Q3 2022 Mueller Water Products Inc Earnings Call
Okay.
Yes.
Yeah.
[music].
Thank you for standing by and welcome to the third quarter of 2022 Investor Relations Conference call. At this time all participants are in a listen only mode until the question and answer session at that time, if you'd like to ask a question. Please press Star then one as a reminder, today's call is being recorded if you have any objections you may.
Disconnect at this time I would like to turn things, we'd hope to your host VP of Investor Relations. Mr. Whit Kincaid. Thank you you may begin.
Good morning, everyone. Thank you for joining us on the Warner products third quarter 2022 Conference call. We issued our press release reporting results of operations for the quarter ended June 32022 yesterday afternoon.
Copy of the press release is available on our website you order products Dot com.
Scott Hall, our president and CEO and Mark <unk>, our CFO will be discussing our third quarter results and our current outlook for 2022.
This mornings call is being recorded and webcast live on the Internet.
We have also posted slides on our website to accompany today's discussion and to address forward looking statements and our non-GAAP disclosure requirements.
Binder, we have changed our management structure and segment reporting effective October one 2021.
We filed an 8-K in January that provided the recast historical quarterly results for 2020 and 2021 at.
At this time, please refer to slide two for slot.
Slide identifies non-GAAP financial measures referenced in our press release on our slides and on this call and discloses. The reasons why we believe that these measures provide useful information to investors reconciliations.
<unk> between non-GAAP and GAAP financial measures are included in the supplemental information within our press release and on our website.
Slide three addresses forward looking statements made on this call. This slide includes cautionary information identifying important factors that could cause actual results to differ materially from those included in forward looking statements. Please review slides two and three in their entirety. During this call all references to a specific year or quarter.
Unless specified otherwise refer to our fiscal year, which ends on the 30th September .
A replay of this morning's call will be available for 30 days at one 880 345839, the archived webcast and corresponding slides will be available for at least 90 days on the Investor Relations section of our website I will now turn the call over to Scott. Thanks Whit.
Everyone. Thank you for joining us for our third quarter earnings call. This quarter, we delivered record net sales with both water management solutions and water flow solutions contributing to the growth in the quarter.
We generated double digit net sales growth in iron gate valves specialty valves and repair and installation products.
Order levels remain healthy again, this quarter driven by end market activity and we ended the quarter with a record backlog.
As expected the growth in the quarter came primarily from the continued improvement in price realization across most of our product lines.
We are benefiting from the multiple pricing actions taken over the past year and we're pleased with the sequential increase in the third quarter.
While the improved price realization led to a sequential improvement in our adjusted EBITDA conversion margin.
Fourth quarter margin was below the expectations discussed on our last earnings call.
Many of the same operational headwinds, we experienced in our second quarter, including ongoing supply chain disruptions inflationary pressures in manufacturing performance.
Our teams are focused on improving production levels or the operational performance as we manage healthy demand and record backlog.
We expect continued benefits from improved price realization in the fourth quarter and will continue to execute initiatives to manage the operational headwinds, which I will discuss later in the call.
Now I'll turn the call over to Marty to review, our third quarter financial results.
Scott and good morning, everyone I will start with our third quarter 2022, consolidated GAAP and non-GAAP financial results. After that I will review, our segment performance and discuss our cash flow and liquidity.
Our third quarter consolidated net sales increased seven 3% to 333 point accumulation compared to the prior year with growth in both waterflood solutions and water management solutions for both segments higher pricing across most of our product lines was partially offset by lower overall volume.
Gross profit this quarter decreased six 7% to $98 $3 million compared with the prior year.
Gross margin decreased 440 basis points to 29, 5% compared with the prior year as the benefits from higher pricing were more than offset by higher costs associated with unfavorable manufacturing performance inflation and warranty obligations.
We increased our warranty accrual based on our historical warranty experience and costs, resulting in a $4 5 million dollar charge. Excluding this charge. The gross margin was 39%, which sequentially improved 100 basis points compared with our second quarter gross margin as we improved our price.
Nation.
Selling general and administrative expenses of $68 million in the quarter increased three 4% compared with the prior year.
The increase which was primarily driven by inflation and investments in personnel G&A trade show activity and professional fees was partially offset by foreign exchange gains.
