MUELLER WATER PRODUCTS

Welcome and thank you for standing by. Your lines have been placed on a listen-only mode until the question and answer session. At that time, if you would like to ask a question, you may press star 1. Today's conference is being recorded. If you have any objections, you may disconnect at this time. And now I'll turn the call over to Whit Kincaid.

Good morning, everyone. Thank you for joining us on Mueller Water Products' second quarter 2021 conference call. We issued our press release reporting results of operations for the quarter ended March 31, 2021, yesterday afternoon. A copy of the press release is available on our website, MuellerWaterProducts.com. Scott Hall, our President and CEO, and Marty Zakas, our CFO, will be discussing our second quarter results, market conditions, and our updated outlook for fiscal 2021. This morning's call was 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. At this time, please refer to slide 2. 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 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 3 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 2 and 3 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 30th. A replay of this morning's call will be available for 30 days at 1-800-839-1190. 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.

Thanks, Whit. Thank you for joining us today. I hope everyone listening to our call continues to stay safe and healthy, and you are able to be vaccinated as we see the light at the end of the tunnel and emerge from the pandemic. Before turning the call over to Marty to discuss our second quarter results, I'll provide a brief overview of the quarter. We delivered a solid second quarter performance, resulting from our team members' focus on satisfying increasing demand despite continuing and new challenges from COVID-19 And inflation, especially material costs. Consolidated net sales exceeded our expectations as we reported a 3.8% increase in the quarter. Both infrastructure and technologies increased sales in the quarter. We increased net sales 1.5%, excluding the $6 million benefit from the elimination of Krause Industries' one month reporting lag. Net sales sequentially improved 12.7% versus the first quarter and compares with a 10.1% increase in net sales in the second quarter of last year. As a reminder, customers placed orders ahead of our effective date for price increases and as a result, shipments were particularly strong last year. We believe our end markets improved during the quarter as municipal spending continues to recover from the pandemic and residential construction continues to see strong demand for single-family homes. Similar to last quarter, are still experiencing a slowdown resulting from the pandemic. I remain impressed with our team members as they continue to do an outstanding job serving our customers. We experienced accelerating raw material inflation during the quarter, leading us to implement additional price increases during the quarter for the majority of our products, which will help margins as we move forward. Despite this near-term inflation headwind, Higher sales and improved manufacturing performance in the quarter led to a 50 basis point improvement in gross margin excluding the inventory write-down associated with the recently announced restructuring plans. I will address these actions later in the call. We generated $50.7 million in adjusted EBITDA in the quarter with a 19.4% adjusted EBITDA margin. Benefits from favorable manufacturing performance and higher pricing partially offset Accelerating Inflation and the Anticipated Increases in SG&A Expenses. I am very pleased with our cash generation this quarter, leading to a $72.4 million increase in free cash flow through the first six months of the year. Our teams remain focused on executing initiatives to deliver pricing actions, improve efficiencies, and improve working capital. We ended the quarter with nearly $230 million in cash and our net debt leverage ratio remains at 1.1 times versus 1.6 times in the prior year. Despite the ongoing operational challenges from the pandemic and accelerating inflation, we believe that end market demand will support further growth this year. Based on our strong first half performance, as well as expectations for our end market sales backlog, pricing and inflation for the rest of the year, We are raising our annual guidance for both consolidated net sales and adjusted EBITDA growth for 2021 for the second consecutive quarter. Later in the call, I will provide more color on some of our key strategies and markets and expectations for the rest of this year. With that, I'll turn the call over to Marty to review our second quarter results.

