Q1 2023 Mueller Water Products Inc Earnings Call
Speaker 1: I I I, we here.
Speaker 2: Welcome and thank you for standing by.
Speaker 3: At this time all participants are...
Speaker 4: During the Q&A session, if you'd like to ask a question, you may press star 1 on your phone. Face calls being recorded. If you have any objections, you may disconnect at this time. I'll now turn the call over to Whit Kincaid. Whit Kincaid Good morning, everyone. Thank you for joining us on Mueller Water Products' first quarter of the 2023 conference call.
Speaker 5: We issued our press release reporting results of operations for the quarter and in December 31st, 2022, yesterday afternoon.
Speaker 6: A copy of the press release is available on our website, www.muellerwaterproducts.com.
Speaker 7: Scott Hall, our president and CEO and Marty Zachis RCFO, will be discussing our first quarter results in Outlook for 2023.
Speaker 8: This morning's call is being recorded and webcast live on the Internet. We have also posted slides on our website to accompany today's discussion, which address our forward-looking statements and non-GAAP disclosure requirements. At this time, please refer to slide 2. This slide identifies non-GAAP financial measures referenced in our press release.
Speaker 9: Slide 3 addresses forward-looking statements made on this call. This slide includes cautionary information identifying important factors that could cause actual results to differ materially from those included in our forward-looking statements.
Speaker 10: Please review Swatch 2 and 3 in their entirety.
Speaker 11: During this call, all references to a specific year or quarter, unless specified otherwise, prefer to our fiscal year, which ends on September 30th.
Speaker 12: A replay of this morning's call will be available for 30 days at 1-800-876-4955. The Archive webcast and corresponding slides will be available for at least 90 days on the Invest Relations section of our website. I'll now turn the call over to Scott. The Archive webcast and corresponding slides will be available for at least 90 days on the Invest Relations section of our website.
Speaker 13: Thanks, Whit. Good morning, everyone. Thank you for joining us for our first quarter earnings 2023 call.
Speaker 14: I'm pleased with our solid start to this year. We again generated a double-digit increase in consolidated net sales as we benefited from past pricing actions taken to help offset inflationary pressures.
Speaker 15: The improved price realization was partially offset by a modest decrease in overall volumes in the quarter.
Speaker 16: Although our brass production levels did improve sequentially, lower production levels compared with the prior year contributed to the decrease in volumes.
Speaker 17: We believe the municipal repair and replacement market remained resilient and helped partially offset the slowdown in residential construction activity.
Speaker 18: As our end markets evolve in this economic environment, we are working closely with our channel partners to manage inventories and order levels.
Speaker 19: We sequentially improve gross margins in the corner as higher price realization combined with a lower level of inflation and better manufacturing performance more than offset lower volumes.
Speaker 20: While the inflationary pressures have eased, they are still elevated compared with the prior year, leading us to implement additional price increases.
Speaker 21: Our teams remain focused on delivering the benefits from our large capital projects.
Speaker 22: Particularly the ramp up of our new brass foundry.
Speaker 23: We are seeing operational improvements at our Kimball facility as our specialty valve products deliver the strongest year-over-year growth in the quarter.
Speaker 24: We believe we are on track to achieve the operational improvements needed to increase margins in the second half of this year.
Speaker 25: While we are pleased with our first quarter results, we also remain vigilant in this environment and are reiterating our annual guidance.
Speaker 26: After Marty discusses our financial results, I'll provide more color on our first quarter performance, end markets, and outlook for 2023. Now I'll turn the call over to Marty.
Speaker 27: Thanks Scott and good morning everyone. I will start with our first quarter 2023 consolidated gap and non- GAAP financial results.
Speaker 28: After that, I will review our segment performance and discuss our cash flow and liquidity.
Speaker 29: Our consolidated net sales increased 15.6 percent to $314.8 million compared to the prior year with growth in both water flow solutions and water management solutions.
Speaker 30: The increase was primarily due to higher pricing across most product lines in both segments and volume growth across most products in water management solutions.
Speaker 31: These benefits were partially offset by a decrease in volume at water flow solutions.
Speaker 32: Gross profit of $93.2 million increased 6.4% compared with the prior year.
However, gross margin of 29.6% decreased 260 basis points compared with the prior year, as benefits from higher pricing were more than offset by increased costs associated with unfavorable manufacturing performance, inflation, and lower volumes.
We sequentially improved our gross margin by 380 basis points in the quarter.
The unfavorable manufacturing performance, which includes the impact of outsourcing, machine downtime, supply chain disruptions, and labor productivity, was primarily driven by our foundry operations.
The negative impact of inflation improved sequentially. However, we continued to experience higher costs associated with raw and purchased materials, utilities, freight, and labor relative to the prior year. Our total material costs increased around 8% compared with the prior year.
Our price realization again improves sequentially more than covering inflationary pressures for the fourth consecutive quarter.
Selling general and administrative expenses of $62.9 million in the quarter increased 11.7% compared with the prior year.
The increase was primarily driven by personnel costs, third-party services, inflation, and TNE expenses, partially offset by foreign exchange gains.
