Mueller Water Products, Inc. (NYSE:MWA) Q2 2024 Earnings Call Transcript

Mueller Water Products, Inc. (NYSE:MWA) Q2 2024 Earnings Call Transcript May 7, 2024

Mueller Water Products, Inc. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Welcome, and thank you for standing by. [Operator Instructions] Today’s call is being recorded. If you have any objections, you may disconnect at this time. I would now like to turn today’s meeting over to your host, Mr. Whit Kincaid. Thank you. You may begin.

Whit Kincaid: Good morning, everyone. Thank you for joining us on Mueller Water Products’ Second Quarter Conference Call. Yesterday afternoon, we issued our press release reporting results of operations for the quarter ended March 31, 2024. We also issued a press release providing an update on our leadership team and Board refreshment. Copies of the press releases are available on our website, muellerwaterproducts.com. I’m joined this morning by Marietta Zakas, our Chief Executive Officer; and Steve Heinrichs, our Chief Financial Officer and Chief Legal Officer. Following our prepared remarks, we will address questions related to the information covered on the call. As a reminder, please keep to one question and a follow-up and then return to the queue.

This morning’s call is being recorded and webcast live on the Internet. We have also posted slides on our website to accompany today’s discussion. They also address forward-looking statements and our non-GAAP disclosure requirements. At this time, please refer to Slide 2. This slide identifies non-GAAP financial measures referenced in our press release, on our slides and on this call. It discloses the reasons why we believe that these measures provide useful information to investors. Reconciliations between non-GAAP and GAAP financial measures are included in the supplemental information within our press release and on our website. Slide 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 forward-looking statements.

Please review Slides two and 3 in their entirety. During this call, all references to a specific year or quarter, unless specified otherwise, refer to our fiscal year, which ends the 30 of September. A replay of this morning’s call will be available for 30 days at 1-866-360-8712. The archived webcast and corresponding slides will be available for at least 90 days on the Investor Relations section of our website. I’ll now turn the call over to Martie.

Marietta Zakas: Thanks, Whit. Good morning, everyone. Thank you for joining our earnings call. It is an honor to continue in the role as CEO, and I thank the Board for placing its trust in me to lead Mueller at this critical juncture. Mueller plays an essential role in helping our customers deliver clean and safe drinking water to hundreds of millions of people. I get the work with the best team in the industry, and we will continue to build on the power of our industry-leading brands and deep channel and end-customer relationships. I look forward to working with Paul and the rest of the team as we continue to execute on our strategy to drive shareholder returns. I’ll now start with a brief overview of our second quarter performance.

We had a fantastic second quarter, reflecting the progress our teams have made executing our operational and commercial initiatives to deliver long-term sustainable growth. We achieved record quarterly net sales with a strong sequential increase in volumes, supported by our continued enhancements in customer experience. We improved gross margin 750 basis points to 36.9%, supported by continued manufacturing and supply chain efficiencies, leading to our highest quarterly gross margin in more than 7 years. With a record quarter for net sales and a strong gross margin, along with SG&A leverage, we delivered over 70% adjusted EBITDA growth compared to the prior year. We also achieved record quarterly adjusted net income per diluted share of $0.30, which increased more than 100% compared to the prior year quarter.

Turning to sustainability, I am pleased to report that in the second quarter, MSCI upgraded Mueller to its highest ESG rating of AAA. This rating is a great accomplishment and a testament not only to the critical products and solutions we provide for our municipal customers and their communities, but also the hard work and dedication of our team members, suppliers and customers. We look forward to sharing our continued progress in the next annual ESG report, which will be published later this year. We are increasing our annual guidance for net sales and adjusted EBITDA. These increases reflect our strong first half performance and order activity across most product lines as well as our belief that overall end market demand is healthy. Municipal repair and replacement activity remains very resilient, and the new residential construction end market is improving relative to a challenging 2023.

We are targeting record gross margin for 2024. The significant expected increase primarily reflects benefits from the actions we have taken over the past year to drive efficiencies in our operations. At the midpoint of our updated annual guidance range for net sales and adjusted EBITDA growth, the adjusted EBITDA margin is a 420 basis points expansion, reflecting our expected improved operational performance. Our teams have worked diligently on improving lead times while controlling costs and driving manufacturing material and freight efficiencies. Our execution allowed us to leverage the increased volumes in the second quarter leading to an improvement in gross margin. This strong conversion included outstanding performance at both our iron gate valve and hydrant manufacturing facilities.

