Ladies and gentlemen, welcome to the Fourth Quarter 2021 Badger Meter Call. My name is Gemma, and I'll be the operator for today's call. It is now my pleasure to turn the conference over to Karen Bauer of Investor Relations, Corporate Strategy and Treasurer. Please go ahead, Ms. Bauer. Thank you.

Good morning and thank you for joining the Badger Meter fourth quarter and full year 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'll 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 earning 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 utility water sales means the designated financial metric excluding the year-over-year impact of the 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 fourth quarter earnings call. Our strong fourth quarter results capped off a record year for Badger Meter with sales surpassing $500 million for the first time in our history. We executed well on many fronts this past year, including successfully integrating two highly complementary water quality acquisitions, managing ever-changing supply chain challenges, the lingering impacts of the pandemic, and implementing value-based pricing and other actions to offset inflationary pressures. I want to thank the Badger Meter team globally for their tremendous execution and focus on the customer. I'll recap the year and talk about the current environment and our market 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 four, our total sales for the fourth quarter were $135.7 million, an increase of 20.8% over the $112.3 million in the same period last year. Total utility water product line sales increased 23.4%. Acquisition-related water quality sales totaled $11.1 million in the quarter compared to $2.4 million last year, which included only two months of s::can results. As a reminder, as we move into 2022, we will anniversary the acquisitions in our reporting of results. Excluding the year-over-year benefit of the Water Quality acquisitions, core utility water revenues increased 14.4% as continued strong order demand and recovering production output was modestly offset by intermittent supply chain disruptions that continued to restrict backlog conversion. We experienced growth in cellular radio and beacon software as a service sales, and we continue to realize the benefit from strategic and value-based pricing actions. Strong order momentum continued in the fourth quarter of 2021, and we exited the year with yet another record high core backlog. Sales for the flow instrumented product line increased 8.9% year over year as steady demand trends across the majority of global end markets and applications were partially offset by supply constraints, which limited production. We were very pleased with the margin performance in the quarter in light of widespread inflation and the dynamic supply chain impact on our manufacturing operations. Starting with gross margins, we increased gross margin dollars by $10.8 million year over year. As a percentage of sales, gross margins improved 120 basis points to 40.4% from 39.2%. Margins benefited from favorable acquisition mix, as well as the higher volumes and positive product sales mix, namely higher radio and SaaS revenues. In addition, the prior year included a non-recurring discreet network sunset provision. These factors combined more than offset the cost headwinds experienced across purchase components, including brass and electronics, as well as increased freighted logistics costs year over year. Looking forward, we anticipate continued inflation in 2022 that may constrain margins with some comparative easing as the year progresses and as 2021 cost increases become anniversary. SEA expenses in the fourth quarter were $32 million generally consistent with the quarterly absolute dollar spend throughout 2021. As a percentage of sales, SEA was 23.6% in the quarter, a 50 basis point improvement year over year and a 110 basis point improvement sequentially due to the higher sales. We expect SEA spend in 2022 to increase as a result of inflation, variable compensation, and ongoing growth investments. Yet we continue to endeavor to improve SEA leverage as a percentage of sales. As a result of the above, overall operating profit margin was 16.8%, a 170 basis point improvement compared to 15.1% in the prior year quarter. The income tax provision in the fourth quarter of 2021 was 24.5%, an increase over the prior year's 22.6% and within our normalized rate in the mid-20% range. In summary, EPS was $0.59 in the fourth quarter of 2021, an increase of 31% from the prior year's EPS of $0.45. Working capital as a percentage of sales was 24.5%, a decrease of 120 basis points compared to the prior quarter end. As expected, the temporary elevation in primary working capital we experienced last quarter did return to more normalized levels as we finished out the year. Free cash flow of $26.2 million was higher than the prior year's $12.7 million, the result of higher earnings and working capital recovery between years. For the full year, free cash flow was $80.8 million and free cash flow conversion of net earnings was 133%. While we operated from the unsustainable higher levels of the past two years, which reflect the structural benefit of low hanging fruit efforts in the areas of primary working capital, this conversion rate exceeds our annual target of greater than 100% free cash flow conversion. With that, I'll turn the call back over to Ken.