G&A as a percent of net sales improved to 18, 2% in the quarter as compared to 18, 9% in the prior year quarter due to the leverage from higher sales.
Operating income of $36 $9 million decreased 13, 6% in the quarter compared with $42 $7 million in the prior year.
Operating income includes the $4 $5 million warranty charge as well as the strategic reorganization and other charges of $600000, which primarily relate to the previously announced plant closures.
Turning now to our consolidated non-GAAP results.
Adjusted operating income of $42 million decreased nine 9% compared with $46 $6 million in the prior year.
The benefits from higher pricing or more than offset by higher costs associated with unfavorable manufacturing performance inflation and SG&A expenses adjusted.
Adjusted EBITDA of $57 $8 million decreased seven 7% in the quarter, leading to an adjusted EBITDA margin of 17, 3% compared with 22% in the prior year.
Adjusted EBITDA margin improved sequentially by 100 basis points compared with 16, 3% in the second quarter for.
For the last 12 months adjusted EBITDA was $201 5 million or 16, 6% of net sales.
Net interest expense for the quarter declined to $4 2 million compared with $6 $8 million in the prior year.
Decrease in the quarter, primarily resulted from lower interest expense associated with the refinancing of our five 5% senior notes with 4% senior notes in May 2021.
The effective tax rate this quarter was 21, 1% as compared with 28% during the third quarter of last year, primarily due to benefits from R&D tax credits for the full year. We now anticipate our effective tax rate will be between 22 and 24%.
We increased adjusted net income per diluted share of five 6% to 19 cents in the quarter compared with 18% from the prior year.
Moving on to segment performance, starting with water flow solutions, which consists of iron gate valves specialty valves and service brass products.
Net sales of $195 $9 million increased 10, 7% compared with the prior year, primarily due to higher pricing across most of the segments product lines.
Iron gate valves, and specialty valves experienced double digit net sales growth compared to the prior year.
Volume decreased compared with the prior year as sales of service brass products were impacted by manufacturing inefficiencies.
Adjusted operating income of $38 $1 million decreased five 2% as higher pricing was more than offset by higher costs associated with unfavorable manufacturing performance inflation and SG&A expenses.
Adjusted EBITDA of $45 $7 million decreased 5%, leading to an adjusted EBITDA margin of 23, 3% compared with 27, 2% last year.
Adjusted EBITDA margin was flat compared with the second quarter.
Turning now to water management solution, which consists of fire hydrants preparing installation natural gas metering leak detection pressure control and software products.
Net sales of $137 $3 million increased two 8% compared with the prior year, primarily due to higher pricing across most of the segments product lines and the addition of <unk>.
Repair and installation products experienced double digit net sales growth compared to the prior year.
Volumes decreased compared with the prior year as sales of hydrant meters in control valves were impacted by manufacturing inefficiencies and the ongoing supply chain disruptions.
Adjusted operating income of $16 $5 million decreased 22, 5% in the quarter as higher pricing was more than offset by higher cost associated with unfavorable manufacturing performance inflation and SG&A expenses adjust.
Adjusted EBITDA of $23 $7 million decreased 16, 8% in the quarter, leading to an adjusted EBITDA margin of 17, 3% compared with 21, 3% last year.
Adjusted EBITDA margin improved sequentially by 220 basis points compared with 15, 1% in the second quarter.
Moving on to cash flow.
Net cash provided by operating activities for the nine month period was $25 million compared with $123 $3 million in the prior year with.
The decrease was primarily driven by higher inventory and payments for other current liabilities, including customer rebate income taxes and employee incentives.
Average net working capital using the five point method as a percent of net sales increased to 26, 7% compared with 25, 9% in the third quarter of last year, primarily due to the increase in inventory and receivables.
Inventories of $250 $9 million at the end of the third quarter were $21 $7 million higher than the end of the second quarter and $66 $2 million higher than the end of fiscal 2021.
For the nine months period, we have invested $36 $7 million in capital expenditures compared with $46 1 million dollar spent in the same period in the prior year.
Free cash flow for the nine months period was negative $16 2 million compared with $77 2 million in the prior year, primarily due to the decrease in cash provided by operating activities, partially offset by lower capital expenditures for the full year, we anticipate that free cash flow will be positive.
