Mueller Water Products, Inc. (MWA) CEO Scott Hall on Q1 2019 Results - Earnings Call Transcript

About: Mueller Water Products, Inc. (MWA)
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Earning Call Audio

Mueller Water Products, Inc. (NYSE:MWA) Q1 2019 Earnings Conference Call February 5, 2019 9:00 AM ET

Company Participants

Whit Kincaid - Investor Relations

Scott Hall - President and Chief Executive Officer

Martie Zakas - Chief Financial Officer

Conference Call Participants

Michael Wood - Nomura Instinet

Brian Lee - Goldman Sachs

Brendan Shea - RBC Capital Markets

Brent Thielman - D.A. Davidson

Bryan Blair - Oppenheimer

Andrew Buscaglia - Berenberg

Andrew Cohen - Northcoast Research


Welcome and thank you for standing by. At this time, all participants are in a listen-only mode. At the end of today’s presentation, we will conduct a question-and-answer session. [Operator Instructions] Today’s conference is being recorded. If you have any objections, you may disconnect at this time.

I would now like to turn the meeting over to Whit Kincaid. You may begin.

Whit Kincaid

Good morning, everyone. Welcome to Mueller Water Products 2019 First Quarter Conference Call. We issued our press release reporting results of operations for the quarter ended December 31, 2018, yesterday afternoon. A copy of it is available on our website,

Discussing the first quarter’s results and our outlook for 2019 are Scott Hall, our President and CEO; and Martie Zakas, our CFO. This morning's call is being recorded and webcast live on the Internet. We have also posted slides on our website to help illustrate the quarter's results, as well as to 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, and 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 2 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 on September 30. I also want to point out that our performance results do not include the acquisition of Krausz Industries, except for the impact of the acquisition on our balance sheet and cash flow statements.

Krausz’s results will be included in our operating results beginning January 1, 2019. A replay of this morning's call will be available for 30 days 1-800-219-6387. The archived webcast and corresponding slides will be available for at least 90 days in the investor relations section of our website. In addition, we will furnish a copy of our prepared remarks on Form 8-K later this morning.

I’ll now turn over the call over to Scott.

Scott Hall

Thanks Whit. Thank you for joining us today to discuss our results for the 2019 first quarter. I will start with an overview of the first quarter. So, please turn to Slide 4. Overall, I am pleased with our team’s performance this quarter as their execution help deliver a solid start to the year. We generated 8.1% organic net sales growth driven by higher shipment volumes and pricing.

In the quarter, both sales growth and our improved manufacturing performance led to a 22.4% increase in adjusted operating income with a 20.4% growth in adjusted EBITDA. Both infrastructure and technologies reported growth in net sales and improved operating performance during the quarter. We have been working constructively with all of the parties involved in the ongoing dispute regarding the tax liabilities of Walter Energy, our former parent.

The IRS provided a $37.4 million calculation of the tax liability emanating from the activities of certain business of Walter Energy. As a result, we recorded the entire amount due to the operation of several liability under federal law. Martie will discuss the details later in the call. Put simply, after many years of uncertainty, we believe we are in a position to settle this matter.

During the quarter, we completed our acquisition of Krausz Industries. We remain very excited about having a high-quality product portfolio for the pipe repair market and the potential synergies we can achieve together. This is our largest acquisition in over a decade and we are working closely with the Krausz team members to plan and execute future growth initiatives, which we will address later in the call.

After a solid start to the year, we are increasing our expectations for 2019 to reflect the impact of the Krausz acquisition. We announced additional price increases for many products, which be effective in February in order to help offset anticipated inflation in 2019. Despite operating in an increasingly challenging economic environment, I am confident in our ability to drive growth through continued focused execution of our key strategies.

With that, I’ll turn the call over to Martie.

Martie Zakas

Thanks Scott, and good morning everyone. I will start with our first quarter consolidated financial results, including an overview of the Walter Energy Accrual and then review our segment performance. After that, I will touch on the Krausz acquisition. Consolidated net sales for the 2019 first quarter increased $14.5 million or 8.1% to $192.8 million, driven by higher volumes at both infrastructure and technologies, as well as higher pricing at infrastructure.

Gross profit increased to 8.5% in the quarter to $60.1 million, yielding a gross profit margin of 31.2%. Higher pricing, increased shipment volumes, and improved manufacturing performance contributed to this increase, but was partially offset by higher material and freight cost and the impact of tariff. Material cost increased nearly 5% year-over-year in the quarter.

Selling, general and administrative expenses were $41 million in the quarter, up $1.2 million from last year with the increase primarily due to higher volume-related personal expenses. SG&A as a percent of net sales decreased to 21.3% in the first quarter from 22.3% in the prior year quarter. Adjusted operating income increased 22.4% or $3.5 million to $19.1 million in 2019 first quarter.

Both segments contributed to the improvement in operating performance. This was primarily due to higher volumes and pricing and better manufacturing performance, which were partially offset by higher costs associated with inflation. Adjusted EBITDA for the 2019 first quarter increased 20.4% to $31.3 million. Over the last 12 months, adjusted EBITDA increased to $185.3 million or 19.9% of net sales.

