Mueller Water Products - Earnings Call - Q4 2018

Transcript

Speaker 0

Welcome and thank you for standing by. At this time, all participants are on a listen only mode until the question and answer session. This conference is being recorded. If you have any objections, you may disconnect at this time. I'll now turn the conference over to Whit Kincaid.

Thank you. Please begin.

Speaker 1

Good morning, everyone. Welcome to Mueller Water Products twenty eighteen fourth quarter fiscal year end conference call. We issued our press release reporting results of operations for the quarter ended September 3038, yesterday afternoon. A copy of it is available on our website, muellerwaterproducts.com. Discussing fourth quarter and full year results and the outlook for 2019 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 September 30. A replay of this morning's call will be available for thirty days at 697.

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 results for the twenty eighteen fourth quarter and full year. I'll give you a quick overview of the quarter and then Marty will follow with additional commentary on our financial results. I'll then provide some further color on key areas later in the call. And finally, we will conclude with a discussion of our outlook for 2019.

We had a solid finish to the year with 12.1% net sales growth and an 8.7% increase in adjusted operating income in the quarter. Improved execution and strong demand in our end markets helped us generate very good volume growth at both Infrastructure and Technologies. We also benefited from the price increases we implemented earlier in the year, which help us offset material cost inflation in the quarter. We continue to feel the impacts of inflation, primarily driven by higher prices for raw materials. In addition, we felt the impact from higher freight costs compared to the prior year.

These headwinds have been especially challenging for the specialty valve portion of our business, which has longer lead times. We have responded by announcing price increases for many of our products in September, which we expect to help offset anticipated inflation in 2019. I am proud of how we executed this year, evidenced by growing annual net sales 10.9, adjusted operating income 11.4% and adjusted net income per share 20.5%. We made significant progress executing our key initiatives to grow and enhance our position as a leading water infrastructure company. We demonstrated our balanced and disciplined approach to capital allocation as we further strengthened our balance sheet with our debt refinancing while increasing our reinvestment in the business and returning $60,000,000 of cash to shareholders in 2018 through dividends and share repurchases.

We've talked about how acquisitions that leverage our strengths can accelerate our organic growth. I'm extremely excited about our announcement to acquire Krausz Industries, which I will touch on later on the call. This is a wonderful opportunity to broaden our product portfolio for our North American customers and expand our global reach. With that, I'll turn the call over to Martie.

Speaker 3

Thanks, Scott, and good morning, everyone. I will start with our fourth quarter consolidated financial results, then review our segment performance. Consolidated net sales for the twenty eighteen fourth quarter increased $27,400,000 or 12.1% to $254,300,000 driven by higher volumes at both Infrastructure and Technologies as well as higher pricing infrastructure. Gross profit increased 5.6% in the quarter to $85,500,000 yielding a gross profit margin of 33.6%. Volume growth and higher pricing contributed to this increase.

We continue to experience the impacts from higher costs due to inflation as well as manufacturing inefficiencies in the quarter, which impacted our gross margin. The primary drivers of inflation include material costs, which increased approximately 5% year over year in the quarter, and higher freight costs. Selling, general and administrative expenses were $42,900,000 in the quarter, up $900,000 from last year, with the increase primarily due to personnel related expenses. SG and A as a percent of net sales decreased to 16.9% in the fourth quarter from 18.5% in the prior year quarter. For the year, SG and A as a percent of net sales decreased 60 basis points to 18.2%.

Adjusted operating income increased 8.7% to $42,600,000 in the twenty eighteen fourth quarter. The adjusted results this quarter exclude $2,100,000 of other charges. The improvement in operating income was primarily due to higher volumes and higher pricing, which were partially offset by higher costs from inflation and manufacturing inefficiencies at infrastructure. Adjusted EBITDA for the twenty eighteen fourth quarter increased 8% to $53,700,000 For 2018, adjusted EBITDA was $180,000,000 or 19.7% of net sales. Turning now to taxes.

For the twenty eighteen fourth quarter, we reported a net income tax expense of $9,700,000 or 28% of income before income taxes. This rate differs from the statutory rate primarily due to the effects of state income taxes, manufacturing deductions and discrete items. On an adjusted basis, the fourth quarter income tax rate was 27.7% which excludes $100,000 of one time impacts from tax legislation. For 2018, the adjusted effective income tax rate was 26.2% as compared with an effective rate of 30.8% in 2017. The 2018 full year adjusted effective rate was lower primarily due to a decrease in the federal income tax rate as a result of new tax legislation.

Our adjusted net income per share increased 13.3% to $0.17 for the quarter compared to $0.15 in 2017. 2018 quarterly adjusted EPS excludes $2,100,000 of strategic reorganization and other charges, dollars 300,000 related to the reduction of our ABL commitment and $100,000 related to the tax legislation. Now I'll turn to our segment performance, starting with infrastructure. Infrastructure net sales grew 9.3% to $223,500,000 in the fourth quarter due to higher shipment volumes and higher pricing. For 2018, Infrastructure had a strong year with 10.7% net sales growth.

