Mueller Water Products - Earnings Call - Q3 2020

Transcript

Speaker 0

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

I would now like to turn the meeting over to Whit Kincaid. You may begin.

Speaker 1

Good morning. I hope everyone is doing well. Thank you for joining us on Muir Water Products third quarter twenty twenty conference call. We issued our press release reporting results of operations for the quarter ended 06/30/2020 yesterday afternoon. A copy of it is available on our Web site, muellerwaterproducts.com.

Scott Hall, our President and CEO and Marty Zakas, our CFO, will be discussing third quarter's results, market conditions and our current outlook for the fourth quarter. This morning's call is being recorded and webcast live on the Internet. We have also posted slides on our website to accompany today's discussion 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 +1 86660738. 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. I hope everyone in the audience is staying safe and healthy during this challenging time. Before we discuss our third quarter results for 2020, I will provide a brief update on how we are adapting to the challenges from the ongoing COVID-nineteen pandemic. Like everyone else, as I think back over this past year, I am amazed at how quickly the world where we live and work has shifted.

Since our last earnings call, the initial shock to our employees, customers and communities has turned into a more normalized cadence as we adapt to a new normal. We took swift action implementing enhanced safety and hygiene processes to create safe and healthy working environments for our employees, customers, suppliers and communities. These are now part of our standard work procedures. Additionally, our response team continues to provide leadership through this crisis as the pandemic continues to evolve. We take great pride in being an essential business, providing products and services needed to manage and maintain our nation's critical water infrastructure.

During the quarter, our manufacturing plants and distribution centers continued to supply products to customers with minimal disruption as a result of the pandemic. I have been impressed by how effectively our teams have transitioned to the new health and safety protocols, which is helping us address the positive COVID-nineteen tests and exposures that we have experienced. We continue to proactively monitor our supply chain and we did not experience any material supply chain issues during the quarter. I believe that our execution in this environment is a testament to our employees and their resolve. Moving on to the third quarter, we realized a 16.7% decrease in consolidated net sales during the quarter.

I was pleased that our net sales were better than our expectations for a year over year decrease between 2030%, as we worked closely with our customers and channel partners to reduce the effects of the pandemic on our business. We saw a smaller than expected downturn in residential construction activity during the quarter. As expected, our channel partners reacted quickly to protect their balance sheets and cash flows by meeting demand with their existing inventory. The increase in construction activity after the initial shelter in place orders in April and May led to a significant sequential growth in sales and orders in June. Overall, we believe that our key end markets excluding certain project related areas experienced a mid single digit decrease during the quarter.

However, there was a wide range of performance depending on geography with some markets close to flat versus the prior year. The lower volumes and additional expenses related to the pandemic resulted in a 33% decrease in adjusted EBITDA during the quarter. As a reminder, we anticipated elevated decremental margins given our fixed cost structure, especially for our core products and additional expenses related to the pandemic. Due to the decrease in volumes, we immediately took actions to adjust our production capacity and SG and A expenses with a combination of temporary furloughs, salary reductions and elimination of some discretionary spending. We benefited from positive pricing dynamics during the quarter, despite the additional challenges from lower market volumes.

Additionally, lower raw material costs helped offset inflation from purchase components and labor in addition to higher tariffs. Despite the decrease in adjusted EBITDA, we generated strong free cash flow during the quarter, resulting in a $59,000,000 increase in cash on our balance sheet. Our performance during such a challenging period positions us well to face additional uncertainty from the pandemic as markets continue to recover. Overall, I couldn't be more proud of everyone at Mueller as they continue to respond to the disruption from the pandemic and to adapt to our new environment. As we look forward, our top priorities remain focused on keeping our employees safe, protecting our communities, delivering exceptional products and support to our customers and increasing cash flow.

We remain hopeful that our end markets will continue to improve in the fourth quarter. Later in the call, I will discuss the current market conditions and our outlook for the fourth quarter of this year. With that, I'll turn the call over to Marty.