S-DNA as a percent of net sales decreased to 20 percent as compared to 20.7 percent in the prior year quarter.
Operating income of $34 million increased 17.6% in the quarter compared to $28.9 million in the prior year.
Operating income includes a net benefit of $3.7 million from strategic reorganization and other charges in the quarter. The net benefit primarily consisted of a $4 million pre-tax gain on the sale of the Aurora Illinois facility. This gain was partially offset by transaction-related expenses.
Turning now to our consolidated non-GAAP results.
Adjusted operating income of $30.3 million decreased $1 million, or 3.2%, compared with $31.3 million in the prior year.
The benefits from higher pricing were more than offset by increased costs associated with unfavorable manufacturing performance, inflation, additional SG&A expenses, and lower volumes.
Adjusted EBITDA of $44.2 million decreased 6.9% in the quarter, leading to an adjusted EBITDA margin of 14%, compared with 17.4% in the prior year.
As a reminder, adjusted EBITDA was also impacted by a year-over-year increase in pension expense of $1.9 million in the quarter.
Net interest expense for the quarter declined to $3.7 million as compared with $4.3 million in the prior year. The decrease in the quarter primarily resulted from higher interest income.
For the quarter, we generated adjusted net income per share of 13 cents, which was flat compared with the prior year.
Moving on to the quarterly segment performance, starting with water flow solutions.
Net sales increased 6.9% compared with the prior year, primarily due to higher pricing across most of the segment's product lines.
We experience lower volumes primarily for our Arngate valve and service brass products, which were partially offset by higher volumes for specialty valve products.
Adjusted operating income of $24.2 million decreased 22.7% in the quarter.
Benefits from higher pricing were more than offset by increased costs associated with unfavorable manufacturing performance, primarily in our foundry operations, lower volumes, and inflation.
Adjusted EBITDA of $31.9 million decreased 17.6%, leading to an adjusted EBITDA margin of 19.3% compared with 25% last year.
Turning to water management solutions.
Net sales of $149.2 million increased 27.1% as compared with the prior year.
This increase was primarily due to higher pricing across most of the segment's product lines and increased volume mainly in hydrant and water application products.
Adjusted operating income of $19.6 million increased 70.4% in the quarter.
benefits from higher pricing and volumes more than offset increased costs associated with unfavorable manufacturing performance primarily at our boundary operations, inflation and additional SG&A expenses.
Adjusted EBITDA of $26.6 million dollars increased 38.5% in the quarter, leading to an adjusted EBITDA margin of 17.8% compared with 16.4% last year.
Moving on to cash flow.
Net cash used in operating activities for the quarter ended December 31, 2022 with $6.5 million, compared with $19.8 million of net cash provided by operating activities in the prior year.
The decrease was primarily due to an increase in inventory.
Average net working capital using the five-point method as a percent of net sales increased to 28.2% compared with 25.4% in the first quarter of last year primarily due to higher inventory levels.
During the quarter, we invested $9.9 million in capital expenditures compared with $11 million in the prior year.
Retashflow for the quarter was negative $16.4 million, compared with positive $8.8 million in the prior year. Primarily due to the decrease in cash provided by operating activities, partially offset by lower capital expenditures.
We did not repurchase any common stock, and as of December 31st, we had $100 million remaining under our sheer repurchase authorization.
At December 31, 2022, we had total debt of $447 million and cash and cash equivalents of $125.6 million.
At the end of the first quarter, our net debt leverage ratio was 1.7 times.
We did not have any borrowings under our ABL agreement at quarter end, nor did we borrow any amounts under our ABL during the quarter. As a reminder, we currently have no debt maturities before June 2029.
At December 31, 2022, we had $288 million of total liquidity, giving us ample capacity to support our strategic priorities, including acquisitions.
Dot back to you.
Scott, back to you. Thanks, Marty.
I'll now comment on our first quarter performance and markets in full year 2020 330' over.
After that, we'll open the call up for questions.
As mentioned earlier, we are pleased with our solid start to the year.
While we sequentially improve gross margins in the quarter, our margins were below the prior year.
We continue to be pleased with our price realization, which more than offset inflationary pressures for the fourth consecutive quarter.
As expected, unfavorable manufacturing performance, primarily at our foundries, partially offset the benefits from higher pricing in the first quarter.
Unfavorable manufacturing performance was impacted by lower production, primarily at our Chattanooga indicator foundries.
leading to under absorption of labor and overhead.
Our Chattanooga Foundry, which is focused on gate valve production, delivered lower volumes due to fewer production days relative to the prior year, primarily driven by increased planned maintenance over the Christmas period.
Brass melt production at our Decatur foundry increased sequentially, however it was more than 30% below the prior year.
Our teams made progress on the operational challenges at the foundry with improved machine uptime contributing to the sequential increase in melt production.
The ramp up of our new brass foundry is well underway.
We have two lines working through the production parts approval process.
prioritizing our highest volume parts, including parts used in our hydrants and gate valves.
We are working through the new casting and machining processes and expect to begin shipping the initial parts using the new alloy later this quarter.
