Good morning, everyone. Thank you for joining us on Mueller Water Products First Quarter of 2022 Conference Call. We issued our press release reporting results of operations for the quarter ended December 31, 2021 yesterday afternoon. A copy of the press release is available on our website, muellerwaterproducts.com. Scott Hall, our President and CEO, and Martie Zakas, our CFO, will be discussing our first quarter results, market conditions, and our current outlook for 2022. 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 and to address forward-looking statements and our non-GAAP disclosure requirements. As a reminder, we have changed our management structure and segment reporting effective October 1, 2021. We filed an 8-K in January, where we provided the recast of historical quarterly results for 2020 and 2021. This is our first-quarter reporting our new segments for Water Flow Solutions and Water Management Solutions. 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, we disclose the reasons why we believe that these measures provide useful information for 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 the 30th of September. A replay of this morning's call will be available for 30 days at 186640312903. The archived webcast and corresponding slides will be available for at least 90 days in the Investor Relations section of our website.

Thanks, Whit. Thank you for joining us today. I hope everyone listening to our call continues to stay safe and healthy. I am very encouraged by the start to our year as our team members delivered strong net sales growth in the quarter while continuing to face challenges from an extraordinarily difficult operating environment. This year's sales growth at both segments benefited from increased volumes and higher pricing across most of our product lines. With healthy demand levels in our primary end markets, we again experienced strong orders in the quarter, leading to a record backlog at the end of the quarter. We remain focused on serving customers in the face of the continuing operational challenges from higher inflation, labor availability, and supply chain disruptions. Despite these obstacles that have increased costs, adjusted EBITDA increased 6.3% in the quarter. The anticipated margin compression this quarter primarily resulted from the lag between the timing of inflation and our price realization. Through the ongoing inflationary pressures, we again increased prices across the majority of our products during the first quarter, which along with the pricing actions we took in 2021, we believe will help improve margins. We have a strong balance sheet and cash position, finishing the quarter with over $200 million in cash outstanding and net debt leverage of 1.2 times. During the quarter, we generated positive free cash flow and repurchased $20 million of common stock. Most importantly, based on our solid first quarter performance, we are raising our annual guidance for both consolidated net sales and adjusted EBITDA growth. While we expect challenges associated with higher inflation, supply chain disruptions, and labor availability to continue in 2022, we are confident that we can make progress on our operational initiatives to deliver enhanced results. With that, I'll turn the call over to Martie to discuss our first quarter results.

Thanks, Scott. Good morning, everyone. I will start with our first quarter, 2022, 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 first quarter of this year, we generated consolidated net sales of $272.3 million, which increased $34.9 million or 14.7% compared with the first quarter of last year. We increased net sales in both segments, Water Flow Solutions and Water Management Solutions. Both segments benefited from higher pricing and increased volumes as we continue to ship against record backlogs. Gross profit this quarter increased $9.2 million or 11.7% to $87.6 million compared with the prior year, yielding a gross margin of 32.2%. While gross margin decreased 80 basis points compared with the prior year, it increased 300 basis points sequentially. The benefits of higher pricing and increased volumes were more than offset by continued higher inflation and unfavorable manufacturing performance, associated with labor challenges, supply chain disruptions, and our plant restructuring. Our total material costs this quarter increased 21% year-over-year, primarily driven by higher raw material costs, which also increased sequentially. As a result of the lag between the realization of our price increases and inflation, our price-cost relationship was negative for the fourth consecutive quarter as expected. Selling general and administrative expenses of $56.3 million in the quarter increased $7.1 million compared with the prior year. The increase was primarily a result of investments in new product development, the addition of i2O Water, IT-related activities, personnel-related costs, general inflation, and higher T&E from increased activity relative to the temporary savings last year due to the pandemic. SG&A as a percent of net sales was 20.7% in the quarter, the same as in the prior year. Operating income of $28.9 million increased $1.1 million or 4% in the quarter compared with $27.8 million in the prior year. Operating income includes strategic reorganization and other charges of $2.4 million in the quarter, which primarily relate to our previously announced plant restructurings and the ongoing challenges in the operational environment. Turning now to our consolidated non-GAAP results, higher pricing and increased volumes more than offset higher costs associated with inflation and higher SG&A expenses. Adjusted EBITDA of $47.5 million increased $2.8 million or 6.3%. Our adjusted EBITDA margin was 17.4%, which is 140 basis points lower than the prior year, yielding an 8% conversion margin. For the last 12 months, adjusted EBITDA was $206.4 million or 18.1% of net sales. Net interest expense for the quarter declined to $4.3 million compared with $6.1 million in the prior year. The decrease in the quarter primarily resulted from the refinancing of our 5.5% senior notes with 4% senior notes. The effective tax rate this quarter was 24.2% compared with 25.8% last year. For the quarter, we increased adjusted net income per share by 18.2% to $0.13 compared with $0.11 in the prior year. Turning now to segment performance starting with Water Flow Solutions, which consists of our iron gate valves, specialty valves, and service brass products.