Thanks, Bob. Turning to Slide five, I wanted to provide a year one assessment of our water quality acquisition integration efforts. In short, I'm extremely pleased with our progress to date. As a reminder, the strategic rationale for these tuck-in acquisitions was to add real-time water quality parameters to Badger Meter's core flow measurement, pressure, and temperature sensing capabilities, and to enhance the scope of actionable data for utilities to improve operating efficiency and resiliency, and for industrial customers to monitor both process and discharge water. From a financial performance standpoint at acquisition, the combined acquired annual sales of s::can and ATi were approximately $37 million with EBITDA margin in the mid-teens. We finished 2021 with a combined $43 million in sales representing a pro forma increase of 16%. EBITDA margins expanded modestly and working capital as a percentage of sales improved. Most importantly, from an integration standpoint, customer discussions confirm the growing need and acceptance of online low maintenance and reagent-free solutions for real-time water quality monitoring. These distributed solutions will be transformational for utilities, wastewater, and industrial customers. We're executing on multiple avenues to drive growth synergies. For example, optimizing the complementary product offerings of both electrochemical and optical sensors across water quality parameters, leveraging geographic strengths for example, the ATI relationships with UK Water Utilities. We've cross-trained and educated sales personnel to effectively sell throughout the water ecosystem, including water utilities, wastewater treatment, and industrial water applications. We're actively working to advance our radio communications to capture the additional data parameters and augmenting our beacon and ION water solutions to provide the digital holistic view of the water network. I'm thrilled with the quality and collaboration of the s::can and ATi teams who share our values, commitment to innovation, and passion for sustainability. Creating a tailorable, scalable digital solution will take time and investment, but we're well positioned to realize the long-term growth synergies we anticipated. In summary, here on Slide Six, our performance through the pandemic in 2020 and widespread supply and inflationary challenges in 2021 demonstrates the resilience of our business model and our global team. We delivered core utility water revenue growth of 9,000 in 2021 building on the 4% growth in 2020. We further expanded our SaaS revenue as a percentage of consolidated sales to over 5%, even with a significant increase in instrument sales. Our strong execution served to build on our track record of improved margins and cash flow, and as I just discussed, we successfully executed and integrated two strategic acquisitions. As we begin fiscal 2022, we're optimistic about our opportunities for growth. Strong order momentum continued throughout the fourth quarter, and even with recovering production levels, our backlog again reached another record high, which bodes well for our expectations moving forward. As always, we could experience variability in the cadence of sales throughout the year. Our robust order activity is evidence of our strong execution and the structural underlying demand for Digital Water Solutions to monitor, manage and support operational efficiencies and sustainability throughout the water distribution system. We're uniquely positioned with a full line of smart water offerings, including market-leading cellular communications and software. In addition, despite the array of macro challenges, we are winning through innovation and exceptional support of our customers. We do anticipate that shortages will persist for a variety of components and that we will continue to see inflationary cost pressures as well as lingering effects from the pandemic. While we work to mitigate the impact of these near-term challenges, our priorities will be focused on executing our growth strategies and delivering value for shareholders. We are proud to be named for the first time as one of Newsweek's Most Responsible Companies. In 2022, we will release our Biannual Sustainability Report covering 2020 and '21 activities, highlighting our progress across the most material ESG risks and opportunities, including employee engagement, safety, reducing greenhouse gas emissions, fostering our culture of inclusion, and of course, promoting water conservation and quality. To close out our prepared remarks, I want to again recognize our team for their commitment to serving customers and for working to preserve and protect the world's most precious resource. With that, operator, please open the line for questions.

Our first question on the line comes from Andrew Buscaglia of Berenberg Capital Market. Andrew, your line is open. Please go ahead with your question. Thank you very much.

So you put together a pretty good year-end quarter, especially around margins and you presumably may have been through the worst. I'm curious where your thoughts are on that comment, if things have gotten worse since Q3 for you guys. Clearly you're navigating it well, but with your visibility into next year, at this point with record backlog, how do you see those margins evolving? Because if you are through the worst and you guys are clearly handling all these supply chain challenges, inflation very well, then you must have some confidence that the gross margin levels are sustainable from here at these higher levels.

