MUELLER WATER PRODUCTS

Welcome and thank you for standing by. At this time, all participants are in listen-only mode. During the Q&A session, if you'd like to ask a question, you may press star 1 on your phone. Today's call is being recorded. If you have any objections, you may disconnect at this time. Now I turn the call over to Whit Kincaid, Vice President of Investor Relations and Corporate Development.

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 31st, 2021, yesterday afternoon. A copy of the press release is available on our website, MuellerWaterProducts.com. Scott Hall, our President and CEO, and Marty Zakis, 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, 2021. We filed an 8 in January where we provided the recast of historical quarterly results for 2020 and 2021. This is our first quarter reporting our news segments with 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.

Thanks, Witt. 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 of 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 in 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 Marty to discuss our first quarter results.

Thanks, Scott, and 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 shift 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 cost 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 a 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 13 cents compared with 11 cents 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 the percent of latest 12-month 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 markets And as of the end of the quarter, we had $115 million remaining under our stock repurchase authorization. At December 31st, 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 31st, 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.

Thanks, Marty. I will touch on our first quarter performance, ESG, and markets in 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 realization to improve sequentially in the second quarter, resulting in nearly a flat price-cost impact. We anticipate that price costs 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 costs 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 the 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 markets, 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 U.S. 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 are 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 have 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 Centrek 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 dividend 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.

The phone lines are now open for questions. If you would like to ask a question over the phone, please press star 1 and record your name. If you'd like to withdraw your question, press star 2. The first question in the queue is from Dean Dray with RBC Capital Markets. Your line is now open.

Thank you. Good morning, everyone.

Good morning.

Good morning. I really like the new segment reporting. It's intuitive. And thank you, Whit, for getting all of the restatements, too, because that was a big help. Although I'll just go on record saying I will miss having technologies as a separate segment. We still like what that business was, these technologies. important startup technologies in smart water. So I know you still have those businesses, but I do like the new segment reporting.

Thank you.

All right.

It is one of those things.

Yes. Let's start with the top line and demand, you know, significantly in water flow better than we were expecting. Was there any kind of budget flush that you benefit from? And then also on the utilities, we had heard some grumblings that utilities, given the infrastructure bill, were going to be a bit hesitant about what they were going to be spending in terms of projects until they got better line of sight, whether the government was going to be handing them a check. So has there been any delays that you've seen in project spending along those lines and just kind of what's driving this nice upside demand this quarter?

Yeah, I think that, you know, the demand profile, I think the munis are relatively flush with cash right now as a result of CARES Act, never mind the infrastructure bill. I do think that in these early days there will be a pause on job lets by municipalities and municipal water as a result of the – Bill being passed, you'll remember back in the American Reinvestment and Recovery Act, we basically saw a stall then. And when we first had the new administration in 2017 take over, they talked about infrastructure, and I think that paused the market as well. Because I do think people want to understand how they make their projects qualify for some of this spending. I also think that the longer-term view, though, from the infrastructure bill should be a cause for people to be excited about the long-term positive impact. When you think about aging infrastructure and you think about, you know, what elements have been allowed in this thing, in particular, the reauthorization for the existing infrastructure budgets that add $550 billion to new federal spending over the next five years. And so, all in all, I think those things are good. But to get back to your original question, Dean, I think in the short term, the pricing activities we've taken, the resilience in the new construction, new home market, and the fact that munis have relatively flush coffers still from the July money that was injected as a result of the CARES Act make us confident that the second half of the year won't feel too much, too bumpy as a result of people not having jobs qualify for for federal infrastructure dollars. Our orders in the quarter were greater than our shipments, so we grew backlogged again in the quarter.

Good. Well, I'd rather have you be in a position of trying to explain stronger demand than otherwise, so that's good. And then second question on price-cost, you gave really good specifics on the raw material increase sequentially. but not a lot of specifics on pricing. Just, you know, what was price realization in the quarter? What are you baking in for the year?

