Participants

Karen Bauer; Vice President - Investor Relations, Corporate Strategy and Treasurer; Badger Meter Inc

Kenneth Bockhorst; Chairman of the Board, President, Chief Executive Officer; Badger Meter Inc

Robert Wrocklage; Senior Vice President, Chief Financial Officer; Badger Meter Inc

Andrew Krill; Analyst; Deutsche Bank

Nathan Jones; Analyst; Stifel Nicolaus

Jeffery Reeve; Analyst; RBC Capital Markets

Scott Graham; Analyst; Seaport Research Partners

Rob Mason; Analyst; Robert W. Baird

Presentation

Operator

Ladies and gentlemen, welcome to the Q1 2025 Badger Meter earnings conference call. (Operator Instructions) 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

Thank you. Good morning. Thanks for joining us for Badger Meter's first quarter 2025 earnings conference call and the 72nd and last quarterly earnings call for me ever with my May 2 retirement date now is two short weeks of late. Joining me on the call today are Ken Bockhorst, Chairman, President and Chief Executive Officer; Bob Wrocklage, Chief Financial Officer; and Barb Noverini, Senior Director of Investor Relations. Please note that 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 the call, we will refer to certain non-GAAP financial metrics. Our earnings slides provide a reconciliation of the GAAP to non-GAAP financial metrics SKUs.
With that, I'll turn the call over to Ken.

Kenneth Bockhorst

Thanks, Karen, and thank you all for joining our call. I'm pleased with our start to the year with another quarter of solid revenue growth, record operating margins and robust earnings per share improvement, which continues to reflect the durable drivers supporting water industry technology adoption.
Our results now include SmartCover following completion of the acquisition in late January. Since then, we've been onboarding our new colleagues and setting common goals to capture the many opportunities we have to drive sales and operating synergies. We've heard strong positive feedback on our combination from many customers who recognize the value of adding SmartCover sewer and elicitation monitoring capabilities to our BlueEdge suite of water management solutions.
I'll be back to provide our outlook later in the call, in which you might expect will also include a discussion about tariffs. But for now, I'll turn it over to Bob to go through the details of the quarter.

Robert Wrocklage

Thanks, Ken, and good morning, everyone. Turning to slide 4. We delivered strong operating performance across the board with our key financial metrics demonstrating solid improvement in the quarter. Total sales grew 13% year-over-year in the first quarter of 2025. Excluding SmartCover, sales increased 10%, which, as a reminder, was on top of 23% growth in the fourth quarter -- first quarter of last year. Total utility water product line sales increased 16% year-over-year or 12% when excluding just over $6 million of SmartCover revenue for the two months since acquisition.
Year-over-year growth in utility water was again led by cellular AMI adoption, including associated meters, ORION cellular endpoints and BEACON software. Sales for the flow instrumentation product lines decreased nearly 5% year-over-year as lower demand in the deemphasized array of market applications offset modest growth in water-related end markets. However, flow instrumentation sales did show sequential improvement of 7% growth from the fourth quarter of 2024.
Turning to margins. We were particularly pleased with the record operating profit margins in the quarter of 22.2%, expanding 360 basis points year-over-year. Gross profit margins came in at 42.9%, a 360 basis point improvement from 39.3% in the prior year comparable quarter and above our normalized gross margin range of 38% to 40%. As we've said in the past, customer and product mix can and does vary quarter-to-quarter with this being an especially favorable example in nearly all respects of a positive sales mix scenario.
For example, the first quarter benefited from a particularly attractive combination of customer mix overall. From a product mix standpoint, software was the top revenue growth contributor, up 25% in the quarter. Similar to the sales unevenness we often discuss. We have variations in gross margins in the short term from various mix elements. While we certainly expect structural sales mix improvements to continue over time, the 42.9% gross margin outcome in the first quarter was a perfect combination of nearly all elements contributing favorably.
At the same time, there remains significant uncertainty surrounding the evolving tariff and turbulent macroeconomic situation. Ken will walk through our manufacturing footprint and supply chain exposures to tariffs as well as our mitigation actions later in the call. In short, we don't believe it is prudent at this time to guide to a higher range for gross margin performance, yet we remain confident in our normalized gross margin range of 38% to 40%, assuming no further changes in global economic and trade policies.
SEA expenses increased by $5.4 million or 13% year-over-year to $46 million in the first quarter. The increase included approximately $1.1 million of intangible asset amortization from the SmartCover acquisition, which on a two month basis is in line with our previously communicated expectation of $6 million to $7 million annually. Excluding SmartCover, SEA expenses increased by $2.2 million or 5%. SEA as a percent of sales was 20.7% in the first quarter or flat year-over-year. Excluding SmartCover, SEA as a percent of sales would have declined a pro forma 90 basis points year-over-year.
The income tax provision increased modestly to 24.4% in the first quarter of 2025 from 23.5% in the comparable prior year period. This remains consistent with our previously discussed 25% tax rate assumption.
In summary, our strong operating results in the first quarter drove a 31% increase in consolidated EPS to $1.30 from $0.99 in the prior year comparable quarter. Primary working capital as a percent of sales increased from 20.8% at year-end to 22% as of March 31, 2025, inclusive of SmartCover. We generated strong free cash flow in the quarter of $30 million, up 60% from $18.8 million in last year's comparative quarter. As is normal, our first quarter reflected typical seasonality with incentive compensation and retirement plan contributions paid out for the respective previous year.
With that, I'll turn the call back over to Ken.

