Mueller Water Products - Earnings Call - Q2 2018

Transcript

Speaker 0

Welcome and thank you for standing by. At this time, all participants are in a listen only mode. After the presentation, we will conduct a question and answer session. A answer Today's conference is being recorded. If there are any objections, you may disconnect at this time.

I'd now like to introduce your host for today's conference, Whit Kincaid. Thank you. You may begin.

Speaker 1

Good morning, everyone. Welcome to Mueller Water Products twenty eighteen second quarter conference call. We issued our press release reporting results of operations for the quarter ended March 3138, yesterday afternoon. A copy of it is available on our website, muellerwaterproducts.com. Discussing the second quarter's results and outlook for the full year 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. We have 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 607-0993.

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 twenty eighteen second quarter results. I'll give you a quick overview of the quarter and then Marty will follow with additional analysis. I will then provide some further color on key performance areas later in the call. We will finish up with an update on our outlook for 2018.

We had a very strong second quarter growing consolidated net sales by 16.8 and increasing adjusted operating income 34.7% compared with the prior strategic reorganization and subsequent changes made over the past year are leading to improved execution of our key initiatives. We achieved our highest quarterly year over year net sales growth in five years. We benefited from lapping poor weather in the prior year and accelerated shipments from our price increases, which I will address later in the call. Most importantly, we are excited about the organic growth delivered at both Infrastructure and Technologies. We're very encouraged by the healthy demand in both municipal and residential end markets leading us to raise our expectations for our annual net sales growth.

The rapid rise in brass and scrap metal costs impacted our conversion margins in the quarter, especially for our project related Pratt specialty valve business. Despite these headwinds from higher material costs, we improved our gross profit margin as we leveraged higher volume and executed our cost productivity initiatives. During the second quarter, we successfully implemented price increases for our valves, hydrants and brass products and anticipate higher pricing will more than offset expected increases in material costs in the second half of

Speaker 3

the

Speaker 2

year. We remain focused on executing our key initiatives to grow and enhance our business as we accelerate new product development, drive manufacturing productivity improvements and improve our go to market strategies as a more customer focused organization. With healthy end markets and focused execution of our initiatives, we remain confident in our ability to deliver strong consolidated net sales growth and conversion margin improvement for 2018. With that, I'll turn the call over to Martie.

Speaker 4

Thanks, Scott, and good morning, everyone. I will start with our second quarter consolidated financial results, then review our segment performance. Consolidated net sales for the twenty eighteen second quarter increased $33,500,000 or 16.8% to $233,200,000 driven by higher volumes at both Infrastructure and Technologies. Infrastructure, which makes up approximately 90% of our net sales, accounted for 29,500,000 of this increase. Gross profit improved this quarter by $22,000,000 to $74,500,000 and gross profit margin increased to 31.9%.

Adjusted gross profit margin increased by 70 basis points excluding last year's discrete warranty charge. As Scott mentioned earlier, in addition to the benefit of volume growth, our cost productivity initiatives and higher pricing have also helped grow our margins despite headwinds from material cost increases. Selling, general and administrative expenses were $42,700,000 in the quarter and $38,700,000 in the second quarter last year. The increase was due primarily to higher personnel related expenses and the additional SG and A from Singer Valve. SG and A as a percent of net sales decreased by 110 basis points in the quarter to 18.3%.

On a trailing twelve months basis, SG and A as a percent of net sales was 18.7%. Operating income improved to $29,900,000 Adjusted operating income increased 34.7% to $31,800,000 in the twenty eighteen second quarter compared with $23,600,000 in the prior year. Our adjusted results this quarter exclude $1,900,000 of expenses related to strategic reorganization and other charges. As we discussed before, we expect to report expenses related to our previously announced strategic reorganization throughout 2018. Operating performance was favorably impacted by higher volumes, cost productivity improvements and higher pricing, which were partially offset by higher material costs and higher SG and A expenses.

Adjusted EBITDA for the twenty eighteen second quarter increased 25.4% to $42,400,000 compared with $33,800,000 in 2017. For the trailing twelve months, adjusted EBITDA was $172,900,000 or 19.9% of net sales. Net interest expense for the twenty eighteen second quarter decreased by $300,000 to $5,200,000 primarily due to higher interest income this year. Now on to income taxes. On December 2237, tax legislation was enacted that made significant revisions to federal income tax laws, including lowering the corporate income tax rate to 21% from 35%, eliminating or limiting certain deductions, and overhauling the taxation of income earned outside The United States.

In this quarter, we recorded a provisional one time expense of $7,500,000 for the transition tax on previously untaxed undistributed foreign earnings. The provisional net impact of the tax legislation to date is a $35,100,000 benefit, including the benefit of $42,600,000 recorded in the first quarter related to remeasurement of our net deferred income tax liabilities. For the twenty eighteen second quarter, we reported a net income tax expense of $14,200,000 which was largely driven by the onetime expense related to the transition tax that we expect to pay over the allowable eight year period. Other than this transition tax expense, income tax expense was $6,700,000 or 27.5% of income before income taxes. This rate differs from the statutory rate primarily due to the effects of state income taxes and discrete items, particularly certain effects of stock compensation transactions.

