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 will now introduce your conference host, Mr. Whit Kincaid. Sir, you may begin.

Good morning. I hope everyone is safe and healthy. Thank you for joining us on Mueller Water Products second-quarter 2020 conference call. We issued our press release reporting results of operations for the quarter ended March 31, 2020, yesterday afternoon. A copy of it is available on our website, muellerwaterproducts.com. Scott Hall, our President and CEO; and Martie Zakas, our CFO, will be discussing the COVID-19 pandemic, our second quarter's results and current market conditions. 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, 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. A replay of this morning's call will be available for 30 days at 1-800-835-8069. 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 the call over to Scott.

Thanks, Whit. Thank you for joining us today. I hope everyone in the audience is doing well and is staying safe and healthy during this challenging time. Before we discuss our second-quarter results for 2020, I will discuss the ongoing COVID-19 pandemic, which is affecting cities and countries around the world. Today's call is a little different given we have participants located in a number of locations. So I apologize in advance for any technical difficulties we may encounter. The COVID-19 pandemic has created significant challenges for our customers, communities and employees. I am incredibly proud of how our employees have responded to the challenges. Our team members quickly stepped up to the challenge, and our COVID-19 response team meets daily to share information and make quick decisions. Our most important priorities are keeping our employees safe, protecting our communities and providing support to our customers. We eliminated nonessential travel for all employees and executed remote work procedures for support staff. With a focus on employee safety and engagement, we enhanced procedures for disinfection, including reinforcing hand washing at all facilities, established processes for physical distancing and increased frequency of communication to employees. We continue to operate as an essential business, providing products and services to customers, which are needed to manage and maintain our nation's critical water infrastructure. We implemented preparedness plans to keep teams safe while they work. These plans include operating our manufacturing plants and distribution centers with new physical distancing measures focused on safe distancing procedures and processes and usage of additional personal protective equipment. All of our facilities are operational and able to fill orders, and our teams have worked effectively to address the few temporary closures we have experienced. We continue to proactively monitor our supply chain and have not experienced any material supply…

Thanks, Scott, and good morning, everyone. I hope you all are staying safe and healthy. I will begin with our second-quarter consolidated GAAP and non-GAAP financial results, then review our segment performance and finish with a discussion of our cash flow, balance sheet and liquidity. We had strong second-quarter sales growth with our consolidated net sales increasing 10.1% or $23.7 to $257.7 million. This increase was primarily driven by increased shipment volumes across most of our product lines at Infrastructure and higher pricing. Our gross profit this quarter increased 15% or $11.2 million to $86 million, with a gross margin of 33.4%. We improved gross margin by 140 basis points over the prior year. The improvement was primarily due to increased shipment volumes and higher pricing, which were partially offset by manufacturing performance and higher costs associated with tariffs. Additionally, the prior-year quarter included $2.2 million of costs associated with the Krausz acquisition. Excluding this impact, we generated a 50-basis-point improvement in gross margin. Cost of sales in our second quarter of 2020 included approximately $1 million of start-up costs associated with our large casting foundry expansion in Chattanooga. Selling, general and administrative expenses were $49.3 million in the quarter, a $3.6 million increase over the prior year. The increase was primarily due to personnel-related costs, IT-related activities and professional fees, which were partially offset by lower T&E expenses as a result of travel restrictions and shelter-in-place orders. SG&A as a percent of net sales was 19.1% in the second quarter, compared to 19.5% in the prior year. Operating income increased 61.3% or $13.6 to $35.8 million in the second quarter, compared to $22.2 million in the prior year. Operating income included strategic reorganization and other charges of $900,000 in the quarter, which are primarily related to prior restructuring activities…

