Q4 2021 Mueller Water Products Inc Earnings Call
In the third quarter, we experienced continued strong demand in the fourth quarter driven by both new residential construction.
Municipal repair and replacement activity.
Fourth quarter orders remained elevated compared with pre pandemic levels and we ended the year with record backlog for our infrastructure products.
While our fourth quarter adjusted EBITDA decreased primarily due to the challenging operating environment, we still achieved six 8% growth for the year.
Although we realized improved pricing in the quarter for the majority of our products. It was not enough to offset the continued higher inflation.
We do expect that our current pricing actions will more than cover anticipated inflation in 2022, assuming material costs do not increase beyond current levels.
Additionally, during the quarter, our specialty valve product portfolio experienced longer delivery time for parts.
<unk> shipments and our ongoing plant restructuring has been impacted by the supply chain disruptions and labor challenges.
I am, especially pleased with our cash flow for the year, where we generated $94 million of free cash flow. We ended the year with a stronger cash position compared with the prior year after acquiring <unk> water for $19 $7 million and allocating $44 $8 million to shareholders.
We repurchased $10 million of common stock during the fourth quarter, and recently announced a dividend increase of approximately five 5% in summary, while we had a disappointing finish to the year from a conversion margin perspective, we delivered strong topline growth and remain focused on overcoming the operational challenges.
We believe that the record backlog across our short cycle products, coupled with the expected realization from higher pricing have positioned us to deliver net sales and adjusted EBITDA growth in 2022. Additionally.
Additionally, we are nearing the completion of our three large capital projects, which we expect to drive gross margin benefits once they are up and fully running <unk>.
I am confident that we are in a great position to accelerate our strategies and improve our culture of execution as we become a world class water technologies company, bringing solutions to critical water infrastructure with that I'll turn the call over to Marty to discuss our 2021 fourth quarter and full year results.
Thanks, Scott and good morning, everyone I Hope you and your families continue to be safe and healthy I will start with our fourth quarter 2021, consolidated GAAP and non-GAAP financial results, then review our segment performance and finish with a discussion of our cash flow and liquidity.
During the fourth quarter, we generated consolidated net sales of $295 6 million, which increased $33 million or 11, 4% as compared with fourth quarter last year.
The increase was primarily a result of increased shipment volumes and higher pricing at infrastructure.
We generated a 10, 8% increase in consolidated net sales when compared with the fourth quarter of 2019, which preceded the pandemic, reflecting improved end market demand our.
Our gross profit this quarter decreased $7 6 million or eight 1% to $86 $3 million compared with the fourth quarter. The prior year, yielding a gross margin of 29, 2% gross margin decreased 620 basis points compared with the prior year.
Higher pricing at infrastructure and increased shipment volumes were more than offset by continued higher inflation and unfavorable manufacturing performance, which includes the impact of labor challenges supply chain disruptions and our plant restructuring.
Our total material costs increased 18% year over year in the quarter, primarily driven by higher raw materials, which increased sequentially and year over year.
Our primary raw materials, our scrap steel and brass ingot and prices of both were up over 50% year every year, while our price realization improved sequentially our price cost relationship was negative for the third consecutive quarter.
Given the acceleration of raw material pricing in the quarter the price cost relationship did not improve as much as anticipated due to the level of inflation.
Scott will discuss the drivers of the decrease in gross margin versus expectations in more detail later in the call.
Selling general and administrative expenses of $56 6 million in the quarter increased $4 $5 million compared with the prior year.
The increase was primarily as a result of investments, including the <unk> water acquisition.
<unk> activities and personnel related costs, the reversal of temporary TNA savings relating to the pandemic and general inflation.
SG&A as a percent of net sales was 19, 1% in the fourth quarter compared with 19, 6% in the prior year.
Operating income of $27 8 million decreased $12 9 million or 31, 7% in the fourth quarter compared with $40 7 million in the prior year.
Operating income includes strategic reorganization and other charges of $1 9 million in the quarter, which primarily relate to our previously announced plant restructurings.
Turning now to our consolidated non-GAAP results.
Adjusted operating income of $29 7 million decreased $12 1 million or 28, 9% as compared with $41 $8 million in the prior year quarter.
Higher inflation unfavorable manufacturing performance and higher SG&A expenses more than offset higher pricing and increased volumes at infrastructure adjusted.
Adjusted EBITDA of $45 $6 million decreased $12 million or 28% leading to an adjusted EBITDA margin of 15, 4%, which is 630 basis points lower than the prior year.
For the full year 2021, we generated adjusted EBITDA of $203 6 million, which grew six 8%, yielding an adjusted EBITDA margin of 18, 4%.
Interest expense net for the 2021 fourth quarter declined to $4 $4 million as compared with $6 million in the prior year quarter.
The decrease in net interest expense in the quarter, primarily resulted from lower interest expense as a result of the refinancing of our senior five 5% notes with senior 4% notes.
The effective tax rate this quarter was 24, 3% as compared with 24, 8% last year.
