Good morning, everyone. Welcome to the 19th annual Oppenheimer Industrial Growth Conference. Kicking things off today, we have the Mueller Water team, CEO Martie Zakas, CFO Steve Heinrichs, and VP of IR Corporate Development and potentially some other things, Whit Kincaid. To kick things off, Martie, perhaps for those a little less familiar with the Mueller story, provide some background on the company, your operating structure, and maybe offer the highlights of your recent print that may have offered pretty standout performance.
Very good. Will do. Well, Bryan, first of all, thanks to you and Oppenheimer for having us here today at your conference. As Bryan said, on Monday we did announce our second quarter results. We are a September fiscal year-end, so with those second quarter results, we also made some announcements in and around our leadership and ongoing board refreshment process. We did announce that the board has named me as the permanent CEO. It also announced that Paul McAndrew, who is our Chief Operating Officer, has been promoted to President. So when we take a step back and look at Mueller, we are a company that has a 165-year rich history. We have been a leader in the water infrastructure industry.
We provide the products and solutions that help municipalities, largely across North America, deliver safe, clean drinking water to hundreds of millions of people on a day-in, day-out basis. The infrastructure products that we are best known for are fire hydrants. They're iron gate valves. They're service brass products. And that makes up roughly two-thirds of our overall net sales. When we look at the end markets, and I'll touch on this a little bit more later, but when we look at our primary end markets, about two-thirds is what we call the municipal end market, which is also considered the repair and replacement business. New residential construction is another component, and that's where basically you're building out new communities of housing developments and need to put the underground infrastructure as support.
And then a little less than 10% of our overall business comes from our natural gas distribution and industrial valve products. We are vertically manufactured with our operations primarily in the U.S. We've got 10 manufacturing facilities. We also have four foundries, currently have two steel foundries, as well as two brass foundries. We also carry with us a history of innovation within our markets and with our products. We have got five R&D centers, and they are located in various areas across the globe. There we focus not only the updated manufacturing and engineering around our core products, but also the R&D focuses on areas such as flow control, leak detection, software, pressure, and our repair products and services. High level, we generated over $1.2 billion in net sales and $237 million in adjusted EBITDA when you look at the last 12-month period.
Bryan referenced some of the different hats that Whit wears. One of them is in and around sustainability. ESG is core to Mueller Water Products, primarily as we provide the critical products and solutions in and around water, but you also see it in the various endeavors that we have with our customers, with our suppliers, and with our manufacturing operations. In that vein, I'm very pleased to report that MSCI recently upgraded Mueller to its highest ESG rating of AAA, which we now carry. I think that really is a testament to the products and services that we provide to the water industry. Importantly, it also just shows the dedication of our employees, of our customers, and our suppliers, and our keen emphasis in and around ESG. At a high level, what do we think are the most attractive reasons for investing in Mueller Water Products?
Well, we have got leading brands. We have got strong specifications across the more than 50,000 municipalities in the U.S. We have a comprehensive, longstanding distribution network through which we sell most of our products, and that's really to be able to reach out to that very fragmented water end market with all the municipalities. And we utilize a lost foam manufacturing process for the manufacture of our iron gate valves and our fire hydrants, which certainly have not only some engineering but some manufacturing efficiencies as well. When we look longer term at the overall end market, we are faced with aging water infrastructure in the U.S. and I think an increasing need for investment in that water infrastructure, which we view as a long-term positive end market dynamic.
Additionally, with the passage of the infrastructure bill a few years ago, we think that also will allow for some additional investment into the water industry. We have been modernizing our manufacturing facilities. Most recently, we are completing a new brass foundry, Decatur, Illinois, which is where we were founded over 165 years ago. In addition to the new, more modern brass foundry that we have, we are also producing there a new lead-free brass alloy, Eco Brass, with our service brass products and are excited about that for a lot of the attributes of that alloy, most importantly being its sustainability features. When you look overall, we've got a very solid balance sheet, but importantly, we've got a lot of capacity and flexibility with a 1.1 net debt leverage ratio that I think allows us opportunities as we consider capital allocation considerations going forward.
To give you a quick recap of the second quarter that we just announced and importantly our outlook for the balance of 2024, we've had a longer-term increase in our net sales at 6.8%. That's the compound growth rate over the last five years. And with some of these new investments as well as the efficiencies that our operations and supply chains are achieving, we see additional improvement for margin benefits. Over the last five years, we've also generated $230 million in free cash flow, and that considers the higher level of capital expenditures that we've had over that period as well. Our second quarter came in extremely strong. We achieved record quarterly net sales. We had a strong sequential increase in our volumes.
