Welcome, and thank you for standing by. At this time, all participants are in listen-only mode. [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.

Good morning. I hope everyone is doing well. Thank you for joining us on Mueller Water Products' Third Quarter 2020 Conference Call. We issued our press release reporting results of operations for the quarter ended June 30, 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 third quarter's results, market conditions, and our current outlook for the fourth quarter. 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 1-866-461-2738. 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 staying safe and healthy during this challenging time. Before we discuss our third quarter results for 2020, I will provide a brief update on how we are adapting to the challenges from the ongoing COVID-19 pandemic. Like everyone else, as I think back over this past year, I am amazed at how quickly the world where we live and work has shifted. Since our last earnings call, the initial shock to our employees, customers and communities has turned into a more normalized cadence as we adapt to a new normal. We took swift action, implementing enhanced safety and hygiene processes to create safe and healthy working environments for our employees, customers, suppliers, and communities. These are now part of our standard work procedures. Additionally, our response team continues to provide leadership through this crisis as the pandemic continues to evolve. We take great pride in being an essential business, providing products and services needed to manage and maintain our nation's critical water infrastructure. During the quarter, our manufacturing plants and distribution centers continued to supply products to customers with minimal disruption as a result of the pandemic. I have been impressed by how effectively our teams have transitioned to the new health and safety protocols, which is helping us address the positive COVID-19 tests and exposures that we have experienced. We continue to proactively monitor our supply chain, and we did not experience any material supply chain issues during the quarter. I believe that our execution in this environment is a testament to our employees and their resolve. Moving on to the third quarter. We realized a 16.7% decrease in consolidated net sales during the quarter. I was pleased that our net sales were better…

Thanks, Scott, and good morning, everyone. I hope you continue to be healthy and safe. I'll begin with our third quarter consolidated GAAP and non-GAAP financial results then review our segment performance and finish with a discussion of our cash flow and liquidity. During the third quarter, we generated consolidated net sales of $228.5 million, which decreased 16.7% or $45.8 million as compared with third quarter last year. The decrease was primarily due to reduced shipment volumes related to the pandemic seen across most of our product lines and was partially offset by higher pricing. Our gross profit this quarter decreased 22.1% or $21.5 million to $75.7 million with a gross margin of 33.1%. Gross margin decreased 230 basis points versus the prior year, primarily due to the decrease in shipment volumes and $5.2 million of expenses related to the pandemic, including certain unfavorable volume variances, voluntary emergency paid leave for employees and additional sanitation and cleaning fees. As a reminder, positive sales in the prior year included $2.3 million of costs associated with the Krausz acquisition. Excluding the acquisition costs in the prior year quarter, our gross margin decreased by 320 basis points. Selling, general, and administrative expenses of $47.1 million in the quarter decreased $400,000 versus the prior year. The decrease was primarily due to lower expenses relating to the pandemic, including reduced travel, trade shows, events, temporary furloughs and pay reductions for employees. The benefits from these actions were partially offset by an increase in personnel-related costs, professional fees, and IT-related activities. SG&A as a percent of net sales was 20.6% in the third quarter, compared to 17.3% in the prior year. Operating income of $20 million decreased 57.6% in the third quarter, compared to $47.2 million in the prior year. Operating income included strategic reorganization and…

Thanks, Martie. I will provide some additional comments on market conditions and our outlook for the fourth quarter. After that, we'll open up the call for questions. The impact of the pandemic was felt across all of our products. However, sales of specialty valves and Krausz repair products performed relatively well during the quarter. The performance of our Krausz repair products confirms the strategic rationale for the acquisition as the demand for these products will continue to gain momentum with the aging pipe infrastructure. Sales of our specialty valve products primarily used in large capital projects with long lead times benefited from the backlog built over the last 12 months. We believe that the municipal end market held up relatively well during the third quarter as utilities focused on maintaining essential services and completing existing projects where possible. The level of repair and replacement and project activity varied greatly depending on the effects of shelter-in-place orders and social distancing practices. We saw delays in some ongoing projects and approvals of new projects, which impacted project-related areas of our business, principally metering, leak detection, and specialty valve products. Since Technologies has a higher portion of project-related business, sales in that segment decreased at a higher rate than in our Infrastructure segment. We do anticipate that the project-related portion of the municipal water market will remain challenging as state and local governments update their budgets and adjust to lower tax receipts and utilities feel the effects from lower water revenues. As a result, new projects could be pushed out further. As a reminder, we estimate that 60% to 65% of our core products are critical to utilities to maintain their networks. This base of business gives us a strong foundation with additional sales coming from residential construction and project-related municipal work. We…

Thank you. [Operator Instructions] Our first question is from Bryan Blair with Oppenheimer. Your line is open.