Thanks, Scott, and good morning, everyone. I hope you and your families and associates are safe and healthy. I will start with our second quarter 2021 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 second quarter of this year, we generated consolidated net sales of $267.5 million, which increased $9.8 million, or 3.8%. The increase in net sales was driven by the $6 million benefit from eliminating the one-month reporting lag, higher pricing, and increased volumes at Technologies. The benefit of eliminating Krause's one-month reporting lag this quarter reflects net sales within infrastructure for the month of March. Note that March was a particularly strong month at Krause, benefiting from the repair needs after the challenging winter weather in February. Overall, Krause has performed very well since we acquired the business in December 2018. Gross profit this quarter was $88.4 million with a gross margin of 33%. Gross margin decreased 40 basis points versus the prior year. Excluding the $2.4 million inventory write-down associated with recently announced restructuring plans, gross margin increased 50 basis points. This increase was driven by benefits from favorable manufacturing performance, higher sales, and eliminating the one-month reporting lag, which were partially offset by higher costs associated with inflation and approximately $1.2 million of additional expenses related to the pandemic. Our total material costs increased approximately 10% year-over-year in the quarter, primarily driven by higher raw materials. Our price-cost relationship was negative this quarter given the rapidly rising inflation, particularly for raw materials. We expect additional price increases will help offset anticipated inflation in the second half of the year. Scott will provide more commentary on inflation and pricing later on. Selling, general, and administrative expenses of $54.2 million for the quarter increased $4.9 million versus the prior year. The increase was primarily due to higher personnel-related costs and an additional month of results due to the elimination of the reporting lag, which were partially offset by reduced expenses related to travel, trade shows, and events as a result of the pandemic. SG&A as a percent of net sales was 20.3% in the second quarter compared to 19.1% in the prior year. Operating income of $33.4 million decreased in the second quarter compared to $35.8 million in the prior year. Operating income this quarter includes the $2.4 million inventory write-down mentioned earlier, a $1.4 million benefit from eliminating the one-month reporting lag, and $800,000 of strategic reorganization and other charges. Turning now to our consolidated non-GAAP results. We generated $35.2 million of adjusted operating income compared to the prior year. Higher costs associated with inflation and higher SG&A expenses were partially offset by benefits from favorable manufacturing performance and higher sales. The estimated expense impact from the pandemic was a benefit of about $600,000 in the quarter. We reported adjusted EBITDA of $50.7 million as compared with $51.8 million in the prior year quarter with an adjusted EBITDA margin of 19.4%. For the last 12 months, adjusted EBITDA was $196.8 million, or 19.8% of net sales. For the quarter, our adjusted net income per share was $0.14, as compared with $0.15 in the prior year. Turning now to segment performance, starting with infrastructure. Infrastructure net sales of $246.9 million increased $7 million, or 2.9%, as compared with the prior year, primarily due to eliminating the one-month reporting lag and higher pricing. adjusted operating income of $52.9 million, increased $2.2 million, or 4.3% as compared with the prior year. The increase is primarily due to favorable manufacturing performance and higher pricing, partially offset by higher costs associated with inflation, primarily for raw materials. The estimated expense impact from the COVID-19 pandemic was a net benefit of $500,000 in the quarter, as $1.5 million of lower SG&A expenses attributed to reduced travel and trade show expense, were partially offset by $1 million of additional manufacturing expenses. Adjusted EBITDA of $65.6 million increased $2.8 million, or 4.5%, leading to an adjusted EBITDA margin of 27.2% and a conversion margin of over 200% in the quarter, excluding the net sales associated with the one-month reporting lag. Moving on to technologies. Technology's net sales of $20.6 million increased $2.8 million, or 15.7%, primarily due to increased volumes and higher pricing. Adjusted operating loss of $4.6 million was flat in the quarter as higher sales were offset by unfavorable manufacturing performance, higher SG&A expenses, and higher costs associated with inflation. The estimated expense impact from the pandemic was a net benefit of $100,000 in the quarter, This benefit resulted from $300,000 of estimated lower SG&A expenses, which were partially offset by additional manufacturing expenses in the quarter. Technologies adjusted EBITDA was essentially flat with a loss of $2.6 million as compared with a loss of $2.5 million in the prior year quarter. Moving on to cash flow. Net cash provided by operating activities for the six-month period improved $66.2 million to $63.2 million primarily driven by improvements in working capital management. Additionally, cash used in operating activities in the first quarter of the prior year included the $22 million Walter Energy tax payment. We invested $31.1 million in capital expenditures during the six-month period compared with $37.3 million in the prior year period. Free cash flow for the six-month period improved $72.4 million to $32.1 million compared with negative free cash flow of $40.3 million in the prior year period. This is a $50.4 million improvement excluding the Walter Energy tax payment in the prior year. At March 31, 2021, we had total debt outstanding of $447.6 million and total cash of $228.2 million. We did not have any borrowings under our ABL agreement at quarter end, nor did we borrow any amounts under our ABL during the quarter. At the end of the second quarter, our net debt leverage ratio improved to 1.1 times from 1.6 times at the end of the prior year quarter. As a reminder, we currently have no debt maturities before June 2026. Our 5.5% notes have no financial maintenance covenants, and our ABL agreement is not subject to any financial covenants unless we exceed the minimum availability thresholds. Based on March 31, 2021 data, We had approximately $154.4 million of excess availability under the ABL agreement, which brings our total liquidity to $382.6 million. We continue to focus on maintaining a strong balance sheet with ample liquidity, which supports our capital allocation priorities. Scott, back to you.