We also expect to have an additional tailwind in the near future from the completion of our new brass foundry project and closure of our old brass foundry by the end of calendar 2024. Our commercial teams continue to do a great job working with our customers. We were pleased to see the strong sequential increase in order activity this quarter across most product lines, which was primarily driven by favorable end market demand. We believe some of this order strength was due to the timing of our price increases and positive sentiment moving into the construction season. We believe that net sales growth in the quarter versus the prior year would have been close to flat without the pull forward. With normalized lead times, we expect this pull forward to impact our third quarter sales, which is reflected in our updated annual guidance.

Our team continues to do an admirable job dealing with the impacts of the Israel Hamas war on our repair products business while also working to satisfy customer demand. As expected, during the second quarter, we experienced higher costs associated with labor, materials and freight. Our accomplishments this quarter and through the first half of the year are a testament to the progress we’ve made with our transformation, especially considering the external headwinds our teams have faced. I am confident in our ability to continue our momentum as we look to leverage our leading market positions and investments to deliver more consistent execution and drive future sales and margin growth. With that, I’ll turn it over to Steve.

Steven Heinrichs: Thanks, Marietta, and good morning. For the quarter, our consolidated net sales were $353.4 million, an increase of 6.2% compared with the prior year. Net sales primarily increased due to higher pricing across most product lines with higher volumes at Water Flow Solutions, partially offset by lower volumes at Water Management Solutions. As we’ve previously mentioned, we believe the lead times and backlogs for iron gate valves and hydrants have normalized. Based on order activity during the quarter, we also believe that valve and hydrant end market demand was healthy in this period. The differences in year-over-year volumes between iron gate valves and hydrants are primarily related to the timing of backlog normalization and channel and customer destocking.

In the prior year quarter, hydrant shipments benefited from serving an elevated backlog. In the second quarter, gross profit of $130.4 million increased 33.3% compared with the prior year. Gross margin of 36.9% increased 750 basis points compared with the prior year and reflects our highest quarterly gross margin in over 7 years. The increase was driven by improved manufacturing performance and higher pricing. Our continued improvements in manufacturing performance were primarily driven by improved productivity, including labor, material and freight efficiencies. This improvement also includes benefits from lower brass outsourcing costs. Higher pricing more than offset inflationary pressures, which mainly related to labor inflation. Total materials costs were slightly higher, primarily due to inflation related to purchase parts which was partially offset by lower raw material costs relative to the prior year.

For the quarter, total SG&A expenses of $63.7 million were $500,000 lower than the prior year. Lower personnel-related costs, third-party fees and engineering expenses were partially offset by higher incentive costs and inflationary pressures. Operating income of $63.5 million increased 93% in the quarter compared with the prior year. Operating income included strategic reorganization and other charges of $3.2 million in the quarter which have been excluded from adjusted results. These are primarily related to the leadership transition, severance, and certain transaction-related expenses. Turning now to our consolidated non-GAAP results for the quarter. Adjusted operating income of $66.7 million increased 98.5% compared with the prior year, primarily due to favorable manufacturing performance and higher pricing, which more than offset inflationary pressures.

Our adjusted operating margin improved 880 basis points to 18.9% compared with the prior year. This is the highest quarterly gross margin since the third quarter of 2019. Adjusted EBITDA of $82.2 million increased 70.9% in the quarter. Our adjusted EBITDA margin improved 890 basis points to 23.3%. Similar to adjusted operating income margin, this is also the highest quarterly margin since the third quarter of 2019. For the last 12 months, adjusted EBITDA was $236.8 million, or 19.1% of net sales, a 470 basis point improvement compared with the prior 12-month period. Adjusted net income per diluted share more than doubled in the second quarter, increasing 114.3% to $0.30 per share, which is a quarterly record. Turning now to quarterly segment performance, I’m pleased to start with Water Flow Solutions, where our operations and business teams led the segment to an outstanding quarter.

Net sales of $205.8 million increased 30.9% compared with the prior year primarily due to higher volumes of iron-gate valves and service brass products as well as higher pricing across most product lines. With normalized lead times, strong net sales growth for iron gate valves benefited from a sequential increase in orders, as well as lapping low orders and shipments in the prior year quarter, primarily due to channel and customer inventory destocking. Net sales growth for Service brass products benefited from improved manufacturing efficiencies and serving an elevated backlog, which we continue to lower. Adjusted operating income of $52.6 million increased 246.1% in the quarter. The benefits from increased volumes, favorable manufacturing performance, and higher pricing more than offset increased costs associated with inflation and higher SG&A expenses.