For the full year, our effective tax rate was 25, 8% as compared with 23, 5% for the prior year for.
For the quarter, we generated adjusted net income per share of <unk> 12.
Compared with <unk> 17 in the prior year.
Turning now to segment performance, starting with infrastructure infrastructure.
Infrastructure net sales of $271 $9 million increased $29 9 million or 12, 4% as compared with the prior year, primarily as a result of increased shipment volumes, particularly of our hydrant Iron gate valves service brass and repair products and higher pricing adjust.
Adjusted operating income of $46 2 million decreased $10 6 million or 18, 7% in the quarter as higher inflation unfavorable manufacturing performance and higher SG&A expenses were only partially offset by higher pricing and increased volumes.
Adjusted EBITDA of $59 $3 million decreased $10 $3 million or 14, 8% leading to an adjusted EBITDA margin of 21, 8% for the full year adjusted EBITDA margin was 25, 2%.
Moving on to technologies Technologies' net sales of $23 $7 million increased one 7% as compared with the prior year, primarily as a result of our acquisition of <unk> water.
Organic net sales declined slightly compared with the prior year as higher pricing was more than offset by lower volumes adjusted.
Operating loss was $4 3 million as compared with adjusted operating loss of $2 3 million in the prior year.
This increase was primarily due to unfavorable performance, including inventory adjustments increased expenses associated with our acquisition of <unk> water and higher inflation, which were partially offset by higher pricing.
Technologies adjusted EBITDA was a loss of $2 4 million as compared with adjusted EBITDA loss of $200000 in the prior year.
Moving on to cash flow net.
Net cash provided by operating activities for the year ended September 32021, improved $16 4 million to $156 $7 million, primarily as a result of the $22 million Walter energy tax payment in the prior year or.
Our net working capital as of September 32021 decreased $11 $3 million to $207 1 million.
Net working capital as a percent of net sales improved to 18, 6% compared with 22, 7% primarily as a result of better inventory turns.
We invested $16 6 million in capital expenditures during the fourth quarter, bringing the year to date total to $62 7 million as compared with $67 $7 million in the prior year. The decrease in capital expenditures for the year, which was below our updated guidance range was primarily due to the supply changes.
Eruptions that has slowed the pace of some planned expenditures, including spending for our large capital projects free cash.
LOE for the year improved $21 4 million to $94 million and exceeded adjusted net income at.
At September 32021, we had total debt of $446 $9 million in cash and cash equivalents of $227 5 million at the end of the fourth quarter, our net debt leverage ratio improved to one one times from one three times at the end of the prior year.
We did not have any borrowings under our ABL agreement at year end, nor did we borrow any amounts under our ABL during the year. As a reminder, we currently have no debt maturities before June 2029, our senior 4% 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 September 32021 data, we had approximately $158 $7 million of excess availability under the ABL agreement, which brings our total liquidity to $386 $2 million. In summary, we continue to have a strong flexible balance sheet with ample liquidity and.
Capacity to support our capital allocation opportunities.
Scott back to you.
Thanks Marty.
I'll touch on our fourth quarter results, New management structure and Merck is in full year 2022 guidance after that we'll open the call up for questions.
As mentioned earlier, there were a number of challenges during the quarter, which impacted our gross margins and led to the disappointing adjusted EBITDA conversion, which was below our expectations for gross margin gap was approximately $15 million with the labor challenges, making up more than one third of again.
Our inflation freight and electricity costs per board also accounted for more than one third of forget.
What are the other factors the operational challenges for our specialty valve product portfolio <unk>.
Largest impact along with unfavorable inventory adjustments.
The labor challenges have led to an increase in costs associated with overtime benefits and efficiencies. We provided additional performance incentives for team members at the plants recognizing their hard work and dedication throughout this exceptionally challenging operating environment.
Additionally, the pandemic continues to pose labor challenges for us even with the progress made with vaccinations <unk>.
<unk> are working closely to continue to improve our relationships with our employees.
Hence our efforts around hiring training and retention.
Raw material inflation continued to be a headwind during the quarter, we experienced another sequential increase in raw material inflation, resulting in scrap steel and brass ingot prices up over 50% versus the prior year.
Raw material prices didn't start to accelerate higher until the second quarter of 2021.
Therefore, we anticipate that raw material inflation will be most impactful in the first half of the year if prices do not continue to increase in the past we have been successful in executing price increases as needed.
To more than cover inflationary expenses over the cycle.
Pricing actions during this past year, which include three price increases across most product lines are helping to offset inflation as we saw a notable sequential increase on our price realization during the fourth quarter.
Unfortunately record backlogs are extending retiring for the realization of continued price benefits. So we do not expect to be in a positive price cost position on a quarterly basis until the middle of 2022.
At this time, we expect that our current pricing actions will more than cover anticipated inflation in 2022.
This belief assumes that material costs do not increase beyond current levels.
The strong demand we have experience has also led to some manufacturing inefficiencies triggered by the rapid increase in volumes, particularly in the second half of our year.
