Badger Meter, Inc.
Q4 2020 Earnings Call Transcript

Published: 29 Jan 2021

[Company Representatives:]

Ken Bockhorst - Chairman, President, Chief Executive Officer Bob Wrocklage - Chief Financial Officer Karen Bauer - Vice President of Investor Relations, Corporate Strategy, Treasurer

[Operator:]

Ladies and gentlemen, welcome to the Fourth Quarter and Full Year 2020 Badger Meter Earnings Conference Call. At this time all participants are in a listen-only mode. After the speakers remarks there will be a question-and-answer session. . 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.

[Karen Bauer:]

Good morning and thank you for joining the Badger Meter, Fourth Quarter 2020 Earnings Conference Call. I hope you’re all doing well and staying safe.

[Ken Bockhorst:]

Thanks Karen and thank you for joining our fourth quarter earnings call. Obviously there are many aspects of 2020 that we, along with many of you, are happy to turn the page on as we focus on a safer and healthier 2021. However, this morning we do want to spend a few minutes looking back and summarizing our fourth quarter and full year 2020 results, and then talk a bit about the new fiscal year and the long term opportunities at Badger Meter. In summary, we were pleased with our fourth quarter results which demonstrated the continued stability and resiliency of our utility water end market. As anticipated, flow instrumentation sales were less worse sequentially, but still down year-over-year. We delivered gross margin improvement, continued cash flow generation and EPS growth, albeit with a number of moving parts that Bob will walk through in more detail. I'm extremely pleased with our ability to complete two meaningful acquisitions over the past several months that are strategic growth drivers for Badger Meter. Earlier this month, we acquired Analytical Technology, Inc. or ATi. Combined with s

[Bob Wrocklage:]

Thanks Ken and good morning, everyone. As you can see on slide four, total sales for the fourth quarter were $112.3 million compared to $107.6 million in the same period last year, an increase of 4%. This reflects the activity stabilization we experienced in the third quarter, which is essentially continued despite the resurgence of COVID-19 cases and various regional restrictions.

[Ken Bockhorst:]

Thanks Bob. Turning to slide five, I'd like to highlight the two transactions we completed since our last earnings call and how we believe they bring significant value to the Badger Meter portfolio. S

[Operator:]

Thank you. We have our first question coming from the line of Nathan Jones with Stifel. Your line is open.

[Nathan Jones:]

Good morning everyone.

[Ken Bockhorst:]

Good morning Nathan.

[Nathan Jones:]

I just want to go back to some of the price cost amortization network impacts on fourth quarter gross margin. I think Bob you said that the networks sunsetting cost you 300 basis points of gross margin in the fourth quarter, and you still did 39.1. There is going to be some impact there for the amortization, so before price cost you would have had, what, all time record gross margins in the quarter. You did say there was a net benefit for price cost in the quarter. So can you talk a little bit more about how that's working, how the inventory accounting impacted the fourth quarter and really what the gross margin expectation here is in the short term?

[Bob Wrocklage:]

Yeah, as you know I’ll speak generally about those different pieces, but you're exactly right. With the 300 basis point impact of the network sunset provision, that would imply we were in that you know low 40% range before that. You know really let's talk about the pricing actions. I talked about strategic pricing initiatives. Those were largely begun late in the third quarter and really were started in earnest before copper started getting a little volatile here in recent months. So really the price impact that you see in the fourth quarter is a result of those late September changes and basically that price impact is coming through in the fourth quarter without a commensurate impact of the copper price increase, which really for us started to be seen in December and will be seeing more evidently in January, based on just how our supply chain works and how we procure our copper related components. I think, again I’ve talked historically about our business does not have the margin stairway to heaven and I think the pivot point that we're at now between the fourth quarter and the first quarter is a good indicator of that; meaning, the low 40% range that we saw pre network sunset provision in the fourth quarter, we don't anticipate to be sustainable moving forward and a large part of that is the pacing of the price versus cost dynamics in Q4 I won’t say reversing in Q1, but effectively the cost piece catching up. And so you're also exactly right in regard to the inventory accounting. Coming off a peak production level at the end of Q3 and how that then plays out through the end of Q4 also was a modest benefit. I would say the acquisition impact that you referenced and that we referenced in the pre-prepared comments is real, but that's not the most sizeable impact. I think the bigger drivers of sort of pre network sunset provision margin profile is the price cost dynamics, combined with really the mixed trend that we've seen throughout the last year or two in terms of the mix dynamic being favorable on margins over time. So, I know I sort of meandered through all that, but hopefully that answers your question.