Adjusted EBITDA of $62.4 million increased 171.3% and our adjusted EBITDA margin also improved significantly to 30.3%. This is the highest quarterly adjusted EBITDA margin the Water Flow Solutions segment has ever achieved. Turning to quarterly results for Water Management Solutions, net sales of $147.6 million decreased 16% compared with the prior year. This was primarily due to lower volumes across most product lines, partially offset by higher pricing across most product lines. Net sales for hydrants were down double digits compared with the prior year quarter. Although our lead times are now normalized and we saw a sequential increase in orders, the prior year quarter’s sales benefited from very strong hydrant shipments as we serve an elevated backlog.

Adjusted operating income of $29 million decreased 9.1% in the quarter. The benefits from higher pricing, improved manufacturing performance and lower SG&A expenses were more than offset by lower volumes. Adjusted EBITDA of $35.7 million decreased 9.8%. However, adjusted EBITDA margin improved 170 basis points to 24.2% despite the decrease in net sales. Moving on to cash flow, net cash provided by operating activities for the year-to-date period was $62.2 million, an increase of $84.4 million compared with the prior year. The increase was primarily a result of higher net income and improvements in working capital compared with the prior year, which includes a smaller increase in inventories. During the quarter, we invested $10.1 million in capital expenditures and invested $15.8 million through the first six months.

While spending through the first half of the year is $4.7 million lower than the prior year period, we do expect spending to be higher in the second half of the year. Our free cash flow for the year-to-date period increased $89.1 million to $46.4 million compared with the prior year, driven by higher cash from operations and lower capital spending. Free cash flow as a percent of adjusted net income was at 70.1% for the first half of the year. During the second quarter, we repurchased $10 million in common stock, and as of March 31, we had $80 million remaining under our share repurchase authorization. At the end of the second quarter, our total debt outstanding was $448.7 million, we had cash and cash equivalents of $179.2 million. Our balance sheet remains strong with our net debt leverage ratio at 1.1x at quarter end, no debt maturities until June 2029 and our $450 million senior notes at a 4% fixed interest rate.

We did not have any borrowings on our ABL agreement at the quarter end nor did we borrow any amounts under our ABL during the quarter. In March, we amended our ABL, which extended the maturity date to March 2029 and lowered our applicable margins. I will now review our updated and improved outlook for fiscal 2024. Based on our strong first half performance and current expectations for the rest of the year, we are increasing our guidance for both consolidated net sales and adjusted EBITDA. We now anticipate net sales will be between flat and down 2% as compared with the prior year. We believe municipal and new residential construction end markets will continue to be healthy in the second half of the year. In addition to raising our net sales expectations, we are significantly increasing our guidance for adjusted EBITDA as a result of our strong first half operating and margin performance, coupled with our current expectations for favorable end market demand.

We now anticipate that our adjusted EBITDA will increase between 23% and 27% compared with the prior year. This includes an expected increase in our total SG&A expenses, reflecting higher incentive compensation and personnel investments. Additionally, we expect our free cash flow as a percentage of adjusted net income to be more than 75% for fiscal 2024 as compared with 62.7% in fiscal 2023. With that, I’ll turn it back to Martie for closing comments.

Marietta Zakas: Thanks, Steve. I want to highlight a few key items before opening it up for Q&A. I’m excited about what we’ve accomplished so far this year, especially given the uncertainties in the external environment. I am thankful for our talented and committed employees who are doing incredible work focusing on serving our customers and driving manufacturing material and freight efficiencies while also executing our large capital projects. There is still work ahead of us, and we are primarily focused on executing initiatives in four key strategic areas. We will continue to drive operational improvements to deliver the benefits from our capital investments. We are making changes to accelerate sales growth and capture the benefits from favorable long-term end market growth trends through product innovation and service.

We are also increasing collaboration and teamwork throughout the organization to create a culture of talent development, enabling us to execute on our targets and make Mueller a preferred place to work. We are well positioned to execute on our strategies to improve margins and increase free cash flow to support future investments. I am confident in our strong foundation of talented and committed employees, industry-leading brands and deep distribution channel and direct customer relationships. That concludes my comments. Operator, please open this call for questions.

See also 20 Best Evernote Alternatives in 2024 and 25 Richest Billionaires in Healthcare Industry.

Q&A Session

Operator: [Operator Instructions]. At this time, we’ll begin our question-and-answer session. [Operator Instructions]. Our first question comes from Brian Lee with Goldman Sachs. Your line is open.

