Mueller Water Products Inc (MWA) 2008 Q2 法說會逐字稿

Welcome and thank you for standing by. At this time, all parties have been placed on a listen-only mode until the question-and-answer session. (Operator Instructions) I would now like to turn the call over to Martie Zakas. Thank you, you may begin

Thank you, Wendy. Good morning, everyone, and thank you for joining us today as we discuss Mueller Water Products' results for the 2008 second quarter. We issued our press release reporting earnings for the period ended March 31, 2008 yesterday afternoon, and a copy of it is available on our Web site. Slides related to this morning's call are also available on the Web site to help illustrate the quarter's results. In addition, we have filed a copy of this morning's call's prepared remarks on Form 8-K. Mueller Water Products had a 115 million shares outstanding as of March 31, 2008, which is comprised of 85.8 million Series B shares and 29.2 million Series A shares. With us on the call this morning are Greg Hyland, our Chairman, President and CEO, and Mike Vollkommer, our CFO.

In our press release and on this call, we reference certain non-GAAP financial measures which are derived from GAAP financial measures. These non-GAAP measures are provided because management finds this financial data useful. We believe this will assist the investment community in assessing the Company's underlying performance for the periods being reported. Reconciliations between GAAP and non-GAAP financial measures are included in the supplemental information within our earnings release. This morning we will refer to adjusted income from operations, adjusted net (inaudible), adjusted EPS and adjusted EBITDA, all of which exclude the previously-announced Burlington restructuring charges in fiscal 2008. These numbers are provided in the press release.

On today's call, we will make forward-looking statements in accordance with the Safe Harbor provision of the Securities Litigation Reform Act of 1995. Remarks containing words such as "expect," "believe," "anticipate" and "project" constitute forward-looking statements. They are not guarantees and such statements involve risks and uncertainties that could cause actual results to differ materially from these forward-looking statements. Please see our Form 10-K for the fiscal year ended September 30, 2007 for a discussion of these risks.

This morning's call is being recorded and web cast live on the Internet. The archived web cast, along with the corresponding slides we are presenting this morning, will be available in the Investor Relations' section of our Web site, www.muellerwaterproducts.com, for at least 90 days after the presentation. After the prepared remarks, we will open the call to questions from our dial-in participants.

I'll now turn the call over to Greg.

Thank you, Martie, and good morning, everyone. We appreciate you joining us this morning as we discuss our results for the second quarter of fiscal 2008. I'll begin today with a brief overview of the quarter. Mike Vollkommer will then follow up with a detailed financial report, after which I'll update you on our strategy, key drivers influencing our business, and our outlook for the second half of the fiscal year. We will then open the call up for your questions.

Our second quarter results reflect the current state of residential construction, rising raw material costs and the general uncertainty of the economy. We saw much less of a seasonal up-tick in shipments this quarter compared to what we traditionally see in the second quarter. Raw material costs were higher in the quarter on a year-over-year basis and they continue to increase in April. Rising raw material costs will remain a challenge, since the higher prices we paid during the second quarter and in April will flow through our results in the second half of the year.

Net sales for the 2008 second quarter totaled $421.6 million. Adjusted income from operations was $29.5 million, and adjusted net income was $6.6 million or $0.06 per diluted share. The adjusted operating income margin was 7% and adjusted EBITDA margin was 12.4%. These results were adjusted for the $1.5 million of restructuring charges recorded in the second quarter associated with the February closure of U.S. Pipe's manufacturing facility in Burlington, New Jersey.

Net sales for the 2008 second quarter were down 8.3% compared to the 2007 second quarter. Sales in our Mueller Company business unit declined $27 million, or 13.8%. U.S. Pipe sales declined $15.5 million, or 12%. Our business continues to be impacted by unprecedented rising raw material costs; the year-over-year impact of which was $12.1 million during the quarter. Cost savings in the quarter of $10.8 million reflect our determination to reduce both fixed and variable costs. I'll talk about these initiatives and our continued plans later in the call.

I'll now turn the call over to Mike Vollkommer, who will discuss our financial results for the second quarter in more detail.

Thanks, Greg. I'll start by reviewing the consolidated results and then discuss segment performance.

Consolidated net sales of $421.6 million in the 2008 second quarter decreased $38.1 million year-over-year due to $51.8 million of lower shipment volumes, principally caused by the continued difficulties associated with residential construction. Lower volumes were partially offset by $6.4 million of higher pricing and a $7.2 million favorable impact from Canadian currency exchange rates.

