Mueller Water Products, Inc. 10-Q

Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion should be read in conjunction with the unaudited condensed consolidated financial statements and related notes thereto that appear elsewhere in this report. This report contains certain statements that may be deemed “forward-looking statements” within the meaning of the federal securities laws. All statements that address activities, events or developments that the Company intends, expects, plans, projects, believes or anticipates will or may occur in the future are forward-looking statements, including, without limitation, statements regarding outlooks, projections, forecasts, expectations, commitments, trend descriptions and the ability to capitalize on trends, value creation, Board of Directors and committee composition plans, long-term strategies and the execution or acceleration thereof, operational improvements, inventory positions, the benefits of capital investments, financial or operating performance including improving sales growth and driving increased margins, capital allocation and growth strategy plans, the Company’s product portfolio positioning and the demand for the Company’s products. Forward-looking statements are based on certain assumptions and assessments made by the Company in light of the Company’s experience and perception of historical trends, current conditions and expected future developments. Actual results and the timing of events may differ materially from those contemplated by the forward-looking statements due to a number of factors, including, without limitation, legal, reputational, audit and financial risks resulting from previously reported cybersecurity incidents and possible future cybersecurity incidents, the effectiveness of the Company’s business continuity plans related thereto, and the Company’s ability to recover under its cybersecurity insurance policies; logistical challenges and supply chain disruptions, geopolitical conditions, including the Israel-Hamas war, public health crises, or other events; inventory and in-stock positions of our distributors and end customers; an inability to realize the anticipated benefits from our operational initiatives, including our large capital investments in Chattanooga and Kimball, Tennessee, and Decatur, Illinois, plant closures, and reorganization and related strategic realignment activities; an inability to attract or retain a skilled and diverse workforce, including executive officers, increased competition related to the workforce and labor markets; an inability to protect the Company’s information systems against further service interruption, misappropriation of data or breaches of security; failure to comply with personal data protection and privacy laws; cyclical and changing demand in core markets such as municipal spending, residential construction, and natural gas distribution; government monetary or fiscal policies; the impact of adverse weather conditions; the impact of manufacturing and product performance; the impact of wage, commodity and materials price inflation; foreign exchange rate fluctuations; the impact of higher interest rates; the impact of warranty charges and claims, and related accommodations; the strength of our brands and reputation; an inability to successfully resolve significant legal proceedings or government investigations; compliance with environmental, trade and anti-corruption laws and regulations; climate change and legal or regulatory responses thereto; changing regulatory, trade and tariff conditions; the failure to integrate and/or realize any of the anticipated benefits of acquisitions or divestitures; an inability to achieve some or all of our Environmental, Social and Governance goals; and other factors that are described in the section entitled “RISK FACTORS” in Item 1A of the Company’s most recent Annual Report on Form 10-K and later filings on Form 10-Q, as applicable. Forward-looking statements do not guarantee future performance and are only as of the date they are made. The Company undertakes no duty to update its forward-looking statements except as required by law. Undue reliance should not be placed on any forward-looking statements. You are advised to review any further disclosures the Company makes on related subjects in subsequent Forms 10-K, 10-Q, 8-K and other reports filed with the U.S. Securities and Exchange Commission. Overview Business We have two reportable segments: Water Flow Solutions and Water Management Solutions. Water Flow Solutions’ portfolio includes iron gate valves, specialty valves and service brass products. Water Flow Solutions represented 50% of our fiscal 2023 net sales. Water Management Solutions’ portfolio includes fire hydrants, repair and installation, natural