Thanks, Martie. I will provide some additional insights into market conditions and how we are adapting. After that, we'll open the call up for questions. We have withdrawn our annual guidance due to the uncertainty of the duration and magnitude of the COVID-19 pandemic, as well as the timing of the recovery. We do expect that COVID-19 will have material effects on all of our end markets in the near term. Our primary end market is the municipal repair and replacement segment, which accounts for approximately 60% to 65% of consolidated net sales. Although water utilities are essential service providers, the economic and operational effects of shelter-in-place orders and physical distancing practices are being felt by all to varying degrees. They have shifted their priorities leading to delays for some ongoing projects and postponement of new projects. As a result, we expect to see a significant near-term sales volume decline in the project-related areas of our business, which primarily affect our metering, leak detection and specialty valve products. To be clear, we believe that the majority of our products for the municipal end markets are essential for water utilities to do their planned and unplanned repair and replacement work in this environment. Residential construction is the second largest end market for our core products and made up approximately 25% to 30% of consolidated net sales in 2019. Based on our organic sales growth through the first half of the year, increased housing starts and industry commentary, residential construction had strong momentum going into March of this year. However, given the economic impacts from COVID-19, we anticipate a sharp decrease in activity as new residential construction significantly slows down with builders focusing on their existing lot inventory. Our exposure to the residential construction market is much lower than it was prior…

[Operator Instructions] The first question is coming from Deane Dray, RBC Capital Markets. Your line is open.

Thank you. Good morning, everyone. Can we start with the range that you're giving for the second quarter? And look, I completely understand and appreciate how fluid this is, how there's lots of uncertainty. But the bias here is, at least from the muni side, you've got a pretty good line of sight on the maintenance. So why would there be such a wide range, 20% to 30%? What would take you to the low end? What would take you to the high end, if we could start there?

Great question. Thanks. And I think the biggest wildcard in this is, from our discussion with our channel partners, is what does the inventory deleverage in the channel look like? We know they're out there in their statement saying that they're going to remove -- protect their liquidity by removing hundreds of millions of dollars of inventory from the channel. And I think that's the biggest piece of it. I think you should think about this 10% first-half growth that we've had. Certainly, we're not sitting here saying that we believe the markets are up 10%. We know that after our Q4 last year that there was a fair deal of inventory taken out of the channel. And now through the first two quarters of our fiscal year this year, we've seen some of that come back in. And certainly, they were relatively bullish as residential was strong, especially Core & Main and Ferguson and some of the big guys and have been bulking up. We had announced our two price increases, one for brass and one for the iron business. And as a result, I think a lot of the growth in our Q2 was actually in channel inventories. So I want to be clear on the call to everyone. We do not believe the market will be down 20% to 30%. We believe we will experience that in the near term as the market will be down probably, let's say, 0% to 10%, and we will see the impact of the channel reducing its inventory position and getting very lean. I believe that most of our partners, Deane, are going to be protecting their liquidity very, very carefully.

Scott, I'm so glad you added that last point about the market size, or what -- the market dynamic would be 0% to 10% because that makes so much more sense. Do you have a sense of how much the pull forward contributed in the first -- the fiscal second quarter?

It's hard for me to give a number, but I would say that if you were to think about everybody else reporting and then knot that, I would say the -- I think of it as about 50-50. Think about 50% of it really being growth and the strength of the market. January and February, a little softness in March. And then the other half kind of building inventories as a result of the announced price increases, trying to take -- the channel taking advantage of the lower cost in the first couple of months. But there's nothing scientific about that. I think of that kind of 50-50 in that range there, Deane.

Great. That's helpful. And then how about, any chance you can size the potential decrementals if -- maybe taking the two ends, the 20% and 30%, what the decrementals might look like in the second quarter? And then for the balance of the year, where might you be managing decrementals to?