Adjusted operating income for the fourth quarter was $50,100,000 a decline of $900,000 The benefits from higher shipment volumes and higher pricing were primarily offset by higher material and freight costs in conjunction with carryover manufacturing inefficiencies we discussed last quarter. For the quarter, higher pricing did cover material cost inflation and for the full year, higher pricing covered these inflationary costs. Adjusted EBITDA for the twenty eighteen fourth quarter decreased $400,000 to $59,800,000 in the twenty seventeen fourth quarter, yielding an adjusted EBITDA margin of 26.8% for this segment. Moving on to Technologies. Technologies performance was much improved this quarter with strong sales growth and a small operating profit.

Net sales increased 36.9% to $30,800,000 in the quarter, primarily driven by higher volumes at Mueller Systems. Adjusted operating income was $300,000 for the fourth quarter, an improvement of $2,500,000 versus 2017. The improvement in adjusted operating income was primarily due to higher volumes and manufacturing performance, partially offset by higher costs associated with inflation. As a reminder, in our third quarter, we had delayed delivery of some sales at the end of the quarter and delivery of those sales helped to benefit this quarter's net sales and operating income. Now I'll review our liquidity.

Free cash flow, which is cash flow from operating activities of continuing operations less capital expenditures, increased $18,800,000 to $33,800,000 for the twenty eighteen fourth quarter. In 2018, we had generated $77,000,000 of free cash flow compared with $18,800,000 in the prior year. The $58,200,000 improvement in free cash flow is due to an increase in cash flow from operating activities driven by both improved operations and timing of expenditures, partially offset by higher capital expenditures. Additionally, in the 2017, we made a voluntary $35,000,000 contribution to our U. S.

Pension plan, which impacted our free cash flow. We invested $28,800,000 in the quarter for capital expenditures and $55,700,000 in 2018, an increase of $15,100,000 from 2017, largely to upgrade our equipment and manufacturing capabilities, which will further drive cost productivity improvements and efficiencies across the organization. We also are investing to expand our large valve casting capabilities in our Chattanooga facility. At September 3038, we had total debt of $445,000,000 a decrease of 35,600,000 from last year. At the end of the fourth quarter, our net debt leverage ratio was less than one time and our excess availability under the ABL agreement was approximately $125,000,000 I'll now turn the call over to Scott.

Speaker 2

Thanks, Marty. I'd like to comment on a few key areas and then discuss our full year 2019 outlook. We are in the early stages of a transformational process as we take a company with a strong history in manufacturing iron and brass products for municipal and residential infrastructure to one that provides more intelligent, value added solutions to help customers manage and deliver important resources. Mueller Water Products is uniquely positioned to leverage its large installed base of fire hydrants and other products with new technology offerings that can help our customers deliver the most important water resources to their communities. As a reminder, we have four key strategic areas we remain focused on to drive results.

Delivering integrated customer focused support and alignment of our people, products and processes is foundational for executing our other key strategies. The strategic reorganization we announced in September was focused on creating an integrated customer centered support structure with centralized common functions and integrated information technology. We reconfigured our divisional structure around products with five business teams that have line and cross functional responsibility for managing specific product portfolios. Under the new organizational structure, engineering, operations, sales and marketing and other functions have been centralized to better align with business needs and generate greater efficiency. As part of this process, we recently launched our new Mueller brand identity at the twenty eighteen WEFTEC Conference to bring our family of brands more closely together in support of our ongoing efforts to drive revenue growth.

The changes we have made over the past year have led to improved execution of our key initiatives across the organization. We are well positioned to grow and play an integral role in building the future of our industry. Accelerating the development of new products will help us expand our market leading position and grow organic sales above market. Increased investment in our product development capabilities, including expanding our engineering staff, has helped develop our pipeline and launch several key new products this year. To accelerate our efforts, we opened a new Technology Center of Excellence in Chattanooga, which will focus on our valves and hydrants.

We are in the process of creating a new technology center in Atlanta to focus on software and communications technologies. With this change, we will transition the network operations center and all hardware and software development activities to the center of excellence in Atlanta. We are pleased to have Chattanooga and Atlanta join Toronto, which is our center of excellence for leak detection. As we invest in engineering talent, we are working to improve manufacturing operations by developing a culture focused on driving we operational excellence. We are bringing best practices focused on lean manufacturing with an investment mindset to deliver manufacturing productivity improvements.

Efforts will facilitate innovation and new product development, helping us drive sales growth and strengthen product margins. Effective capital investments and efficiencies at our facilities will allow us to drive down costs, which can fund additional productivity initiatives and continued investment in product development. We believe these efforts will help improve our conversion margins in 2019 and beyond. We are successfully implementing a go to market strategy that leverages all of our products and services. This helped us achieve our highest annual net sales growth since 2013.