I am pleased to share that Mewdur product utilizing components manufactured at the new foundry will continue to be certified under NSF 61 for drinking water system components through underwriters laboratories.
This certification is crucial to ship products containing parts with the new alloy to customers.
With elevated backlogs, our teams remain focused on improving production levels to reduce lead times and satisfy orders.
especially for our hydrants and brass products.
We continue to experience higher cost year over year, primarily related to outsourcing materials, machining and maintenance.
We expect these headwinds to carry on into the second quarter as well as the second half of the year. Increasing brass production levels from both foundries will ultimately allow us to bring some production back in-house and lower costs.
As backlog levels normalize and our new brass foundry begins shipping product, we anticipate decreasing the use of outsourcing.
Additionally, we are working to add shifts at our Albertville Foundry to increase internal production for key hydrant parts.
I've already mentioned the sale of assets associated with the closure of our Aurora facility.
We are pleased that we now have completed the investment of all the locations from which operations.
have transitioned to the new Kimball, Tennessee facility.
Our specialty is large-boiled CopEx investments.
are continuing to ramp up this year and we expect the margin benefits to follow accordingly.
During the first quarter, our specialty valve products delivered the strongest year-over-year growth of all of our product lines, which resulted in a sequential and year-over-year improvement in gross margin.
I will now briefly review our end markets.
As mentioned earlier, we believe the municipal repair and replacement market remains resilient, helping partially offset the slowdown in residential construction activity.
For the Municipal Repair and Replacement Market, we remain excited about the benefits of the infrastructure bill starting to take effect later this year.
The first wave of distributions have taken place with additional guidelines from the EPA regarding the Build America by America domestic sourcing requirements.
This further supports the strategic rationale for all three of our large capital projects.
As domestic sourcing requirements for iron and steel products increase, we believe we will be well positioned with our increased domestic capacity for our larger valve and service brass products.
Looking at the new residential construction market, total housing starts were down 15.6% year-over-year during our first quarter with around a 1.4 million seasonally adjusted annual rate in December .
We expect construction activity to pick up in the spring relative to our first quarter, which is the typical seasonality of our core products.
For fiscal 2023, we continue to forecast that total housing starts will be in the 1.3 to 1.4 million range.
While we expect higher interest rates and economic uncertainty to continue to impact residential construction.
We believe lot inventories remain relatively low.
Moving on to our outlook for 2023.
As expected, we experienced the slowdown in order activity during the first quarter.
While our total backlog decreased sequentially, we continue to have an elevated backlog, especially for shorter cycle products like service brass and hydrants.
With product lead times and project timelines improving, we anticipate our backlog levels could normalize over the coming quarters depending on end market activity.
We expect to get a clearer sense of cell-through, channel inventory plans and order levels as we move into the upcoming spring construction season.
As mentioned earlier, we are reiterating our guidance for 2023, which we provided with our fiscal 2022 fourth quarter earnings.
We anticipate that our consolidated net sales will increase between 6% and 8%.
Our backlog at the end of the first quarter and the expected realization from higher pricing position us to deliver net sales growth again in 2023.
We expect our adjusted EBITDA will increase between 10% and 14% as compared with the prior year, primarily driven by benefits from higher price realization and operational improvements in the second half of the year.
In closing, our teams continue to focus on maintaining our strong customer relationships while executing our top priorities for the year, which include achieving operational improvements, delivering benefits from our large domestic capital investments, accelerating development and commercialization of new products.
in generating ongoing price realization.
We are on track with the ramp up of our new brass foundry which will have significantly more capacity.
to deliver the best long-term manufacturing solutions and advance our sustainability initiatives with a new lead-free brass alloy.
We are in a transformational period for Mueller, with our large capital projects in various stages of ramping up. We believe the benefits from these projects and ongoing operational improvements will greatly enhance our position in the market.
These investments are especially important as water utilities increase needed repair and replacement projects supported by the Federal Infrastructure Bill and the requirements for domestically manufactured products.
Our broad portfolio of products and solutions enable us to help water utilities address growing challenges from the aging infrastructure, climate change, and workforce demographics.
While uncertainty from the external environment has increased, we are a much more resilient organization supported by a strong balance sheet.
This gives us liquidity and capacity to continue to reinvest in our business while returning cash to shareholders primarily through our quarterly dividend.
We are confident that our growth strategies, capital investments, and operational initiatives will deliver both further net sales growth and a return to pre-pandemic margins in 2025.
That concludes my comments. Operator, please open this call for questions.
The phone lines are now open for questions. If you would like to ask a question over the phone, please press star 1 and record your name. If you'd like to withdraw your question, press star 2. One moment for the first question.
The first question to Q is from Dean Dre with RBC Capital Markets. Your line is not open.
Thank you. Good morning everyone.
Good morning.
Hey, maybe we can start Scott with your perspective on the demand dynamics in the quarter. You know with respect to some of the order slowdowns. We're hearing lots of commentary across the industrials about de-stocking and we can see what's going on in the RESI side and in particular you had a
and I know there's going to be offset from the muni break and fix but just very specifically on the resi side. Thanks.