Gross profit was $98.8 million in the 2008 second quarter, a decrease of $19 million compared to $117.8 million in the 2007 second quarter. Gross margin was 23.4% compared to 25.6% in the prior year period. The declining gross profit was primarily impacted by $16.8 million from lower shipments and $12.1 million of higher raw material costs, which exceeded sales price increases of $6.4 million. Cost reductions of $10.8 million offset the negative impact of $10.3 million of under-absorbed overhead resulting from reduced production levels.

Selling, General, and Administrative expenses were $69.3 million in the 2008 second quarter compared with $64.1 million in 2007 second quarter. The increase was primarily due to a $1.1 million provision for doubtful accounts, higher administrative costs largely associated with realignment of Anvil's Canadian manufacturing and distribution operations, and the comparative impact of Canadian currency exchange rates.

The 2008 second quarter results also included cash restructuring charges of $1.5 million comprised of severance and other costs in connection with the previously announced closure of U.S. Pipe's manufacturing operations in Burlington, New Jersey. Last November, the Company announced its intention to cease manufacturing at this facility and convert it into a full-service distribution center for customers in the Northeast. This initiative remains on schedule and within our projected costs.

Year-to-date the Company has recorded $17.7 million of total restructuring charges, of which $14.8 million are non-cash asset impairment charges, and $2.9 million are cash charges related to employee severance and other closure costs. Final cash restructuring charges of about $1 million are expected to be incurred in the second half of fiscal 2008.

Income from operations adjusted for the restructuring charges was $29.5 million compared to $52.9 million in the 2007 second quarter. Second quarter 2008 adjusted operating income margin and adjusted EBITDA margin of 7% and 12.4%, respectively, compare with the 2007 second quarter margins of 11.5% and 17%, respectively. The margin declines were principally from the impact of lower shipments and higher raw material costs.

Interest expense, net of interest income declined $3 million to $18.1 million in the 2008 second quarter compared to $21.1 million in the 2007 second quarter. Gross interest expense totaled $19.1 million in the 2008 quarter compared with $21.7 million in the prior year quarter, reflecting the benefits of the May 2007 refinancing, reduced debt levels and lower interest rates.

Our effective tax rate was 42.4% in the 2008 second quarter compared with 43.7% in the 2007 second quarter. Diluted earnings per share were $0.06 on an adjusted basis excluding the restructuring charges, and was $0.05 per share on a GAAP basis. This compares with diluted earnings per share of $0.16 in the 2007 second quarter.

I'll now move on to the segment performance. Net sales for the Mueller Co. segment were $168.9 million in the 2008 second quarter compared to $195.9 million in the prior year quarter. Net sales declined primarily due to reduced volumes of $31.7 million, partially offset by higher pricing and favorable Canadian currency exchange rates.

Shipment volumes of iron gate valves and hydrants declined 17.6% and brass service products declined 41.6% in the quarter, primarily due to the soft markets associated with the continued downturn in residential construction.

Income from operations of $27.4 million and EBITDA of $39.7 million in the 2008 second quarter compares to income from operations of $42.8 million and EBITDA of $55.8 million in the 2007 second quarter. Volume declines reduced profits by approximately $12.7 million. Higher sales pricing of $2.8 million did not offset the $4.2 million increase in the cost of raw materials and purchased components. The negative impact of reduced production which resulted in under-absorbed overhead $6.8 million was partially offset by cost reductions of $4.5 million.

Net sales in the U.S. Pipe segment of $114.2 million in the 2008 second quarter decreased from $129.7 million in the prior year quarter. Both periods reflect full-quarter results for the January 2007 acquisition of Fast Fabricators. Lower shipment volumes as a result of overall weakness in residential demand and a less favorable product mix caused $16 million of the decline. Slightly higher pricing only partially mitigated this decline.

Loss from operations of $2.8 million in the 2008 second quarter includes the cash restructuring charges of $1.5 million. Excluding these charges, adjusted loss from operations was $1.3 million and adjusted EBITDA was $4.1 million. These results compare to income from operations of $6.8 million and EBITDA of $13 million in the 2007 second quarter. The 2008 second quarter operating income was negatively impacted by $7.5 million of higher raw material costs, and $3.8 million due to lower shipments and a less favorable product mix. Cost savings of $6.3 million realized during the quarter helped reduce the impact of negative factors such as higher raw material costs and lower shipments.