We have executed multiple price increases to cover inflation, while delivering strong volume growth at Infrastructure and improved growth at Technologies. Our plan is to continue to enhance sales growth of our existing products by strengthening our relationships with our customers and channel partners and realizing synergies among our product lines with a unified sales and marketing strategy. Our key strategies are supported by a strong balance sheet and substantial free cash flow, which enable us to reinvest in our business while returning cash to shareholders. We further strengthened our balance sheet this year by refinancing our debt to provide us with a structure that yields long term flexibility and preserve secured debt capacity. We also reduced uncertainty by extending our debt maturities and fixing our rate at what we felt was an attractive interest rate when you consider rates over the long term cycle.

In 2018, we generated $133,000,000 of operating cash flow, which we used to reinvest in the business and return to shareholders. We increased our capital spending in 2018 to $56,000,000 enabling us to further accelerate manufacturing efficiencies and expand our capabilities to meet the growing demand for water infrastructure products as utilities repair and rebuild their aging infrastructure, including the large valve manufacturing capabilities in Chattanooga. In addition, we repaid $36,000,000 of debt and returned $60,000,000 of cash to shareholders through a combination of dividends and share repurchases. Our acquisition pipeline is focused on leveraging our existing channels, strengthening our market position and expanding our geographic footprint. Yesterday, we announced an agreement to acquire Krausz Industries, which we believe offers an excellent opportunity to broaden our product portfolio by adding a high quality brand of pipe repair products to our infrastructure business.

Krausz is a family owned company with a long track record of innovation and growth. We believe this acquisition is complementary from customer, product and manufacturing perspectives. The Himax family of products allows us to address a broader scope of needs for the water infrastructure system while expanding our global presence. Our understanding of their end markets and our shared customers will allow us to accelerate their efforts in The U. S.

And abroad. Going forward, we will continue to look for opportunities which are close to our core areas of expertise. I'd like to now review our full year 2019 expectations for consolidated results. Our annual guidance excludes any impact from the pending Krausz acquisition, which we expect to close in December 2018. For 2019, we anticipate continued healthy demand in all of our end markets.

This includes municipal spending, which represents approximately 60% of sales growing in the low to mid single digit range. Residential construction, which makes up approximately 30% of sales, is expected to grow in the mid single digit range. Finally, we anticipate mid to high single digit range of growth for the natural gas distribution market, which represents a little less than 10% of sales. I am very encouraged about the progress we have made executing strategies to drive sales and increase adjusted operating income, which are creating a strong foundation for future growth. We continue to believe we are operating in healthy markets, which will accept price increases to cover economic costs.

Our annual guidance assumes that the future impact of tariffs will be covered by price increases and market activities. Any additional tariffs could impact the timing of our ability to change prices to cover additional costs. For 2019, we expect to increase our organic consolidated net sales between 46% on top of strong sales growth of nearly 11% in 2018, with organic adjusted operating income growth between 79%. We believe our balanced and disciplined capital allocation supported by a strong balance sheet and substantial free cash flow will continue to benefit shareholders while supporting organic growth and acquisitions. Now Marty will provide some final comments on other components of our 2019 outlook.

Speaker 3

Thanks, Scott. Corporate SG and A expenses are expected to be between thirty five seven million dollars We anticipate that depreciation and amortization will be between $50,000,000 and $53,000,000 net interest expense will be between $20,000,000 and $21,000,000 and capital expenditures will be between 56,000,000 and $60,000,000 We anticipate that our effective income tax rate for the full year will be between 2527%. We will benefit from a lower corporate income tax rate in 2019 compared with our 2018 blended rate. However, our 2019 estimated effective tax rate reflects the elimination or reduction of certain deductions that benefited 2018, such as the elimination of the domestic manufacturing deduction. With that, operator, please open this call for questions.

Speaker 0

Thank you. At this time, if you'd like to ask a question, first please ensure your phone is unmuted, then press 1 and record your name to enter the question queue. Our first question is coming from Seth Weber with RBC Capital Markets. Your line is open.

Speaker 4

Hi, thanks. This is Brendan on for Seth. Just a couple to start here. Were there any pull forward I mean, your volume was a lot better than we had thought. Was there any pull forward ahead of the price increases that you announced?

Speaker 2

We don't think there was too much there. We we we did a you know, as as we said in the prepared remarks, the September price increase was fairly rapid with a kind of a short window with relatively few releases allowed for our channel partners. So we don't think much got pulled into the year. But, you know, certainly, there is some possibility. But to to give everybody an idea here, the the notice period was right at the minute of thirty days, and the the pull forward allowance was for a single release.

And so people couldn't push full pricing into the future for very long. But there may have been a little bit there.

Speaker 5

Okay. And

Speaker 4

then another pleasant surprise versus our model was the profitability in your Technologies business. You mentioned earlier that it benefited from some of the delayed orders last quarter. Is that was that the driver really for the profitability this quarter? How should we think about your ability to sustain profitability going forward? And is that $30,000,000 sales, is that kind of like your breakeven point going forward?

Speaker 2

Look, I think the you know, as as we said last quarter, we we always wanna make sure we're real straight about that. You know, I told you I think we left a couple of million dollars on the dock at the q three call. And so, obviously, we got the benefit of that couple of million bucks. So it it helps sales in in q four. So you you saw it come through.