Speaker 3

Thanks, Scott, and good morning, everyone. I hope you continue to be healthy and safe. I'll begin with our third quarter consolidated GAAP and non GAAP financial results, then review our segment performance finish with a discussion of our cash flow and liquidity. During the third quarter, we generated consolidated net sales of $228,500,000 which decreased 16.7% or $45,800,000 as compared with third quarter last year. The decrease was primarily due to reduced shipment volumes related to the pandemic seen across most of our product lines and was partially offset by higher pricing.

Our gross profit this quarter decreased 22.1% or $21,500,000 to $75,700,000 with a gross margin of 33.1%. Gross margin decreased two thirty basis points versus the prior year, primarily due to the decrease in shipment volumes and $5,200,000 of expenses related to the pandemic, including certain unfavorable volume variances, voluntary emergency paid leave for employees and additional sanitation and cleaning fees. As a reminder, cost of sales in the prior year included $2,300,000 of costs associated with the Krausz acquisition. Excluding the acquisition costs in the prior year quarter, our gross margin decreased by three twenty basis points. Selling, general and administrative expenses of $47,100,000 in the quarter decreased $400,000 versus the prior year.

The decrease was primarily due to lower expenses relating to the pandemic, including reduced travel, trade shows, events, temporary furloughs and pay reductions for employees. The benefits from these actions were partially offset by an increase in personnel related costs, professional fees and IT related activities. SG and A as a percent of net sales was 20.6% in the third quarter compared to 17.3% in the prior year. Operating income of $20,000,000 decreased 57.6% in the third quarter compared to $47,200,000 in the prior year. Operating income included strategic reorganization and other charges of $8,600,000 in the quarter, which primarily relate to an accrual for a potential settlement with Siemens, facility relocation expenses and senior executive severance costs.

Turning now to our consolidated non GAAP results. Adjusted operating income of $28,600,000 decreased 45% or $23,400,000 in the quarter. The decrease is primarily due to lower volumes and higher expenses related to the pandemic at both infrastructure and technologies. Expenses associated with addressing the pandemic reduced our consolidated adjusted operating income by approximately $5,700,000 during the third quarter. However, we also benefited from lower SG and A expenses relating to the pandemic, resulting in estimated net COVID-nineteen related expenses of approximately $2,500,000 Adjusted EBITDA of $43,800,000 decreased 33% or $21,600,000 leading to an adjusted EBITDA margin of 19.2% and decremental margin of 47%.

For the last twelve months, adjusted EBITDA was $189,900,000 or 19.7% of net sales. For the quarter, we generated adjusted net income per share of $0.11 compared with $0.24 in the prior year. Turning now to segment performance, starting with Infrastructure. Infrastructure net sales of $209,900,000 decreased 16.1% or $40,300,000 as compared with the prior year, primarily due to reduced shipment volumes related to the pandemic, partially offset by higher pricing. Adjusted operating income of $43,800,000 decreased 30.4% or $19,100,000 in the quarter.

The decrease is primarily due to lower shipment volumes and $4,500,000 of expenses related to the pandemic, partially offset by higher pricing and lower SG and A expenses related to the pandemic. Adjusted EBITDA of $56,000,000 decreased 24.5% or $18,200,000 leading to an adjusted EBITDA margin margin of 45% in the quarter. Moving on to Technologies. Technologies net sales of $18,600,000 decreased 22.8 or $5,500,000 as compared with the prior year, primarily due to lower volumes related to the pandemic, partially offset by higher pricing. Much of our technologies business is project related.

So shelter in place orders negatively impacted our volumes this quarter for metering and leak detection products and services. Adjusted operating loss was $3,800,000 as compared with an operating loss of $2,200,000 in the prior year. This was primarily due to lower shipment volumes and $700,000 of expenses related to the pandemic, partially offset by lower SG and A expenses and higher pricing. Technologies adjusted EBITDA was a loss of $1,500,000 in the quarter as compared with a loss of $200,000 in the prior year, leading to a decremental margin of 24% in the quarter. Moving on to cash flow.