Additionally, during the quarter, we repurchased $5 million in common stock and have $110 million remaining under our share repurchase authorization.
As of June 32022, we had total debt outstanding of $447 million and total cash of $154 9 million.
At the end of the third quarter, our net debt leverage ratio was one four times.
We did not have any borrowings under our ABL agreement at the end of the quarter, nor did we borrow any amounts under our ABL during the quarter, our 4% senior notes have no financial maintenance covenants and our ABL agreement is not subject to any financial maintenance covenants, unless we exceed the minimum availability through.
<unk> holds.
Based on June 32022 data, we had approximately $167 million of excess availability under the ABL agreement, which brings our total liquidity to $315 $6 million we.
We have no debt maturities before June 2029, and continue to maintain a strong flexible balance sheet with ample liquidity and capacity to support our capital allocation priorities.
Scott back to you. Thanks, Marty I will discuss our third quarter performance and markets and updated expectations for this year.
After that we'll open the call up for questions.
The third quarter, we faced a variety of the same operational challenges that impacted our conversion margins in the second quarter.
<unk> included inflationary pressures higher costs associated with the ongoing supply chain disruption and manufacturing inefficiencies.
Inflationary pressures continue to be challenging, especially in relation to materials freight energy and labor are.
Painting raw materials and purchase cards remains a top priority for our teams as they work to be production schedules, while dealing with long lead times and price premiums.
<unk> of the scrap steel market have caused us to shift to a more expensive mix of steel at all here in order to get targeted materials.
<unk> is playing out in many of our purchase parts, where we continue to see log retards.
While we believe the decrease in commodity prices will eventually lower our raw material costs, we expect the benefits will take longer than usual to impact our conversion margins due to the magnitude of breath of inflation in this economic environment, we anticipate higher costs will continue into 2023.
On favorable manufacturing performance at our foundries was the primary reason for the lower than expected conversion margins in the quarter.
Our Chattanooga at Albertville, foundries, which purchase of energy from the Tennessee Valley Authority were both impacted by emergency loan curtailments.
Actions impacted melt capacity, which lowered production volumes for hydrants and valves.
GE downtime at our brass foundry indicator significantly impacted both capacity mid June this downtime decreased shipments for service brass products and led to waterflood solutions year over year decline in volumes.
We did experienced healthy order activity during the quarter and ended the third quarter with a record backlog for service brass products.
While we would typically be able to get the machines back in service of less than a week the supply chain disruptions continue to extend lead times for critical replacement parts.
To help address the backlog of approved lead times, we have increased our use of third party maintenance personnel and outsource it to achieve higher production levels.
Our teams also remain focused on completing our due brass foundry, which will eventually replace the existing properties.
Replacing the century old play out with our new state of the art facility that we believe will provide very lasting benefits.
New facility, which will use a new lead free brass alloy will increase capacity for Dolby receded and suddenly it will expand product development capabilities. The facility will help achieve many of our sustainability goals because it will lower energy usage per pound.
Reduce waste improve the product lifecycle.
Safety.
It will also provide cost savings relative to the current facility with enhanced productivity sourcing and product design capabilities.
While we have made significant progress with supply chain disruptions of labor availability challenges.
Pushed our construction completion date to the end of fiscal 2023 with a production part approval process extending into 2024.
We continue to anticipate that the three large capital projects. We have previously announced we will account for a combined 30 billion annualized incremental gross profit with all of our complete at a full run rate.
With a record backlog and healthy demand our teams are focused on maximizing production levels at our foundries.
These actions include adding shifts operating equipment and investing in inventory all to ensure that we have the material labor of machines to increase production and improve delivery times to.
To support our efforts we have proactively invested in our hourly production team members by working with us prior to contract renewals to.
To help address the impact of inflation that workers are experiencing we are implementing wage increases for union argued hourly production teams.
While these labor investments will add near term pressure to our margins. We believe our teams can deliver improvements of 2023, which will profit from the continued price realization more manageable inflation and improved operational performance.
Additionally, we continue to monitor the overall inflationary environment closely and we will take price actions as needed to help offset the ongoing cost pressures from materials labor and supply chain disruptions.
I will now briefly review our end markets and updated outlook for 2022.