Yeah, so I think that the the dynamic is, you know, much as you described, but if you recall my comments in previous quarters.
There is a big piece of this theme that is DRP driven or distribution resource planning driven.
And it's this notion that as the lead times collapse.
that you'll kind of get hit with this double whammy. One, the sell-through may have slowed as housing goes from that 1.5, 1.6 down to the 1.3, 1.4 range.
But lead times are coming down as well. And so the amount of material that's needed in the channel continues to decline. And so what's necessary and what's not. So I think the end market evolution, work closely with the channel partners to look itself through and to manage.
to be overly bearish once you start to see the negatives. But I would also point to the January jobs report, which would indicate that employment levels and potentially income levels could be rising for the average American, which I think would be kind of the counterpoint to the housing starts. Will these people enter the housing market? I think that's a good point.
of more interest in the drinking water stream from governments that is going to kind of offset the...
the kind of demand profile reduction that we'll see from the housing market. So we remain, let's call it cautiously optimistic.
That's all really helpful. And we've heard that whole dynamic about the slowing the pace of orders as lead times normalize. So that's getting to be pretty familiar for us as well. All right. So follow up question for Marty. Can you talk about the impact of the COVID-19 pandemic?
of your inventories on free cash flow because that was really well below your typical free cash flow use.
Is that inventory, is it still buffer inventory? Is this a supply chain issue? Scott just talked about how there's less inventory in the channel, there's destocking going on, but you're taking on more inventory. So just walk us through that, please.
Yeah, so I'll say certainly looking at the, you know, the negative free cash flow that we had in the quarter, as you point out was was driven by the higher inventory levels. As we work through our 2023 and certainly consistent with the guidance that we have reiterated with respect to.
to be largely driven by working capital improvements and that's going to come from inventory terms. So I'm going to say, as our production teams are focused on improving the lead times that Scott just talked through, lowering the backlog levels, particularly with the short cycle products that we've had, and with the outsourcing. I think
We've had more that philosophy of we're going to bring in the inventory and the needed parts just in case rather than just in time. All the supply chain disruptions.
I think we are going to look to sort of transition to that as we begin to see some improvements in the supply chain. We're going to look to shift that focus. And certainly look to bring down these inventory levels through the year. Which will help with that. There will be some.
As the new grass boundary is coming up, we will have some elevated inventory levels associated with that.
Scott referenced in and around, you know, de-stocking activity and what we could see from distributors through the balance of the year. And I would say, you know, certainly if the de-stocking is greater than what our estimates are, that could impact our overall inventory levels and our free cash flow guidance.
Marty, that's real helpful and I probably should have prefaced it with that throughout the industrial reporting season, most of the companies have under delivered on free cash flow, I think versus expectations. So you're in good company here. It's just we're all anxious to see that working capital come down.
But I think what we're all learning is it's going to take longer throughout the year to see it. It's not just a one-quarter flush. So appreciate the reference about the time frame for you. Last question for me, Scott, it's been a while since we had an opportunity about a potential guidance boost.
So, you know, we saw nice results first quarter out of the year. It's still early. I get that. But when you're not boosting after a quarter like this, does that imply a lower outlook? Is it, you know, a bit more cautious? Just help us frame.
the idea of reaffirming guidance and not boosting it here? So I think that the, with some...............
definite difference in how the first quarter came out, external estimates to internal. So I think that our timing may have differed from the market's timing. So when we talk about on our last earnings call where we provided the initial guidance for 2023, we talked about the initial guidance for 2023. We talked about the initial guidance for 2023.
What I can say is that the start to the year was solid with the sequential improvement in margins.
But I'm mindful that we're still early in the year and additionally we're still in the ramp up period of the new brass foundry improving those proving those PPAP processes.
And I would also say that remains a fairly high level of uncertainty in the external involved. So residential construction has slowed. Product lead times and project timelines are improving. I expect that the backlog levels could normalize over the coming quarters depending on about embarking activity.
So I expect to get a clear sense of the cell through in the channel and the channel inventory plans as we move into the spring construction scene. I think that will be a critical time Dean as we look at what happens with the cell through in the channel inventory.
And I think that will set the pace for the balance of the year. So I think we elected, when we looked here, certainly a little better first quarter than anticipated, but we elected to kind of keep our powder dry as we look at the rest of the year. I think there's a couple of ways.
this can go and I would speak to everybody and say the most important elements.
For our guidance to be met is to hit our throughput numbers at our own facilities and not hit throughput
by using other people's materials or outsource materials. And those are going to be the keys for execution. And I think it's just too soon to say where we are on that path.
That's really helpful. Thank you.
really helpful. Thank you. Thank you.
Next question is from Brian Blair with Oppenheimer. Your line is open.
from Brian Blair with Oppenheimer. Your line is open.
Good morning, bro.
So let's start to the year. It's to see that price continues to outpace inflation. Being four quarters into that catch-up process.
Are you now at a point where price cost is margin accretive year on year or is that still pending?