So, you know, if you take that away at our at our marginal costs, you know, maybe it would have been slightly negative or breakeven. But you should think about the technologies business as, yes, you know, somewhere in that standard margin, $3,032,000,000 is kind of breaking through the breakeven mark. But, you know, there's a lot of pieces moving in that business, but, you know, we we we were pleased with performance. I was especially pleased with manufacturing performance, which helped. And you'll recall in q three, it hurt.

So, you know, performance matters and execution matters, and I think the team did a better job.

Speaker 1

Alright. Thank you.

Speaker 0

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

Speaker 6

Good morning. Thanks for taking my questions.

Speaker 2

Good morning, Mike.

Speaker 6

First, just wanted to ask about the 2019 outlook. It looks like it implies roughly 25% conversion margins. Since you had a lot of operational issues in 2018 and you're going to begin to lap some inflation, just curious if you can give us some color or commentary in terms of those conversion margins and why they're maybe not a bit stronger like we've seen in the past.

Speaker 2

I think it's a fair pickup on your part. The the reality is I think the outlook we provided kinda takes the averages of the last two years if you think about both the demand point of view and then what is gonna happen from a material inflation net to net. And what we do as you lap q one and q two inflation is you look at what the sequential has been, and there's still gonna be inflation next year. So I think that the reality for us on conversion margin is going to be some period, not for long, lapping some you know, our backlog and some period of lapping inflation. Think that's the weighted average.

Speaker 6

Great. Scott, you'd mentioned in some of your prepared remarks that you have accelerated some productivity initiatives. You also talked about some investments. Can you update us on that longer term target that you had with the 100 basis point growth, 50 basis point net productivity and whether or not you can achieve that in 2019?

Speaker 2

Well, I think what we do with our guidance is try to get you to the the the sales number and the OI number. I think the you know, what how much more we're gonna make there and how much of it comes from productivity, you know, and then you've got the increased depreciation associated with the increased capital investment. There there's a lot of moving pieces there. I I tend to think of those as, you know, long term targets. You know, if you think about averaging the last two years, if you think about what's going on, I think I think you should use that model kind of for your multiyear, look at the business.

But discreetly next year, it's gonna be or I should say this year and early part of next year, you're have some big, big execution tasks around large casting foundry. Just use that moment to to remind everybody that we will be out of the insourcing of big bodies sometime during fiscal two thousand nineteen, big valve bodies, as we bring our large casting foundry online. There'll be a lot of moving pieces in that. I'm sure we'll have some start ups and things of that nature. But I think in the whole, 100 basis points of improvement, 50 basis points of flow through are achievable in the long term for this business.

I continue to be convinced that the opportunity set we see from a manufacturing productivity point of view is a healthy one. And I think we have kind of an open field in front of I think as you get into the anomalies of each quarter as an investment comes on or as start ups happen, you know, there may be some noise in that, but I'm not terribly worried about it. And, you know, at at this quarter, I think, I saw the cost savings, reviewed the cost saving projects. They were real savings. We just had noise in the quarter associated with the things we talked about in the prepared remarks.

Speaker 6

Great. Finally, can you just give us a little bit of color in terms of the Krausz margins once that deal closes so we can better model in that impact?

Speaker 2

Yes. And I'll get Marty to fill in the nitty gritty. But overall, this is a business that caught my attention early because our EBITDA margins and their EBITDA margins are similar. They're not identical. They're similar.

But I think that what I saw is that when you think about how much money is going into pipe repair and infrastructure repair and whether you see that as growing over the next five to ten years or shrinking, I think it is going to take more and more of the utilities budget. So I like the repair space. And when we reviewed the the the multiyear model, I think that, you know, we got it for a fair value for where we think it could be. But, Marty, you wanna be a little more particular?

Speaker 3

Well, I think, yes, overall, looking you said they had revenues for fiscal seventeen at about $43,000,000. You know, through, '18, we have seen them continue with the kind of growth rate that they've exhibited in the past. As Scott said, when we look at their EBITDA margins, we could sort of put them in a a a comparable, sort of the same same zone as where Mueller Water products are as well. So but I think, importantly, as we look you know, as we think about what the the synergies are and the fit with the company, we just think this one, goes very nicely clearly from a customer perspective. Certainly, the overlap that we have with our customers, certainly from a product perspective, as well as from a manufacturing perspective.

Speaker 6

Great. Thank you.

Speaker 0

Our next question comes from Brent Thielman with D. A. Davidson. Your line is open.

Speaker 5

Great, thanks. Good morning. Good morning, Brent. Scott, just maybe back on the acquisition, is this indicative of the sort of transactions you're sort of cultivating in the pipeline, I guess, given the margin profile seems to be in the same ZIP code? Is it unique versus other things you're looking at out there?

Speaker 2

I wouldn't call it unique. When we think about, you know, in in this particular case, brass gas and repair or the value stream, and we think about where our product gaps are, all of the businesses, you know, all of these value streams have some product gaps. So those bolt ons that that help fill out product offerings are something that definitely we want to do in the future. But that is not to say it's the only profile we have. We we have we we have markets as I've talked about on previous calls, you know, especially especially as as it it relates relates to to geographic expansion and, you know, more industrial or maybe even more storm water, wastewater exposure, things like that, that we would also invest in.