Thanks, Marty. I'll review some of our key strategies and markets and expectations for full year 2021. After that, we'll open the call up for questions. As Marty mentioned, raw material inflation accelerated during the second quarter, impacting our gross margins. Due to the magnitude of the inflationary increases, especially raw materials, and the lag between pricing actions and realization, we experienced an unfavorable price cost impact during the quarter. We have taken additional pricing actions beyond our initial price increases in December, which will help our price cost position in the second half of this year. Thank you for joining us. We expect to benefit from the multiple pricing actions after the cycle peaks. Our goal is to get price to more than cover inflationary pressures over the entire cycle, which we expect to continue into 2022. At the end of March, we announced additional restructuring plans to close two facilities in Aurora, Illinois and Surrey, British Columbia. Most of the activities from these plants will be consolidated into the new facility in Kimball, Tennessee. The Kimball facility, which focuses on specialty valves, includes operations from three previously announced plant closures. The facility is strategically located between our foundries in Chattanooga, Tennessee and Albertville, Alabama. We have already begun to implement this restructuring and expect to substantially complete it by the third quarter of fiscal 2022. These actions, in addition to our previously announced multi-year investment to modernize our manufacturing facilities, will help accelerate product development, drive additional operational efficiencies, reduce duplicative expenses, and aid us in advancing our environmental initiatives. As a reminder, the Kimbell facility is one of the three transformational projects we have previously discussed along with the New Brass Foundry in Decatur and the Large Casting Foundry in Chattanooga. Due to the pandemic's impact on the project-related portion of our valve business, we have reevaluated the timeline for the sales ramp-up of existing and new products. The new restructuring initiative will help us to achieve our overall gross margin expectations upon completion of the three large projects once they are at full run rate. In total, we continue to anticipate these three projects will contribute $30 million in cumulative gross profit benefiting from cost savings and increased sales after all are complete and at full run rate. Similar to our first quarter, our end markets improved during the quarter as municipal spending continues to recover from the pandemic and residential construction continues to see strong demand for single-family homes. For the first half of the year, we increased consolidated net sales 6.1%, excluding the one-month reporting lag, which compares to a 10.2% net sales increase in the first half of last year. While our distributors increased inventory levels during the first half of this year, resulting from both anticipated demand and the timing of pricing actions, We believe that overall end market growth is in the mid single digit range. This growth has been driven by the residential construction end market, which was again very strong in the quarter. Single family housing starts increased 20% in the quarter, leading to over a million starts over the last 12 months. While we believe that the residential construction end market will continue to experience strong growth this year, We do anticipate that the level of growth will start to moderate later this year as we lap the strong growth in the prior year and supply challenges push out new lot development. Our view on the municipal end market is similar to last quarter. We are seeing some delays in the project portion of the market, which we expect to continue to varying degrees. While an infrastructure bill mentioning water investments is a positive for our industry, We believe that it will take some time for the final bill to be approved and a number of years for the federal dollars to reach the municipalities. Additionally, since over 90% of water utility funding comes from state and local sources, we expect the pace of recovery for large CAPEX projects to move more slowly than the repair and maintenance portion of utility spending, which remains relatively resilient. Over the long term, we believe that any federal infrastructure funding efforts will help municipalities address their aging distribution networks at a faster pace, and importantly, help to highlight the need for investment in our aging infrastructure. Now moving on to our current expectations for 2021. As mentioned earlier, consolidated net sales growth in the second quarter exceeded our expectations. Demand remained strong throughout the second quarter, and we finished the quarter with an all-time high backlog. For the remainder of 2021, We continue to expect that strong growth in the residential construction end market will more than offset any temporary delays in the project-related portions of the municipal end market caused by the pandemic. Based on our expectations for our end markets, sales backlog, pricing, and inflation for the rest of the year, we now anticipate that consolidated net sales growth for 2021 will be in the 8 to 10 percent range, as compared to our previous guidance for net sales to increase between 4 and 6%. Our expectations for adjusted EBITDA growth for the year are now between 9 and 12% as compared to our previous guidance for adjusted EBITDA to increase between 5 and 8%. Finally, we continue to expect to generate healthy free cash flow for the rest of the year. In summary, 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. At the same time, we continue to execute our strategies to reinvest in our business, to drive efficiencies, advance our ESG goals, accelerate growth, and provide more technology-enabled products and services to increase the resiliency of the aging water infrastructure. We have now spent a full year operating in the midst of the pandemic. Our team members have stepped up in their role as essential workers meeting our customers' needs. They have adjusted to the new processes put in place to help ensure their safety and health. Our focus on working capital management and cash flow has yielded improvements, as we have increased our free cash flow in the last 12 months by about $98 million, excluding the Walter Energy tax payment. We are learning new ways of managing our business with more remote training and new product seminars for our customers. Importantly, we see the clear need for more digitally enabled products and services to allow for municipalities to manage their operations remotely as they plan for accelerating talent challenges with the expected retirements due to an aging workforce. We continue to successfully convert existing customers to our Centrix software platform, which will provide more opportunities for us to expand our technology portfolio with existing customers. During the second quarter, we completed smart hydrant pilots with two large water utilities and a third pilot is scheduled to be completed in early summer. Additionally, we're seeing smart hydrant order growth in our sales pipeline as water utilities begin to allow sales teams back into their facilities for in-person meetings. I am confident that we are well positioned to strengthen our leadership role in the water industry and benefit from the enhanced attention the water industry is receiving. With a strong balance sheet and cash generation supporting our strategies, we are well positioned to benefit all of our stakeholders by becoming a world-class manufacturing company and innovative industry leader bringing technology to our water infrastructure products and services. And with that, operator, please open this call for questions.