Well, that's a great question. One we kind of thought a lot about. I think in the third quarter, our decrementals will be the worst. And the reason is that is because I have, with the leadership team, we spent a couple of days together in virtual meetings, talking about what the recovery looks like. And I want our investors to understand that we've run two contingencies. Contingency A is kind of the traditional recessionary recovery with slow quarter-on-quarter growth. And the other is more like a V. The probability we see for both of those recoveries, the rapid jump in a near term, let's call it our Q4, and the probability of the slower recovery, we estimate to be equally probable at this point. We don't know how much of a jump we'll get when the economy starts up again. But certainly, it won't be as bad as it was in April. So that's a long way of saying, we have elected to keep our powder dry. We have not laid off any of our hourly workforce. We entered into MOUs with all of the unions, and we gave ourselves max flexibility here in Q3 to make sure that if there is a pop, we have all of our operators. We have no learning curve. We have the right inventory position. We have the right skills mix on the floor. And so basically, done a little bit to reduce our fixed costs as a result of the furloughs and the reductions to pay for the leadership team and the board. But on the whole, we have maintained max flexibility so that we can be the strongest coming out of this and as strong as we were going in. As a result of that, to get to your point, I…

Appreciate all the color. Best of luck to everyone. Thank you.

The next question is coming from Brian Lee of Goldman Sachs. Your line is open.

Hey, Scott. Good morning, everyone. I hope everyone is doing well. Thanks for taking the questions. Maybe just a follow-up on Deane's. I know you're not giving specific guidance, Scott, and you're reserving a little bit of dry powder here. But to the extent that this isn't a six-week V-shape type of recovery, and you do have to manage a little bit through the cost structure. If Q3 is the worst quarter from a decremental perspective, you're saying kind of 40s, 50s range. Where do you think you can manage that down to if you had to sort of start to drive some more structural changes in the cost structure, let's say, moving through the year, if that happened to be the case?

Well, that's a really tough question. You mean you have your fixed and you have your step fixed. And certainly, I'm not sure how much of that I want to get into. But you should expect that the decrements, we're a kind of a 35% gross margin business, I believe. Your decrements are going to be in the 40% range, even in the best of cases because you've got to look at what the elements of that 20% to 25% of fixed costs are. You're not going to get rid of the fact that you've got a lot of depreciation. We are a vertically integrated manufacturer. So we will look a little different than a lot of the peer set that we tend to look at in water. So I think that our depreciation load and just our fixed utility load and things like that are going to be a little tougher to get out. But sizing the business, I just want to give everybody some confidence that we -- this is not our first rodeo. I mean, we've been through these downturns in '80s, the '90s, dot-com bubble in 2000, 2008. I mean, it's what do you do? You reduce the amount of indirect labor you have handling materials; operators get their own materials. You look at what efficiencies are. You look at staffing levels. You look at all of those things that we would need to flex, and we will. So I think that the good news is, is we're a high gross margin, high EBITDA business. The bad news is your decrements get tougher to manage when you're already sitting there at 21% kind of EBITDA margin business.

Yeah, fair enough. I appreciate the color. And then also on fiscal Q3, you mentioned this is going to be by far the worst quarter here moving through the crisis and appreciate some of the color around inventory trends and ho0w it's more specific to your view than the market outlook. But in the context of not giving full-year guide, you are calling for Q3 to be the bottom here for you. Is there anything besides the inventory data, specific, that you can point to? Other indicators that you're looking at to make that call right now? And can you kind of walk us -- a bit?

Sure. So I think the most important thing we've done in the last 45 days is we are watching the order intake at the channel as opposed to at just what is coming through. So the sell-through that we look at, at the channel is it's kind of, I think, a better indication of where the market is. And you see some people that are just basically flat year over year through the first kind of 35, 40 days of the quarter. And then you see a bunch of people would be down 0% to 10% kind of depending on the region where you see the activity. And so I think there is a lot of uncertainty of how it comes out in terms of the rest of the quarter. But I don't think there's any question that right now, we believe April will be the bottom. It will have the double whammy of inventory adjustments, along with the least amount of economic activity because basically, every state was closed for some period of time in the month of April. And the Northeast has basically, the alliance of the northeastern governors have basically shut down that whole territory for 45 days. So the color I think you should take is that we're at the -- we're kind of in the trough in April. As these states start to open up even partially, we'll start to see improvement in the sell-through for the channel. And we'll kind of grow from there, I think. And so to try and say, is it 25%? Is it 22%? Is it 27%? I don't know how much inventory is going to come out of the channel. But I do know that the underlying demand for muni is going to be pretty steady. And I do know that we're not going to go to 0 housing starts. So I know that that will also not just be 35% of our business taken out. And so to answer the question directly, we're not -- it's really cloudy, the visibility to the demand profile. But from what we've seen, we think we've given you a fairly fair range.