Andrew, this is Ken. Yeah. Thanks for the question. Obviously, we're really proud of how the quarter and the year turned out both from a growth and a margin point of view. Clearly the inflationary environment has been difficult, and it continues to be somewhat uncertain, but what we are confident in is that the solutions that we're providing to our customers are valued by them. And we have a great process in place to continue to manage throughout this period with what we view as really strong performance. In terms of how we see that playing out, I'll let Bob talk about what he thinks from an inflationary point of view, but extremely confident that we'll be able to continue to monitor or perform very well regardless of what comes.

Yeah, Andrew, I think the only thing I'd add to that, clearly 2021 was a tale of two halves as it relates to price cost dynamics. Clearly we started the first part of the year with more favorable price cost dynamics, as we had implemented some value-based pricing actions in late 2020 arriving into 2021. Copper at the same time was still rising in the first half of 2021 and albeit capped out sort of mid-year and stayed relatively steady thereafter. I would just say our price cost dynamics became more neutral to negative in the back half of the year. And I think when you contemplate that record backlog, while we've made pricing actions here in the very recent past, actually in the fourth quarter, we implemented a list price increase, which will take some time to work its way into the P&L. We do have this elevated backlog that still is not subject to those price increases, and so there's a bit of needing to lap that and needing to lap the cost increases in 2021 that will impact sort of the year-over-year comparisons. We've talked historically in the past about a tightening of our gross margin performance from historically 36% to 40% to a tighter band of 38% to 40%. I think we're more comfortable with an even tighter band than that. I think the hesitation of migrating that figure north is just those current short-term items that I just discussed.

Okay. Very helpful. I have another question about the water utility sales side. The organic growth this quarter and for the year overall has been impressive, especially with record backlog as you head into the year. Are there concerns that this might be a short-term surge and that it could result in a downturn later? Or, given that record backlog, is there something that assures you can maintain a growth rate higher than historical levels for the foreseeable future?

First, when we consider the macro drivers for the utility sector, particularly regarding AMI digital solutions, these drivers were strong before COVID hit. In 2020, we experienced a 4% increase in utility sales, and this year, sales grew by 9%. Growth could have been even higher without some supply chain challenges. We remain confident that these macro factors, coupled with an aging and often insufficient workforce, are now even more significant than before. The issue of aging infrastructure remains prevalent, continuing to present opportunities for replacement business. We are very optimistic about the market direction and believe we can capture a fair share of a robust market.

The next question on the line comes from Nathan Jones of Stifel. Nathan, your line is open. Please go ahead.

I wanted to just start off with a question on the backlog. You guys haven't historically reported backlog. I know you've been reporting it because it's elevated due to the supply chain challenges. What is your current view for the timeframe for you to be able to work that backlog back down to a more normal level? Are the supply chain challenges likely to continue to see that backlog build? Do you think that you're in a position now where either you'd like to deal with it well enough that it can stay flat or you can begin to start working it down, just how you're thinking about getting that backlog back into a more normalized level.

Yeah, it's interesting. As you pointed out, we haven't talked about it before, and frankly I didn't expect to be talking about it still, but we just still find it relevant to point it out. We won't always talk about backlog, but it's got a long tail on it. Our customers were working very closely with them on making sure that we're filling all the most important demands. There may be some aspect of pull forward to Andrew's question before, but that really isn't the main driver in the backlog being elevated. But I expect that it will be elevated for quite some time. We'll manage through it effectively, but this isn't going to be a situation where we're back to a normalized backlog in Q1 or Q2, or maybe even Q3. But we won't talk about it forever because at some point, supply, the way that we see supply playing out this year is there's still going to be challenges in the first half of the year. We're certainly better off today than we were six months ago. But the first half of the year, we view will be more challenging than the second half. So probably see more recovery in the second half of the year than the first.

That's helpful. Thanks. So second one, I wanted to go on with balance sheet capital deployment. You got $87 million of cash, no debt, you could probably comfortably deploy $250 million of capital today and cash generated after dividends about $50 million annually. Can you just talk about the plans to put that capital to work, to generate value for shareholders and what the most likely outlets to get a reasonable amount of leverage on the balance sheet?