gas, metering, leak detection, and pressure management and control products and solutions. Water Management Solutions represented 50% of our fiscal 2023 net sales. Approximately 60% to 65% of our 2023 net sales were associated with the repair and replacement of municipal water infrastructure, approximately 25% to 30% were related to residential construction activity and approximately 5% to 10% of net sales were related to natural gas utilities and industrial applications. In October 2023, the Israel-Hamas war caused a temporary shutdown of our facility in Ariel, Israel. While we have reopened the facility, the war has caused supply interruptions and may hinder our ability to acquire the necessary materials we 23 Table of Contents need to make our products. Supply disruptions from lack of access to materials have adversely impacted, and continue to adversely impact, our ability to produce and deliver our products from our facility in Ariel, Israel. Additionally, production at this facility has been adversely impacted by limited labor availability in the region. We have made investments in recruiting and training new team members, expanding our suppliers and expediting product shipments to increase production levels and meet customer delivery times. As announced on October 28, 2023, we identified a cybersecurity incident impacting certain internal operations and information technology systems. We believe we have contained and eliminated the unauthorized access and activity. All of our facilities are fully operational and have returned to normalized operations. The cybersecurity incident consisted of unauthorized access and deployment of ransomware by a third party to a portion of our internal information system infrastructure. The incident caused temporary disruptions and limitations of access to portions of our business applications supporting aspects of our operations including shipping, receiving and payment functions. Operational delays and investigation and remediation costs in connection with the incident adversely impacted our results for the first quarter of 2024; however, on a fiscal year-to-date basis, there was no impact to our consolidated net sales. We have restored the impacted applications and systems. As reported on November 29, 2023, we identified a separate cybersecurity incident, which primarily related to a system that was at the end of its useful life and was already in the process of being replaced in the ordinary course of business and the replacement of this system was concluded during our second quarter. In the first quarter of fiscal 2024, we incurred approximately $1.5 million of expenses related to the cybersecurity incidents. We continue to analyze and remediate the impacts of the cybersecurity incidents, including making enhancements to our cybersecurity processes and analyzing the data accessed, exfiltrated or otherwise impacted in connection with the cybersecurity incidents. Although we believe that our channel and customer inventory levels normalized during the first quarter of 2024, the external operating environment remains uncertain. We expect to continue to face challenges emanating from the higher interest rate environment, the Israel-Hamas war and labor inflation and availability. From a comparable perspective, in fiscal year 2023, we benefited from fulfilling an elevated backlog for certain products, which has now become more normalized as we have reduced short-cycle backlog across our portfolio, particularly with regard to iron gate valve and hydrant products. For fiscal year 2024, we anticipate that consolidated net sales will be flat to down two percent as compared with fiscal year 2023. We anticipate stable demand in the municipal repair and replacement end market driven by the aging water infrastructure despite budgetary pressures on municipalities. Additionally, we anticipate that new residential construction activity will stabilize relative to the challenges we experienced in fiscal 2023 where Census data indicates that total housing starts decreased 12.9% compared to 2022. In April 2024, Blue Chip Economic Indicators forecasted a 0.7% increase in housing starts for the calendar year 2024 as compared to the calendar year 2023. Finally, we anticipate that high interest rates will continue to negatively impact new lot and land development, depending on the geography. For the remainder of fiscal 2024, we anticipate that inflation will continue to modestly impact manufacturing costs, primarily due to wage inflation but also raw materials and purchased parts. Inventory for the first half of fiscal 2024 experienced approximately 0.1% deflation. We expect external challenges to persist during the balance of fiscal year 2024. We will continue to monitor the market and economic conditions impacting our business and take appropriate actions to address inflationary and other cost pressures such as price increases, cost containment measures and supplier management, among other things. 