MUELLER WATER PRODUCTS

Good morning, everyone. Thank you for joining us on Mueller Water Products' second quarter 2023 conference call. Yesterday afternoon, we issued our press release reporting results of operations for the quarter ended March 31st, 2023. A copy of the press release is available on our website, MuellerWaterProducts.com. Scott Hall, our President and CEO, and Marty Zaktas, our CFO, will discuss our second quarter results in markets and current outlook for 2023. Following our prepared remarks, we will address questions related to the information covered on the call. As a reminder, please keep to one question and a follow-up, and then return to the queue. This morning's call is being recorded and webcast live on the Internet. We have posted slides on our website to accompany today's discussion. They also address forward-looking statements and our non-GAAP disclosure requirements. At this time, please refer to slide two. This slide identifies non-GAAP financial measures referenced in our press release, on our slides, and on this call. 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 three addresses forward-looking statements made on this call. This slide includes cautionary information identifying important factors that could cause actual results to differ materially from those included in forward-looking statements. Please review slides two and three in their entirety. During this call, all references to a specific year or quarter, unless specified otherwise, refer to our fiscal year, which ends on September 30th. A replay of this morning's call will be available for 30 days at 1-800-839-1117. The archived webcast and corresponding slides will be available for at least 90 days on the investor relations section of our website. I'll now turn the call over to Scott.

Thanks, Whit. Good morning, everyone. Thank you for joining us for our second quarter earnings call. I hope everyone is doing well. I am encouraged by our team's performance this quarter. We increased consolidated net sales 7.2% compared with the prior year. strong performance at water management solutions, and higher pricing across most product lines more than offset lower volumes in water flow solutions. We continue to benefit from past pricing actions, which again more than offset ongoing inflationary pressures. The decrease in volumes was in line with our expectations as channel inventories normalized to reflect lower residential construction activity and improvements in product lead times. Our teams continue to make progress on our operational initiatives, including ramping up our new brass foundry. Adjusted EBITDA margin was also in line with our expectations. While it was lower than the prior year, we sequentially improved our adjusted EBITDA margin by 40 basis points. A significant increase in hydrant shipments helped water management solutions achieve more than a 22 percent adjusted EBITDA margin for the quarter. While performance at water flow solutions was impacted by lower volumes, we anticipate improved performance in the second half of the year based on cost reduction actions that we've taken and an expected increase in brass production. We are reaffirming both net sales and adjusted EBITDA growth guidance for fiscal 2023. We just released our third ESG report highlighting our focus on sustainability. During 2022, We continue to make progress on key initiatives that enable us to help water utilities address the growing challenges related to aging infrastructure and climate change. Our broad portfolio of products and services help customers reduce non-revenue water, extend pipe life, and provide life-saving fire protection. We made progress on our targets and commitments and disclosed additional ESG metrics relevant to operations. We continue to drive down operational emissions and achieved our initial emissions target significantly ahead of plan. We contribute to the circular economy using approximately 86% recycled metal to produce our products. When compared to our total waste, we are a net negative producer of waste. Our new brass foundry is a major step in advancing our environmental commitment and is a noteworthy advancement in sustainability for our customers and communities. As we strive to become a sustainability leader in our industry, we are committed to providing intelligent products and services that help cities and municipalities repair and replace their aging infrastructures, increase the resilience of their distribution networks, and respond to water-related climate impact. In 2022, we made substantial progress against our goal for our EcoShore leak detection product that helped clients identify an estimated 1.3 billion gallons of water loss. Notably, since 2020, we have enabled our clients to identify an estimated 2.8 billion gallons of water loss. From a governance and climate perspective, we launched our first index aligned with the TCFD recommendations, representing how climate-related risks and opportunities are embedded in our business decisions. I am proud of our team's accomplishments and the way we work to advance our ESG programs. I invite you to read our 2022 ESG report available on our website. Before providing more commentary on our results and outlook for 2023, I'll turn the call over to Marty to discuss our financial results.

