around 150% by the end of 2020. I want to emphasize that while we had a strong start to the year, one quarter does not set the tone for the full year. We're aware of the backlog sequencing and recovery in the second quarter compared to an easier comparison. This may lead to some challenges regarding primary working capital moving forward. I suggest thinking of it as a standard deviation lower than last year’s conversion. We aim for over 100% conversion but don't expect to consistently achieve that 150% rate in the future. I understand that this is influenced by a strong conversion rate in the first quarter, but one quarter alone doesn't define the whole year.

Yes. Understood. And just the latter part of that question was just do you think that the shift towards increasing software and higher technology sales alters free cash flow relative to historical trend? Or do you think we should use that as sort of a guide going forward?

I don't think there's a dramatic change in the cash flow as a result of that. One might think that there's a bunch of BEACON prepayments and other things that happen with multiyears in advance. And while that is an element, it's not the broad base of that revenue stream. A lot of that is month-to-month, so it doesn't necessarily change in a step-change way the cash flow profile.

Your next question comes from the line of Rick Eastman with Baird.

I have a quick question that I want to revisit. Bob, could you clarify the impact of s::can and ATI on the gross margin? The press release seems to indicate that the contribution to gross margin was positive despite the inventory step-up costs in the quarter. Could you also provide us with the details on what the inventory step costs were this quarter so that we can plan accordingly going forward?

Here's what I would explain about the quarter. So 200 basis points of gross margin expansion. I would tell you the majority of that came out of the base business and wasn't necessarily acquisition related. I would tell you, the acquisitions themselves in normal times and in even in the time frame whereby they're absorbing a higher cost structure from the inventory step-up amortization are above line average. That's not like it's 20% above line average, but it's above line average. So I would just try to frame it that way, short of giving you the defined number.

Yes. So going forward, without the inventory step, it will be somewhat more accretive. And then If you think about your price cost commentary and it's quite visible here in the quarter. But I think about where we are on the raw material side, I mean, electronic shortages, but I would think pricing resin costs up freight costs. So are you able to match price with those other raw material inflation dynamics there around the other components and freight. So do we stay positive price/cost here rolling through the second, third, and fourth quarters here?

Yes. My earlier comment specifically referred to the price of copper on a one-to-one basis. When I mentioned our ability to offset costs, I wasn't considering the additional effects related to logistics and other inputs. While it's straightforward for customers to grasp changes in copper pricing since it's a widely published figure that can be tracked over time, other factors like air freight and logistical issues are more complex. Additionally, electronics costs are more varied across different components, making them less easy to identify as a single commodity. Therefore, our overall ability to absorb these costs is likely not as directly aligned with those additional factors. However, we did experience a favorable price-cost situation in the first quarter, which gives us some flexibility, although it’s not as straightforward as the copper pricing scenario. I hope that clarifies things.

Well, and so second, third, and fourth here going forward, there could be a bit of a drag around price cost, including all direct materials, if you will, is that fair?

Yes. So Rick, this is Ken. So it's obviously a very dynamic situation. Things are moving very quickly. But the one thing that I would just like to point out on what we're doing around value-based pricing is, again, when we think about operational excellence, we think about that beyond the shop floor. And what we're applying here is a real program in process to manage that price/cost value. So while there may be drags here and there and there may be upside here and there, I think we've really done good work around this process, and I think we see it in the results. And then also, which didn't come through in the quarter because of some of the challenges with supply chain is that we're also winning at least our fair share of orders. So we're not making rash decisions to try to collect a quarter and drop a dollar. I feel like our process is hitting on all cylinders.

Yes, Rick, the other thing I would add is just that what you just described and what Ken just articulated in terms of the dynamic nature of the situation and how it's evolving day by day. That's part of the reason why we're not going to sit here and declare a new gross margin profile in excess of 40%. The other thing to real is, I don't want anyone walking away from this conversation thinking our pricing execution is a copper surcharge. It's much more sophisticated than that. So those are just two add-on comments that I'd make there.

Okay. Okay. Fair enough. And just my last question. When you think back, Ken, is there any history of when you think about the flow business on the meter side, is there any history of business drifting away from the installed base if another vendor can actually supply the meter? Again, I know some of these supply chain issues that are constricting supply are not unique to Badger, but regardless, in the flow business, where you're talking about meter upgrades, if one vendor amongst the big three cannot supply at any given point in time. You consider that ending up in backlog, but is there any history of that business drifting to another vendor that can supply?

Yes. So let me try to be succinct but probably have a long-winded answer. So as we think about the supply challenges and just the Badger Meter portfolio, right, you always hear us talk about choice matters. So if we think about this in radios or meters and communications, right? So as this global electronic shortage situation tightens, abates, whatever happens here over the future, we have a full product line of meters. So we have both polymer and brass. We have both mechanical and ultrasonic. Thankfully, we can offer our customers a full solution of meters, which many of our competitors cannot. So one, we're in a much better position on the meter side than most. Two, the D-Flow acquisition that we did in 2017 gives us much more control over our destiny with ASICs and perhaps people who have to buy them from other suppliers. So on the meter side, even though we're challenged, we certainly feel protected, if you will, better than most in terms of being able to hold on to our share or maybe even take advantage of some opportunities. Then if you flip it to the radio side, the majority of the exciting growth we're seeing on the radio side is, of course, in the cellular area. And that's a case where we're rock solid. If someone has decided they're going on the cellular side, they can't and won't flip to a fixed network solution. On the flip side, they could start installing cellular radios because there's no upfront infrastructure or anything that takes to go into it. So from a radio side, we feel really good there too. So even though this is challenging and it doesn't feel good at all to have supply challenges from being able to defend ourselves, our Choice Matters platform is going to be really valuable this year.