Thank you. We will now begin the question and answer session. If you would like to ask a question, please unmute your phones. Press star 1 and record your name clearly. To withdraw your question, you may press star 2. Again, press star 1 to ask a question. And one moment, please, for our first question. Our first question comes from Brian Lee with Goldman Sachs. Your line is open, sir. You may ask your question.

Hey, everyone. Good morning. Thanks for taking the questions. Just jumping into the guidance real quickly, Scott and Marty, can you quantify a bit how much is price and then how much is volume if you're thinking about the quantification of the increased growth outlook here for the year and then what are the specific assumptions around price and then separately price-cost spread that are embedded in the outlook?

Well, what's embedded versus what, you know, the guidance understands that there's a range of outcomes that could happen, you know, to do with later inflation. I don't think that the copper market or, frankly, the scrap steel market are going to remain flat, Brian. So, you know, we have a range of cause and effect, if you will. But what I will say about that is that, you know, we now have a backlog that, you know, is basically priced – about 60% prior to the February-March price increase, and we won't see the benefit of those price increases until about 45 days after they were effective. So we'll be through April's volume still at previous pricing, and as you know, we have a 60- to 90-day lag on average. What we don't do is we don't announce price increases on the investor call. But what I will say is that the market has been rational in the past. I expect that if the continued pressure in copper resulting in higher brass, if the continued pressure in scrap supply, pressure in pig iron, all of those raw materials continues, then I think that we should expect the market to react and that we'll have to recover those costs. But as to foods in the forecast specifically, we have a range of outcomes. I think if you were to say that no shocks in inflation are contemplated, but that some steady increases from here could be handled and we could still meet the guidance. That's basically how we think about it. What I'm most concerned about, though, is I can't remember where we are. I think we got as high as 460 in copper, but... No $5 copper is contemplated. How's that?

Understood. Okay, fair enough. And then just a follow-up question I had was around some of the commentary you made around conversion margins, Scott. That was helpful. But if we think about the bridge here, I think you're insinuating a 20% or so EBITDA conversion margin for 2021 based on the updated guidance. is the historical 35% to 40% long-term target still intact for that metric? And then is that something we could see exiting calendar 2021 given the pricing actions that are being contemplated and are going to be passed through here moving through the years at more of a 2022 event? Thank you.

Well, I think the only way we can answer that, Brian, is for you to look into the crystal ball and say what's going to happen with price costs through the last six months of the year. So to be clear, I believe in a stable market with stable commodity prices and stable material prices, no massive moves in the value of the U.S. dollar, as we've seen recently, that we are a 35% to 40% long-term flat conversion margin business. And we do that when you see flat and falling commodity prices. through a period like this where price cost is going to have this lag, depending on how long that lasts, I think you're accurate in the implied conversion margin. So that kind of 20% to 30% range as we play catch-up and we purge the backlog at the pre-price increase levels. I think the other thing that we have to watch is where we are, especially with those project-based businesses. I mean, we can live with some delays, but I don't want those delays stretching out into 9, 12, 14 months while we're in an inflationary period, and we'll have to take actions and have subsequent negotiations on those where we can. So I think you're right. In the near term, it's probably in that 20 to 30 range. Once we get back to stability in the price-cost world, I think we'll revert back to the 35 kind of number.