As mentioned earlier order levels remain healthy during the quarter.
We believe municipal repair and replacement and market activities remained very strong.
Overall, the market continues to benefit from healthy budgets, especially larger municipalities. As a reminder, we estimate that approximately two thirds of our debt sales are related to repair and replacement activities of utilities, providing resiliency for our business.
The infrastructure Bill with $55 billion of new phones dedicated to water wastewater and storm water infrastructure represents the highest level of federal spreads since the mid seventies.
While there appears to be a high level of interest in the infrastructure Bill for municipalities. There is a process, mostly driven by the states to access the body that has the offer directly earmarked by the bill.
We don't anticipate any benefit this year I believe benefits for next year could be limited due to ongoing supply chain constraints and labor availability challenges that could impact the timing of projects we.
We expect that beyond that time period, we should benefit from the infrastructure build spending.
For the new residential construction end market, specifically lot land development activity, we believe that demand continued to be healthy levels during the quarter.
However, based on the most recent monthly housing start data and other data points. The increase in interest rates is contributing to slower new residential construction activity. We continue to anticipate that this will lead to lower levels of law and land development activity we.
We expect activity will slow for the rest of the year relative to <unk> levels during the pandemic.
Low inventory.
Demographics and population shifts suggest that we could return to normalized activity that is above pre pandemic levels.
Due to strong municipal demand levels, we believe our lower level of new residential construction activity could help municipal repair and replacement activity given challenges with labor availability for construction.
Moving on to our updated outlook for 2022.
With one quarter Rebating, we're pleased to be on track to deliver our second consecutive year of double digit consolidated net sales growth for.
For the full year, we are narrowing our pure forecasted range for consolidated net sales growth to be between 11, and 12% as compared with the prior year.
This forecast takes into account the current expectations for orders price realization at the end market demand.
We expect to benefit from improved price realization to continue with the fourth quarter, resulting from our multiple price increases we have already announced we also anticipate that our conversion merger in the fourth quarter will be lower than previously anticipated.
Early due to the operational challenges previously discussed.
As a result, we now expect adjusted EBITDA will be comparable to the prior year.
Looking beyond 2022, we anticipate delivering better conversion margins with improved operational performance and higher price realization from pricing actions, we've already taken.
With the ongoing economic uncertainty, we will benefit from our strong flexible balance sheet and our disciplined and balanced cash allocation strategies, we will continue to reinvest in our business as appropriate and return cash to shareholders through our quarterly dividend.
Share repurchases, we have repurchased $35 billion of common stock over the last 12 months, including the $5 billion were purchased in the third quarter, and we have $110 million related under our share repurchase authorization.
At closing water utilities faced many challenges, including accelerating aging infrastructure climate change and favorable demographics workforce demographics.
We have a broad product portfolio, primarily serving the drinking water network that is well positioned to benefit from a strong municipal demand environment, our product development operational and commercial strategies are focused on capitalizing on key trends in water.
The accelerating adoption of technology enabled products and increased demand for products that qualify for the American iron and steel and build America buy America requirements, but most important priorities for our teams are to execute our operational improvements and deliver the benefits from our ongoing capital of vessels.
In conjunction with a favorable municipal Ed bucket and continued price realization, we expect to deliver sales and adjusted EBITDA growth in 2023, MBR and with that operator. Please open this call for questions.
Thank you as a reminder, if you'd like to ask a question. Please press Star then one remember to mute your phone and record your name clearly when prompted if she'd like to withdraw that question you May press star two.
Our first question comes from Bryan Blair with Oppenheimer. Your line is open.
Thank you good morning, everyone.
Good morning, good morning.
Yes.
Okay, and given your record backlog and order momentum in your fiscal <unk> growth seems pretty locked in barring major disruption I assume the same goes for early 'twenty three.
And maybe offer a little more color on the puts and takes as market activity and demand drivers.
As we look forward for municipal repair and replace.
Creating new construction respectively.
Yes.
The net price realization of expected.
<unk> improved sequentially, which is really the driver in growth in our Q4, we would expect.
Some more.
But as it relates to <unk>.
Orders in the future.
The backlog at a record level.
Q3, I think is a bigger function to all throughput at the plants.
