Mueller Water Products - Earnings Call - Q1 2020

Transcript

Speaker 0

Welcome and thank you for standing by. At this time, all participants are in a listen only mode. Today's call is being recorded. If you have any objections, you may disconnect at this time. I'd now like to turn the call over to Mr.

Whit Kincaid. Sir, you may begin.

Speaker 1

Good morning, everyone. Welcome to Mueller Water Products first quarter twenty twenty conference call. We issued our press release reporting results of operations for the quarter ended December 3139, yesterday afternoon. A copy of it is available on our website, muellerwaterproducts.com. Discussing the first quarter's results and our outlook for 2020 are Scott Hall, our President and CEO and Marty Zakas, our CFO.

This morning's call is being recorded and webcast live on the Internet. Have We also posted slides on our website to help illustrate the quarter's results as well as to address forward looking statements and our non GAAP disclosure requirements. At this time, please refer to Slide two. This slide identifies non GAAP financial measures referenced in our press release, on our slides and on this call and discloses the reasons why we believe that these measures provide useful information to investors. Reconciliations between non GAAP and GAAP financial measures are included in the supplemental information within our press release and on our website.

Slide three addresses forward looking statements made on this call. This slide includes cautionary information identifying important factors that could cause actual results to differ materially from those included in forward looking statements. Please review Slides two and three in their entirety. During this call, all references to a specific year or quarter, unless specified otherwise, refer to our fiscal year, which ends on September 30. A replay of this morning's call will be available for thirty days at 604-0817.

The archived webcast and corresponding slides will be available for at least ninety days in the Investor Relations section of our website. In addition, we will furnish a copy of our prepared remarks on Form eight ks later this morning. I'll now turn the call over to Scott.

Speaker 2

Thanks Whit. Thank you for joining us today to discuss our first quarter results for 2020. We had a very good start to 2020 as we generated solid organic consolidated net sales growth, improved margins and increased adjusted EBITDA in the quarter. Our net sales increased 10.3% driven by the benefit of the Krausz acquisition with organic net sales increasing 3.1%. Both higher pricing and increased shipment volumes of our core infrastructure products drove our organic net sales increase.

We increased our gross margin by two ninety basis points to over 34% in the quarter. Higher pricing, favorable product mix and the addition of Krausz more than offset increased costs from tariffs and inflation. Both infrastructure and technologies contributed to the gross margin improvement in the quarter. I was especially pleased to see technologies achieve breakeven adjusted EBITDA in the quarter. This performance and the addition of Krausz helped deliver nearly 20 consolidated adjusted EBITDA growth.

During the quarter, we settled the Walter Energy tax liability with a $22,200,000 payment to the IRS. After a significant effort managing and resolving a complex situation over the past four years regarding the obligation of our one time parent company, we can finally put this matter behind us. For fiscal twenty twenty, we expect to see continued favorable demand in our end markets driven by healthy municipal spending and improved residential construction. However, we remain cautiously optimistic due to continued uncertainty from global and domestic matters. After a solid start to the year, we are increasing our expectations for both net sales and adjusted EBITDA growth for fiscal twenty twenty, which I will discuss in more detail later in the call.

With that, I'll turn the call over to Martie.

Speaker 3

Thanks, Scott, and good morning, everyone. I will begin with our first quarter consolidated GAAP and non GAAP financial results, then review our segment performance. Our consolidated net sales for the quarter increased 10.3% or $19,800,000 to $212,600,000 This increase was primarily driven by the acquisition of Krausz as well as higher pricing and increased shipment volumes at Infrastructure. As Scott mentioned, we achieved organic net sales growth of 3.1% in the quarter. Our gross profit this quarter increased 20.8% or $12,500,000 to $72,600,000 Gross margin of 34.1% improved two ninety basis points over the prior year.

This improvement was primarily due to higher pricing, product mix and the addition of Krausz and was partially offset by higher costs associated with tariffs and inflation and approximately $500,000 of start costs associated with our large casting foundry expansion in Chattanooga. Selling, general and administrative expenses were $49,900,000 in the quarter, an $8,900,000 increase over the prior year. The increase was primarily due to the addition of SG and A from Krausz, which accounted for about half of the increase, and IT related activities, personnel related costs and professional fees. SG and A as a percent of net sales was 23.5% in the first quarter compared to 21.3% in the prior year. Our current expectations for full year 2020 are for total SG and A expenses to be about 20% of consolidated net sales.

Operating income increased 27.7% to $20,300,000 in the first quarter compared to $15,900,000 in the prior year. Operating income included strategic reorganization and other charges of $2,400,000 in the quarter versus $3,200,000 in the prior year. Turning now to our consolidated non GAAP results. Adjusted operating income increased 18.8% or $3,600,000 to $22,700,000 in the quarter. Both Infrastructure and Technologies increased adjusted operating performance in the quarter, which was partially offset by higher corporate SG and A expenses.