Our adjusted net income per share was $0.12 for the quarter compared to $09 in 2017. 2018 quarterly adjusted EPS excludes the provisional onetime transition tax expense, strategic reorganization and other charges. Now I'll turn to our segment performance, starting with Infrastructure. Infrastructure had a very strong quarter, growing net sales by 16.2% to $211,100,000 This increase was primarily due to higher shipment volumes, higher pricing and the addition of Singer Valve. Adjusted operating income for the twenty eighteen second quarter increased $9,000,000 or 25% to $45,000,000 primarily due to increased shipment volumes, higher pricing and cost productivity improvements, which were partially offset by higher material costs and SG and A expenses, including the additional SG and A from Singer Valve.

Material costs have continued to increase both year over year sequentially. Despite these headwinds, infrastructure achieved a conversion margin of 30.5%. Adjusted EBITDA for the twenty eighteen second quarter increased $9,500,000 or 21.1% to $54,500,000 versus $45,000,000 in the twenty seventeen second quarter. Moving on to Technologies. Technologies delivered 22.1% net sales growth this quarter to $22,100,000 This increase was driven by higher Mueller Systems volumes and increased leak detection sales.

Adjusted operating losses were essentially flat year over year at $3,900,000 for the second quarter compared with $3,800,000 in 2017. Adjusted operating results were similar in both periods as the benefits of higher volumes were offset by higher warranty expense. Now we'll review our liquidity. Free cash flow, which is cash flow from operating activities of continuing operations less capital expenditures, was negative $6,900,000 for the twenty eighteen second quarter compared to negative $6,300,000 for the prior year quarter. Through the first half of the year, free cash flow was negative $12,800,000 compared with negative $30,400,000 in the first half of the prior year.

As a reminder, our cash flow from operating activities is typically lower in the first half of the year driven by the seasonality of our business and timing of our working capital. We invested $8,000,000 in the quarter for capital expenditures largely to upgrade our equipment and manufacturing capabilities and to further drive cost productivity improvements and cost savings across the organization. At March 3138, we had a total debt of $479,000,000 including $477,000,000 outstanding of senior secured term loan debt due November 2021. The term loan accrues interest at a floating rate equal to LIBOR plus a margin of two fifty basis points. We have interest rate swap contracts that effectively fix the interest rate on 150,000,000 of our term loan borrowings at 4.8% through 09/30/2021.

Net debt leverage ratio was less than one, and our excess availability under the ABL agreement was about $134,000,000 Scott will now talk more about our results and updated full year 2018 outlook.

Speaker 2

Thanks, Marty. I'd like to address a few key areas and then discuss our updated full year outlook. Infrastructure's strong second quarter net sales growth of 16.2% was driven by growth across all of its major product lines. The improvements we have made in our go to market strategies have enabled us to achieve strong organic growth. We have realigned our sales team to become a more customer focused organization to serve the needs of all customers.

This included developing key account strategies and changing incentive programs. This quarter, our volume growth also benefited from lapping the severe weather conditions in the Western Part Of The U. S. In the prior year. Additionally, we believe customers accelerated shipments in the second quarter ahead of our announced price increases and we believe that distributors are more comfortable with higher levels of inventory entering this year's construction season.

In February, we announced price increases for our iron gate valve, hydrant and brass products in The United States and Canadian markets. As part of our enhanced go to market strategy, we successfully executed price increases by working closely with partners. Our customers were given a window of time to order products at the old price and many took advantage of that opportunity. Although this had a favorable impact on our shipment volumes in the second quarter, the additional benefit from these price increases will occur successfully in the second half of the year. While we have benefited from higher pricing over the past four quarters on both a sequential and year over year basis, we have not been able to fully offset the increase in material costs in the first half of this year due to the continued rise in brass and scrap metal prices in 2018.

Second quarter material costs rose about 6% compared with the prior year quarter. This quarter, however, we did essentially offset the increase in material costs with higher pricing. Although we offset these inflationary costs, this led to a lower than expected consolidated conversion margin of 24.5% for the quarter. We are actively managing our supply chain to work to minimize any impact to margins and believe the rate of increase in year over year material costs will slow in the 2018 compared to the first half of the year. We believe that our price realization will offset these increases in the second half of this year.

Over time, we expect to more than offset increases in material costs with pricing. Driving manufacturing productivity improvements remain one of our top priorities as we look to reinvest some of these savings in our business to generate new product development. Due to improved execution of operations over the past year, our cost productivity improvements have helped increase Infrastructure's gross profit margin to 33.4% through the first half of the year. At Technologies, we were pleased to see the 22.1% net sales growth as the teams work to execute new go to market strategies. The AMI mix continues to increase and we are having success using distributors.

Higher volumes at both systems and ecologics improved conversion margins, which was offset by an increase in warranty expense. This expense was related to the warranty reserve we recorded a year ago. Despite this, I believe the team is on the right path to strengthening our position in the market and executing productivity strategies to enhance profitability. We remain focused on strengthening and growing technologies as this will allow us to further integrate and differentiate our core infrastructure business. We believe that building water technology expertise is an important part of our long term commitment to address the evolving needs of our customers.