We had opportunity to.
To ship more and so.
Answer the question directly I expect of improving environment from a volume performance.
Backlog is there to support it I believe that the mix of price will contribute to that growth in demand.
But I think the biggest driver is the muni budgets remain extremely strong.
I think that the larger municipalities as I mentioned in my prepared remarks, Brian have in front of them.
A pretty large menu of projects.
Okay understood.
I guess to level set a little more on the.
And the margin pressures that your team has faced in recent past can you maybe isolate the impact of <unk>.
Price versus material cost than parse out the headwinds from unfavorable manufacturing performance in Q3.
Compare that to the second quarter and then.
Can you walk us through how your teams thinking about these variables in that.
Timeline to more normalized conversion margins going forward.
So yes. So overall, we did continue to see strong price realization.
This quarter, probably that slightly improved sequentially from the second quarter and.
Up close to double digit that did more than cover.
Inflationary expenses that we experienced this quarter.
The real pressure there.
<unk> from the unfavorable manufacturing performance.
That we saw as well as the continued supply chain disruptions.
Some of the challenges during the quarter some of our foundries, where we purchase energy from the Tennessee Valley Authority, we're impacted by some emergency loan curtailments and that impacted our melt capacity.
But the main driver that we talked about was the machine downtime at our century old brass foundry, which limited our pounds of production.
And what that contributes to us we ended up with sort of inefficient.
Labor.
As well as overhead inefficiencies when the machines are down our materials arent in place et cetera.
A lot of that impacted the shipments of our service brass products and that was one of the key drivers of the year over year.
Volume decline that we experienced.
Say looking out we have got a number of initiatives.
To address the equipment failures.
We have increased our use of third party maintenance personnel.
Well as we've engaged in outsourcing for certain products.
Help with the availability.
Certainly longer term.
Once we get our new brass foundry coming online that we think that will help. Additionally, I would say as we as we look.
Al.
And to our 2023, I think as Scott talked about with what we've got.
Backlog and outlook for the municipal segment.
We've got.
Opportunity as we look into 2023.
For improving margins.
Okay all helpful color.
Thanks again.
Sure.
Thank you.
Thank you and our next question comes from Deane Dray with RBC capital markets. Your line is open.
Thank you and good morning, everyone.
Good morning.
Okay.
Continue that line of question just trying to reconcile.
Yeah, what came up in the third quarter.
Was the tipping point in terms of saying you've got a lower EBITDA guidance.
Supply chain kind of didn't change it's still it's a big.
A big headwind, we get that same thing unemployment inflation, so and Marty just to clarify it sounded like it was the manufacturing inefficiencies at the foundry was more of the tipping point.
That youre in.
Not going to make up that EBITDA shortfall.
To hit your guidance is that fair.
Yes, I think Thats fair.
And I'll turn it to Marty, but I want to everybody on the call to understand.
It was basically brass product in every product we make so if you think about a gate valve theres brass components and it is if you think about our hydrants brass components of it.
The brass foundry downtime I think was the tipping point for.
Looking at the rest of the year and certainly we're experiencing.
Downtime issues with <unk> and things like that it as we speak.
And so what does that force you to do once once you have that supply problem, yes, the service price sales as part of it but it forces outsources of components.
Four four gate valves and for hybrids as well.
And those were the that was the biggest driver as we thought about providing insight for investors and that is what we think will happen in the fourth quarter.
That really made us reevaluate.
We're assuming in our fourth quarter.
We will have.
Some outsource supply chain issues.
Through the fourth quarter as we as we work through these equipment issues of the indicator prouder.
So when you have the new foundry in place.
How much of these operational manufacturing inefficiencies go away.
Alright, I would say all of them because the reality is is that things like our.
Our perform machines in cores and things like that are all data on equipment.
<unk>.
Both you and I, So I think.
A lot opportunity, yes, there is opportunity for them.
Improvement.
We got to go tour the progress on the new foundry.
Last month.
I think I think that's going to be.
A step change improvement both from a worker environment of the throughput capability.
Early warning detection systems.
The availability.
City of machine data for four running machine learning things like that I think they are all.
Really really positive.
Cited to get it opened.
Looking for ways to try to accelerate the paper process. So that we can.
