Ladies and gentlemen, welcome to the third quarter 2021 Badger Meter Earnings Conference Call. My name is Charlie, and I'll be the coordinator for today's call. You have the opportunity to ask a question at the end of the presentation. If you'd like to register a question, please press star followed by 1 on your telephone keypad. 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 third quarter 2021 earnings conference call. On the call with me today are Ken Bockhorst, Chairman, President, and Chief Executive Officer, and Bob Wrocklage, Chief Financial Officer. The earnings release and related slide presentation are available on our website. Quickly, I 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. Finally, during this call, we will refer to core results for various financial metrics, for example, core water utility sales. Core means a designated financial metric excluding the impact of the recent s::can and ATI acquisitions.
We believe this reference point is important for year-over-year comparability. With that, I'll turn the call over to Ken.
Thanks, Karen, and thank you for joining our third quarter earnings call. I'm not sure how often the term supply chain challenges or inflation are going to be referenced during the quarterly earnings cycle over the next month, but I can only imagine it's going to be an all-time record. While we clearly face our fair share of those challenges, I want to focus my introductory comments on recognizing the tremendous execution of our Badger Meter teams globally for their proactive and constructive dialogue with customers to manage priorities, expectations, and build trust. For their agility in effectively redesigning certain product components to provide greater flexibility on supply sources. For their unrelenting diligence in supplier and logistics management, and for their collaboration across functions to maximize our deliveries to customers.
These strategic and tactical actions by our world-class team allowed us to deliver record sales and earnings this quarter while we added to our already record backlog. I'll talk about the current environment and our outlook later in the call. For now, let me turn the call over to Bob to go through the details of the quarter.
Thanks, Ken. Good morning, everyone. Turning to slide four, our total sales for the third quarter were $128.7 million, an increase of 13.3% over the $113.6 million in the same period last year. Total utility water product line sales increased 12.2%. Excluding approximately $10 million of sales from the s::can and ATI acquisitions, core utility water revenues increased 1.7% year-over-year. A great result considering both the difficult prior year comparison and current year supply chain challenges. As we reminded you in our prepared remarks on the July earnings call, during the third quarter last year, our manufacturing operations were recovering production after the initial COVID lockdowns, therefore, our sales and profits reflected the benefit of a sizable backlog recovery and lower pandemic-impacted SE&A costs.
In addition to the difficult comparison, our manufacturing output in the current quarter continued to be limited by supplier shortages of certain electronics and other components, along with logistics challenges. We did experience growth in mechanical meter, cellular radio, and BEACON software as a service levels, and we continued to realize the benefit from strategic value-based pricing actions. Strong orders continued in the third quarter of 2021, and we exited the quarter with another record-high backlog. Our water quality solution sales were also impacted by supply chain challenges on a more modest basis, yet still delivered results in line with our expectations. The flow instrumentation product line did not escape the impact of production limitations from component shortages, but delivered a strong 18.5% year-over-year increase in sales.
Improved demand trends across the majority of global end markets and applications, as well as an easier comparison led to the increase year-over-year. We were very pleased with the margin performance in the quarter in light of widespread inflation, difficult comparisons, and the dynamic supply chain impact on manufacturing operations. Starting with gross margins, we increased gross profit dollars by $6.2 million, and as a percent of sales, gross margins improved 20 basis points to 39.8% from 39.6%. Margins benefited from favorable acquisition mix as well as the higher volumes and positive product sales mix, namely higher SaaS revenues along with favorable value-based pricing realization. These factors combined more than offset increasing cost headwinds across purchase components, including higher brass, resin, and other materials, as well as freight and logistics.
As our margins demonstrate, we have executed well thus far in proactively implementing pricing mechanisms to offset existing cost increases. However, as has been well-publicized, the breadth and pace of inflationary pressures is increasing. We will continue to actively monitor pricing in light of these circumstances, recognizing there will be leading and lagging impacts in this dynamic environment. SE&A expenses in the third quarter were $31.7 million, consistent with the first two quarters on a dollar basis, with sequentially improved leverage as a percent of sales to 24.7%. SE&A expenses increased $6.2 million year-over-year, with the inclusion of the water quality acquisitions, as well as more normalized pandemic impacted expenses such as travel.