I’ll now address the Walter Energy Accrual. As Scott mentioned, earlier, for the quarter ended December 31, 2018 we recorded a $37.4 million accrual related to the Walter Energy liability. After extensive work and discussions with the IRS, The Department of Justice, The Walter Energy Bankruptcy Trustee, and other involved parties and experts, the IRS has provided us with a $37.4 million calculation of the tax liability emanating from the activities of certain businesses of Walter Energy, our former parent.

The IRS calculation includes interest amounts calculated through January 31, 2019, which will continue to accrue until the matter is finalized and paid. The accrue we recorded includes $7.4 million for the underlying tax matter and $30 million of related interest. The company’s previous activities in tax positions were not the source of the Walter Energy liability.

However, we recorded the Walter Energy Accrual due to the operation of several liability under Federal Law. A payment settlement agreement has not been reached with The Department of Justice and IRS. The recent government shutdown did affect negotiations during this time period and we do not have an estimate as to when or if a settlement agreement can be reached. We will continue to work constructively with all the parties involved in this matter in an effort to negotiate a settlement.

Turning now to taxes. In the 2019 first quarter, we reported a net income tax benefit of $5.9 million or 21.9% of loss before tax. This includes a $7.7 million benefit on the Walter Energy Accrual and a $600 thousand favorable adjustment related to the one-time provisional expense of $7.5 million recorded in the prior year for the transition tax on previously untaxed, undistributed, foreign earnings.

Our adjusted net income per share increased to $0.07 for the quarter, compared to $0.06 in the prior year quarter. Our 2018 quarterly adjusted EPS excludes the Walter Energy Accrual and strategic reorganization and other charges.

Now, I’ll turn to segment performance starting with infrastructure. Infrastructure net sales grew 7.4% to $172 million in the first quarter, due to higher shipment volumes and higher pricing. Adjusted operating income for the first quarter increased 10% to $30.9 million, primarily due to shipment volume growth, higher pricing, and improved manufacturing performance, partially offset by higher costs associated with inflation and SG&A expenses. Adjusted EBITDA for the 2019 first quarter increased 10.5% to $41 million yielding an adjusted EBITDA margin of 23.8% for this segment.

Moving on to technologies. Technologies net sales increased 14.3% to $20.8 million in the quarter, primarily driven by higher volumes at Mueller Systems. Our adjusted operating performance improved $900 thousand in the 2019 first quarter, primarily due to improved manufacturing performance and higher volumes, partially offset by higher costs associated with inflation. Adjusted operating loss for the quarter was $3.7 million, compared to $4.6 million last year.

Now, I’ll review our liquidity. Cash flow from operating activities improved $9.4 million to $9.9 million, compared to the prior year quarter. We invested $15.9 million in capital expenditures in the quarter, primarily to upgrade our equipment and manufacturing capabilities, as compared with $6.4 million last year.

Free cash flow, which is cash flow from operating activities, less capital expenditures was negative 6 million, similar to the prior year quarter. At December 31, 2018, we had total debt of $445.6 million and cash and cash equivalent of $198.8 million, which is lower primarily due to the Krausz acquisition. At the end of the first quarter, our net debt leverage ratio was 1.3 times.

I’ll now turn to the Krausz acquisition. As Scott mentioned, in early December, we completed the acquisition of Krausz Industries for $140 million before adjustments. We anticipate incurring $2 million to $3 million of future transaction and integration expenses, which do not include expense associated with the inventory step-up and any potential one-time tax payments for changes in tax structuring.

From a reporting perspective, Krausz will be part of the infrastructure segment and will be included in the company’s operating results beginning January 1, 2019. The operating results of Krausz will be reported on a one-month lag beginning in the quarter ended March 31, 2019. This means that the 2019 second quarter results will include Krausz’s results for December, January, and February.

For the quarter ended December 31, 2018, the consolidated balance sheet includes an estimated opening balance sheet for Krausz and the cash flow statement reflects the acquisition. However, the consolidated statement of operations excludes the results of Krausz’s operations.

I’ll turn the call back to Scott to talk more about our results and updated outlook for 2019.

Scott Hall

Thanks, Martie. We were pleased to the start the year with 8.1% organic consolidated net sales growth, including a 7.4% increase at infrastructure, and a 14.3% increase at technologies. The increase was driven by volume growth at both segments in higher pricing at infrastructure. As Martie mentioned, we are still experiencing higher inflation. Although the rate of material cost inflation has slowed, compared with the prior year, we anticipate higher inflationary pressures driven by a combination of material costs, freight, labor, and tariffs in 2019.

We recently announced additional price increases for many of our products, which will be effective in February, impacting U.S. and Canadian markets. This is in addition to the price increases we announced in September. Our price cost relationship improved in the first quarter, and we expect higher pricing will help offset anticipated inflation, as well as cover some of the material and freight cost increases, we experience last year. Going forward, we will remain focused on improving our conversion margin through price realization and productivity initiatives.