Net sales in the Anvil segment were $138.5 million in the 2008 second quarter compared with $134.1 million in the prior year quarter. The net sales increase was driven by a $5.4 million favorable impact of Canadian currency exchange rates and higher sales pricing, partially offset by volume decline. Income from operations of $12.9 million and EBITDA of $17.9 million in the 2008 second quarter compares with $13.6 million and $19.3 million, respectively, in the 2007 second quarter. The 2008 second quarter operating income was primarily impacted by administrative expenses associated with the Canadian realignment, lower volumes and slightly higher raw material costs. Currency exchange rates had an immaterial impact on income from operations.

Before I return the call back over to Greg, I will review cash flow. Cash provided by operating activities in the 2008 second quarter amounted to $4.8 million compared to $32.8 million in the 2007 second quarter. Historically, the second quarter is our weakest operating cash flow quarter and at times has been negative due to the typical seasonality of the business. However, this was not the case in 2007, when the second quarter was stronger than the first quarter, primarily due to timing of receivable collections between the two quarters. On a fiscal year-to-date basis, free cash flow which is cash from operating activities less capital expenditures, amounted to $23.4 million in the 2008 first half compared with $14.2 million in 2007. This is a $9.2 million improvement. For the second half of fiscal 2008 we expect to see positive free cash flow that follows business seasonality.

Net debt as of March 31, 2008 was $978.2 million, a decrease of $81 million from March 31, 2007, and a decrease of $23.4 million from our prior fiscal year-end.

With that I'll turn the call back over to Greg.

Thanks, Mike. During last quarter's conference call, we said we believed revenues for the second half of fiscal 2008 would be comparable to the second half of fiscal 2007. As a result of second quarter market developments, as well as a number of key drivers, we now believe flat revenues in the second half of the year could be challenging. These drivers, which include residential construction, our distributors' buying patterns, municipal spending and price increases could also cause revenue to vary significantly.

The ongoing downturn in new residential construction impacts a portion of our business. While we expect the downturn to continue for the foreseeable future, the extent and length of this downturn is still uncertain as is the timing of the eventual recovery of the market. For instance, during the last three months the consensus blue chip economic indicator forecasts for housing starts for 2008 dropped from $1.1 million to $980,000.

As we mentioned earlier, the increase in revenues we saw in the second quarter over our first quarter of fiscal year 2008 was minimal, and the seasonal increase was much less than in previous years. January, typically, is the largest booking month for Mueller-branded products, which include iron gate valves, hydrants and brass products. Mueller Company has a pattern of increasing prices effective February 1, which it did again this past February. Distributors usually place stocking orders in advance of the increase, and while January was our largest booking month of this fiscal year, bookings in January decreased $27 million from January 2007.

A number of factors possibly contributed to this decline. The downturn in residential construction undoubtedly contributed to weaker demand, but we believe our distributors may also have adjusted their buying patterns this year by waiting for the beginning of the construction season before bringing in inventory to more tightly manage their working capital. We expect that their purchases in the second half of the year could be more closely aligned with their expected demand.

It's hard to assess if the general uncertainty of the economy will affect municipal spending over the next six months to repair and replace aging water infrastructure. However, we are confident that the need exists and the long-term prospects remain encouraging. Our ductile iron pipe quotation as to public works dropped 20% in terms of tons in the second quarter on a year-over-year basis. One quarter certainly does not constitute a trend, but it is a change that could highlight the uncertainty in the market.

We are implementing price increases in each of our three businesses. We do expect to attain at least a portion of these price increases, but the extent of the realization of these increases could materially affect net sales.

Now, I will address the variables that will impact profitability in the second half of the year. In addition to the effect of price increases, residential construction, our distributors buying patterns and municipal spending, our profitability will also be impacted by the cost of raw materials and benefits from cost savings. We will continue to be challenged by rising raw material costs in all three of our business units.

For example, in January, we paid $333.00 per ton for scrap as U.S. Pipe. In April, we paid $492.00 per ton. That's a 48% increase in just three months and an 82% increase over what we paid in April 2007. At Mueller Company we paid $395.00 per ton for scrap in January. By April, that had increased 52% to $599.00 per ton. And Brass increased from $2.64 per pound in January to $3.12 per pound in April.

The higher prices we paid during the second quarter and in April will flow through our costs and goods sold in the second half of the year. As I discussed in our last conference call, we implemented a 15% price increase on ductile iron pipe effective January 25, and a 5% price increase on our iron gate valves and hydrants effective February 1.