It's a tough question because the announced increases versus who's booking, you know, is it mostly distribution? You know, retrospectively, you know, I think between 5% and 7% I think is what the first quarter looked like in realization. And as you know, we've taken a series of price increases over the past 15 months. And some of those orders, depending on the timing of them, they get compared to a reference period of the quarter from the previous year. So sometimes it's unknown what you're going to realize in your comp to comp, if you will, from what's in the backlog versus what you shipped. So the way we're thinking about it is that we've got a fairly good handle on what brass, steel, and components look like in our Q2. We know what the near-term load is from our Q2 shipments. And so, you know, that's why we're saying that we need this to be around break even. We need to get a lot of these older orders that are in our backlog at lower prices purged through the system. So to answer the question, you know, directly, I think for the first quarter, it was between 5%, 6%, something like that, realized I would expect that to improve a couple of hundred basis points or so in the second quarter. But ultimately, by the time we get to 2023, you know, I'll say to all investors, I think we, you know, if you've followed the previous comments, we have about $20 million that we have to go get in price to get the $20 million price to go get back to kind of break even before we offset the dilution effect as a result of, you know, the quarters that were negative price costs in 2021.

All right, that's really helpful. Just a last one is a clarification. And it sounds as though you cannot reprice backlog. Wouldn't there be some escalators, you know, tied to CPI, something like that, that would give you some flexibility or you just stuck with the terms of the original order?

So that's kind of two different answers to that one. So things like our AMI orders, Things like our multi-year supply for projects that have long tails on them, yes, those have price escalators in them and indexes that allow us to go back into these windows and reprice the jobs based on indexes that we've agreed to with customers. The problem we have is the majority of our backlog is in the short cycle business. It's in the distributor-ordered business, and that is not being repriced. and you know i remind everybody that you know it's been our experience that yes through the inflationary cycle this is um this is a little bit painful um but on the other side of it once you see stabilization or you start to see um you know raw materials and components start to fall back from their from their peaks generally that becomes you know margin increases for us and our conversions go up as we're not giving that price back you know our price increase philosophy for the past 30 or so years has been to be measured to put it through and and not to retreat from price increase levels now obviously if something shocked the system there there could be a difference but but we anticipate all the price we've put through in these past price increases including the ones that we did in the fourth quarter that we will we will be benefactors if you will once the once the inflationary cycle is brought back under control.

That's real helpful. Thank you.

Thank you, Dean.

Next question is from Brian Blair with Oppenheimer. Your line is now open.

Thanks. Good morning, everyone. Good morning, Brian. I was hoping you could offer a little more insight into specialty valve operating trends. Obviously, some challenges there. Last quarter, I suspect, extended into this quarter. Has there been a catch-up on shipments? How did productivity metrics on the impact of temporary costs compare to Q4? And how should we think about those variables over Q2, Q3?

Okay, great question. Thanks, Brian. Yeah, I think the way people should think about it is, yes, we've had some marginal improvement. We've had, you know, an uptick probably in the 5% to 7% range in productivity from the labor that's there. We're getting more throughput than we had in the fourth quarter. But the headwind that we saw in Q4 when we inundated the plant with volume and we were still trying to close the Aurora plant, your rural plant is still open. And so, basically, you've got those double costs in our Q1 results, and that will continue into our Q2 results. And so, as I said in our fourth quarter call, you know, we got the one-timers out of the way. We had some sequential operating improvement in specialty. But, you know, the headwinds of the $5 or $6 million that we outlined in Q4, you know, four or so of that is still around. And that will get better over time as we reduce headcount and reduce reliance on our facility.

Appreciate the color. And in terms of the infrastructure bill, we know that's not factored into your fiscal 22 outlook, but you mentioned customer feedback on the potential of or likely lift in terms of their spending plans. If we look to year fiscal 23 and beyond, how's your team thinking about what that will mean for Mueller's business and in which of your individual businesses should we expect the most meaningful catalyst?