Thanks, Martie. I will touch on our first-quarter performance, ESG, end markets and updated full-year 2022 guidance. After that, we'll open the call up for questions. We sequentially improved our gross margins in the first quarter compared with the fourth quarter of last year. This improvement was primarily driven by one-time items experienced in the fourth quarter, as our margins were impacted by many of the same challenges we discussed last quarter. Due to continuing higher inflation, labor availability, and supply chain disruptions, gross margin was lower compared with the prior year quarter. Although raw material inflation for brass and scrap steel appears to be stabilizing, overall material inflation increased again sequentially in the quarter, partly due to the ongoing challenges with the supply chain disruptions. In order to meet customer demand, our supply chain team has focused on acquiring parts from alternative suppliers where needed. And in some cases, using alternative parts or materials to help ensure availability for production. These decisions to acquire imports to maintain production led to significantly higher input costs for certain components. Additionally, labor availability at the plant continues to be a significant challenge, especially in the southeastern part of the United States. Absenteeism remains elevated at many of our plants due to the ongoing impact of COVID-19 in addition to hiring challenges. To address labor availability, our manufacturing teams are offering enhanced benefits and incentives. Finally, similar to last quarter, we continue to experience higher freight and energy costs which impact our foundries. As noted earlier, our price-cost relationship was negative in the first quarter and has been negative for four consecutive quarters. To help address the ongoing inflationary pressures, we again increased prices across the majority of our products during the first quarter of this year. Record backlogs are extending the timing for the price realization benefits. So much of our most recent price increases will not benefit us until the fourth quarter of this year. However, multiple price increases from last year should drive sequential improvements in price realization in 2022. As a result, we expect price realizations to improve sequentially in the second quarter, resulting in nearly a flat price-cost impact. We anticipate the price-cost will be positive in both the second half of the year and for the full year, which will help improve margins. With this outlook, we are also assuming that raw material costs and other inflationary pressures do not continue to worsen. As a result of the timing and magnitude of the inflationary cycle starting in early 2021, as well as record backlog, we do not expect price-cost to be breakeven over the inflationary cycle until 2023. However, as a reminder, over the entire inflationary cycle, our goal is to have price increases more than cover inflationary expenses and preserve margin. I will now turn to ESG. In January of this year, we released our second ESG report, highlighting our strategy initiatives, annual performance targets and goals. Our long-term environmental goals for waste disposal and greenhouse gas emissions are aligned with our business strategies to create a safer and more sustainable environment. We're very excited about our new brass foundry, which is scheduled for completion in 2023. The new foundry will enable us to pour a new lead-free brass alloy, which is a noteworthy advancement in sustainability for our customers and end-users. As we strive to become a sustainability leader in our industry, we are committed to delivering smart products that are safer for the environment and more efficient for our customers while also minimizing our water and energy footprints. Turning to our end markets. Overall in our first quarter, we continued to experience healthy order activity relating to both municipal repair and replacement and new residential construction end markets. We believe distributor inventory levels have increased due to higher inflation, anticipated end market demand, and extended project delivery timelines due to the supply chain constraints and labor availability. For the new residential construction end markets, inflation and supply chain disruptions are extending builder timelines. However, builder confidence remains high due to low inventories and buyer demand. For the municipal end market, repair and replacement activity is extremely healthy; constraints. Most importantly, we're not seeing any cancellations. Our customers are providing feedback about the new federal infrastructure bill and its impact on their plans. We continue to be excited about the long-term positive impact that we believe the bill will have on the aging water infrastructure in the U.S. As a reminder, we have not included any benefits from the bill in our assumption for 2022 guidance. I will now discuss our current expectations for 2022. Based on our solid first quarter performance, we are raising our annual guidance for both consolidated net sales and adjusted EBITDA growth for fiscal 2022. We believe that our current backlog, pricing actions, and strength of our end markets together support our growth expectations. We anticipate that consolidated net sales and adjusted EBITDA will both increase between 6% and 10% for the year. This outlook assumes the following; price realization continues to improve sequentially, we achieve nearly a flat price-cost impact in the second quarter. Price-cost is positive both in the second half of the year and for the full year. Finally, raw material costs and other inflationary pressures do not continue to worsen. We had a solid start for the year for free cash flow generation. While our annual guidance for capital expenditures points to an increase in quarterly spending from the rest of the year, we expect to generate positive free cash flow for the full year. In conclusion, we remain focused on executing our strategic initiatives to grow and enhance our business. These initiatives include accelerating new product development, driving operational excellence, executing key capital projects, developing and expanding our Sentryx software sensing and control platform, and implementing sales and channel strategies. We are excited about our new management structural reporting segments. We believe they will help promote the execution of our strategic initiatives and position us for improved long-term growth and increased margins while helping to accelerate the commercialization of our technology-enabled products and software platform. Our commitment to advancing our ESG goals will remain at the forefront of how we operate our business as we strive to positively impact our world. Finally, we will continue to take a balanced approach to our cash allocation strategies, focusing on reinvesting in our business, accelerating growth through acquisitions, and returning cash to shareholders through our quarterly dividend and share repurchases. We are confident that our growth strategies, capital investments, and operational initiatives will enable us to drive sales and adjusted EBITDA growth. And with that Operator, please open this call for questions.