Kenneth Bockhorst

Thanks, Bob. Turning to slide 5 on the topic of the tariffs. As we've seen play out over the past several weeks, what we know for sure is that uncertainty and volatility in the tariff picture remains likely. The key takeaway for Badger Meter is that we will adeptly manage what is in our control, just as we've gone through COVID, supply chain disruptions, inflation and other challenging macro dynamics that we faced over the past five plus years.
With that in mind, I'll walk you through our status given the current set of circumstances. As many of you know, we operate a world-class assembly facility in Nogales, Mexico which we're proud to say, celebrated its 45th birthday last week. The facility is in maquiladora, which essentially acts as an extension of our US operations on Mexican soil. It's the primary assembly site for our residential meters and radios, the vast majority of which qualify for exception from tariffs under the USMCA.
The component coming into this Mexico facility for assembly originate from a wide range of countries, and we will continue to manage component sourcing into Mexico, which limits our exposures to a certain degree.
For our US-based manufacturing facilities, including our Buy America Build America compliant assembly line, we could face import tariff exposure on electronics and related components from China, Southeast Asia and Israel, among others. This means that US manufactured products are likely to face higher tariff-related input costs under the structure is currently in place.
We will institute targeted pricing offsets to manage this potential impact. We could also face tariffs on the finished goods we import from our European manufacturing facilities, which produce certain flow instrumentation and water quality products for sale in the US. This represents a relatively small percentage of Badger Meter's overall sales, but targeted pricing actions may also be required for these products.
Finally, let me share an example of the knock-on effect of the tariffs that may not be as obvious from the headlines. China has implemented export controls on certain chemical and rare earth elements as part of its response to US tariff actions. Bismuth is an element that's included in the supply restrictions. While bismuth happens to be a small component of our brass I get recipe, the prices increased nearly tenfold since early this year.
China produces 90%-plus of the bismuth in the world, a pivot away from bismuth and the recipe is not possible in the short term and strategic sourcing initiatives won't help reduce the cost of a supplier restricted rare element. We will therefore need to adjust pricing accordingly.
Obviously, copper makes up a far greater percentage of the recipe. And while copper prices have been volatile, current pricing is only modestly higher than it was at the beginning of the year. We will continue to watch this closely as we always do. All told, we believe there's a level playing field competitively for these targeted mitigation actions.
As Bob mentioned earlier in his remarks on margins, the gross margin we delivered this quarter demonstrates that the structural mix benefit of technology adoption within our business is real. Yet the various cost pressures and let the impact of mitigation actions from the tariff situation that informed our decision to maintain our normalized margin -- normalized gross margin range at least for now.
Turning now to our outlook. We have a proven history of differentiated operational execution, and we'll continue to focus on controlling what we can control in a turbulent economic environment, particularly in the management of our supply chain manufacturing footprint and value-based pricing strategy. Our first quarter results demonstrate the resilience and durability of our replacement-driven business.
As previously communicated, the second quarter represents our most difficult prior year comparison, and we've already walked through some of the puts and takes we have on the margin side, especially in the near term as we navigate the evolving tariff situation. Nevertheless, the attractive fundamentals of the water industry and the growing extensibility of our BlueEdge suite of solutions, which now includes sewer and lift station monitoring with the acquisition of SmartCover, continue to support a long-term average revenue growth outlook of high single digits and modest margin improvement over time.
Even after the SmartCover acquisition, we have available cash, continue to generate strong free cash flow and remain debt-free. Our balance sheet has ample capacity to invest in both organic and inorganic growth while we continue to work our way through any further macroeconomic volatility. We were proud to be named the Barron's list of 100 most sustainable companies for the third year in a row. We think very seriously our role in protecting the world's most precious resource and believe this responsibility aligns with the creation of shareholder value over the long term.
Finally, as you heard from Karen earlier in the call, this is the last earnings call for illustrious career in Investor Relations spanning 72 quarters. I know I speak for Bob as well when I say that we have been proud to have her with us here at Badger Meter for the last 26 of those quarters. Moving into our first roles as public company CEO and CFO, we knew this is important to have an accomplished professional with us that could help create and drive a successful strategy, deliver clear messaging that employees and investors alike to rally around and who also happens to be a great person to work with.
The only choice for us was Karen. While she will be missed by all who work with her, we are all happy for her to begin the next chapter of her life after leaving a great legacy behind here. Equally, we're excited for Barb to step into the role officially and put her own mark on things moving forward.
With that, operator, please open the line for questions.