We're pleased to report a gross margin of 36.9% in the quarter, and that was largely supported by the ongoing manufacturing and supply chain efficiencies, and that was our highest quarterly gross margin in more than seven years. We also achieved a record adjusted net income per diluted share of $0.30. In addition, for the balance of our 2024, we increased the guidance that we provided. We increased the guidance and are now projecting net sales to be between a decline of 2% and flat. But importantly, when you look out to the balance of the year, that implies growth as we look to the second half of that year. We also increased our expectations in and around our adjusted EBITDA, looking for that to have a growth rate between 23%-27%.
Just to help with some of the framing of that, if you look at the midpoint of the guidance that I just walked through, that would represent a 420 basis point improvement in our adjusted EBITDA margin for 2024 versus 2023. Additionally, as we look at free cash flow, looking at it as a percentage of net income, we expect that to be more than 75% in our 2024, which is a higher level than we had in our 2023. So, Bryan, that'll wrap up my introductory remarks to give just a brief overview, and we'll turn it over to you for further questions.
All right. Thanks, Martie. Great intro there, and offered to segue to a lot of topics. Given your strong first-half results, kind of a step change in profitability, certainly the second quarter print, maybe offer some finer points on how your team's thinking about the back half and the upside-downside considerations relative to your guide. And I do want to make clear, I feel like your team isn't overemphasizing this, but you have, based on the guidance, already achieved or you're on track to achieve your fiscal 2025 margin target this year. So I think that is a key consideration in terms of that step change that I referenced and the progression and trajectory that your team is on.
Yeah. So to overall take a look at what we have seen, I'd say, through the first half of this year as well as looking into the second half, I think overall in looking at our demand level that we're seeing going back and referencing the key end markets, municipal, and we think overall the municipal end markets remain fairly resilient as we look at that piece of it with respect to the new residential construction market. As I said, if you think about that, that's when new communities are being built out. They probably don't have that underground water infrastructure. So there it is largely the contractors and the land developers that need to build that underground infrastructure to support the new community there.
With respect to resi construction, we certainly look at it on a relative basis to 2023, and we are seeing certainly an improvement relative to 2023, particularly when we look at the single-family housing starts. Certainly, that said, we do have the backdrop of a continuing higher interest rate environment, which impacts mortgages. So that's probably a little bit of a counter to that. But I would say overall, again, on a relative basis, we are seeing improvements relative to 2023. When we look sort of at the cadence that we had from the first quarter to our second quarter, even though we did see lower net sales in our first quarter, I think importantly, that was really more reflecting the level of elevated short-cycle backlog that we had in 2023.
If you go sort of a little bit back in history, given COVID, given supply chain disruptions, given the very rapid inflation, we had abnormally high short-cycle backlogs and were working through that during a lot of 2022 and 2023. I think important to us, as we really kicked into our little bit in our first quarter, but moving into our second quarter, we have worked down those elevated backlogs with our fire hydrant product line as well as our iron gate valve product line. And so really are back now more in the normal cycle where we look at the order pattern on the short cycle for what our expectations can be in the near term in and around net sales and shipments. We still do have a higher backlog with our service brass products, which again are typically classified as a short cycle.
But importantly, we are continuing to work down those backlog levels, worked them down in the first quarter, further worked them down in the second quarter. Our expectation is we'll have those fully worked down by the time that we get to the end of our fiscal 2024. Putting all that together and with the increasing sequential orders that we've seen through the first six months of the year, we do expect that we will see some sales growth moving into the second half. Probably one other callout on the net sales side that I want to give that we shared yesterday is we did announce a price increase in February of this year.
As a result of that price increase and the order levels that we saw, and importantly, our shipment delivery times, we did see some pull forward of orders probably from the third quarter into the second quarter because of our ability to deliver those in a timely manner. Let me shift over to the profit margins and flowing from there our adjusted EBITDA. We really demonstrated, I think, some in the first quarter and clearly in the second quarter, the improvements that we are seeing from an operational perspective. We are seeing greater efficiencies with our material, with our labor, with our freight. I think a lot of this is attributed to some of the operating efficiencies that we've seen as well as the work of our supply chain and sourcing teams where we are able to lower some of those costs.
We also, in the past, due to the demand levels that we were seeing in backlog, we had outsourced some of our parts. We also have benefited from some lower outsourcing costs that we've had. That, I think, has been a benefit looking into the quarter. Very pleased to see the level of gross margin that we had. You can see in the guidance that we are looking for a continued strong year-over-year improvement on the gross margin side.