You know, we're looking for where we have strength and we can leverage our strengths or where a target may have strengths and could put us into markets that we aren't in today. So those are, you know, kind of all of the the basic one zero one things we look at. But, yeah, if there were more crowds out there, I would definitely be interested.

Speaker 5

Okay. And then on on the infrastructure segment, you know, a lot of companies this quarter have been talking about the, in some cases, pretty extraordinary challenges with weather and just getting work done. It doesn't look like they were it doesn't sound like there was much pull forward. I was pleasantly surprised with the volumes. I mean, did you get have you gotten feedback that, that hindered your growth to some degree?

Or is this sort of volume expectations you'd have going into fiscal nineteen?

Speaker 2

Well, I you know, to to be clear, we we got, you know, something less than, we had this year and, for fiscal nineteen. We think the markets remain heavy. I think we're right in line with or remain healthy. I think we're right in line with our, you know, our our longer term guidance that we're kind of in that 150 basis points better than GDP kind of number. Now to answer your question specifically, you know, we saw a meaningful impact a year and a half ago when Harvey were from Houston, but, we didn't see as much with, you know, the Mexico Beach or the the the Florence up in The Carolinas.

So I'm not really sure why that is, but certainly we have presence in both of those markets. But I think the the damage to drinking water drinking water infrastructure was a lot different in those two events.

Speaker 5

Okay. And one more, if I could. Do you see the industry responding on the tech side of the business with price increases to offset inflation? Or is that more likely to be absorbed? And I guess if you could just kind of help quantify what those costs are as a percentage of the COGS, that'd be helpful too.

Speaker 2

Yes. I'm not going to get into segment COGS cost. I think, certainly, you know, with with brass increases, if you think about meters and radios, there's been inflation. But, obviously, we think healthy markets allow real increases, you know, represented back in price. The only thing I would say different about the technology businesses is you tend to get into longer term price agreements when you take these large transitions.

So it'll be a longer cycle or a a longer leg to recover inflation in the technology.

Speaker 5

Okay. Thank you.

Speaker 0

Our next question is coming from Andrew Buscaglia with Berenberg. Your line is now open.

Speaker 7

Hey, guys. Thanks for taking my question. You just comment on, you your residential exposure? It's about 30%. That's definitely come into more focus given recent concerns in that space.

Can you just talk about how you guys play into that sector and kind of where you fit in the cycle there and how you guys are thinking about, you know, any potential downside from there.

Speaker 2

Certainly, I I think you're referencing the the cooling nature of ready forecast.

Speaker 7

Yeah.

Speaker 2

The thing to remember about us is that we we tend to be early cycle, and we tend to be in the lot development stage. So if you think about pipe going in the ground and hydro is going, valves going in, it tends to be when when the land is being developed. I think, historically, you should think about us, you know, suffering from an overhang of overdevelopment in the past, but we do not believe the inventory of loss, even in this lower outlook period is such that we're going to be impacted as negatively as, say, a homebuilder. You know, there's still with 1.4, 1,500,000 homes kind of targeted as the as the outcome we think we have in front of us still a fairly healthy 02/2019, potentially even in 02/2020. You know, the caveat here and and, you know, this is for everybody.

Philosophically, we understand that if interest rates accelerate rapidly, then, you know, cost of money for municipalities, cost of money for homeowners, home development, you know, you could temper future demand. But, you know, from what we've seen from the Fed, from what we've seen from the interest rate environment, while while we expect it to go up, we don't you know, I think a rapid rise would hurt us more. I think that's how you should think about it. Think about our

Speaker 5

Okay.

Speaker 7

Okay. Yeah. That's that's helpful. And did you guys disclose, multiple you paid for crowds, or would you like to? And then, you know, talk about a synergy potential, you know, how how it how that would factor into the multiple.

Speaker 2

Sure. Go ahead, Marty.

Speaker 3

Yeah. Just you know, if we think about it from a from a multiple perspective, looking at their forward EBITDA, sort of looking a couple years out and certainly not factoring in any what we would deem onetime costs or associated acquisition expenses. Looking at that two year out adjusted EBITDA, we'd say we'd probably pay a little less than 10 times.

Speaker 7

Okay.

Speaker 3

And with respect to synergies, you know, I think we're gonna would expect to have savings, certainly on the cost side as we look to to leverage, our capabilities, and I think importantly, on the revenue side as well.

Speaker 7

Okay. Alright.

Speaker 3

You know, she said we think this one, you know, as we look at it from a customer, as we look at it from a manufacturing, as we look at it from a product perspective, it really is a very complimentary fit with our business today. It also gives us, expansion from a geographic perspective as well.

Speaker 7

Yeah. Sounds like it. So it sounds like you can get a couple or maybe a turn out of there with the synergies that you have that you guys talked about. So but, yeah, thanks for that. I just, just wanted to see kinda how expensive a deal like this would be, but, I guess, looking at it, it's pretty it seems like a pretty good deal.