The next question is coming from Ryan Connors, Boenning and Scattergood. Your line is open.

Great. Thanks for taking my question. Hope everybody is well. So I don't want to beat the dead horse, but I appreciate the distinctions you draw, Scott, between the business and the portfolio now versus the last cycle. Certainly valid. But just to play sort of devil's advocate. I mean, one of the lessons of the last recession was that there was this correlation between housing and the municipal infrastructure spending, which is, of course, because tax receipts are a big part of those local government revenues. So we actually saw pretty big decline in municipal, albeit on a two- or three-year delay. And so those two markets actually ended up behaving similarly, but housing was kind of a leading indicator on where muni was headed. And then you see things like AWWA surveying their membership a couple of weeks ago and saying 68% of U.S. water utilities as of a couple of weeks ago were planning budget reductions heading into budget discussions. Most of them are on a June fiscal year. I mean, we just don't want to see people making the same mistake twice and making the same call that was made in '08, which is muni will be resilient when, in fact, we've seen that wasn't the case in the past. So what is it that gives you the confidence to call the bottom with all those things in mind?

Yeah. I think it's a fair point. And something, I told you we had a virtual meeting with our senior leadership team, and something we dwelled on a great deal. I think, in a nutshell, the two biggest differences between '08 and today, for muni is, A, the most important is that crisis was a crisis of liquidity. And what basically happened was the ability to borrow evaporated, not just for homeowners, but if you think about the whole banking system, what happened. And even munis found it difficult to raise money. And the idea of taking on debt when a lot of their projects were then in question, is probably the biggest reason we see them getting very inexpensive money right now to do the upgrade. That's point A. Point B is we are 11 years on in the aging of this infrastructure. I can't get into the actual specifics. But suffice it to say that even in March and April, the amount of break-fix, that Krausz kind of coupler product all grew appreciably. Why? Because we're into the kind of the point of the curve, the bathtub curve, that the amount of money that's going to have to go to emergency repair is going to continue to increase. And so those are the two big drivers. And the last but the -- not least is I believe that this time, as we start talking about stimulus that unlike the last time in 2010, when I think you actually froze the market with ARRA, you actually had projects that got left on the sideline. I think this time, lessons learned in Washington that any stimulus will qualify for water upgrades as opposed to kind of the Obama ARRA period freezing municipalities from actually pulling the trigger on projects as they waited to see what they could get.

Yeah. In essence, they had to understand some of the provisions of the ARRA, which really put a lot of the water projects on hold as they had to get in there and specifically say, well, what does it mean for buy America? Is there a small component of this project that wouldn't qualify so they delayed a lot of the spending. And so I think it was more a timing of the spending that you saw that a lot of it we attributed back to the provisions of the -- the more the detail of the ARRA, not the fact that there was money available.

Right. And the way they made the money available, too, I think, if you recall, Ryan, it will likely change this time as well.

Got it. My other one has to do with technology, which, I guess, we've discussed a little bit less here on the call. But just it seems like there's a bit of a Catch-22 there where you've got to keep up on innovation and R&D if you want to stay relevant in terms of your product line. But then again, obviously, the business was already unprofitable even before COVID. So without some pretty sharp cost reductions, it could become a pretty big drag on earnings. So how do you manage the balance between having to do some things, but yet making sure that you're keeping up with the Joneses? Because obviously, some of the larger players will just keep plowing money into R&D.