Well, year on year, I guess you could argue that it is accretive. But as you know, Brian , we don't measure it that way. We go back to the trough. We know that the entire inflationary cycle is multiple years on.
So when we said in our prepared comments at the end there that we expect to be back to pre-pandemic margins in 25, we are looking at the rate of accretion. So we're still not accretive.
to inflation over the entire cycle going back to 2020. But we expect that we will be back to break even on the dilution effect of 2020.
sometime this year, if the price that's trapped in the backlog and the throughput assumptions we have in there, we'll kind of get back the price piece sometime in 2023.
sometime this year if the price that's trapped in the backlog and The throughput assumptions we have in there will will kind of get back the price piece Sometime in in 2023 We believe that we'll be at pre-pandemic
margins in 2025 so the price piece of it is you know
one part of it, but the actual throughput and getting rid of the outsource and getting rid of the other things won't have us back to pre-pandemic margins until 2025.
So I hope that answers it. You know, we'll be a creative year on year, but we still got a ways to go to get back to when the inflationary cycle began in 2020. And the headwinds associated with the outsource and the other product inefficiencies are made from manufacturing inefficiencies.
We won't have those out of our system until we can close that second foundry until we can hit all of our production targets internally and be anticipate everything to be back to pre-pandemic margins by 2025.
I appreciate all the color there. I guess to simplify that progression it would be you're getting back to
recovering margin by price cost this year, damping inefficiencies into next year, and then allowing for the read-through of the projects.
once you are...
past completion and...
at that full run rate, driving the, I think it's 30 million or so in benefits that you would call that would be 24 into 25. Is that kind of the step forward? Yeah, yeah, so if you were to look at us could be at a high level, like, you know.
2019 or 19 20% call it 20 and they even are margining now or you know in the 1415 range You know we will get that five 600 basis points in 25 and it's a combination of a lot of things The the biggest two things though is I've been saying repeatedly
is the brass foundry, the elimination of outsource, and getting throughput levels back to at our own foundries. Those are the two big morts. It really is, and that's what...
we will end up with, you know, as long as the end markets hang together, we'll be fine.
I think the other thing I'd point out for everybody here is I think the end markets are
conducive to us to continue the growth, but we're probably gonna have to look to the IIJA timing you know to carry us through what will likely be a temporary housing slump.
And that's actually a perfect segue there, Scott. Any other color you can offer on...
You know, IJ impact data by some minimal. More importantly, your confidence in...
I know there being a
tangible impact looking to the latter part of 23 into 24, 25. Just looking at SRF funding data and specifically the awarded funding and it's somewhat underwhelming right now. Seem to be a lot of administrative issues at hand.
a lot of work that remains just to coordinate the project funding before moving forward with a lot of this. I'm just curious your perspective on that and then again, level of confidence or incremental confidence in this being a real catalyst going forward.
Well, I think it'll be a real catalyst going forward. I think you're seeing whenever we have some of these government programs, you're seeing the
the sausage making process, you know, there's there's going to be all these new rule sets like
give you an example like a fastener. Is a fastener have to be American made as part of the American Iron and Steel? Or can we use imported fasteners?
Well, how many fasteners are there being manufactured in the US that meet the stainless steel block all these things? So, you know, the EPA is working through all those real rulesets to say what the exemptions are what they're not what materials have to constitute the bulk of the cost what the labor contents so all those
kind of sausage making has been going on for the last nine months. And you saw some funds released to California, some of the bigger states, and as you said, it was a small piece of the 100-ish billion that we expected to see. And so I would say that, you know, the money is going to be sent. I believe it will be a catalyst for 24 and 25 and beyond.
But any project that got approved, let's say today even, let's say that the dam broke today. None of those installs are going to happen in 23 or even the early part of the 24.
By the time those jobs were engineered, those bills and material are cut. The water system is in a position where the install could happen and the labor is available. You know, these are multi-month projects about to mention the size of the backlog and especially valve business or large gate valve business. So I do think...
Yes, I'm very, very bullish as a result of the funding and we can see the need for where these dollars need to be spent in both the stormwater, wastewater and drinking water investment opportunities. Yes, we think it's actually going to have a meaningful impact on the size of the stormwater.
Now open.
Good morning everybody, it's Pez on for Mike.
Morning.
So another question on backlog. So how are you thinking about backlog duration at this point, versus normal? Obviously a lot of puts and takes. The backlog levels are elevated. We talked about the numerous puts and takes on the manufacturing and outsourcing side. But then also on the flip side, we talked about an opportunity to normalize backlog levels this year. It would be great if this were something??? Del discovered and arranged, as a planned person.
And then secondarily, based on the answers to Dean's question, I suspect I know the answer here, but I'll ask anyway, how much if any backlog normalization is assumed in the current
Oh.
Let me let me hit the first how I think about it I probably think about it a little differently than that and the analyst on the call because I'm keenly interested in knowing where our Sector competitors are in their lead times and you know, I think we're advantaged in our lead time at gate belts right now
The chapter of the plan has done a great job of plowing through the backlog there. But I believe we're...
disadvantaged and hydrants right now. I think our lead times are too long compared to our competitors.