Speaker 2

We think so. We're excited.

Speaker 5

Alright. Thanks, guys. Our

Speaker 0

next question comes from Brian Lee with Goldman Sachs. Your line is open.

Speaker 8

Hey, guys. Thanks for taking the questions. Good morning. Hey. Hey, Scott.

Maybe first thing just on the I just wanted to ask a few clarifying questions. You know, Marty, you you alluded to the revenue that Cross had done in 2017 and that they had been growing in 2018. It's sort of the level you'd been expecting them to or that they have been at. Can you give us some sense of what that is? What is that historical sort of growth rate then?

Are they in the mid single digits, the way you guys are forecasting, for for your for your segment into next year?

Speaker 3

Well, first of all, I'd say, well, certainly, you know, once we close the transaction, we'd expect to give you more, more insights as well. So let me just say that. But, no, you know, I think, certainly, as we cited the market that they play in, I think Scott referenced it in some of his prepared mark remarks. But as we look at the pipe repair market and we think about how municipalities will look for alternative ways to more efficiently manage, their expenditures, certainly, the ability, to repair products rather than a full replacement is one of the reasons we think that this is an attractive market for us, as we looked at the Krausz acquisition, and importantly, as we looked at where municipalities we think will continue to spend the aging infrastructure, which is certainly something that is not new news to anybody, but, you know, continuously how do municipalities manage their expenditures? We think this is a a great area for them to do it.

They have seen, I think, very nice growth, probably in the low double digit over time. And I think as we look at it as type of care market, we think that will continue to be a good long term market.

Speaker 8

Okay. No. Great. That's, I appreciate that color. And then, on technologies, you you also alluded to, part of the, you know, part of the big results this quarter was some 3Q to 4Q push out.

Can you quantify in in dollars sort of, you know, what what that amount was?

Speaker 2

Yeah. I I said last last quarter, Brian, that we thought we left about $2,000,000 on the dock while we went through, you know, some extra QA. And and and that was you know, that's how you should think about it, couple million bucks.

Speaker 8

Couple million bucks. Okay. That's great. And then, maybe just going back to the, earlier question around, margin expansion targets for 2019. I know there's a lot of moving pieces in the macro that have been impacting your costs and then also resulting in driving some pricing actions this year.

But as you think about the conversion margins, you've historically talked about 35% to 40% or more 25 to 30 based on the guidance you're giving, for next year. Just wondering if you can, you know, not not so much walk through the puts and takes. I think I get what what's going on in terms of why that's a little bit lower than what you might historically have targeted. But, is that a new normal in your view? I guess is the first question.

And then if not, what are some of the sort of initiatives that you think you start to put into play as you move through the year, I would imagine, to get you back toward your original targets and and kind of the out years?

Speaker 2

Okay. I'm gonna I'm gonna try and answer this, but I this is one of the reasons that couple of quarters in, tried to get out of the conversion margin game. You know, you've gotta you've gotta look. You know what our primary inputs are in there around brass and scrap metal. If you think about a longer term view, basically, metal prices, all of them dropped from 15 to through basically the '60, and they started to inflate.

And so you've got tremendous conversion margins as your material costs ran away from you, got got lower and lower. And then as they turned, you know, we've been in this flag of getting price after we see inflation. And I think that I I don't want anybody to sit there and say, oh, this is the new normal. I think it's completely reasonable to expect, we tried to put it in the prepared comments, for us to actively manage markets to get price. So this year, we've just barely covered material inflation with price increases.

So that's a good outcome. Now if if everything flattened out, you can do that math over next year. We will have decent conversion margins. If our blended cost and blended cost changes, whether it's labor, freight, all of the input costs, if if it's gonna inflate, we're gonna get dilution. If it's gonna deflate, we'll get margin expansion.

And and that's all that's happened. And I just wanna reiterate, very happy saw in September with the price increases we put through. The order book stayed strong. We continue to see strong orders into October. So I am I am not forecasting a new normal forever.

I think if you go back to my long term guidance, 150 basis points better than GDP, 50 basis points of margin expansion over the long term a year, take out kind of this quarterly noise, you'll see that we think we're we're on the right path with both our investment strategy, our selling strategy, our acquisition strategy. So I feel pretty good about the future.

Speaker 8

Okay. Great. Now that's I appreciate that color. Maybe two last ones from me, and I'll pass it on. One is you alluded, to the manufacturing efficiencies having impacted you.

I know you had talked about that coming into the quarter. Can you give us some quantification of what that impact was and if those issues are all behind you or if there's some still lingering impact heading into fiscal Q1? And then secondly, just any updates you can provide on the tax liability issue that's been playing you guys?

Speaker 2

Okay. I'll take part one. Marty, you can take part two. Part one, yeah, last quarter, I said, if you recall, just to remind everybody on the call, we we lost a holding furnace in one of our facilities. We had to kind of run inefficiently by melting and then pouring, didn't didn't get the the benefits of, you know, having a large holding furnace.