Brian Lee: Hey, everyone. Good morning. Thanks for taking the questions and kudos on the impressive execution here. Maybe a big picture question for you, Martie. You’ve had quite a tenure at Mueller, you’ve seen a lot of change at the company over the years, and you’re not necessarily new to the CEO role as it becomes your full-time responsibility though. How are you thinking about kind of the strategic priorities? I know you touched upon a few here at the end of the call, but what’s kind of changed here as you’re taking on the role. Obviously, the company is in a different spot. But as you think about your strategic priorities in that role, can you kind of speak to what you think you can change or enact change going forward?

And then one thing I think, in particular, I’d be curious to hear your take on, as you mentioned, sales growth and product innovation. Can you elaborate a bit more on kind of where you see Mueller headed and where the best opportunities might be when it comes to that particular piece of the stool?

Marietta Zakas: Great. Yes. Thanks, Brian, and thanks for the question. Look, I think one of the most important things I’m going to say is, look, we have been continuing to lead change, not just today going forward, but I think even looking at the last eight months, and importantly, as we look out, we are a water-focused company. We do have a long history within the business, but I think in many ways, the time has never been better for us to really leverage many of the products that we have together. And importantly, as we say, when we look at the opportunity, as we have aging infrastructure, as we have continued focus on water-starved areas and importantly, particularly how different regions are going to need to focus on improving their ability to provide water and provide water at a reasonable cost to all their customers.

We have, over the years, look to broaden our portfolio. We’re a full service provider as we look across valves, hydrants, certainly brass products, and I can emphasize brass products here because with the emphasis, with the infrastructure bill and the designated funds for the lead service line replacement, I think importantly, our role with the service brass products that we provide and importantly, with the additional capacity that we have just brought on with our new brass foundry and the Eco Brass product that we have, which has many sustainability benefits, I think that is one of the additional products and services that plays well as we look forward. The other piece that I want to talk about, and it’s an area where we have, I think, reenergized ourselves, and that’s really in and around our focus on the customer experience.

We are focused on improving our delivery lead times. We are looking to even further deepen the relationships that we have with our customers and overall enhancing that customer experience, that we think will also further to promote ourselves in that and the breadth of products and services that we offer, I think, is helpful. In and around the area of technology, I certainly think that the areas that we focus on with our leak detection, with our pipe condition assessment, looking to get into pressure management and again, looking to bridge ways for the municipalities to gain more intelligence in and around what their systems have and the solutions to help them better manage it. And that’s where I think increasingly, you’re going to see us look to link these infrastructure products that we have and how they can be used and we can bring more intelligence to those products.

And I think we will absolutely continue along those lines as well. With that, I want to — I’ll hit one other thing because I think it’s important, and I really appreciate the longer term question that you have asked. When we look, I think as Steve talked through, when we look at the capital structure that we have, that we put in place when we look at the capacity that we have and the flexibility that we have, we are positioned to look to broaden our product portfolio and/or deepen our product portfolio. And I will say that we are going to — we will continue to look for those right opportunities at the right valuations to allow us to continue to grow, not only organically but inorganically as well.

Brian Lee: That’s all super helpful.

Marietta Zakas : The other piece that I think you’ve — sorry, you’re saying, but I want to hit on the operations piece as well because with some of the internal realignment that we have recently done, part of that has been further investment in and around our operations capabilities and importantly, I think, a real forward vision in terms of how we can continue to improve our operational performance for our margins to continue to grow over time.

Brian Lee: Yes. Maybe that’s a good segue into just the second question I had, a little bit more mundane and less big picture, and then I’ll pass it on. When you think about this kind of 7-year high in gross margins, you mentioned specifically price and manufacturing improvements. How sustainable do you kind of see those two pillars? It seems like you still have some outsourcing benefits that are still to come and then price sounds like it’s something that’s moving into your wheelhouse in terms of something you can leverage. But can you kind of speak to sort of the impacts on gross margin this quarter between the two buckets and then how you think about them going forward as having sustainability?

Marietta Zakas: Absolutely. So in and around price. I think when you look over certainly a longer-term period, I think is, we have generally benefited from price over the longer term. And our objective, as we said, is always for price to more than cover any of the inflationary costs that we are experiencing. Not to delve too much into the history, but I think with sort of the level of inflation that we had, coupled with some of the challenges with COVID and demand levels, that it was a challenging period, but I think we’ve gotten back into, you’ve seen this quarter, we’re probably sort of mid-single digit in and around pricing. I think we told you last quarter that we had implemented a price increase across most of our product lines in February.