Adjusted EBITDA for the quarter increased 19.5% or $6,100,000 to $37,400,000 Adjusted EBITDA margin improved 140 basis points to 17.6%. Consolidated adjusted EBITDA conversion margin was 31%. For the last twelve months, adjusted EBITDA was $204,400,000 or 20.7% of net sales. As compared with the prior twelve month period, we have increased latest twelve months adjusted EBITDA 10.3% or $19,100,000 and improved adjusted EBITDA margin 80 basis points. Net interest expense for the twenty twenty first quarter was $7,400,000 as compared with $5,500,000 in the prior year quarter.

The increase in net interest expense in the quarter resulted from a non cash adjustment to capitalized interest and decreased interest income due to lower cash balances and lower interest rates. Our updated full year 2020 expectations are for net interest expense to be between 24,000,000 and $25,000,000 Income tax expense was $3,100,000 or 23.1% of income before tax as compared with an income tax benefit of $5,900,000 or 21.9% of loss before tax in the prior year quarter. The prior year quarter included a 7,700,000 tax benefit on the Walter Energy accrual. We continue to expect our effective tax rate for 2020 will be between 2426%. Our adjusted net income per share increased to $08 for the quarter compared to $07 in the prior year.

Turning now to segment performance, starting with Infrastructure. Infrastructure net sales increased 12.1% or $20,800,000 to $192,800,000 in the quarter. This increase was due to $13,800,000 in sales from Krausz and a 4.1% increase in organic net sales this quarter, which was primarily driven by higher pricing and increased shipment volumes of our core products. Adjusted operating income for the quarter increased 15.5% or $4,800,000 to $35,700,000 The increase was primarily due to higher pricing, product mix, increased shipment volumes and the inclusion of Krausz, partially offset by higher costs associated with tariffs and inflation, increased SG and A expenses and approximately $500,000 of start up costs previously mentioned. Adjusted EBITDA for the quarter increased 16.3% or $6,700,000 to $47,700,000 yielding an adjusted EBITDA margin of 24.7% and a conversion margin of 32% in the quarter.

Moving on to Technologies. Technologies net sales decreased $1,000,000 to $19,800,000 in the quarter, driven by lower shipment volumes at Metrology, which were partially offset by higher volumes at Echologics. Adjusted operating loss improved $1,700,000 from the loss of $3,700,000 in the prior year, primarily due to product mix and higher pricing, partially offset by lower shipment volumes and higher costs associated with inflation. Technologies adjusted EBITDA also improved $1,700,000 in the quarter to breakeven as compared with a loss of $1,700,000 in the prior year. Concluding with liquidity, cash used in operating activities for the first quarter was $12,400,000 with negative free cash flow of $27,600,000 Both cash flow from operations and free cash flow were impacted by the 22,200,000 payment associated with the Walter tax settlement.

As a reminder, our cash generation is generally stronger in the second half of our fiscal year due to the seasonality of our business. We invested $15,200,000 in capital expenditures in the period, which was similar to the first quarter of the prior year. We continue to expect our capital expenditures will be between 80,000,000 and $90,000,000 for 2020. At December 3139, we had total debt of $446,400,000 and cash and cash equivalents of $136,800,000 At the end of the first quarter, our net debt leverage ratio was 1.5x. Finally, on October 1, we adopted new accounting requirements for leases.

As a result, we recorded assets and liabilities of approximately $30,000,000 each related to our operating leases, which had previously not been recorded on the balance sheet. I'll turn the call back to Scott to talk more about our results and outlook for 2020.

Speaker 2

Thanks, Marty. I will provide some additional insights into key areas and then comment on our full year 2020 outlook. After that, we'll open the call up for questions. Going forward, we are continuing to focus on executing our key strategic priorities. These include accelerating new product development, developing a fully integrated technology platform for infrastructure monitoring, driving operational excellence and modernizing our manufacturing facilities.

Our goal is to deliver above market organic net sales growth and improvements in our margins from productivity initiatives and continued price cost realization. Our organic net sales in the first quarter performed well as we benefited from higher pricing as well as higher volumes in our core valve and hydrant and leak detection products. During the quarter, our natural gas and metrology product sales experienced headwinds versus the prior year. Our natural gas product sales experienced what we believe is a temporary slowdown in sales. We expect that sales will improve through the balance of the year as our end markets normalize.

For metrology products, our 2019 sales benefited from a significantly stronger backlog entering the year. Our current backlog is meaningfully lower than the prior year due to an inconsistent pipeline of large orders. As a result, we expect our metrology sales to be flat this year. In recent years, we have focused on developing stronger partnerships in the distribution channel. As a result, we have enhanced our partnership with Ferguson, one of our largest customers for many of our metrology products and have seen a greater percentage of our metrology sales go through their distribution channel.