Okay, thank you. Appreciate it.

Thank you.

Thank you. Our next question comes from Ryan Connors with Benning in Scattergood. Your line is open, sir.

Great. Thanks for taking my question this morning. Scott, my question, I wanted to keep on this theme of the pricing for a second in the pass-through, and I think about the different types of sales that you make. It's easy for me to understand how a builder in this environment puts in that infrastructure and has no problem kind of embedding that into the cost of a million dollar house and that kind of sails right through. But then I think about the average municipal water utility kind of operates at break even, a lot less wiggle room to sort of accept price. So can you kind of talk about the different dynamics you're seeing in those different markets and sort of how you're faring in each of those and the outlook and risk in that context?

They're great and thanks for the opportunity to kind of delve into it a little bit, Ryan. So Ryan is absolutely right for everybody on the call that we have, you know, kind of multiple pricing structures. You have everything from supply agreements where prices are fixed for 12 months and then, you know, you have renegotiation periods and you can renew after 12 months or they'll go back to bid. Then we have the spot market, which is really where most of the contractor work is done. and so as a developer decides he's going to develop some lots, he'll get a bid. You'll probably have a 90-day window where the distributor will be holding prices to the contractor, which is why the distributors get a 30-day notice on when we're doing price increases for the spot market. And then you have, let's call it the structure of the water utilities where Where there is channel power, they can enter into supply agreements and kind of force a fixed price for a period of time. But then when there isn't channel power, so if it's, you know, if the math, you think about, Ryan knows this, that 50,000 water utilities out there, the distributors in ourselves certainly are not going to enter into supply agreements, you know, with a bottom 49,000 supply. Water Utilities are probably 49,500. So the vast majority of the market, the contractor market and the water utility market, operate in the spot market with supply agreements. And that's why you often hear us talk about Price Increase Amounts, and then we talk about yields, because obviously we can't just unilaterally increase prices at a LADWP or a New York City. We have to wait for the negotiating window to open. And so yields generally are in that 40% to 60%, with 50% being the most likely outcome of announced price increase. So yields end up being, if you have a 3% price increase yields will tend to be in that 1.4% to 1.7% range depending on what your mix of supply agreement to spot market is. Does that explain it?

It does. It's safe to say that I can paraphrase that it is a bit more of a there's more complexity and challenge in the municipal side than in say the developer side. Is that a fair statement?

Absolutely, because I think there's a lot of guessing as to what the volumes will be from which part of the water utility side is buying spot and which part is buying under a supply agreement. Yep, yep, okay. That's very helpful. And then my other one, you know, go ahead. One thing I want to make clear, though, is that when we have distributors that enter into supply agreements and we are not part of the agreement, We do not honor the supply agreement. That's the distributor's risk at that point.

Got it. Okay. Interesting. My other one is, you know, it seems like small potatoes, but it was material enough that you called it out in the press release, and Marty talked about it in her remarks, you know, travel and trade show events, you know, those expenses down. How do you see that new normal emerging there? Are the big industry events going to be as important as they used to be and those expenses will ramp back up? Or are we going to be in more of a virtual kind of world in terms of those events going forward or those events are smaller? To what extent does that stuff creep back versus maybe a structural change there?

I'm hopeful that they creep back because, frankly, I think that the interaction of multiple water utilities with each other at these trade shows, at these conferences, talking about what is possible, especially as we're trying to accelerate the digitization of the water utility industry, are critically important. I know you've been to a lot of them, GWI and others, and I think that the coming together of the minds to talk about what's possible and how applications and what different problems are is invaluable. And frankly, the richness in the virtual world, while it's been very, very good, it's not the same as the in-person meetings. And so I'm hopeful, especially as it relates to the digitization of the water industry, that the technology leadership kind of events get back to in-person. But I think that the number of travel days for sales calls or for some of the more routine things that we've learned how to effectively do will be reduced. So I think the snapback costs will be at a percentage of their historical level. I don't think we'll ever get back to exactly where we were, so a little bit lower. But I really do hope that the things like ACE and Waterworld and things like that do get back to in-person.

Yep, couldn't agree more. Hopefully they do, and look forward to seeing you there when they do. Thanks for your time today. Thank you, Ryan.

Thanks. Thank you. And this question comes from Dean Dre with RBC Capital Markets. Your line is open. You may ask your questions.