The phone lines are now open for questions. If you would like to ask a question over the phone, please follow the instructions provided. The first question in the queue is from Deane Dray with RBC Capital Markets, your line is now open.

Thank you. Good morning, everyone.

Good morning, Deane.

Good morning.

I really appreciate the new segment reporting; it's clear and thank you for addressing all of the restatements as that was very helpful. I want to say that I will miss having technologies as a separate segment. We still value what that business represented, particularly with the important startup technologies in smart water. I understand you still have those businesses, but I do prefer the new segment reporting.

Thank you.

All right.

As much as we can go swiftly.

Yes. Let's start with the top line and demand significantly in Water Flow better than we were expecting. Was there any kind of budget flush that you benefited from? And then also on the utilities, we heard some grumblings that utilities, given the infrastructure bill, were going to be a bit hesitant about what they were going to be spending in terms of projects until they got better line of sight whether the government was going to be handing them a check. So has there been any delays that you've seen in project spending along those lines and just what's driving this nice upside demand this quarter?

I believe that the demand landscape is currently strong, as communities have ample funds due to the CARES Act and the infrastructure bill. However, in the short term, I anticipate some hesitance from municipalities and municipal water projects, similar to what we experienced when the American Reinvestment and Recovery Act was introduced. There was a period of uncertainty then, as new administration officials discussed infrastructure, which led to a temporary slowdown in the market. Project leaders want to clarify how to align their initiatives with the new funding opportunities. Nonetheless, I remain optimistic about the long-term benefits of the infrastructure bill. Given the challenges of aging infrastructure and the inclusion of additional federal spending that amounts to $550 billion over the next five years, there are positive implications ahead. In the immediate term, our pricing strategies, resilience in new construction and home markets, along with the financial capacity of municipalities, especially from the funds received in July, give us confidence. We believe that the second half of the year may not be overly problematic due to job qualification issues for federal funding. Notably, our orders this quarter exceeded our shipments, which has allowed us to increase our backlog again.