Thanks, Scott, and good morning, everyone. I'll start with our second quarter 2023 consolidated GAAP and non-GAAP financial results. After that, I will review our segment performance and discuss our cash flow and liquidity. During the quarter, our consolidated net sales increased 7.2 percent to $332.9 million compared with the prior year. This increase was primarily due to higher pricing across most product lines in both segments and increased volumes at water management solutions which more than offset decreased volumes at water flow solutions. Gross profit of $97.8 million increased 5.4% compared with the prior year. However, gross margin of 29.4% decreased 50 basis points compared with the prior year, as benefits from higher pricing were more than offset by a decrease in volumes at water flow solutions, higher costs associated with inflation, and unfavorable manufacturing performance. For the fifth consecutive quarter, higher pricing more than offset ongoing inflationary pressures. We continue to experience higher costs associated with raw and purchased materials, freight, and labor relative to the prior year. Our total material costs increased around 6% compared with the prior year. The unfavorable manufacturing performance was primarily driven by outsourcing and underabsorption at our Chattanooga and Decatur facilities. We continue to use outsourcing, primarily for brass parts used in hydrants, to mitigate lower production at our brass foundry operations as we work through the startup of our new brass foundry. The cost premiums related to outsourcing represented about 150 basis points year-over-year headwind for gross margin in the quarter. We expect that outsourcing will continue until our new brass foundry is at run rate production levels. Selling general and administrative expenses of $64.2 million in the quarter increased 10.7 percent compared with the prior year. The increase was primarily driven by inflation, deferred compensation, consulting and legal fees, and increased travel and trade show expenditures. SG&A as a percent of net sales increased to 19.3 percent in the quarter as compared to 18.7 percent in the prior year quarter. Based on our annual guidance for SG&A expenses, we expect the year-over-year increase to decelerate in the second half of the year. Operating income of $32.9 million decreased 3.8% in the quarter, compared with $34.2 million in the prior year. Operating income includes strategic reorganization and other charges of $700,000 in the quarter, which were primarily related to severance and certain transaction-related expenses. Turning now to our consolidated non-GAAP results. Adjusted operating income of $33.6 million decreased $1.2 million compared with $34.8 million in the prior year. The benefits from higher pricing were more than offset by the decrease in volume, increased costs associated with inflation, unfavorable manufacturing performance, and higher SG&A expenses. Adjusted EBITDA of $48.1 million decreased 4.9 percent in the quarter leading to an adjusted EBITDA margin of 14.4% compared with 16.3% in the prior year. As a reminder, we incurred $1 million of pension expense other than service during the quarter compared with a benefit of $1 million in the prior year quarter. For the last 12 months, adjusted EBITDA was $188.7 million, or 14.4% of net sales. Net interest expense for the quarter declined $600,000 to $3.9 million compared with $4.5 million in the prior year. The decrease in the quarter primarily resulted from higher interest income. For the quarter, adjusted net income for diluted share was $0.14 compared with $0.15 in the prior year. Turning now to segment performance, starting with Waterflow Solutions. Net sales of $157.2 million decreased 14.5% compared with the prior year. Higher pricing across most of the segment's product lines was more than offset by lower volumes for iron gate valves and service brass products. Specialty valves experienced double-digit net sales growth compared to the prior year, driven by both higher prices and increased volumes. Service brass product shipments were impacted by machine downtime that contributed to both reduced throughput and manufacturing inefficiencies. Adjusted operating income of $15.2 million decreased 57.1 percent in the quarter. The benefits from higher pricing were more than offset by lower volumes, higher costs associated with inflation, and unfavorable manufacturing performance. Adjusted EBITDA of $23 million decreased 46.4%, leading to an adjusted EBITDA margin of 14.6% compared with 23.3% last year. Moving on to water management solutions. Net sales of $175.7 million increased 38.8% compared with the prior year due to increased volumes, primarily in hydrant and water application products, and higher pricing across most of the segment's product lines. Adjusted operating income of $31.9 million increased 170.3 percent in the quarter. Benefits from higher pricing and increased volumes more than offset higher costs associated with inflation, higher SG&A expenses, and unfavorable manufacturing performance, largely due to higher costs as a result of outsourcing. Adjusted EBITDA of $39.6 million increased 107.3 percent in the quarter, leading to an adjusted EBITDA margin of 22.5 percent, compared with 15.1 percent last year. Adjusted EBITDA conversion margin for the quarter was 41.8 percent. Moving on to cash flow. Net cash used in operating activities for the six-month period ended March 31, 2023, was $22.2 million, compared with net cash provided by operating activities of $800,000 in the prior year period. The decrease was primarily due to higher accounts payable turnover, partially offset by higher collections of receivables. Average net working capital, using the five-point method as a percentage of net sales, increased to 29.9%, compared with 25.8% in the second quarter of last year, primarily due to higher inventory levels. During the six-month period, we invested $20.5 million in capital expenditures compared with $26 million in the prior year period. Free cash flow for the six-month period was negative $42.7 million compared with negative $25.2 million in the prior year, primarily due to a decrease in cash provided by operating activities, partially offset by lower capital expenditures. For the full year, We anticipate that free cash flow will improve based on the seasonality of our operating cash flows, including a decrease in net working capital in the second half of the year. We did not repurchase any common stock, and as of March 31st, we had $100 million remaining under our share repurchase authorization. As of March 31st, 2023, we had total debt outstanding of $447.5 million in cash and cash equivalents of $89.2 million. At the end of the second quarter, our net debt leverage ratio was 1.9 times. 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. As a reminder, we currently have no debt financing maturities before June, 2029. At March 31st, 2023, we had total liquidity of $251.7 million, giving us plenty of capacity to support our strategic initiatives. Back to you, Scott.