Thanks. Good morning everyone.

Good morning, Bryan.

I was hoping you could parse out the monthly sales rate for your resi products. I assume that April into May was completely frozen, and it seems like it's a decent rebound since.

Yes. So, we're not going to give monthly guidance per se, but the initial shelter-in-place impacted business, I think, in April and May the most, but to varying degrees, depending on the region. I think if you think about the Northeast, where the seven governors got together, really locked down, we saw the biggest impact there. And then kind of in the Southeast, where it was a little more lax, the least amount there. So, I think that as construction activity increased, sales and orders improved. And I think you could kind of time that with really the last half of the quarter. So, I think the good news is many contractors maintained their labor forces during April and May, took advantage of the federal incentives to keep people employed and then were able to react quickly, and that return to work quickly as possible kind of helped things dramatically, too. So, I think that the biggest wait-and-see to see here is going to be around the project-related, Bryan, I think that's where it is. I think what everybody needs to remember, as far as Mueller goes is that we were probably more impacted early in the first two months as we saw inventory destocked out of the channel. And that probably had more impact really for the quarter. So, if you think about what the prepared comments were, we think we're mid – or 0 to mid-single digits down as a market, but we were down almost 17%. I think the difference is the destock.

Got it. That makes sense. Appreciate the color. And if we think about the fourth quarter sales guide by end market, what are you assuming across muni, residential and natural gas distribution? Just trying to frame what drives the low versus high end of the range.

Yes. I think it's more of the same. I think there's a lot of uncertainty around how long construction will remain as strong as it has been for – certainly for the last 6 to 8 weeks. So, I think that that will be a big piece of it. I think the other piece that's going to really impact it is where we see municipalities, if they keep their spending at these current OpEx levels. Operating expenses through April, May and June, I think, hung in there very well. And if you were to take the other pieces, the construction piece and the project piece and say some of that got delayed, you take out the impact of the meter business because people weren't allowed in homes to install meters, and we had a lot of field delays there, I think that the big variables are going to be how much of that gets to happen in the fourth quarter. A lot of it, and you'll be at the top end of the range. And very little of it will be at the bottom end of the range. Really, I expect the actual Infrastructure business to be pretty steady. I think it's the other pieces around it that have the variability in it.

Got it. And then last one on capital allocation priorities. Balance sheet is in good shape. Still sound a little cautious on that front. Would you be comfortable getting back to M&A or repurchase activity for the coming quarters?

Absolutely. I think we're not – we've said all along that during the difficult times, we think that's when opportunity presents itself. That's why I've had the team and the organization focused on generating cash to make sure we do have that flexibility. We would do M&A in this environment if – and there are assets out there we covet that we would like to have if they get reasonably priced. But right now, we're focused on running the business, as well as we can. We want to have – keep our powder dry and build a little more powder. And so capital allocation is just what we've always said. We're going to remain balanced between our priorities around CapEx, M&A and then returning cash to shareholders, primarily right now in the form of the quarterly dividend, which I think is a pretty good yield.

Understood. Thanks again.

Thank you, Bryan.

Our next question is from Deane Dray with RBC Capital Markets. Your line is open.

Thank you. Good morning, everyone.

Good morning, Deane.

Scott, you've given some terrific color here on what's going on in the muni world, and I always want to preface the comments that actually come from you that you got to be careful about painting the municipal market with the same brush because it really does vary region by region, but from your perspective, how does the whole COVID fallout make this recession different from what might be a more normal economic recession? Because we've seen some of the same impacts about push outs and project delays. But from your perspective, where and how does this play out? And might there be any changes permanently in terms of how municipals do business?