We recently announced another round of price increases, including an additional 10% for our ductile iron pipe products effective April 25. We also announced that the price of our iron gate valves and hydrants will be increased an additional 15% effective June 2. On March 26, we announced a 12% price increase on brass products to be effective this week. This is the first price increase on our brass products since June 2006. These additional price increases are necessary in responding to rising raw material costs.

Our competitors announced similar price increases, but we recognize that reduced market demand could make it more challenging to realize the full effect of these price increases, particularly with some products. For instance, we have yet to achieve the full amount of the increases we announced that were effective in January for our ductile iron pipe and in February for our valves and hydrants. Even with these market challenges we continue to believe that our announced price increases are reasonable and supportable in the market.

We continue our focus on enhancing productivity by reducing our manufacturing cost structure and executing on our restructuring action. During the second quarter, we achieved $10.8 million of cost savings which included those associated with the closure of the Burlington manufacturing operations. We continue to improve productivity and reduce headcount in a number of our production facilities. During the quarter, we reduced headcount at our Decatur operation by 7%, or 41 positions. Also, lean manufacturing initiatives enable us to improve our processes at both our Union City, California and North Birmingham, Alabama ductile iron pipe manufacturing facilities. As a result, over the last four weeks we reduced production headcount in these U.S. Pipe operations by 19%, or 113 positions.

The current market environment is tough, but our operating teams are meeting the challenge. They are focused on developing processes that will yield cost reductions and improve efficiencies, which will make us that much stronger for the future.

In the second half of fiscal 2008, Mueller Company's financial performance will be dependent on the outcome of all the variables I just discussed. In addition, I want to remind you that we experienced approximately $5.5 million of under-absorbed overhead costs in the fourth quarter of 2007 related to our inventory reduction plan. That is now behind us. By taking into account market demand, price increases and raw material costs, operating income margins in the second half for our Mueller Company business unit should be down year-over-year.

During our last conference call, we stated our expectations that U.S. Pipe could possibly see lower operating income margins in the second half of 2008 than those in the second half of 2007. Given the recent trends, especially the unprecedented increases in cost for scrap iron and other key materials, we now believe U.S. Pipe is very likely to see lower operating income margins in the second half of the year than those in the second half of 2007. Certainly, our ability to implement price increases to offset a highly-inflationary cost environment is a key variable, even with the expected savings from the Burlington closure.

Commercial construction spending is a driver for our Anvil business, and based on where demand for our products fall in the construction cycle, our outlook for this segment remains stable for the remainder of the year. We are anticipating modest top-line growth for Anvil in fiscal 2008, and we expect to see a slight improvement in segment margins for the second half of the year, as compared to the prior year's second half.

The primary objective for fiscal 2008 is maintaining strong, free cash flow. As Mike discussed earlier, our first half 2008 free cash flow was $23.4 million, a $9.2 million improvement over 2007. We will continue to manage inventory levels and match production with market demand. We will also continue to focus on managing working capital with a significant component of our management incentive programs being based on improving working capital.

Other key variables for 2008 are corporate spending of approximately $38 million. Our tax rate is expected to be approximately 42%. We estimate 2008 net interest expense to be within the range of $73 to $75 million, as we realize the full-year benefits of our debt refinancing in May 2007 and the effect of lower interest rates. And we expect capital expenditures to be about $80 million, within the range of $75 to $85 million.

With our cash on hand and the free cash flow we expect to generate in 2008, we have considered re-investing in the business, paying dividends, repaying debt, repurchasing stock, and making strategic acquisitions. As I just mentioned, we expect to re-invest approximately $80 million in the business this year, including completing our automated ductile iron pipe facility which remains on schedule. We anticipate the facility will begin operations by the end of this calendar year. We will continue to invest in programs that provide a meaningful return.

We evaluate the repayment of debt and repurchase of stock on an ongoing basis. It is important to note that in May 2007, we obtained financing at rates and with terms that are significantly more favorable than those available today. We have also carefully examined the benefits of implementing a stock repurchase plan. Because we are confident of our strategy and our ability to execute it, we believe our current stock price represents a compelling value. However, the decision to implement a stock repurchase plan, as well as repaying debt, is being balanced with the decision to maintain liquidity. At this time, we believe we should preserve the flexibility our current liquidity affords us given the volatility of today's economy.

There are a lot of uncertainties and challenges in the market, but we will continue to take decisive actions; in particular reducing costs, matching production to market demand and, wherever possible, implementing price increases to at least offset rising raw material costs. However, we are committed to maintaining our market leadership position and retaining the flexibility to respond to growth opportunities as they present themselves. We are confident in the long-term prospects for the water infrastructure industry.