Thanks, Marty. I will comment on our second quarter performance, end markets, and full year outlook for 2023. After that, we'll open the call up for questions. As mentioned earlier, our second quarter adjusted EBITDA margin was in line with our expectations with a 40 basis point sequential improvement. Water management solutions achieved more than a 22% adjusted EBITDA margin for the quarter, primarily driven by increased hydrant shipments. Manufacturing performance at our Albertville Hydrant Facility improved from better machine uptime, increased staffing levels, outsourcing, and better execution. The increased hydrant production allowed us to reduce our elevated backlog and realize higher pricing from our previous price actions. Due to the current production levels at our brass foundries, we are still outsourcing production of critical brass parts. Waterflow Solutions was primarily impacted by lower volumes for both iron gate valves and unfavorable manufacturing performance at our brass foundry in Decatur. Manufacturing performance at our Chattanooga iron gate valve facility has been the most consistent over the past two years. As a result, the team has efficiently worked through the elevated backlog over the past two quarters. Primarily due to the improved, shorter lead times, we have seen the anticipated slowdown in order activity as channel inventories normalized. We are working closely with our channel partners to understand sell-through and local inventory levels. Due to the expected year-over-year decrease in production levels, we have taken actions at the facility to reduce labor costs and plant spending. Lower production in our old foundry impacted our service brass shipments in the quarter, and led to underabsorbed labor and overhead costs, as well as the need for outsourcing. While we have rebuilt many pieces of equipment used in the foundry process, we have not been able to get consistent daily uptime. We have made adjustments to teams, including filling key maintenance positions. We do expect to deliver improvements while utilizing our old foundry and believe that we can increase brass production at the old foundry, even as the new foundry ramps up. During the quarter, we made further progress on the production parts approval process at the new brass foundry, with an emphasis on our highest volume parts, including those used in hydrants and iron gate valves. Our teams are now focused on increasing production volumes for these higher volume finished parts. We expect to deliver a sequential improvement in brass production levels relative to the second quarter from both our existing foundry and the ramp-up of the new foundry. We continue to believe that the new foundry will be able to fully ramp up by the end of fiscal 2024. This will allow us to close the current foundry and eliminate outsourcing costs, primarily associated with brass parts, ultimately helping us return to pre-pandemic margins in 2025. Turning to our end markets, we believe the new residential construction markets accounted for 25 to 30 percent of net sales in 2022. Total housing starts were down 18 percent year over year during our second quarter, driven by a 29 percent decrease in single-family starts. In March, the seasonally adjusted annual rate for total housing starts was around 1.4 million units. We expect higher interest rates and economic uncertainty to continue to impact residential construction especially given the increase in interest rates and elevated activity during the pandemic. However, lot inventories remain relatively low, and demand appears to be stabilizing due to a variety of factors. We believe activity levels compared with the prior year will continue to normalize slightly below our forecast from last quarter. While the slowdown isn't affecting all areas of the U.S. equally, it is influencing local distribution inventories to various degrees. We believe the municipal repair and replacement market, which we estimate accounted for 60 to 65 percent of net sales in 2022, continues to grow at a steady pace, helping to partially offset the anticipated slowdown in residential construction activity. During the quarter, we saw continued strength in the municipal repair and replacement market, with municipalities benefiting from healthy budgets, especially at larger municipalities. While we have not included any benefits from the infrastructure bill in our assumptions for 2023 guidance, we are beginning to see bid activity for projects utilizing IIJA funding. The EPA is administering the majority of the federal funds through the drinking water and clean water state revolving funds. The first phase of funding has been distributed to the state which will allocate money to individual projects based on their priorities. We believe that this level of funding is a tailwind for water infrastructure activity on top of the current tailwind from the aging infrastructure. In addition, there is an increased emphasis on using iron and steel products made in America and remediating the lead service lines connecting water mains and meters to customers. We believe the increased funding from the infrastructure bill benefits five main product categories to various degrees. They include iron gate valves, service brass, specialty valves, hydrants, and repair products, which account for approximately 75% of the consolidated net sales. Currently, we anticipate benefits will be focused on products used in larger projects. Water infrastructure project examples include the expansion and replacement of drinking water and wastewater facilities, lead service line removal, repair and replacement of water mains, and water retention and management. I will now briefly comment on our outlook for 2023. We are reiterating our annual guidance for 2023 consolidated net sales and adjusted EBITDA growth. We continue to anticipate that higher pricing will drive top-line growth this year and more than offset lower volumes. Our guidance includes benefits from elevated backlogs for hydrants and service branch products. Also, we continue to expect lower volumes compared with the prior year as our channel partners adjust their inventory and order levels to reflect shorter lead times and lower new residential construction demand. Operational improvements are expected to drive an improvement in adjusted EBITDA margins in the second half of the year, supporting our adjusted EBITDA growth and conversion margin expectations. In summary, I continue to be impressed with our team members' dedication and perseverance in navigating the challenging external environment as they focus on driving operational improvements, prioritizing customer service, and executing our strategic initiatives to grow and optimize our business beyond 2023. As mentioned earlier, we are excited about the future benefits from the federal infrastructure bills, incremental funding for new water infrastructure projects. Our product portfolio is well positioned for continued growth given accelerating impacts from aging infrastructure, government stimulus focused on repairing water networks, and improving operations, including benefits from our capital investments. We are in a transformational period with our large capital projects in various stages of ramping up. We believe the benefit from these projects and ongoing operational improvements will greatly enhance our position in the market. With increased domestic manufacturing capacity for insourcing and new product development, we will be positioned to have industry-leading delivery times and capture demand for American-made products. We have a strong balance sheet, liquidity, and cash flow, which support our strategies. We are confident that our growth strategies, capital investments, and operational initiatives will deliver both further net sales growth and a return to pre-pandemic margins in 2025. And with that, operator, please open this call for questions.