Karen Bauer

That was not in the first slide prepared remarks. Thank you.

Question and Answer Session

Operator

(Operator Instructions)
Andrew Krill, Deutsche Bank.

Andrew Krill

And congratz to Karen on your retirement. I was hoping -- I want to ask or just any more color you can provide on the especially favorable product customer mix benefits. Now you called out SaaS growth, but just anything else would be helpful because the margins are just so outsized and impressive. And then secondly, if we were to in the tariff backdrop was somewhat stable from here, should we be expecting gross margins to moderate all the way back to the 38% to 40% range in 2Q? Or is this more of like a worst-case scenario?

Kenneth Bockhorst

Yes. So obviously, quite a bit to unpack there and in this pretty uncertain environment. The one thing that I think everyone should be excited about is that even in this really crazy environment, we feel really strong about the flow of our margins, which we've talked about for years now about the durability and the realness of the positive structural mix.
So going forward, we certainly expect that in a tariff situation that we consider -- that we currently consider manageable. We feel like we're in pretty good shape going forward. I'll let Bob give any more detail on some of the mix and some of the particularly favorable things. But overall, I feel great about the ability to manage and the state of the business.

Robert Wrocklage

Yes. Hopefully, you can tell from the prepared remarks that essentially, a lot of things went in our favor in the first quarter. And so while we're absolutely proud of the result, we're in this tenuous or uncomfortable position of almost apologizing for that great margin against the backdrop of potentially increasing input costs, particularly which in the short term, the mitigation actions that we talked about can't be implemented immediately, right?
They have -- they can be implemented immediately, but the effect will lag essentially the input cost increase, which is nearer medium. And so that's a long way of saying there are certainly aspects of what drove the outcome and Q1, the 42.9% gross margin that are durable and will sustain. And there are elements that are more episodic and or mix specific or customer specific that we can't expect to happen each and every quarter.
So I think another way of saying that is if we're not for essentially this backdrop of tariff input cost pressures. I think given our last four quarters of margin performance, we'd likely be redeclaring a new line. It's just very difficult to do that against this backdrop of uncertainty, particularly in the short term.