With the increased demand, we are having to run our foundries during peak periods, leading to much higher energy costs.
Apply chain disruptions have also led to higher freight costs and extended lead times for some third party purchase parts our.
Our supply chain teams have been focused on obtaining needed supplies on a primary basis been working to find alternative sources where possible.
While we believe our actions will put us in a better position to increased shipments to meet demand.
We anticipate the supply chain disruptions and labor availability, we will continue to be headwinds well into next year.
In the fourth quarter, the operational challenges, where even greater for our specialty valve product portfolio, which accounts for approximately 15% of annual sales.
These products are typically used in large projects with long lead times.
Due to a longer manufacturing and delivery times, the gap between material cost inflation and pricing improvements can be more than nine months.
Additionally, as a reminder, we announced a major plant restructuring project in the second quarter of 2021.
At that time, we were anticipating a different operating environment with strong demand and supply chain disruptions and labor challenges have impacted shipments for these products and increased the transition costs for our plant restructuring.
We remain confident that we will fully complete the transition and ramp up in 2023 with emerging benefits following accordingly.
We recently announced a new management structure, beginning with the first quarter of 2042.
The new structure is designed to increase revenue growth drive operational excellence accelerate new product development and enhanced profitability.
We believe that the new structure positions us for improved long term growth and increased margins, while helping to accelerate the commercialization of our technology enabled products Endocentric software platform.
The two newly named business units, our water flow solutions and water management solutions.
Water flow solutions product portfolio includes R&D fell specialty valves and service for us products.
Net sales of products in the water flow solution business.
We're approximately 60% of 2021 consolidated net sales within.
Within the water flow solutions business unit, we will advance manufacturing and assembly efficiencies across valve and brass products, while driving the expected benefits from our three large capital projects. Additionally, we will look to increase growth and existing product areas and support experience or the valves into adjacent markets.
Water management solutions product and service portfolios include fire hydrants repair and installation natural gas metering leak detection pressure control and software products.
Net sales of products of the water management solutions business unit, where approximately 40% of 2021 consolidated net sales.
Within the water management solutions business unit, we look to leverage our hydrants, which provide a bridge for digital communications throughout the water system with enhanced coordination among products and services also we plan to reduce product development cycle times with enhanced coordination of digitally enabled products and network management.
Turning to our end markets.
We again experienced strong demand and order growth in our fourth quarter, driven by both new residential construction and municipal repair and replacement activity.
While we expect end markets to remain healthy in 2022.
We do anticipate that growth will slow down relative to the strong recovery we experienced during 2021.
State and local budgets appear to be in good shape, especially at the larger municipalities.
The aging water infrastructure will continue to be a driver of repair and replacement activity at water utilities.
We were pleased to see that the federal infrastructure Bill was passed over the weekend.
It is an important step forward for the needed investments in our aging water infrastructure we have.
Have not built any benefits from the bill and through our assumptions for our 2022 guidance.
While we expect residential construction activity continued to be healthy relative to pre pandemic levels. We expect that it will be difficult to achieve significant growth again in 2022.
Residential construction activity was incredibly strong during 2021 highlighted by total housing starts increasing approximately 18% in single family starts increasing around 23%, we believe that supply chain disruptions, which are extending overall build cycles for new residential construction could support a healthy <unk>.
Land environment, well beyond 2042.
Moving onto our expectation for 2020 to the.
The record backlog across our short cycle products and the expected realization from higher pricing position us to deliver net sales growth in 2020 to continue.
Continuing with strong net sales growth achieved in 2020.
We believe the operating environment will remain challenging, especially in the first half of the year with the potential for gradual improvement during the second half of the year.
We currently anticipate that our full year 2022 consolidated net sales will increase between four and 8% with our adjusted EBITDA also increasing between four and 8% as compared with the prior year.
We expect to generate solid free cash flow during the year.
These expectations assume the challenges associated with higher inflation labor availability and supply chain disruptions and the pandemic impact will modestly improve relative to 2021.
Material costs do not increase beyond current levels.
Our focus remains on keeping our employees safe protecting our communities delivering exceptional products and support to our customers and generating strong cash flow.
During 2022, we will remain focused on executing our strategic initiatives and overcoming the external and internal operational challenges.
We are committed to improving our culture of execution as we become a world class water technologies company, bringing solutions to critical water infrastructure. We are excited about the progress we have made in our new product development programs and the growing market acceptance for digitally enabled product offerings, such as our Super security and smart hydrant.
Centric software platform in the ICU or pressure management solutions.
Additionally, we are making progress on our sustainability initiatives and we will share our strategic goals and progress in our second ESG report to be published in January of 2022.
With a strong balance sheet liquidity and cash flow, we are very well positioned to accelerate growth and efficiencies through capital investments and acquisitions.
We will continue to maintain a balanced approach to capital allocation investing in our business and returning cash to shareholders. We recently announced another increase to our quarterly dividend.
Marking the fifth increase since the end of 2016. Additionally.