Thank you. To ask a question, please press star 1. To withdraw your question, press star 2. Once again, to ask a question, please press star 1. Our first question comes from Ryan Connors with North Coast Research. Your line is open.

Yeah, great. Thanks for taking my question. I wanted to discuss the margins in the water management solution segment. I know that segment does include the former tech segment, but a lot of other stuff too. But given the relatively recent realignment of the segment reporting, we don't kind of have a great context on what that run rate is and how sustainable the nice jump here in 2Q is. So can you just kind of discuss, you know, the big picture margins in that business and whether we should kind of view this jump as something we can hold on to, you know, going forward or whether it's more of a short-term blip?

So, overall, water management did have a very strong first half of the year with both, as you point out, sort of strong sales growth as well as strong improvement on gross margin and EBITDA conversion. When we look at the reasoning behind the net sales improvement, it was due to the continued higher pricing that we're seeing across most of the segment's product lines. And then the other piece to call out is the increased volumes that we saw primarily with the hydrant product that's there and also saw some volume growth with our water application products. So the price realization benefits were good really at both segments, both at water management and water flow, but we had particularly strong shipments of hydrants versus the prior year. Overall, the manufacturing performance that we've seen at our Albertville hydrant facility has improved significantly. We've had better machine uptime. We've had improved staffing levels, the outsourcing, which has allowed us to keep the production levels up, as well as improved execution. As you remember, we have had very high backlog with some of our shorter cycle products recently. And as we've been able to increase the production levels of our hydrants, it's allowed us to reduce some of the elevated backlog, which brings through both improved volume as well as some of the higher pricing. Give you a little bit of a reminder that Iron Gate valves, which is part of our water flow solutions, really took down more of their backlog last year. And hydrants, we're seeing the better performance this year. So I'd say when you look at sort of the current production level that we have at our brass foundry that we referenced, we are still outsourcing some of the production of some critical brass parts. So going forward, once we're able to eliminate that and get the production of the brass foundry up, that should help our margins as we look out into the future. But I'd say, you know, overall at Water Management Solutions, we expect to continue to see stronger sales growth. Again, it's probably the volume largely from the improved hydrant production levels that we're seeing versus a more challenging 2022. Yeah, okay.

Thanks, Marty. And then my follow-up was, you know, I know we've asked this question in the past, and you've always said that all of Mueller Systems but obviously you've had some changes in the board membership. And I'm wondering if there's been any further discussions on that, any change in the thought process around, you know, exploring strategic alternatives for pieces of that business, whatever it might be, but specifically the metering piece.

Well, I would say that the answer to that is that, you know, every year we run a strategic process. I know you're all familiar with. variations on the ocean planning process and derivatives of it, and we're no different than most of the companies, industrials in North America that run a similar strategic process, whether we call it policy deployment, goal deployment, strategy deployment, it's all basically the same. And so as part of that, you have to look back and say, okay, what were my assumptions? What were the things I think about? How do I feel about our progress today? And I think that you know, Ryan, that I have long held the view that the land and expand approach to getting integrated infrastructure monitoring into the mainstream of the water utilities is really actually more important to their operating model and more important to their operating costs than simply metering and having the cash register tell you how much water was consumed at the end points. That's far more efficiencies can be gained by flying the non-REV water streams and also by optimizing the pressure in high variability altitude environments. And so that we think there's far more dollars and cents to be gained there. So meters have long been a part of that notion that says if we can land with our meters and get those contracts, will we be able to get pressure monitoring? Will we be able to get flushing zones? Will we be able to get leak detection and start the spread from that kind of land and expand strategy? So we've been talking about this for five years, and one of the questions that has to be answered in this strategic cycle is, how many of our meter customers are echo and pressure customers? How many of our echo and pressure customers are meter customers? And is Landon Expand, in fact, proving out to be a successful strategy in the context of how we laid it out, you know, four years ago? So, answer's depending on that, but we do expect a fulsome and comprehensive dialogue around those strategic discussions. I will say that the, you know, the Capital Allocation and Operations Committee is really more focused on the execution around the CapEx programs, the three large projects, with certainly some periphery discussions of the technologies business. But I think the whole Board understands the value having intelligence integrated with our iron products so that we could do more than simply be the physics of moving the water, but also provide some of the insights to operating the network. And so I don't see that leaving anytime soon. Great. Thanks for the color.