I’ll now give a quick update on the Krausz acquisition. Krausz had another strong year of growth, generating double digit net sales growth in calendar 2018 with healthy adjusted margins. We are working closely with the Krausz team members to execute growth initiatives with plans to enhance Krausz's efforts in the U.S. and abroad by generating sales and operating synergies that will expand future growth.

The annual Krausz sales meeting took place in January. During the meeting, we made progress planning sales strategies for a number of key areas, including cross-selling with our Mueller portfolio, leveraging our distribution and sales rep relationships, and examining expansion into adjacent markets beyond water utilities.

The product management teams are also working together to identify opportunities for collaboration related to product innovation, upcoming product launch plans, and new product development, which will help further position us as we prepare to penetrate new markets and introduce new products.

I'd like to quickly touch on our capital allocation strategies. Since the end of calendar 2016, we have demonstrated a track record of strategic investments with $108 million allocated towards capital expenditures and $163 million spent on acquisitions. In addition, we have returned $147 million of cash to shareholders through a combination of dividends and share repurchases.

We also further strengthened our balance sheet during this period with the senior note refinancing, and have a net debt leverage ratio of 1.3 times, after the Krausz acquisition. Our capital allocation strategy remains focused on enhancing our position as a water infrastructure company and adding long-term value for our shareholders.

Moving forward, we will continue to balance our capital allocation among strategic investments to strengthen and grow the business while returning cash to shareholders. As I have previously discussed, we expect near-term capital expenditures to be higher than they have been historically to help support our strategic growth initiatives, as well as to keep our facilities poised for manufacturing improvements.

Additionally, we will continue to look for strategic acquisitions to expand our product portfolio and geographic footprint. I will wrap up my comments with a review of our current full year expectations for consolidated results. For 2019, we anticipate continued growth in all of our end markets. This includes residential construction growing in the low-single digit range, with municipal spending in the low to mid-single digit range.

Finally, we anticipate mid-single digit range of growth for the natural gas distribution market. Our expectations for residential construction are lower than what we previously communicated as residential growth has slowed in the near-term. After a solid start to the year, we are increasing our expectations for 2019 to reflect the impact of the Krausz acquisition.

We expect to increase our consolidated net sales between 8% and 10% in 2019. We expect to deliver adjusted EBITDA growth between 14% and 17% with no change in our expectations for full-year organic adjusted operating income growth. As I mentioned earlier, we are facing an increasingly challenging operating environment.

We will continue to focus on executing our key strategies to grow and enhance our business by accelerating new product development, driving operational excellence, and improving our go-to-market strategies as a more customer-focused organization.

Martie will now provide some final comments on our 2019 outlook.

Martie Zakas

Thanks Scott. For 2019, we expect that depreciation and amortization will be between $51 million and $54 million, which excludes amortization related to the acquisition of Krausz. Corporate SG&A expenses are expected to be between $35 million and $37 million. Net interest expense is expected to be between $22 and $23 million, reflecting lower interest income as a result of funding the Krausz acquisition with cash on hand.

Our adjusted effective income tax rate for the full-year is expected to be between 25% and 27%. Finally, we expect capital expenditures to be between $58 million and $62 million, and are considering some projects which would increase our expected expenditures for 2019.

With that, operator, please open this call for questions.

Question-and-Answer Session


Thank you. [Operator Instructions] And our first question is from Michael Wood with Nomura Instinet. Your line is open.

Michael Wood

Hi, good morning. My first question is on the tax settlement, the tax reserve. Is this covering all of the tax years that were at issue, and is this figure based on the settlement that was proposed? Can you provide some more color there?

Scott Hall

Sure. Martie, why don't you start, and, but the answer to the question on a high level, yes.

Martie Zakas

Yes. So, look before I get to your questions specifically Mike. I just want to reiterate what Scott said earlier that we’re pleased to be in the position that we’re in today. We know that the Walter Tax Liability has been an open question for an extended period of time. To give some perspective, we think we’re in a position today, and importantly we’re working toward a reasonable resolution with the IRS and the Department of Justice. I hope that you’re hearing from us and that you understand that we think we’re on the path to a solid resolution of what’s been a very challenging matter.

It’s complex, it’s being managed by our attorneys and experts, as well as the attorneys and experts with the Department of Justice, the IRS, the bankruptcy trustee, and other parties. You can also imagine that we’re reluctant to provide detail regarding ongoing specifics about the settlement negotiations. But the $37.4 million accrual that we took this quarter was a number that the IRS provided us and that’s a calculation of the tax liability that emanates from the activities of Walter Energy. The calculation does include interest amounts through January 31, 2019 and they will continue to accrue until the matter is finalized and paid. So, we're working towards concluding the settlement negotiations, but we don't know, you know at this point when or if a settlement can be reached.

Michael Wood

And when this is finally behind you, Scott, how does this impact how you view or the board views the balance sheet in terms of the net leverage, leverage isn’t very high right now, I imagine this visibility could help give you some confidence to deploys some more capital.