Andrew Krill

That's Very helpful. And then , could you just touch on the front log of activity you have? And is your core customer showing any signs of potentially pulling back on spending or delay spending with all the uncertainty? Or is -- again, just the replacement term and nature of your business and the ROI still compelling enough that the kind of business as usual as much as it can be.

Kenneth Bockhorst

Yes. So we're not seeing or hearing from customers anything on pullbacks. I think it's important to forget the 100 years of history that talked about this being a very durable replacement-driven market. If you just look at the last five years, even in the COVID year, where essentially, we lost an entire quarter, we still grew 4% even in the COVID year. And then if you want to consider tariffs maybe against the highly inflationary year that fell out two years later, we were up 14% that year.
So I think given some of the really difficult environments you've seen in the last few years, the customer is particularly around these benefits that come from ROI and the technology adoption of our other products as well as the replacement driven when the meter is due to be replaced to replace it just because also in difficult times serves as the cash register. So that's the last thing they cut if they do have budget problem. So we see -- still feel as positive on the outlook as we did through those other difficult times.

Operator

Nathan Jones, Stifel.

Nathan Jones

And congratulations to Karen for May. I guess the first question I'd like to ask you. So Bob, are we on the stairway to heaven yet?

Robert Wrocklage

I would say, again, if you track our gross margin over time. So Nathan's question is referring to a comment that I often make, which is it is -- the margin profile is not a stairway to heaven because there's obviously some of the dynamics that this quarter particularly are favorable, sometimes are unfavorable. And so -- and again, that we largely play in a competitive environment that while rational, we're all trying to steal each other's lunch through the best of our ability, which has proven difficult over time.
That being said, I think, again, we have a great input here of a result. I think hopefully, the way I answered the previous question rings true here as well is that a lot of things went right in this quarter. There are certainly some of those that are durable and other of those that will be episodic and could go the other way next quarter. But yes, there's definitely a positive trend.

Kenneth Bockhorst

I like how you handled the real positive trend out there.

Nathan Jones

I guess a more serious question around the tariffs. Are you guys able to quantify what you think the aggregate impact to your COGS input here is and just confirm that you believe whatever that number is, you'll be able to cover it with price.

Kenneth Bockhorst

Well, so that's a difficult question. If you could just tell us how this is going to play out, we can tell you exactly what it would be. So like everybody else, we've watched the news everyday and we understand --

Nathan Jones

It's going to stay exactly -- it's going to stay exactly where it is now.

Kenneth Bockhorst

Okay. If you're going to say it's going to stay exactly the way it is now, I would tell you that our current situation is not competitively disadvantaged and its managed.

Robert Wrocklage

The synopsis for that answer is the title on slide 5. Manageable. Some lag effects contained within our normal range and competitively level playing.

Nathan Jones

I mean, it sounds like the kind of message, I don't know, maybe I'm making numbers up here, but it's kind of a less than mid-single digit kind of impact overall to your costs?

Kenneth Bockhorst

Well, it's a multifactor variable question, right? Because then there's also the targeted pricing actions that we take to mitigate and all those different pieces. So I think it's probably prudent to think about the range that we provided and the strength that we feel above the [floor]. And remember that through a myriad of difficult operating environments, we've been, I think, extremely -- our employees around the world have done an extremely great job of managing the ups and downs at difficult times, and I think we're prepared to do it again.

Nathan Jones

Fair enough. Is there any perception that customers might have pulled forward some orders into the quarter in front of potential price increases or in front of potential supply chain disruptions or anything like that? Or did it kind of progress through the quarter as you would expect it to normally?

Kenneth Bockhorst

So two things to remember is that 75% of our revenue is direct to end users and end users really, in many ways, cannot pull forward because they can't really put them into meter pits or homes faster and they don't have the warehouse space to typically hold it. So a large portion of the revenue really doesn't even have that leverage pull. And then the 25% that goes through distribution, we've not seen large pull forward orders. So it was a pretty normal order environment.

Nathan Jones

Normal is good in this environment.

Kenneth Bockhorst

Yes, thanks.

Operator

Jeffrey Reive, RBC.