Net cash provided by operating activities for the nine months ended 06/30/2020, improved $60,000,000 to $77,800,000 primarily driven by improvements in working capital management and the timing of tax payments. As a reminder, cash provided by operating activities was adversely affected by the $22,200,000 payment associated with the Walter tax settlement in the first quarter of this year. Additionally, for the twenty twenty fourth quarter, our tax payments will be higher than usual due to the changes in filing dates from June to July. We invested $13,900,000 in capital expenditures during the third quarter, bringing the year to date total to $51,200,000 Free cash flow for the year to date period improved $61,700,000 to $26,600,000 As a reminder, our debt includes $450,000,000 of 5.5% senior unsecured notes and we also have an asset based lending agreement with up to $175,000,000 revolving facility. We did not have any amounts borrowed under our ABL agreement at the quarter end.

At 06/30/2020, we had total debt of $447,600,000 and cash and cash equivalents of $170,700,000 At the end of the third quarter, our net debt leverage ratio was 1.5 times. We currently have no debt maturities prior to June 2026. Our 5.5% notes have no financial maintenance covenants and our ABL agreement is not subject to any financial maintenance covenants unless we exceed the minimum availability thresholds. On 07/30/2020, we renewed extended our ABL agreement, which was set to expire in 2021. The new agreement has similar terms and terminates on 07/29/2025.

Based on 06/30/2020 data, we had approximately 116,100,000 of excess availability under the ABL agreement, which brings our total liquidity to $286,800,000 With a strong balance sheet and ample liquidity, we believe that we are well positioned to face the future challenges from the COVID-nineteen pandemic. I'll turn the call back to Scott to talk more about market conditions.

Speaker 2

Thanks, Marty. I will provide some additional comments on market conditions and our outlook for the fourth quarter. After that, we'll open up the call for questions. The impact of the pandemic was felt across all of our products. However, sales of specialty valves and Krausz repair products performed relatively well during the quarter.

The performance of our Krausz repair products confirms the strategic rationale for the acquisition as the demand for these products will continue to gain momentum with the aging pipe infrastructure. Sales of our specialty valve products, primarily used in large capital projects with long lead times, benefited from the backlog built over the last twelve months. We believe that the municipal end market held up relatively well during the third quarter as utilities focused on maintaining essential services and completing existing projects where possible. The level of repair and replacement and project activity varied greatly depending on the effects of shelter in place orders and social distancing practices. We saw delays in some ongoing projects and approvals of new projects, which impacted project related areas of our business, principally metering, leak detection and specialty valve products.

Since technologies has a higher portion of project related business, sales in that segment decreased at a higher rate than in our Infrastructure segment. We do anticipate that the project related portion of the municipal water market will remain challenging as state and local governments update their budgets and adjust to lower tax receipts and utilities feel the effects from lower water revenues. As a result, new projects could be pushed out further. As a reminder, we estimate that 60% to 65% of our core products are critical to utilities to maintain their networks. This base of business gives us a strong foundation with additional sales coming from residential construction and project related municipal work.

We were pleased to see the residential construction end market rebound during the third quarter after a sharp decrease in activity in many regions in the first half of the quarter, as shelter in place restrictions were lifted across the country. With mortgage rates at historic lows, relatively low lot inventories, pent up demand and supportive demographic trends, we believe that residential construction activity could continue to improve. However, the pace of the recovery will continue to vary greatly and is highly dependent on the pandemic. In June and July, we saw strong bookings across our entire infrastructure segment, especially for our shorter cycle products, which include gate valves, hydrants and brass products. In addition, the backlog of our specialty valve products increased 9% versus the prior year to $98,000,000 Although this gives us momentum going into our fourth quarter, we remain cautious due to the highly uncertain environment and unknown impact of the pandemic.

Moving on to our fourth quarter guidance. As a reminder, we withdrew the previously announced full year 2020 financial guidance. With increased confidence in the improvement in our end markets, we are providing guidance for certain financial metrics for the twenty twenty fourth quarter and full year. Based on our most recent outlook, we believe that third quarter of this year will have been the most challenging quarter of our fiscal twenty twenty. We currently anticipate that our consolidated net sales for the fourth quarter will be between flat and 5% lower compared with the prior year quarter.