Scott Hall

I think as we’ve answered repeatedly, I’ve been asked several times over the years whether or not this was impacting our capital allocation strategy, and it has not. So, we have been looking at our M&A pipeline, we have been looking at our organic investment in capital expenditures. We’ve been looking at, you know what we do in share buyback dividend policy all of those things because we believe that while we have these opportunities to reinvest in the business, whether through acquisitions or in these other manners we just discussed that we would take a balanced approach and we would take the best path forward to us.

So, I agree that some would argue we’re under leveraged right now [or 1.3 times], we’re starting to see, I think that if we can get a deal at the right multiples, we’ll do that. We have an interest in continuing to grow through acquisition. And if you're to look at our performance, we went through how we spent our cash over the last couple of years.

You could see we obviously have somewhat of a bias to reinvest in the business in terms of our capital expenditures. And I think that’s more an outcome of what was a prolonged period of debt pay down from 2006 through, let's call it 2016. So that we still have a target rich environment from both productivity, product quality, and manufacturing capabilities to in source.

So, it really hasn't changed anything Mike, but it certainly, it’s good to get this overhang, which I think was impacting the investment community behind us. So, I’m very pleased with the work that the general counsel and Martie’s team have done to get us to this point.

Michael Wood

One final question. Are you able to break out the volume and price split within the infrastructure organic growth and just roughly where price cost was for the quarter?

Scott Hall

I don't give it specifically, but suffice it to say that, as I said in the prepared comments, performance and price exceeded the inflation for the quarter, but it only exceeded it, let me put it this way, exceeded it less then covering last year's behind. So, if you recall last year, we’ve been tracking this price increase, are we lagging still, how much of the inflationary period have we lagged, have we recovered it over the whole inflationary cycle? And I can tell you, we did beat it in the quarter, but we didn’t beat it by enough to offset the ground given up in fiscal 2018. So, while it was positive, it was slightly positive. But I don't want to get into giving specific numbers on price cost. So, I think it just gives too much competitive information.

Michael Wood

Thank you.


Our next question is from Brian Lee with Goldman Sachs. Your line is open.

Brian Lee

Hi, guys. Thanks for taking the questions and good morning. Maybe, first on the Krausz details, I know you’re providing an updated revenue outlook, including the contribution, just wondering, you know how you're thinking about operating margins? I know you’re reiterating the organic view, but if you could provide a bit of a similar view, including the Krausz contribution? And then, maybe related to that, any early reads on synergies or cost reductions or when we could think about getting some clarity around that as you move through the integration process?

Scott Hall

Sure. So first, we reiterate that we think that in the long run that Krausz EBITDA margins are unlike our consolidated margins. I think you should, you know they will be pretty much close to one another. I wouldn't say that even, but they are close enough for what we’re talking about. Certainly, the other thing I want to reiterate is that, Brian, as I said in the last call, you don't buy this business for the cost synergies. We haven't got a big plan to consolidate manufacturing businesses or anything like that, we anticipate operating in Israel for manufacturing for many years to come.

This is really a sales synergy play, and we still see those opportunities to continue to grow both the Mueller's presence, the amount of products that we sell into the repair market being complementary to what Krausz sells, and conversely when we think about the channel, we think it gives us more channel synergies, it gives us a little more channel power frankly to have more and more of what the big distributors are selling to municipalities.

And we also think that we get some synergies from a spec position where we can go in and provide, complete repair solutions along with complete repair techniques, if you think about insert valves and couplers and the grips, and you think about restraint and hydrants, and there's a lot of things that we think we can do with this in the medium-term. So, we are highly focused on that. We’ve compiled a team from both sides. It’s the integration team.

In fact, we’ll be meeting with them later this week and we’ll be reviewing the status of where we are not just with the tactical things like payroll and things like that, but also the more important things, the customer facing things as they relate to product development, process development, and bringing our process based manufacturing processes to bare their facilities, get them in our productivity programs, and get a status update basically on where we’re going both from a market and manufacturing point-of-view.

So, you know, I think we’re right now, right around day 32, sorry day 42, and I think we’re in really good shape as far as the team’s ability to get the important things up on their radar for us to completing – the integration team has been knocking them out one-by-one.

Brian Lee

Okay. Now that’s helpful. I appreciate that Scott. I guess just on the EBITDA comment and the new guidance around 14% to 17% growth, I appreciate that context, but is that meant for us to read in that you’re not necessarily anticipating any additional growth on top of the 7% to 9% adjusted operating income growth with Krausz embedded in the numbers for the full-year?

Scott Hall

The 7% to 9% was the organic, you know you guys can use to 7% to 9% organic in your model. Then you get the EBITDA growth with Krausz. The reason I did it that way and the reason Martie is talking about it that way is, we haven't got the purchase price allocation figured out. So, what the amortization piece looks like at the adjusted operating income growth completed yet. And when we have all that work done with opening balance sheets and things like that. You will have a better idea on the operating income line, but the 7% to 9% you heard in the comments, please hear that that was organic growth. And that the acquisitive piece of that at the operating line will have to be post amortization calculations for the purchase price.