Recently, we worked with Ferguson to win a $34,000,000 multi year AMI water meter contract for Newport News, Virginia. This contract win is an example of how we were able to differentiate ourselves with our technology for remote disconnect meters. We could start benefiting from orders associated with this contract in the fourth quarter of this year. I was pleased with the gross margin improvement we generated in the quarter. This was driven by a combination of increased volumes of our core valve anhydrants, which are some of our higher margin products and improved price realization.

During the first quarter, we benefited from carryover pricing, which included two price increases for iron products and more than offset the impact of increased costs from tariffs and inflation. We recently announced additional price increases in The U. S. And Canadian markets for many of our infrastructure products, which will be effective in February and March. The timing of these announcements is comparable to the prior year.

Although raw material costs are not currently contributing to inflation, we expect this higher pricing will help offset the anticipated increases in material costs and other inflation for the balance of the year. The execution of our key capital investment projects to accelerate the modernization of our manufacturing facilities, equipment and processes is well underway. We have major projects driving capital spending above historical levels in order to both deliver above market sales growth by broadening our product capabilities and expand gross margins. As we have previously discussed, we have three large projects underway including the large casting foundry expansion in Chattanooga, Tennessee, a new brass foundry in Decatur, Illinois and a new specialty valve manufacturing facility in Kimball, Tennessee. These transformational projects are forecasted to account for approximately $130,000,000 of capital spending.

Based on current timelines, we expect that these projects together will drive approximately $30,000,000 of incremental gross profit in 2023 through both operational efficiencies and sales growth. As mentioned previously, we expect capital expenditures as a percent of consolidated net sales to decrease to less than 4% in fiscal twenty twenty three. We have nearly completed the large casting foundry expansion in Chattanooga. We expect to begin producing product with our own castings by the end of the second quarter. As a reminder, this was a large multi year investment in our Chattanooga facility to expand domestic manufacturing capabilities for large valves and introduce additive manufacturing technologies to our foundries.

This includes one of the largest three d printers in the world, which will help decrease time to develop new tooling and shorten turnaround times for our customers. This investment will help us further differentiate ourselves in the marketplace. Historically, we have focused on small valves, which are less than 12 inches as they are used much more frequently. Increased population density and urbanization are driving a greater need for large valve sizes. Although today the market for large gate valves in North America is less than 30% of the gate valve market, we expect large gate valves to grow at a faster rate than small valves.

As a result, this investment will add additional flexibility and capabilities for new product development and help us provide a broader range of products to our customers. In addition, it helps with product efficiencies through in sourcing and provides more products which will satisfy our customers made in America specifications with less reliance on sourcing valve bodies from China. As with any large project and new capabilities, we expect there to be a ramp up this year and anticipate that we will ultimately recognize the benefit of this project in fiscal twenty twenty one. The impact of the startup costs until full ramp up of these new operations is included in our annual guidance and was $500,000 this quarter. I will wrap up my comments with a review of our updated expectations for full year 2020 results.

During fiscal twenty twenty, we expect to see favorable demand in our end markets driven by healthy municipal spending and improved residential construction. The residential construction market appears to be improving based on the housing start data reported for our first quarter. It's still early in the year and we continue to see a wide range of predictions for housing growth in 2020. For our fiscal year, we anticipate residential construction growing in the low single digit range. Municipal spending, which accounts for the majority of our end markets, continues to be healthy.

For our fiscal year, we expect the municipal end market will grow in the low single digit range. Despite continued uncertainty from global and domestic matters, we are increasing our expectations for growth in both net sales and adjusted EBITDA for fiscal twenty twenty. Based on our current expectations for end market growth, we anticipate that our 2020 full year consolidated net sales growth will be at the high end of the 3% to 5% range we previously provided. This growth will be driven by higher pricing, increased shipment volumes and the contribution from Krausz in the first quarter. Additionally, we expect adjusted EBITDA growth to be at the high end of the 4% to 8% range we previously provided.

I am confident that we are in position to accelerate our transformation to become a municipal and residential solutions company with a growing percentage of our products incorporating technology. The traditionally conservative water and wastewater utilities are increasingly more open to using digital tools to deliver more benefits to their stakeholders with limited resources, not to mention many face significant challenges from the aging infrastructure. We expect technology enabled products to achieve significantly higher growth rates than some of the traditional products in the water utility industry. In fact, the overall digital water market is expected to grow at a 6.5% compound annual growth rate between 2019 and 2030 as forecasted by Bluefield Research. The segments most relevant to our growth strategies like asset network and information management are forecasted to grow even faster.