We do expect that our adjusted EBITDA conversion margin will improve relative to the third quarter. As a result, adjusted EBITDA is anticipated to be between flat and 10% lower as compared with the prior year quarter. Additionally, we expect to generate positive free cash flow during the fourth quarter and increase the cash on our balance sheet at the September 2020. Given the continued uncertainty for our end markets and the economy, we are executing initiatives to reduce operating expenses. We recently announced the closure of our Woodland, Washington Knifegate valve manufacturing operations, which will be relocated to our new facility in Kimball, Tennessee.

As a reminder, we announced the opening of the Kimball facility in November 2019. It is located between our two iron foundries in Chattanooga, Tennessee and Albertville, Alabama. Kimbell is one of the three large capital projects underway, which we have previously discussed. Moving the manufacturing and assembly of our knife gate valve product line will enable us to drive additional efficiencies by insourcing certain activities and further leveraging our capabilities at our Chattanooga and Albertville facilities. The benefits from this move are part of the annualized incremental gross profits expected after the completion of the three transformational capital projects.

Going forward, we will continue to maintain tight cost controls. Additionally, we will continue to evaluate opportunities to streamline our manufacturing operations and SG and A expenses. However, we will remain focused on balancing our actions to reduce costs with the pace and timing of the recovery in our end markets and customer demand. In summary, although the COVID-nineteen pandemic continues to create significant challenges for our team members, our customers and our communities, I am confident that Mueller Water Products has taken the right steps to adapt and execute in this new environment. The improvements that we have made over the past few years to our processes, systems and personnel will help us address the additional challenges from the pandemic.

With our flexible balance sheet and strong cash flow, we are well situated to strengthen our position in water infrastructure products and services. We believe that we have ample liquidity to see us through the pandemic. In the near term, we will continue to prioritize allocating cash towards capital investments to grow and strengthen our business and returning cash to shareholders through our quarterly dividend. As we navigate challenging times ahead, we will maintain our focus on keeping our employees safe, protecting our communities, delivering exceptional products and support to our customers and increasing cash flow. We are in a strong competitive position with leading brands and specifications municipal water market.

We also have a large installed base of valves and hydrants, strong customer relationships and a comprehensive distribution network. Our long term end market dynamics continue to improve primarily due to the aging infrastructure in North America and the potential adoption of technology enabled products by water utilities to manage their drinking water infrastructure. As a result, I remain excited about the opportunities ahead of us to further incorporate technology into our infrastructure products, while also modernizing our manufacturing facilities and operations. And with that operator, please open up the call for questions.

Speaker 0

Thank you. We will now begin the question and answer session. Our first question is from Brian Blair with Oppenheimer. Your line is open.

Speaker 4

Thanks. Good morning, everyone.

Speaker 2

Good morning, Brian.

Speaker 4

I was hoping you could parse out the monthly sales rate your resi products. I assume that April into May was completely frozen and it seems like a decent rebound sense.

Speaker 2

Yes, so we're not going to give monthly guidance per se, but the initial shelter in place impacted business, I think in April and May the most, but to varying degrees, depending on the region. Think if you think about the Northeast, where the seven governors got together really locked you know, we saw the biggest impact there and then kind of in the Southeast where it was a little more lax, the least amount there. So I think that as construction activity increased, sales and orders improved. And I think you could kind of time that with really the last half of the quarter. So I think the good news is many contractors maintain their labor forces during April and May took advantage of the federal incentives to keep people employed.

And then we're able to react quickly and that return to work quickly as possible kind of help things dramatically too. So I think that the biggest wait and see to see here is gonna be around the project related Brian. I think that's where it is. I think what everybody needs to remember as far as Mueller goes is that, we were probably more impacted early in the first two months as we saw inventory destock out of the channel And I probably had more impact really for the quarter. So if you think about what the prepared comments were, we think we're mid or zero to mid single digits down as a market, but we were down almost 17%.

I think the difference is the destock.

Speaker 4

Got it. That makes sense. Appreciate the color. And if we think about the fourth quarter sales guide by end market, what are you assuming across muni residential and natural gas distribution? Just trying to frame what drives the low versus high end of the range?

Speaker 2

Yeah, I think it's more of the same. I think there's a lot of uncertainty around how long construction will remain as strong as it has been for, certainly for the last six to eight weeks. So I think that that will be a big piece of it. I think the other piece that's going to really impact it is where we see municipalities. If they keep their spending at these current OpEx levels, operating expenses through April, May and June, I think hung in there very well.