Additionally, we repurchased $10 million of common stock during the fourth quarter after resuming our share repurchases earlier this year.
We currently have $135 million.
The remaining authorization on our share repurchase program.
That concludes my comments operator, please open this call for questions.
Thank you we will now begin the question and answer session. If you would like to ask a question. Please press star one on your <unk>.
Record your name and company clearly when prompted this information and just required to introduce your question. If you need to cancel your question for any reason you can press star two.
If you'd like to ask a question over the phone. Please press star one.
Our first question today comes from Bryan Blair. Your line is now open.
Thanks, Good morning, everyone.
Good morning, Brian Good morning.
So you covered the headwinds you faced at a high level and I'm, just hoping you could quantify.
The impact is of price costs supply chain delays labor specific challenges in the quarter and how youre thinking about each of those factors looking into the early part of your fiscal 'twenty, two and the impact on incremental progression.
Yes.
Well I think that the.
As a reminder, the updated annual guidance replied.
Lower.
Adjusted EBITDA conversion as compared with the prior guidance range that we gave for Q4, so I'll kind of try and do the delta to the guidance. We gave so net sales growth and a little bit higher slightly higher than the midpoint of our implied Q4 guidance.
The <unk>, 3% decrease in adjusted EBITDA compared with the midpoint of our implied Q4 guidance.
It was driven almost exclusively by the reduction in gross margin.
Challenges during the quarter that impacted our gross margin.
Let's call it $15 billion to keep it simple.
I would say that the labor challenges and their knock on effects.
The premiums paid for over time.
Attendance incentives all of those kinds of things as I said in my prepared comments, a little more than 33% of the $15 million.
Then when you get into the fact that we had the surcharges on freight we had surcharges on utilities.
And the higher inflation than anticipated.
That was a little more than a third as well. So those were the two big drivers and then let's call it.
<unk> Park.
Yes.
30% or whatever the math works out to 28%.
The biggest in there was that there was a lot of cats and dogs in there, Brian but I think the biggest one was.
The challenges faced in Kimball.
Both with hiring and ramping up.
A new plant at these higher demand levels.
I think our wanted and have always been lumpy.
Blogged about these things with you guys and so I'm not going to change I think one of the big drivers here is if we had our tieback.
We have accelerated the closure of salary and Aurora.
Sure.
In this kind of demand environment I think the answer is no we wouldn't have.
We had a different operating environment, we had a different assumption about how the specialty valve business would look we expected project work to actually contract.
And that's probably the biggest driver of when you look at this $15 million of headwind what did we get wrong I think it.
It comes back to the decisions we took when we did the lay offs. When we did the furloughs, while we accelerated the closures we were expecting very different demand environment.
That's all OSM will accept the responsibility for it.
Okay I appreciate all that detail.
You mentioned accelerating price realization in the quarter.
Was that figure for your fiscal <unk>.
And given carryover price from back half increases and assumes fiscal 'twenty two increases.
If you assume that there will still be above average level.
What price is contemplated in your plus 4% to 8% sales guidance.
Okay I'm sorry.
First we have already.
Price three price increases that we have announced.
The first price increase now is completely I think in our results. The second price increase is about 30% in our results and the forward price increase will start coming into our results.
This fall and beyond so if you look at where the backlog was when the timing of the price increases are what our ship rates have been.
We have <unk>.
Basically that third price increase.
That we announced in August completely tied up in our backlog.
So.
As long as we.
Get stable cost environment, we should start turning positive price cost.
In our fiscal Q3, so negative Q1, let's call it breakeven Q2.
And then positive Barton, yes, so when we when we taking what Scott said when we look at the Expo.
Expectations for full year, 2000 to 2022 and that assumes that.
Raw material and other costs don't increase from where we are we expect to be positive on price cost for 2022, but we wouldn't square as we always say over the full cycle, our expectations are to more than cover our costs and preserve margin don't expect at this point could be at that position in 2022.
Correct.
Okay understood.
You mentioned the infrastructure bills now having passed.
High level positive, but not factored into your.
Fiscal 'twenty two outlook.
Looking forward, how should we think about the impact on demand and potential catalysts for formula.
And thinking that for smaller municipalities.
The rate of <unk> adoption may increase.
Having that that incremental funding could be.
Similar game changing as we look to your fiscal 'twenty three 'twenty four.
Curious any insights you can provide there.
Yeah, So yeah, absolutely positive news.
Your question definitely you should see it as.
A tailwind for us in our forecast I think I do have some concerns there.
Given the machinations of the.
The federal government that followed the availability in 'twenty, two I think it could be.
Very very.
Aggressive.
I think the key areas, where the bill is there's 12 billion each for drinking water in Clearwater state revolving funds 15 billion for replacement of a lead contaminated drinking water infrastructure and approximately 10 billion to address emerging contaminants such as P. Fast.
And then there's another $50 billion outside of that that would go toward making the infrastructure system more resilient, including protecting it from droughts floods and cyber attacks that $50 billion has to be shared with the.