Brian Lee

Okay. Fair enough. We'll look forward to more details on that. Maybe one last question from me, and I’ll pass it on. You mentioned the price increases to cover inflation and rising cost, are these in-line from, you know if you can quantify to any degree in-line with the pricing increases that you implemented around this time last year and then can you talk a bit to how much of this is to address labor versus raw material inflation? I know last year a lot of it was on the [brass], but it does seem like that could be reversing some this year. So, how much of this is backward-looking versus how you’re thinking about your positioning around raw material costs as we move through the year? Thank you.

Scott Hall

Yes. So, just to give everybody a little bit of color, I think that what you're referencing is that the inflation on as a result of brass, especially with the copper import is kind of steadied now and we don't really see massive movements in copper prices from a year ago, but we still see significant, you know, I think, better than high-single-digit inflation in scraps deal. So, the majority of our pricing activities when you got out and we’re talking to our customers, the majority of our pricing activities are still driven by increases in scraps deal. That’s probably the biggest offender right now.

The labor piece of it, while meaningful in the kind of 3% range for our union employees and 3%, 3.2% range for all other is a piece of it. I think labor is still such a small piece of our overall cost of goods sold that the inflation impact is relatively small, and so when we’re out talking to customers about the real biggest reason for these, you know what has been a fairly rapid increase in pricing over the past two years, it is primarily driven by raw materials.

Brian Lee

Okay. Thanks guys.


Our next question is from Seth Weber with RBC Capital Markets. Your line is open.

Brendan Shea

Hi, thanks. This is Brendan on for Seth. I was wondering a couple of things here. As we look towards you dealers, any commentary or more color you can give on how you're feeling right now about your channel inventory levels?

Scott Hall

Sure. I think that inventory levels are probably a little bit higher as we go here into the second quarter. I think that it’s a mixed bag in terms of what is going on. I think, we still got a lot of tailwinds as you’d think about employment in the economy, you think about the Fed recently, kind of steading their outlook for rates, but I think there’s a lot of good things happening economically that give us hope, but I think the shutdown along with what has been a loss of fair number of construction days in this this polar vortex that we saw in the Midwest and then made its way east, I think we lost on average 3 to 5 construction days in there.

So, I would imagine that we have a little bit higher channel inventories as a result of what’s been through January in this part of February, a little bit more difficult selling environment for the channel partners. When you take the natural buildup that happened as a result of the price increases in September, maybe there was a million or so more in the fourth quarter inventories. I think on average now, you could say there is 10 days to 15 days more in the channel. That’s kind of where our thinking is.

Brendan Shea

Okay, thank you. And then the growth in the end markets, you lowered some of those there. When we think about the products that you sell into muni – into the residential and into nat gas, is there a significant, not a significant, but a marked difference in the margin profile for those products? Are they relatively similar, are we expecting headwind or tailwind towards a shift in mix?

Scott Hall

Yes. As I’ve said repeatedly, if you think about iron, in particular gate valves and hydrants, they would be the best products and then down from there you get into what we call specialty and brass kind of similar, and then the technologies having a fairly high fixed cost as a result of still needing a lot more volume out of their manufacturing base. So, that’s how we think about the three tiers of margins and I’ve said that to investors in the past. But when we think about what impact that the end markets are going to have, I think as long as that muni hangs in there, we’re going to be not experiencing a great deal of mix vulnerability.

What’s changed and I want to be clear about this to everybody is, the only thing that changed in our outlook is we’ve taken residential down a little bit into that low-single-digit range, and that’s basically reflecting what was, you know a very disappointing December from a housing starts point-of-view. But we're still looking at inventory, and inventory would give us encouraging future signs, it says, even at this level, we could see more land development.

So, while we have taken our housing start look down and we think it’s cautious, we’re also sitting there saying that we know we’re early in the land development cycle when they put in [indiscernible]. That’s when they put in water and, as long as inventories kind of stay at these lower levels, I think there are still some reasonable hope that that could recover in the last half of the year.

Brendan Shea

Okay. Thank you.

Scott Hall

Thank you.


Our next question is from Brent Thielman with D.A. Davidson. Your line is open.

Brent Thielman

Thanks, good morning. Scott on the muni-related market, the low-to-mid single-digit growth, I guess you’ve seen and you’re talking about for this year, is that fairly consistent across the country? Have you seen state or regional trends in a much wider range, just trying to get is there any reason to think maybe in territories Mueller plays in, you could see something somewhat faster than that?

Scott Hall

Yes. I think that is a great question, but the way that we think about it actually is more as it relates to size of population and age of infrastructure., the – you know the big old cities, New York, Philly, Boston still going to have their O&M spending, their operations and maintenance spending is going to be highly, highly predictable because they have such a large infrastructure. The maintenance of that infrastructure is kind of a fixed number and we know at the rate with which they’re going to have to do, let us call it both their repair and replace and they’re emergency replacements. So, there are large enough networks that statistically you can kind of come up with your own model.

I think the contractor driven business tends to be more demographically run and think about that as housing starts, and those would be in the growing parts of the, let’s call that infrastructure buildout. Some of that is muni-driven as they make more water available you think about places like Colorado where there’s lot of population growth in Utah, where there is population growth, great population growth in Texas and the Southwest. Southeast, Southwest kind of this, been this hotbed if you will of municipal spending in order to increase supply because they have such large population growth. And then last but not least, you basically have what is a difficult environment for the shrinking cities and you think about the [indiscernible], and you think about more and more of their spend is going to emergency.