Good. My brother have you be in a position of trying to explain stronger demand and otherwise, so that's good. And then the second question on price costs. You gave really good specifics on the raw material increase sequentially, but not a lot of specifics on pricing. Just what was price realization in the quarter, what are you baking in for the year?

That's a difficult question because the reported increases versus actual bookings relate mainly to distribution looking back. I believe it was around 5% to 7% for the first quarter. As you're aware, we've implemented a series of price increases over the past 15 months, and some of those orders are compared to the same quarter from the previous year based on their timing. This can lead to uncertainty regarding what will be realized in the comparison of backlog versus what is shipped. We have a good understanding of what the costs for brass, steel, and components will be in our second quarter. We are aware of the near-term demands based on our Q2 shipments, which is why we expect to reach a break-even point. We need to clear out many of the older orders in our backlog that were at lower prices. To address your question directly, I think for the first quarter, the realization was between 5% to 6%. I anticipate that will improve by a couple of hundred basis points in the second quarter. Ultimately, by the time we reach 2023, I would say to all investors that we need to achieve around $20 million in price increases to reach the $40 million needed to get back to break-even, before considering the dilution effect from the negative price costs experienced in 2021.

That's really helpful. Just a last one, it's a clarification. Does it sound as though you cannot re-price backlog? Wouldn't there be some escalators tied to CPI, something like that that would give you some flexibility or you just stop with the terms of the original order?

So there are two aspects to consider. For our AMI orders and multiyear projects with long timelines, we do have price escalators and indexes that allow us to revisit and adjust pricing based on what we’ve agreed upon with customers. However, the bulk of our backlog is in the short-cycle business, particularly distributor orders, which are not subject to re-pricing. I want to point out that while navigating inflation can be challenging, historically, once we see stabilization and a decline in raw materials and component costs, this typically results in increased margins for us since we retain our pricing. Our approach to price increases over the past 30 years has been cautious, consistently implementing increases without retreating from those levels. Naturally, this can be disruptive, and while there might be fluctuations, we expect to benefit from the price increases we've implemented, including those from the fourth quarter, once inflation is controlled.

That's really helpful. Thank you.

Thank you, Deane.

Next question is from Bryan Blair with Oppenheimer. Your line is now open.

Thanks. Good morning, everyone.

Good morning, Bryan.

I was hoping you could offer a little more insight into the specialty valves operating trends. Obviously, some challenges there. Last quarter, that, I suspect, extended into this quarter. Has there been a catch-up on shipments? How did productivity metrics and the impact of temporary costs compare to Q4? And how should we think about those variables over Q2, Q3?

Okay. Great question. Thanks, Bryan. The way people should think about it is yes, we've had some marginal improvement. We've had an uptake probably in the 5% to 7% range in productivity, from the labor that's there; we're getting more throughput than we had in the fourth quarter. But the headwind that we saw in Q4, when we ended date of the plant with volume, and we were still trying to close the Aurora plant. The Aurora plant is still open. And so basically you've got those double costs in our Q1 results, and that will continue into our Q2 results. And so as I said, in our fourth quarter call, we got to get the one-timers out of the way. We had some sequential operating improvement in specialty. But the headwinds of the $5 million or $6 million that we outlined in Q4, four or so of that is still around. And that will get better over time as we reduce headcount and reduce reliance on our Aurora facility.

I appreciate the color. And in terms of the infrastructure bill, we know that's not factored into your fiscal 22 outlook, but you mentioned customer feedback on the potential or likely lift in terms of their spending plans; if we look to your fiscal 23 and beyond, how's your team's thinking about what that will mean for the Mueller business and in which of your individual businesses should we expect the most meaningful catalysts?

