Earnings Call Transcript - BMI Q2 2025

Operator, Operator

Ladies and gentlemen, welcome to the Second Quarter 2025 Badger Meter Earnings Conference Call. It is now my pleasure to turn the conference over to Barbara Noverini, Head of Investor Relations. Please proceed.

Barbara Noverini, Head of Investor Relations

Thank you. Good morning, and thank you for joining the Badger Meter Second Quarter 2025 Earnings Conference Call. I'd like to introduce myself as the new Head of Investor Relations. With me on the call today are Ken Bockhorst, Chairman, President and Chief Executive Officer; and Bob Wrocklage, Chief Financial Officer. The earnings release and related slide presentation were made available this morning 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'll turn the call over to Ken.

Kenneth Bockhorst, CEO

Thanks, Barb. Welcome to our second quarter 2025 earnings call. I'm pleased to report another quarter of record sales and solid financial results that demonstrated disciplined execution and the durability of the drivers that support technology adoption across the water industry. Against difficult comparisons in the prior year quarter, sales grew 10% year-over-year or 5%, excluding the SmartCover acquisition. Despite trade-related cost headwinds, gross margins continued to trend above our normalized range of 38% to 40%, and we generated robust free cash flow in the quarter. Halfway through the year, I remain encouraged by the resilience of our business, as we face ongoing macroeconomic trade and policy uncertainty. Our proven history of differentiated operational execution, combined with ongoing customer demand and momentum in technology adoption trends, positions us to successfully navigate this near-term uncertainty while supporting the long-term goals of our customers. Bob will review the details of the quarter, and then I'll be back to provide some thoughts on BlueEdge and our outlook. Go ahead, Bob.

Robert Wrocklage, CFO

Thanks, Ken, and good morning, everyone. Turning to Slide 3. Total sales of $238 million in the second quarter of 2025 represented an increase of 10% year-over-year or 5% sales growth when excluding just over $10 million in sales from SmartCover in its first full quarter under our ownership. Total utility water product line sales increased 11% year-over-year or 6% excluding SmartCover. As expected, moderating core sales growth from recent double-digit levels was primarily a function of the difficult second quarter sales comparison, which was the high watermark for the prior year. In the quarter, we delivered higher sales of meters, BEACON Software as a Service, water quality and remote monitoring solutions. Sales for the flow instrumentation product line were essentially flat year-over-year, as lower demand in the deemphasized array of market applications offset modest growth in water-related end markets. Turning to profitability. Operating earnings increased 8% year-over-year to $44.9 million, with operating margins down 40 basis points to 18.8% from the prior year's 19.2%. The structural mix benefit of technology adoption by our customers continues to benefit gross margins, which expanded 170 basis points to 41.1% in the second quarter from 39.4% in the prior year quarter. As expected, this did represent a sequential decline from 42.9% in the first quarter of the year, which you'll recall was the result of favorable customer and product mix that quarter that did not repeat this quarter. Gross margin in the second quarter of 2025 also continued to benefit from ongoing operational excellence initiatives, while recently implemented price increases partially mitigated certain tariff-related cost pressures in the quarter. Year-to-date, we have adeptly managed the controllable aspects of the known tariff landscape. However, the trade environment remains fluid. As an example, copper prices recently spiked on copper-specific tariff concerns. Although we primarily use recycled brass in our ingot recipe, secondary markets like these do experience ripple effects when the primary commodity is impacted. Last quarter, we walked you through the manufacturing and supply chain footprint supporting our U.S. sales, along with the tariff-related exposures and mitigation efforts. While announced and rumored tariff rates by country and commodity continue to evolve, our underlying tariff-related exposures and mitigation actions remain the same. Most importantly, we continue to see the competitive playing field as level in terms of both exposures and planned mitigation actions, including any potential targeted pricing actions. That said, the ongoing trade uncertainty and lag impact of mitigation actions once again prompts us to leave our normalized gross margin range of 38% to 40% unchanged for now despite another quarter of gross margin performance above 40%. SEA expenses in the second quarter were $52.9 million, an increase of approximately $9.1 million year-over-year, due primarily to the addition of SmartCover, including $1.6 million of intangible asset amortization. Excluding the acquisition, SEA expenses increased $3.3 million, the result of higher personnel costs to support growth and approximately $1 million of deferred compensation expense resulting from the year-over-year change in stock price that is unique to this quarter. The income tax provision in the second quarter of 2025 was 24.5%, modestly above the prior year's 23.8%. Consolidated EPS was $1.17 versus $1.12 in the prior year quarter. Primary working capital as a percent of sales at June 30, 2025, was 21.8%, consistent with the prior quarter end and about 200 basis points better than a year ago. Free cash flow increased 19% year-over-year to $40.6 million, largely due to higher earnings and working capital differential between years. With that, I'll turn the call back over to Ken.