And if you were to take the other pieces, the construction piece and the project piece and say, some of that got delayed. You take out the impact of the meter business because people weren't allowed in homes to install meters. And we had a lot of field delays there. I think that the big variables are going to be how much of that gets happened in the fourth quarter, a lot of it and you'll be at the top end of the range and very little of it will be at the bottom end of the range. Really, I expect the actual infrastructure business to be pretty steady.

I think it's the other pieces around it that have the variability in it.

Speaker 4

Got it. And then last one on capital allocation priorities. Balance sheet is in good shape. Still sound a little cautious on that front. Would you be comfortable getting back to M and A or repurchase activity in the coming quarters?

Speaker 2

Absolutely. I think we're not we've said all along that during the difficult times, we think that's when opportunity presents itself. That's why I've had the team and the organization focused on generating cash to make sure we do have that flexibility. We would do M and A in this environment if, and there are assets out there, we covered that we would like to have if they get reasonably priced. But right now we're focused on running the business as well as we can.

We want to have keep our powder dry and build a little more powder. And so capital allocation is just what we've always said. We're going to remain balanced between our priorities around CapEx, M and A and then returning cash to shareholders primarily right now in the form of the quarterly dividend, which I think is pretty good yield.

Speaker 4

Understood. Thanks again.

Speaker 2

Thank you, Brent.

Speaker 0

Our next question is from Deane Dray with RBC Capital Markets. Your line is open.

Speaker 5

Thank you. Good morning, everyone.

Speaker 2

Good morning, Dean.

Speaker 3

Good morning, Dean.

Speaker 5

Hey, Scott, you've given some terrific color here on what's going on in the muni world. And I always want to preface the comments that actually come from you that you've got to be careful about painting the municipal market with the same brush because it really does vary region by region. But from your perspective, how does the whole COVID fallout make this recession different from what might be a more normal economic recession? Because we've seen some of the same impacts about pushouts and project delays. But from your perspective, where and how does this play out?

And might there be any changes permanently in terms of how municipals do business?

Speaker 2

Yeah, I think, if I could, that's a huge question. Thanks, Dean. There's, I think a lot of uncertainty on how it plays out first and foremost, because I think it is very different. What I like about shouldn't say like, but what's very different and more encouraging, I think for all of us is that the liquidity in the market and the willingness of the Fed, let's call it the economic pressures are much, much less in this recession. I don't think we have, the strain on the banking system that we saw in 2008 or the strain in the financial system that we saw when the dot com bubble burst.

And so what we have now, I think is a lot more uncertainty and as a result, a lot more volatility around demand. So I think the biggest differences are also why I am a little bit more bullish on coming out of that. And that is because the money availability is there, because the infrastructure is in fact twelve years old, older than it was kind of the last go around and our break fix is increasing at a fairly significant rate. And then thirdly, the fact that the housing market really has been under invested for a long period of time. If you think about 02/2007, when we peaked at 2,100,000 homes, and then you look at the twenty, thirty year average of one point, let's call it 1.3, 1,400,000 homes, We have been under that average now for the best part of fifteen years.

And so I feel like with low interest rates, good demographic, good family formation numbers, low inventories that that 30% of the business is going to be fairly healthy in the next, let's call it four to eight quarters. And so I think that if we get euphoric and we overbuild it again, like we did the last time, we could create structural problems for the municipal water market. But I think that, we've got really good fundamentals right now. And that in the fact that people are becoming more and more aware of wanting to live in their homes and that travel may be a long way off. The way we spend our money may be a long way off.

Think we're all drivers for people to want clean water and water utilities to have good support to bring modernization to their world.

Speaker 5

That's real helpful. And restoring guidance for your fiscal fourth quarter, I liked how you framed the zero to five having to do with the swing factor in projects. How does this framework change how you're thinking about 2021? I know you're not giving numbers, but just qualitatively entering 2021, how are you thinking about the top line both from projects and infrastructure?