Well, I think it's going to be broad-based. If you look at $12 billion each for drinking water, clean water, state revolvers, $15 billion for the lead line replacement, $10 billion for modernization, underserved or lower-income communities, better access; it doesn't matter whether you're making a fire hydrant or you're making a gate valve or you're making something smart; there's $6 billion set aside for smart water initiatives. So the whole thing is going to be really, but obviously the greatest need is going to come in the distribution network underground. So I believe that the Water Flow Solutions business, when you look at the size of dollars and size of needs, even though technology starts from a smaller number, and you think about our smart hydrants and you think about things like flushing technologies and all of that, they will get benefit from this. But yeah, I think that the power alley of the business in the distribution network will be the biggest benefactor over the next eight years that more dollars will funnel into it in aggregate because of the nature of the breakdown of the quality of the infrastructure. There is no amount of technology that's going to get us away from meeting pipes and valves and reroutes of infrastructure that is aging at that 70-75 year mark.

That makes sense. And then circling back on your recast segment structure, the rationale and the shift in external reporting certainly makes sense. Internally, what changes have been made in terms of leadership or operating structure, and how those changes impacted the day-to-day of Mueller so far? And what's expected going forward?

Great. Thanks. Look, I think that the team did a really good job before the reorganization, trying to put their big Mueller Water Products hat on and do the right things. But it was a little bit not what you would expect. So if you thought about a flushing technology like a Hydro Guard, using what was in the technologies teams, some of their circuits, the software interfaces, their resources to write the EPROM and EPROM kind of operating structures, the team was working back and forth well between the old infrastructure kinds of products and the technology kinds of products. I think what really brought it to ahead for me was I didn't feel like the rate of deployment and the rate of adoption of improvements in our new smart hydrants was happening fast enough. So things like bought are redesigned so that you could house more electronics, things like the hollow stem for housing the batteries and housing the Bluetooth circuits, things like that. And you realize the team was still trying to do their day jobs and be responsible as a product manager for making sure that this customer got their five-and-a-quarter inch Super Centurion and kind of on the side also, make sure they were doing the right thing for a smart hydrant. But they weren't being centered on that. They were being measured on that because that was infrastructure, and all the technology-enabled products were in technology. So I wanted to get all of the alignment, if you will, of the management incentives into common channels for common products. When considering Hydro-Guard, smart hydrants, and transducer-enabled repair products, such as a future coupler that may include a flow meter and temperature probe, or a control valve that adjusts pressures dynamically based on flow and pressure drops, I aimed to consolidate these advancements within a single management structure. Our motivation for this decision wasn't driven by financial reporting but rather by the need to hold people accountable for product development and market introduction. This restructuring was essential for fostering accountability. After contemplating the changes, Martie emphasized that if we were to manage the business in this way, we needed to reassess our reporting methods to align with the new management structure and the information required for decision-making.

Okay. Helpful color. Thanks again.

Thank you.

Next question is from Brent Thielman with D.A. Davidson. Your line is now open.

Hey, thank you very much. Congrats on a quarter. Scott, maybe just on the new residential market, you talked about you've certainly had some of the disruptions builders had to deal with, as well as just in terms of getting new homes to completion. I guess question is, do you think you've been relatively isolated from that though, just because I would think they don't want to wait to start that next development, which is really where you coming into play, or have you seen that process slow as well?

I don’t believe we’ve observed a slowdown. Many inventories are prepared as a reminder to everyone that we are still in the early stages of development. We get involved when the curbs and sewers are in place, rather than waiting for permanent fixtures, which we use as an indicator of the construction market's health. However, developed water inventories are low. If anything, I think it's the contrary; we may be experiencing a better development environment over the past couple of quarters compared to what has been observed in sell-through for builders. I believe they are working to build up a lot of inventories over the last six months since they have seen this as a barrier to initiating new contracts. There was a brief period when consumers hesitated to enter into variable-priced housing construction contracts due to uncertainty around lumber and spending costs. But for the most part, that seems to have subsided now. Builders appear to be successfully securing orders and contracts, and it seems they remain optimistic about developing lots.