As a result of the above, overall operating profit margin was 15.1% compared to a record 17.2% in the prior year quarter. The income tax provision in the third quarter of 2021 was 18.3%, below the prior year's 23.9% and our normalized rate in the mid-20% range, due to a discrete favorable income tax benefit related to equity compensation transactions. In summary, EPS was $0.54 in the third of 2021, an increase of 6% from the prior year's EPS of $0.51. Working capital as a % of sales was 25.6%, an increase of 140 basis points compared to the prior quarter end. The modest elevation in accounts receivable and inventory are temporary byproducts of the current supply chain environment. For example, we are strategically maintaining higher levels of certain inventory components and work in process, capitalizing on spot availability and capacity.
In addition, certain customers are understandably deferring payment on partial shipments. We believe these are transitory repercussions of the current environment. Free cash flow of $13.9 million was lower than the prior year, the result of this higher working capital. On a year-to-date basis, free cash flow conversion of net earnings is 125%. With that, I'll turn the call back over to Ken.
Thanks, Bob. Turning to slide five, we've updated the quarterly sales comparison chart, which highlights the key factors driving uneven year-over-year top-line trends. The growth rate we experienced this quarter, excluding the acquisitions, was the result of strong customer demand, which was muted by headwinds from the varied supply chain challenges and difficult prior year core utility water comparisons. As we enter fourth quarter and look to 2022, our backlog is supportive of continued sales growth, with the level of quarterly sales, quite frankly, dependent on the level of supply chain disruption. While this could lead to variability in the cadence of sales, it is important to recognize 2 things with regard to our execution. 1, our performance thus far is delivering total sales growth despite the significantly supply-challenged environment. 2, that our orders and awards are not being canceled or postponed, but simply shifting to the future.
We feel very good about our competitive position and the underlying drivers supporting our markets. In summary, here on slide six, we believe that our strong order momentum and backlog confirms the underlying market demand for our solutions, which combine data, communications, and analytics into tailorable solutions to enable customers to be more efficient, effective, and sustainable throughout the water ecosystem. The water quality acquisitions continue to perform well, and the integration work that has been underway, including customer discussions, confirm the growing need and acceptance of online low-maintenance and reagent-free solutions for real-time water quality monitoring. These distributed solutions will be a game changer for utilities, wastewater, and industrial customers alike. We remain optimistic about our future prospects as we continue to execute on our growth strategy.
In tandem, we are acutely aware of the challenges presented by the current disruption to the supply chain and global shortage of electronics and other components, accelerating broad-based inflation, as well as the potential for further impacts from the pandemic. While these challenges are not unique to Badger Meter or even our industry, the ongoing headwinds have the ability to impact top-line growth rates and exert increasing margin pressures. The breadth of these challenges is greater than what we've experienced previously. The playbook for addressing them is not new. As I discussed in my opening remarks, we're working all aspects of the playbook within our control, with the best team, to mitigate the challenges and deliver sustainable solutions for our customers. Finally, I want to mention our work with AT&T on the Connected Climate Initiative they launched in August.
We are one of several partners that AT&T highlighted for our efforts to reduce the impact of climate change via the water and energy savings associated with our Smart Water offerings. Using infrastructure-free cellular technology in our ORION LTE-M radio enables our AMI solutions to deliver more resilient, efficient, and sustainable water solutions. You can learn more about the AT&T initiative, as well as the resiliency of the cellular AMI solutions in the wake of extreme weather events highlighted in a recent Badger Meter Smart Water show by clicking on the links on today's slide presentation. With that, operator, please open the line for questions.
Our first question comes from Nathan Jones of Stifel. Nathan, your line is now open.
Good morning, everyone.
Hi, Nathan.
Morning.
Ken, I was going to ask about something else, but seeing as you brought up supply chain and inflation, I guess we'll talk about that.
I didn't think that would come up today. I thought I was getting ahead of it.
No, I can see that. It was unlikely anybody was going to ask any questions about that. You noted in the press release this morning, you took a variety of strategic actions in the face of ongoing electronic and other component delays. Can you just give us some more color on what those strategic actions are and how you think they'll help to mitigate some of these challenges?