Kenneth Bockhorst, CEO

Thanks, Bob. Next, I'd like to talk about the progress we've made since the launch of BlueEdge last year. As a reminder, BlueEdge is the brand that unifies the comprehensive suite of products and solutions that enable our customers to manage their water and wastewater systems beyond the meter. In June, our booth at the ACE tradeshow in Denver, which is our industry's biggest event of the year, highlighted the various use cases of our extensible solutions and included SmartCover for the first time. We also featured our new Field App, which brings the power of our BEACON software to utility field personnel, and we introduced Cobalt, which leverages machine learning for advanced insights within our BEACON platform. Our booth was the physical representation of our evolution behind the meter. Today, our BlueEdge portfolio of water management solutions provides tremendous value to customers, and it was exciting to see the energy in our booth as well as the enthusiasm that both long-standing and soon-to-be new customers have for our solutions. While it's only been a year since we've launched this concept, we've already seen meaningful momentum in our efforts to inform utilities of the advantages of our BlueEdge solutions. Furthermore, we've elevated our already strong reputation as a trusted partner. A long-term relationship with us means that we'll be there to enable our customers as they evolve and plan for the future. We're seeing increasing numbers of RFPs that ask for solutions beyond the meter, and our offering elevates our standing in the bid process while providing tangible reasons for us to continue our partnership with customers post-sale even after their AMI projects are complete. In summary, we're very pleased with the strong start to this evolving aspect of our long-term strategy. Finally, turning to the outlook. We routinely highlight that our business can be uneven quarter-to-quarter and year-to-year; it is simply the nature of the business, given utility replacement cycles, project deployment schedules, project phase-in, phase-outs, et cetera. The difficult second quarter comparison from a year ago that Bob discussed earlier is just one example of this phenomenon. Another example is that we did have a number of AMI projects wrap up in the second quarter. While we already have new AMI projects in hand to replace them, the timing of the start of those projects is such that we expect absolute sales to decline sequentially in the third quarter of 2025. Despite the moderation in sales, we still expect sales growth year-over-year, excluding SmartCover. Nevertheless, despite the macroeconomic trade and policy uncertainties we've experienced year-to-date, the multiple long-term secular trends fueling growth where we are positioned in the water industry remains strong. Our core products and solutions are critical to the operations of the water utility, commercial, and industrial customers. As a reminder, the meter is the cash register of the utility and remains a priority for investment. Thus, our ongoing conviction and high single-digit revenue growth over the long term is underpinned by these enduring favorable industry fundamentals, along with customer order and demand trends, project awards, pending and future RFP activity, and the competitive positioning of our broad portfolio of solutions to best address water challenges. We continue to generate strong cash flow and retain a balance sheet with significant financial flexibility to withstand macroeconomic pressure while pursuing both organic and strategically relevant inorganic investments, all while paying a dividend that has grown in line with earnings for over three decades. After nearly six months of integration, we remain on track to deliver the anticipated sales and cost synergies associated with the SmartCover acquisition. We've made tangible progress in leveraging Badger Meter resources across SmartCover's business and continue to identify go-to-market opportunities for SmartCover as part of our BlueEdge suite of solutions. Finally, I'd like to call out our recently published 2024 Sustainability Report. I'm proud that the collective efforts of our team allowed us to exceed and raise our targets for greenhouse gas intensity reduction while also delivering record 2024 financial results. Our continuous improvement philosophy towards sustainability efforts continues to produce favorable outcomes as it has across the entire business. In summary, we're carefully managing through uncertainty in the broader environment by focusing on what we can control in the near term while diligently executing against the long-term strategic plan that we're confident will continue to create value for both our customers and our shareholders. With that, operator, please open the line for questions.