The electric grid.
I think that.
All in all that the Bill I think we'll address.
A lot of what's wrong, what I, particularly like about the bill.
Which I don't believe that these incentives I think they moved demand around generally and they don't create new demand and I think this bill may actually not do that I think as bill will actually make funds available to people, who will not be able to afford to invest and so those both communities that have a declining population and perhaps have a declining.
Average income in real dollars that we're going to be strapped to maintain their system I think up in the upper Midwest thinking the parts of the northeast and the old Rustbelt.
Those communities are going to be able to access the farms faster than.
Anybody else and they will qualify quicker so if youre in a community that has growing population growing income for your base is increasing your rate is increasing it.
There will be more difficult for you to access some of these volumes, but if youre at all void.
<unk>.
Community, that's that's kind of fallen on hard times I think you will get some renewal dollars for your infrastructure that you otherwise would not have been able to afford it so I feel pretty good about that.
Remind everybody, it's an eight year timeline, all the investment cycle and I expect it'll be a little slower in the beginning and then the investments will ramp up in the middle years.
Okay I appreciate all the color. Thanks again.
Thank you.
Our next question comes from Deane Dray with RBC capital markets. Your line is now open.
Thank you and good morning, everyone.
Good morning, Good morning, Hey, I appreciate all the specifics and being able to size the headwinds on the inflation and supply chain.
And so forth can you give some color about how the monthly cadence of this progressed in the quarter because it really does seem like it got away from you more.
More so than other companies that we cover.
I appreciate how frankly of giving the specifics, but maybe just yes.
How much did this kind.
Kind of catch you by surprise was it.
Last month in the quarter event, maybe some some color there please.
Yes, so just to give everybody. Some idea if you look at the inflation curve that we've experienced for the year.
Almost half of our full year inflation happened in the fourth quarter.
So I think we will.
We will see that it was like 49% of all inflation for the year happened in the fourth quarter and then as we pressed into the final two months of the quarter that is when our labor problems had been exasperated exacerbated.
And I'm going to tell you that that.
That is probably something that we should have caught wherever you are running as much over time as we are right now when you're in the dog days of summer and you go through June and July.
August September time frames.
That's when you should probably have anticipated.
The absenteeism ticking up as it did but that certainly wasn't in our wheelhouse, we had thought that.
Our attendance would be kind of flat being so yes more of it back loaded in the quarter certainly inflation has been.
<unk>.
In the last half of the year and the vast majority of it in our fourth quarter. When you look at our performance our manufacturing performance.
Basically.
All of it was lost in the last two months. So we were basically at breakeven so the pluses.
Material savings.
<unk> projects capital projects implementations were kind of fighting off some of the increased costs and inefficiencies associated with the pandemic. During the first nine months of the year than in the fourth quarter.
The labor driven the shortage driven the fact that we were in our utility peak periods.
Basically.
Drove our manufacturing performance for the year negative alright, Thats really helpful and give us context about kind of what real time, what's happening and it's clear look every time Scott you've spoken during the course of the whole COVID-19.
Era, if you want to call that.
You've been upfront about what youre doing for your employees and incentives.
We fully appreciate that.
The efforts that you've gone there.
Just the idea on the hedging of materials I mean, those are big numbers on steel and brass can you remind us how your hedging.
And I don't mean financial hedges, but are you doing pre buying how much is locked in in the current quarter.
And that would be helpful.
Yes, so we buy our ingot forward as far as our backlog goes.
So.
Ill give you. An example, if you've got 3 million pounds on backlog.
Then we try to have 3 million pounds of purchases out there, it's actually less than that because we rebuilt our chips, but.
Those numbers. Unfortunately, what's happened in a couple of other markets, including the scrap market as availability from the supply base to get that many pounds forward has been.
Has been difficult and so I think right now we're a quarter forward our brass, but we still have exposure on scrap steel because theres just not enough scrap steel.
Out there that we can that we can acquire and the shredders in the <unk>.
Cutters or not or not.
Accepting orders beyond what they have because they don't know what their inbound is.
Okay.
Alright, that's helpful and just last one since you brought up backlog.
Not typically see a bigger backlog build in your shorter cycle.
Businesses do you have the ability to reprice on the backlog and is there any kind of past due backlog number you could share.
Yes, so we don't really have the ability to reprice the short cycle.
Product backlog and so that's what the price increases get announced they have their forward by window.
They've take advantage of it I think.
Philosophically I'm not I'm, not making your market announcements here, but philosophically I would like to find a way that while the backlog is above I'm, making this up say ex days.
That.
When we announce a price increase there will be no pre buy period that it will be pricing effect that type of ship that has not been done that's something we're kicking around with our channel partners right now, but to announce a fourth price increase here.
In the next few months and then have the.
Pre buy simply drive everything out again, I think we'd be a pointless exercise.
And so.
We're looking to see what we can do to change during these circumstances.
In general.
Very little to do on the brass.