With our market leading positions and extensive installed base of infrastructure products, we are well positioned to take advantage of these trends. Today, we have a number of products addressing these segments, including Ecologics Pipe Condition Assessment Services and Fixed Leak Detection Solutions, Metrology's Advanced Meters and Communications Equipment, Smart Hydrants, Pressure and Water Quality Monitors and most recently our Centric Software platform. In summary, we are well on our way to incorporating technology into our infrastructure products while also modernizing our manufacturing facilities and operations. As a result, we believe we will be able to deliver above market sales growth and drive margin expansion and earnings growth while also continuing to return cash to shareholders. And with that operator, please open the call for questions.

Speaker 0

The phone lines are now open for And the first question in the queue is from Michael Wood with Nomura Instinet. Open.

Speaker 4

Hi, good morning. Great job this quarter. Infrastructure gross margin stepped up versus last quarter despite the seasonally slower sales. Was there anything unusual there? I know you typically experience a seasonal gross profit margin decline.

So I'd love it if you can just talk about what drove margins higher, whether they're sustainable and how that compared to your expectations?

Speaker 2

As we said in the prepared comments, I think it was a combination of things. Certainly infrastructure, the Krausz impact along with pricing were probably the two largest driving items. And then the mix that we mentioned that we got with hydrants and R and D valves being a larger portion of sales also skewed the margin. So as long as we're talking about sustainability, I believe as long as we keep those kinds of mixes with IVH, then we'll have favorable trends throughout the year.

Speaker 4

And how should we think about the three projects contributing to that $30,000,000 of gross margin improvement? Is it roughly $10,000,000 each, one larger or smaller than the other? And can you just talk about how long it takes once a plant is up and running to get the planned efficiencies?

Speaker 2

Yes. I think you should think about it that the brass foundry is certainly the largest project of the three. And that the $30,000,000 is going to be frankly fairly lumpy with the first piece coming from improvements as a result of the Chattanooga large casting foundry being virtually complete by midway through this year. And then the balance with Kimball and Decatur having a much longer fuse and the of the savings coming in the back half as a result of Decatur and Kimball.

Speaker 4

Got it. Just finally, I wanted to ask on the guidance. It seems early in the fiscal year to increase guidance. So just wondering if you could shed some more light on maybe the top one or two things that you're seeing that gives you the confidence and the visibility. I

Speaker 2

think that the biggest thing is when you come out of the gate at 10.3% and you do the weighted average math for the rest of the year, right, I feel confident that we should be able to maintain implied organic growth rates in that 3.5%, 4.5% range given bookings and the state of the market. We also put the language in there that we're cautiously optimistic given some of the global domestic uncertainties. And certainly we recognize as we're in the early days of the coronavirus that there could be some supply chain impact. And nodding to what's been a strong order book through the first four, five months, but at the same time recognizing there's some risks on the horizon.

Speaker 4

Great. Thank you.

Speaker 0

Next question in the queue is from Brent Thielman from D. A. Davidson. Your line is now open.

Speaker 5

Hey, thank you. Hey, Scott, maybe just touching on that last point. I mean, anything in particular you're looking at related to supply disruptions or risks that you're monitoring? I'm assuming with no change in the guidance, you don't see a lot, but just curious where you might see it show up?

Speaker 2

Yes. So I think with our facilities in China, we have a great handle on what they produce, how they produce, what's at risk, what the timeline of the month being and running in that is. What I think the uncertainty for all of National Association of Manufacturers, Maypie and other organizations is, how much of your domestic supply chain is dependent on components from foreign supply chain and what does that foreign supply chain dependence look like especially in the Hubei province in China. So I think that's the part that we're all scrambling frankly to figure out where resource components are two or three steps back in the supply chain. And I think that's where the real risk to manufacturing lies in the next, let's call it twelve to sixteen weeks.

Speaker 5

Yes. Okay.

Speaker 6

And then can you just

Speaker 5

talk about kind of how Krausz is integrating or benefiting from the integration in the Mueller? I mean, it seems like pretty good growth. Are they seeing faster core growth in their business and sort of benefiting from the synergies and kind of distribution channel you brought to them?

Speaker 2

Yes. I believe that everything that we identified in our synergies case when we made the acquisition, we've tracked quarter by quarter. And I would say that without question on at the aggregate, we're very pleased with the acquisition, how it's performed, where we've gotten growth, the introduction to existing Mueller customers and conversely very pleased with exposure to some of the traditional Krausz customers of Mueller products. In the aggregate, I would give it an A. The team has done a very good job of integrating the sales teams and a very good job of harmonizing programs across our customer base.

But we still have room for improvement and we're going to continue to measure and manage, measure and manage, measure and manage all the way through the process until we get to our fully integrated state, which I think is another year away.

Speaker 5

Okay. And then any views or I guess expectations built in related to kind of larger municipal CapEx projects, which some of your larger products and valves are attached to you? Is this going to be a stronger year based on what you can see today?