Thank you. Our next question comes from Joe Giordano with TD Cowan. Your line is open.

Hey, good morning, guys. Just curious, you're holding your guidance here. I think 2Q, at least relative to street, was a little bit light. I'm just curious how 2Q showed up relative to your internal models, you know, in terms of, like, the outsourcing headwinds and things like that. Is there movement, like, within the full year range now because of 2Q? And how do you think about that guide, you know, today versus you did three months ago?

Yeah, so I think that, you know, honestly, three months ago, Joe, I tried to say that we hadn't beaten the Q1 by as much as consensus would have indicated and say that, you know, the reason we reiterated after what was described as the Q1 beat was because we were basically where we thought we would be after Q1 and we are basically where we thought we would be after Q2. With that said, you hit on the most important point, so I'll kind of give you a little more on that. I still think that this kind of 25-ish, 26-ish million-dollar run rate on premium for outsourced student brass is something that we're going to have all year. If you look at the guidance for when we're going to be run at rate, when we think we can have the old foundry closed so we get rid of those double-breasting costs of operating two foundries at the same time, If you go back and read all those things, I think you'll realize that we've kind of been contemplating that we're going to have this, you know, $5, $6 million, $6.5 million kind of outsource rate with us through the whole year. And so what has to happen? Well, the lull we saw in gate valves, you know, as the channel burns off some of that inventory that we put there through Q4 last year and the we start to see flow-through demand come through instead of this inventory adjustment period. We'll get volume and gate valves to go with the volume we're experiencing in hydrants in the second half. And that's really where the lift comes from. So, you know, I think this Q2 is kind of where we thought it would be. I think, you know, the important deliveries in Q3 and Q4 now is that we thought we were going to have about a 70-day, 80-day period in lull, if you will, of low iron gate valves orders as the channel worked off their inventory position. And now we expect to see that sell-through volume start coming, and that's what has to happen in the second half for us to achieve our forecast.

Now, that's helpful color there. And then just last for me, you mentioned last call that in your view your lead times on hydrants was unacceptable and kind of put you at a competitive disadvantage. Where do you think you stand? Obviously, you've got a lot more product out the door this quarter, but where do you think you stand on that now?

Yeah, I think we are back to parity. And I think with the extra people we brought on, I'll remind everybody in our Q4 and part of our Q1, you'll recall we had about 50 to 100 people in our Albertville facility that were learning how to assemble and how to make hybrids so that they ultimately could go to their own shift and potentially work Saturdays and Sundays as well if we needed. And we started to see the benefits of that this quarter. So I think that the – The hydrant throughput level knocked about nine weeks off our lead times from where they were in the past quarter. I think that gives us parity, and I fully expect at the end of this quarter to be inside the competition and able to flex some delivery muscle from our increased level of throughput.

Thank you.

Thank you. As a reminder, to ask a question, please press star 1. Our next question comes from Dean Dre with RBC Capital Markets. Your line is open.

Thank you. Good morning, everyone. Good morning, Dean. I was hoping to get more color on the whole certification process at the new foundry. Where does it stand? Any specifics you can provide or just a sense on the kind of production? What's the target? The target is going to be somewhere 50,000 to 75,000 pounds in order to do the switchover, but you're saying that won't happen?

What Dean is referring to is what we talked about a couple of quarters ago, is that we really need an exit rate of about 70,000 pounds a day in our Q4 so that we can have confidence. that the 24 outsource can begin its rapid reduction so that we can recover the 600 or 700 basis points we talked about in terms of getting back to pre-pandemic margins in 2025. And so where we are, Dean, is the 172 PPAPs. 100% of those 172 have had at least one run. Fallout rates, I think, uh, for our, you know, our fourth gate, uh, still right around 62% complete. So I think it's 38% to be done. Um, but, uh, you know, kind of on track with, uh, at the end of Q1 getting all 172 through gate one, the end of gate two, I think we're, we're, we're slightly behind maybe 15 parts behind on the 172 target for gate four, um, at the end of, um, Q3. Um, Long story short, we have pivoted a little bit and are making some emergency products on the second out-of-pour line instead of just completely dedicating everything to PPAP. Decision was made, and I support the decision to make sure we looked after some customer demand. I think that we're experiencing 2,000 or 3,000 pounds a day of production. You know, at a At a higher level, if you were to look at moles per hour, we're exactly where we thought we would be, which is about 75% of run-at-rate. If you were to look at the manipulator accuracy, right around 88%, exactly where we thought we would be. At this point, we don't expect to get into the 90s. with the automatic cutting and the shot blast until Q1 or Q2 of next fiscal year as this equipment all proves out and we run a ton of material over it and get the repeatability where we need to get it. So, you know, the way I characterize it for the board and for our investors is we are on target. We've got a little noise in a couple of the operations, but I want to give everybody the assurance that, you know, There's not much more than a day goes by here that somebody isn't talking about each and every operation of the new foundry to say where is it and what are the next steps to ameliorate or eliminate variation in those processes.