Dave valve and hydrant fraud, when we have.
When we have fixed price agreements and the 30 day window for them to change their systems and Thats something I would like to just comment on a bit for everybody is that look part of the pre buy window is not just to move demand around it's also if you could imagine a customer with five or 600 branches.
Needing to get all of their systems updated so that they have coordinated by information time, it affect things like that so that they could scrub their existing contract commitments.
It's difficult for them to just wake up one morning, and say, okay. The prices are up.
Yes, we absolutely appreciate that.
The complexities of the timing on price increases and the obligations you have your channel partner so.
I appreciate that additional color and just last one it's not a question just a comment we really do like the new <unk>.
<unk> Mentation makes all kinds of sense. So congrats on making that move it hopefully Marty has lots of restatement quarter lease for us because that's a big help.
Yeah. Thank you. Thank you.
Our next question comes from Brian Lee with Goldman Sachs. Your line is now open.
Hi, This is miguel on for Brian Thanks for taking the question.
On an.
Adjusted EBIT adjusted EBITA margins they were down this quarter and then and then the midpoint of your guidance suggests flat adjusted EBITDA year over year. So just a couple of questions to start on a on supply chain and inflation and labor and also just the timing on price realizations. Each quarter can you talk through how you expect each of these two.
Evolve over next year and then based on the visibility you have was this quarter sort of the bottom or how should we think about when we start to see some of these things get better and then you.
You start to see a rebound in margins and then I have a quick follow up thank you.
Yes, so generally I would say as we're looking out over our 2022 I think a lot of it goes back to the discussion in and around the price cost relationship.
We've referenced what we've seen in terms of price increases for raw material and other material costs. So our expectation is as we go into 2020 to.
That will be a <unk>.
Tougher curve because if you remember we really started seeing the price increases coming around our second quarter of 2021. So we think will have the toughest comparisons in the first half of 2022.
Proving that price.
Cost on a quarterly basis.
And.
Again with the assumption that material cost increase beyond current levels and with the pricing actions that we have taken to date.
We do expect that will cover.
The inflation expected material cost inflation in 2022.
Great. Thanks for the color and then just one more if I could if I could squeeze it in and I'll pass it on.
To what extent if any have you seen maybe any demand being pulled forward ahead of price increases in and if so should we expect maybe a stronger early part of.
Fiscal 2022 versus typical seasonality.
Yes, I think that there is some expectation that Q1 will be which is.
The tapering of the construction season.
January quarter, probably being the slowest but there.
There will be some.
Production going back into the channel.
It probably.
We will alter some of the seasonality of the business. So I think that's something we can expect but as far as the.
Sure.
Inventory in the channel.
It's really tumultuous right now like if you look at the people who've reported their inventories are up.
But if you talk to the middle of a lot of them have inventories up simply because.
Kind of having logistics problems for instance, I'll give you an example might be a much longer lead times than the valve and the hybrids and so they're they've got a contract for a job.
Product day comes in they're still waiting on product be the contractor doesn't want it until they can have an install youre not going to put pipe in the ground without valves are going to put valves on the ground with our pipe. So.
They've got a lot of that kind of going on in the channel right now, but I do believe in general.
While inventories are up demand is up enough that when they get some of these logistics levels sorted out we expect that they would still be in a need for material and their inventory that is to say that they are under inventory given their contract obligations. They have currently.
Okay. Thanks, a lot for the extra color I appreciate it.
Our next question comes from Joe Giordano with Cowen. Your line is now open.
Hey, guys good morning.
Good morning, Joe.
So and we've kind of asked this a bunch of different ways, but if I look at your revenue guidance for next year.
How much of that do you think you hit from just price capture alone. So I guess I'm trying to understand what's the implied volume growth next year.
On that like 48%.
I think you could think of it as kind of a.
About half.
And then the balance economics, whether it's price or.
Price inflation.
Okay.
Fair Thats, what were trying to get at.
And then.
While we have seen in the last quarter here has generally been the advantage of being vertically integrated as a company because youre not getting stuck with eye component parts and things like that so that's what I think maybe just a little more surprising.
I understand that some of the restructuring actions are kind of.
Created that issue, but maybe you could talk to what gives you confidence in.
The leverage inherent.
Inherent in your production base given.
High demand is when you'd want to have that kind of set up right and you got it.
Electricity charges and stuff so.
<unk> is going to ramp down a little bit.
Just talk about what the leverage is in your system.
So I do think we're going to be able to react better I do think that we are going to be in a position, even with 11, 4% growth thats, probably going to be better than anybody who isn't vertically.
Integrated because.
There are problems associated with.
The supply chain, if theyre getting their castings from Poland, or they're getting them from China or whatever they're going to have these.
These huge.
Delays just like our specialty business is experiencing right now.
Let me back up.
I'm not big on cell flagellation, but let's let me say something I said earlier, if we had if you.
You were to take this apart and say how could we have not experienced some of this $15 billion of headwinds we had in Q4 I would put almost half of our problems.