I think if I could – that's – this is a huge question. Thanks, Deane. There's, I think, a lot of uncertainty on how it plays out, first and foremost, because I think it is very different. What I like about – shouldn't say like, but what's very different and more encouraging, I think, for all of us is that the liquidity in the market and the willingness of the Fed, let's call it, the economic pressures are much, much less in this recession. I don't think we have the strain on the banking system that we saw in 2008 or the strain in the financial system that we saw when the dot-com bubble burst. And so what we have now, I think, is a lot more uncertainty, and as a result, a lot more volatility around demand. So, I think the biggest differences are also why I'm a little bit more bullish on coming out of that. And that is because the money availability is there, because the infrastructure is in fact, 12 years older than it was kind of the last go around and our break/fix is increasing at a fairly significant rate. And then thirdly, the fact that the housing market really has been underinvested for a long period of time. If you think about 2007, when we peaked at 2.1 million homes, and then you look at the 20, 30 year average of 1 point – let's call it, 1.3 million, 1.4 million homes, we have been under that average now for the best part of 15 years. And so I feel like with low interest rates, good demographic, good family formation numbers, low inventories that, that 30% of the business is going to be fairly healthy in the next, let's call it, 4 to 8 quarters. And so, I think that if we get euphoric and we overbuild it again, like we did the last time, we could create more structural problems for the municipal water market, but I think that we've got really good fundamentals right now. And that and the fact that people are becoming more and more aware of wanting to live in their homes and that travel may be a long way off and the way we spend our money may be a long way off, I think, are all drivers for people to want clean water and water utilities to have good support to bring modernization to their world.

That's real helpful. And restoring guidance for your fiscal fourth quarter, I liked how you framed the 0% to 5% having to do with the swing factor in projects. How does this framework change, how you're thinking about 2021? I know you're not giving numbers, but just qualitatively, entering 2021, how do you – are you thinking about the top line, both from projects and infrastructure?

Yes. One of the things we want to be careful about in 2021 is that – we actually had a decent Q3 from a bookings point of view, if you think about it from a Technologies point of view. So, we're really challenged in getting into homes, getting into manholes, confined workspaces, working with water utilities due to social distancing. So, those are near-term kind of challenges, but in the longer-term, we know that Technologies has actually had a fairly decent first three quarters of the year from a bookings point of view, certainly led by increases associated with Newport News and a couple of marquee projects, but overall, an uptick. And so as we think about 2021, we are trying to balance where will we be from an allowed-to-work perspective? The new protocols, just if you think about our pipe condition assessment business, you get a couple of guys, you send them down a manhole. They put some equipment on that manhole. They run down to another manhole. They're all in these confined workspaces. Sometimes they have the water utility with them, sometimes they're using a third-party contractor, sometimes it's just our field people. How are those protocols going to work? And should we say that all of that, that we expected to do in pipe condition assessment should be in our 2021 forecast? Or should we expect a 50% rate or a 75% rate? Because I think, as you pointed out about these geographic demands, the geographic differences, the geographic differences are being driven by policy around how we do work. It's not being driven by a difference in economics. It's being driven by – if you look at the Northeast after the seven governors said, here's how we're going to handle our shelter-in-place responsibility, then here is what a critical worker looks like versus, say, Mississippi, Alabama, Tennessee and Georgia, who basically got in line with we're going to keep the states open, that's where the differences are coming. And we have decided – a little commercial here – we have decided to kind of get out of the political game. And I've said it repeatedly in my prepared comments, we're going to focus on the health of our employees, and we're going to focus on their well-being and safety in the communities that they're in. And so we're going to make our decisions around that project work based on how many cases we see and whether it's safe for our employees to go in those manholes, to be in those environments. And so it's going to be tough for you as analysts, I understand that, but we're going to ask you for more time so that we can have a clearer picture of what our supply situation will look like more so than the demand situation because I believe the demand is going to continue to be okay.

That is just so helpful, Scott. I appreciate all the elements of your answer there. And just last one for me is the – and you touched on this in your prepared remarks and then in the first question on the distributor destocking. And how do you think that – what's your assumption for the fourth quarter? Would – is that – any more destocking still happen? Are they at bare minimums? Will there be any restocking? So might you see a reversal where you're actually growing faster than the end market?

Well, we believe that virtually all of the destocking impact was seen in Q3 and really was more concentrated in April and May. As noted in the prepared remarks, we think the overall end markets declined mid-single digits in the third quarter. This implies that the destocking accounted for at least half of the decrease in consolidated net sales in Q3. So if you do that math, we need to see where demand hangs in there. But I think that the big thing, I don't expect to see inventory rebuilds in what will be their Q3, our Q4. I think the seasonality dictates this is the heavy construction season, and so this is when they would destock anyway. And so I do believe that we've seen the worst of it, but we probably won't get a great deal of lift as they restock. One interesting thing I will point out is that, I do believe, because they're carrying less stock, we're going to see a little uptick in cost of freight. Most of these shipments come in truckload. And as they have inability to manage the dribs and drabs from the water utilities, we're getting a higher concentration of less-than-truckload orders. So, we're going to have some challenges there as order count goes up, but I believe our net sales decline was less than expected. So, I think good news there, and I believe it will continue into Q4. I see nothing in the housing market that's given me the reason to pause.