Thank you. Good morning, everyone. Good morning. Hey, just like to finish up the thought here on price cost. And I frankly learned a lot in Scott, your explanation about the mix. You know, it's not until you're in a situation like this where some of those nuances really do come through. So I appreciate the explanation. And when you reference the yield of the 40, 50 percent on the price increases, You said it really does depend on the mix. Is there any consideration of elasticity of demand? Do you have customers going elsewhere? Is that part of the idea that you get a lower yield because of competition? Any context or color there would be helpful.

Yeah, I think we've been fairly successful. It's drawing conclusions from past price increases where we've been the only person out there with a price increase and watch what happens with demand. And I feel like the stickiness of our product with utilities is really, really high. So I think that you really have to Thank you for joining us. Thank you for joining us. is actually growing, and we see shortages and increased prices for scrap and other things. But the other thing is a lot of these commodities are global commodities, and the value of the U.S. dollar has declined. And as a result, in U.S. dollars, there's been kind of this double whammy. One, real price inflation, and two, our dollar not going as far as it used to, causing kind of stack-on inflation. I think that customers understand that, and yes, I think there is a fair deal of price elasticity, but we believe that most of our customers have bought into the value proposition. There will always be an element of the market, Dean, that does everything on price. I think the bigger risk, and where it's not as elastic and the competitive situations are more keen, if you will, is on the project-based business. Big public bids, big projects with lots of scrutiny.

Sure, that's really helpful. All right, so separate question on that $30 million of gross margin benefit with the new plants. I get that there would be cost savings just because of the efficiencies of the new operations, but you are assuming some higher sales. Are these new products? That you would be, you know, some of the larger castings that you can do yourself. I recall that might be an issue, but just if you could flesh out maybe size what the new sales opportunity is with these plants.

Yeah, sure. I think the biggest driver of sales growth when you think about the 30 million dollars is When we finish the new Decatur plant, it will be more capable than the plant that we built in 1918. It will actually have a lot more melt capacity, have a lot faster changeover for materials. It will have a lot of Ability to expand the kinds and types of alloys that we melt. And as a result, we'll be able to enter new product areas as well. So there is, of course, more capacity in Kimball than, say, in Aurora. There is more capacity as a result of the large casting foundry. But the bulk of the sales increase comes from the new capability associated with the brass foundry. And I don't want everybody to get too focused on that. I mean, there is a piece that sails. But if you think about the elimination of, you know, Hammond, Indiana, Surrey, British Columbia, Aurora, Woodland, Washington, you know, five plant managers go to one, five controllers go to one. So it's really a lot of it is the reduction of the duplicative costs associated with running plants. Five relatively small facilities as opposed to putting those five facilities into a single operating structure, which Kimball can handle. That's where the bulk of the 30 million comes from.

That's helpful. And just last question from me, it'll be for Marty. Just some context of the Kraus, that elimination of the one-month lag. I don't know if it's shame on me for not knowing there was always a one-month lag, but how did that happen? Because, I mean, you acquired it back in 2018. Are there other components or businesses that are on a different calendar? Thanks.

Great. Thanks for the question, Dean. So you're exactly right. Going back to when we acquired Krause in December of 2018, we made the determination at that time, given the business, given that its headquarters and operations were in Israel, we made the determination from an accounting perspective to report it on a one-month reporting lag. and very pleased that after two years of our ownership that we were in a position to eliminate the lag at Krause and put it on the same reporting schedule as the rest of the company. Teams did a very good job just to get us up to that place. So really what that means is when we look at the quarter, second quarter of this year, we are reporting four months for Krause rather than the usual three that you would report. So we've got the months of December, January, February, and March that are reported in the second quarter of this year. And that's why, just from a transparency perspective, we wanted to make sure that we called out what the impact of that was. So, you know, in essence, this is going forward because, if you will, we were short a month after acquiring it, and we've added that month back in essence this quarter. So anyway, call that out and we should, it'll be, if you will, on a regular basis going forward.

And if I may, Dean, your emergency team has done a great job. The business was a sole proprietorship and not necessarily closing monthly, kind of more of a quarterly close. Time to close at the end of the month became limited. something that we evaluated and Marty rightly made the call to put it on the lag and her team has done a tremendous job to put the systems in place that they can close within our six, seven day time frame at the end of every month.

You know, I had forgotten that that was an Israeli company and so I fully appreciate the accounting challenges and getting that done. And just if I can sneak one other one in since we're on the topic, are there other Krauss-like deals out there because it seems like Fixing water main breaks is going to be a growth industry for a long, long time. And Krause has been such a home run there. So hopefully there's some other adjacencies for you. Thanks.

