Ladies and gentlemen, welcome to the Third Quarter 2021 Badger Meter Earnings Conference Call. My name is Charlie, and I will be the coordinator for today’s call. You’ll have the opportunity to ask a question at the end of the presentation. 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 Third 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, 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. Finally, during this call, we will refer to core results for various financial metrics. For example, core water utility sales. Core means a designated financial metric excluding the impact of the recent 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 third quarter earnings call. I’m not sure how often the term supply chain challenges or inflation are going to be referenced during the quarterly earnings cycle over the next month, but I can only imagine it’s going to be an all-time record. While we clearly faced our fair share of those challenges, I want to focus my introductory comments on recognizing the tremendous execution of our Badger Meter teams globally for their proactive and constructive dialogue with customers to manage priorities, expectations, and build trust, for their agility in effectively redesigning certain product components to provide greater flexibility on supply sources, for their unrelenting diligence in supplier and logistics management, and for their collaboration across functions to maximize our deliveries to customers. These strategic and tactical actions by our world-class team allowed us to deliver record sales and earnings this quarter, while we added to our already record backlog. 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. Turning to slide 4, our total sales for the third quarter were $128.7 million, an increase of 13.3% over the $113.6 million in the same period last year. Total utility water product line sales increased 12.2%. Excluding approximately $10 million of sales from the recent acquisitions, core utility water revenues increased 1.7% year-over-year. A great result considering both the difficult prior-year comparison and current-year supply chain challenges. As we reminded you in our prepared remarks on the July earnings call, during the third quarter last year, our manufacturing operations were recovering production after the initial COVID lockdowns, and therefore our sales and profits reflected the benefit of a sizeable backlog recovery and lower pandemic impacted costs. In addition to the difficult comparison, our manufacturing output in the current quarter continued to be limited by supplier shortages of certain electronics and other components along with logistics challenges. We did experience growth in mechanical meters, cellular radios, and BEACON Software-as-a-Service levels. And we continued to realize the benefit from strategic value-based pricing actions. Strong orders continued in the third quarter of 2021. And we exited the quarter with another record-high backlog. Our water quality solution sales were also impacted by supply chain challenges on a more modest basis, yet still delivered results in line with our expectations. The flow instrumentation product line did not escape the impact of production limitations from component shortages, but delivered a strong 18.5% year-over-year increase in sales. Improved demand trends across the majority of global end markets and applications as well as an easier comparison led to the increase year-over-year. We were very pleased with the margin performance in the quarter in light of widespread inflation, difficult comparisons, and the dynamic supply chain impact on manufacturing operations. Starting with gross margins, we increased gross profit dollars by $6.2 million and as a percent of sales gross margins improved 20 basis points to 39.8% from 39.6%. Margins benefited from favorable acquisition mix as well as higher volumes and positive product sales mix, namely higher SaaS revenues along with favorable value-based pricing realization. These factors combined more than offset increasing cost headwinds across purchased components including higher brass, resin, and other materials as well as freight and logistics. As our margins demonstrate, we have executed well thus far in proactively implementing pricing mechanisms to offset existing cost increases. However, as has been well publicized, the breadth and pace of inflationary pressures is increasing. We will continue to actively monitor pricing in light of these circumstances, recognizing there’ll be leading and lagging impacts in this dynamic environment. SEA expenses in the third quarter were $31.7 million, consistent with the first two quarters on a dollar basis with sequentially improved leverage as a percent of sales to 24.7%. SEA expenses increased $6.2 million year-over-year with the inclusion of the water quality acquisitions, as well as more normalized pandemic impacted expenses such as travel. As a result of the above, overall operating profit margin was 15.1% compared to a record 17.2% in the prior year quarter. The income tax provision in the third quarter of 2021 was 18.3%, below the prior year’s 23.9% and our normalized rate in the mid-20% range, due to a discrete favorable income tax benefit related to equity compensation transactions. In summary, EPS was $0.54 in the third quarter of 2021, an increase of 6% from the prior year’s EPS of $0.51. Working capital as a percent of sales was 25.6%, an increase of 140 basis points compared to the prior quarter-end. The modest elevation in accounts receivable and inventory are temporary byproducts of the current supply chain environment. For example, we are strategically maintaining higher levels of certain inventory components and work-in-process, capitalizing on spot availability and capacity. In addition, certain customers are understandably deferring payment on partial shipments. We believe these are transitory repercussions of the current environment. Free cash flow of $13.9 million was lower than the prior year, the result of this higher working capital. On a year-to-date basis, free cash flow conversion of net earnings is 125%. With that, I’ll turn the call back over to Ken.