Our capital allocation priorities will stay the same. First, we will continue to invest in our core R&D services, including software. I mentioned earlier about ongoing investments in software initiatives to enhance water quality parameters and create more use cases for our utilities and their end users, focusing on new product developments, which remains our top priority. Second, we've raised dividends for 29 consecutive years and plan to keep increasing them annually. The third priority is pursuing more acquisitions like s::can and ATi. We are continuously seeking strategic tuck-in technology deals to support our strategies in smart metering, water quality, and software. We have a robust pipeline of targets we are evaluating, and we maintain a disciplined approach to the process. We are excited about the capacity we've built and are looking forward to identifying more quality companies like ATi and s::can in the future.

Are there enough out there to do that? Internally investments, new product development, new increasing the dividends is not going to be sufficient to put capital to work to the level that you have available on the balance sheet. And you would have to do quite a fair number of s::can and ATi kind of investments to move that capital off the balance sheet and put it to work for shareholders. Are there enough out there for you to do on that front?

Sounds like you're implying that we've created a first-class problem. So yeah…

That's a very high-class problem.

Yeah. So, there's definitely a lot of targets out there. There's a lot of things that we're working at, but you accurately point out a challenge that we do see there's not an over-abundance of targets available, but we continue to work diligently and we feel confident in our ability to do this. Maybe not at the pace that some would expect, but we have a disciplined process we follow and will be successful when we do it.

Okay. Thanks for taking my questions, guys.

Rob Mason from Baird, you have the next question. Please go ahead with your question.

Yes, good morning. And I finished through the year. Ken, a question regarding a comment you made in your press release. You talked about just speaking about the industry, you talked about customer requirements to enhance operational efficiency, security, and awareness. And I'm just curious, over the last year, has there been anything that has changed, on the requirements side? Has it been to say mandate, but there were some security events we've seen. I'm just curious if there's anything that's evolved over the last 12 months that you can point to on that front.

I would say nothing has evolved from a regulatory point of view, but just from a practicality point of view from an efficiency point, fewer laborers and employees are costing more than they did before. So that's only pronounced. In terms of cybersecurity and awareness, you can't read any story online without hearing people being concerned about it and the water industry. So definitely a growing drumbeat of interest in some of these other digital aspects of the business that makes us so excited about our software offering and what we can continue to build to fill those gaps because they certainly are trends that are going to pick up in steam.

I see. Okay. Just also a question in referencing the fourth quarter performance revenue performance, I know that you have been downplaying the significance of seasonality in your business has become more muted over time. But I'm just curious if you think, as you think about the supply chain as it is in your backlog, is the fourth quarter a representative jumping off point as we go into 2022 in terms of what can be delivered? I'm not sure if there was anything unusual in there. You mentioned growth in cellular radios and beacons. I didn't hear anything about mechanical meter growth but just some thoughts there in terms of how we flow into 2022 off the fourth quarter.

Yeah, I would say, I know there's been some historic perspective on seasonality. As you may mentioned, we’ve downplayed that over the last several years. So I don't see market change quarter to quarter or Q3 to Q4, Q4 to Q1. So while I'll stop short of saying, take Q4 and make that your number for Q1, I just, I don't think there's a high degree of seasonality to contemplate there's no real outliers.

Is there Bob, you talked about logistical challenges last quarter. Have those abated any?

Yeah, so a lot of times when we get into these questions on relative feel of whether it be supply chain or logistical concerns, it's a bit like the frog in the boiling water. So any answer we give you is going to be relative to recency bias. So certainly that Ken alluded to, some of the pressures we've felt seem like they were easing in Q4, but that's relative to the peak and not necessarily relative to normal. So while easing sequentially, we're not back to normal, nor do we expect either supply chain, whether that's component availability or logistics to be all of a sudden magically back to normal anytime soon in 2022, while we do think there's some easing of those pressures as the calendar progresses they're not going away anytime soon.

Sure. Okay. Understood. I'll pass it along. Thank you.

We currently have no further questions registered at this time. So I'll hand back over to the management team. Thank you.

Thank you all for joining our call today. For your planning purposes, our first quarter 2022 call is tentatively scheduled for April 19. I'll be around all day to take any follow up questions you might have. Have a great day and a great weekend.

Thank you very much for joining us today. Ladies and gentlemen, you may now disconnect your lines. This concludes today's call.