Speaker 2

So thanks for that and happy to get into it. I think that in the large valve market, will see far more kind of project base. It's not going to be kind of the routine maintenance kind of thing. And so there will be some lumpiness in that. And the fuse on these things tends to be much longer timeline.

So jobs that are bidding for a 72 inches valve today are likely not going to be in an install phase for another twelve eighteen months and sometimes even longer. And so we expect the large gate valve and the large butterfly valve markets behave very much like the Henry Pratt business where we have a fairly significant carry forward of backlog with longer fuses on big capital projects. And so I think that to call it a meaningful impact in the current fiscal year would be a misnomer. And we look at it more in the things we're bidding now, 54, 60 inches or 72 inches valve being installed in fiscal twenty twenty one beyond. So I do not anticipate a huge lift this year from large valves.

Speaker 5

Yes. Okay. I appreciate it. I'll pass it on. Thank you.

Speaker 7

Thank you.

Speaker 0

Next question is from Deane Dray with RBC Capital Markets. Your line is now open.

Speaker 6

Thank you. Good morning, everyone.

Speaker 2

Good morning, Deane.

Speaker 6

Hey, just congrats on resolving that tax overhang. I know that was annoying and it did take cash to do it, but it is resolved. So just a moment of appreciation for that. Thanks.

Speaker 2

Thank you.

Speaker 6

So Scott, I was really interested in hearing more regarding when you listed all the different technologies at Mueller today that you're developing and between the Ecologics, Metrology, the Smart Hydrants, SentriX. So how will you and you say you like to measure and manage. What's the deployment of these, what's the take rate of these technologies, what's the contribution either this year and the ramp in the next couple of years. I know each one of them is different, but from our perspective, this is where all the growth is going to be the higher growth, the higher margins that will come through. Maybe in terms of Triage, the most important ones, just expectations of take rates and growth and contribution, and maybe we can start there, please.

Speaker 2

Okay. So that's quite a lot. So let me speak in general, Dean, and then we can and you can ask follow-up questions. I think the most mature technologies that we have right now relate to obviously AMI being the most mature where there is a fair deal of take by water municipalities. That business has transitioned in my three years from about, let's call it seventy-thirty between AMR and Visual Read to 30% AMI to now that the business is majority kind of AMI dependent software revenue dependent project management dependent.

And so it's the most mature. And so when we talk about the meter business, we're really talking more about radios, collectors, hubs being a bigger, bigger portion of sales going forward. When you think about the next most mature, it would have to be in both pipe condition assessment and our fixed leak detection from the Equishore DX. And I think those two things in particular are kind of in their nascent stage of kind of exploding. I think people estimate that market to be between 100,000,000 and $200,000,000 today, growing over the next Bluefield uses 19,000,000 to 30,000,000 So we'll use that to something that could be north of $1,000,000,000 by 02/1930.

And you have to look at pipe condition assessment and does that include the related services of repair of the pipes? Does it include the other aspects? But it's the next most mature. And we really expect those technologies for that business to kind of double every three to five years kind of numbers. But we're starting with relatively small numbers and so its impact is not going to be as huge, if you will, in the near term.

And then last but not least, I would take all of this water quality piece as it relates to smart hydrants, pressure, flow, water quality monitoring, as it relates to sampling stations, flushing stations and those kinds of things and say it's the least mature. But it has the most potential for revolution, if you will, in what bringing smart water means. And I think that there is a view out there by some people that says, we will continue to see large utility owned wireless infrastructure being deployed for five to ten years. Certainly, if you looked at people's values multiples, what prices are being paid, you would say that we are going to be in the utility owned deployed wireless network for maybe three or four more generations or iterations of the technology. And we believe that five gs and what we understand of its power requirements that that maybe has one or even two generations left.

And that five gs with its tremendous bandwidth will probably put us in an environment in water with more mesh networks and more kind of backhauling over five gs cellular for multiple devices. And that's why we think once people realize the amount of bandwidth that could be available at a smart hydrant hub and then the vast number of data points that could be connected to it through a mesh network, we could have kind of a step change in potential adoption in a five gs world. And so we continue to believe and we continue to develop both AMI solution with backhaul over AMI, backhaul over LoRaWAN, backhaul over cellular both mesh and unique because we're not in business of betting on which one will win. And so we've maintained all along, we're the open architecture solution where if you invest, you will have max flexibility at a future date. And that's kind of been our take.

So now the second part of your question is, what does the take rate look like? Well, we have launched customers with SentriX. As you know, we've had successful launches in fixed leak detections. We have more than 50 pipe condition assessment customers. We're well on our way to establishing acoustics and non invasive pipe condition assessment technologies on a broad basis.