Understood. I appreciate all the color. Kudos to your team execution and getting to the run-rate profitability that you have. Obviously, the manufacturing modernization and optimization there, it's been a challenging process at times and a lot of moving parts there and so much to navigate. But this is basically what your team has spoken to for quite a while. It's the level of profitability you should achieve as all of those inefficiencies are stamped out and get toward run rate, particularly with the foundry. So good to see the second quarter print and the confidence that you have in the outlook going forward. Speaking of outlook, how are you feeling about just demand runway overall? Obviously, you don't have a fiscal 2025 guide out there, so I'm not asking for specific numbers. But if we think about the muni backdrop, it's been very resilient, obviously, placement-weighted demand.
Resi, there's naturally quite a bit more volatility through the cycle. There's the kind of puts and takes of realistically being underbuilt, but we're still in a higher rate environment. How is your team thinking about that just on a preliminary basis as we think about the next fiscal year?
Yeah. So I think, first of all, with respect to the municipal end market, our views are that largely is healthy and fairly resilient. I think I'll touch on one other point too, which is as part of some of the backlogs that we had, we did experience with our distributors going through some destocking, I think, as we saw through the end of 2023 and into our first quarter. Our sense is by the end of the first quarter, most of that destocking was completed. So I think in seeing the order patterns that we saw increasing as we move from our first quarter into our second quarter, I think the sense is as we move into the construction season, we are thinking that we are going to see resiliency and growth in and around the municipal end market. And part of that is because of the aging infrastructure.
As I look at sort of what I have seen and heard and researched and all in the water industry over a longer period of time, there have been many different independent organizations from independent educational institutions, the American Society of Civil Engineers, all sorts of groups and including various governmental groups that have continued to cite the underinvestment that broadly we have had in our water infrastructure. I think you're seeing a couple of reasons why it's probably getting more attention and more attention where consumers are starting to realize it. One of the reasons is, I think, because we are seeing some of the disaster scenarios that can happen when you haven't properly invested in the water system. We can certainly talk about water quality issues that we've seen.
Certainly, Flint, Michigan, is probably the one that comes to mind most, the frequency that you might see in and around water breaks. Certainly, all of that helps to raise the awareness. Importantly, as you raise the awareness, then I think it's easier for the elected government officials to say, "We need to take some of our money to reinvest in our water systems." Additionally, when you look at the cost of water has always been high, and many municipalities have undercharged for that water. As we're seeing generally, the water rates rise where consumers and businesses are really paying more for that cost of water to compensate for what it costs. I think, again, those rising water rates raise the awareness with consumers. I think it's overall that aging infrastructure and the level of repair that is needed does support the long-term growth.
Can also call out the Infrastructure Bill that was passed a couple of years ago. It's the highest federal dollar amount that we have seen that has allocation for investment in our water infrastructure in the U.S. We think that's going to be a nice longer-term tailwind. To be clear, we have not seen that. We really haven't seen the dollars flowing yet. And I will tell you, it's not surprising because you find a lot of times once Congress will pass a bill, they're allocated, and then there's a lot of the devil is in the details in terms of how the different organizations you've got HUD, you've got EPA, you've got the Department of Transportation, all of those different agencies are now going through the various rules, regulations, requirements, etc., as to exactly how that money will begin to flow.
But when we look out longer term, we think that's going to be a nice tailwind for the industry and for Mueller.
No, we certainly agree. And perhaps touch on medium-term resi outlook.
Yeah. Sorry. So to hit on residential construction as well. So 2023 was certainly a challenged year. So as we look initially into 2024 and even looking over the last 12-month period, particularly on the single-family housing start side, we've seen a growth of about 8%. And that's an industry growth rate in and around single-family. But I think importantly, as we look on the residential construction side, we do see more pockets of growth. It's not broad-based, I'd say, geographically, but we'll see it more in certain geographic areas, largely in the South, largely in the Midwest, largely in the West, where you're seeing, I think, more population migration, which is leading to more development and more housing demand in those areas. I think you certainly called out it's an area where we can certainly see volatility going forward with the spike in mortgage rates.
A year or two ago, I think you did see a pullback on the residential construction side. I would say so sort of right now, we don't think there is an overdevelopment of land brilot development, seeing an improved year, I would say, versus 2023. But certainly know that the level of mortgage rates, largely compared with what consumers saw a few years ago, could be a little bit of holding back some of what otherwise you would see as growth coming from demand.
