Ladies and gentlemen, welcome to the First Quarter 2023 Badger Meter 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 2023 earnings conference call. On the call with me today are Ken Bockhorst, Chairman, President and Chief Executive Officer; and Bob Wrocklage, Chief Financial Officer. The earnings release and related slide presentation are available on our website. Quickly, I will cover the safe harbor, reminding you that any forward-looking statements made during this call are subject to various risks and uncertainties, the most important of which are outlined in our press release and SEC filings. On today's call, we will refer to certain non-GAAP financial metrics. Our earnings slides provide a reconciliation of the GAAP to non-GAAP financial metrics used. With that, I will turn the call over to Ken.

Thanks, Karen, and thank you for joining our first quarter earnings call. The Badger Meter team started off the year continuing the exceptional performance of 2022, delivering record revenue and profit while still achieving yet another positive book-to-bill ratio. Operating profit margin improved, benefiting from both gross profit margin expansion and continuing SEA expense leverage. Early in the quarter, we completed the Syrinix acquisition, adding pressure monitoring and acoustic leak detection capabilities to our broad smart water solutions. We're pleased with the integration progress and the early discussions we're having with customers about our expanded offerings, reinforcing our views on the complementary and scalable nature of the acquisition. I'll provide an update on the macroenvironment and outlook later in the call, but for now, I'll 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 in the first quarter were $159 million, an increase of 20% compared to the $132.4 million in the same period last year, representing an all-time record sales quarter for Badger Meter. Total utility water product line sales increased 20% year-over-year, as we experienced continued strong order demand, sequentially improving supply chain dynamics and ongoing price realization. Strong orders and shipments associated with utility cellular AMI adoption, including higher ORION Cellular endpoint and BEACON Software as a Service sales continued. Additionally, we saw increased sales of meters, including E-Series Ultrasonic meters in residential and commercial applications. Finally, while the impact was relatively small, Syrinix sales were included for the full quarter. The strong demand environment resulted in another record utility water backlog exiting the quarter, even with the record top-line sales performance. Sales for the flow instrumentation product line increased an exceptional 22% year-over-year, led by solid demand in water-related markets and improved component supply availability. Order trends were strong with our emphasis on water-related applications outperforming general industrial end markets. Turning to margins. We are very pleased with the operating margin expansion of 150 basis points in the quarter, with both gross margin expansion and continuing SEA spend leverage contributing to the improvement. Gross profit dollars increased $12 million year-over-year, and, as a percent of sales, improved 120 basis points to 39.5%, at the higher end of our normalized range. The combination of higher volumes, favorable mix, including higher SaaS revenues, value-based pricing and some leveling off of input cost inflation drove the improvement. SEA expenses in the first quarter were $37.8 million, an increase of approximately $6 million year-over-year, due primarily to personnel-related costs, including higher headcount, salaries, sales commissions and travel. The addition of Syrinix with its related intangible asset amortization also contributed to the increase. Despite the higher spend levels to support growth, SEA as a percent of sales declined 40 basis points to 23.7% from 24.1% in the comparable prior-year quarter. Note that historically the first quarter tends to be on the higher end for SEA leverage and we would expect modestly improved sequential leverage in the remainder of the year. With higher interest rates, we are seeing some return on our cash balance, as noted in the interest income line. To address the related topical question on the strength of our banking partners, we are not involved with any of the named troubled banks, we have no debt, and we've reviewed asset makeup and other data with our primary banking partners and do not anticipate any concerns. The income tax provision in the first quarter of 2023 was 24.3% compared to 23.7% in the comparable prior-year quarter. In summary, consolidated EPS was $0.66, a robust 35% improvement from $0.49 in the prior-year comparable quarter. Working capital as a percent of sales was 23.1%, a 100 basis point increase from the record low 22.1% at calendar year-end, but still improved from 24.7% in the prior-year comparable period. While working capital did increase to support growth, we continue to carefully manage customer payments and strategic inventory investments. Free cash flow of $13.7 million was improved from a year ago, primarily on higher earnings and reflects the typical seasonality with incentive compensation and retirement plan contributions earned in 2022 based on those strong results and then made in the first quarter. With that, I'll turn over the call back over to Ken.

