Mueller Water Products (MWA) Reports 2022 First Quarter Results - Transcript Summary

Whit Kincaid: Good morning, everyone. Thank you for joining us on Mueller Water Products First Quarter 2022 Conference Call. We issued our press release reporting results of operations for the quarter ended December 31, 2021, yesterday afternoon. A copy of the press release is available on our website, muellerwaterproducts.com.

 

Scott Hall, our President and CEO; and Martie Zakas. our CFO, will be discussing our first quarter results, market conditions and our current outlook for 2022. 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 and to address forward-looking statements and our non-GAAP disclosure requirements.

 

As a reminder, we have changed our management structure and segment reporting effective October 1^st, 2021. We filed an 8-K in January, where we provided the recast of historical quarterly results for 2020 and 2021. This is our first quarter reporting our new segments, Water Flow Solutions and Water Management Solutions.

 

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. It discloses the reasons why we believe that these measures provide useful information for 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 the 30th of September. A replay of this morning's call will be available for 30 days at 1-866-431-2903. The Archived webcast and corresponding slides will be available for at least 90 days in the Investor Relations section of our website.

 

I'll now turn the call over to Scott.

 

Scott Hall: Thanks Whit. Thank you for joining us today. I hope everyone listening to our call continues to stay safe and healthy. I am very encouraged by the start to our year as our team members delivered strong net sales growth in the quarter, while continuing to face challenges from an extraordinarily difficult operating environment.

 

Net sales growth for both segments benefited from increased volumes and higher pricing across most of our product lines. With healthy demand levels in our primary end markets, we again experienced strong orders in the quarter leading to record backlog at the end of the quarter. We remain focused on serving customers in the face of the continuing operational challenges from higher inflation, labor availability and supply chain disruptions. Despite these obstacles that have increased costs, adjusted EBITDA increased 6.3% in the quarter. The anticipated margin compression this quarter primarily resulted from the lag between the timing of inflation and our price realization. Due to the ongoing inflationary pressures, we again increased prices across the majority of our products during the first quarter, which along with the pricing actions we took in 2021, we believe will help improve margins. We have a strong balance sheet and cash position, finishing the quarter with over $200 million in cash outstanding and net debt leverage of 1.2 times.

 

During the quarter, we generated positive free cash flow and repurchased $20 million of common stock. Most importantly, based on our solid first quarter performance, we are raising our annual guidance for both, consolidated net sales and adjusted EBITDA growth. While we expect challenges associated with higher inflation, supply chain disruptions and labor availability to continue in 2022, we are confident that we can make progress on our operational initiatives to deliver enhanced results.

 

With that, I'll turn the call over to, Martie, to discuss our first quarter results.

 

Martie Zakas: Thanks, Scott. Good morning, everyone. I will start with our first quarter 2022 consolidated GAAP and non-GAAP financial results. Then review our segment performance and finish with a discussion of our cash flow and liquidity.

 

During the first quarter of this year, we generated consolidated net sales of $272.3 million, which increased $34.9 million or 14.7%, compared with the first quarter of last year. We increased net sales in both segments, Water Flow Solutions and Water Management Solutions. Both segments benefited from higher pricing and increased volumes as we continue to ship against record backlogs.

 

Gross profit, this quarter increased $9.2 million, or 11.7% to $87.6 million compared with the prior year, yielding a gross margin of 32.2%. While gross margin decreased 80 basis points compared with the prior year, it increased 300 basis points, sequentially. The benefits of higher pricing and increased volumes were more than offset by continued higher inflation and unfavorable manufacturing performance associated with labor challenges, supply chain disruptions and our plant restructurings.

 

Our total material costs this quarter increased 21% year-over-year, primarily driven by higher raw material costs, which also increased, sequentially. As a result of the lag between the realization of our price increases and inflation, our price cost relationship was negative for the fourth consecutive quarter as expected.

 

Selling, general and administrative expenses of $56.3 million in the quarter increased $7.1 million compared with the prior year. The increase was primarily result of investments in new product development, the addition of i2O Water, IT related activities, personnel related costs, general inflation and higher T&E from increased activity relative to the temporary savings last year due to the pandemic. SG&A as a percent of net sales was 20.7% in the quarter and in the prior year.

 

Operating income of $28.9 million increased $1.1 million, or 4% in the quarter, compared with $27.8 million in the prior year. Operating income includes strategic reorganization and other charges of $2.4 million in the quarter, which primarily relate to our previously announced plant restructurings and the Albertville tragedy.