All right, that's really helpful. What would be the, just since this is going to be a recurring theme for multiple quarters, what's the best way for you all to keep us updated on on the progress of the certification? Would it be the pounds per day that you're up to, or is it the actual PPAPs that have been complete, just so we're ready to kind of see the cadence of how this comes online?

Yeah, I think that the average pounds is a good surrogate, but I want to caution everybody that I don't want to, you know, if I go and say, okay, what's my heaviest parts? My heaviest parts are the parts that go in hydrants, right? But they're also the easiest source and probably in the end cost me the least amount of premium. And so, um, I want to caution everybody that pounds per day is, is a good indicator, but I think, uh, I've said publicly that there's, um, 24 pounds of brass in every hydrant. And so, you know, the, uh, The way to get weight is to make simple things that you don't have to finish. Well, to answer the question directly, I think pounds per day is a good surrogate, but don't put everything on it. I think that outsourced premium per quarter is the thing that we, as a management team, need to manage and for investors to have confidence that we're managing it correctly to start to get that to come down from that, you know, ballpark $25 million-ish a year kind of run rate.

All right, that's really helpful. I'm glad you pointed out that nuance about really depends on what product is being manufactured, because the pounds per product is it differs. So that was helpful. And then separately, and I might have missed this. But what's the reasoning or the factors around the lower capex guide for the year?

Yeah, I think the biggest reason is just more timing again. We've got a couple of things moving out into Q1, Q2 of next year, just delivery of equipment. Some of it is a result of The ongoing chip issues in some of the PLCs, it's not to say that there's a broad-based chip issue, but some of the PLCs have long lead times right now. And then I think the ongoing supply chain challenges that we've experienced in some of the more, let's call it higher levels of automation, have also caused some of the delay. And then the final thing, Dean, I want to... perfectly clear on is that Marty and I have said no. Let's be clear. If we have everything at the new foundry running, great. But if you're telling me we're going to put some machine in and I'm going to take resources away from the new foundry, or if you tell Marty you're going to take resources away from the new foundry in order to do this project or that project, then it's going to delay. And so we are conscious and working very closely with the plants to make sure that we don't detract from the three large CapEx projects as we are in the final stages of all three. And I would like to just put a commercial out there for the guys in our Kimball facility because they've just done a phenomenal job. And, you know, our specialty valve throughput being up and our specialty valve manufacturing performance being so positive, it really was a bright spot in the quarter. So I think that that plant is well on its way. But the other two, you know, we're not going to allow a – a dilution of attention with some of these other CapEx programs.

That's helpful. And just last one from me. Where does the whole distributor destocking process stand? Does that run its course, you know, sell-in versus sell-through at this point? Any color there would be helpful. Thanks.

I think it's a tale of three product lines, Dean. I think we're virtually through it now with gate belts. because we basically eliminated the backlog there in our December-ending quarter. We're in the middle of putting a lot of hydrants in the channel last quarter and this quarter, so I would expect that we'll have a lull in hydrant bookings as the DRP systems adjust to these lower lead times. And then we continue to see really high backlogs in BRASC. and service brass in particular. And so I don't expect that we'll start to see that to come down until fiscal next year. And I would note that the two major competitors in that space also have extremely long lead times. And so I would expect that as this new capacity comes into the market, of which we'll be the first to be able to flex, the other two guys have announced some capacity expansion as well, but They're further behind the curve than us. We expect that that will be a problem next year where we'll see the lead times come down from the 26 to 30 weeks as we push that into the channel that we'll have a lull there. So it's going to all happen eventually. I think we're through most of it in gate valves. We're in the middle of it in hydrants, and it is yet to come in service brass.

That's really helpful. Thanks for that product call. I appreciate it.

Thank you. Our next question comes from Mike Halloran with Baird. Your line is open.