Operator, Operator

Our first question today comes from Nathan Jones with Stifel.

Nathan Jones, Analyst

I guess my question is going to be on the SG&A expense line. Just looking at it sequentially, it's kind of gone up about $7 million, which was, I think, more than people were looking for. You've got an extra quarter of SmartCover in there and that one-time deferred compensation number in that. Can you talk about the other investments that have been made there to support future growth? I guess, and excluding the $1 million write-up of deferred compensation, is this kind of $52 million a new level of SG&A that we should be expecting going forward?

Robert Wrocklage, CFO

Yes. I think you picked up on the two main pieces that are relevant to the quarter, Nathan. Certainly, yes, a full three months of SmartCover's SEA run rate, which, of course, we mentioned that the acquisition is above-line average organically. And then when you add the intangible amortization to that, which again we've sized for the year and the quarter, that's certainly an element of that uptick sequentially. You've also picked up on the very unique item to the quarter, that being the deferred compensation expense to the tune of about $1 million. So absent those items, essentially SEA growth year-over-year is up $2 million to $3 million. And it's ongoing investment to support the wonderful things that we're doing in the marketplace in terms of continuing to evolve our software offering to keep it leading best-in-class, continue to bring innovative product development to market that differentiates not only our meter-to-cash products but our around the meter technologies and continues to drive the adoption of those technologies, which remain very early stage in terms of U.S. and North American water utility adoption. And so yes, I mean those are pieces of it. Obviously, we don't guide, but you've picked up on the outliers that would help to inform your outlook moving forward.

Nathan Jones, Analyst

I guess the $1.6 million of intangible amortization, is any of that like inventory step-up or something that goes away? Or is that what you expect the continuing level of amortization to be?

Robert Wrocklage, CFO

Yes. That is entirely the intangible asset amortization. The inventory step-up that was a small amount in association with the acquisition passed out in the first quarter. So essentially, that's the continuing run rate for the life of those varying live intangibles that we disclosed in the financials.

Nathan Jones, Analyst

Okay. So there's no reason to expect it to be less than $52 million in the SG&A line going forward?

Robert Wrocklage, CFO

Yes, we'll leave that to you to figure out. But ultimately, you picked up on the two unique pieces. Yes.

Nathan Jones, Analyst

Fair enough. I guess then maybe you could provide a little bit more color. I mean, you ran through a few of the things there, Bob. But just on what kind of capabilities, let's not call them expenses, we call them capabilities, have been added to the business to support future growth.

Kenneth Bockhorst, CEO

Yes. So Nathan, as you reflect on the past five years, it's probably not fair to think about it because Q2 2020 was the COVID quarter, but we're up 165% revenue over that five-year period. So some of it is just the random things of continuing to increase capacity on some of the product lines that we continue to invest in and some of it is investing in, of course, people. As we go through our five-year strategic plan every year, and we look forward on what the new skills and new offerings are, we're going to have sometimes that drives investing in different kinds of skills that we currently have today, continuing to invest in our software business that we're totally excited about. So all the things that we've told you over the years that we're investing in to grow, it's just a matter of continuing to do that. And frankly, we still feel taking the SmartCover piece aside, our ability to grow at a rate faster than our investment in SEA still intact.