I think it's going to be broad-based. I mean, if you look at it, $12 billion each for drinking water, clean water, state revolvers, $15 billion for the lead line replacement. $10 billion for the modernization, underserved or lower income communities, better access. It doesn't matter whether you're making a fire hydrant or you're making a gate valve or you're making something smart. I think there's $6 billion set aside for smart water initiatives. So I think the whole... the whole thing is going to be good, but obviously the greatest need is going to come in the distribution network underground. And so I believe that the water flow solutions business, when you look at the size of dollars and size of needs, even though technology starts from a smaller number and you think about our smart hydrants and you think about things like flushing technologies and all of that. They will get benefit from this. But yeah, I think that the power alley of the business in the distribution network will be the biggest benefactor over the next eight years, that more dollars will funnel into it in aggregate because of the nature of the breakdown of the quality of the infrastructure. I mean, there's no amount of technology that's going to get us away from needing pipes and valves and reroutes of infrastructure that is aging at that 70, 75-year mark.

That all makes sense. And then circling back on your recast segment structure, the rationale and the shift in external reporting certainly makes sense. Internally, what changes have been made in terms of leadership or operating structure and how have those changes impacted the day-to-day of Mueller so far and what's expected going forward?

Great. Thanks. Look, I think that the team did a really good job before the reorganization trying to put on their big Mueller water products hat and do the right things. But it was a little bit not what you would expect. So if you thought about a a flushing technology like a HydroGuard, you know, using what was in the technologies teams, some of their circuits, the software interfaces, their resources to write the EEPROM and EEPROM kind of operating structures. You know, the team was working back and forth well between, you know, the old infrastructure kinds of products and the technologies kinds of products. I think what really brought it to a head for me was I didn't feel like the rate of deployment and the rate of adoption of improvements in our new smart hydrants was happening fast enough. So things like bonnet redesign so that you could house more electronics, things like the hollow stem for housing the batteries and housing the Bluetooth circuits and things like that. And you realize the team was still trying to do their day jobs and be responsible as a product manager for making sure that, you know, this customer got their five-and-a-quarter-inch Super Centurion and kind of on the side also make sure they were doing the right thing for a smart hydrant. But they weren't being incented on that. They weren't being measured on that because that was an infrastructure and all the technology-enabled products were in technology. So I wanted to get all of the alignment, if you will, of the management incentives into common channels for common product. And so, you know, when you think about HydroGuard, when you think about smart hydrants, when you think about transducer-enabled repair products like a coupler that one day will probably have a flow meter on it, certainly a temperature probe or maybe even a pressure monitoring point, when you think about a control valve that is now going to vary pressures dynamically based on what flows are or based on what pressure drops are up the line, and you start putting some of these smarter abilities into traditional infrastructure products. I wanted to get all of those families into a signal management structure. That's why we did it. We didn't do it for the financial reporting, didn't drive the decision. What drove the decision is the rate at which We will hold people accountable to develop products and bring them to market. That's really why we changed the structure. That's why you see control valves Hydrance and HydroGuard coming out of the old traditional infrastructure product line and putting them firmly in the management stack of the guys responsible for software and of the ladies and guys that are responsible for all of our AI initiatives and analytics initiatives. So, yeah, that was what the restructuring was. As a matter of fact, after we contemplated the restructuring as an ELT, that's when Marty came along and said, hey, look, if we're going to run the business like this, I got to look at, you know, what our reporting looks like. And I think, you know, she did a good job of saying, you know, this is what the management structure looks like. If this is the information you're looking at to make decisions, then we're going to have to do the reporting this way.

Okay. Helpful color. Thanks again.

Thank you.

Next question is from Brent Thielman with DA Davidson. Your line is now open.