And so I think now it's really a matter of educating our customers and being obviously economically viable for them to want to adopt these technologies. And for that, we think we have both the best business case and the most, let's call it, lowest risk implementation methods to determine the health of the utilities. So we feel very bullish about it. Now will that translate into 8%, 9%, 10% growth rates? In a normal environment, I would say yes, absolutely.

And we should be very bullish about it. But as I've said many times to people on the phone, we're also in now the tenth year of an economic expansion that gives us pause to say, trees don't grow to the sky. What does spending look like? What the interest rates long run interest rates look like? And so we tempered that a little bit, but we have not given multiyear guidance.

Speaker 6

Scott, I know I asked a pretty complex question, but I admire how thoughtfully you clicked through all the different technologies. I really appreciate the answer, and we do consider this to be the exciting part of the story. And I'll stop there. Thank you.

Speaker 2

Thank you.

Speaker 0

Next question is from Brian Blair with Oppenheimer. Your line is now open.

Speaker 8

Good morning, everyone. Nice start to the year.

Speaker 2

Thank you.

Speaker 8

I was hoping we could circle back on the quarterly cadence baked into your guide. I know you've touched on some of this, but you had a very strong first quarter, relatively easy second quarter comp. And then it seems like your guide contemplates flat to down operating profitability in the back half. So I guess two parts to that. One, am I correct in what is assumed in your guidance structure?

And two, if that is the case, what are the specific points of conservatism that looking into the fiscal third and fourth quarter, admittedly more difficult comps? But on top of that, what drives the conservative stance?

Speaker 2

Brian, I'm going to give that Marty. As you know, we don't guide to quarters. Guide to the year. So I'm not sure what the inference is. And I'll leave that to the higher mathematical brains in the room, Marty.

Speaker 3

Well, I think just starting off, I think I'd understand one piece is certainly in our first quarter is the last quarter that we have as additive on a year over year base. So as we move into the second half of our year, or sorry, the last three quarters of our year, Krausz will have been in the prior year's results. So I think that's certainly a portion of what we saw with the growth rate in first quarter on net sales. And I think as you heard with the guidance now towards the upper end of the net sales range that we gave with the baked in addition of Krausz this quarter that sort of implies continued organic net sales growth going forward. And we would say with that it also implies continued growth from an adjusted EBITDA perspective as well without any particular guidance with respect to the quarters other than as you know we're typically going to see stronger growth in the second half of our year due to the seasonality of our business.

Speaker 8

Okay. I appreciate the color there. And then also appreciate the additional detail you've offered on the large project investments, in particular the $30,000,000 in incremental gross profit step up. I just wanted to clarify that as we look out to 2023 that is truly incremental as an additive to the more normalized margin progression that you've spoken to upward of 100 basis points of gross margin improvement each year via your typical productivity initiatives and drop through?

Speaker 2

Right. So I kind of expected that question because so let me say that it's mostly additive that there's a think of it as a third of it coming from volume and absorption and incremental profit on that. Think of two thirds of it kind of coming from operational efficiency. So the question being asked, if I could restate it is, you outlined 50 basis points net, 100 basis points of productivity a year, 50 basis points net after you reinvest in engineering and some of the other things. Can I use the 50 basis points and $20 ish million of it as the cumulative or is there some overlap?

And the answer is there is a slight amount of overlap. If you think about the math and you think about what's going on with depreciation and you think about the depreciation offset with it, then there is by definition incremental productivity that has to take place. But I think for the purposes of modeling, I am confident that we can find the noise, if you will, in other productivity initiatives and other capital projects that we still have baked in and the out years that are not fully available for us to see today because if we can see them, we do them. But I trust from my twenty odd years of doing this that there will be cost savings projects that will allow us to say that this is additive. So I think you should think about it that way, kind of the 50 basis net improvement and then the $30,000,000

Speaker 8

Okay, excellent. And then the last one for me. On capital deployment, your balance sheet is obviously in good shape. You do have these large projects underway, but still have decent capacity. So I assume if something Krauss esque came along, you could pull the trigger on it in terms of deploying that capital.

Would you, at this stage of Krauss integration, be able to take on another deal of that size and the complexities that come with it?

Speaker 2

Yes. I think what I said to everybody when we bought Krauss is that we would not do deals for ninety to one hundred and eighty days until we saw how the we're well beyond that now. And I feel like the playbook from the team on the integration and where we are with integration that I'm eager to exercise those muscles as an organization again. But it's got to be the right deal at the right price. And so yes, we would.

Nothing to disclose today.

Speaker 8

Got it. Thanks again.

Speaker 2

Thank you.

Speaker 0

Next question in the queue is from Joseph Giordano from Cowen. Your line is now open.

Speaker 9

Good morning, guys. This is actually Francisco Amador on for Joe. What's your outlook for profitability for tech for the rest of the year? And do you guys have a longer term outlook as well?