Robert Wrocklage, CFO

I think that's the key there is that there's nothing unique about the rate of investment in this quarter that is anything different than what we've been doing for the last four or five years in terms of our primary capital allocation priority of organic investment in the business. It's just the way I think it's sequencing on a year-over-year basis and in concert with those two unique items that you mentioned to start your question.

Operator, Operator

Our next question comes from Scott Graham with Seaport Research Partners.

Scott Graham, Analyst

I have a similar question to Nathan and want to approach it from a different angle. It seems clear from your bullet points regarding the SEA that the $1.6 million remains, but the $1 million in variable deferred compensation is specific to this quarter. Should I understand that this amount will not be present in the next quarter?

Robert Wrocklage, CFO

Not in its entirety, but when you experience a quarter where the stock price goes up over $50 from beginning to end and you have liabilities associated that track that, there's going to be an oversized impact that is absolutely unique to the second quarter.

Scott Graham, Analyst

Understood. That's clear. However, I have another question about this, Bob. You mentioned that if you exclude those items, there was a $3 million core increase. Based on my calculations, that $3 million core increase year-over-year is roughly the same as your overall sales growth, which implies there might have been a bit more since you usually achieve leverage from that line; it suggests possibly more investment this quarter, even though you just stated that wasn't the case. Could you help clarify that for me?

Robert Wrocklage, CFO

So I think the simplest way to say this is that we're comparing to a quarter of SEA as a percent of sales at 20.2%, which is abnormally low. Stripping out all the noise in the quarter, so in essence, stripping out SmartCover for all intents and purposes, we'd have been at 20.7%. So yes, there is a 50 basis point increase, but that is in any way different than where we've been historically or in recent quarters and is still indicative of our ability to leverage SEA over time, just not quarter-to-quarter.

Kenneth Bockhorst, CEO

Yes, we have done...

Scott Graham, Analyst

Thank you for that clarity. Okay. So then let me just ask this one last question, if I may. The third bullet point says that strategic price increases mitigated certain tariff impacts, which suggests to me that you were maybe price/cost negative in the quarter? And then if that's the correct assumption, should you essentially be price/cost neutral for the rest of the year?

Robert Wrocklage, CFO

So I think you're picking up on the right dynamic. Certainly, our book of business here varies in terms of go to market. Sometimes we're direct. Other times, we're through distribution. Sometimes we have PO to PO pricing. Other times, we have long-term contracts, right? The pricing actions implemented in the quarter were implemented in, call it, mid-April. And by default, they won't be effective on everything that we shipped in the quarter. To the extent tariff cost pressures remained static, which I don't think anyone is saying those to be the case, you're exactly right in your diagnosis of how we've characterized the second quarter results. I think what remains to be seen, and the main priority reason why we're not redrawing a gross margin line or normalized gross margin range in this quarter despite, again, once again, having 41.1% gross margins, is the uncertainty associated with tariff costs. So the last part of your question is difficult to answer, not knowing exactly what the forthcoming reciprocal tariff impacts are as well as then the tariff around copper, which at this time is just a rumored statement, nothing that's been firmly implemented. And so that's the overall hesitancy to tell you that we're going to be cost neutral moving forward because the cost side can change, while equally the price side can change as well.

Operator, Operator

Our next question comes from Andrew Krill with Deutsche Bank.

Andrew Krill, Analyst

I wanted to follow up on the comments about the AMI projects in the funnel and it being a little unclear when they might start. So just is this like a change where they've been deferred or pushed out a little bit? Or is this more normal course of business? And can you maybe also just generally comment on municipal activity in general because I think there have been some fears maybe of like a little bit of softness there.