24 Table of Contents Results of Operations Three Months Ended March 31, 2024 Compared to Three Months Ended March 31, 2023 Three months ended March 31, 2024 Water Flow Solutions Water Management Solutions Corporate Total (in millions) Net sales $ 205.8 $ 147.6 $ — $ 353.4 Gross profit $ 77.2 $ 53.2 $ — $ 130.4 Operating expenses: Selling, general and administrative 24.6 24.2 14.9 63.7 Strategic reorganization and other charges — — 3.2 3.2 Total operating expenses 24.6 24.2 18.1 66.9 Operating income (loss) $ 52.6 $ 29.0 $ (18.1) 63.5 Non-operating expenses: Pension expense other than service 1.0 Interest expense, net 3.6 Income before income taxes 58.9 Income tax expense 14.6 Net income $ 44.3 Three months ended March 31, 2023 Water Flow Solutions Water Management Solutions Corporate Total (in millions) Net sales $ 157.2 $ 175.7 $ — $ 332.9 Gross profit $ 37.2 $ 60.6 $ — $ 97.8 Operating expenses: Selling, general and administrative 22.0 28.7 13.5 64.2 Strategic reorganization and other charges — 0.2 0.5 0.7 Total operating expenses 22.0 28.9 14.0 64.9 Operating income (loss) $ 15.2 $ 31.7 $ (14.0) 32.9 Non-operating expenses: Pension benefit other than service 1.0 Interest expense, net 3.9 Income before income taxes 28.0 Income tax expense 6.7 Net income $ 21.3 25 Table of Contents Consolidated Analysis Net sales in the three months ended March 31, 2024 were $353.4 million as compared with $332.9 million in the prior year period, an increase of $20.5 million or 6.2%, primarily as a result of higher pricing across most product lines and overall increased volumes. Gross profit in the three months ended March 31, 2024 was $130.4 million as compared with $97.8 million in the prior year period, an increase of $32.6 million or 33.3%, primarily as a result of an increase in both favorable manufacturing performance and pricing. These increases were partially offset by Cost of sales inflation of approximately 2% while inflation impacted Gross profit by approximately 3%. As a result, Gross margin was 36.9% in the three months ended March 31, 2024 as compared with 29.4% in the prior year period. Selling, general and administrative expenses (“SG&A”) in the three months ended March 31, 2024 were $63.7 million as compared with $64.2 million in the prior year period, a decrease of $0.5 million or 0.8%, primarily due to a decrease in salary and benefit expense associated with our restructuring activities, as well as lower third-party fees, and engineering materials, partially offset by approximately 3% inflation, an increase in bad debt expense and incentives. SG&A as a percentage of net sales was 18.0% and 19.3% for the three months ended March 31, 2024 and March 31, 2023, respectively. Strategic reorganization and other charges in the three months ended March 31, 2024 were $3.2 million and primarily consisted of expenses associated with our previously announced leadership transition, severance and certain transaction-related expenses. Strategic reorganization and other charges for the three months ended March 31, 2023 were $0.7 million and primarily consisted of severance and certain transaction-related expenses. Net interest expense in the three months ended March 31, 2024 was $3.6 million as compared with $3.9 million in the prior year period, a decrease of $0.3 million or 7.7%, primarily due to higher interest income as a result of higher interest rates, partially offset by lower capitalized interest. The components of net interest expense are provided below: Three months ended March 31, 2024 2023 (in millions) 4.0% Senior Notes $ 4.5 $ 4.5 Deferred financing costs amortization 0.2 0.3 ABL Agreement 0.3 0.2 Capitalized interest — (0.8) Other interest expense 0.1 0.2 Total interest expense 5.1 4.4 Interest income (1.5) (0.5) Interest expense, net $ 3.6 $ 3.9 26 Table of Contents The reconciliation between the U.S. federal statutory income tax rate and the effective income tax rate is presented below: Three months ended March 31, 2024 2023 U.S. federal statutory income tax rate 21.0 % 21.0 % Adjustments to reconcile to the effective tax rate: State income taxes, net of federal benefit 3.4 3.4 Tax credits (2.1) (1.5) Global Intangible Low-Taxed Income 0.2 0.8 Foreign income tax rate differential (0.8) (1.6) Nondeductible compensation 1.0 0.6 Uncertain tax positions 0.5 — Other 1.6 1.2 Effective income tax rate 24.8 % 23.9 % Segment Analysis Water Flow Solutions Net sales in the three months ended March 31, 2024 were $205.8 million as compared with $157.2 million in the prior year period, an increase of $48.6 million or 