Speaker 2

Yeah, one of the things we want to be careful about in 2021 is that,

Speaker 5

we actually

Speaker 2

had a decent Q3 from a bookings point of view, if you think about it from a technologies point of view. So, you know, we're really challenged in getting into homes, getting into manholes, confined workspaces, working with water utilities due to social distancing. So, you know, those are near term kind of challenges, but in the longer term, we know that the technologies is actually had, you know, a fairly decent first three quarters of the year from a bookings point of view, certainly led by increases associated with Newport News and a couple of marquee projects, overall an uptick. And so as we think about '21, we're trying to balance where will we be from a allowed to work perspective. You know, the new protocols, just if you think about our pipe condition assessment business, you know, you get a couple of guys, you send them down a manhole, they put some equipment on that manhole, they run down to another manhole, they're all in these confined workspaces.

Sometimes they have the water utility with them. Sometimes they're using a third party contractor. Sometimes it's just our field people. How are those protocols going to work? And should we say that all of that, that we expected to do in pipe condition assessment should be in our 2021 forecast or should we expect a 50% rate or a 75% Because I think as you pointed out about these geographic demands, these geographic differences, these geographic differences are being driven by policy around how we do work.

It's not being driven by difference in economics. It's being driven by, if you look at the Northeast after the seven governors said, here's how we're gonna handle our shelter in place responsibilities, and here is what a critical worker looks like versus say, Mississippi, Alabama, Tennessee and Georgia who basically got in line with we're gonna keep the states open. That's where the differences are coming. And we have decided a little commercial here. We have decided to kind of get out of the political game.

And I've said it repeatedly in my prepared comments, we're gonna focus on the health of our employees and we're gonna focus on their well-being and safety and in the communities that they're in. And so we're gonna make our decisions around that project work based on how many cases we see and whether it's safe for our employees manholes to be in those environments. And so it's gonna be tough for you as analysts, I understand that, but we're gonna ask you for more time so that we can have a clearer picture of what our supply situation will look like more so than the demand situation because I believe the demand is gonna continue to be okay.

Speaker 5

That is just so helpful, Scott. I appreciate all the elements of your answer there. And just last one for me is the and you touched on this in your prepared remarks and then in the first question on the distributor destocking. And how do you think that what's your assumption for the fourth quarter? Would is that any more destocking still happen?

Are they at bare minimums? Will there be any restocking? So might you see a reversal where you're actually growing faster than the end market?

Speaker 2

Well, we believe that virtually all of the destocking impact was seen in Q3 and really was more concentrated in April and May. As noted in the prepared remarks, we think the overall end markets declined mid single digits in the third quarter. This implies that the destocking accounted for at least of the decrease in consolidated net sales in Q3. So, if you do that math, we need to see demand hangs in there. But I think that the big thing, I don't expect to see inventory rebuilds in what will be their Q3 or Q4.

I think the seasonality dictates this is the heavy construction season. And so this is when they would destock anyway. And so I do believe that, you know, we've seen the worst of it, but we probably won't get a great deal of lift as they restock. One interesting thing I will point out is that, I do believe because they're carrying less stock, we're going to see a little uptick in cost of freight. Most of these shipments come in truckload and as they have inability to manage the dribs and drabs from the water utilities, we're getting a higher concentration of less than truckload orders.

So, we're going to have some challenges there as order count goes up, but I believe our net sales decline was less than expected. So I think, good news there and I believe it will continue into Q4. I see nothing in the housing market that's given me the reason to pause.

Speaker 5

Thank you very much.

Speaker 2

It is good to talk to you, Dean. Great.

Speaker 0

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

Speaker 6

Hey, good morning. Congrats on the quarter and hope everyone is safe and well right now.

Speaker 2

Thank you, Zane. Same to you.

Speaker 6

Thank you. So first off, have your views changed regarding OpEx versus CapEx spending by municipalities and utilities since the last quarter? And like, you have guys really been seeing any evidence there that utilities are curtailing spending even if housing isn't as bad as we thought? Are you seeing this different in different geographies?

Speaker 2

Yeah, I think what's happened is we saw scheduled work that normally would have taken place, especially in April and May in different geographies where shelter in place orders. You know, if it was not an emergency repair, there were water utilities that were not sending crews to do OpEx. If it was considered quote unquote discretionary. And so I think that, you know, in those states where discretionary work was basically banned for at least eight weeks is where you saw the drawdown.