Okay. Appreciate that. And I think about this in context to the guidance, Scott and Martie, but which doesn't reflect I guess the cost assumptions sort of worsen or with raw material costs assumptions. And it looks like prices for some of your variable inputs rolled over a bit recently. But then you've got things like fuel, which impact the foundries, wage growth, etc., kind of moving higher. How do you look at the net impact? Have these various costs today if we sort of topped out for now or on a net basis, are costs still moving up, maybe from a quarter ago?

Yes. I think you've laid out some things that certainly are part of what we're looking at. I think we've spent, I'll say, a fair amount of time talking overall about inflation, related specifically back to the raw materials as well as our purchase components. And we've probably seen scrap creep up a little bit more, but expectations are that we start to see some stabilization in the market with respect to those. But I think calling out, for example, energy; I know we called out energy as a higher cost for us in our fourth quarter given our production, particularly the foundries we were producing as we were incurring some of the peak-level energy costs. And I will tell you that it's something again, we experienced first quarter. And our expectation is that overall higher energy costs is something that we will continue to experience. We'll also call out freight costs. I think in combination with that I think we have seen and expectations will continue to see higher freight costs. And that certainly reflects back as well on a lot of what we're seeing with supply chain disruptions, with the challenges of labor, timing of need to get material, etc. So I would expect that we'll continue to see higher freight costs as well. I'll also call out higher labor costs. I think again, the inflation that we're seeing, our expectation is our labor costs will be higher going forward as well. None of those hit the magnitude of the raw material and product inflation that we've seen, but are some of what we think about as we look into our 2022 is that we'll see some generally higher inflation around those inputs as well.

Okay. Maybe just lastly, I mean, with all the price initiatives, you had to implement, as well as the industry, kind of the overall afford cost pressures and construction market overall, I guess I'd think your end users would be more sensitive to that. I guess any feedback through the channels about what they're saying as they try to manage budgets on a go-forward basis?

I believe there are advanced municipalities with supply agreements with our distributors, and we are utilizing those agreements to negotiate using the specified terms for price increases, as I previously mentioned regarding the overall market. Most of the transactions in the spot market, which I consider the majority of sales, are either spot jobs or just occasional spot usage by utilities. These occurrences are infrequent enough that there isn’t a significant outcry. They understand the challenges, and their expectation is to pay slightly more tomorrow than what they did yesterday. I think our industry has managed these expectations well because we have been transparent about market conditions, including the scrap market and the effects of tariffs imposed by China and our government on Chinese products. We have also communicated the cost drivers, such as the fees related to containers being held off the coast of Long Beach. All these factors are well understood and documented. Thus, when we discuss the impact on pricing and what future pricing adjustments need to be, I don't anticipate much resistance. I believe the market is rational and will continue to act in this manner.

Encouraging. Thank you for taking the questions. Appreciate it.

Next question is from Walter Liptak with Seaport. Your line is now open.

Hey, thanks. Good morning everyone, and great quarter. I wanted to ask about the distributors potentially pulling forward inventory in preparation for the construction season. It seems like the revenue this quarter was somewhat unusually high for the season. Looking ahead to next quarter, do you expect a typical seasonal increase, or do you think there was some pull-forward in this quarter?

I think we need to consider the pre-pandemic and post-pandemic inventory levels. It's important to see if companies can service their customers as effectively as they did before the pandemic. The math indicates that price increases have likely affected inventory levels. What I see is not so much a buy-ahead situation but rather companies replenishing stock that was reduced during the pandemic. The construction market started to recover in our fiscal Q4, and the industry has been trying to catch up since then. I don’t think there’s a real loss of buy-ahead; rather, lead times have extended, causing companies to place orders for those windows. This has led to backlogs becoming somewhat self-fulfilling. However, there is sufficient demand in the distribution channel for companies to use their orders, and I believe the municipal market is strong enough that they shouldn’t have issues clearing out any excess inventory.