Ill get there sooner, but we are facing the headwinds associated with contract labor and.
Facing the headwinds associated with the supply chain of getting all of the parts for the new prouder yet.
Alright that part is really helpful and thanks for that additional color.
Just to clarify on the cut in Capex, what projects or initiatives are getting pushed.
I'd say overall in terms of looking at the the lower guidance on Capex I think some of what we have has seen as just some.
Project delays some of that is coming from supply chain disruption.
A portion of the <unk>.
Spending for the new Decatur Brass foundry, you got a portion of that.
Pushed into our 2023 and I think additionally, some of the delayed projects are.
As a result of the teams focusing on some of the operational challenges. So I think that's certainly one of the reasons. Additionally, as we continue to look at.
The various.
Capital project opportunities, we have elected to de prioritize some of them going forward.
Okay and then.
Last one on the warranty charge, so what triggered it.
Are there particular products.
And is.
I just wanted to get a sense of how broadly this covers.
The warranty experience that you've had.
Yes, so with respect to the warranty charge it relates to the sales of our metering products and just as a reminder, that as part of our water management solutions segment, and what we do on an ongoing basis as we monitor and analyze our warranty obligations periodically and.
Revised any accruals as necessary.
We did increase our warranty accrual and that was primarily due to the historical warranty experience on certain products as well as some higher product replacement costs.
Has there been any noticeable claims experience is there is this the first of many or is this more routine just based upon.
Whatever time period you're.
Account and say that you are supposed to.
<unk> that.
That reserve.
Yes, so what I would say it was the warranty period I would say generally within the industry tends to be very long, we do review them regularly and.
It's an estimate that we have based on that.
Judgment with the best information, we have available at the time, so as we get more information experience will evaluate an update.
Estimates and adjust as appropriate and that was what we did this quarter. Okay. Thank you.
Thank you. The next question comes from Joe Giordano with Cowen Your line is open.
Hey, guys good morning.
Good morning.
So just wanted to like take into next year.
The foundry gets pushed.
End of 'twenty, three Hartford roll into 'twenty for now.
What gets better from a just from a margin for like manufacturing productivity types setup.
What is under your control to get better into 'twenty, three and what offsets that by delays and the push out of the project.
Yes.
Think that.
Certainly not withstanding the highly uncertain economic environment, given the interest rate.
Great rises in the supply chain disruptions.
We acknowledge Jim or believes that.
We are growing inflationary pressure was offset by the monetary policy the photos taken could lead to a re.
Assertion.
But I think the biggest thing that we think about it.
We're going to benefit from significant carryover price.
Thats already locked in the backlog for actions we've already taken.
We expect to end 2022 risks very high backlog levels, especially for our short cycle products, which will help offset expected decreases in demand related to the slowdown in the resi construction market.
So we anticipate municipal repair and replacement market continue to benefit from the healthy budgets at municipal level, we expect to improve the adjusted EBITDA conversion margins as commodity prices remain below peak levels. Since we didn't implement any of the surcharges as part of our pricing actions.
We would not expect to have any.
Raw material adjustments.
For the items that have already been order, but I also believe that we will have improved manufacturing performance, which will contribute significantly to the year.
Year over year improvement.
Certainly.
Where are the dog days of summer from an upside perspective, but I do believe that.
These will improve as a result of the initiatives, which Marty and I are in the <unk> review pretty much on a weekly basis to see what we're doing to make sure our throughput to get back to levels that they were at.
Prior to the summer.
Mindful of the headwinds for ongoing inflationary pressures relating to higher wage rates utilities or freight.
But as I said in my prepared comments I expect that we will take the actions of <unk>.
A rational market that will offset those and so that's.
That's the basis for I guess, our bullishness for 43 from a margin improvement in conversion margin performance perspective.
And then just thinking about the housing data that's come out on single families pretty.
<unk>.
Now looking great.
Referenced that what kind of actions are like plans are you drawing up internally to kind of adjust your business to a world where housing is potentially.
Decently worse than it is now.
Yes, I think in Q3, new residential construction end market, specifically lot and land development.
Activity continued continue to be at healthy levels.
Which is also reflected in our Q3 order book so.
I understand that the permits pulled.