Speaker 6

Gotcha. Gotcha. And then during the quarter, you guys also shut down the Woodland facility for opportunity reducing the operating costs and prep for further COVID uncertainty. At this juncture, how do you guys balance facility shutdowns with new capital projects aimed at those operational efficiencies and how are you looking at both going forward?

Speaker 2

Well, I think that, as I said in my prepared comments, we expect the Kimball facility to have multi capabilities. And I believe that, when we look at night gate valve assembly and night gate valve, piece part production. A lot of that is with third parties. Now we see this opportunity to consolidate and in source more and more of it so that we're in a better supply chain situation. And I believe that the long story short is we will continue to look at CapEx from an economic point of view.

And if it makes great economic sense, which this does, and it increases our flexibility, which this does, and it gives us a chance to both improve quality and have a higher number of products in the market, which this does, then we will continue to do it. But I think that, as we bought Kimball, I think I told all the investors that we were going to put the Hydrogate product in there and we were going to close our Hammond facility. Now we'll get the Woodland facility in there. And I think that, there's a fair deal of opportunity to get some synergies from the new facility as we look at all of our product offering.

Speaker 3

And just will add there too, that as we look with the closure of that, that the benefits that we expect from it are built into what we see as the benefits from our three large capital projects. As we talked about what we expect to be the improvement and incremental gross profit that will come through some of the efficiencies, such as we just mentioned as well

Speaker 6

Thank you. And last one for me. On a modeling perspective, year over year, you guys have been able to reduce absolute SG and A value. But how should we be thinking about that as a percentage of sales? And is there going be a particular cadence different from historical norms through this next year?

Speaker 3

Yes. So talking about overall SG and A, we certainly saw SG and A down slightly Q3 on a year over year basis. And as we look back at that, we benefited certainly from some of the temporary actions that we took, which was primarily furloughing some of the salaried employees. We had salary reductions for our senior leadership team And our Board of Directors also took a reduction in their fees. So that certainly helped some of our SG and A.

Additionally, due to shelter in place, we saw overall our expenses down when you looked at when we looked at travel, when we looked at events and conferences and other things as well. So certainly going forward, as we see economic activity pick up, we would expect to see some uptick from our third quarter with respect to some of the travel and other related expenses. Additionally, as we look into our fourth quarter, we won't have the benefit coming from some of the temporary actions that we took in and around the furloughs, etcetera. So do expect, I'd say, quarter to be higher from an SG and A perspective. And look, I think this is just one of the areas that as we look out, we will continue to look very closely and manage largely our G and A expenses as we can sort of based on what we see going on with market activity.

Speaker 6

Our

Speaker 0

next question is from Brian Lee with Goldman Sachs.

Speaker 7

Hey, everyone. This is Alex on for Brian. Maybe a bit of an expansion on the prior questions and your prepared remarks a little. Can you bifurcate between the delays you've seen on for the ongoing projects in comparison to approvals for new projects, which you said were delayed, but are they essentially on hold for the time being?

Speaker 2

Yeah, basically what we've seen with the pipe condition assessment, some of the leak detection, know, Aquashore DX deployments and some meter projects is a push out of the scheduled install dates and, you know, they remain in flux. And so when you say cannot bifurcate, I can tell you that year over year, bookings are up in technologies. I'm not gonna get into actual numbers, but they're up year over year and backlogs have grown year over year, but sales are down. So, you know, I think the long story of this is that I think there's some uncertainty about when we'll gain access back to consumers' homes and when we'll gain access back to confined workspaces, but I think the fundamentals for the adoption of the technology continue to give me encouragement and I'm encouraged by where the Echo team and the meter team But I don't want to get into splitting the hairs here and I'd remind everybody that it's less than 10% of our sales as well.

Speaker 7

Right, that's helpful. Thanks. And maybe on margins, can you talk can you provide a little color on how you expect operating margins to trend at least directionally by quarter by segment in the quarter?