Understood. That all makes sense. Price cost is always a focus for investors. We tend to run the somewhat simplified analysis of thinking of volume incrementals, decrementals, then overlaying just basic price cost impact. For your team, that hasn't been so simple over recent years given the manufacturing investments. As I mentioned, a lot of moving parts, even navigating and the future looks much brighter on that front, thankfully. Maybe offer some detail on where you are in the cycle of price cost management from Mueller. It is always through the cycle consideration. Then touch on the efficiency gains lapping the inefficiencies on a trailing basis of the manufacturing investments and what the next few quarters hold in terms of getting to a run rate and all of the investments in aggregate starting to read through in terms of productivity depth.
All right. Well, Steve, you want to talk on price cost?
Yeah. We see going forward in the second half a little bit of inflationary headwinds, particularly with respect to copper and rubber. Over the cycle, and we've demonstrated historically, we have been able to offset inflationary pressures with price. We realized mid-single-digit price in the quarter, and we expect to continue to realize that level of price in the rest of this year. As it relates to Decatur, we are still on target to close the old Decatur foundry by the end of calendar 2024, which would be our first fiscal quarter. So at the end of our first fiscal quarter, that is likely going to generate 80 basis points-100 basis points in margin improvement as a result of not carrying the duplicative costs of the old Decatur foundry going forward.
I think in the long term, it's hard to put a number on it, but inflation is here. We have wage inflation. We have raw material inflation coming at us. But other than that, we've been able to offset that level of inflation historically with price. And the operations teams, the supply chain teams have done a tremendous job. You can see in our margin performance in the past couple of quarters that we've really been picking up efficiencies with respect to the cost side of the equation. And it has delivered outstanding margins on both the gross and EBITDA level.
Understood. And I ask this respecting again that you don't have fiscal 2025 guidance out. But given where you are in price cost management, the efficiencies that are beginning to read through in terms of your manufacturing investments, preliminary demand outlook, is there any reason, just given current visibility net of all of those factors, that profitability should not be higher next year?
So maybe stepping back and giving a little context. So I think as we had talked about the timing, certainly, of our key capital projects coming along, price cost, important question. But I think, as Steve just said, we really are sort of on the other side of addressing that very rapid rise in inflation. And when we had looked at those items, we had said that we expected by 2025 to get back to pre-pandemic margins when we looked at our gross margin and when we looked at our adjusted EBITDA margin. If you look at the midpoint of the guidance we just provided, I think you'll see that we are close to basically to those levels.
I think it's in terms of some of those efficiencies that we have been able to achieve, where we are with the new capital projects, where we are with pricing, importantly, where we think we can see volume, I think it is as we look at that, we'll have the moving very close, in essence, to those pre-pandemic margins with the guidance that we see for our 2024. You're absolutely right. We have not given any future guidance beyond our 2024. What I will certainly tell you as an operations team, as a management team, we remain very focused on operational excellence and continuing to look for ways to drive efficiencies in our operations, which I think will help margin.
I think the other piece that will be a big factor as you look out and ask the question in 2025 will be where we see volume levels in 2025 because that will certainly be another factor in that just because of the leverage we can achieve being largely a vertically integrated organization.
Yeah. The demand environment in 2025 will dictate a lot of that.
Completely understood. I appreciate the color. Certainly back to medium- to long-term catalysts, you did bring up infrastructure spending and the fact that over time, that should be a nice tailwind for your team and really the sector overall and certainly much-needed spending. A lot to like there. Maybe offer a little more detail on exactly where you expect to benefit from the ramp in that spending, which Mueller products have the most leverage to the spending categories. Based on what we've seen to date in terms of the rollout of funding, as phased as it has been, as slow as that trickle has been, there is some momentum building. How do you think about the cadence of spend and the impact or the overall magnitude of Mueller catalysts as we think about fiscal 2025, 2026, 2027?
As Martie mentioned earlier, this is the highest level of funding to the water infrastructure space since the 1970s, $55 billion going into water infrastructure with $43 billion of that directed to state revolving funds. These projects require Made in America products, which we're a leading American producer. It gives us an advantage with respect to attacking the funding of those projects. Like with any government project, it's taking some time for it to be fully deployed. You may recall going back to ARRA that there were significant delays in the commencement of projects. Our perspective is that we will start seeing these projects start coming through at the end of this calendar year. So we won't start experiencing them until our first or second fiscal quarter of 2025.