Okay, that sounds good. I am curious about the stock price being down; you did more share buybacks than we anticipated. Initially, you planned for about $10 million for the whole year, but it seems like you executed $20 million. Since you have that authorization, what are your expectations for share repurchases for the remainder of the year?

I believe when we consider our capital allocation, we describe it as disciplined and balanced. We take a long-term view, especially regarding returns to shareholders, which includes our dividend and share repurchase. Our Board raised the dividend last November. Share repurchase has been an important part of that strategy. We are also focused on reinvesting in the business through capital expenditures and exploring M&A opportunities for growth. Looking ahead, we had a $115 million authorization at the end of the first quarter. As we continue to evaluate capital allocation, we will keep considering those three areas.

Great. Thank you.

Our next question is from Joe Giordano with Cowen, your line is now open.

Good morning. This is Michael.

Hi, Mike.

I believe you'd see if to say results this past quarter were higher than most of us probably anticipated. How should we be thinking about cadence over the next few quarters, and potentially explain in 2023?

I think our guidance indicates a growth rate of 6% to 8% in EBITDA relative to sales. We're not expecting to return to a positive situation regarding the negative price-cost pressures. To maintain margins when costs rise by $1—assuming a margin of 30%—you would need to increase prices to around $1.33 to fully recover the cost increase. We're currently assessing timing, anticipated throughput, and pricing on orders in our backlog. While we experienced good flow-through in the first quarter, we're cautious about the second half regarding flow-through efficiency. I’m not suggesting that we've lost control over all inputs, but there are enough variations and uncertainties in demand for Q4 and our throughput and labor costs that make the operating environment challenging. I believe the flow-through in the second half should be better than in the first half. In Q2, due to the effects of inventory revaluation from high inflation on our income statement from Q1, I expect some margin compression, followed by a return to margin expansion in the third and fourth quarters. This is the pattern we anticipate over the next three quarters.

One more if I may mention commitment towards inorganic growth to expand the portfolio. Can you give us any insight into the products and markets you see as most favorable and if there's any geographic considerations there? Thank you.

Yes. I definitely agree. In Martie's prepared comments, she mentioned that products related to the infrastructure distribution network, such as gate valves and hydrants, as well as the repair and installation market, all saw double-digit growth. We believe this growth will continue. The valves and hydrants used in the distribution network are expected to see significant growth in 2023 and beyond as a result of the infrastructure bill, which will drive demand. Regarding your geographic question, it's clear to see the population migration trends in the country. The American Southwest, Northwest, and Southeast are where most growth is happening. While there are some areas in the Northeast, like New York City, Boston, and parts of Vermont and New Hampshire, that are seeing some population growth, most of the new construction is concentrated in areas like Nashville and the core regions of Utah and Denver, where builders are focusing their efforts, and that's where we are experiencing a lot of our growth.

Thank you.

Thank you.

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

Hi everyone. This is Miguel in for Brian Lee. Thanks for taking the question. I just wanted to touch on the new segmentation. When you're thinking about this year, but mainly beyond when we get out from these special inventory and then cost dynamics happening this year. Is there anything notable or new on what we should expect in terms of a more normal seasonality for each of the segments versus what we've seen historically for maybe the old infrastructure and technology segments?

I don't anticipate significant changes because the spending patterns in the industry generally reflect our own. Most water utility work occurs between April and November, primarily due to the underground nature of the work. While we may see more winter activities related to water treatments or pumping centers, the majority of investments in our customer base will still take place mainly in the summer, along with the spring and early fall, to avoid issues with frozen ground. I believe the electronics and software-driven business will experience less seasonality. However, even in the most optimistic growth forecasts for that area, it will still represent less than 20% of the spending associated with water utilities. Therefore, I expect the seasonality to remain relatively stable.