We are a leader in non invasive leak detection and have developed technologies to use the pumper cap of a fire hydrant as a node for a fixed leak detection solution. Echologics' Echosure DX product is a great example of how we are working to integrate technology into our core products as Mueller systems develop communications technology. This product allows a utility to locate leaks and identify where they need to repair infrastructure to reduce non revenue water loss. Notable customers who are using the EcoShore DX product line include San Jose Water and American Water. Although leak detection is a small portion of the technologies business, it continues to gain momentum.

With our market leadership position in water infrastructure, it's important for Mueller to be at the forefront of integrating technology into solutions and products for our customers. Over the long term, this will allow us to enhance our competitive advantages. Moving to capital allocation now. Our capital allocation strategy remains focused on enhancing our position as a water infrastructure company and adding long term value for our shareholders. Our strong balance sheet and free cash flow enable us to reinvest and grow our business through capital investments and acquisitions, while returning cash to shareholders through dividends and share repurchases.

Through the first two quarters of the year, we have returned $34,000,000 of cash to shareholders through the quarterly dividend and ongoing share repurchase program. We continue to evaluate capital investments that will help us expand our product portfolio, broaden manufacturing capabilities and efficiencies and support growth initiatives. Recently, we announced an investment in our Chattanooga facility to expand domestic manufacturing capabilities and introduce additive manufacturing technologies to our foundries. In addition, we are focused on our acquisition pipeline to leverage our existing channels, strengthen our market position and expand our geographic footprint. Going forward, our goal is to maintain a strong balance sheet with a debt structure that provides flexibility to support our capital allocation strategies and longer term growth initiatives.

I'd like to review our current full year expectations for consolidated results. We continue to see favorable dynamics in our primary end markets and all indications are that the fundamentals are very good for a healthy demand environment throughout 2018. For our key end markets, we expect residential construction market percentage growth to be in the mid to high single digit range with municipal spending growth in the low to mid single digit range. For full year 2018, we are increasing our expectations for consolidated net sales growth to 7% to 9% from the 4% to 7% range we previously communicated. This means that our consolidated net sales growth for the second half of the year will be lower than the 12% consolidated net sales growth we achieved in the first half of the year.

The primary reason for this are the higher level of orders we received and shipped in the second quarter related to our February pricing action as well as the severe weather conditions in the West that we lapped in the second quarter. We expect our conversion margin for the full year to be between 2530%, which is higher than our 19% conversion margin through the first half of the year. Higher volumes, improved pricing and continued execution of our cost productivity initiatives are all expected to contribute to the improvement in our conversion margin in the second half of the year. In addition, we will be lapping the significant increases in brass and scrap metal costs in the second half of the prior year. We remain on track to deliver our cost productivity savings for the year and anticipate that these efforts in conjunction with improved price realization will more than offset additional increases in material costs in the second half of the year.

I'd like to turn it back over to Marty to provide some final comments on our 2018 outlook.

Speaker 4

Thanks, Scott. Turning now to some of the other expectations for our 2018 performance. Corporate expenses are expected to be between 33,000,000 and $35,000,000 We expect depreciation and amortization to range from $45,000,000 to $47,000,000 net interest expense to be between 21,000,000 and $22,000,000 and capital expenditures to range from 50,000,000 to $60,000,000 We anticipate that our adjusted effective income tax rate for the full year will be between twenty six percent and twenty eight percent, excluding any onetime impacts from the new tax legislation. With that, operator, please open this call for questions.

Speaker 0

Thank you. At this time, if you would like to ask a question, please press star then 1. You will be prompted to record your first and last name. To withdraw your request, press 2. Once again, if you would like to ask a question, please press star then 1 now.

Our first question comes from Seth Weber with RBC Capital Markets.

Speaker 5

Hey, good morning.

Speaker 2

Good morning, Seth.

Speaker 5

First question, the tempered incremental margin guidance for the year, is that purely a function of material cost inflation? Or is there some push out on the tech profitability ramp that you might have previously thought was coming? Thanks.

Speaker 2

No. It's it's all associated with, like, if you normalize for price and material and and, you know, take them both out of kind of the unexpected range, you'd see that we're right below 40% on our conversion margin when you we actually do the math. So what you have is the inflation on one hand and which we're offsetting with extra price is diluting the conversion margin to the tune of about, I wanna say it's like 9% or more, but that is what it is. And no, we are not tempering our our expectations on technologies. I think what happened Technologies was I was pretty pleased with the with what worked out to be about a 25 conversion margin.

And then we came over the top with that $9,800,000 We remind investors and people on the call, we took a charge a year ago for some product that had been made prior to 02/2016. We had some true up associated with what that population looked like, and increased that population, so we took a charge. We didn't adjust at this time because, you know, I just think we, you know, it wasn't material, but, and the and the team has to overcome those kinds of things in future anyway. So, yeah, that's, kind of where we ended up on on the Technologies business. Was kind of in line with what we expected, but unfortunately, to take a warranty charge.

Speaker 5

Sure. Okay. And then you took your CapEx number up again. I think this is the second or third quarter in a row. Is there any color on what you can that you could share with what you're doing with that extra capital?

Speaker 2

Sure. We're looking, as we said in the prepared statement, we've announced an expansion of our capabilities in the Chattanooga facility. We'll be able to buy additive manufacturing is a nice way of saying that we're going to be adding some new technologies to both the tool making capabilities and curing technologies so that we hope to reduce our cycle time, become capable of more custom capability. And so that project is actually pretty large and, you know, gonna it's a multiyear project. So we we expect that, that for the piece that will be invested this year is the main driver and why the guidance went up.