Kenneth Bockhorst, CEO

Yes. So Andrew, yes, so as we talk about all the time in this business, it can be uneven from quarter to quarter. So we're just basically letting you know it's not a stack bar where you add one quarter to the next, and it can be the same. So just trying to be transparent here that some projects have rolled off, but we certainly are excited about the projects that we'll be rolling up that our funnel remains as robust as ever. So not a concern for the long term in any way. It doesn't change our view on high single digits through the cycle. Just pointing out that we still expect to grow next quarter and into the future, but it's just not a stack bar from sequential. In terms of total just market demand, like we always have, we continue to spend a lot of time talking to customers in several pieces of the cycle on who's working with consulting firms on AMI projects that we'll see in 3 to 5 years, how we're doing on RFPs that are currently in motion, things that are currently being rolled out, orders, backlog. We're every bit as bullish as we've ever been. So customer demand side in terms of people inquiring about new projects or moving forward with projects remains largely unchanged.

Andrew Krill, Analyst

Okay. Great. That's very helpful. And then a quick clarification on the comments about sales being down quarter over quarter into 3Q. Just was that a total sales comment or more core sales? So in other words, I kind of strip out SmartCover and your core dollars are down as well?

Kenneth Bockhorst, CEO

Yes, Andrew, that's a core comment.

Robert Wrocklage, CFO

Yes. So the script specifically clarified excluding SmartCover. So essentially, core growth within, obviously, the non-comparability of SmartCover in Q3 '25 not being in Q '24.

Operator, Operator

Our next question comes from Rob Mason with Baird.

Rob Mason, Analyst

Ken, Bob, I want to quickly touch on SmartCover. The sales for this quarter appear to be above the sales run rate they reported last year. I'm interested to know if this is due to seasonality in the business or if it's indicative of underlying organic growth. How should we interpret the $10 million contribution from SmartCover sales this quarter, and what might the quarter-to-quarter pattern look like moving forward?

Kenneth Bockhorst, CEO

I'm excited to share some thoughts about the SmartCover acquisition. We’ve now had about five months to assess it, and the feedback we've received at ACE has been outstanding. We’re experiencing strong positive momentum in the market, and so far, the integration process has gone very well. We are extremely satisfied with the results and the team involved. I am optimistic about the long-term prospects. Bob was planning to discuss the sales, so I’ll let him take it from here. However, I want to emphasize that our initial beliefs about SmartCover have been validated early on.

Robert Wrocklage, CFO

Yes. I mean you hit the main point, which is, of course, I know everybody's immediate concern is quarter to quarter, but our long-term growth outlook for SmartCover is multiyear, if not multi-decade, again, referencing back to the sewer line monitoring portion of this business is virtually greenfield with very low digital adoption in the less than 0.5%. So essentially, we believe not only in the revenue growth in the short term, but the long term. I would say this is little to do with seasonality and entirely to do with advancing our positioning as a leader in the market and helping utilities solve primarily four main use cases in what generally tends to be out of sight, out of mind, in fact, underground infrastructure that is blind spots for those utilities. And so yes, we're pleased with the revenue growth thus far, but certainly have high aspirations as we move forward as well.

Robert Mason, Analyst

And Bob, my quick math around the contribution from SmartCover at the EPS level. I know this is a GAAP number, of course. Would have been in the neighborhood of kind of $0.06, $0.07 dilutive in the quarter year-over-year?

Robert Wrocklage, CFO

Yes, you're not too far off. As I'll remind everyone, we said at acquisition, EPS accretive in year one and certainly a path to EPS contributions shortly thereafter primarily in year two. So as you can imagine, a lot of that is about market adoption and the great sales opportunities and sales growth that we mentioned, while also leveraging what at the current time is an above-line average SEA business. But that we think, over time, provides well above-line average incrementals, both through the combination of software attachment rates and then leveraging the cost base.

Robert Mason, Analyst

Yes. If I could sneak in one more real quick. Just again, we'll have to see how the tariff around copper ultimately play out. But if you think that there could be some added cost to copper and that ultimately flows through to scrap brass. Do you think that could have any influence on the adoption rate between mechanical and solid-state meters? I mean, does the pricing differential that exists today, does that narrow? Does it make the value proposition for solid-state stronger relatively?