Thank you very much.

Good to talk to you Deane.

Great.

[Operator Instructions] Our next question is from Zane Karimi with D.A. Davidson. Your line is open.

Hey, good morning. Congrats on the quarter. And I hope everyone is safe and well right now.

Thank you, Zane. Same to you.

Thank you. So first off, have your views changed regarding OpEx versus CapEx spending by municipalities and utilities since the last quarter? And like, have you guys really been seeing any evidence there that utilities are curtailing spending even if housing isn't as bad as we thought? Are you seeing this different – in different geographies?

Yes. I think what's happened is we saw scheduled work that normally would have taken place, especially in April and May, in different geographies where shelter-in-place orders, if it was not an emergency repair, there were water utilities that were not sending crews to do OpEx if it was considered "discretionary." And so I think that in those states where discretionary work was basically banned for at least eight weeks is where you saw the drawdown.

Got you. And then during the quarter, you guys also shut down the Woodland facility for opportunity, reducing the operating costs and in prep for further COVID uncertainty. At this juncture, how do you guys balance facility shutdowns with new capital projects aimed at those operational efficiencies? And how are you looking at both going forward?

Well, I think that, as I said in my prepared comments, we are – we expect the Kimball facility to have multi capabilities. And I believe that when we look at knife gate valve assembly and knife gate valve piece part production, a lot of that is with third parties now. We see this opportunity to consolidate and in-source more and more of it so that we're in a better supply chain situation. And I believe that the long story short is, we will continue to look at CapEx from an economic point of view. And if it makes great economic sense, which this does, and it increases our flexibility, which this does, and it gives us a chance to both improve quality and have a higher number of products in the market, which this does, then we will continue to do it. But I think that as we bought Kimball, I think I told all the investors that we were going to put the Hydro Gate product in there, and we're going to close our Hammond facility. Now, we'll get the Woodland facility in there. And I think that it's – there's a fair deal of opportunity to get some synergies from the new facility as we look at all of our product offerings.

And just will add there, too, that as we look with the closure of that, that the benefits that we expect from it are built into what we see as the benefits from our three large capital projects as we talked about what we expect to be the improvement in incremental gross profit that will come through some of the efficiencies, such as was just mentioned, as well as sales growth.

Thank you. And last one for me. On a modeling perspective, year-over-year, you guys have been able to reduce absolute SG&A value, but how should we be thinking about that as a percentage of sales? And is there going to be that particular cadence different from historical norms through this next year?

Yes. So talking about overall SG&A, we certainly saw SG&A down slightly Q3 on a year-over-year basis. And as we look back at that, we benefited certainly from some of the temporary actions that we took, which was primarily furloughing some of the salaried employees. We had salary reductions for our senior leadership team, and our Board of Directors also took a reduction in their fees. So that certainly helped some of our SG&A. Additionally, due to shelter-in-place, we saw overall our expenses down when you looked at – when we looked at travel, when we looked at events and conferences and other things as well. So certainly, going forward, as we see economic activity pick up, we would see to some uptick from our third quarter with respect to some of the travel and other related expenses. Additionally, as we look into our fourth quarter, we won't have the benefit coming from some of the temporary actions that we took in and around the furloughs, et cetera. So do expect, I'd say, fourth quarter to be higher from an SG&A perspective. And look, I think this is just one of the areas that as we look out, we're going to – and we will continue to look very closely and manage largely our G&A expenses as we can sort of based on what we see going on with market activity.

Thank you for all the color here today.

Thank you, Zane.

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

Hi, everyone. This is Alex on for Brian. Maybe a bit of an expansion on the prior questions and your prepared remarks a little. Can you bifurcate between the delays you've seen on – for the ongoing projects in comparison to approvals for new projects, which you said were delayed? But are they essentially on hold for the time being?

Yes. Basically, what we've seen with the pipe condition assessment, some of the leak detection, EchoShore-DX deployments and some meter projects is a push out of the scheduled install dates, and they remain in flux. And so when you say can I bifurcate, I can tell you that year-over-year, bookings are up in Technologies. I'm not going to get into actual numbers, but they're up year-over-year, and backlogs have grown year-over-year, but sales are down. So, I think the long story of this is that I think there's some uncertainty about when we'll gain access back to consumers' homes and when we'll gain access back to confined workspaces. But I think the fundamentals for the adoption of the technology continue to give me encouragement, and I'm encouraged by where the Echo team and the meter team is right now. But I don't want to get into splitting the hairs here. And I'd remind everybody that it's less than 10% of our sales as well.