So, it’s not proactive spending. It’s a result of water main [ph] breaks or distribution leaks and things like that, and they tend to be having to spend more of their O&M maintenance budget on emergency repair. And that's got a little bit more lumpy, I think, you know that recent cold snap we just saw through the Northeast and the Midwest. It will be interesting to see if we see a spike in muni spending as more and more water main breaks and distribution breaks occur when you see a great deal of frost, even if you see these extreme swings in temperature.

So, instead of calling it, kind of the migration pattern, I think you can say that you’ve got a really highly reliable base in O&M, you think about that as your old vibrant cities in New York, Boston, LA, Philly that kind of thing. You have the kind of emerging demographic markets when you think about the Southwest and the Southeast. And then you have this kind of lumpy piece on top, which is really going to determine the degree with which we have seen how much muni spending goes up or down based on kind of the more difficult demographics with population declines, but still meaningful infrastructure in the ground.

Brent Thielman

Okay, that’s helpful commentary. The specialty valve business that has the longer lead times, I know you mentioned, I think you were slightly positive on price cost, are you still seeing negative price cost comparisons there or are you beyond that now in that business?

Scott Hall

No, I said last quarter, we have in front of us, probably another 6 months. We had 9 months is what I said at the last quarter, we probably have another 6 months at the end of this quarter, and that’s as we make our commitments on those orders, we took that had, you know 9, 10-month lead time for those big projects. So, you know, with scrap steel where it is, with the elements that are subject to tariffs where it is, if tariffs go up even more in May as threatened, those are all things that specialty valve business still has left to digestive in front it. But I don't expect when we – you know to be frank, when we gave you our guidance, we anticipated making good out of our contracts in that business, so that’s rolled in.

Brent Thielman

Okay. And I know you're not providing segment level guidance. Is there any qualitative/quantitative commentary about order trends, major wins, and backlog in the tech side or I guess some sense as we kind of model out the growth in that business as you would be thinking about, you know, sort of a prior three-year average we can use going forward, just you know some sense there?

Scott Hall

Oh! Yes, I can definitely give you some qualitative information. We expect that business to grow faster than the infrastructure business, just as you saw in the second quarter. You know those kinds of – sorry, first quarter. Those kinds of growth rates, you know, I think are to be expected. With that said, we are very happy that we are able to win business and continue to grow both our awards and backlogs year-over-year in the first quarter. I think in the technology business, when you think about what’s going on with [eco awards] for the Leak Detection both in East Baymont, San Jose, American water places like that along with the awards in the AMI business, you know, we expect that business to be a 20% plus business growth course for a while, and we've got to continue to invest in the engineering cost and invest in the manufacturing infrastructure in order to make sure it’s making high-quality products for a long period of time, and take our – let’s call it our natural share in that space.

At the same time, they do that, we’re starting to see, for the first time, you know, good growth on things like Hydro-Guard, where we actually have pressure monitoring, a communication system where we will actually flush hydrants and flush overpressure situations using the technology’s radio infrastructure. You can have that available either in your AMI network or you can have it available over the cellular network. So, you know, as I’ve been talking about for some time saying, you’re going to starting to see technology’s products integrated into infrastructure traditional areas, we’re starting to see that now and we’re starting to actually have, you know, it’s much, a couple of hundred thousand here and there, but you’re actually starting to see customers understand the power of putting information in the infrastructure as opposed to keeping it just at the meter point.

So, yes, very, very positive. I think the team has a long way to go, you know, so I’ve resisted any segment calls. I know before I got here, there were all these proclamations around, oh! It will be breakeven by this point or breakeven by that point. You know, what I want to get everybody level set on is that, we will invest in the technologies that we think will be key to making the infrastructure meter business and leak detection business an integrated informatics company for our customers. So, that’s the investments we’ll continue to make and we need to put pressure sensing and turbidity, alkalinity, chlorinity sensing in the distribution network and the only way we’re going to do that is to continuing to invest in the product developments in this segment.

Brent Thielman

Okay. I appreciate the color. Yes, thank you, Scott.


Our next question is from Bryan Blair with Oppenheimer. Your line is open.

Bryan Blair

Hi, good morning. Thanks for taking my question. I respect that the legacy Walter Energy tax liability hasn’t affected this capital deployment strategy today, but it certainly had some impact on your valuation in the credit that you’ve received for an improving balance sheet and what can do with that. That in mind, I was hoping you could provide some color on, you know, trends in your deal funnel, and you know, whether it's realistic to expect some more strategic M&A Krausz [indiscernible] that’s come through in your fiscal 2019?

Scott Hall

Well, I think the most important thing before I – you know, will get to answering your question, but the most important thing we need to execute on as a team first is, the successful integration of Krausz. It’s fine to have these deal machines and we certainly have lots of the next deal in mind, but excellence of execution means that when you go and spend $140 million that you're exquisite in your execution of the integration plan. And you know, we have spent a lot of time as a senior management team involved in the day-to-day – the members of my executive leadership team that are involved in the integration planning and activities is the most important thing we have to do in the next three quarters. That is mission critical.