At the feet of the decisions, we took when the pandemic started and we did the layoffs and we did the furloughs and we've clamped down on planned spending and we reduced inventories and we did all of those things to protect liquidity and.
It is useful as a management team to sit down and say, okay. What did we do right. What did we do wrong I think that was the wrong call. If we had known the demand environment, we're going to see.
I wouldn't have laid off a single person.
Because.
A lot of those people that we did lay off went and got other jobs and now we're scrambling for labor and skilled labor to boot that has made us.
You don't have some problems here so as we work through that as we get these temps up to speed.
What theyre, making I believe that our leverage on volume.
Yes, we will still have to pay freight surcharges, yes, we will still have the utility surcharges, but I expect a lot of the let's call them.
Transitory expenses that we had in the fourth quarter of that $50 million I expect them to go away.
And even if it's.
40%.
That go away immediately we will get that lift.
And then we get the lift on the on the fact that we're getting higher than normal Q1 volumes as a result of the strength of the backlog and so yes, I have confidence that we will be in a better position than everybody else.
Who is dependent on third party supply.
Further castings and for their for their assembly and so I do think we have leverage in front of us and that's why.
We came out with guidance that we feel like it's.
Something that we can achieve.
Do you worry at all that there is structural labor issues and I know you have some of your facilities and fairly remote areas are there.
Structural problems with the labor supply for an extended period is there any worry about that.
Yes, I do think so I mean, I am worried about it but I think that.
No.
We have good jobs, there union representation.
Labour challenges have led to an increase in costs associated with overtime benefits and efficiencies I think the pandemic continues to pose the labor challenges for us even with the progress made with vaccines I think these osha rules.
Some of those things as well.
Not helpful.
And trying to say here is what the labor pool looks like I think there's people on both sides of the aisle, saying I am going to get back in the workforce, where I'm not going to get back in the workforce.
At these elevated demand levels, our absenteeism remains a challenge because we are working people I think too much and not getting people in the front door fast enough.
So, yes, I am I am concerned about it but I would also remind everybody that labor is a relatively small piece of our cost of goods sold.
As a result, even if I had to grow 10%, 20% premium at current levels I still think it would be well worth it economically to make sure. We've got people in the door to make the product.
Because the payoff is so much higher our problem.
When you get down to the materials and things like that that that came in I think our greater risk to our financials would come from.
Another shock the world economy that drove.
More inflation and I am concerned that you go in you spend $1 two trillion dollars over eight years.
We've got a lot of money in.
Creation right now in the system that we could have a little lingering effects from inflation that I think thats, probably a bigger risk than the labor risk I think the labor risk as a short term risk.
Thanks for the color.
Thank you.
Our next question comes from Walter Liptak with Seaport. Your line is now open.
Hi, Thanks.
Good morning.
Good morning.
I wanted to ask about.
You guys called out the buyback a couple of times during the presentation, then pointed out to us the authorization is there a.
Kind of a balance that youre looking at with the share repurchase versus M&A.
Should we read something into that or are you just pointing that out.
This is pointing it out I think we've been really consistent with our capital allocation philosophy.
I think that we've said for years now we want a balanced approach.
Between returning cash to shareholders between our capex programs in between acquisitions.
I would say it.
It's an old volume business, but getting into technology.
Starting the digital transformation in the business I think there is lots of opportunity to invest back in the business I think we've shown that we're doing that with the increases in dividend and the share buybacks. If we want to remind everybody that we continue to.
Returning cash to shareholders, so not a signaling.
Comment at all just simply reminding you all that.
Our philosophy around a balanced approach to capital allocation hasn't changed.
Okay great.
All of our companies are getting hit by this inflation labor issues supply chain. So it's.
Nothing new to us, especially this late in the quarter.
Seems to be.
Stable stabilization going on.
My question is when you were looking at the guidance it looks a little bit on the conservative side.
I mean, what could go well in your view that.
That might make the 2022, a little bit better than expected.
Well I wouldn't call it conservative.
I would say, we're being cautious given the given the current environment because there is still a great deal of uncertainty.
But certainly there are some tail winds out there is no question that depending on what happens with.
The speed with which infrastructure spending gets in place.
How communities with the there's still a lot of money in the municipal budgets as a result of the.
The work that was done in the cares Act piece I mean, if you go back three years ago, I think there is $50 billion assigned to.
Sure.
Municipalities and so I think that.
There are some some tailwind that they could find their way into making.
Drinking water in particular, a priority and that could have more infrastructure change out.
We also believe that.
The break fix pieces of business.
Good have some upside depending on what failure rates look like.
Going forward and whether they continue to accelerate or not so so there are some positives.
I wouldn't characterize the guidance as.
Conservative so much is cautious.
Okay, Okay fair enough.
And then the last one for me.
On the residential outlook I wasn't sure if I understood 2022 are you expecting volume growth.
In your residential products in 2022.
So we're expecting some more.
Modest amount of growth.
In the resi market as a result of what developments.