Speaker 2

I'm not going to give segment guidance per se, but I think, as I said earlier, I expect technologies to have some high degree of variability around it. I expect infrastructure to remain kind of steady as we've seen through Q3. And if you take out the impact of the destocking for, you know, hydrants, balance, brass, things like that, I think, you you see it. Let kind of change your question around a little bit though and say this, I do expect as we see the case count to rise, that our costs associated with fumigation, our costs associated with emergency paid leave, our absenteeism rates to become more and more challenging. So I believe that our Q4 margins will have pressure on them on the cost side from labor costs and from cleanup costs, because you know, our protocols, work with a third party Galen Medical to come up with keeping our plant environment safe.

We have protocols in place for sanitization. We have, you know, multiple levels of exposure for COVID. We send people home on mandatory quarantine if they've had certain criteria met. So I do think there will have some pressures there. On the other hand, I expect utilizations in the fourth quarter.

I expect that the sales environment and our ability to react to demand now that the channel has destocked to drive our absorption numbers and get some lift that we had as a result of the poor volume in Q3. So all in all, I expect, you know, our Q4 guidance obviously implying a lower adjusted EBITDA conversion margin versus 47% decremental margin in the third quarter being driven primarily by the COVID-nineteen expenses, higher SG and A expenses because we expect T and E to be up Q4 versus Q3 and pressure from cleanup and COVID absenteeism costs. So I think that's the kind of enough of the matter and we've got to manage that throughout Q4 and we've got to watch our absenteeism rates very, very closely.

Speaker 7

Great, thanks for the additional color.

Speaker 0

Our next question is from Joe Giordano with Cowen. This

Speaker 1

is Robert in for Joe.

Speaker 8

I just have a quick one, just on the 4Q sales guide. And just if you could parse it out between segments, just even directionally. I know tech is a relatively small piece of overall revenue. But in Q4 last year, did see a bit of an increase in 4Q. I just wondered if you're expecting a similar sort of ramp in 4Q twenty twenty.

Speaker 2

No, and thanks for asking that because I think that some of the failed dimension is, this is a really tough comp for tech because you'll recall that the bulk of the San Jose leak detection shipments happened in our Q4 last year. And so I don't expect that go to have that multi thousand unit, Echo Shore order replaced quarter versus quarter. So I expect that the overall sales will be more negatively impacted in technologies than I do in infrastructure. I think pipe condition assessment service projects have been especially challenged since the pandemic began. I think availability to homes to do meter installs has been challenged.

I think the project related mentality, if you will, water utilities continues to push it. So I think you could absolutely expect a much bigger drop in technologies and pretty even Steven kind of performance out of infrastructure as OpEx and CapEx continue to chuck along at kind of historical rates.

Speaker 8

That's great, thank you very much for that. Appreciate it.

Speaker 2

Just one other thing point out for all the people on the call. We're not experiencing any cancellations. I know there were some chatter about that out there. So, everything we see is kind of delay, delay, delay. We're not seeing any actual demand perish.

We just kind of see a push to the future. Ultimately be the timing issue.

Speaker 0

And at this time, I'm showing no further questions.

Speaker 2

Okay, well, thanks everyone. It was a very challenging quarter from a kind of a social point of view, as we learned a great deal about COVID-nineteen, how to respond to a pandemic. As I said several times in my comments, really proud of our team, really proud of how our plant employees, have risen to the task. I mean, we have had really, really good participation, really, really good throughput and a great deal of flexibility, especially from our hourly workforce on trying to do things different. This is how we used to put this together.

Now we have to put it together like this. So the social distancing, the wearing the face masks, sanitizing the workspace, sanitizing common areas. I think everybody's just been really, really super into this free decor, I think in our plants gives me faith that we're gonna be in really, really good shape as we come out of this, because I think that everybody's got the right attitude and I think we're on the right path. I think the quarter could have been worse, but it was good and I'm encouraged by what I see both from an economic activity point of view, residential construction point of view and where we are with our water utility customers. So thanks for coming in today.

Thanks for calling in and here's the Q4 and we'll see where we are. We'll talk soon. Thank you.

Speaker 3

Thank you.

Speaker 0

This now concludes today's conference. All lines may disconnect at this time.