[Nathan Jones:]

Yeah, no I think that you're realizing the price before you are realizing the additional cost and that’s just a matter of the accounting conventions. You guys have said 36% to 40% gross margins, and have been consistently in the upper half of that over the last few years. The business did get down briefly into the lower half of that kind of range. The last time we saw copper spike up back in ’17, ’18. Do you guys think you can maintain gross margins in that kind of upper half of that 36% to 40% range or is it more reasonable to think that we might get down into the lower half here; just in the short term as you see some of the price cost dynamics play out.

[Bob Wrocklage:]

Yeah Nathan, as things are evolving and we talked you know over the past couple years about the structural shift to more software as a service and more radios, you know that is a structural change that is a positive mix factor going forward, and we continue to grow in those spaces that we're very pleased about. This more dynamic view of pricing and really getting more granular if you will, in our pricing models to make sure that we're providing value for customers at a price that they're willing to pay for while still winning new business is a balance that we're really starting to find. We are being I think a little more pre-active about getting out in front of those things. So long story short, I think with the positive mix actions, the way that we're going to market with how we think about price, we still feel like we're going to be able to stay in the upper half of that range. Certainly more challenged with the things that you're aware of, but we feel comfortable we can do that.

[Nathan Jones:]

That makes sense and I think these pricing initiatives here are pretty self-evident that they're working a little bit better than the company has historically. So congratulations on that and I’ll pass it on.

[Ken Bockhorst:]

Yeah, thank you.

[Operator:]

We have our next question coming from the line of Ryan Connors with Boenning and Scattergood. Your line is open.

[Ryan Connors:]

Hey, good morning. Thanks for taking my call.

[Ken Bockhorst:]

Sure, hi Ryan!

[Ryan Connors:]

So my question is actually kind of big picture. You know I was wondering if you can comment on the federal situation. Obviously we got a new administration in place since your last call and a lot of talk about stimulus and infrastructure spending, some of it presumably related to your product lines and focus areas. Any update on what your expectations are there and how it could impact Badger, both tactically and strategically?

[Ken Bockhorst:]

Yeah, so the thing about the changes in the federal government and stimulus and our infrastructure, whenever there is more money that comes in and is available for water utilities, particularly given all the macro drivers of aging infrastructure an aging workforce, it can only be helpful for the long term and mid-term, where it can be challenging and I think we talked about this before is, if it tends to drag on, be vague, sometimes utilities particularly now could have potential to wait and see how that plays out. But for the most part you know we think that will work itself out. We are confident in our growth drivers. We think that the positive things that are happening with the market and what we're offering, we have the ability to grow anyway, but we do think for the long term that this could be potentially positive.

[Ryan Connors:]

Got it, okay, and then my second – my next question was obviously a lot of volatility in the market. You know your stock's been caught up in that. Sometimes it seems like there's no rhyme or reason, you’ve got a great quarter today, you beat earnings stocks down. I'm curious on your reaction to that volatility and especially how it relates to M&A, because you've been acquisitive, you've got great cash flow, presumably you want to remain active there. How have this seller expectation in the private company side, have been impacted by all the volatility, especially some of the increase in valuations and some of the public equities. Have you seen that flow through in valuations or is there some arbitrage there where you're able to capitalize on your currency, with a more stability in the private valuations?

[Ken Bockhorst:]

You know if you just look at the couple of deals that we just did, I'm very pleased with the fair, I would say multiples that we got two really quality assets at. So we don't see wild changes in the valuations and seller's expectations. It’s been relatively stable and I think good.

[Ryan Connors:]

Okay, and then just lastly, do you think – I think that the water quality side, I appreciate your comments there. I think it is a pretty compelling strategic area for you to be exploring. Is there more to do there? I mean – or do you sort of, you feel like you've got the footprint you need and then you grow organically or do you think there'll be more opportunities to add to that via further M&A?