 

Turning now to our consolidated non-GAAP results, adjusted operating income of $31.3 million increased $2.1 million, or 7.2%, compared with $29.2 million in the prior year. Higher pricing and increased volumes more than offset higher costs associated with inflation and higher SG&A expenses. Adjusted EBITDA of $47.5 million increased $2.8 million or 6.3%. Our adjusted EBITDA margin was 17.4%, which is 140 basis points lower than the prior year, yielding an 8% conversion margin. For the last 12 months, adjusted EBITDA was $206.4 million, or 18.1% of net sales.

 

Net interest expense for the quarter declined to $4.3 million, compared with $6.1 million in the prior year. The decrease in the quarter primarily resulted from the refinancing of our 5.5% Senior Notes with 4% Senior Notes. The effective tax rate this quarter was 24.2% compared with 25.8% last year. For the quarter, we increased adjusted net income per share 18.2% to $0.13, compared with $0.11 in the prior year.

 

Turning now to segment performance starting with Water Flow Solutions, which consists of iron gate valves, specialty valves and service brass products. Net sales of $154.9 million increased $26.1 million, or 20.3% compared with the prior year, primarily due to increased volumes and higher pricing. Iron gate valves and service brass products experienced double-digit net sales growth compared to the prior year. Specialty valve shipments were impacted by the ongoing facility consolidation in addition to supply chain challenges, primarily related to extended lead times. Adjusted operating income of $31.3 million increased $8.1 million, or 34.9% in the quarter, as higher pricing, increased volumes and favorable manufacturing performance were partially offset by higher costs associated with inflation and higher SG&A expenses. Adjusted EBITDA of $38.7 million increased $8.1 million, or 26.5%, leading to an adjusted EBITDA margin of 25% compared with 23.8% last year.

 

Moving on to Water Management Solutions, which consists of fire hydrants repair and installation, natural gas, metering, leak detection, pressure control and software products. Net sales of $117.4 million increased $8.8 million or 8.1% compared with the prior year, primarily due to increased volumes and higher pricing. Fire hydrants and repair and installation products experienced double-digit net sales growth compared to the prior year.

 

Sales of meter and control valve products were constrained by a variety of headwinds. including shortages of electronic components, extended lead times and production challenges. Adjusted operating income of $11.5 million decreased $5.5 million in the quarter, as higher pricing and increased volumes were more than offset by higher costs associated with inflation, higher SG&A expenses and unfavorable manufacturing performance. Adjusted EBITDA decreased $5 million to $19.2 million in the quarter, leading to an adjusted EBITDA margin of 16.4% compared with 22.3% last year.

 

Moving on to cash flow. Net cash provided by operating activities for the first quarter decreased to $19.8 million, compared with $34.1 million in the prior year. The decrease was primarily driven by higher inventories, which increased 13.5% in the first quarter. Average net working capital using the five-point method as a percent of latest 12 month’s net sales, improved to 25.4% compared with 28.8% in the first quarter of last year. We invested $11 million in capital expenditures during the first quarter, compared with $15.6 million spent in the prior year. Free cash flow for the quarter was $8.8 million, compared with $18.5 million in the prior year.

 

During the quarter, we repurchased $20 million of common stock in the open market. And as of the end of the quarter, we had $115 million remaining under our stock repurchase authorization. At December 31, 2021, we had total debt outstanding of $446.9 million and total cash of $207.3 million. At the end of the first quarter, our net debt leverage ratio was 1.2 times. We did not have any borrowings under our ABL Agreement at the end of the quarter, nor did we borrow any amounts under our ABL during the quarter. As a reminder, we currently have no debt maturities before June 2029. Our 4% Senior 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. Based on December 31^st, 2021 data, we had approximately $133.8 million of excess availability under the ABL Agreement, which brings our total liquidity to $341.1 million. We continue to have a strong flexible balance sheet with ample liquidity and capacity to support our capital allocation priorities.

 

Scott, back to you.

 

Scott Hall: Thanks, Martie. I will touch on our first quarter performance, ESG, end markets and updated full year 2022 guidance. After that, we'll open the call up for questions. We sequentially improved our gross margins in the first quarter compared with the fourth quarter of last year. This improvement was primarily driven by one-time items experienced in the fourth quarter, as our margins were impacted by many of the same challenges we discussed last quarter.

 

Due to continuing higher inflation, labor availability and supply chain disruptions, gross margin was lower compared with the prior year quarter. Although raw material inflation for brass and scrap steel appears to be stabilizing, overall material inflation increased again, sequentially, in the quarter, partly due to the ongoing challenges with the supply chain disruptions. In order to meet customer demand, our supply chain team has focused on acquiring parts from alternative suppliers where needed, and in some cases using alternative parts or materials to help ensure availability for production. These decisions to acquire inputs to maintain production led to significantly higher input costs for certain components. Additionally, labor availability at the plants continues to be a significant challenge, especially in the southeastern part of the United States. Absenteeism remains elevated at many of our plants due to the ongoing impact of COVID-19, in addition to hiring challenges.