Speaker 5

Okay. And then sorry, just to go back to the warranty expense, does that should that be it then for that expense going forward? Or does that continue to be an overhang in the first I

Speaker 2

think the I don't want to foreshadow one way or the other. We do reliability studies on this stuff all the time. I think Marty is better prepared to answer how she does the true up on the accruals every quarter that she looks experience and things like that. And I don't know where you are in that process for this quarter, but it'll all happen again and again and again. Yeah.

Speaker 4

No. Look, that is that is something that we'll continue to evaluate over time. We do use third parties that will help us in terms of, you know, assessing various things, you know, in and around rate of failure, etcetera. So that is we will continue to monitor it and do expect to continue to monitor that to to see where we are in terms of, you know, what the failure rates are that we're seeing, what our costs are to Remediate. Remediate those, you know, how we address our customers, etcetera.

Speaker 2

Well, wouldn't wanna call it an overhang. I think I I would go back to what I said a year ago. Look, there's a population that were potted poorly prior to 02/2016. That's part of being in this business, and we have to find a way to to make sure we manage and keep those customers happy. But we you know, I'll reiterate for everything everybody.

Ever since we put in the new potting process, our experience failure rate is way less than one half of one percent. So I think we've licked it. We're just gonna have to live with the these things from time to time whenever the finance department decides they want another reliability study. It's just Go ahead.

Speaker 6

Okay. Okay. Thank you

Speaker 5

very much, guys. Appreciate it.

Speaker 2

Thank you.

Speaker 0

Our next question comes from Brian Lee. Your line is open.

Speaker 7

Hey, guys. Thanks for taking the questions. Maybe just to round out that line of discussion. I know, Scott, you said you don't want the team to continue to be adjusting for these factors, and that's why you're not breaking it out. But just for our modeling purposes, can you give us a quantification of what the warranty impact was on margins for the quarter in Technologies?

Speaker 2

Yeah. I guess we we Yeah.

Speaker 4

We Go ahead. The conversion yeah. If you look at conversion margin for Technologies sort of was about a 25% conversion margin for the quarter.

Speaker 7

Ex ex the warranty issue.

Speaker 4

For second quarter.

Speaker 7

Just just to be clear, ex the warranty issue. Correct?

Speaker 2

Yeah. Ex warranty issue. Correct.

Speaker 7

Sorry about that. And then, I guess, on technologies, just, you know, pretty pretty good results, on the top line. Wondering if there were any big projects that helped in the quarter and if you expect those to persist through the next couple of quarters. I think in the past or maybe last call, you had talked about getting back to year on year growth rate starting in fiscal 3Q for technology. So it seems like you're little bit ahead of schedule, but wanted to see if there were any timing issues related to projects or anything else in the quarter?

Speaker 2

No, I think maybe you're referring to some of the push outs we've had the past. But just remind everybody that a 100% of this business is project business. So with all projects, but, you know, there's not a not a lot of carry on. But, no. Nothing nothing of note.

I think what we're seeing is I think what the sales team has done where where where we now reward people for selling to distribution or we reward people for the old system sales team that still exists. We put in the key account strategy. What you're starting to see is some of the distributor regions now are starting to take product, whether it be visual read or even drive by or upgradable AMI. And we're starting to get some pull through into that channel. I think the comp program, I think the changes the sales organization has made in both their structure and working together have led to incremental sales in especially the meter business.

And that was the intent when we did the reorg and that was the intent when we changed the way we pay people in the sales organization. And I think we're starting to get some momentum there. I think those are the big drivers.

Speaker 7

Okay. Fair enough. And then maybe last one for me. I'll pass it on. The the working capital increase in the quarter, how should we be thinking about this moving through the next few quarters?

And then how it relates to any sort of target you have for free cash flow in the year? Thank you.

Speaker 2

I think you'll notice on the working capital, a big increase far and away is in inventory. And, you know, if you dig into it, you're gonna see that the biggest increase in the inventory comes in the raw material area. And and really what's happened there is, you know, we're trying very hard to make sure that when we have an order book that we're not short. You know, if you if you think about taking a position, if you sell something and you don't have the raw material to make it, you're essentially short. So, you know, we have bought brass indicator.

We have bought higher levels of scrap steel to make sure that when we quote something, we know what it's going to cost to make it. So I think Marty can keep me honest here. I think I think raw materials are up, like, $9,000,000 versus previous year. So, you know, that's the bulk of the inventory increase. We have a little more whip as well, and then inflation is driving, you know, part of the increase too.

Speaker 4

You know, we're we're gonna certainly say a long term target for us is to grow our free cash flow greater than our adjusted net income. That can vary in any given year, but we'd say over the long term, that's what we'd certainly look to accomplish.

Speaker 7

Okay. Thank you. Appreciate it.

Speaker 0

Our next question comes from Michael Wood with Nomura Instinet. Your line is open.