[Ken Bockhorst:]

So one of the hallmarks of Badger Meter that I've been proud of is our ability to execute and now that we've acquired two great companies, our tremendous focus right now is on doing a great integration, and you know so for now as we talked about, it's business as usual for them. They are already really strong companies. So we want them to keep operating and we're going to be investing and all the things that we need to do to you know incorporate into BEACON over time and do the different things. They are going to be able to grow organically already because they're strong companies and brands and we're going to be able to get some synergy throughout this strategic cycle here. I caution you, that doesn’t happen overnight. The industry is still risk averse and slow moving, but we think these businesses have the opportunity to continue to grow at an impressive organic rate, and that for the mid to long term we're going to have really exciting synergies.

[Ryan Connors:]

Great! Well, thanks for your time this morning.

[Ken Bockhorst:]

Yeah, thank you.

[Operator:]

We have our next question comes from the line of Richard Eastman with Baird; your line is open.

[Richard Eastman:]

Yeah, just a couple of questions. Just kind of a follow-up here on s

[Bob Wrocklage:]

Yes, so specific to the gross margin line, I would say s

[Richard Eastman:]

So when you say mismatch, so the GAAP EBIT again, just kind of on a normalized basis here, you know second quarter and beyond, is that run you know something like low teens GAAP EBIT contribution from the two, would be like you know 12, 13.

[A - Ken Bockhorst:]

I think when you factor in the purchase accounting aspects of now, a higher level of amortization, it would be a little bit lower than that, but you know I think you could think of it that way.

[Richard Eastman:]

Okay, maybe 10%, 12% to bring it into the model. And then maybe the other question would be – and Ken, I think you referenced this, but some of the costs here to get – integrate the technologies into your technology base and install base, does that pull you know that GAAP OP percentage down or is there enough you know just overhead synergies here that you can kind of offset that investment?

[A - Ken Bockhorst:]

Yes, so I think Rick, I think the way I think about it is you know let's just go through the line items if you will. You know we think as we talked about in the script, putting the whole bundle together, SEA in the 25% to 26% range, inclusive of what Ken mentioned in terms of the long term R&D investment to get there, I don't think it's a fundamental change in the overall EBIT level of the business in aggregate when you think about it over the medium and long term.

[Richard Eastman:]

Okay, okay fair enough, yep. And then also just maybe the thought here, do we – as we bring ATi in and s

[A - Bob Wrocklage:]

Yeah, absolutely Rick. So we've already begun that, you know we’ve owned s

[A - Bob Wrocklage:]

But that's a multi-year journey?

[A - Ken Bockhorst:]

Yeah, that's yeah.

[Richard Eastman:]

Yeah, no that’s fair. It's just you know again really nice companies and seem like they have really nice technologies, but you look at their tenure, their history and they obviously haven't grown double digit for 20 years and so it seems like you know the strength of those two franchises, s

[A - Ken Bockhorst:]

Yep, yep, and the thing about that is, you know remember we always say this, a broken record for sure, you know slow moving, risk averse industry. They are on the innovative end of the technology, which is why we really like them, and they just didn't have the same channels that we have, so we certainly think we can help there.

[A - Bob Wrocklage:]

The short summary is brand channel and scalable software enablement is what gets us all those things.

[Richard Eastman:]

I see, okay, okay. And I just have two more quick questions. One is just, you know the industrial flow business, I mean we have some easy comps, but do you envision that business or is it in maybe the ‘21 plan that you know we can squeak out growth for the full year. I mean can that business be you know low single digits to mid-single digits for the full year with the, you know the comps that it has and any signs of recovery in demand there?

[Ken Bockhorst:]

Yeah, I would expect that to be in the low to mid-single digits. It's still going to be a challenge for us I think here in the first portion of the year, but you're right, then we certainly start to get into some easier comps that I'm pretty confident that we can get over.

[Richard Eastman:]

Okay, and then just lastly for me, when I think about you know the business overall for Badger, you know exclusive of s

[Ken Bockhorst:]

Yeah, so let's take it this way. So throughout this entire pandemic we've spent – I'm sure you could realize, the amount of time we've spent talking to customers and trying to understand activities and behaviors and what would happen, and we've been very pleased that throughout this cycle things that have been in the bid funnel have converted into orders. So we're sitting here now with a strong you know – we feel good through the fourth quarter on how we were doing with orders. Backlog is still healthy, bid pipeline is still there, so I would just say generally it's relatively stable. What we don't have is, I just want to be clear, because I wanted to spell – we don't have pent-up demand, we don't have inside set type things that are holding us back, so don't model any pent-up demand into the future I would say.