Speaker 2

Yes. So we do not give guidance by segment and found it to be kind of a trap in the past and so I'm not going to get back into it. But I will say that I expect Teck to do exactly what it did in the first quarter, which is to show operational improvements quarter over quarter over quarter over quarter through taking necessary actions both on the manufacturing floor in the market from a pricing perspective and from a deal point of view to make sure that we continuously improve profitability. I am not interested in being the largest meter manufacturer in the world and not making any money. I am interested in being profitable and we are going to continue that March.

I think since I've gotten here, we've gone from a $15 ish loss and we've been steadily marching that down. At the same time, we've steadily merged that down. We've launched the SentriX platform. We've launched myNet-four. We've launched multiple radios in the LoRaWAN network.

We've gotten a lot of really good technology out of the group that we can apply to infrastructures. And I think that the team has done a good job showing good progress. Will it eventually get profitable? Of course, that's why we invest. But I think that we're going to have some time left.

And I would point out again, if you listen to Marty in her section, know we've got a ways the And with we'll

Speaker 0

year. And

Speaker 9

answer and certainly encouraging to see the of margins improving there. And then when does the impact from price increases last year in infrastructure start to fade out? And do you guys have any more price increases planned for the year?

Speaker 3

Yes. So just to give you a reminder, this is sort of the last quarter where with a lot of our products we've got the benefit of two price increases, the one that we implemented back in September 2018 as well as the February 2019. So going forward, we have announced price increases for a number of our infrastructure products sort of in that February timeframe. And so I'd say from that piece, we're reasonably comparable on a year over year basis, but this would be the last where you'd see the benefit of a couple of price increases.

Speaker 9

Okay, great. Thank you. If I could squeeze in just one quick one on the outlook for interest expense. Noticed it's about $3,000,000 higher than what it was last quarter. Is this related to the capitalized interest or lower cash interest?

Or what exactly is driving the increase?

Speaker 3

I'd say largely certainly looking at the quarter for the noncash adjustment for capitalized interest. And then I think as well just a small piece with just lower interest income outlook going forward.

Speaker 9

Okay, excellent. Thank you for your answers.

Speaker 0

Next question is from Brian Lee with Goldman Sachs. Your line is now open.

Speaker 10

Hey, guys. Thanks for taking the questions. I guess starting with technologies, the Q1 comp was obviously tough, so I can appreciate the 5% revenue decline year on year. But just wondering how should we be thinking about growth in this segment for the next several quarters? Comps seem to be getting easier here, at least until you get to the fourth quarter.

And then just, I guess, higher level, do you expect technologies overall to grow in line below or above the 3% to 5% consolidated view?

Speaker 2

Yes. So I think in our prepared comments what we said was that metrology you should expect flat performance year over year. And as I discussed, we're going to transition the business to more of the Ferguson kind of distribution model and we've got a lower backlog as we've ceased the elephant hunting at lower prices. And we've recognized the improved performance. We've recognized improved both from a cost perspective and from an operating perspective.

So I think that we're going to continue to run the business that way. So you should think about the meter business kind of being flat for the year. The growth part of technologies ought to be in our fixed leak detection and our pipe condition assessment business. That's where we're focusing sales selling resources. That's where we're focusing our marketing resources so people can start to get a broader based acceptance of the Equishore DX product line.

And we've got good penetration at San Jose in Connecticut and other big customers, marquee customers that are using this technology successfully to find leaks in their network. And this will be the years of kind of getting it out into a much broader acceptance arena. That number, what that growth should be, we're not disclosing any of that for obvious reasons. And I think that we'll have relatively slower growth because of the flat meter business, which is the bulk of the segment today, but won't be in the long run.

Speaker 10

Okay. Helpful. Appreciate the color. And then just a second question and I'll pass it on. I might have missed this, but the EBIT conversion margin in the quarter, we get to something like high teens, if our math is correct.

So wondering if that sounds like it's about in the right ballpark and if you have any thoughts on the trend line kind of moving through the rest of the year in the context of your historical targets of 35% plus. I know you have a number of different initiatives moving through the year. So wondering how we should be thinking about that conversion margin line. Thank you.

Speaker 3

Look, I think overall as we think about conversion margins, you can absolutely find some lumpiness as you look think about it on a quarterly basis. So I'd sort of I think you've got implicit with the guidance we've given where the conversion margin falls out from that. But certainly on a quarterly basis, it's there can be lumpiness.

Speaker 10

Right. Fair enough. Thanks, guys.

Speaker 0

Next question in the queue is from Walter Liptak with Seaport Global. Your line is now open.

Speaker 7

Hi, thanks. Good morning, everyone. Wanted to ask about Krausz. And you guys didn't call out what the contribution was either in percentage or whatever for the quarter. And since this is the last one, I think, where it's incremental, I wonder if we can get that number.