That said, this is an exciting level of funding for our industry, and it should provide us with tailwinds going forward. With respect to the water infrastructure, we have kind of probably five product categories that it would hit. That would be iron gate valves. It would be service brass, specialty valves, hydrants, and repair products. I think that in particular with the focus on lead line replacement, that we think that service brass will be a focus area where we have a really meaningful position and goes right into our new brass foundry, which is ramping at exactly the right time. In addition, specialty valve products, as there are large treatment plants and other things, we have a very nice position in that market. And we can see that that could also impact positively our specialty valve market. And we are pretty well positioned for this.
Us and other American manufacturers have been working with the EPA, the DOT, the HUD, and you name the acronym alphabet soup to ensure that American manufacturers like us get some exemptions for things like fasteners, which are all made offshore. We believe that we will be able to, that us and other participants in this funding will be able to continue to deliver on the projects when they come.
Yeah. Well, it's all very encouraging. I appreciate your comments on the brass foundry, getting to run rate at a pretty good time to service the inflection or likely inflection demand.
Yeah. Now, if you look at two of the largest capital projects that we've had over the last few years, it's building the new brass foundry in Decatur, Illinois, which is not only sort of a requirement when you've got a 100-year-old brass foundry, but importantly, as I said, it increases our capacity, and we're producing the new true lead-free alloy there. The other area where we've had a lot of investment was where we consolidated a number of plants into a single new plant in Kimball, Tennessee. And that's the plant that's largely responsible for the manufacture of our specialty valves. So again, sort of ties in very nicely to answering your question as to where we think we could have maybe sort of an outsized benefit coming from the infrastructure bill when you consider where those dollars are most likely to be invested.
Absolutely. All right. So last topic, capital deployment. Your balance sheet's in good shape. You're starting to throw off more cash. Suspect that that will be a steadily improving trend going forward, much less resource distraction. So yeah, you have a lot of optionality at this point. And how are you thinking about capital deployment strategy, the relative appeal of M&A versus buybacks at this point? And on the M&A side, what kind of assets would be most interesting or compelling as you think about the Mueller in the future?
Yeah. No, look, appreciate the question. And I think, as you said, we feel we've got a terrific capital structure. We've got no debt due until 2029, and we've got a 4% fixed interest rate. So very strong from that perspective, gives us capacity, gives us flexibility. So we describe how we think about capital allocation as being balanced and disciplined. We have paid a dividend since we were spun off as a publicly traded company. And our board has increased that dividend, I think, eight times since 2015. We have also accompanied that with a share repurchase program. We did repurchase $10 million of stock in our fiscal second quarter. And as of the end of the quarter, we had $80 million remaining authorization on that. We have had higher levels of capital expenditures, largely because of some of the investments that we thought that were important to us.
We spent some time talking about those investments on this call. Because we're vertically integrated, we're going to need to continue to spend capital to support and upgrade and improve our manufacturing facilities. But we don't think it'll be at the same level that we've had recently. That will certainly be ongoing. But we also view M&A and the acquisitions as being integral to our long-term growth as well. We are purchasing and expanding our portfolio and deepening it. When we purchased the Krausz with the repair products, it was a terrific addition for us. We had synergies when you looked at the end-market distribution channels, the manufacturing process. And it just ties very nicely into where there was long-term growth as well.
We would love to find more opportunities where we can leverage manufacturing, leverage our strong customer relationships, and deepen or broaden the services that we have within water infrastructure. It could be that we look for some technology that can continue to enhance or accelerate some of the areas that we're in, in and around leak detection, pressure monitoring, pressure management. So I would say acquisitions remain very important to us. Probably our bigger challenge is not so much finding the opportunities, but finding them at a time when they are available. But I would say that is of high interest for us as we move forward from a capital allocation perspective.
Completely understood. Again, appreciate all the color. We've covered a lot. Anything that you would like to leave the audience with today?
I will say, first of all, again, thank you for having us at your conference. I would say, look, we as a management team are certainly very pleased with the performance that we have delivered as we look through the first half of the year. We are very confident when we look out at where the end market and the long-term opportunities are. We think we are very well positioned with the manufacturing facilities that we have and, importantly, the teams that we have in place to continue to drive operational improvement as we look forward.
We look forward to tracking and staying with the story. It's been a great one recent past week. Expect that'll continue.
Very good.
Again, thank you very much for your time, Martie, Steve.
All right. Thank you.
Thank you.
Thanks, everybody.
Bye-bye.