Speaker 8

Hi, good morning. At a high level, there seem to be a lot of moving parts impacting volume growth during the quarter with weather comparisons to pre buy. Can you just give us some more color in terms of how you're able to evaluate where underlying demand volume growth is? And are you still seeing the crowding out of water infrastructure, or has that dissipated I think from the

Speaker 2

that the crowding out has dissipated. That's why I think we're seeing in of in our municipal market about mid single digits kind of growth in municipal. I think that to remind everybody on the phone, there was a period in our last fiscal year where water was actually municipal water was growing slightly, but it was really all in dewatering pumps and wastewater management and actual water supply investment was actually down year over year. I think that's reverted now and that when the census data comes out, we'll see that the sell through from distribution into water infrastructure and water supply is probably in the mid single digit range and that we're benefactors of that. To address your other points, we do think that there was a lot of moving parts.

And certainly, I never want to be the one that kind of said ducks or tried to take credit for something that's not there. I think we know we had an easier comp in q two because of western flooding last year, and we saw that kinda normalize here. So that was part of it. We we saw a fairly healthy price environment where we were able to offset the inflation. So that kind of basically inflates your sales, but it doesn't inflate your profits, just really offsetting costs.

And that was a piece of it. We had about a point of Singer valve, and and then we had, what I will call, you know, some of the buy ahead in distribution that, you know, kinda moved some sales out of q three. But I think the underlying demand, take it, you know, what we said in the prepared statement, is that, you know, resi, kinda high single digits, muni, kinda low to mid single digits, is where we think we'll end up for the whole year, and I think that will normalize when we get out of the lumpiness of the quarter to quarter. And remind everybody that really my primary driver way back when we said we wanted to kind of get the yearly guidance away from this quarterly guidance because there's just too many moving parts in each quarter.

Speaker 8

And you said distributors were happy to carry higher inventory. How does that compare with a more typical year? I know last year was very unusual with basically not seeing a pre buy. So can you compare that maybe with two years ago or when you were in a more normal environment and how that stands in terms of your comfort level with where the inventory is?

Speaker 2

Yeah. The way I would answer that is, a, I wasn't here. But I think in general, since 02/2008, this is the most bullish we've seen in the construction markets. So I think that anybody involved both in infrastructure and resi and land development, the sentiment right now, if you look at Zelman and all of these things, are this is this is the best time we've had for for that kind of development since 2008 in the crisis. So, you know, certainly, I think distribution, understanding that that was going to accelerate, was more bullish as well.

So I would say it's probably been the best in ten years, but I wasn't here ten years ago.

Speaker 3

Thank you.

Speaker 0

Next question comes from Brian Connors with Boenning and Scattergood.

Speaker 6

Great, thanks. Good morning. I wanted to just clarify conceptually where we stand right now actual versus expected price cost management? Because on the one hand, you say that you sort of largely offset raw material inflation with price in the quarter and that was kind of actual. But on the other hand, you say that one of the drivers in the quarter was customers sneaking in orders ahead of the price increase, which would suggest that maybe price wasn't as big a factor.

So was it really more the volume leverage that drove the margin in the quarter? Or was there really how much was price cost really a factor given the pre buy?

Speaker 2

So let me clarify a couple of things. One, I don't think anybody sneaked anything. I think that we went to them and said the price is gonna be effective this day. And that is our custom to give them thirty days so they can change their systems. And then they they have that window to pre buy, and they have a fixed number of releases, things like that.

So it was in our, you know, in our plan all along. The other thing we're doing is we're kinda mixing our metaphors. We're comparing price to a year ago as opposed to previous quarter. That's why I keep talking about sequentially and year over year. So on a year over year basis, I wanna say, Ryan, price was think about it in that 4,000,000 ish range as was inflation in that same range.

So they virtually offset. I think it might have been a $100,000 difference. You know, unlike some of the people who talk to you, they take their cost productivity and their price, and they look to offset inflation. And, you know, we we try to make sure that the markets are healthy. I think healthy markets have price offsetting inflation.

And then we, as people running a business, take the cost productivity and we make intelligent investments or we let extra operating income flow through or invest it in SG and A or other new product activities. And so I think overall in the quarter, as we said, they offset. And if you took the sales reduction for the $4,000,000 of price and you increased the artificial cost increase, you would see that we were right around 39% on the conversion margin. So it's basically all dilution, as I said before. But I think that the reality is that going forward, the big increases that we saw a year ago, I think brass was up in 2Q a year ago, somewhere in the neighborhood of 25% Q2 to Q3.

So we're going to lap that in this next quarter. So that even at these price levels, should start to see spread open, provided we don't have really high inflation again in the third quarter. We should start to see spreads open where price more than covers inflation. And so I think the the guidance is is meant to get everybody kinda normalized for, you know, what has been a, you know, unusually high inflationary period.

Speaker 6

Got it. No, that does clarify it quite well. Thanks, Scott. My other one was regarding your forecast for the end markets. You said, for example, that you're expecting low to mid single digit growth in municipal spend and that you expect to see that in the census data and so forth.

But obviously, they're paying higher prices now too. You're not alone in raising price. So what's your view on what percentage of that growth in municipal spend and therefore the market per se is being driven to some extent by the price as opposed to organic volume growth, if that makes sense.

Speaker 2

I think that's a fair question. And I think the way we think about it is, I'm going to do this at a very high level, that we think that the actual volume increase that you've seen in Q2 is less than 5% but more than two. So if you were to count hydrants, count valves, count pounds of brass process, that's the kind of number you would see so far. And then if you were to take that and take the revenue part of it, and I'm holding mix kind of flat here, I think that's what you're going to kind of see in the volume. So now then, the next part of that question comes back to, well, of that, how much of it is driven by the resi increase versus how much is driven by muni?