When I think about our specialty valve business, I think we're near par, but we should with the investment and we can get the throughput. We should be advantaged.
You know, we're domestic and you know, we're not as dependent on that trying to supply chain as some of the competitors in the Speciale Val Market, so I want to see improvement there. I want that backlog reduced in terms of days of production because I think it's an opportunity to take share.
So, you know, I know you're asking me, and I'm kind of evading the financial answer to your question, but you know, that is how I think about the backlog, and I want to be honest with you about that. I don't think about it in the context of how much price is trapped there, although there's a considerable amount, or what an optimal number is.
What I do think normalization looks like though is that what we call the short cycle business, the smaller gate valves, let's call them 4-6-8s, and the 5-1-4 Super Centurion or a couple of the wet barrel sized hydrants, those have to get inside two weeks.
because that has to be the rapid turn for the channel. Those are probably the most competitive markets for the channel and therefore they need to turn that inventory rapidly. They don't want to be sitting on months of gate valves or sitting on months of hydrants.
And so with our channel partners, you know, we have to get that supply chain balanced out, which is continues to be out of balance today. So ideally we would see that continue to shrink.
and get back inside of a 30-day backlog by the end of the year.
The project business, I expect that those lead times will continue to grow. That as IIJA money puts more of these bigger projects out there, that we and our competitors will start having more and more A, engineered valves, and B, longer and longer lead times on those engineered valves. If anybody remembers back when we did the large casting foundry, we put in a 20 foot by 20 foot bed for a 3D printer for tools. So we could make large tools for build America buy America products.
We expect that our cycle time to engineer will be better than the competition, but that our throughput times will be on par. And so, you know, we hope to be advantaged there. So I know that's a long-winded answer to say, expect backlogs to continue to fall. And it's more important, I think, in the market for us to be competitive.
or advantaged even, than to worry too much about where we are in context of days. No, absolutely, that's incredibly helpful, Scott, and a much better answer than it was questioned, so thank you. I'll switch gears a little bit.
The balance sheets in good shape, you called out ample capacity to pursue your strategic priorities. Could you maybe just provide a little color on what the M&A landscape looks like? Is there anything out there that has you excited right now?
I mean, there's always properties that we're constantly evaluating our pipeline and I would say our pipeline is fulsome right now. I think that the opportunities that you see where the investment dollars are going probably over the next six to eight years offers some adjacencies for the Mueller line, you know, valves or bolt-ons that
perhaps we don't offer today that we think will gain money, I would say that you know if you look at the conversation in the country around what water retention looks like, especially on the West Coast, you see the water crisis around Lake Mead and around these declining aquifers. I think there's going to be massive amounts of investment needed to
to move water from where we have plentiful water to the areas where we seem to be moving and getting population concentrations.
So all of those things I think drive and feed our acquisition pipeline. And we continue to be fairly bullish on our ability to get some of that done. But nothing is in the next quarter, that's for sure.
Excellent. Thank you for all the color. I'll pass it on.
Excellent. Thank you for all the color. I'll pass it on. Thank you.
The next question the queue is from Brian Lee with Goldman Sachs, your line is open.
Hey everyone, this is Miguel on for Brian . We just had one question. I wanted to touch on the question about the
on the channel inventory dynamic again. Could you go into more detail possibly on the
on that dynamic that you're seeing, is there a way that you've been able to estimate how much is out there for the key products that you're monitoring, maybe in terms of number of weeks or months and to what level that the channel is trying to get down to? Thanks.
Yeah, it's a hard question to answer because I think if you're asked the channel, they would say a lot of the inventory is committed inventory. And so, you know, if you look at what's happened with price, so you take your baseline going in and you add, you know, I'm making this up, don't take this, but, you know, 30 to 40% of the increase in inventory that you've seen in the channel is.
It's just price driven. So units are constant and the balance is the increase as a result of the inflationary pressures that we've seen price increases taken in the water space. So you say that's 30 to 40 percent inflation.
Then the balance of, you know, it's called a ballpark, 100% increase is units. That 60 or 65% of increase that's, you know, in units.
There's a huge portion of that that is committed, but waiting on pipe.
or waiting on labor, or waiting on, but when the distributor took the order for that contractor, for that municipality, it was earmarked. And so there's a fairly high backlog now, measured in weeks, what's just logistics backlog.
So the specular of inventory would be the balance, right? You know, let's call it...
15, 20% of channel inventories are on the speculums of base.
I would expect that that's the piece that would get targeted quickly. And so, you know, I think that that's the at risk.
The other parts, for the channel to add value, they have to serve those contractors and those municipality jobs. Those are almost always delivered a job site.
They're not going from the distributor's warehouse to...
to some municipality works center and then being loaded on a truck again. Some of that, a lot of that inventory and a lot of that backlog for the distributor is, when we have the crew there we want you to deliver this, this, this, this, this simultaneously for install here, here and here and, and that piece of it I think has
left because it's been, you know, the least times between pipe valves and other fittings have become so disparate between one another that we end up with a much larger inventory needed to support the logistics piece.