Thanks, Bob. Turning to slide 5, we’ve updated the quarterly sales comparison chart, which highlights the key factors driving uneven year-over-year top-line trends. The growth rate we experienced this quarter, excluding the acquisitions, was the result of strong customer demand, which was muted by headwinds from the varied supply chain challenges and difficult prior-year core utility water comparisons. As we enter the fourth quarter and look at 2022, our backlog is supportive of continued sales growth, with the level of quarterly sales, quite frankly, dependent on the level of supply chain disruption. While this could lead to variability in the cadence of sales, it is important to recognize two things with regard to our execution. One, our performance thus far is delivering total sales growth, despite the significantly supply-challenged environment; and two, our orders and awards are not being canceled or postponed, but simply shifting to the future. We feel very good about our competitive position and the underlying drivers supporting our markets. In summary, here on slide 6, we believe that our strong order momentum and backlog confirm the underlying market demand for our solutions, which combine data, communications, and analytics into tailorable solutions to enable customers to be more efficient, effective, and sustainable throughout the water ecosystem. The water quality acquisitions continue to perform well, and the integration work that has been underway, including customer discussions, confirms the growing need and acceptance of online, low-maintenance, and reagent-free solutions for real-time water quality monitoring. These distributed solutions will be a game-changer for utilities, wastewater, and industrial customers alike. We remain optimistic about our future prospects as we continue to execute on our growth strategy. But in tandem, we are acutely aware of the challenges presented by the current disruption to the supply chain and global shortage of electronics and other components, accelerating broad-based inflation, as well as the potential for further impacts from the pandemic. While these challenges are not unique to Badger Meter or even our industry, the ongoing headwinds have the ability to impact top-line growth rates and increase margin pressures. The breadth of these challenges is greater than what we’ve experienced previously, but the playbook for addressing them is not new. As I discussed in my opening remarks, we’re working on all aspects of the playbook within our control with the best team to mitigate the challenges and deliver sustainable solutions for our customers. Finally, I want to mention our work with AT&T on the Connected Climate Initiative they launched in August. We are one of several partners that AT&T highlighted for our efforts to reduce the impact of climate change via the water and energy savings associated with our smart water offerings. Using infrastructure-free cellular technology in our ORION LTE-M radio enables our AMI solutions to deliver more resilient, efficient, and sustainable water solutions. You can learn more about the AT&T initiative, as well as the resiliency of the cellular AMI solutions in the wake of extreme weather events highlighted in a recent Badger Meter Smart Water Show by clicking on the links on today’s slide presentation. With that, operator, please open the line for questions.

Our first question comes from Nathan Jones of Stifel. Nathan, your line is now open.

Good morning, everyone.

Hi, Nathan.

Ken, I was going to ask about something else, but the thing that you brought up, supply chain and inflation, I guess we’ll talk about that.

I didn’t think that would come up today. So I thought I was getting ahead of it.

No, I could say that. It was unlikely anybody was going to ask any questions about that. You noted in the press release this morning, you took a variety of strategic actions in the face of ongoing electronic and other component delays. Can you just give us some more color on what those strategic actions are? And how you think they’ll help to mitigate some of these challenges?