Yeah, no, look, I absolutely agree. Just to spend a moment commenting on Kraus, you know, if you go back to the strategic rationale that we laid out for Kraus, I think, you know, very pleased with the performance that we've seen over the last couple of years, you know, from a manufacturing, from a customer, and importantly, from a, you know, expanding our product line. We saw it as a great opportunity, and I think, you know, even despite pandemic and other things, we've been very pleased with the performance that we've seen out of Kraus. It's grown nicely, probably, you know, on average, just about 10% on a compound growth rate. So, you know, I would say comparable acquisitions for Kraus would be great going forward. You know, it's just the kind of thing that we would... And Scott, are there other Krauses out there?

Yeah, I think that, you know, there are other people involved in repair. I think there's materials going on saying, you know, how do you Thank you Thank you

Thank you. And as a reminder, if you'd like to ask a question, press star one. Our next question comes from Joseph Giordano with Cowan. You may ask your question.

Hey, good morning, guys. This is Francisco on for Joe. I wanted to ask about what you guys are seeing on the muni spending side. Maybe talk a little bit about where you see the budgets going, both in terms of CAPEX and OPEX.

Yes, so I'd like to start by saying I think that budgets, you know, are one thing, but anybody who's been listening to me for a while knows that I believe that what we'll call the planned budgets are going to continue to get squeezed at water municipalities. I think that, you know, there is a fixed amount of money, and as we've seen the break-fix part of You saw it in Tulsa with the freeze. We saw it in Texas when they had the weather in February that more and more of the budget is going to have to go to kind of fixing what breaks because the frequency of breaks continues to increase. And so I think that the water utilities, if they want to increase or do their planned capex, Their emergency spending budgets are going to have to increase or they're going to have to be willing to live with going over budget. I think that the federal stimulus could help them with some of their big capex so that they can devote some more of their, let's call it operating budget, to break-fix. But, you know, I still think in front of us, the same thing I've been saying for the is that budgets by necessity will have to increase. I think we'll have some timing bumps over the next five to ten year horizon. But water, water infrastructure, wastewater, wastewater infrastructure, stormwater and stormwater management and retention of stormwater all are going to face, you know, Thank you. That's helpful.

As a follow-up, in terms of the technology segment, it's nice to see the increase in sales. Can you maybe talk about longer term where you see it going and when it turns to profitability?

Yeah, I've kind of gotten out of the crystal ballgame with that. I think that we've seen operational improvements at the plants. I think this is This quarter we saw sales growth. It didn't translate into EBITDA. I think a lot of that had to do with other market conditions where we spent money to retain and to gain customers. But notwithstanding that, I expect the business to continue to improve its operating margins as a result of manufacturing and pricing actions in the meter business. Take the meter business and put it to the sides in technologies. I expect the ecologics business, the smart hydrant business, the hydroguard business, the sampling station business. I'm looking for those businesses to start to fuel the growth of technologies because all of those new products, everything that we have introduced over the last three years in electronic enablement, Thank you for joining us. Will it be enough to get the whole segment profitable? We shall see. But I am, you know, I'm continuously encouraged by the progress the sales team is making with introducing these new products to our customers. And I think, you know, reminder to everybody, all of our Ecologics customers are now looking at acoustics on Centrix. All of our customers... that are on Centrix. We have data analysis services that are being done in Toronto. And so we'd like to see more and more of that happen as we put more sensors in the market. And I believe that the long-term annuity, if you will, for the data services after that will continue to grow. Thanks. Thank you.

Thank you. And our last question comes from Walter Liptack. Your line is open to me after your question.

Hi, thanks. Thanks for taking my question.

I wanted to ask one about the two, the factory relocations. And I wondered about some of the timing of the move and the cost related to that. How are we going to see that show up in the financials?

Well, I think that most of the activities from the two facilities we just named, Aurora and Surrey, that are going into Kimball, they were not part of the original plan announced at the end of 2019 when we acquired the facility. But as you know, we're constantly evaluating our footprint and we will always communicate any actions we take to our employees first prior to sharing it with the public. But the biggest change in the operating landscape has been the pandemic. And I think the pandemic's impact on the project-related portion of the business, you know, reevaluated some of the timelines for the sales ramp-up of existing products and some of the new products as well. And in order to stay on track with our financial targets, we elected to close those two facilities. Now, how is it going to work, you know, financially? Let me say that both those projects paybacks are just like the others, you know, kind of sub four years, three years in that range. But it is kind of improving the $30 million as we adjusted our, let's call it jumping off point for sales for the others. Incrementally, though, we are not changing our CAPEX outlooks as we have explained in the past. And so you'll see that we found the CAPEX for these two closures Basically, by removing the CapEx, those plants would have probably spent in the future anyway. And so I see it as being CapEx guidance neutral and basically gross margin improvement neutral.