And I tend to think muni is about half of the resi volume right now in terms of percentage growth. It's not as hot in muni as it is in resi.

Speaker 6

Got it. Okay. That's actually really helpful. Thanks so much for your time this morning.

Speaker 2

No problem.

Speaker 0

Our next question comes from Walter Liptak with Seaport Global.

Speaker 9

Hi. Thanks. Good morning. Maybe just a follow on to the last one in talking about the muni growth versus resi. The resi part of the growth, is was it an inventory buy that makes you feel so confident about resi, or is it actually, you know, material that's going into the ground?

Because we had heard about, you know, some disruptions related to weather, you know, impacting some of the residential in the quarter. And, you know, how does that play into kind of your view for the rest of the year, especially second quarter next quarter?

Speaker 2

Well, I I'm I'm not sure if I follow, but I I'll let me let me try it this way. We believe land development is in a really good phase right now with home inventories and housing starts, with some room to get back to their natural, let's call it steady state. So let's say one point five one point four million to 1.6 is steady state in the housing formation in the country. I think last year we finished at eleven ninety or something like that. You know, there's still 20 ish percent growth left till you get to steady state.

Now we've had an unusual period where we had far less inventory of lots waiting to be developed as a result of the overhangs that existed for for many, many years. And now we're starting to see that pick up again. We're starting to see subdivision developments where people lay curb and fire hydrants and valves and all of that stuff kind of commensurate with how we can get that 10%, 12% growth rate through the commercial. So when you normalize for the full year, I think that we have in front of us a really good opportunity to see that what we keep saying is that kind of high single digit growth in the residential land development and housing start business driving our business. So I'm not sure if it's a sentiment thing.

We're confident that people who are buying inventory are selling it through. In distribution volumes as they report, we think they're healthy too.

Speaker 9

Okay. Sounds good. And if I could just switch gears to the technology segment. And I wonder if you have any new thoughts on when the segment may begin to turn profitable. It sounds like some of the sales channel changes are really starting to pay off, and you're happy with the growth rates.

I wonder how you're thinking about profitability after this quarter.

Speaker 2

Yes. This is one of those ones that try very hard to to not say everything thinking. The reality is is is it's a project business. We're trying to get to yearly. It's a really small part of the business.

We are going to focus on continuous improvement or Kaizen and just keep driving, putting one foot in front of the other. And at the end of it, I expect we will be profitable. Now I know everybody wants a timeline. And, you know, I've I've said it before. I'll say it again.

We can make what we call technologies profitable tomorrow. We could get all of our engineering costs and purge it from the segment, and it would be profitable. And it would be the stupidest thing I could do. We've just introduced a Hydroguard product that has uses a cellular technology link that the technologies team developed for the core infrastructure team. We're working on expanding the capability of the nodes in the hydrant so that one day we could look at pressure, we could look at turbidity or alkalinity or chlorinity in the water down at the gate valve and say, Hey, back to an operator, this is good.

All of that technology, all of that development is engineered in that segment. And as we adapted to these other parts of the business, we have to continue to invest in technologies. We have to stay high and hot on engineering costs in order to make sure that we don't become ironmongers in the future, but that we are the technology solution for everything in infrastructure, whether it be a gate valve, a butterfly valve, actuation, fire hydrants, you name it. So I really I think somebody wrote recently that management emphatically said they would not sell technologies. And it would be mortgaging infrastructure's future to sell technology.

So no, I would never do it. So how do I get it to profitability? I wanna see the meter business get to average margin and stop being dilutive to the overall business. I wanna see the echo business get scale so they can get to profitability. And then I wanna take what we what we're calling software, radio, and communications technologies.

And I don't know if I wanna leave them in in technologies forever or just make them a shared service corporately, but we have to start integrating those things into what what you would call infrastructure products in the future. And so I I I don't know when it will be profitable because I don't know when I'm going to stop having expense associated with these other developments. And I would say to all investors, you know, we're really excited. If you think about five g and and what we think is coming with five g, how much bandwidth will be available if it if it goes that way? You know, what will that do to cellular communications?

We think about where we're able to go with our both our proprietary spectrum and our public spectrum AMI technologies. What other information can we piggyback on on those networks? And I think it's exciting. I think there's a lot of possibilities of how we can add value to existing products to increase margin and to increase our presence.

Speaker 9

Okay. Thank you for that thoughtful answer.

Speaker 0

Our next question comes from Zane Karimi with D. A. Davidson. Your line is open.

Speaker 10

Good morning. Zane on for Brent Thielman. First off, I was hoping to get some color on something you mentioned last quarter. You spoke to the contract negotiations in technology business that you were thinking could drive fiscal 'nineteen shipments. I believe you said that was AMI.

Can you give us some updates on those?

Speaker 2

I think that, you know, we we have under negotiation contracts currently. We, you know, we signed contracts last quarter. I think where we are, though, is right right kind of where I I said last quarter, I'm trying to remember what I said. So I'm looking looking Marty at, you know, what we what he's referring to, but I think we might have been talking about a couple of municipalities that, you know, we did go ahead and land and we did go ahead and book that the legal folks were working on. So I think that, yeah, we're pretty pleased with the order book in AMI the quarter.