[Richard Eastman:]

Yes, yeah, yeah, okay. And so again, you kind of carried that tone out of the third quarter where it was kind of the day-to-day business had normalized and maybe the bid pipeline is solid or stronger, strengthening, but are some of those releases kind of coming to fruition here or you know is that kind of what we're still watching as the wildcard.

[A - Ken Bockhorst:]

It's pretty stable. I mean we're still seeing you know activity, customers still have all the same issues that we talked about three months ago, right. There’s still – maybe it's difficult doing work, it's not as efficient as it used to be, but generally things continue to move forward. We feel good about the stabilization of the market as good today as we did three months ago.

[Bob Wrocklage:]

And when we talk about stabilization, we’re viewing that in aggregate. We're not differentiating between I think what you call kind of the normal flow business and project business. We're talking about it in general, that that stabilization is there.

[Richard Eastman:]

Okay, alright, well thanks for the time.

[A - Ken Bockhorst:]

Yeah, thanks Rick.

[Operator:]

We have our next question coming from the line of Andrew Buscaglia with Berenberg Capital Management; your line is open.

[Andrew Buscaglia:]

Good morning guys.

[Ken Bockhorst:]

Hi Andrew.

[Andrew Buscaglia:]

I wanted to go through – your velocity of M&A has really picked up here and you have the cash flow to do – in recent years to do more M&A and it sounds like your kind of full now or you got what you wanted in water quality monitoring, but bigger picture, do you foresee once you digest these smaller acquisitions in the next couple of quarters, adjacent technology beyond water quality monitoring or you know something you can't go much deeper than water quality monitoring, you got what you want. I’m just trying to look out five years and see like what is Badger Meter as a, like a kind of a holistic portfolio?

[A - Ken Bockhorst:]

Yes, so our M&A strategy hasn't changed. You know we've acquired two really exciting quality assets in the water quality space. We're going to continue to look to grow in water quality organically and you know we'll continue to keep an active funnel of opportunities there. On the software side we've been I think pretty open about our desire to continue to invest and to grow organically as well as M&A around bringing more monitoring and control type abilities to our end users. Certainly things with a global component where we could continue to leverage; that was one of the things we're excited about, of bringing ATi and s

[Andrew Buscaglia:]

And just to reiterate here, there will be a little bit of a pause here before your using activity in M&A right.

[Ken Bockhorst:]

Well, so let's just take that in two pieces. So financially there's no need to pause. I mean clearly we're still in a net cash position, we've got full access to the revolver and we're a really strong cash flow business, so there's no need to pause whatsoever from a capital allocation point of view. And from a pause point of view, we would not stop ourselves from acquiring another great strategic asset if it were available today. We continue to look at companies, we continue to do things. So we're not saying that we are taking in any way a deliberate pause. We're just making sure that we're doing a very thorough quality integration of these companies, and if the right strategic asset comes available right now, we would be on it.

[Andrew Buscaglia:]

Okay, and in your remarks what did you say SaaS is as a percentage of your revenue currently? I believe…. Yeah.

[A - Ken Bockhorst:]

We finished the year at 5%.

[A - Bob Wrocklage:]

Of total revenue.

[A - Ken Bockhorst:]

Yeah, total rev, yeah.

[Andrew Buscaglia:]

Okay, and you know with water quality monitoring, what – should we keep our eyes on any headlines around you know with the Biden administration, any specifics around regulations. Is there anything you guys are talking that you're you know a little more excited about than you were a month or two ago?

[A - Ken Bockhorst:]

Well, you know so I just think this is a trend that has been growing. You hear more and more people talking about having access to real time information about water quality and then just the innovation and being able to do it more efficiently that these types of companies and solutions can provide. So whether it's the Biden administration or whether it just happens or already has been occurring, we think that's a positive trend with or without the Biden administration, but certainly it seems like the Democrat agenda is focused around these types of activities, so that could be positive, but you know we'll see how they come out.