30.9%, primarily as a result of higher volumes and higher pricing across most product lines. Gross profit in the three months ended March 31, 2024 was $77.2 million as compared with $37.2 million in the prior year period, an increase of $40.0 million or 107.5%. This increase was primarily a result of higher volumes across most product lines, favorable manufacturing performance driven by overhead, material and labor efficiencies, as well as higher pricing. Additionally, inflation negatively impacted Cost of sales by approximately 2% and Gross profit by approximately 4%. As a result, Gross margin was 37.5% in the three months ended March 31, 2024 and 23.7% in the prior year period. SG&A in the three months ended March 31, 2024 was $24.6 million as compared with $22.0 million in the prior year period, an increase of $2.6 million or 11.8%, primarily as a result of higher incentives, inflation of approximately 3%, as well as increased travel expenses partially offset by lower salary and benefit expense associated with our restructuring activities, and third-party fees. SG&A as a percentage of net sales was 12.0% and 14.0% in the three months ended March 31, 2024 and 2023, respectively. Water Management Solutions Net sales in the three months ended March 31, 2024 were $147.6 million as compared with $175.7 million in the prior year period, a decrease of $28.1 million or 16.0%, as a result of lower volumes across most products lines partially offset by higher pricing across most product lines. Net sales were impacted nominally by the Israel-Hamas war. Gross profit in the three months ended March 31, 2024 was $53.2 million as compared with $60.6 million in the prior year period, a decrease of $7.4 million or 12.2%. The decrease was primarily a result of lower volumes across most product lines and impacts of the Israel-Hamas war, partially offset by favorable manufacturing performance driven by material efficiencies and lower supply chain costs and higher pricing. Gross margin was 36.0% in the three months ended March 31, 2024 as compared with 34.5% in the prior year period. SG&A in the three months ended March 31, 2024 was $24.2 million as compared with $28.7 million in the prior year period, a decrease of $4.5 million or 15.7%, primarily due to lower salary and benefit expense associated with our restructuring activities, third-party fees and engineering material expenses, which were partially offset by increased costs related to incentives as well as approximately 4% inflation and increased bad debt expense. SG&A as a percentage of net sales was 16.4% and 16.3% in the three months ended March 31, 2024 and 2023, respectively. 27 Table of Contents Corporate SG&A in the three months ended March 31, 2024 was $14.9 million as compared with $13.5 million in the prior year period, an increase of $1.4 million or 10.4%, primarily as a result of higher incentive costs and third-party fees, as well as approximately 3% inflation. Six Months Ended March 31, 2024 Compared to Six Months Ended March 31, 2023 Six months ended March 31, 2024 Water Flow Solutions Water Management Solutions Corporate Total (in millions) Net sales $ 347.1 $ 262.7 $ — $ 609.8 Gross profit $ 123.8 $ 92.9 $ — $ 216.7 Operating expenses: Selling, general and administrative 43.8 48.8 28.0 120.6 Strategic reorganization and other charges 0.2 — 9.6 9.8 Total operating expenses 44.0 48.8 37.6 130.4 Operating income (loss) $ 79.8 $ 44.1 $ (37.6) 86.3 Non-operating expenses: Pension expense other than service 2.0 Interest expense, net 6.9 Other expense 1.6 Income before income taxes 75.8 Income tax expense 17.2 Net income $ 58.6 Six months ended March 31, 2023 Water Flow Solutions Water Management Solutions Corporate Total (in millions) Net sales $ 322.8 $ 324.9 $ — $ 647.7 Gross profit $ 83.8 $ 107.2 $ — $ 191.0 Operating expenses: Selling, general and administrative 44.4 55.7 27.0 127.1 Strategic reorganization and other charges (benefits) — 0.2 (3.2) (3.0) Total operating expenses 44.4 55.9 23.8 124.1 Operating income (loss) $ 39.4 $ 51.3 $ (23.8) 66.9 Non-operating expenses: Pension benefit other than service 1.9 Interest expense, net 7.6 Income before income taxes 57.4 Income tax expense 13.6 Net income $ 43.8 28 Table of Contents Consolidated Analysis Net sales in the six months ended March 31, 2024 were $609.8 million as compared with $647.7 million in the prior year period. a decrease of $37.9 million or 5.9%, primarily as a result of a decrease in net volumes partially offset by higher pricing across most product lines. Gross profit in the six months ended March 31, 2024 was $216.7 million as compared with $191.0 million in the prior year period, an increase of $25.7 million or 13.5%, primarily as a result of higher pricing and favorable manufacturing performance