We are also going to be exquisite in our execution of the opening of the large casting foundry. You’ll recall we talked about that Chattanooga capital project, I think now about six months ago and we do our weekly updates and our monthly project reviews as a senior leadership team around that too. So, to give you some color to answer your question, yes, there are more things in our deal funnel that we would do, all in line with the guidelines that I have outlined to you all in the past, you know, as they relate to geographic expansion, as they relate to bolt-ons, as they relate to adjacencies.

So, the pipeline is still full of those things and I do think we can get some deals done where value will be in line with what we think we should pay. But with that said, you shouldn't expect in the next 90 or 180 days a deal as we have to do this Krausz thing well, and if I’ve learned anything in my experience, it’s that just simply on-boarding companies and on-boarding companies and on-boarding companies as a strategy generally leaves the heavy lifting to a later date and that has to be done up front. So, you’re going to see us acquire Krausz, integrate Krausz and acquire the next thing.

Bryan Blair

Okay, that’s very helpful color.

Scott Hall

So, shouldn’t be too near. Then with that said, to answer your question directly, we still see a, you know, a fairly healthy organic investment if you think about our CapEx environment as well where we think that both cost and technology flexibility could come from further investment there. So, to the extent that there is more CapEx that we could do, we’re evaluating those opportunities as well.

Bryan Blair

Alright, very good. Thanks again.


Our next question is from Andrew Buscaglia with Berenberg. Your line is open.

Andrew Buscaglia

Hi, guys. Just want to ask a, maybe a little high-level strategic one with regards to your technology business. First of, you know, metering specifically within that business for you is a bigger chunk of the piece of technologies? You know, how do you guys see yourself fitting into the landscape given there is a significant amount of competition out there? There are players out there with a lot more market shares than you have. So, can you talk a little bit about why – you know what’s your plan to compete and how you view your pricing power relative to competitors just given, again, how your share is a lot smaller?

Scott Hall

Yes, so I think that, you know, I can talk a little bit about how we got to where we are and that will hopefully help you understand where we're going. So, I think that everybody who is larger than us, the three players that I think you’re referencing that are larger than us, basically all got their move. We were up in that Top 3 as a meter company when private equity owned us, then the drive by AMR Technologies emerged, you know, where you could just do a collection and basically private equity owned the business at that point, didn't invest in that technology. And so, we had visual read meters, we weren’t really a player in AMR, and we basically didn't win any new cities. So, we missed an investment cycle and we came up with the AMI products as they related to, you know, Mi.Net, Mi.Host, all of the radio technologies for AMI.

And basically, the strategy has been if we can win AMI at faster than the market is growing, we will eventually get back to where we were before we missed the AMR investment cycle and we’re doing that. So, I’m happy to report that if you look at most of the high teens low 20s depending on what report you look at as the growth for AMI, adoption in the market and you look at our growth, our growth in AMI products is actually significantly higher than that. So, we’re taking share in AMI albeit from slow numbers. But that's not the important thing. Let me say it again, that's not what's important, what's important is to have collectors out there that are agnostic in what information you're sending them, whether it’s a meter reading or water temperature or whether it can hear a leak from a fire hydrant Echologics' DX-node or its communicating over an Echologics' TX-node or it’s a pressure sensor or it’s a turbidity sensor and its integrated.

So, if you buy our system, you are buying the ability to not just read and build you meters, but you are buying the ability to listen to your network and to have pressure sensors in you network and to see what your water quality is in your network and you only have to invest once. You don’t have to go buy a SCADA system, you don't have to do -- so as we get this integrated technologies platform delivered to customers, we will grow faster than the market and the people that continue to define the information infrastructure as a meter-only market, I believe, will leave the potential behind, potential for growth and the potential to perform analytics on networks.

And that is what we believe we’re investing in, that is why I have been steadfast in my refusal to continue to look at the technologies segment as anything more, but the linchpin to the future of our infrastructure business being more than just iron and the functional thing. It will actually be information points that will allow you to analyze your network and that’s why I believe we are different than everybody else because we are the only player who can marry intelligence and infrastructure management with a software platform and with communication technologies. We are the only people who can do it, and we think our offer is compelling.

Andrew Buscaglia

Okay. That was a really helpful answer, and presumably I mean it sounds like, you know, the leak detection business for you is first off, it sounds like you guys have a higher market share than most think, I think. Secondly, that seems to be like you said the kind of the linchpin of this whole thing. So, presumably, you would be probably investing in that area specifically over time if it means whether it's M&A or internal investment, but what areas within leak detection are you – what are you missing within that specific segment that you need to invest in still?

Scott Hall

Yes, that’s a great question and it’s one that, you know, I'm not going you dodge on you. I’m simply going to say, I would like to, for instance, have a hydraulic model. So, [indiscernible] and buy software that had hydraulic modeling. But then, at the same time, I would like to do that. I’m going to tell you straight up that we are dependent on a lot of the consulting community who have their own hydraulic models that provide those services to go in and look at, you know, a thousand miles of pipe for municipality and we’re dependent on them to say, come and use us for our pipe condition assessment.