Yes. So, I think, one of probably the most impactful ones that you’re hearing other companies talk about as well is that our engineering team has been really engaged tightly with our supply chain teams. So, as we’re identifying some of these challenges that are going to be a little more impactful or perhaps longer lasting, we’ve done a really effective job of reengineering some components out and finding alternate replacements and dual sources for supply. So, I’ve been really proud of the nimble response there; I think maybe not as strategically so, but just in terms of tactical communication. You may recall we were talking about upcoming challenges before others in the industry. So, we’ve had a really strong communication line between our customers and our group. I just couldn’t be more proud of how we’ve managed through it, both in strategic actions and tactical work.

Okay. Follow-up on that, the water utility business, excluding the acquisitions, revenue was up 1.7. I think that probably implies to me that price is up more than that and volume was probably down a little bit. Can you tell us about just how much lower productivity you’re getting? What kind of impacts the supply chain challenges are having on scheduling and production? We’re hearing things about, you don’t know what’s going to be late until it’s late in this environment, which I’m sure makes it difficult to schedule production and creating efficiency units? So, what kind of productivity are you losing from these kinds of things?

Well, it’s a good point that you bring up on the inefficiencies, because it isn’t just about component availability; it’s also about logistics and being able to get it to you. And that certainly has been an inefficiency challenge that, again, I couldn’t be more proud of our team for overcoming that, but certainly a factor. When it comes down to pricing, it’s not quite as simple as we sold the widget last year for a price and this year we sell it for something more. As we get more sophisticated with AMI solutions, we’re selling a different mix of meters that could be mechanical versus ultrasonic or radios and software. This is why we talked about our pricing programs as value-based pricing. We’re really focused on making sure that we provide great solutions to customers, that we get all the value for it that we deserve, and that we win at least or more than our fair share in a really strong, growing market. I feel like we’re executing on all aspects of that.

Is there any kind of range or color that you can give us around what kind of productivity you think you’re losing because of all of this supply chain disruption?

First off, I know a lot of people are talking about labor shortages and that impacting things. Let me just clarify that we’re not having labor-related challenges. Our labor workforce is here doing a great job, knocking things out. In terms of quantifying, I haven’t. I don’t know, I’m looking at Bob. But I just know that there’s disruption there that we’re working through. But I frankly haven’t thought to quantify it.

I would view it more as adjustments rather than outright lost production. There are complexities involved in reordering and prioritizing production. It’s not as straightforward as it may seem. There are indeed underlying impacts, but we are managing them to the best of our abilities.

Our next question comes from Connor Lynagh of Morgan Stanley. Connor, your line is now open.

Yes, thanks. I suppose we’ll continue with the supply chain topic, as you anticipated. I’m curious if you could highlight the areas where you’ve seen the most tension within the supply chain. I’m particularly interested in how this has evolved throughout the quarter and where we currently stand regarding visibility on some of the major pinch points. Are they improving or worsening? What are your expectations in the near term?

That’s a great question. We’ve observed some evolution in this area. While there’s a lot of focus on semiconductors in the news, the situation is actually more widespread. Overall, electronics pose the biggest challenge for us. There are multiple components involved in producing a radio or an ultrasonic meter, and the specific components we need can change from day to day. In general, the issues with electronics have remained relatively stable; it’s just about securing our supply throughout the year. The recent thaw has created challenges with resins, including both cost increases and availability issues. We are starting to see improvements in resin availability, but inflation remains a concern. Additionally, logistics continue to pose significant challenges. Sometimes you might expect components to arrive on time, but then they are delayed. Our supply chain team likens it to a game of whack-a-mole, which is an apt description of the situation.

That’s helpful. It certainly strikes me that you guys have been doing very well relative to some other peers out there. Has that translated into any opportunity to take share, be it on an incremental contract or just backfilling where others can’t? I know you described the industry as relatively rational and oligopoly-like. So, curious if that’s really altering the competitive dynamic at all or if you’re really not seeing that.