Hey, good morning, everybody. You have Pez on for Mike this morning. Good morning. A lot of puts and takes around the backlog, the lead times. And apologies, Scott, if you got to this. But I guess ultimately, you know, the question is, will backlogs have the opportunity to normalize before the incremental wave of demand from the legislation comes? And, you know, really does it matter? Because it sounds like you're pretty confident that, you know, for instance, the hydrant lead times should be coming within the competitor window. Can you maybe just give a little bit of color on how you're thinking about backlog phasing and kind of how that changes?

Yeah, I think that the backlog we experienced for the past two years is anomalistic. Anomalistic because of the knock-on effect of the COVID shutdown where we all flexed down our production, we laid people off, we did all that, and recovery was more of a V, plus there was a lot of public funds put into the municipalities. Interest rates were low, housing was booming, and so we've basically shrunk supply while demand was increasing. Once we get the short cycle products back to their historical lead times, which is, you know, within that two-week window, so a hydrant ordered today ships in three or four days, a gate valve ordered today ships in three or four days, and the flow business gets back to flow and the project business is the lead time business. Once we get back to that dynamic, I believe, that we'll get back to a more normalized backlog. And if you were around four or five years ago, you'd know that the specialty valve, the large gate valve, the non-standard hydrant were always lead time items. So they've always had, you know, a San Francisco Fryer hydrant has always had a lead time. It's not something anybody carries in stock. You know, a 60-inch gate valve has always had a lead time because nobody keeps five-foot opening gate valve line around in the yards to rust. So all of those things will get back to the norm. And I think that, you know, we had a lot of ordering that caused the backlog that was of a speculative nature, and we had a lot of it that was just a result of lead times getting longer and longer and longer, and the machine basically saying I have to. So once we get that back under control, I fully expect, that there will be enough flex capacity in the industry to keep the normal short cycle business back in that normal short cycle window. And that the impact that you will get from IJA in those kinds of projects and projects will be able to be flexed. within the existing capacity. To give everybody some idea, I think that during this uptick to get this backlog down, you know, we've seen about a 45, 50% increase in throughput in the hybrids. We went from, you know, we had about a 33% peak-to-peak improvement in gate valves. So, you know, maybe 2,100, 2,200 gate valves a day. So, you know, I think there's more than enough flex capacity there demonstrated as a result of this inventory takedown, or this backlog takedown, sorry, that when IIJA comes in, that the system will be able to flex for that increased capacity.

That's very helpful color, Scott. Thank you so much. And then, you know, secondarily and separately, you know, you sounded, you sound pretty confident about a little bit of improving performance at the old foundry. You know, how much of that is just you, you've, you've got the right people in the right places now versus maybe, you know, understanding what should be outsourced first, maybe what shouldn't be. Can you just provide a little bit of color on what's giving you the line of sight and the comfort of the improving performance of the older foundry?

Yeah, sure. I think that, you know, obviously, I said it in my prepared comments, getting key maintenance personnel in positions on all three shifts and paying the shift premiums to make sure that when something does happen that we have qualified people on the line to help the operator get back up as quickly as possible is one of the key things. I also think that the failure mode analysis that have been done The failure modes are fairly common. I'll give you an example. Pusher rods, you know, go through pusher rods fairly frequently now. What causes pusher rod failure? Well, that's when you stop a line and you have to push material through the pouring and through the auto-pour, and you do it manually. And long story short, if you stop the line more often, you have to use the pusher rod more often. If you have to use the pusher rod more often, it tends to fail more quickly. So, you know, get back to the root causes of why are we having to stop lines so frequently? Why are we having to use the pusher out so frequently? And get into some of that analysis that, you know, six months into this that we're getting better and better and better at diagnosing the root causes. And so I feel like learning has been part of it. I feel like the right people in the right place has been part of it. But I also feel like the dedication of the people at the plant and their understanding of what has to happen to complete their job is getting better and better with the communications with our alley folks. And so, yes, I have a level of confidence, but I'm not so naive to say, you know, it's clear sailing from here. You know, I'll remind everybody, the plant is 105 years old this year. Opened in 1918, and it's not to say the equipment's that old, but there's just inherent problems with the footprint.

Right. No, that's... Very helpful, Scott. As always, a better answer than question. I'll pass along. Thank you.

Thank you. As a reminder, if you would like to ask a question, please press star 1. Our next question comes from Walt Libtech with Seaport Research. Your line is open.

Hi, thanks. Good morning, guys. Yeah, I just have a couple of follow-ups. And I apologize if some of the stuff you touched on, I just didn't pick it up. The IIJA, what are you thinking of the timing for that flowing? Are you already starting to see projects that are developing? And, you know, how excited should we be about, you know, as that demand starts to come in, hopefully the production's in place? You know, how meaningful do you think that that could be?