Your next question comes from the line of Brian Rafn with Morgan Dempsey.

I wanted to stay on the topic of electronics. When considering electronics and batteries, thoughts often go to AMI and many next-generation solutions. However, you also mentioned D-Flow and ultrasonic, which I believe are significant components. Can you clarify which product line is most affected by this? Is it primarily AMI, the ultrasonic, or is the impact fairly uniform across all areas?

I think as we think about the last several months and the coming 12 months, that can kind of ebb and flow. It could be radios for a certain supplier; it could be electronics. I would just say it's not limited to one or the other; it could be in both areas because it's more electronics as the broad-based category that I would say is challenged. It just happens to sometimes manifest itself in a part that may be going into an electronic meter or it might be a transceiver that goes into a radio. It's not limited to one side. And again, it's broad-based. I'm not speaking for Badger Meter there. I feel like I'm making a declaration on electronics in general.

Got it. Okay. And then what about the fact that manual read meters still represent a significant portion of the market? It's somewhat surprising to consider in today’s age. Is there a risk of a shift in preference among customers who are uncertain about whether to stick with a more manual solution that has less electronics compared to an upgrade? Could they decide that due to this ongoing shortage, it’s better to choose a more basic solution that may offer lower profit margins? Is there any risk associated with that?

No, not for us because, in fact, as we like to point out over and over, we still sell 80% of our meters are mechanical. So if somebody has a problem with a competitor's static meter, we would be happy to sell them a mechanical, if that's what they wanted. Our ultrasonic, which we think will be better than most in position to do that. And then frankly, again, with our cellular AMI adoption, if there's a supply issue in the second quarter, so what? They can put them on the third quarter. They can put them out in the fourth quarter. They don't have to chase this fixed network investment. So we have complete flexibility, and that will certainly, I think, be in our favor.

Got it. Okay. And then one more, just maybe the silver lining camp. If we link this issue over to another issue, kind of pre-COVID, one of the big, I guess, talking points and issues people talked about was new entry into North America by some of the Scandinavian players and so forth. I mean one would think that that might have been interrupted by COVID in the first place, some of that new entry. And now when you're having these kinds of global supply issues, maybe folks would concentrate on their home core markets and kind of dial back ambitions about new market entry. Can you update us on that whole kind of new entry situation in North America where that stands?

Yes. Well, you and I, we had several discussions on that a couple of years ago. And as you recall, we felt really good about our ability to protect our position to begin with. And now you layer on COVID. And then you layer on the fact that one of the things we felt the most strongly about is that our competitors from Europe trying to take over with just a portion of a product line. And now that product line is being challenged by electronics. Yes, I felt good two years ago when everybody was talking about this; I felt better last year, and I feel even better today.

Your next question comes from the line of Hasan Doza with Water Asset Management.

Two questions for Bob and then a high-level question for Ken. Bob, on the accounts payable and inventory, I noticed the year-over-year uptick, and I assume some of that is due to acquisitions. So my question is, can you help us kind of isolate the trends in your core utility and flow business in terms of payables and inventory, excluding the recent acquisitions? Just wanted to understand the reason for the uptick in inventory and payables, excluding the impact of the acquisitions.

Yes, Hassan, the best way to observe that is by looking at the cash flow statement. It effectively neutralizes the impact of the acquisitions, allowing you to see the true working capital improvement on a year-over-year basis, excluding the acquisitions. You will find that it contributed approximately $8 million or $9 million to free cash flow during the quarter.

Okay. And also in terms of raw materials, can you help us understand your exposure to resin and glass prices, if any?

Yes. So we typically don't bifurcate cost of goods sold by independent commodities or inputs. Obviously, the one we get closest to doing that is on copper historically. Yes, is there resin and glass in our various products? Absolutely. But it hasn't been a significant impact or change; we'd have been talking about it. So really, right now, it's pretty quiet from that front. That isn't to say that there aren't changes in dynamics that happen every day, but it's just not a significant piece for us.

Okay. Just would like to close with one high-level question for Ken. Coming back to the topic of industry dynamics, Ken, can you kind of talk about the pricing environment, especially in this post-COVID world, so to speak. If any of the players being irrational, lowering prices to get new business? I know you guys are obviously very disciplined. I'm kind of just wondering if anyone, especially the new entrants, are being irrational to kind of book new business in this environment?

Yes, we haven't observed that. If you look at our competitors who reported earnings last quarter, they all mentioned that they would be recovering inflation. This clearly shows they do not plan to engage in irrational pricing. We are frequently asked about the new entrants, and while there may be an occasional example, overall, there is nothing that raises concern.

There are no further questions in queue at this time. I turn the call back to the presenters.

Great. Well, thank you all for joining our call today. For your planning purposes, our second quarter call is tentatively scheduled for July 20. I will be around all day to take any follow-up questions you may have. Have a great day.

And this concludes today's conference call. Thank you for your participation. You may now disconnect.