Right. That's helpful. And maybe on margins, can you talk – can you provide a little color on how you expect operating margins to trend at least directionally by quarter, by segment, in the quarter?

Yes, I'm not going to give segment guidance per se, but I think, as I said earlier, I expect technologies to have some high degree of variability around it. And I expect Infrastructure to remain kind of steady as we've seen through Q3. And if you take out the impact of the destocking for hydrants, valves, brass, things like that, I think you see it. Let me kind of change your question around a little bit, though, and say this. I do expect, as we see the case count to rise, that our costs associated with fumigation, our costs associated with emergency paid leave, our absenteeism rates to become more and more challenging. So I believe that our Q4 margins will have pressure on them, on the cost side, from labor cost and from cleanup costs because our protocols – we work with a third party, Galen Medical, to come up with keeping our plant environment safe. We have protocols in place for sanitization. We have multiple levels of exposure for COVID. We send people home on mandatory quarantine if they've had certain criteria met. So I do think there will have some pressures there. On the other hand, I expect utilizations in the fourth quarter. I expect the sales environment and our ability to react to demand, now that the channel has destocked, to drive our absorption numbers and get some lift that we had as a result of the poor volume in Q3. So, all in all, I expect our Q4 guidance obviously implying a lower adjusted EBITDA conversion margin versus 47% decremental margin in the third quarter being driven primarily by the COVID-19 expenses; higher SG&A expenses because we expect T&E to be up Q4 versus Q3; and pressure from cleanup and COVID absenteeism costs. So, I think that's the kind of the nub of the matter. And we've got to manage that throughout Q4, and we've got to watch our absenteeism rates very, very closely.

Great. Thanks for the additional color.

Our next question is from Joe Giordano with Cowen. Your line is open.

Hi, good morning. This is Robert in for Joe. Thanks for taking my question. I just have a quick one just on the 4Q sales guide. And just if you could parse it out between segments, just even directionally. I know tech is a relatively small piece of overall revenue, but in Q4 last year, we did see a bit of an increase in the 4Q. I just wondered if you're expecting a similar sort of ramp in 4Q 2020.

No. And thanks for asking that because I think that something I failed to mention is, this is a really tough comp for tech because you'll recall that the bulk of the San Jose leak detection shipments happened in our Q4 last year. And so, I don't expect that, though, to have that multi-thousand unit EchoShore order replaced quarter-versus-quarter. So, I expect that the overall sales will be more negatively impacted in Technologies than I do in Infrastructure. I think pipe condition assessment service projects have been especially challenged since the pandemic began. I think availability to homes to do meter installs has been challenged. I think the project-related mentality, if you will, the water utilities continues to push it. So, I think you could absolutely expect a much, much bigger drop in Technologies and pretty, pretty even-steven kind of performance out of Infrastructure as OpEx and CapEx continue to chug along at kind of historical rates.

That’s great. Thank you very much for that. I appreciate it.

Just one other thing to point out for all the people on the call, we're not experiencing any cancellations. I know there was some chatter about that out there. And so, everything we see is kind of delay, delay, delay. We're not seeing any actual demand perish. We just kind of see a push to the future, ultimately be the timing issue.

Right. And at this time, I'm showing no further questions.

Okay. Well, thanks, everyone. It was a very challenging quarter from a kind of a social point of view as we learned a great deal about COVID-19, how to respond to a pandemic. As I said several times in my comments, really proud of our team, really proud of how our plant employees especially have risen to the task. I mean we have had really, really good participation, really, really good throughput and a great deal of flexibility, especially from our hourly workforce on trying to do things different. This is how we used to put this together. Now, we have to put it together like this. So the social distancing, the wearing of face masks, sanitizing the workspace, sanitizing common areas, I think everybody has just been really, really super. And the esprit de corps, I think, in our plants gives me faith that we're going to be in really, really good shape as we come out of this because I think that everybody's got the right attitude and I think we're on the right path. And I think the quarter could have been worse, but it was good, and I'm encouraged by what I see both from an economic activity point of view, a residential construction point of view and where we are with our water utility customers. So, thanks for coming in today. Thanks for calling in. And here's to Q4, and we'll see where we are. We'll talk soon. Thank you.

Thank you.

This now concludes today's conference. All lines may disconnect at this time.