Well, I think I would characterize it this way. The oligopoly is still very strong. Customers are still very sticky and loyal. But, at the end of the day, sometimes they just need a meter or a radio. We have, with our choice matters that we like to talk about with our portfolio of being able to produce mechanical meters, both composite or brass, ultrasonic meters on the static side, and all the different variations of radios, we’re offering a solution for any problem. I think, in many ways, that has helped us through this. I would say, opportunistically, I know that we’ve picked up some additional orders. Will that translate into share that we keep? I don’t know, but I do feel like we’ve got enough information in the market to know that our portfolio is helping us pick up some additional orders.

Think of that as on the fringes, not necessarily wholesale conversions.

Our next question comes from Rob Mason of Baird. Rob, your line is now open.

Yes. Good morning. I wanted to know, Ken…

Hi, Rob.

Good morning. I wanted to know, Ken, how you’re thinking about just seasonality here in the short term from the demand side. I know from the supply side, that may be dictated or the cadence will be dictated by what comes in. But historically, there is some seasonality from the demand side. And just given that you have elevated backlog, would your customers kind of buck that seasonality if the supply is available?

So, regarding seasonality, it has become less significant for us in recent years as we have increased our sales of radios and software has grown within our portfolio. We are not limited to weather-related markets. Clearly, customers in the south and west are consistently active. I believe seasonality has been naturally diminishing. With our record backlog, which we discussed in Q1 and again in Q2, we just added to it in Q3. Therefore, it’s challenging to predict expectations due to the supply chain. However, I anticipate that seasonality will continue to be less of a concern for us as we approach Q4.

Okay. Bob, regarding the gross margin this quarter, is there a way to quantify how inflation in your overall cost structure might have affected the gross margin during this period?

Yes. So, typically, we don’t get that granular. If I just diagnose kind of the year-over-year comparative, certainly, you’ve got a variety of dynamics taking place. We have the structural mix that we talk about every quarter. You heard us mention selling more radios year-over-year and selling more software year-over-year. So, that’s a buoy to gross margins. And then, of course, we’ve talked in the past about acquisition mix being a favorable contributor to our margins on a year-over-year basis. Naturally, just given the talk on inflationary and cost pressures and pricing, I think we started out 2021 with a great move, with strategic pricing initiatives. I would say for the first half of the year, we outpaced price costs in that world. And I would argue that in the third quarter, that gap narrowed because of the inflationary cost pressures that have crept up. So when you mold all that together, you’ve got some pluses and minuses, and that’s really driving the outcome in the quarter. I think you can tell from our tone and from the script that we’ve talked about with inflation continuing. As we look forward, I would expect that to be a pressure in the fourth quarter.

Regarding your question about value-based pricing, I remember that you began incorporating some aspects of this strategy around September last year. Does this approach still provide you with the necessary tactical flexibility to manage certain areas of inflation?

Yes, absolutely. While the lion’s share of the effort was a year or so ago, that isn’t a point in time, and then we’re done. We’re continually revisiting that each and every month, and we’ll continue to do that as we move forward. So, there’s still opportunity. We’ve talked in the past three quarters about the leading and lagging in the price cost dynamics. We’re still able to pull those levers, and we will be as we move forward.

At this time, we currently have no further questions. So, I’ll hand back over to Ms. Bauer for closing.

Great. Thank you. I did want to let you know that today we posted to the Investors section of our website a report from our Board of Directors addressing the topic of Board diversity. I encourage you to read that report. And please feel free to reach out to me with any questions or comments on the report. Finally, for your planning purposes, our fourth quarter year-end 2021 earnings call is tentatively scheduled for January 28, 2022. Thanks everyone for joining our call today. I’ll be around all day to take any follow-up questions you might have. Have a great weekend.

Ladies and gentlemen, thank you all for joining. You may now disconnect your lines.