Peter would indicate that but I think as I remind everybody you really have to look at lot inventories because we use housing starts as a surrogate, but certainly it will follow in the future.
Could have lower levels.
As expected I think the increase in interest rates.
Leading slower new residential construction activity.
June total housing starts declined slightly to slightly less of I believe about $1 6 million pace with single family starts decreasing but interestingly multifamily is increasing and so I think that there's still some underlying housing demand.
Family starts now running at a lower pace, but it's still higher than the pace in the decade before the pandemic. So if you were to convert if you were to compare the average annual we're still significantly above it.
I think the sharp rise in borrowing costs, clearly leading home builders to scale back production plans.
We'll continue this downward trajectory so I anticipate that.
We'll see.
<unk> for US just as we were slow to get in was housing started.
There will still be a lot of curb and sewer reported.
The land lot development and I believe that.
A lower level of new Red reconstruction.
Would help municipal repair and replacement activity.
I'll spend a minute on that not long but.
The homebuilders turned out to be the people reportedly the curb and sewer so they tend to be contractors and they tend to be the exact same contractors that the municipalities contracts supported.
To do repair and replacement work so a lot of the.
The trenching and a lot of the.
Repair work are the same people and so given the squeeze on labor and we expect that those healthy beauty budgets will pick up some of that slack and we remain bullish about that.
I think the biggest indicator is the healthy order activity, we saw in the third quarter and I think July orders were largely with our expectations. So.
I feel confident that.
That while there will be some slowdown the tailwind we have for <unk>. The tailwind we have for muni budgets.
More than offset.
Thanks for all the color.
Thank you.
Thank you and our next question comes from Walter Liptak with Seaport. Your line is open.
Okay.
Hi, Thanks, Good morning, guys.
Wanted to ask about.
The outsourcing and some of the temporary.
Workers are those.
Can you give us an idea of.
The incremental cost from that and maybe the expectation for how long those costs will be in place.
Yes.
Yes, that's harder to parse out.
We're looking at performance.
We looked at what it would've cost us versus.
What the actual costs was the kind of shows up in.
A couple of different places, but long story short manufacturing performance.
It was the biggest reason before.
Our cost increases experienced in Q3, a part of that is machine a proud part of that is outsourcing part of that frankly is freight and so it's.
It's hard to parse it and im not sure that is something I would want to get into.
Okay and Walter.
Okay, Alright, Thats fine let me, let me ask it.
This week.
It comes down to gross margin in the fourth quarter.
And I'm sorry.
Mentioned this already but what gross margin should we be thinking about.
For the fourth quarter and then what.
And then how do you think the gross margin ramps.
Maybe ed on stronger footing with some of these manufacturing issues.
Yes, I think.
Gross margin is going to be under pressure in Q4.
I think that the reason.
When we took it down if you do the implied.
Adjustments to our fourth quarter EBITDA as a result.
Going from 7% to 10% down to flat you can see that Q4 will be.
At or near the significant pressure that we've seen.
In Q3 so.
Might even have.
A little.
A couple of basis points of.
Pressure.
I think the other thing of note in our Q4 is that we will expect to have higher SG&A just based on the seasonal way.
Our national sales meeting takes place in some of those other things that are significant expenses in our fourth quarter.
Ed.
So I think if you were to take a little bit higher SG&A and then infer what would have to happen in the fourth quarter to be flat from a.
EBITDA perspective, you would determine that there is.
Okay.
Little or no improvement of gross merger gave our Q4 I think the turning point comes in the first half of next year as we get more of these things will behind us as far as throughput reliance on outsourcing.
Some of these free premiums were paying today in order to get materials expedited I would like to remind everybody that at the end of the day, we are in the business of satisfying customers and satisfying.
Build schedules for municipalities and that is job one for US is that we are going to do the things necessary to hang onto our share we're going to do the things necessary.
In order for our customers.
Vacate and Ed have a preference for newer water products and sometimes that the customer cost certainly in the third quarter, we expect that that private continue in the fourth quarter before improving.
Okay, great. Thank you that helps.
Thank you and our next question comes from John Ramirez with da Davidson. Your line is open.
Good morning. This is John speaking appropriate building how are you.
Okay. Thank you how are you.
Okay.
So historically <unk> has had a very different business issues and market share in your car and your core products.