related to labor, overhead, material and logistic efficiencies, partially offset by overall lower volumes. As a result, Gross margin increased 600 basis points to 35.5% in the six months ended March 31, 2024 as compared with 29.5% in the prior year period. Selling, general and administrative expenses (“SG&A”) in the six months ended March 31, 2024 were $120.6 million as compared with $127.1 million in the prior year period, a decrease of $6.5 million or 5.1%, primarily due to a decrease in salary and benefit expense associated with our restructuring activities, third-party fees, commission, and engineering materials expense, partially offset by higher costs associated with approximately 3% inflation, the impact of foreign currency fluctuation and higher incentives. SG&A as a percentage of net sales was 19.8% and 19.6% for the six months ended March 31, 2024 and March 31, 2023, respectively. Strategic reorganization and other charges in the six months ended March 31, 2024 were $9.8 million, primarily consisting of expenses associated with our previously announced leadership transition, approximately $1.5 million of expenses related to the cybersecurity incidents, severance, and certain transaction-related expenses. Strategic reorganization and other charges for the six months ended March 31, 2023 were a benefit of $3.0 million, which primarily consisted of a $4.0 million gain, before tax, on the sale of our Aurora, Illinois facility, which was partially offset by certain transaction-related expenses. Net interest expense in the six months ended March 31, 2024 was $6.9 million as compared with $7.6 million in the prior year period, a decrease of $0.7 million or 9.2%, primarily due to higher interest income as a result of higher interest rates, partially offset by lower capitalized interest. The components of net interest expense are provided below: Six months ended March 31, 2024 2023 (in millions) 4.0% Senior Notes $ 9.0 $ 9.0 Deferred financing costs amortization 0.5 0.6 ABL Agreement 0.5 0.4 Capitalized interest (0.1) (1.5) Other interest expense 0.3 0.3 Total interest expense 10.2 8.8 Interest income (3.3) (1.2) Interest expense, net $ 6.9 $ 7.6 Other expense in the six months ended March 31, 2024 was $1.6 million from the release of an indemnification receivable related to an expired uncertain tax position. There was no Other expense in the six months ended March 31, 2023. 29 Table of Contents The reconciliation between the U.S. federal statutory income tax rate and the effective income tax rate is presented below: Six months ended March 31, 2024 2023 U.S. federal statutory income tax rate 21.0 % 21.0 % Adjustments to reconcile to the effective tax rate: State income taxes, net of federal benefit 3.4 3.4 Excess tax deficit related to stock-based compensation 0.1 0.3 Tax credits (2.1) (1.5) Global Intangible Low-Taxed Income 0.2 0.8 Foreign income tax rate differential (0.8) (1.6) Nondeductible compensation 1.0 0.6 Uncertain tax positions (1.6) — Valuation allowances — (0.2) Other 1.5 0.9 Effective income tax rate 22.7 % 23.7 % During the six months ended March 31, 2024, we recorded $1.6 million in income tax benefits due to the release of an uncertain tax position that expired on December 31, 2023. Segment Analysis Water Flow Solutions Net sales in the six months ended March 31, 2024 were $347.1 million as compared with $322.8 million in the prior year period, an increase of $24.3 million or 7.5%, primarily as a result of higher pricing and higher volumes across most product lines. Gross profit in the six months ended March 31, 2024 was $123.8 million as compared with $83.8 million in the prior year period, an increase of $40.0 million or 47.7%. Gross margin was 35.7% in the six months ended March 31, 2024 and 26.0% in the prior year period. This increase was primarily a result of higher pricing across most product lines, favorable manufacturing performance driven by material, labor, overhead, and logistic efficiencies, and higher volumes across most product lines. Additionally, Cost of sales and Gross profit were negatively impacted by approximately 1% inflation. SG&A in the six months ended March 31, 2024 was $43.8 million as compared with $44.4 million in the prior year period, a decrease of $0.6 million or 1.4%, primarily as a result of lower salary and benefit expense associated with our restructuring activities, and third-party fees, partially offset by approximately 3% inflation and increased incentives. SG&A as a percentage of net sales was 12.6% and 13.8% in the six months ended March 31, 2024 and 2023, respectively. Water Management Solutions Net sales in the six months ended March 31, 2024 were $262.7 million as compared with $324.9 million in the prior year period, a decrease of $62.2 million or 19.1%, primarily as a result of lower volumes across most product lines partially offset by higher pricing across most product lines. Gross profit in the six months ended March 31, 2024 was $92.9 million as compared with $107.2 million in the prior year period, a decrease of $14.3 million or 13.3%. This decrease was primarily a result of lower volumes, offset by pricing and favorable manufacturing performance. Gross margin was 35.4% in the six months ended March 31, 2024 and 33.0% in the prior year period. Additionally, Cost of sales and Gross margin were impacted approximately 1% by deflation. 