Speaker 10

Thank you. And then just to follow that up real quick. Beyond materials, are you experiencing cost pressures in logistics, freight, for example? And how meaningful is that for you guys?

Speaker 2

Sure. Yeah. I mean, there's, you know, there's freight, and it's it's not as meaningful as we look to mitigate. You know, one of the things we're trying to do is make sure our load optimization I think we had a little room left in load optimization where we could kind of blunt the the freight impacts, the freight inflations. But overall, it's nowhere near as meaningful as the brass and steel inflation, and so we tend to focus on it.

But if you were to break our inflation down, in the quarter, we had a little bit of labor inflation as we had some increases that triggered February 1 at a couple of plants. We had some freight inflation associated both with diesel surcharges and scarcity problems in the hauling industry. And we also had some inflation in, you know, just purchased component parts that were based on, you know, raw materials that have inflated like copper and and brass and steel and things like that. So all in all but far and away, you know, if you look at the quarter, I think I said it was around 4,000,000, you know, probably 70% of that or 75% of that was associated with the raw materials. So but, yes, there's broad based inflation.

I think it's something we as business people all have to be thinking about because, we may be in a period where it's something we have to be careful about and we have to take the appropriate pricing actions and have the appropriate discussions with customers.

Speaker 10

Great. Thank you very much. I'll jump back in queue.

Speaker 0

Thank you. Our next question comes from Joe Giordano with Cowen.

Speaker 3

Hey, guys. Good morning.

Speaker 2

Good morning, Joe.

Speaker 3

Just a question on the guide for the second half. Just given some of the pull forward in 2Q and the tougher comps you have in infrastructure in the back half, just how do you parse out where the growth is coming from between your two segments in the back half?

Speaker 2

Well, I think the the vast majority of it obviously has to come from just the scale of the numbers. Infrastructure is, like, 80 90% of our revenue. I think I think that technologies will grow a little more on a percentage basis. But at the end of the day, this is a sub $100,000,000 kind of number, I think. So obviously, the vast majority has to come from infrastructure.

So I I can't remember what the math was, but, you know, we're we're still holding to some kind of that 20% number for for the technologies business that we guided at the beginning of the year.

Speaker 3

Your 20% growth for the full year?

Speaker 4

We have not given specific guidance by segment. We've looked at everything in aggregate and so consolidated for the full year, we're looking at seven percent to 9%. I think we were, certainly technologies had a 22%, I think, growth this quarter, stronger growth in the second quarter, I think down a little bit in the first quarter. But we have not given specific guidance by segment.

Speaker 2

No, you're correct. That is right.

Speaker 3

Okay. Just curious, your conversation earlier about Echo and on the leak detection side, I'm just curious how you view that landscape of that offering now, given some moves by other large players in the space to kind of enter leak detection through some of their through some smaller acquisitions as well. So how do you see that landscape break right now?

Speaker 2

I think I think look. I think it's great, and I think there's room for everybody. I think the techniques are are vastly different. You know, there's there is gonna be a time for, you know, invasive techniques where you actually have to send something up a pipe. And I think that there will be times when you can't actually break into the drinking water stream and you need to do a non invasive method.

I think there will be times when you need to do kind of pipe condition assessment. There'll be times when you need to do But I welcome everybody into this space because I think when you start thinking about non rev water loss and awareness grows about the impact of non rev water loss on utilities, that we will start to see better O and M performance from the utilities. And I think better O and M practices and better O and M behaviors and awareness will drive more business for us and for people like us. I think it'll grow our share of the repair market. And I certainly welcome it.

And I'm not sitting here saying that, oh, we're gonna compete on this or no, no. They are complementary technologies out there that if you think about a triangle before you kinda say, I'm gonna do this method and this method. Then when I need pinpoint accuracy on mission critical you know, water mains with listening devices, are twenty four hours a day, seven days a week, three hundred and sixty five days a year, then there's solutions for that too. So I think as you go up the need scale, there is room for all of the techniques, and they each have their niche. And they will all, without exception, grow as we start to wrestle with what is becoming a a more and more precious commodity.

Speaker 3

And then last for me, and I can check the queue, any update on the tax liability with Walter, the Legacy?

Speaker 2

Yeah. Go ahead, Marty.

Speaker 4

Yeah. Just with respect to the liability, the case does remain in bankruptcy court in Alabama, just Walter Energy's in Chapter seven. We still don't know whether or to what extent, if any, we could be liable for any of their open tax audits. These audits have been very long standing with the IRS going back to the 1980s. But I will say that we believe that if you look at some potential tax refunds for certain years and you apply them against the asserted tax liabilities that are out there, that the amount of any net tax liabilities that could be owed, if any, would be substantially less than what the IRS has filed in its proof of claim.

Look. We continue to monitor the case. You know, don't don't have a time line. But, as we have said and continue to say, we will vigorously assert any and all defenses that we might have.

Speaker 3

Thanks, Ed.

Speaker 0

Thank you. Our next question comes from Jose Garza with Gabelli Asset Management.

Speaker 11

Hey, good morning, guys.

Speaker 2

Good morning.