I think one of probably the most impactful ones that you're hearing other companies talk about as well is that our engineering team has been really engaged tightly with our supply chain team. As we're identifying some of these challenges that are going to be a little more impactful or perhaps longer lasting, we've done a really effective job of re-engineering some components out and finding alternate replacements and dual sources for supply.
Been really proud of the nimble response there. I think maybe not as strategically so, but just in terms of tactical communication. You may recall, I think we were talking about upcoming challenges before others in the industry. We've had a really strong communication line between our customers and our group, and I just couldn't be more proud of how we've managed through it, both in strategic actions and tactical work.
Okay. Follow-up on that. The water utility business, ex the acquisitions, revenue was up 1.7. I think that probably implies to me that price was up more than that and volume was probably down a little bit. Can you talk about just how much lower productivity you're getting? What kind of impacts these supply chain challenges are having on scheduling and production? We're hearing things about you don't know what's going to be late until it's late, in this environment, which I'm sure makes it difficult to schedule production and creates inefficiencies in there. What kind of productivity are you losing from these kinds of things?
Well, it's a good point that you bring up on the inefficiencies, because it isn't just about component availability, it's also about logistics, being able to get it to you. That certainly has been an inefficiency challenge that, again, I couldn't be more proud of how our team has overcome that. Certainly a factor. When it comes down to pricing, it's not quite as simple as, we sold a widget last year for a price, and this year we sell it for something more. As we get more sophisticated with AMI solutions of selling the different mix of meters that could be mechanical versus ultrasonic or radios and software. This is why we talked about our pricing programs as value-based pricing.
We're really focused on making sure that we provide great solutions to customers, that we get all the value for it that we deserve, and that we win at least or more than our fair share in a really strong growing market. I feel like we're executing on all aspects of that.
Is there any kind of range or color that you can give us around what kind of productivity you think you're losing because of all of this supply chain disruption?
Well, first off, I know a lot of people are talking about labor shortages and that impacting. Let me just take that first off. We're not having labor-related challenges. Our labor workforce is here doing a great job knocking things out. In terms of quantifying, I haven't. I don't know, I'm looking at Bob, but I just know that there's disruption there that we're working through. I frankly haven't thought to quantify it.
Yeah. I would think of it more not necessarily as lost production, but more the dog paddling under the surface that has to occur to sort of reorder and rejuxtapose production prioritization. I think it's not as simple as the two-dimensional question that you allude to. Yeah, obviously there's impacts underneath the surface, but we're navigating them as best we can.
Okay, thanks for the color. I will pass it on.
Perfect. Thank you. As a reminder, it's star followed by one on your telephone keypad to submit a question. Our next question comes from Connor Lavecchia of Morgan Stanley. Connor, your line is now open.
Yeah, thanks. I suppose we'll stick with that supply chain topic, as you anticipated. I guess I'm curious if you could just quantify, well, quantify might be the wrong word, but point to the areas that you've seen the most tension within the supply chain. I'm mostly curious the evolution of that as we've moved through the quarter and as we sit here today, and to what degree you have visibility on some of the major pinch points. Are they getting worse? Are they getting better? What's your sort of expectation in the near- term here?
Yeah. That's an interesting question. We've seen this evolve, and I know when you read the news, there's all the talk about semiconductors, but it really is quite a bit more broad-based than that. I would say it's electronics in general is the largest challenge as we work through this. There's several components that go into making a radio or an ultrasonic meter, and while you might be chasing one today, it could be a different one tomorrow.
I would just say, in general, the electronics challenges haven't really gotten better or worse. It's a matter of just working through and making sure you can secure your supply. Throughout the year, because of the deep freeze, there have been challenges with resins, both inflationary and availability. I think what we're starting to see there is availability is starting to get better on the resin side.
Inflation is still real there. Some of the bigger challenges are just on the logistics, as I mentioned previously. You might think you've got components showing up today and then all of a sudden, maybe they don't for a few days. Our supply chain guy refers to it as Whac-A-Mole, and that probably is the best example that I could use to describe it.