30 Table of Contents SG&A in the six months ended March 31, 2024 was $48.8 million as compared with $55.7 million in the prior year period, a decrease of $6.9 million or 12.4%, primarily due to lower salary and benefit expense associated with our restructuring activities, third-party fees, and engineering materials expense, partially offset by unfavorable foreign currency fluctuation, and higher costs associated with approximately 4% inflation and increased incentives. SG&A as a percentage of net sales was 18.6% and 17.1% in the six months ended March 31, 2024 and 2023, respectively. Corporate SG&A in the six months ended March 31, 2024 was $28.0 million as compared with $27.0 million in the prior year period, an increase of $1.0 million or 3.7%, primarily as a result of higher costs associated with approximately 3% inflation, increased incentives, higher third-party fees and unfavorable foreign currency fluctuation, partially offset by lower salary and benefit expense associated with our restructuring activities, and lower travel expense. Liquidity and Capital Resources We had cash and cash equivalents on hand of $179.2 million at March 31, 2024 and $162.6 million of additional borrowing capacity under our ABL based on March 31, 2024 data. At March 31, 2024, cash and cash equivalents included $76.2 million, $1.7 million and $9.0 million in Israel, Canada, and China, respectively. We declared a quarterly dividend of $0.064 per share on April 23, 2024, payable on or about May 20, 2024 to stockholders of record as of May 10, 2024, which will result in an estimated $10.0 million cash outlay. We repurchased $10.0 million of our outstanding common stock during the six months ended March 31, 2024 under our publicly announced share repurchase program, and as of March 31, 2024, we had $80.0 million remaining under our share repurchase authorization. The ABL and 4.0% Senior Notes contain customary representations and warranties, covenants and provisions governing an event of default. These covenants limit our ability to engage in certain specified activities, including but not limited to the payment of dividends and the redemption of our common stock. Net cash provided by operating activities was $62.2 million during the six months ended March 31, 2024 as compared with net cash used in operating activities of $22.2 million in the prior year period. The increase in net operating cash flow was primarily driven by higher net income and improvements in working capital compared with the prior year period, including a reduction in Inventory purchases as well as a lesser impact of Accounts payable and Other current liabilities. Capital expenditures were $15.8 million in the six months ended March 31, 2024 as compared with $20.5 million in the prior year period. Capital expenditures decreased primarily as a result of lower expenditures associated with the new Decatur foundry as compared with the prior year period. For the fiscal year 2024, we have provided guidance that our capital expenditures are expected to be between $40.0 million and $45.0 million. We anticipate that our existing cash, cash equivalents and borrowing capacity combined with our expected operating cash flows will be sufficient to meet our anticipated operating needs, income tax payments, capital expenditures and debt service obligations as they become due through the twelve months from the date of this filing. However, our ability to make these payments will depend largely on our future operating performance, which may be affected by general economic, financial, competitive, legislative, regulatory, business and other factors beyond our control. ABL Agreement Our ABL is provided by a syndicate of banking institutions and consists of a revolving credit facility for up to $175.0 million in borrowings that matures the earlier of (a) March 16, 2029, which is ninety-one days prior to the stated maturity date of our 4.0% Senior Notes if the Notes are still outstanding on that date or (b) March 28, 2029. The ABL includes the ability to borrow up to $25.0 million of swing line loans and up to $60.0 million of letters of credit. The ABL permits us to increase the size of the credit facility by an additional $150.0 million in certain circumstances subject to adequate borrowing base availability. 