Thanks, Bob. Turning to our outlook, I remain excited about the opportunities ahead. With continued robust order pacing, a strong bid funnel and record backlog, we remain confident that our exceptional customer support and winning portfolio of digital smart water solutions position us well for sustainable growth. To date, we've seen no evidence that the higher interest rate environment or the banking sector consternation are having an impact on customer budgets. In addition, with 85% of meter volumes being replacement driven, an increasing level of replacement radio volumes and recurring software revenue, we expect very limited impact from any potential moderation in new residential or commercial construction markets. I'm also encouraged by the sequential improvement in supply chain dynamics. Coupled with moderation in the rate of input cost inflation, value-based pricing and continued SEA leverage, we continue to expect gradual operating margin improvement in 2023. Our cash on hand, overall strong free cash flow generation and debt-free balance sheet provide us with ample capacity to further invest in both organic and acquisition-enabled growth. Finally, we were proud to be named for the first time as one of Barron's 100 Most Sustainable Companies. We have a long history of working to grow our business and our positive impact in the world by enabling our customers to do the same. This type of recognition demonstrates that it is possible to deliver both strong financial and sustainability performance. In closing, I want to thank our team for their ongoing commitment and efforts in serving our customers. With that, operator, please open the line for questions.

Certainly. The first question comes from the line of Nathan Jones of Stifel. Please proceed.

Good morning, everyone.

Hi, Nathan.

Hi, Nathan.

Good morning, Nathan.

Just want to start with a question around supply chain. Some pretty positive commentary, I think, in your prepared remarks and in the press release this morning. Can you just talk about where supply chain is now compared to, say, where it was last year, where it was in 2019 before COVID? Is it still a problem with throughput, or are you back to normal capacity utilization today?

Yeah. So, as we've talked throughout this entire challenging time with supply chain, we're still not back to pre-COVID supply chain reliability, but we're certainly in the best position that we've been since COVID. So, 2021 was extremely difficult. 2022 remained extremely difficult and started to improve a bit at the end of the year, and certainly Q1 is the best that we've seen. Now that doesn't mean that we still didn't have some challenges that limited some output, but overall, the way that we've thought it would play out is how we're seeing it. We do still think there will be some intermittent challenges in the first half of the year, but again still improving. And then, we think towards the back half of the year, it will be perhaps hard to predict, but perhaps back to pre-COVID levels.

Fingers crossed, right? Are metrics like on-time delivery and past due backlog still a little bit below where you would have been in 2019? And it sounds like maybe hoping to be back to that level by the end of '23.

Yeah. So, we have a very high bar in expectations for on-time delivery and past due backlog. And admittedly, yes, on-time delivery is lower than we expect of ourselves and past due backlog is higher, but I definitely think as we start to see supply chain improve, which will lead to better efficiency and throughput, that we'll be making progress in those areas going forward.

Let's say hypothetically that the supply chains are back to normal by the end of 2023. Is there a meaningful amount of backlog for you to work down? Or is the record backlog more a result of strong demand? Or is it still going up as supply chains are improving? Just trying to get a sense of how much of that backlog should get worked down, or whether that’s something that’s going to stay consistently high.

Yeah. So, as with many things, it's a multi-variable situation. The backlog is perhaps inflated a bit because demand has been so hot and supply chain has caused some things to be later in backlog. There is the very positive side of it as we've talked for years now about growing technology adoption, so now we're selling a larger portion of radios with meters. So just by definition, the backlog is going to be higher than it used to be because of the average sale price of a bundle. So, I think we're going to continue into the future at an elevated rate versus pre-COVID, but it's still certainly elevated beyond where I think it will normalize after we get through the supply chain operational challenges.

Great. Thanks for taking the questions. I'll get back in queue.

You bet. Thanks.

Thank you. The next question comes from Ryan Connors of Northcoast Research. Please proceed.

Good morning. Thanks for taking my questions, and congrats to the team on another great number.

Yeah. Hi, Ryan. Thanks.

Hi, Ryan.

So, my first question was just on price versus volume. I apologize if I missed it, but I didn't hear any breakdown there. Are you able to provide any breakdown on top-line in that regard?

Yeah. So, we haven't quite disclosed that, but it is certainly much more volume driven than it is price.

Okay. And then, my other question was, as I mentioned, you've had great numbers here. You've been, I think, kind of outperforming your peers really for the last year or plus. Is it your view that anything is going on here that you're actually taking share? And what would be your comment on that? Or do you just believe that you're participating in some more systemic factors in the markets that are lifting all boats? And just trying to break down the relative contributions there, because certainly you've made some good bets on technology with cellular and otherwise.