And I think that that has match rings.
then you will start to see that inventory shrink as well. And so if you use the 30% price, let's call it 30% logistics, 30% speculative, as you see the lead times.
Crash you'll be able to use one as you see the
Prices increase, that will be an upward pressure, and as I said in my prepared comments, we increased prices last quarter again. And then as you see the other part go, it too will drive down channel inventories. I think you have to look at all three elements.
and then make the timing piece what you can of that mix of their inventory, what's driven it.
Okay, great. That's very helpful. Thanks. I'll pass it on.
The next question is from Joe Giorgano with Cowen. Your line is now open.
Hey, guys. Hey, John .
Can you talk about price utilization in the quarter and what's embedded for the full year? I assume that like, how much of the full year expectations like baked based on actions you've already taken. I assume it's probably a little bit harder to like incrementally do this given inflation is like moderating sequentially, right?
Yeah, look, I think the sequential increases in price realization in Q1 was something we were very pleased with. We're benefiting from the multiple price actions taken over the past year with price realization in the mid-teens for Q1. I think that improved price realization, as I said earlier, more than always, and I think that's what we're seeing.
here at Marty, but it included purchase price. Remain, you know, elevated and was somewhere around 8% year over year versus approximately 14% a year ago. Well, negative impact or inflation.
improved sequentially, we continue to experience higher costs associated with raw and purchased materials.
So, you know, to answer your question, I'm not trying to, you know, there's a lot of pieces moving there to say, will it be diluted or, and it really depends on, you know, how quickly we can ship the backlog, how much of the price it's trapped in the backlog, you know, obviously shipping sooner is better as evidenced by our Q1 having kind of that mid-teens.
price in it. So, you know, it's hard to say, I can tell you what's in our guidance.
So, you know, it's hard to say. I can tell you what's in our guidance is that we get back to...
I think we can put him in a demo.
flat level with 2020 in terms of price to inflation, so it's no longer dilutive this year, but that will not offset all of the inefficiencies and costs associated with outsourcing and the other problems that we talked about. So we won't be back to pre-pandemic margins.
Contributed by price and then the efficiency is until 2025.
But within that, my full year revenue growth guide, is it fair to say that the price contribution is higher than the overall growth guide?
So like in time to place, right? Yeah, perhaps you missed it. Yeah, no, last, you know, when we did the guidance, we were explicit that the actual unit volume we expect to be slightly down in all of our growth, all of the 6% to 8% growth.
that we talk about is being driven from price.
Yes, that's what I feel. Okay.
With respect to the new, the ramp up of the caterer and things like that, bye.
What do you need to see to kind of know that you're on the right track? Like how far into the year or like what kind of trigger points along the way? Kind of give you comfort at okay like this is progressing how we need to see like this is going to work.
Yeah, I mean, we meet every week. You know, how many parts are PPAP? Where is that on our PPAP schedule? Of those parts that are PPAP, what's the machining trials going like? You know, if you look at our 4K process, you start out kind of with a dimensional
answer and you know gate two you get into you know whether it's form fit function, porosity, all of those things, the machining and then your gate free is a gamma-rom that that's some significant volumes and then gate four is machining and significant volumes and looking at you know tooling where things like that so you know we know where we...
right and wrong in these next 90 days. But at the end of the day, our exit rate at 2023.
of pounds produced.
Has to, you know.
Approach somewhere between 50 and 70 thousand times a day. And you know, we get into that 60 range.
at the new foundry and we can afford to then shut the existing foundry and satisfy all of our customer demands and all our internal demands.
afford to then shut the existing founder and satisfy all of our customer demands and all our internal demands.
I don't know how to really answer your question other than to say, you know, one thing's gone right and the other thing will go wrong. At the end of the day, you would react in a debt, react in a debt, react in a debt to ensure that you get to the capital project targets in throughput. And that's what we're focused on. Let's go.
Yes, there's a huge part of our margin improvement that comes from avoiding the outsourced premiums we're paying because of our inability to produce brass.
And that's job one in this project execution.
Can you maybe speak to what the cost differential is between these outsourced products that you have to bring into what at scale the cost would be in terms of?
Absolutely not, and it's not because I wouldn't. It's that obviously you have multiple partners and I don't want people trying to infer you're paying this premium here and that premium there. They obviously know what we're paying, so no, I'm not going to get into the spreads of premiums.
Sure. And that's for me. You mentioned your expectation for housing starts for the year. Can you kind of maybe compare that to what you think lot development will look like this year?
Yeah, as I said in my comments, look, we still believe that lot inventories and even options on lots, I know a lot of the builders are talking about in their prepared comments now with her.
what their option portfolio looks like is still, I think, you know, if you think about a 1.4 million housing start year, and then you try and back into that, which we try to do, but, you know, it's more art than science, unfortunately, because people don't publish the numbers.
we still think lot inventories are relatively low and that there's not a huge backlog of developed lots for the builders to sell either spec or custom order or homes into. And so, you know, I'm saying that this is real stuff in a REIT
I guess the way I would describe it is after living through the 2007 overhang as a business, I wasn't here, but certainly lots of people work and how long it took to work off that overhang. This one looks like it will be measured in days or...
even weeks, but it's not going to be measured in years. And so, you know, the inventory is, I think, at a much, much lower level than it was in 2007 by a factor of, you know, two or three.
to be measured in years. And so the inventory is, I think, at a much, much lower level than it was in 2007 by a factor of two or three. Great. Thanks, Scott.