31 Table of Contents In December 2023, we obtained a waiver under our ABL (“ABL Waiver”) to provide for additional time associated with certain reporting requirements that were delayed as a result of the cybersecurity incident announced on October 28, 2023. Under the ABL Waiver, the maximum aggregate amount of borrowings and other credit extensions under the ABL was limited to $50.0 million at any time outstanding until all of the required reports were delivered. During our first fiscal quarter of 2024, we delivered the required reports, and on February 6, 2024, the ABL Waiver was terminated. Accordingly, we are no longer subject to any additional restrictions or borrowing limitations under the ABL, including the $50.0 million temporary limit on credit extensions. On March 28, 2024, we amended our ABL to, among other things, (i) extend the maturity date from July 29, 2025 to the earlier of (a) March 28, 2029 and (b) 91 days prior to the stated maturity date of the Company’s 4.0% Senior Notes due June 15, 2029 (as may be extended from time to time in accordance with the Indenture governing the notes) if the 4.0% Senior Notes are then outstanding, (ii) decrease the grid-based interest rate margins by approximately 50 basis points to 150 basis points for Secured Overnight Financing Rate (“SOFR”) loans and 50 basis points for base rate loans when average availability is greater than 50% of the aggregate revolving commitments, and to 175 basis points for SOFR loans and 75 basis points for base rate loans, when average availability is less than or equal to 50% of the aggregate revolving credit commitments and (iii) replace the previously fixed 37.5 basis point unused commitment fee with a grid-based, quarterly unused commitment fee equal to (a) 37.5 basis points if average daily outstanding credit extensions for such quarter under the ABL (“Total Outstandings”) are less than or equal to 50% of the aggregate revolving credit commitments or (b) 25.0 basis points if Total Outstandings for such quarter are greater than or equal to 50% of the aggregate revolving credit commitments. We incurred approximately $0.8 million in debt issuance costs in connection with the ABL amendment which were capitalized and will be amortized over the term of the ABL. Borrowings under the ABL bear interest at a floating rate equal to SOFR plus an adjustment of 10 basis points plus an applicable margin range of 150 to 175 basis points, or a base rate, as defined in the ABL, plus an applicable margin range of 50 to 75 basis points. At March 31, 2024, the applicable margin for SOFR-based loans was 150 basis points and for base rate loans was 50 basis points. The ABL is subject to mandatory prepayments if total outstanding borrowings under the ABL are greater than the aggregate commitments under the revolving credit facility or if we dispose of overdue accounts receivable in certain circumstances. The borrowing base under the ABL is equal to the sum of (a) 85% of the value of eligible accounts receivable and (b) the lesser of (i) 70% of the value of eligible inventory or (ii) 85% of the net orderly liquidation value of eligible inventory, less certain reserves. Prepayments can be made at any time without penalty. Substantially all of our United States subsidiaries are borrowers under the ABL and are jointly and severally liable for outstanding borrowings. Our obligations under the ABL are secured by a first-priority perfected lien on all of our United States inventory, accounts receivable, certain cash balances and other supporting assets. The ABL includes a commitment fee for any unused borrowing capacity of 37.5 basis points per annum when the unused capacity is above 50% of the credit commitments, with a step down to 25.0 basis points per annum when unused capacity is less than or equal to 50% of the credit commitments. At March 31, 2024, the commitment fee was 37.5 basis points. Borrowings are not subject to any financial maintenance covenants unless excess availability is less than the greater of $17.5 million and 10% of the Loan Cap as defined in the ABL. Excess availability based on March 31, 2024 data was $162.6 million, as reduced by $12.2 million of outstanding letters of credit and $0.2 million of accrued fees and expenses. 