And as a result, we also had the repair costs. And, basically, the way the system works, right or wrong, we end up with anything you put in inventory at the higher cost is there at the higher cost. And so when you sold those in q four, the ones that you made in q three that were still in inventory, it basically had lower margins. I forecast, and I think on the q three call, that that was gonna be a million dollar hangover or so. And it was right around that number.

I'm not gonna get exactly because I can't recall it. But it was a let's call it a million dollars of manufacturing inefficiency hangover from q three. Apart from that, we saw relatively good performance at the foundries. Apart from that, a hangover from q three. So don't see any residuals, but, you know, I think it's a you know, these things these things are, you know, part of the business as as a management team to to manage them, and I I think we have the safeguards in place.

And on the tax issue, Marty?

Speaker 3

Yeah. Really, Brian, there's no no updates, I think, since we last private provided our disclosure in and around the Walter tax situation. You know, I think we said at that time, we continue to work constructively to reach an agreement. We did call out that we think that certainly when you consider the refunds for certain of the years or applied against some of the liability, that the net liabilities, will be substantially less than those that the IRS, put forth in their proof of claim. But, you know, until there's further progress, we're not in a position to predict the amount, or the extent to which we might be responsible, and we do not have, any update with respect to, timing or reaching a resolution with the parties.

Speaker 8

Alright. Thank you.

Speaker 0

Our next question is coming from Joe Giordano with Cowen. Your line is now open.

Speaker 9

Hey guys, good morning. This is Tristan in for Joe. I'm sorry, I'd just like to go back a little bit on profitability discussion. If we look at Technologies next year, is your guide what's implied exactly for your guide next year at Technologies?

Speaker 2

I am not providing guidance at the segment level. I think it's it's, you know, meaningless at this point when we're talking about what is less than 12% of sales or something like that. So we're gonna continue to work technologies. We're gonna continue with the innovation we've put in place with our MINET product lines, our radios, our meters. We're gonna continue the integration of both cellular leak detection along with AMI, leak detection.

We're gonna continue to integrate with smart hydrant and, hopefully, a smart valve at some point in the future, and focus the team on development of, you know, sustainable differentiation and sustainable differentiated products, and not get into a cycle on a, you know, a 90 ish million dollar business, you know, with the vagaries of community demand. So not not not gonna go there. But I feel very good about the progress the team has made, both from a manufacturing point of view. Very happy with the product development reviews that's done with as far as their, you know, new collector systems, how many different software initiatives they have underway right now, improvements to both range, power utilization of our radios. Very, very happy with technology.

Speaker 9

Sure. Fair enough, Scott Scott. And could you remind us how much of your manufacturing and procurement is done in China?

Speaker 2

I we we have a facility in China.

Speaker 3

I don't I don't think I

Speaker 2

don't think we published it, but it's not much.

Speaker 3

Yeah. I don't think we've broken it out, but it's it's not not that large. Our largest plants are all located in The US.

Speaker 2

And and let me say again that, you know, if if if you think about what the impact of tariffs have been, I I don't know that number, but it's, you know, it's less than a million or so. So it's not a it's not a a big number. My point is a year and a half ago, long before there was any trade dispute, you know, we knew that we wanted to be able to get all of our bodies, all of our discs, actuators, and be in control of our own destiny. That's why eight months ago, we told you about, you know, the launch of the Chatnew Galeric Gassing facility so that we would be able to three d print all the tooling and then, you know, take cycle times from what right now is, you know, twelve to fourteen weeks for four made and and equally long for domestically made valve bodies. And, you know, we should be up and running.

You know, we'll have PPAPs running probably in June through September 2019 and, you know, like to be in full production with the ability to make American made and American sourced valves completely, you know, by September. So I think we have a leg up on everybody else who continues to bring in for made valve bodies.

Speaker 9

Okay. Thanks. So you're you're not seeing any oh, yeah. You're not expecting any tightness in the supply chain at all, right, at this point?

Speaker 2

I don't I don't know about tightness. I mean, it's really difficult with the rhetoric around the next $200,000,000,000 and what's involved and what's not involved and what those actual dates are. So the one thing I've learned over the years is you can no longer say there's you know, the the ripple effect or what it could do to domestic supply in some other area will, you know, certainly impact the supply chain. So if the automotive sector all of a sudden starts changing how they buy steel, you know, it will have an impact. Maybe it'll impact scrap.

Maybe you know? But I haven't foreseen how that will happen. I can tell you that today, we believe that given the status quo, that tariffs will negatively impact 2019, and we think we have that expectation in our guidance.

Speaker 9

Great. Thank you, guys.

Speaker 2

Our

Speaker 0

next question comes from Walter Liptak with Seaport Global. Your line is open.

Speaker 1

Hi, thanks. Good morning, guys. I wanted to just do a couple of follow ups. One on Krausz, can we get the geographic breakdown? It looks like they're centered or came out of Europe, but might have a

Speaker 7

lot of exposure in The US.

Speaker 2

No. To be clear, they're they're an Israeli company with about, you know, think about them at 75% or so of their sales US based. North American based, sorry, I shouldn't say US.