[Andrew Buscaglia:]

Alright, thank you.

[Operator:]

We have our next question coming from the line of Jose Garza with Gabelli; your line is open.

[Jose Garza:]

Hey, good morning guys.

[A - Ken Bockhorst:]

Hi Jose.

[Bob Wrocklage:]

Good morning.

[Jose Garza:]

Hey, and just for the record, should have gone for it.

[A - Ken Bockhorst:]

Yes, yes. I even had one of our British employees ask me, why did they go for the three pointer?

[Jose Garza:]

Yeah well, moving on, just a quick question for me on your pricing initiatives. I just wanted to get a little bit more granular on that, just you know some of the things you guys are doing and maybe kind of where you are on that journey as you guys – now that you guys are more proactive there.

[A - Ken Bockhorst:]

Yeah, you know I think as you think about the history of price management here, it's been kind of a list price increase and you know in the old days of primarily selling meters, that would flow through. But as our product line has become more evolved and more about solutions and software as a service and full AMI with radios and meters, it's become more complicated than just passing a list price and hoping to realize something. So you know we've had a strong focus over the past several years on operational excellence throughout the business, that's not just the thing on the shop floor. So in all of our processes, up to now and including pricing, we're trying to just be more dynamic, again about finding that balance of what's the true value to the customer that they're willing to pay for that we can win work, provide a true valued service to a customer and try to extract as much value from that for Badger Meter as we can. That's a very high level view, but there's a lot of mechanics and pieces to it. But just using more data and analytics and making it more of a living process rather than an annual list price bump.

[Jose Garza:]

Makes sense and kind of you know where would you be on kind of the journey today?

[A - Ken Bockhorst:]

You know I think if I just reflect on the success that we've had early, I feel really good about where we are on the journey, but we're pretty early in. You know so I think we've had some really strong early results, but there's certainly more work to do.

[Jose Garza:]

Okay, excellent! Thanks guys and congrats on the results.

[Ken Bockhorst:]

Thank you.

[Operator:]

We have a follow-up question coming from the line of Nathan Jones with Stifel; your line is open.

[Nathan Jones:]

Good morning again.

[A - Ken Bockhorst:]

Hello!

[Nathan Jones:]

I just wanted to get a clarification about our code. You’ve said a couple of times on this call talking about SEA in the 25% to 26% range. Can you just clarify, are you talking about the whole company as SEA at 25% to 26% and that would be you know higher than we've been running at here for you know pretty much ever. What's getting it to that kind of level?

[A - Ken Bockhorst:]

Yes, so when I say 25% to 26%, I’m talking consolidated with the acquisitions effectively. The two contributing factor are exactly what we just described in terms of – I think the two acquisitions, they tend to run above line average at the SEA line naturally and then you've got you know basically amortization of the acquired intangibles rolling through that line, and so when you roll that together with the anniversaring if you will of some of the costs – COVID related cost activity in ‘20 versus ’21, plus those two pieces, that's what's driving the consolidate up to 25% to 26%.

[Nathan Jones:]

Got it. So are those businesses high enough on the gross margin level to mix that gross margin up, so that you know your kind of holding operating margins here. I know the acquisitions themselves are going to be a little bit diluted to operating margins just given the amortization, but maybe we can talk about it at an EBITDA level. Are the businesses – are these two acquisitions going to be accretive to the EBITDA margin level?

[A - Ken Bockhorst:]

So let's do a simple math. The base businesses you know this past, EBITDA margins in the low 20’s. We just acquired two businesses that out of the gates without synergies are mid-teens, so naturally it's going to be a drag on EBITDA margins. Obviously absolute dollars is a different story and of course our equation is we’ll be able to improve those overtime, so that answers the EBITDA question. Again, we believe the acquisitions to be accretive in year one and of course there after as well, EPS accretive.

[Nathan Jones:]

Okay, got it. Thanks very much for the clarification.

[Operator:]

There are no further questions at this time. I will now turn the call back over to Karen Bauer.

[Karen Bauer:]

Great! Thank you everyone for joining our call today. For your planning purposes, our first quarter 2021 call is tentatively scheduled for April 20. I'll be around all day to take any follow-up questions you might have. Have a great day!

[Operator:]

This concludes today's conference call. You may now disconnect.