Speaker 2

Yes. Think what we said and we'll continue to say is that you should think about it as consolidated EBITDA margins for the business would be about equal. But we're not getting into what pieces are trading in as we negotiate pockets of products. We're decidedly not disclosing that. So I think, Walt, if you think about it in the context of kind of at par with the consolidated results, you'd be pretty close.

Speaker 7

Okay. All right. Great. And then the CapEx startup costs, you called out, I think, $05,000,000 of incremental costs in the first quarter. Is this something that continues on?

Or was this lumpy where we got you had extra costs this quarter, but then they ramped back down in the second and third quarter?

Speaker 3

What I would say we did, we called out the roughly $500,000 this quarter for the large casting foundry, which includes depreciation. And as we said, we expect to start production by the end of the second quarter. And what I would say is start up costs, our expected start up costs for the balance of the year are incorporated into the guidance that we have provided.

Speaker 7

Okay. Yes, I heard that. But I guess the question is, does the $05,000,000 keep ramping? Like is it another $05,000,000 or more in the second quarter and then continuing to ramp through the year?

Speaker 3

Yes. What we have we called out the dollar amount in the first quarter. We do expect more through the balance of the year and that is incorporated in the guidance that we have just provided.

Speaker 7

Okay. Okay. Got it. And then if I could just ask the last one on Ferguson and the tech margins. Is there something structural that changes with the Ferguson relationship where you have better visibility to profitability in the tech segment now?

Speaker 2

No, I wouldn't say it's better visibility or that the lumpiness of the jobs will go away or anything like that. I think what it is, is that on the contrary, the way we used to do it, go elephant hunting for these multi year contracts and you look at the average price point on a contract, you look at the average price point in the replenishment market and there's a significant spread. I'm not going to say how much, but just it's better business. It's better business from a flow perspective and it's better business from a yield perspective. And so yes, it's not got some of the complexity and we would take more of it.

I'd be happy to have more distribution business.

Speaker 7

Okay, great. Sounds good. Thank you.

Speaker 0

And the last question in the queue is from Jose Garba with Gabelli. Your line is now open.

Speaker 11

Hey, good morning,

Speaker 2

Good morning, Jose.

Speaker 11

Hey, Scott. I noticed you guys bought in that Pratt JV. Just I guess talk about if kind of any structural difference that you guys are undertaking now that you guys kind of bought that in small amount?

Speaker 2

Go ahead, Marie.

Speaker 3

Yes. So let me just start off. So this was a joint venture that we entered into in 2014. Just to be clear, as you think about it from a financial statement perspective, since we entered into that joint venture, we have always consolidated the results within our operations. So as you look at it, you won't see anything different from that perspective.

It was just the small amount of the equity interest that was factored out. But we did acquire the balance, the non controlling interest that we had of about 51%. It was just a little over $5,000,000 It's a small business. It's part of our Pratt brand and gives us capabilities largely in the industrial valve segment of the business. And we think it's a good opportunity.

It's a business that we certainly watch for the last five years. And we'll continue to look to grow that business and integrate it as we need to.

Speaker 11

So I guess nothing strategic difference?

Speaker 2

Well, I would say the strategic rationale to take it over was to be in control of both the brand and the product offering. We like the industrial space. There are certain applications there that we think have long term growth capabilities and that we think we can also bring some technology to that will give us an ability to be successful against the traditional competitors there. But are you asking me are we going to go into flow control in the industrial and bump up against the Emerson's etcetera? No, not interested in doing it.

We have our niche. We believe it's got some attractiveness to it. That's why we bought it out.

Speaker 11

Okay, fair enough. And then you talked quite a bit about the technologies new product introductions. I guess if you could talk about on the infrastructure side, your new product pipeline kind of going into this in this year and then compare that to where you've been?

Speaker 2

Yes, I think that been working tremendously. I'm not going to say or announce something here that we plan to announce at ACE or something, but I think you've seen at the last couple of ACEs some new restraints. You've seen some integration of hydrants and the Krausz products. You've seen some integration of valves in the Krausz products. You've seen some early indications of a new insertion valve.

There's been many, many things that the infrastructure team has been working on that over the past three or four product entry windows we have launched. And the pipeline is full for the year. That is to say that when we review our product development pipeline and we look at our engineering resource availability, we currently set for the year at a deficit that is we have more projects than we have resources that we go through the prioritization process and come up with what we'll be launching next. And if you come to ACE or you come to Westech, hopefully you'll see some things you have not seen before.

Speaker 11

You know I'll be there. Thanks very much guys.

Speaker 2

Thank you, Jose.

Speaker 5

Thanks.

Speaker 2

Operator, thank you. I believe that ends the queue and you can wrap up now.

Speaker 0

This concludes today's call. Thank you for your participation. You may disconnect at this time.