Speaker 1

Okay. 75% US. Okay. No.

Speaker 8

And it

Speaker 9

okay.

Speaker 3

Clarify. 75% come from North America.

Speaker 1

From North America. Got it. Okay. And the the sectors, it looks like part is muni and some might be some irrigation. I wonder if you could help us with understanding the sector mix.

Speaker 2

Well, it's a majority of them in in drinking water and storm water management. But I think that the the reason you probably read that on websites is such is that as you

Speaker 9

think

Speaker 2

about water use and and ag being such a big part of it that I believe the the company feels that they have a tremendous opportunity to go in and do site repair in these sub trading systems that a lot of the ag systems use. Okay. It is a growth opportunity. Okay. That's helpful.

Speaker 1

Thanks. And just I apologize if you talked about this already, but the Atlanta Tech Center consolidating things there. Have you talked about the dollar amounts or timing? And I think you you spoke about some cost savings from that tech center. I wonder if there's any kind of quantification about that.

Speaker 3

Marty? Yeah. So, in terms of, setting up the Atlanta Center for Excellence, that is is underway. We do think that we'll incur some onetime costs associated with that, probably, in the neighborhood of about $5,000,000. And then we do expect, that we will get some savings over time as well associated with that, which probably look for less than a a three year payback, I would say on that.

And, you know, in terms of timing, as I said, it's in process, and I think, we would look to have it sort of fully up and running, in our 02/2019.

Speaker 5

Okay. Great. Thank you.

Speaker 3

To expand on a little bit further, I think, you know, certainly, we think Atlanta is attractive from a from a talent perspective. But I think I also wanna point out that when we look at where our other facilities are, and particularly if you look at the location of our Chattanooga facility, we think, by moving this to Atlanta, it will certainly make it much easier and and enhance, you know, the the synergies, the leverage that we get from the having those manufacturing facilities in Chattanooga as well as the technology center Correct. As well as our Albertville plant, which is just a little over two hours away.

Speaker 2

And I think the, you know, the next the complete technology in in our is is really what we're going for. So the the savings obviously are great, but that's that's not the

Speaker 3

size factor. It's not drive it's a factor, but it's really not the driver behind the decision.

Speaker 1

Okay. Alright. Thank you.

Speaker 0

And our next question comes from Jose Garza with Gabelli Management.

Speaker 10

Hey, Scott. I was hoping you could maybe just kinda comment on inventory levels at the distributor level and and anything kinda notable there.

Speaker 2

Yeah. We we, you know, we we don't I I was actually in the field with a with a couple of large distributors, at GWI and then meeting a couple others. We don't see anything out of the ordinary there. You know, they're still looking at their gross margin return on investments, how many turns they're getting. They're kind of around their historical averages.

We've not seen any, you know, kind of end of year buying to to get to levels for programs or anything like that. So I think that, you know, we're pretty much at the norm. And with that said, you know, I think as we went through October, we were watching bookings levels pretty closely, especially as it related to infrastructure, and they were basically in line with our expectations.

Speaker 10

Okay. Okay. Excellent. And just on just on Krausz, it looks like they might have just one facility in The US. Is is that accurate, or do they have more manufacturing?

Yeah.

Speaker 2

They they have a a single facility in The US as far as doing any value add, and I think they have two more warehouses.

Speaker 3

Yeah. Ex exactly. They've got some distribution facilities here, one one large and two sort of smaller ones. Yes.

Speaker 2

There might be some painting and things like that going on with the one large one.

Speaker 10

Okay. And just lastly for me, on the gas side, on the gas distribution side, I guess a little bit higher growth rate on that business. Anything worthwhile noting there? Maybe is there some projects or is it new product introductions or anything that's kind of, I guess, a little bit higher growth rate in that business as you guys look at it in 'nineteen?

Speaker 2

Well, I actually had one person say to me that the consequences of not maintaining your water infrastructure are a little different than the consequences of not maintaining your natural gas infrastructure, and therefore, they're a little more hyper about it. But nothing there's there's no fundamental change other than that you do have a little bit better growth associated with gas because it's not 100% penetrated. So if you think about water, every house is served by water. But today, gas lines pass many, many houses that aren't being served. And so you have that opportunity that becomes a a lower cost way to heat or to manage water.

So, you know, it's just the dynamic of having, you know, the natural growth plus that little bit as you get more adoption of natural gas to a home.

Speaker 10

Okay. Appreciate it. Thanks, guys.

Speaker 2

No problem. Well, I just wanna I think we're near the end. Or, operator, is there any more calls?

Speaker 0

We have no further questions.

Speaker 2

So I want to thank everybody for coming. Like I said, I felt we had a pretty good quarter. And I think that the growth was a highlight for Q4. And I think that we had decent performance as well from our manufacturing facilities even though we had some challenges from a cost side. So all in all, I feel pretty good about 2019, and I look forward to seeing you all again soon.

Thank you very much. Operator?

Speaker 0

Thank you. With that, we'll conclude today's conference. You may disconnect your lines at this time.