 

To address labor availability, our manufacturing teams are offering enhanced benefits and incentives. Finally, similar to last quarter, we continue to experience higher freight and energy costs, which impact our foundries. As noted earlier, our price-cost relationship was negative in the first quarter and has been negative for four consecutive quarters. To help address the ongoing inflationary pressures, we again increased prices across the majority of our products during the first quarter of this year. Record backlogs are extending the timing for the price realization benefits. So, much of our most recent price increases will not benefit us until the fourth quarter of this year. However, multiple price increases from last year should drive sequential improvements in price realization in 2022.

 

As a result, we expect price realizations to improve, sequentially, in the second quarter, resulting in nearly a flat price-cost impact. We anticipate the price-cost will be positive in both, the second half of the year and for the full year, which will help improve margins. With this outlook, we are also assuming that raw material costs and other inflationary pressures do not continue to worsen. As a result of the timing and magnitude of the inflationary cycle starting in early 2021, as well as record backlog, we do not expect price-cost to be breakeven over the inflationary cycle until 2023. However, as a reminder, over the entire inflationary cycle, our goal is to have price increases more than cover inflationary expenses, and preserve margin.

 

I'll now turn to ESG. In January of this year, we released our second ESG report, highlighting our strategy, initiatives, annual performance, targets and goals. Our long-term environmental goals for waste disposal and greenhouse gas emissions are aligned with our business strategies to create a safer and more sustainable environment. We are very excited about our new brass foundry, which is scheduled for completion in 2023. The new foundry will enable us to pour a new lead-free brass alloy, which is a noteworthy advancement in sustainability for our customers and end users. As we strive to become a sustainability leader in our industry, we are committed to delivering smart products that are safer for the environment and more efficient for our customers, while also minimizing our water and energy footprints.

 

Turning to our end markets. Overall, in our first quarter, we continued to experience healthy order activity relating to both, municipal repair and replacement and new residential construction end markets. We believe distributor inventory levels have increased due to higher inflation, anticipated end market demand and extended project delivery timelines due to the supply chain constraints and labor availability. For the new residential construction end market, inflation and supply chain disruptions are extending builder timelines. However, builder confidence remains high due to low inventories and buyer demand. For the municipal end market, repair and replacement activity is extremely healthy. However, we continue to see some municipal project delays related to the pandemic or supply chain constraints. Most importantly, we are not seeing any cancellations. Our customers are providing feedback about the new federal infrastructure bill and its impact on their plans. We continue to be excited about the long-term positive impact that we believe the bill will have on the aging water infrastructure in the US. As a reminder, we have not included any benefits from the bill in our assumption for 2022 guidance.

 

I will now discuss our current expectations for 2022. Based on our solid first quarter performance, we're raising our annual guidance for both, consolidated net sales and adjusted EBITDA growth for fiscal 2022. We believe that our current backlog, pricing actions and strength of our end markets together support our growth and expectations. We anticipate the consolidated net sales and adjusted EBITDA will both increase between 6% and 10% for the year. This outlook assumes the following: price realization continues to improve, sequentially, we achieve nearly a flat price-cost impact in the second quarter, price-cost is positive, both in the second half of the year and for the full year. And, finally, raw material costs and other inflationary pressures do not continue to worsen.

 

We had had a solid start to the year for free cash flow generation. While our annual guidance for capital expenditures points to an increase in quarterly spending for the rest of the year, we expect to generate positive free cash flow for the full year. In conclusion, we remain focused on executing our strategic initiatives to grow and enhance our business. These initiatives include accelerating new product development, driving operational excellence, executing key capital projects, developing and expanding our Sentryx software sensing and control platform and implementing sales and channel strategies.

 

We are excited about our new management structure and reporting segments. We believe they will help promote the execution of our strategic initiatives and position us for improved long-term growth and increased margins, while helping to accelerate the commercialization of our technology-enabled products and software platform. Our commitment to advancing our ESG goals will remain at the forefront of how we operate our business as we strive to positively impact our world.

 

Finally, we will continue to take a balanced approach to our cash allocation strategies, focusing on reinvesting in our business, accelerating growth through acquisitions and returning cash to shareholders through our quarterly dividends and share repurchases. We are confident that our growth strategies, capital investments and operational initiatives will enable us to drive sales and adjusted EBITDA growth.

 

And with that, operator, please open this call for questions.

 

Q&A

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