That's helpful. It certainly strikes me that you guys have been doing very well relative to some other peers out there. Has that translated into any opportunity to take share, be it on an incremental contract or just backfilling where others can't? I know you described the industry as relatively rational and oligopoly like. Curious if that's really altering the competitive dynamic at all or if you're really not seeing that.
Well, I think I would characterize it this way. The oligopoly is still very strong. Customers are still very sticky and loyal. At the end of the day, sometimes they just need a meter, right? A radio. We have, with our Choice Matters that we like to talk about with our portfolio of being able to produce mechanical meters, both composite or brass, ultrasonic meters for on the static side, all the different variations of radios. We're offering a solution for any problem.
I think in many ways, that has helped us through this. I would say, I think opportunistically, I know that we've picked up some additional orders. Will that translate into share that we keep? I don't know. I do feel like we've got enough information in the market to know that our portfolio is helping us pick up some additional orders.
Think of that as on the fringes, not necessarily wholesale conversions.
Okay. Makes sense. I'll turn it back. Thank you.
Perfect. Thank you, Connor. As a reminder, it's star followed by 1 on your telephone keypad to submit a question. Our next question comes from Rob Mason of Baird. Rob, your line is now open.
Yes, good morning.
Hi, Rob.
Good morning. I wanted to know, Ken, how you're thinking about just seasonality here in the short- term from the demand side. I know from the supply side, that may be dictated or the cadence will be dictated by what comes in. Historically, there is some seasonality from the demand side, and just given that you have elevated backlog, would your customers kind of buck that seasonality if the supply's available?
A 2 things on that. I think over the past few years, the idea of seasonality has become less of an issue for us as we sell more radios and software becomes a bigger part of the portfolio. We don't only sell in weather-related areas. Obviously, people in the South and the West continue to work. I think the seasonality has been naturally muting anyway. Now with our backlog, if you recall, we talked about it in Q1 being a record, we talked about it in Q2 being another record, now we added to it again here in Q3. I think it's really a difficult situation to talk about what to expect given the supply chain. I would expect seasonality to continue to be less of an issue for us as you think about Q4.
Okay. Bob, on the gross margin in the quarter, is there a way to quantify with the inflationary, your overall cost bucket, how that might have impacted gross margin in the quarter?
Typically we don't get that granular. If I just diagnose kind of the year-over-year comparative, certainly you've got a variety of dynamics taking place. We have the structural mix that we talk about every quarter. You heard us mention selling more radios year-over-year and selling more software year-over-year. That's a buoy to gross margins. Of course, we've talked in the past about acquisition mix being a favorable contributor to our margins on a year-over-year basis. Naturally, just given the talk on inflationary and cost pressures and pricing, I think we started out 2021 with a great move with strategic pricing initiatives. I would say for the first half of the year, we outpaced price cost in that world. I would argue that in third quarter, that gap narrowed because the inflationary cost pressures have crept up.
When you mold all that together, you got some pluses and minuses, and that's what's really driving the outcome in the quarter. I think you can tell from our tone and from the script that we've talked about with inflation continuing. As we look forward, I would expect that to be a pressure in the fourth quarter.
To your point on the value-based pricing, as I recall, it was around September last year that you started to work some elements of that into the business. Does that approach still give you the tactical flexibility you need to address some of these pockets of inflation?
Yeah, absolutely. While the lion's share of the effort was a year or so ago, that isn't a point in time and then we're done. We're continually revisiting that each and every month, and we'll continue to do that as we move forward. There's still opportunity. We've talked in the past three quarters about there'll be times of leading and times of lagging in the price cost dynamics. We're still able to pull those levers, and we will be as we move forward.
Very good. Thank you.
As a final reminder, it's star followed by one on your telephone keypad to submit a question. At this time, we currently have no further questions, so I'll hand back over to Ms. Bauer for closing.
Great. Thank you. I did want to let you know that today we posted to the investor section of our website a report from our board of directors addressing the topic of board diversity. I encourage you to read that report, and please feel free to reach out to me with any questions or comments on the report. Finally, for your planning purposes, our fourth quarter year-end 2021 earnings call is tentatively scheduled for January 28th, 2022. Thanks everyone for joining our call today. I'll be around all day to take any follow-up questions you might have. Have a great weekend.
Ladies and gentlemen, thank you all for joining.