Hey, thank you very much. Congrats on a good quarter. Scott, maybe just on the new residential market, you talked about and certainly heard some of the disruptions builders have had to deal with as well, just in terms of getting new homes to completion. I guess the question is, do you think you've been relatively isolated from that, though, just because I would think they don't want to wait to start that next development, which is really where you come into play. Have you seen that process slow as well?

No, I don't think we've seen it slow. I think a lot of inventory is ready for, as everybody on the call should be reminded, that we're early in the development process. We go in when the curb and sewer goes in, not when the house pulls a permit. We use that as a surrogate for the health and construction market. But I think lot inventories, developed lot inventories are low. And so I don't, you know, I think if anything, it's the opposite, that we're enjoying maybe a little bit better development environment in this last couple of quarters than perhaps you've seen in sell-through for the builders. Because I do believe they're trying to build, you know, develop a lot inventories over these past six months because they have seen it as a constraint situation. to entering into new contracts. You know, I do think we saw a pause. There was a short time there where I think consumers were unwilling to get into variable priced housing construction contracts where they didn't know what their lumber costs were going to be or they didn't know what their cement cost is going to be. But for the most part, that seems to have passed now. It seems like the builders are able to get orders and contracts in place. And so I think they're bullish, remain bullish on developing lots.

Okay, appreciate that. And I think about this in context of the guidance, Scott or Marty, which doesn't reflect, I guess, the cost assumptions sort of worsen or these raw material cost assumptions. I mean, it looks like prices for some of your variable inputs have rolled over a bit recently, but then you've got, you know, things like fuels, which impact the foundries, wage growth, et cetera, kind of moving higher. So how do you look at the net impact of these various costs today? Have we sort of topped out for now or on a net basis are costs still moving up, you know, maybe from a quarter ago?

Yeah. So, you know, I think you've laid out some things, you know, that certainly are part of what we're looking at. I think we've spent, I'll say, a fair amount of time talking overall about inflation. related specifically back to the raw materials as well as our purchase components. And we've probably seen scrap creep up a little bit more, but expectations are that we start to see some stabilization in the market with respect to those. But I think calling out, for example, energy. I know we called out energy as a higher cost for us. In our fourth quarter, given our production, particularly at the foundries, we were producing as we were incurring some of the peak level energy costs. And I will tell you that is something, again, we experienced first quarter. And our expectation is that overall higher energy costs is something that we will continue to experience. We'll also call out freight costs. I think in combination with that, I think we have seen and expectations or will continue to see higher freight costs. And that certainly reflects back as well on a lot of what we're seeing with supply chain disruptions, with the challenges of labor. timing of need to get material, etc. So I would expect that we'll continue to see higher freight costs as well. I'll also call out higher labor costs. I think, again, the inflation that we're seeing, our expectation is our labor costs will be higher going forward as well. None of those hit the magnitude of the raw material and product inflation that we've seen, but our some of what we think about as we look into our 2022 is that we'll see some, you know, generally higher inflation around those inputs as well.

Okay. Maybe just lastly, I mean, with all the price initiatives you've had to implement as well as the industry, you know, kind of the overall upward cost pressures in the construction market overall, I guess I'd think your municipal end users would be more sensitive sensitive to that? I guess any kind of feedback to the channel about what they're saying as they sort of try to manage budgets on a go-forward basis?

Yeah, I think that, you know, there's sophisticated municipalities out there with supply agreements, both with us and with, you know, distributors that we use, and those supply agreements we're you know, using the negotiating windows, using the index language, things like that for increases, as I mentioned when I was talking to Dean Dre. But I think the rest of the people in the spot market, which I would say is the majority of the sale market, so it's either, you know, spot job or just, you know, spot usage for most of the utilities, they're infrequent enough that they're not there's nobody out there screaming, and they all understand the challenges. And so their expectation is that, you know, they will pay tomorrow a little bit more than what they would pay yesterday. And I think that, you know, we've managed as an industry those expectations well because we have, you know, been transparent about what things look like both in the scrap market, what happened when the tariffs get put in place by China or by our government for Chinese companies products? What are the drivers of cost? What is the cost of a container being held off the coast in Long Beach now? And so all of those things, I think, are well understood or well documented. And so when we're talking about what the impact on price is and what the impact on price going forward needs to be, I don't see a lot of resistance. And I believe that the market is rational and will continue to behave that way.