Okay, well, to answer your first question, there's no IIJA project. funds in our 2023 guidance uh and we think that 2024 will be you know some impact but really that it's the years three through six three through seven that has the bulk of the money um the eighth year will be a tailing year and so you know it's uh if you read the the actual document the one point $2 trillion that have been earmarked is over eight years, and the eight years is fairly back-end loaded in years five, six, and seven. So, you know, I don't have any reason to believe that the funding, as outlined in the $1.2 trillion, won't actually mirror itself in the water space, and that's how we think of it. But I think we're tracking the bids, and at this point, we're seeing a few bids specifically pointing to IIJA and Desire for America-Made Products. As a key domestic supplier for many of these products, we're working closely with the regulatory agency, primarily EPA, DOT, and HUD, to harmonize the BABA language and waiver language related to certification process for the American-made products. You know, we believe that it's a big part of the process between the federal government's fund allocations and actual spending on products. So I think that the top-line benefits are going to be – you know, focused on products that are used in the larger projects. And so I think that you'll see the water utilities try to do some of their own, let's call it distribution infrastructure rehabilitation from their existing receipts because they don't seem to be having any problem getting those returns paid for from their local PUCs. But some of these bigger projects, for instance, interlinking water reservoirs or putting in new large pumping stations and things like that. I think those larger projects are the ones that are going to be up first. And so we really expect to see our specialty valve business, our large gate valve business, our large casting foundry, all to be big recipients in the IIJA process. And as I said, primarily over years five, six, and seven.

Okay, and then presumably you're working on making sure that for those specialty products, the larger products, larger gate valves, that that's going to be ready when that demand starts to hit.

Yeah, to be clear, well, thanks for bringing that up again because I brought it, I talked about it last quarter. You know, I think we've been pretty straight about all this all throughout our history. You know, the large casting foundry is now capable of making large casting, but the the market to get it to its run-at-rate level has not yet developed there. We still have great faith that it will, but I would say we're probably a couple of years early on the large casting foundry and a couple of years late on the new brass foundry, right? Like if we could have flip-flopped the start dates on those two, I definitely would have done it. And it's just that we thought that the infrastructure bill would frankly get passed in the first Trump administration. I don't know if you all remember, but we were – fairly confident that an infrastructure bill would go through then, and that's why we pulled the trigger on Chattanooga first. But I want to be clear, the large casting foundry is capable of making 66, 72-inch castings for both butterfly and gate valves, and that if the market were to develop faster, we believe we're already in a position to take advantage of that. remind everybody again, we put in a 20 foot by 20 foot 3D printer so that we can wrap and tool for some of those specialty projects too. So I think our cycle time and our capability is best in the world at the large casting foundry as it stands today.

Okay, great. Okay, yeah, thanks for that reminder. And then Marty, in your discussion of SG&A, you said that I think you said that it was up a little bit because of legal fees and consulting. And then you said it's going to be down in the back half. And I just wanted to get a clarification of why you think it's going to be down and what do you think the level might look like?

Sure. So overall, when you look at the SG&A guidance that we gave for the full year, we've given guidance of between $255 and $265 million. And overall, when we look at where we've come out for the first half of the year, that was really basically in line with our expectations. So, you know, certainly in addition to the items that you cited for the increase that we saw in SG&A in the second quarter, we also have been impacted by inflation, deferred compensation, and in the other areas, certainly higher travel and trade show expenditures. Some of that's certainly part of the inflation that we're seeing as overall that industry has seen some substantially higher rates. But additionally, we're getting out more. And so that's sort of the other reason for that increase. So, you know, overall, when we look at sort of where we were for the first half of the year and how that ties into the second half of the year, we do expect the year-over-year increase in our SG&A will decelerate versus what we saw in the first half of this year. Okay.

Okay. Thanks very much.

Okay. Well, first of all, I want to thank everyone for joining us on today's call. I think, you know, we're pleased with our first half of the year, especially given the uncertainty in the external environment. And as you know, it's a transformational time for both Mueller and the water industry in the U.S. as this influx of money comes in and we see the convergence of interest and political action around clean drinking water for the masses. And so I think that... we are feeling pretty good and fairly excited about where we are with the large capital projects. I think, you know, as we talked about earlier, if we had the timing perfect, you know, we would be opening large casting foundry now, and the other one would be up and running. But I think that we're excited about where we are, and I'm very grateful that we have the support of the board to make the investments that we made when we made them so that when the eventuality of this time actually came, we're in a position to capitalize on. And so I do think we're well-positioned to continue to grow net sales. And I do think that with the improvements we're seeing, both from an earned labor hour and from a material utilization perspective, that we are well-positioned to get back to our pre-pandemic margins in 2025. And so I think that the ability to produce domestically produced products where we are with large capex, where we are with the development of the market, You know, we have a very, very bright future, and we're looking forward to executing in that landscape. And so I just want to thank everybody for your continued interest. And with that, operator, please conclude the call.

Thank you. Thank you for your participation. Participants, you may disconnect at this time.