But there's I don't think there's enough capacity in the system to strip.
Terrific growth, we had last year I mean, I think we said that housing starts were up 18% single family homes up 23%.
Last year I don't think those kinds of numbers can be BRAF.
Be replicated I think that.
When we look forward.
It's about residential delivering additional growth beyond 'twenty, one levels with around 1 billion won.
Family starts I think where our model is.
Okay, Alright, great. Thank you.
Thank you.
As a reminder, if you'd like to ask a question. Please dial star one and record your name and company name when prompted.
Our next question comes from Zane Karimi with D. A Davidson your line is now open.
Hey, good morning, and thank you for taking my questions.
Good morning.
So first off a little bit around the technology solutions business are you seeing any challenges around getting chips or anything like that.
Are there any signs that.
That alleviating.
Yes, Great question, Yes, we are seeing difficulties, especially on the comm side of the business whether it would be.
On the on the sell chips or even the radio chips Center.
And our.
My node line so.
So far we've been able to meet demand with.
Aftermarket sourcing and.
Scouring the earth for different.
Distribution sources.
At a premium.
I think the supply chain have done a great job to find alternative suppliers.
We're right now focusing on alternative sources.
And those sources I think as we've been talking about for the last hour or so has driven some of the inflation that we've seen.
I expect those supply chain disruptions to continue.
And to be a challenge in 2022, but I believe we can continue to improve sales and technology enabled products and services based on the progress we made versus 2019 sales.
And I think that.
We've got.
We're going to have lots of challenges with sourcing, but I don't see it getting in the way of us achieving our numbers in 2022 I do not think we're going to see an easing and frankly I am concerned about the level of rhetoric that exists right now between the U S and China, which.
China has a lot of the chipset manufacturing.
There and so I think.
Sourcing from Taiwan, and Vietnam, and other places and it's something that we're going to continue to focus on as we go forward.
Okay. Thank you for that color and then I know, we've talked a bit about pricing today, but from an industry perspective are you seeing similar price increases from your competitors and I feel like historically, there hasn't really been any product substitution any reason to see that change or be different in the coming year.
Paul.
No comment on what our competitors are doing.
Nor by really aware of anything but I do think we have well developed markets for inputs. So we're dealing with the same inflation challenges of the competitive base and so.
I believe we operate in a rational market and expect everyone to adjust prices as they experienced significant increases in material costs and so I think that's been.
A hallmark of this of this industry and it's something I've been saying for five years I do believe we operate a rational environment as to what the specifics are.
Not really aware, but I do think the switching costs are such that.
Two or 300 basis point difference in price is not going to turn out.
Municipality, one way or the other unless they have their own design and we all have their tools.
Okay.
Okay and last one for me.
<unk> contribution.
Look compared to what you were expecting or hoping for this quarter.
So far I think we.
We're very very excited with the integration.
I think that where we are with the <unk> and <unk>.
I saw a demo just the other day of <unk> using the pressure control.
So we've got a beta out there right now and I think I'm excited about the progress. The team has made on the process of integrating software platforms for the North American market I think we have lots of synergy opportunities yet to exploit through.
To include pressure loggers to.
To provide data with the <unk> product connect that to <unk> and then.
Have better insights about whether something is a real leak or maybe even the shape. The leak I think theres a lot of promise around using AI to use pressure anacoustic data.
To characterize leaks more accurately better.
And so I think that the team is working diligently on that.
A couple of notes, though I think we have multiple pilots underway.
We have got the pressure controller that will allow you to.
Gary pressures in our pressures out we've got the pressure loggers, which will I think provide synergistic data with.
With ecological.
And we're right in the.
The application interface beats.
Between <unk> and <unk> and so I expect that.
2022 will be an important year for IQ always acceptance into the north American market, but all in all I would say it's.
Good progress adds for their contribution is so small.
It is currently.
A very small business.
Loss, making business, but that's not why we bought it we bought it because we wanted to get into pressure controlling and pressure monitoring along with the acoustics longer.
Thank you for the color.
Yes.
Okay. Thank.
Thank you.
Thank you operator look before I leave.
I think we've we.
We spent a lot of time.
Talking about the inflation I think the takeaways.
The cost side, certainly I hear what people are saying, but on the positive side I do think achieving the 11, 4% sales growth getting the units out the door.
Satisfying contracts and customer demands, making sure we remain as a service focused organization.
As in the end as important as making the money and so I do think that the $50 million of headwinds we experienced in the quarter.
Wish we could have avoided them absolutely but.
What I have not shipped something in order to.
I think our position in the market are number one fire hydrant positioning our number one gateway will position us all enhanced by.
The team's commitment.
To operations and to satisfy customer demand.
I like to think that given the strength of sales that we have that we had a very good quarter executing on the.
On the on the growth side and still have some work to do on the cost side, but all in all difficult, but please in quarter. So I'd like to thank everybody for joining us this morning, and operator with that you can close it up.
Thank you all for participating in today's conference you may disconnect at this time.
Okay.