It's encouraging. Thank you for taking the question. Appreciate it.

Next question is from Walter Littak with Seaport. Your line is now open.

Hey, thanks. Good morning, guys, and good quarter. You guys have talked about this a little bit already, but I wonder about the distributors just pulling forward inventory just to get ready for the construction season. It seems like the The revenue this quarter was a little bit more, you know, seasonably high. And, you know, I wonder, you know, like in next quarter, do you have an expectation for sort of a normal seasonal uptick from here? Or do you think there was a little bit of pull forward in this quarter?

Look, I think that what we've seen and, you know, when you listen to the ones that are public anyway, you have to kind of ground yourself Walt and go back to pre-pandemic, post-pandemic and look at what inventories were pre-pandemic and look at what inventories are now. Take the inflationary impact out and say, are they able to service their customers as well as they were servicing them pre-pandemic? It's all rough math, but you get all those indexes kind of pulled together and say, okay, we've had this kind of increases in price. So their inventory would be up this much just on price alone. And, you know, I think what you conclude is I wouldn't call it buy ahead as much as I would call their service model needing to get back into stock positions that they depleted just as we depleted. You know, the whole industry basically paused when the pandemic started. We took inventories down. We took labor headcount down. We took You know, capacity out of the system. And then basically, in what was our fiscal Q4, there was a V recovery in the construction market. And we've been running play and catch up as an industry ever since then. And so, you know, I don't believe there is a lot of buy ahead. I think it's our lead times creeped out. They were forced to then place orders for those windows. And that's why the backlog has almost become a little bit of a self-fulfilling prophecy as a result of lead times going out. But I do believe that there is enough underlying demand in the distribution channel for them to utilize what they have on order. And I believe that the municipal end market environment is hot enough that they won't have any problems burning off the orders or burning off the inventory if there's any excess there.

Okay. All right, great. That sounds good. You know, I wonder, too, about the, you know, with the stock price down, you guys did a little bit more share buyback than we thought. I think you guys were going to do about $10 million for the full year, and it looks like you got $20 million. You know, you have that authorization out there. What's your expectations on share repurchase for the rest of the year?

Look, I think when we, you know, we really take it back to our capital allocation, I think we, you know, characterize it as being, you know, disciplined and balanced. We look at it along different lines, you know, certainly return to shareholders, which encompasses our dividend as well as share repurchase. You know, our board did increase our dividend with the last November. Share repurchase has clearly been a component of that as well. We certainly have the reinvestment in the business from a capital expenditures perspective, as well as certainly looking at M&A opportunities for growth. So I think going forward, we have 115 million authorization at the end of our first quarter. And I think as we continue to look at capital allocation, we will continue to look at across those three opportunities.

Okay, great. Thank you.

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

Good morning. This is Michael. I'm asked to see you in for Joe.

Hi, Mike.

I believe it's safe to say your results this past quarter were higher than most of us probably anticipated.