Thank you, that's very helpful. I have a follow-up question about margins for the new segments based on the historical data you provided for the two segments. It appears that Water Flow has higher margins than Water Management. I noticed that adjusted operating margins for Water Management were slightly down this quarter. When do you expect Water Management to recover? I believe I saw a 16% operating margin in 2020 for Water Management compared to 20% for Water Flow. Will Water Management eventually align with Water Flow in terms of growth? I'm trying to understand the relationship between the two.

I believe that over the long term, there will be growth. However, in the short term, the supply chain issues related to production control valves and the challenges with supply and labor in the meter business were significant drawbacks for water management this quarter. Another factor we expect to be addressed in the second quarter, with possible effects spilling into the third quarter, is the issue of substitution. The scrap market for shred and plate has been very tight, and we have been substituting some porcelain scrap, which is considerably more expensive than plate and shred. This also affected the Alphaville facility. I think our significant capital expenditures in Water Flow are starting to yield benefits. To answer your question, we will return to parity, and hopefully, in about 3 to 5 years, the applications business will become more profitable than the core business.

Okay, thanks. That's very helpful. Thank you.

Just a reminder, if you would like to ask a question over the phone, please follow the operator's instructions. The next question is from Andrew Buscaglia with Berngiler. Your line is now open.

Morning, everyone. I have a question regarding capital allocation and M&A, especially with the new segmentation. Where do you see interest lying with M&A? Are you considering deals similar to those in crowd-sourcing or technology that can enhance the Water Management side? What are your thoughts based on the current pipeline?

Yeah. I think that the bolt-ons in the valve business areas that we don't have geographic expansion, those are all viable strategies for what you would define as the water flow business. And we have a fulsome pipeline there that we would consider. For the sensing side, and on the technologies, software, workforce management, kind of integrating supply chain if you will, for water utilities. So that when you identify a leak then the right repair equipment gets here and those kinds of enabling technologies are all things we're interested in on the acquisition side for that side of the business, and of course geographic expansion there as well. And so, long story short, I think we have a lot of people that we're interested in. We've got to find the right fit at the right price, and it's got to work for who we're acquiring and work for us. I think there are suites out there that we do covet and that we're going to have to think long and hard about where the sources of synergies can come from so we can meet some of these multiples.

Are you noticing any significant changes in the past few months in your conversations, particularly regarding the challenges we're facing, such as supply chain issues? I'm curious if this year might become a breakthrough year for mergers and acquisitions, based on your tone when discussing this topic.

Yeah, I don't think so. I think that exactly what you said is that if anything, the complexities that have been introduced this year as a result of supply chain complications. As a result of some of the geopolitical stuff going on has made uncertainty a little bit higher. So I think that as far as breakout years go for M&A, with where we are with nine months or eight months left in our fiscal year, I think that the pipeline is full, but we have our operating challenges as well that are also going to take management time.

Fair, okay. Thanks, Scott.

Great. Thank you. All right. Thanks, Operator. I'd like to thank everybody for joining us on the call today. I think if I haven't said it, I want to make sure everybody understands. I'm pleased with the solid start to our year. As we work through our ongoing operational challenges, I think while price costs has been challenging for the last four quarters, we are in a great position to improve margins as we benefit from the steps we took in the price increases in previous quarters. But I think the teams continue to focus on improving our operations on a daily basis, very customer-focused, very much in tune with where they are from an operational needs, absenteeism, labor coverage, those kinds of things, and taking the right steps. I believe we are well-positioned for continued growth given the accelerating impact from aging infrastructure, the government stimulus focused on repairing water networks, and improving operations, including the benefits from our large CapEx investments. And I'm excited about the path we're on to become a sustainability leader as evidenced by our second ESG report, which showcased our rapid progress and improved the long-term trends and goals that I think that we need to. I think in closing, we're confident we're creating a stronger foundation for our future growth and that we have the right strategies in place to expand our presence in the market. And so I'd like to thank everybody for joining us again. And I'd like to thank you for your continued interest and with that Operator, please conclude the call.

Thank you. This concludes today's call. Thank you for your participation. You may disconnect at this time.