Jeffery Reeve

First, I just want to say thanks to Karen for all your help and insights and wishing you the best in your retirement. Could you guys provide some comments around the health of municipal budgets today? How are you seeing utilities prioritize AMI investments in the current backdrop? And maybe more broadly, what's the risk that broader price inflation in other areas of utilities budget could crimp meter demand?

Kenneth Bockhorst

Okay. I'll start, and I think that was about three questions. I'll ask Bob to fill in what I guess. But the first part on municipal budgets to remember is with 50,000 utilities in the United States and the myriad of different ways that utilities can fund investment, there's no one-size-fits-all answered to that. But in general, one of the things we feel great about with our sales model is selling 75% of our revenues are active. We talk to customers on a very constant basis, and we're continually asking them about their budgeting cycles, whether that's in the short term this year or the three to five year outlook.
And what we're hearing in general, specific back to metering is, if the utility is facing budget issues, oftentimes, they will reprioritize their budget to do their metering replacements because clearly, with serving as the cash register, if you do for your meter replacement, you're going to do it for a myriad of reasons. Either it's an older system and you're looking for more efficiencies in the REITs to capture non-revenue water or eliminate waste and conservation.
And then secondly, if you're into a longer-term drive buy or AMI offering, those are battery-powered devices. And when they go dark, they need to be replaced. So that's where when I talked earlier about the inflationary period in COVID, I think it's been proven just within the last five years twice that when times are tough, this is not the area of the utilities time. I was giving you the hindsight --

Jeffery Reeve

Yes. Curious if there's an opportunity or maybe greater customer reception to alternative pricing models like a meter as a service in this backdrop?

Kenneth Bockhorst

So generally, again, if I compare it to the other difficult times over the last five years, sure, you might have some that would look at that. But I would say, in general, the buying habits have not changed.

Operator

Scott Graham, Seaport Research Partners.

Scott Graham

Heartly congratulations to you, Karen, you've done great jobs in both of your positions that I've known you. I wish you the best of luck. I wanted to ask a couple of questions around some of the statements that you make in the press release and then reiterated here, Ken, specifically, you talk about the company's ability to manage certain tariff-related cost challenges. You've amplified on that in the presentation here.
I'm just wondering if you can provide some color on what the triggers are where certain becomes -- or managed certain becomes, well, this is more than what we expected. Like would it trigger be a rollback in the USMCA. Is it steel tariffs? Is it the electronic components piece, what would be the one or two or whatever many triggers that would have you concerned about your ability to manage.

Kenneth Bockhorst

Yes. So for us, we called out the Mexico facility by name. So clearly, we're very proud of the operation we have there. We wouldn't be leaving there. So if there were some change in the USMCA, that would have an impact that we would have to consider it pretty seriously.
And the other areas that we look at, I think it's really well known about our linkage to copper, and I called out bismuth. So anything that's particularly damaging in that area that would happen in the future would be something that has to be considered. Those are the two primary ones.

Scott Graham

Okay. That's very helpful. And then my follow-up is simply really, you indicated that you're talking to customers frequently daily. And you said they are not looking -- you haven't heard anything about pauses or delays in deployments and what have you. I'm wondering though, if on the mix within the orders that you're seeing right now, whether it's price, the mix trade-up with AMI with radio, AMI with communications and software, leak detection, all of these trade-up factors that can go into your sales per unit.
Has any of these elements change? In other words, has something become -- in this quarter in particular, what was sort of the standout on mix? And then more importantly, on the orders, has that changed that the mix components?

Kenneth Bockhorst

Yes. As we've talked about for many of the years from quarter-to-quarter, it can be generally sometimes a whole different set of utilities that can be the mix of small versus medium versus large. There's the turnkey elements. There's so many factors that you really can't point to one. One of the things I'm particularly proud of, though, is that our software business is becoming a pretty meaningful part of the portfolio, and you saw that grow again, 25% in the quarter. And that's a very positive structural change that provides tremendous benefits for customers and does a lot of good work for us on our continuous improvement move forward on margin enhancement.

Scott Graham

I think I hear you saying that --

Robert Wrocklage

Fundamental has got no real changes.