But when you think about that inverted funnel with, you know, hydraulic modeling at the top, and then pipe condition assessment, and then, you know, lower in the pyramid you’ve got, you know, your other leak detection methods where you put devices out there and at the very point you can send crawlers and image the inside walls of pipe, those are all part of telling me what the help of infrastructure is, whether it go from a theoretical to an averaging method, and then to a pinpointing method to say, here is where all your pinpoints are and your pipe walls are, here’s where your leaks are, those kinds of things.

All of those are in scope for our investment, but each one of them come with their own challenge. For instance, at the very endpoint where you get into imaging pipe, whether you send a crawler or a ball or whatever up a pipe, those are service intensive industries where you need crews, you need trucks, you need geographic diversity, you need to be able to carry those salaries through the low periods, as well as make money through the half full-employment period.

So, they all have their own challenges, and each one of those investment opportunities to us is something that we have to look and has to make sense on its own because to the extent that it can actually be accretive fairly quickly, we'd be interested, but to the extent that it can, well then, we’d probably be better off building from an organic perspective. And so, we look at that investment opportunity, if you will, from both angles. So, yes, we remain interested in the space. No, we can’t do it just willy-nilly. There are market dynamics involved, and then there is also the economic dynamics that we have to take into account.

Andrew Buscaglia

Okay, got it.Alright, those are great answers. Thanks for the help.

Scott Hall

Thank you.


Our next question is from Andrew Cohen with Northcoast Research. Your line is open.

Andrew Cohen

Hi, you kind of touched on this, but I just -- looking for maybe a little more clarity and I hope I’m not putting words in your mouth, but when the holding furnace went down last year, there was kind of the impression that there was perhaps some CapEx catch-up that needed to be done for prior years. Is – obviously, there is always more that you want to do, but do you feel like what's in places up to-date or along those lines?

Scott Hall

No, no. I still think we’re target-rich. I don't want to give anybody the impression that, you know, the elevated levels of CapEx that we've experienced is over. As I said about -- I think about a year ago I said, Andrew, that, you know, I think we still have some upgrading to do. And I’ll give you for instance -- and I’m not saying we’re doing this right away, but, you know, if you look at coreless furnaces and state-of-the-art in foundry today, you would look at our energy usage and look at our water footprint and look at our non-peak energy usage and still say, you know, technology to be invested in your furnaces is something that you should consider and it’s something that I think will pay for themselves. You know, we got to look at those economic models. I would expect to do that over time, over the coming 3 to 5 years.

When I look at where we are from a machining point of view, and that is a repeatability as far as, you know, face quality, things like that, I would expect to continue to invest in that. So, there is a target-rich environment out there. The limiting factor is our capacity to implement. I’m not going to sit here and say, we can do it all and do it all greatly in, you know, in a matter of a quarter or two. I think we have a multi-year CapEx plan in front of us that remains to be fully flushed out. But I've been very pleased with where we are from a productivity perspective. If you think about the last two years, we have hit our, you know, kind of 100 basis points target that we talked about. We’ve had some headwinds with inflation and other things that muted it, but we have been able to get the cost savings as a result of making intelligent investment in our manufacturing footprint. So, I continue to think that we have some opportunity there.

Andrew Cohen

Thank you. That’s helpful. I guess the other question I have and just maybe tougher to measure, but I had to sit through the middle of this polar vortex, and you did mention that knocked some construction days out, but I would think longer-term not just water main breaks, but leakage opportunities do you see this is something that’s ultimately going to be a positive for business or a negative for business or how are you guys looking at this incident?

Scott Hall

All of our data would indicate that, you’re right, in the quarter it’s going to hurt business and beyond that quarter it’s actually going to help business. Whenever we see large swings in temperature, I think last year's data in Saint Louis as we saw the intake temperatures or the Mississippi River get down into the high-30s, you know, the amount of pipe breaks trebled. This is well-known science that the more you vary the temperature of the underground and the more rapid that temperature plays – temperature swing takes place the more damage it does to the underground infrastructure, which unfortunately is good for us because it drives the replacement cycle. It actually speeds up the replacement cycle and so it should be a positive in those areas impacted in the long run for the business.

Andrew Cohen

Thanks very much.

Scott Hall

Thank you. So, I think that’s 9:59. I think we’re right at the end there. So, I’d like to thank everybody for joining us this morning. I’m very happy with the solid start to 2019. 8% organic consolidated sales growth, and a 20% plus kind of EBITDA growth. Where all things I think were a testament to execution in the quarter.

Very happy to have finally gotten this Walter tax thing where we could shed some light on it, and to mention it for all of you because I know it’s been top of mind in the past, and I think the $37.4 million, which is inclusive of the years of 1984 through 2016 can finally put this in perspective for our investors because it was something I was asked a great deal.

I think we're really excited about where we are taking the company and everything we can achieve, and so I just want to thank you once again for your interest and hope that you have a great week. We’ll talk to you next quarter. Thanks.


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