Kenneth Bockhorst, CEO

Yes, the first thing I want to highlight is that we have an excellent ultrasonic line. Even if circumstances change, we believe this wouldn't be a negative outcome. We have recently transitioned personnel from mechanical to ultrasonic within our offerings. Additionally, there seems to be a misconception regarding mechanical meters. We recognize that mechanical meters can also incorporate smart features with communications and software. Many utilities still have valid reasons for purchasing mechanical meters. We believe we can effectively manage cost challenges while still selling a substantial number of mechanical meters, and if anyone wants to switch to ultrasonic, we are ready to assist them.

Operator, Operator

Our next question comes from Jeffrey Reive with RBC.

Jeffrey Reive, Analyst

You mentioned you're progressing as expected on SmartCover integration. Could you remind us of the cost synergy opportunity, where you are today and capturing it? And maybe how quickly you can expect to realize the remaining upside? And is this mostly an SEA cost-out opportunity?

Kenneth Bockhorst, CEO

So I don't believe we ever sized the cost-out opportunity publicly.

Robert Wrocklage, CFO

Yes. So I think let me just clarify. So certainly, when we talk about the most dramatic and impactful synergies of the SmartCover acquisition, it is all about commercial synergies, accelerating what was already great stand-alone organic revenue growth by advancing the connectivity of the technology to our existing installed base, whether that's direct at customers or through distribution. So a number one priority from a synergies perspective is commercial synergies. As it relates to cost, the comment I made earlier was about leveraging an existing SEA cost base. So prior to Badger's ownership, SmartCover was private equity-owned, and they were in basically revenue growth mode. They invested heavily in advancing the technology and software, having the right feet on the street for sales. And so they carried a higher level of SEA coming into our acquisition. We're not saying we're reducing that. We're saying we're able to leverage that as the incremental sales growth that we bring to the table through our great access to market and long-tenured customer relationships occur. There are certain aspects of cost synergies when you start to look at the product side, meaning the product that SmartCover sells for sewer line monitoring has PCBA and has batteries in it and are components that we're familiar with buying. And whereas we buy hundreds of thousands, if not millions, of those parts and components, SmartCover in history has only sold smaller amounts. And we believe we can leverage certain of those components through our supply chain and otherwise, but that is absolutely secondary to the primary synergy, which is commercial synergies. And so a big part of taking this from EPS accretive in year one to EPS accretive in years two, three, and beyond is all about the top-line revenue growth and then not having to invest in SEA at a rate commensurate with that great high organic above-line average sales growth.

Jeffrey Reive, Analyst

Got it. And maybe just switching gears. There has been some discussions about potential cuts to the EPA budget. Do you have a sense of how that could impact demand for metering? And maybe at a high level, how would you break down customer project funding between just municipal budgets and federal support like state revolving funds?

Kenneth Bockhorst, CEO

Yes, Jeffrey. Utilities have various methods to finance their projects. As I mentioned earlier, the meter and AMI function as the utility's cash register, making it a top priority despite the availability of funding. There are state revolving funds that may limit some new projects, but local cost interest loans supported by the federal government are still available. Utilities can also raise rates and issue municipal bonds, creating multiple funding avenues. Our direct sales approach allows us to engage directly with utilities about their future plans. We have been particularly proactive in this aspect over the last three months given the current environment, and we are optimistic about maintaining high single-digit growth because utilities are still committing to investments, and we believe we are well positioned in the water industry to withstand potential budget cuts.

Operator, Operator

We have no further questions in the queue. So I'll hand it back to Barbara for any closing comments.

Barbara Noverini, Head of Investor Relations

Thank you, operator, and thank you all for joining our call today. For your planning purposes, our third quarter 2025 call is tentatively scheduled for October 21, and I'll be around all day to take any follow-up questions you may have. Thanks, and have a great day.

Operator, Operator

This concludes our call. Thank you very much for joining. You may now disconnect your lines.