Yeah. So, we generally maintain the Midwest humble approach and usually shy away from making claims about taking share. But I think if you look at our competitors, we clearly have performed and delivered, I think, significantly more than most of them throughout this period and also carry an elevated backlog. So, when you look at some of the areas where we've seen the outsized growth, I think being first in Ultrasonic has been extremely beneficial for us. Being on the lead and changing, if you will, the way the AMI market views the value within it, our cellular approach certainly, I believe, is taking share on the AMI side. Coupled that with our best-in-class software package that comes with that and the continued 45% CAGR on software, I do believe that, yes, I can confidently tell you we are taking share in the AMI space.

Yeah, seems to be. And then, my last question was just on sort of the visibility. I know that you don't have perfect visibility on what kind of funding is driving every order, but is it your sense that a lot of the strength we're seeing today is actually some of the federal money finally flowing through, or is this kind of organic local municipal funding coming through? I mean, any comments about the relative contribution of where the funding is coming from that’s driving the strength?

Yeah, thanks for asking that. Yeah, I mean, we've been pretty consistent throughout this entire period that with the fundamentals, the macroeconomic drivers that we have around AMI, whether it's now water quality with the acquisition that we did there, that we didn't need infrastructure money to grow. And I will tell you that through these couple of years, since the bill was passed, we've seen little to no uplift from the infrastructure bill.

Got it. Okay... Just a quick housekeeping for Bob. In the flow instrumentation, you mentioned these water-related markets. Can you just be specific, just call out a few of what those are? I'm just curious what exactly you're referring to there.

Yeah. So, following the strategy over the last few years, now that we've pivoted away from some more of the general industrial markets and focused on water, wastewater, buildings, sustainability, HVAC. And so, when we talk about water-related markets, that's where our focus is. And in the quarter, we saw above-line average growth in those lines or in those market focuses versus, say, the more general industrial, which were still up year-over-year, but just to a lesser extent. So, really we're talking about building sustainability and water-wastewater.

Yeah. And if I could remind you that even in those other markets, we're still generally doing water-related activities. It's just that the markets that we talk about when we call those out are the ones that are specifically water-related markets.

Got it. Thanks for your time today.

Thank you.

Thank you. The next question comes from Rob Mason with Baird. Please proceed.

Yes, good morning. Your first quarter revenue was a pretty good size step up, high single-digit step-up versus the second half and you already identified supply chain getting better. That's probably a contributor. But you had previously spoken about some capacity expansions that would be ongoing. Are we starting to see the benefits from those? Is that flowing through? Or are those projects still kind of in progress?

Yeah. So, obviously, we did signal the capacity investment over the course of last 2022. We would say that basically the revenue growth you saw in the first quarter was sans any benefit from those investments that are very early stage. So, while the CapEx is elevated in the quarter and there is some of that that's oriented toward capacity expansion, it's not bearing fruit in what you're seeing in the first quarter.

How did maybe your historical pricing actions, how did those contribute to the first quarter maybe versus the fourth quarter? And maybe what I'm trying to understand is how those actions that you've taken in '22 are perhaps resident in the backlog, if that question is clear to you?

Yeah, well, let me take a shot at it, Rob. And then, I think Bob will clean up anything that maybe I don't hit. But if you think about our pricing model, what we started in 2020 when we moved to a more value-based pricing model, it's something that we do on an ongoing basis. It's much more dynamic with the growth of AMI and some of the project-based nature of the backlog. We transitioned away from what used to be the annual list price increase and you'd see that come through in the beginning. So, I think in my view, Q1 versus Q4, there is not that much of a price step-up change. But I don't know, Bob...

Yeah. I mean, untangling price for us becomes a bit challenging because when we talk about price impact, it's not only the traditional list price increase that you're referring to, but also certainly the average sell price evolution combined with this value-based pricing initiative Ken described. So, there is an impact of price in the quarter, that's a benefit to us. As Ryan had asked, we typically don't parse that out percentage-wise or attribute a portion of dollars to each element. What we would say, as Ken mentioned earlier, is the largest share of the increase in dollars and in percentage is unit volume driven. And while there is a price benefit certainly, it's the minority of the year-over-year growth.