um you know how should we be thinking about cadence over the next few quarters and potentially explaining to 2023 yeah i think uh you know the uh the the way we've put the guidance michael is you know six to eight percent kind of unity if you will on uh on ebitda on sales growth as you know we're not going to get back on the plus side of the negative price cost just for everybody's benefit you know if you're if your costs you know, increase a dollar and your margins are, you know, 30%, then, you know, I think you need $1.33 or something like that in order for your, in price in order to maintain your margin, not have just the cost increase recovery become dilutive. And so, you know, I think we're looking at timing. We're looking at what we expect our throughputs to be. We're looking at what the individual price in each order in the backlog is. And that is why I think that, you know, while we had no leverage and fixed cost and no operating leverage in our results in the first quarter, even though we had really good flow through on the increment, that we've been kind of cautious about what the second half looks like from a flow through perspective. And so, you know, I'm not sitting here saying, excuse me, I'm not sitting here saying that that we haven't got all of the inputs under control, but I think that there's enough variation coming in the second half, and there's enough unknown about both the demand environment in our Q4 and where we are going to be in throughput and labor costs that I think that we have in front of us a challenging operating environment. So I would say the cadence is You know, the second half ought to be better on flow through than the first half. Q2 going to be, you know, from a margin point of view, when you think about how inventory revaluations from high inflationary periods kind of impact the income statement in Q1, as that gets amortized in Q1, I would expect a little margin compression in Q2 and then back to expansions in 3 and 4. You know, I think that that's the cadence here. that you would expect to see over the next three quarters.

And one more, if I may. You previously mentioned a commitment towards inorganic growth to expand the portfolio. Can you give us any insight into the products and markets you see as most favorable and if there's any geographic considerations there? Thank you.

Yeah, so I think that for sure, you know, I think in Marty's prepared comments, she outlined that the products associated with infrastructure, distribution network, like gate valves, hydrants, and then the repair and return or repair and installation market, you know, all experience double-digit growth. We expect them to continue to have these growth numbers, and I think you'll see the valves that are used in the distribution network and the hydrants in the distribution network will experience a lot of growth. as you see what happens at 23 and beyond resulting from the infrastructure bill. So I think there will be a lot of tailwinds there on demand. As for your geographic question, all you have to do is look at the migration of people in the country, American Southwest, American Northwest, American Southeast. You know, that's where all of the growth is. That's where all of the – population movement is going. I think we have pockets in the Northeast, like New York City, like Boston, parts of Vermont and New Hampshire that are experiencing some population growth, but the vast majority of new construction in that Nashville market, in that Utah, Denver kind of corridor, those are where all of the builders are clustering, and certainly that's where you see a lot of our growth.

Thank you.

Thank you.

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

Hi, everyone. This is Miguel on for Brian Lee. Thanks for taking the question. I just wanted to touch on the new segmentation. When we're thinking about, I guess, this year, but mainly beyond when we kind of get out from these special inventory and cost dynamics happening this year, is there anything notable or new on what we should expect in terms of, I guess, a more normal seasonality for each of the new segments versus what we've seen historically for, say, the old infrastructure and technology segments?

I don't think it's going to change that much because I think the spending patterns for the industry tend to mirror our kind of patterns, which is You know, our months between April and November are when the vast majority of water utility work gets done. And that's because so much of it is done on the ground. I think that you'll see a lot more winter work, for lack of a better word, in things like water treatment or pumping centers. But the long and the short of it is the bulk of the investment in our customer base is going to be made disproportionately in the summer months and spring, early fall, so that you haven't got to deal with frozen ground. I expect we'll have less seasonality in the electronics and software-driven business, but I think even in the most aggressive forecast for growth in that particular area, we'll still only be less than 20% of the spend that's getting associated with water utilities. So I would expect the seasonality to remain pretty constant. Miguel.

Awesome, thanks. It's very helpful. And then second one, and I can pass it on. How do we think about margins for the new segments, just based on the historicals that you guys put out for the two segments? It looks like water flow is higher margins than water management. And water management, notice that adjusted operating margins You know, we're just a little bit down this quarter. So when does, I guess, when does water management kind of get back to, I think I saw 16% operating margin in 2020 and water flow at 20% adjusted operating margins? Does water management kind of grow to be in line with water flow? Just trying to think about the two in relation to each other.