Some of that product challenges impacted that at all presumably your competitors are facing the same issues, but I'm wondering if some share shift is still occurring as a result.
Yeah.
Yes, I don't think Theres, a lot of share shift going on either us.
Losing share or us gaining share I think that there is a.
Our spreads if you will going on to make sure that the projects that are scheduled.
Taking out work lab network.
I would say on hydrants, our lead time are outside.
Competitors, and I would say our gate valves, where.
Inside.
Our competitors as far as lead times and so.
The.
The reality is is that.
Material costs are a small piece and so I don't think theres, a huge share shift going on I think that.
When you look at the municipalities that.
That we are supplying other supply agreements and those in the spot market.
It's the same cast of characters I think that.
Where do you think about where we bid where we are it's for the.
Kind of a market that's probably of that I don't know 12, 1300 valve a day kind of gate valve market.
Significantly higher than that over 2000 barrels a day today and so.
I don't think that that.
That anybody has.
<unk> much more than we have flex them. So I feel good about where we are from a share shift perspective.
Got it.
And just a follow up if I could.
Could you provide more color on.
How much the availability issue.
<unk> since the last quarter and I'm, sorry, if you already mentioned, but what strategies are being taken to secure.
Those raw materials.
Pork falling.
This quarters as well as going into next year. Thank.
Thank you that's a great question.
So look I think that we've seen.
Some softening if raw material prices, but peculiarly.
We've also seen some availability challenges so normally you can't get shred or you take a plague.
<unk>.
There is pressure upward pressure on the price, but we've actually seen it come down.
As I've explained in some previous quarters.
We had availability or the quality, we have too much read out of that place.
<unk>.
We lose efficiencies and what our yield per <unk>.
So we've had to substitute.
Things like Fortunately.
At a high cost.
Preview.
Into a recipe in order to keep yields up and.
Those costs are certainly.
Our near term view too.
Q4 looks like as we will continue to ensure that we get what we could get.
Into the market from a finished goods perspective, and so I think that these recipe premiums that were.
That we're experiencing today, especially in the steel market.
We will continue so your question that is.
How forward or you buy we're basically buy.
As much as.
We are allowed to.
<unk>.
Under the agreements, we have with our supply base people like progress rail and others and the reality is that you could only buy forward in those markets right now.
21% to 30 days.
And just a quick follow up so you said 21 to 30 days and in a normal environment, where you didn't have the availability issues.
What are these.
How much you are allowed to buy higher does that or is this just the top.
I think that.
I understand what you're asking I think thinking about it correctly when we have one to two days of backlog on what we call our <unk> materials.
There is there is an adjusted time mentality around the supply chain as we take orders we look at what the pound's required or that we go ahead of.
And all of those materials.
It's a daily order rig daily shipment, even flow, but now that were months away from.
Basically backlog, what we call short cycle materials.
The lead to Dubai forward increases, obviously and so we're in a.
Usual tie, but thats why were trying to match our forward by with the pounds. We have in backlog so that we could lock in our margins.
When we get back to let's call. It a more normal state we would expect the supply chain to get back into ordering today for what we sold yesterday.
Yes.
To say it that relates to steel Doc brass brass is a different animal where you buy your rig.
30 to 90 days in advance.
Alright. Thank you so much I appreciate the additional information you provided.
Back in the late year. Thank you.
Okay.
No more questions.
I'd like to thank you operator, thanks to everyone for joining today's call maybe while we're pleased with our net sales growth and a price realizations at this point the year. We are disappointed with the lack of progress this quarter of addressing the internal and external challenges. Most importantly machine downtime issue we've discussed.
I really want to say that we continue to be inspired by our team's dedication as they deal with unprecedented external environment. While also executing on initiatives to transform our manufacturing capabilities and service our customers.
We are well positioned to improve margins in 2023, as we continue to get price in the market address operational challenges execute our capital projects that increased production volumes that we're seeing healthy orders or to have a record backlog for our shorter cycle products.
We are excited about the tail winds for the water infrastructure end markets and our ability to help municipalities address the accelerating challenges. So I'd like to thank you all for your continued interest and with that operator, please conclude the call.
Thank you and that concludes today's conference you may all disconnect at this time.