Thank you. Just a reminder, if you would like to ask a question over the phone, please press star one and record your name. The next question is from Walt Litak with Seaport Research. Your line is open.
Hey, good morning guys. I wanted to go back to Dean's question about...
about that and where you commented about the forecasting and he said you had the internal forecast versus You know the self-side forecast and then we were just that they were wrong
So the question is, I thought that the first half was going to be weaker, and then the second half was going to be stronger.
And so I guess the question is, so this is helpful to everybody, is, you know, how are we doing on the second quarter? Seasonally, you typically have.
pick up going into this that spring selling season are you expecting that you know the you know are we going to see sort of a sequentially flat quarter you know what are you thinking about
Okay, well, it's hard to get it, you know, gross margin expectations around Q2 is kind of how I...
And I don't want to get into giving quarterly guidance, but I will say this in general. Look, I think our annual guidance applies year-over-year improvement in the justice of even the margins around. I don't know. 70 basis points at the midpoint.
I think it was driven by improvements in gross margins, which are approximately
by approving gross margins, which are approximately 190 basis points.
with headwinds, I think, from the pension expense and higher total SG&A. So, you know, that's call it 70 improvement. I think the inflation pressures and manufacturing performance headwinds will have to continue in Q2. We certainly are going to be dependent on the outsource.
And I think we're going to be dependent on third-party maintenance services indicator for all, certainly all of the quarter.
I think the timing issue with our capitalized variance and the inventory write-up associated with the inflation that took place.
It believes that it says that gross margins ought to be kind of flatish in Q2 with Q1. And that you won't start to see the step-up of improvement that will generate the leverage on the volume growth until you're actually able to start impacting those two things. Does that help your model? No.
Yeah, that does and on that revenue piece for the quarter, the second quarter.
I think what you're saying is that you've got to, you know, if you get that regular seasonal uptick, you've got to wait and see because you don't know how the channel inventory is going to be. Is that fair? Yeah, I think we have a big enough backlog that we should be able to hit our sales number. I'm not as concerned about that as you are about the
I'm more concerned about the margin flow through and getting the throughput up sequentially.
So you know as I said in my comments we had fewer days and gate valves in in our q1 because we took down the Chattanooga facility for an extended period of time
versus a previous year so that we could do some auto-pour relining and some other maintenance that needed to be done. And so we had fewer days in Q1. We expect that we'll be able to get gate valve volumes back up in Q2. We expect improvement in throughput in Albertville for hydrants in Q2.
We expect to continue the improvement in throughput from Kimball and they've been corner on corner on corner improvement since we've opened them so please with that. So I think that's really where you think about that implied improvement in justice EBITDA. We're only going to get clawing back some of them.
Okay, all right great. Thanks for the color. You know I guess another one for me is
All right, great. Thanks for that color. I guess another one for me is...
Last quarter, I think one of the big takeaways was that activists that you guys are working with, you didn't comment on them at all. Are you still thinking about it the same way? Is anything changed?
Yeah, I mean, we're still thinking about it the same way. I think, you know,
I think that the committee is off and running with the two new board members, but I don't want anybody to be mis-lettering. We don't speak to the activists. They got independents that weren't associated with their company.
Part of our agreement with them was that we would have new board members, and I think that the integration is It's gone well, but you know we're not we're not in Contact with and Cora any more than we are with any other shareholder and certainly we don't comment about You know our discussions with shareholders, so
I think the committee though is, you know, we've had our inaugural meetings and we've had our discussions about capital allocations, about, you know, operational improvements. And I think we have, you know, alignment and what the priorities for the business are. Those priorities are as I've been.
Talk about them from the large CAPEX projects. So I feel good about it. Okay, thank you very much. Thank you.
Well, I think we're at the top of the hour, operator, and I just want to thank everybody for their uh …
you know, staying with us and sitting through the call and joining us this morning. Final thing, though, I want to remain focused on our customers while delivering the benefits from our capital investments. We will continue to outsource, not to preserve ours, but to preserve our customers and keep our place with them, because I think share is terribly important in these times of uncertainty.
I'd like to thank our teams for their continued dedication, especially as they deal with the ongoing uncertainty in the external market. I think the transformation that Mueller is going through and the water industry is going through at this time is going to be a remarkable and exciting time to be at Mueller and to be investing in the industry.
Then the inflation cycle, our increased volumes, primarily from growth and muni repair and replacement, improved manufacturing performance, and realization of the benefits from the large capital projects. And so, I don't want to be Pollyannish and rosy that it's nothing but blue skies from here because there's certainly a lot of work left to be done. But I want to thank you for your...