4.0% Senior Unsecured Notes On May 28, 2021, we privately issued $450.0 million of 4.0% Senior Unsecured Notes (“4.0% Senior Notes”), which mature on June 15, 2029, and bear interest at 4.0%, paid semi-annually in June and December. We capitalized $5.5 million of financing costs which are being amortized over the term of the 4.0% Senior Notes using the effective interest method. Substantially all of our United States subsidiaries guarantee the 4.0% Senior Notes, which are subordinate to borrowings under our ABL. Based on quoted market prices, which is a Level 1 measurement, the outstanding 4.0% Senior Notes had a fair value of $407.7 million at March 31, 2024. An indenture governing the 4.0% Senior Notes (“Indenture”) contains customary covenants and events of default, including covenants that limit our ability to incur certain debt and liens. There are no financial maintenance covenants associated with the Indenture. We believe we were in compliance with these covenants at March 31, 2024. 32 Table of Contents We may redeem some or all of the 4.0% Senior Notes at any time prior to June 15, 2024 at certain “make-whole” redemption prices and on or after June 15, 2024 at specified redemption prices. Additionally, we may redeem up to 40% of the aggregate principal amount of the 4.0% Senior Notes at any time prior to June 15, 2024 with the net proceeds of specified equity offerings at specified redemption prices as set forth in the Indenture. Upon a Change of Control, as defined in the Indenture, we could be required to offer to purchase the 4.0% Senior Notes at a price equal to 101% of the outstanding principal amount if there is a Ratings Decline (as defined in the Indenture). Our corporate credit rating and the credit rating for our debt and outlook are presented below: Moody’s Standard & Poor’s March 31, September 30, March 31, September 30, 2024 2023 2024 2023 Corporate credit rating Ba1 Ba1 BB BB ABL Agreement Not rated Not rated Not rated Not rated 4.0% Senior Notes Ba1 Ba1 BB BB Outlook Stable Stable Stable Stable These ratings are not a recommendation to buy, sell or hold securities and may be subject to revision or withdrawal at any time by the assigning rating agencies. Material Cash Requirements We enter into a variety of contractual obligations as part of our normal operations in addition to capital expenditures. As of March 31, 2024, we had (i) debt obligations related to our $450.0 million 4.0% Senior Notes which mature in 2029 and include annual cash interest payments of $18.0 million in 2024 through 2029, (ii) cumulative cash obligations of $36.6 million for operating leases through 2033 and $2.3 million for finance leases through 2028, and (iii) purchase obligations for raw materials and other parts of approximately $105.3 million which we expect to incur during the next 12 months and $0.9 million beyond March 31, 2025. Additionally, we may continue to invest to strengthen our systems, cybersecurity training, policies, programs, response plans and other similar measures. We expect to fund these cash requirements from cash on hand and cash generated from operations. Off-Balance Sheet Arrangements We do not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as “structured finance” or “special purpose” entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. In addition, at March 31, 2024, we did not have any undisclosed borrowings, debt, derivative contracts or synthetic leases. Therefore, we were not exposed to any financing, liquidity, market or credit risk that could have arisen had we engaged in such relationships. We use letters of credit and surety bonds in the ordinary course of business to ensure the performance of contractual obligations. At March 31, 2024, we had $12.2 million of letters of credit and $13.7 million of surety bonds outstanding. Seasonality Our business is seasonal as a result of the impact of cold weather conditions. Net sales and operating income historically have been lowest in the three-month periods ending December 31 and March 31 when the northern United States and most of Canada generally face weather conditions that restrict significant construction activity. Critical Accounting Estimates The preparation of financial statements in accordance with GAAP requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues, expenses and related disclosure of contingent assets and liabilities. These estimates are based upon experience and on various other assumptions we believe to be reasonable under the circumstances. Actual results may differ from these estimates. We consider an accounting estimate to be critical if changes in the estimate that are reasonably likely to occur over time or the use of reasonably different estimates could have a material impact on our financial condition or results of operations. Our critical accounting estimates can be found in the “Critical Accounting Estimates” section 33 Table of Contents in Management’s Discussion and Analysis of Financial Condition and Results of Operations included in the Company’s 2023 Annual Report on Form 10-K. There have been no changes in the Company’s determination of critical accounting estimates since September 30, 2023.