Yeah, and Walt, maybe just to expand on the other piece, you know, we've estimated that, you know, could be total expenses running around $14 million. I think, as you saw, we called out this quarter $14 specifically $2.4 million that was an inventory write-down that was part of our cost of sales within infrastructure. Additionally, we had some other expenses that we called out in our restructuring and other charges line. And I would say going forward, as we said, we expect that to be complete by our third quarter of fiscal 2022. As we look at the other costs going forward, which will be termination benefits and some decommissioning costs, moving costs, et cetera, I think by and large you will see those flow through other restructuring charges, but we'll generally try to ensure that you're understanding the financial statements going forward as well.

Okay. Are you building any inventory or kind of trying to protect against – Any kind of disruptions related to these MOOCs, or are they small enough where we shouldn't get any of that?

No, I think it's fair to say there will be, you know, in a midterm kind of inventory build. Anybody who's done this knows that while you do your double breasting and The new plant is coming up, running its PPAPs. The old plant is continuing to look after customers, that when you go to that final shutdown period, that inventory will be somewhat higher as you protect the new plant's processes to get up the learning curve. And I think anybody who's gone through multiple plant consolidations, sounds like you have, Walt, probably... know that we'll have a slight increase in inventory for a 90- or 120-day period as you live through the learning curve.

Okay. All right. Great. And then I enjoyed the discussion of the different pricing structures, too. And one of the questions I had, though, is with the distributors, what percentage of your sales flows through your distribution channel partners? Yes.

I think the number to use there in general is around kind of a 60-40 number. I think in our queue we say exactly what our split is, but my recollection is in that 60-40 kind of range.

Yeah, in our queue what we do is we call out our net sales to our largest distributors. Right.

But please understand on this pricing thing, just to be clarifying then, is there are some distribution sales that are fixed price. So we lock hands with a Core and Main or we lock hands with a Ferguson. For instance, in the meter contract, we have an agreement with Newport News, with Ferguson. It's a three-way agreement where the pricing structures are agreed to. and what the negotiating windows are, what the max increases can be, those kinds of things. So not all distribution sales are spot sales and I don't want anybody to get confused about that. Sorry. Okay. All right, great. Thank you. Well, thank you. Thank you, operator. Look, I'm really very happy with our second quarter results. As I guided in the past, I expected this to be our toughest quarter due to the strong comp from a previous year and frankly due to the fact that a year ago on this call was the call where we took away guidance and we had kind of rolled back some of our accruals because the uncertainty was tremendous. And here we are a year later into the pandemic. I think the team at the plants has done a great job satisfying the strong demand. I think that the housing market has been a pleasant surprise. I think that the thesis that we had as an investment that, you know, continue to focus on this break-fix part of Muni has been rewarded as, you know, I think when you look around water, people like ourselves and Certainly some of the pipe guys and others have done very, very well through the pandemic. And when you consider that, you know, we're kind of first two quarters of this year, kind of post pandemic compared to the first two quarters of last year, which were virtually all pre pandemic. To post up 6% growth, I feel like the team has done a great job. And it would be even higher if the backlog hadn't grown in the first half. And so I'm very bullish. And that's why we basically take our guidance from 4 to 6 to 8 to 10. And I think that we've seen good resiliency among our customers, among our customers. Our distribution partners, and I think that in general we're starting to see a fairly much more bullish environment as we go forward. Reflecting on the past 12 months, I think we're clearly in a different frame of mind than we were last May, and I think we're approaching the next 12 months in a great position. with a lot more confidence to get through the external challenges and continue to focus on executing our key strategies. I think the engineering team going to remote work when you do the project reviews to see where they are in product development, you remain impressed with the resiliency of that team to continue to collaborate, to use all these new virtual tools, and to keep schedules on track, to keep budgets on track. And so I'm encouraged by that. and I think just in finishing with a strong balance sheet, our healthy cash generation, we're really well positioned to benefit all of our stakeholders on our path to becoming a world-class manufacturing company and an innovative industry leader, bringing technology to water and continuing down the path that we set two years ago. So I thank you for your continued interest in our company and I look forward to talking about next quarter with you in 90 days or so. So with that operator, we'll close the call.

Thank you. This does conclude today's conference. At this time, you may disconnect your lines.