Scott Graham

Well, I think -- yes. I'm hearing that. And I get the second quarter guidance and just the mix components are so important for your sales and earnings. So I just had to ask if there was any specific change that you're seeing in present order rates. And it sounds like your answer to that is no, and it's because there are so many factors at play.

Kenneth Bockhorst

That's right. That's right. So the thing that I would hope to have people take away from this, is that as we've talked about the structural mix for years, and we've kind of stubbornly stayed in our range. This at least gives you a view into what's possible here. And all of these levers continue to be strong, and we continue to take our one step forward at a time approach to how we manage and how we communicate that these drivers are real, and this is a quarter where you just saw more of them come together than it does in many quarters.

Operator

(Operator Instructions)
Rob Mason, Baird.

Rob Mason

And my congratulations, to you, Karen as well. Certainly appreciate all the help over the years. And Ken, I just I wonder to maybe clarify, have you already notified customers of price increases that you plan to take? Or is that forthcoming?

Kenneth Bockhorst

So that's the forthcoming. So we're being very prudent in making sure we understand the situation, making sure that we're being very fair with our customers. I mean this -- I want to be clear, this isn't something we're happy about. They're trying to do price grabs. They're trying to be the first in the market.
Your question, yes, some competitors have notified customers that we've heard of, many of our distributors are hearing from several of the other suppliers of other things that they sell, whether we've got to be piping or valves or those types of things.
So it's getting out into the market and this is one of those things where -- that's why we're confident that our ability to recover price is manageable because it's already happening. It's just we haven't been on the lead of raising people's prices.

Rob Mason

Understood. Well, maybe as a follow-on to that, I know, frankly, inflation risk and the ability to handle that is always a consideration for you. But when you think about some of these AMI projects or multiyear deployments and contracts, does it require you to do something different? Or are the customers asking for anything different in terms of allowing those to go forward? I guess I'm thinking of the upfront decisions around those to make sure that both sides are protected in that sense? Has that changed?

Robert Wrocklage

Yes, I would say there was an evolution with the inflationary pressures of 2021 and 2022, where multiyear price hold requests were very common from utilities in the past. And I think we learned from past as well as navigating that inflationary environment to push back on that more aggressively.
And I would say competitors have done that as well. So I would say that the benefit of the current situation is some of that historic practice or requests or common understanding changed two, three years ago. But absolutely, we've got the lesson learned from past cycles as well as the ongoing desire to keep as much flexibility as we can, realizing that not all customers are created equal to difference amongst customers.

Rob Mason

Understood. If I could sneak in one more real quick, Bob. Just on -- I know you said that you didn't really notice a change in customer order patterns cadence beyond the normal. But your receivable line was up a fair amount sequentially. I was just -- what would have caused that? I understand acquisition probably contributed some, but just curious.

Robert Wrocklage

Yes. So a small piece of that is the addition of SmartCover, as you just alluded to. And I would say the remaining amount is simply, I would say, timing difference between the half of sales in Q4 versus Q1. Nothing there in terms of kind of a risk element or anything like that, its simply timing as the sales fell in the quarters, respectively, Q4 versus Q1.

Operator

(Operator Instructions)
We have no further questions, so I'll hand the call back to Karen for some closing comments.

Karen Bauer

Thank you for everyone -- to everyone for joining the call for your planning purposes, the second quarter 2025 call scheduled for July 22. I will obviously not be on that call. So let me take a minute to first thank Ken and Bob for giving me the opportunity to lead IR here at Badger Meter along with their unwavering support to drive ESG and strategic planning initiatives here in recent years.
I also want to thank all of Badger Meter colleagues. You've given me the easiest job on Wall Street with your world-class execution, supporting our customers and delivering phenomenal results day after day, quarter after quarter and year after year. And finally, I thank you to our analysts and investors, past and present for the many interesting and informative discussions over the years, the diversity of your styles, viewpoints and questions insured I was never bored. So with that, I'll wrap up the first quarter call. Bob and I will be around to take your follow-up. Thank you.

Operator

This concludes today's call. Thank you very much for your attendance. You may now disconnect your lines.