Yeah. I think that the mission-critical. If you think about these economic downturns, one of the exercises you do as you go down the road five years, and you say, if you try and do the visioning purpose of who are we? Why do people buy from us? What's the selling proposition? What are we known for? Those kinds of things. And if you think about our tag line of where intelligence meets infrastructure and you think about smart hydrant, a smart valve, informatics, diagnostics, our Sentryx platform. And those things are all critical to our long-term success and leading Mueller through the digital disruption of the water space, just as electrical and gas and all the others have gone through in the years before. Then it gets pretty clear that we have to keep the communications, and we have to keep the software piece and software-as-a-service piece at our very core. We have to be able to develop sensing and transducer technologies, whether it be around pressure, temperature, turbidity, all of those things that we talk about. The thing that I think is fair and that the team has to face into is, in and of itself a meter with or without smarts with or without communication radios, with or without diagnostics has to be economical. And I think it's -- we're living with the puts and takes of that being a very lumpy business. So sales were really poor in the Metrology business, but bookings were really good. Why? Well, we've won Newport News, and we have the announcement out there. And so we'll run for a while, where it looked like our bookings were really good and until we win the next thing. So until you get scale in meters, we're going to have this lumpiness. But meters is the window on what's happening on the communications technology and the most information-rich point to do your data analytics. And so I think we have to be there. So I take the criticism that we have to be more profitable at it. We have to manage it better. But I also know that if I'm going to be where I want to be in five years, I need that window on the world.

Got it. Well, listen, I really appreciate the thorough response. Thanks for your time.

The next question is coming from Andrew Buscaglia of Berenberg. Your line is open.

Hey, guys. If you take that technology comment one step further and just talk about kind of in this environment. I know a lot of people were piloting your Echologics products. But can you talk about what the conversations are like there? And then is Echologics positioned beneficially to be kind of a bigger cost savings, more differentiated leak detection product out of this downturn? Would that be attractive to these people piloting?

Yeah. I think -- thanks for the question. I think yes, to answer quite -- and it's not just us. So I don't want to sit here and say, oh, we are the only game in town. I think in general, there is a feeling that through this downturn, that those that were technology-enabled and those that are technology savvy had better control of their network through the stay-at-home piece of the kind of the social distancing and all the rest of it. So I think that -- I think Bluefield recently came out and said that they think that the impact of the pandemic will be that it will actually aid in the adoption process around things like acoustic leak detection, around electronics, around remote monitoring, around the digitization, if you will, of the water infrastructure. And I believe that to be true as well. And so to answer the question succinctly, the answer is yes. We do see that, and we do believe that. And the conversations have been relatively favorable. If you can imagine, going with your backhoe to fix a leak and getting it right the first time as opposed to punching holes in the ground every five feet, I think you can see the attractiveness of it for our users.

And you had all these kind of long-term plans to retrofit and build new facilities. Where do you stand with that based on what's going on in this downturn now? I know you cut your capex a bit, but if you could provide some color, how you're thinking about that?

Sure. So I think that -- and thanks for the question. Something I wanted to get into is, okay, we've talked to our employees in Hammond, Indiana. The announcement is out there. We will be closing that plant. So it's full speed ahead in Kimball, Tennessee. We're going to continue with that capital program. We're going to continue to consolidate capabilities in there. We're going to be able to make big hydro gates along with the big valves that Hammond's making. So that's still a go and all of the timetable expenditures and savings on track. We've elected to delay spending in Decatur. If you think about Decatur, Andrew, about half the money -- or think of it as half and half. About half the money came from improvements to mixing, the ability to have sleeves, the ability to quickly change between Bismuth brass or brass or silica brass, all of those things. But then there was a whole bunch of savings -- or payback associated with the fact that we would actually have more capacity, the capacity would allow us to serve more markets. And so there was a growth element in 2023 associated with Decatur. So we've kind of kept all of those plans, but we've delayed them. And we pushed the schedule for Decatur's go-live out by delaying the purchase of some equipment. This is calculated risk. On the one hand, we're being told that you'll have to wait and it's going to push the time line for the project out. But we also know that on these big capital projects that if everybody is starting to pull their horns in, the lead times could change. And so we have to look at what that recovery curve looks like. And if we need the capacity and we need to pull that time line back in, I still think we have some levers left. But really, what we're doing is delaying the Decatur Brass foundry think of it as a year. So we'll be pushing some spending out of this year into next year and beyond.