Yeah, I think in the long run it will grow, but I think in the short term, you know, the supply chain challenges we were referencing in the production control valves, along with supply chain and labor challenges associated with the meter business, were the two big detractors in water management for the quarter. The other dynamic that we have going on there that we think is going to be, you know, let's call it rectified here in, you know, during the second quarter, maybe some bleed on impact into the third quarter is this notion of substitution. You know, the, the shred and plate scrap market have been very tight and we have been substituting some bushling scrap for, you know, bushling a lot more expensive than, than plate and shred. And so, you know, that also impacted the Albertville facility. So I think we have, large capex in water flow that's paying some dividends. But yes, to answer your question, we will get back to parity and hopefully at some point, you know, three to five years from now, you will see the applications business be more profitable than the core business or the flow business. Okay, thanks.

That's very helpful. I'll pass it on. Thank you.

And just a reminder, if you would like to ask a question over the phone, please press star one and record your name. Next question is from Andrew Biscaglia with Barenberg. Your line is now open.

Good morning, guys. Just one for me. You know, you talk about capital allocation and M&A, and now that you've got this new segmentation, I guess if you – where does the interest lie with M&A in terms of reducing your next deal – being more of like a kind of a crowd-like deal or something like in technology that will, you know, benefit the water management side. I guess, what's your hunch? Or I guess it's based on maybe like what the pipeline looks like at the moment.

Yeah, I think that the, you know, the bolt-ons in the valve business, you know, areas that we don't have, geographic expansion, those are all viable strategies for for what you would define as the water flow business, and we have a fulsome pipeline there that we would consider. On the sensing side and on the technology, software, workforce management, kind of integrating supply chain, if you will, for water utilities, so that when you identify a leak, then the right repair equipment gets there, those kinds of enabling technologies are all things we're interested in on the acquisition side for that side of the business and, of course, geographic expansion there as well. And so, long story short, I think we have a lot of people. um that that we're interested in we've got to find the right fit at the right price and um it's got to work for who we're acquiring and work for us i think there are suites out there that um that that we do covet and that you know we're going to have to think long and hard about where the sources of synergies can come from so we can meet some of these multiples is there are you sensing any meaningful change i guess in the last few months with i don't know um just in your conversations this

based on all the challenges we're seeing across the supply chain issues. I just wonder if this year ends up being a year where you see kind of a breakout in M&A. I don't know, just based on your tone.

Yeah, no, I don't think so. I think that exactly what you said is that If anything, the complexities that have been introduced this year as a result of supply chain complications, as a result of some of the geopolitical stuff going on, has made uncertainty a little bit higher. And so I think that as far as breakout years go for M&A, where we are with nine months or eight months left in our fiscal year, I think that the pipeline is full, but we have our operating challenges as well that are also going to take management time. Yeah, fair. Okay. Thanks, Scott. Great. Thank you. All right. Thanks, operator. I'd like to thank everybody for joining us on the call today. I think, you know, if I haven't said it, I want to make sure everybody understands I'm pleased with a solid start to our year as we work through our ongoing operational challenges. I think while price cost has been challenging for the last four quarters, we are in a great position to improve margins as we benefit from the steps we took in the price increases in previous quarters. I think the teams continue to focus on improving our operations on a daily basis, very customer focused, very much in tune with where they are from a operational needs, absenteeism, labor coverage, those kinds of things and taking the right step. I believe we're well positioned for continued growth given the accelerating impacts from aging infrastructure, the government stimulus focused on repairing water networks and improving operations, including the benefits from our large CapEx investments. And I'm excited about the path we're on to become a sustainability leader as evidenced by our second ESG report, which showcased our rapid progress and includes the long-term trends and goals that I think that we need to. I think in closing, we're confident we're creating a stronger foundation for our future growth and that we have the right strategies in place to expand our presence in the market. And so I'd like to thank everybody for joining us again, and I'd like to thank you for your continued interest. And with that, operator, please conclude the call.

Thank you. This concludes today's call. Thank you for your participation. You may disconnect at this time.