If you look at your backlog as it stands today, is there a way to assess how the mix should impact you this year? Would it be more favorable, less favorable, the same versus '22?

Yeah. So, when we talk about our confidence in our margin resiliency, again that always starts with the positive structural mix change that we have, which continues to be ongoing. We clearly keep a good view on the health of our backlog and that's where in our commentary or the press release, when we talk about we're very confident in our ability to be margin resilient through any period, we do that through obviously having a lot of excitement around our product line and at the same time analytics that we have in the backlog.

I think if you're specifically trying to drive toward gross margin, I guess I would just reinforce our universal messaging of a normalized range of 38% to 40%. Certainly, we continue to believe in the ability to leverage SEA as revenues grow. And so, operating margin and EBITDA margin expansion are going to come through those two. I think the oversized impact in 2023 will be more from SEA leverage than it will be from gross margin contribution.

Understood. Very helpful. Maybe just one last question quickly. Ken, you noted Syrinix. I know it's early under your ownership, but I'm just curious if you have any initial impressions around how you think that product will slot into your channel maybe comparatively versus other products that you've added to the portfolio inorganically and need to work into the sales channel? Just how we should think about uptake there?

Yeah. So, keeping in mind that it's starting from a very small base, but we've had extremely positive reaction from our channel partners. So, many of our long-standing great utility distributors have been really positive about feeling like they know how to sell this immediately to customers that we already have. So that's not usually the case within the water industry, but with Syrinix, it's a lot closer to the center of what we're doing and how we talk about AMI and real-time information within the market. But do keep in mind, it is small, but there's a lot of excitement around it. And as we've talked about before, small deals for us are certainly not viewed as a bad thing, because it takes a while sometimes to get the leverage, but when we do, it's very good. The other thing that we're really excited about Syrinix is now if you take our BEACON software platform, which was built on AMI, and now since we acquired s::can and ATi, now we can leverage in the water quality information. And now with the fully-developed RADAR software that Syrinix, that we acquired with Syrinix, we're now giving utilities the opportunity to monitor all three of those in one software platform, which is something that our customers are finding very valuable.

Very good. Thank you.

Thanks, Rob.

Thank you. And the next question comes from Tate Sullivan of Maxim Group. Please proceed.

Thank you. Ken, sticking with the demand from utility customers in the U.S. for real-time water quality monitoring, is it a constant sales process, or is it most of the time that you're selling when meters are up for replacement for utilities, please?

No, it's a constant selling process, similar to with other budgeting concerns and things that utilities tend to budget out into the future. So, the water quality sales team is out there selling independently. The water quality sales team is selling jointly with the utility business. So, it's an ongoing thing.

Are your customers still significantly concerned about water quality in their systems? It's been since 2014, so can you share what you are hearing from customers? Do they still have worries about water quality and their infrastructure?

Yeah, I think if you just turn on the news and look online on any news, people don't open newspapers that much anymore, but the news just continues to grow on people being concerned about what's in their water, and that's why we were so excited about s::can and ATi because of the high-tech nature and the ability to provide that water quality real-time, on-demand information. So, certainly people are interested in it, and that interest we view as growing, which is why we really want to get into that space.

And then, I think you mentioned in your prepared remarks more radio replacement meter levels. When were your first ultrasonic meters in the field? And when is the replacement cycle going to start for those ultrasonic meters?

Yeah. So, I think the point that I was making was on radios, but I'll answer your meter question first. So, meters, whether they be mechanical or ultrasonic, are about 85% annual replacement volume. What I was speaking to on the radio replacement volume is that now if you think about the drive-by radios, they've been in the market 25 to 30 years. AMI radios have been out there now roughly 10 years. And as more and more radios get deployed, you're going to see the same over time, right? It takes a long time because these are long-cycle products in the field. But radio replacement volume is going to be the same exciting 85% once you get full saturation in the market. So, every year, we see a higher level of replacement volume in radios just because that's the nature of the business.

Okay. Thank you very much.

Yeah. And you're welcome.

Thank you. There are currently no additional questions registered at this time. So, I will pass the conference back over to Ms. Bauer for closing remarks.

Great. Thank you, operator, and thank you all for joining our call today. For your planning purposes, our second quarter 2023 call is tentatively scheduled for July 20. I'll be around all day to take any follow-up questions you might have. Have a great day. Thanks.

And with that, we will conclude today's call. Thank you for participating. You may now disconnect your lines.