The next question is coming from Joe Giordano of Cowen. Your line is open.

Hey. Good morning, guys. So I just want to keep going on the Technologies a little bit. I appreciate what you said about the critical nature of the communications and the software. But just looking back at the business now, back for the last, I don't know, call it, six years, it's been unprofitable in a range of like $80 million to $100 million top-line run rate. Most likely, that run rate has to go toward the low end, I'd assume, in this kind of environment where projects are going to be more challenged. I understand you're saying you have to do it more profitably, and I get that. But like what -- how does that happen? Like a lot of what's happened in the last couple of years has been in pretty good municipal markets. So now if we have a more challenged one, what gives you the confidence that sustained profitability at a lower run rate is realistic for that business? Like how viable is it as a going concern?

Well, I think the creation and focus on an $80 million, well, segment versus in a $1 billion business is still one that garners way more attention than it ought to. You should think of it as a $4 million loss last year was basically all development costs. I mean, are you going to stop developing software and equipment for Echologics? Are you going to stop development of Hydro-Guard? Are you going to stop development of sampling stations, transducers, Sentryx, all of that stuff? If you are, then yes, you can sit there and say, yes, that $3 million isn't worth it. That $4 million, whatever it was, isn't worth it. I want out. And I want to see profitability there. But if you take a longer view of the business and you say that they're all merging and that you do believe there's a digital disruption taking place in the water space, then you've got to look at the business holistically. And if you look at the business holistically, I think you'll see, you've got a 20% EBITDA business. And how do you protect your share of that profit pool in five years? And the way you do that is to make sure that profit pool doesn't get eaten away by the people who come in and provide the data and analysis. I'll go back, Joe, and say exactly what I said two years ago, which is if you look at every industry that's gone through digital disruption, and then you take the profit pools and you look at how much of the profit pool shifted from the equipment manufacturer to the information provider, the insights and solutions provider, you will see that the bulk of the profit pools over time move toward information, not just the utility of…

Has there been a discussion internally about, like, I don't know, if this is all one segment and then that's just considered like R&D for the core business rather than a stand-alone segment that loses money, might be easier to digest for people?

Look, appreciate your question. It was a few years back that we made the determination to break Technologies out into a separate segment. As much as anything, it was a desire to provide more transparency through for investors. There are certainly a lot of considerations when you go through and you determine what the segments are. But that was really a lot of the thinking behind it, in terms of why we broke it out. But certainly, it's something that I would say in terms of segments, that's something that we do continue to look at going forward, but appreciate that any changes require a lot to get there. But that was the reason that we did it several years back.

And let me also say that one of the things that we and the board, our board of directors committed to is, frank, transparent, robust discussion of issues and trying to hide something or not. When I came in, I said, look, however people think about the business, if there's a technology one and infrastructure one, that's fine. We will deal with it, frankly, openly and in a transparent manner. And so this is one of the downsides of that is gosh, Scott, you're flowing a lot of money into this Technologies thing with not a lot of sales coming out of Infrastructure. But if you don't buy my premise, then you should say, this is not a good idea. But if you do believe that water infrastructure is going to digitize, that we are in the early stages of digital disruption in the water utility space, then I think you'd see this as prudent investment. Before we wrap up, I wanted to just kind of say a couple of things. Things I wanted to touch on that didn't come up. When I look at our long-term positioning, I remain comfortable that we are still moving in the right direction. I think the large casting foundry in Chattanooga is going to play very well into this renewed sense of buy America. The fact that we're vertically integrated. The ability to move castings into a nearby facility in Kimball that's coming online as expected. I think our ability to rapidly adopt digital technology and integrate it into the core products that are very important in delivering clean, safe drinking water to the public continues to leave us in a leading position. So we can punch above our weight in our discussions with large utilities about where they go next. I think…

This will conclude today’s conference. All parties may disconnect this time.