Speaker 11

Wanted to just kinda get your thoughts, Scott, on you know, you the CapEx number seems to be kinda going up, you know, a couple quarters in a row now. Just it seems that you're finding more as as you keep looking. Kinda get us a a level set of of just what what the maintenance level is and and how to think about that over the next several years in in in in terms of the incrementals as well that you'll be spending.

Speaker 2

Okay. Well, one of the things that's going on, I told you last quarter, we were actively looking at things that we could while we have the higher tax rate, we wanted to see if there were things that we could get in service so that we get kind of the better tax benefit of having it all deductible in year one. That was part of it. And this the foundry capability increase in Chattanooga was the other part. And it's almost all new technologies and new capacity adding.

Our ongoing maintenance spend has been a little less than half of the number you see there. So the old $40,000,000 guidance, something less than 20 is the maintenance number. But let me say this, As I look around and I see more and more technologies, cordless technologies, furnaces that could use, you know, 40% electricity to melt, as I look at, you know, options to dose your steel for for for ductile, you know, in mold or out of mold, in in holding furnace, out of molding furnace. There I think there's still tons and tons of really good investments that that rational investors would make in order to to drive cost out. And, you know, I think when you couple that with what I believe are long term trends that will see Chinese produced products become more and more and more expensive, the more I believe there is an opportunity to recapitalize foundries in this country and make them greener and make them safer and make them actually more efficient than trying to import from a low cost country steel.

And so I'm not prepared at this point, Jose, to say, you know, you know, it's gonna be a 100,000,000 over ten years or whatever a modernization thing would be. But, I do as I dig in more and more, think that we'd be remiss not to to do some of that. And I'd like to point to all of our investors. Go ahead and look at the gross margins from the improvements we've made. I've been very pleased with the team's ability to translate investment, manage a project, bring it up on time, bring it up and get it to run at rate, and start achieving the manufacturing savings that we thought we could achieve when we made the investment.

So I think there are I think it's a a target rich environment, and I think that we'll continue to do that elevated investment level for some time.

Speaker 11

Okay. That's very helpful. And I guess if you wanted to comment just on kinda your m and a pipeline and and how you're seeing things in, you know, I guess, year after Singer, if if you have any kind of thoughts there, you know, one year later.

Speaker 2

Yes. As as I've said before, we know, you the the pipeline is more fulsome, and we have a, you know, a better idea of, you know, what we wanna do geographically, what we wanna do technically, what we wanna do from a channel synergy point of view. And so we have more more candidates in there. But I my commitment to you all is that we will be disciplined. We will be disciplined around price.

We will we will see a path to synergies before we we pay what to me are are some pretty heavy multiples. And, you know, I've I've done this before. I have you know, in a previous life, I did quite a bit of acquisitions, and I know that the keys are keeping our strategic discipline around our original strategic intent and having great discipline around price. Because it's really easy to wreck a balance sheet buying things that you can't get your synergies on, and we're not gonna do that. But certainly, lot of properties out there, a lot of opportunities that we like, but, you know, we've gotta be able to do it for what we think is fair value.

Speaker 6

Fair enough. Thanks very much, Scott.

Speaker 2

Thank you.

Speaker 0

Thank you. Our next question comes from Seth Weber with RBC Capital Markets.

Speaker 11

Hi, thanks. This is Brendan on for Seth. Thanks for allowing us to get a follow-up. Two quick ones. The first is I was wondering if you're willing to quantify how big the price increase was that you implemented.

And then second, I'd like to confirm a comment you made about second half growth. You still expect technology sales to increase year over year in both the third quarter and fourth quarter. Correct?

Speaker 2

That is correct. Yeah. We we expect to grow the business, quarter to quarter, as as as we go. But overall, you know, we got 22 points of it out of the way this this point. As Marty said, we're we're trying to stay in a in a yearly view to that business.

Our fascination with the $80,000,000 is I don't know. It's gonna be a small number. I mean, you know, we're talking about $8,000,000 growth or or whatever, but it's, you know, it's gonna be dwarfed by what we hope to be, you know, realistically 50 or $60,000,000 of growth, whatever the math worked out to on on infrastructure. But, yes, we expect to grow.

Speaker 11

Okay. And then the price increase, are you willing to quantify how how big that was?

Speaker 2

Cannot really quantify. I mean, we, you know, we have fixed contracts with certain municipalities. We announced the distribution price increase. We got 4,000,000 this quarter versus previous year quarter. And we'll see what our yield is.

I think our yield in the first month, look at mix where you have how much of your business came in on contract versus how much of your business came in on the spot market. I think that yield looks like going forward we should be able to continue that kind of performance, like that kind of 4,000,000 ish quarter kind of number. I'd like to think. We eventually have to get on the other side of cost increase.

Speaker 11

Okay. Thank you.

Speaker 2

Okay. I think we're at right at 10:00, Marty. So we should operator, provided there's no one else no no other calls, I'd like to thank everybody for joining us this morning. And, you know, we we felt like we had a really good quarter. I felt like the execution was really good.

Pleased to see traction in our sales force, pleased to see traction with the operations team. And so thank you for joining us, and we'll talk to you next quarter.

Speaker 0

Thank you for joining today's conference. That does conclude the call at this time. All participants may disconnect.