With that I'll open it up for questions.

Thank you. (Operator Instructions) Keith Hughes, you may ask your question and please state your company name.

It's Keith Hughes, SunTrust Robinson Humphrey. I just wanted to drill into some of the numbers you gave on the Mueller sales. Did you say the brass products were down 41% in the quarter?

That's correct.

Wow! What was there to make it so much worse than the valve and hydrant side?

A couple things, Keith, one I think that when you see the valve and hydrant side -- our brass products are 100% correlated to housing starts. And secondly, on the valves and hydrants we do continue to see a repair and replacement market for valves and hydrants that we would not see on brass products. Sometimes, too, and we had a price increase last year on brass products that we announced February 1, and of course, then our distributors placed orders in advance last January. If you recall, we later rescinded that price increase. We are not the market share leader in that product. The market share leader did not increase prices. We found that we were under some pretty extreme pressure so we rescinded that. So, I think we may have some year-over-year noise in what happened to orders, because this year on February 1 we did not announce a price increase in brass products. But as I just mentioned, we did announce one effective this week, as did the market share leader on that product.

So I would say that the key reason is that we would expect to see brass products drop more than valves and hydrants, because brass products are driven 100% by housing starts. Valves and hydrants we have a repair and replacement demand. And I would say that if you look at last January, there was probably some noise in terms of a year-over-year comparison because of the price increase we announced on brass products last year February 1 and not this year.

How much of the Mueller segment does that represent in terms of revenue?

That's about $110 million.

$110 million?

Yes, and that was in '07.

Okay. The price increases you discussed are pretty significant increases coming here in the next couple of months. Given how weak the parts of your end-user markets are at this point, is it going to take the full year to get these truly implemented until we see the benefits?

That's a good question and that certainly is a variable that I think that we need to see how that plays out. I think that for the pipe we should start seeing that. Again, let me go back and say that certainly all the variables and the raw material costs that we're seeing our competitors are seeing. Not one of us has an advantage and we don't believe in raw material purchases and we all use about the same amount of raw materials in our products. So clearly, we believe our competitors will be having the same raw material pressures.

On the Mueller price increases, if you'll notice that I said that that was not effective to June 2. When we announce a price increase, we typically give 45 to 60 days' notice, because a number of our distributors -- our distributors have a number of outstanding quotations and we just don't think that that would be fair if we in a sense quoted one price and then they have to buy it at another price. So we give them that time to protect those quotations. So when we see this price increase effective on June 2, I would think we would not start seeing the benefit of that maybe until the fourth quarter.

I think on our brass products, I think we would start seeing that probably at the end of this quart, possibly early in the fourth quarter. In our pipe, we're hopeful we'll start seeing that sooner or maybe late third quarter into the fourth quarter. But I think that you're right, given what's going on in the marketplace. If you look at what we have in our backlog and so on and so forth, we wouldn't expect any of the price increases we just announced to start really falling through until the fourth quarter. But as we said on the last conference call, the price increases that we announced in February and in January for pipe, February for Mueller, that we wouldn't see any benefit of those in the second quarter. We would expect to start seeing the benefits of those now in the third quarter.

Okay and final question, you had mentioned a 20% increase in quotation activity in U.S. Pipe. Does that have to do with given the fact that the industry is going up pretty significantly again in price?

I'm sorry, Keith, I said that was on our public works' quotations for U.S. Pipe and on a year-over-year basis that was a decrease.

Oh, okay, I'm sorry. I misunderstood what you said. All right, thank you very much.

Yes. Thanks, Keith.

Thank you. Our next question is from Mike Schneider. You may ask your question and please state your company name.

Thank you and good morning. It's Mike Schneider from Robert Baird.

Hi, Mike.

Good morning and I guess if we could stick to pricing for a second. So, as we look into the third quarter, the price increases of January and February start to roll through. So when you look, for example, starting with Mueller, Mueller Co. that is, they had pricing of positive $2.8 million this quarter. Raw materials hit them by $4.2. Would you expect that gap to actually increase or decrease given that you've got the beginning benefit of the prior price increases yet? Raw materials are headed obviously substantially higher.

Yes. What we have seen our backlog right now for Mueller is we're starting to see the increase of -- the impact of the increase in February. To date if you look, we announced a 5% price increase on valves and hydrants on February 1. Right now, our backlog is showing about a -- we're achieving about 100 basis points of that and we're still early. I would think certainly on a year-over-year basis given the increase that we've experienced in raw material that the price increases that we announced in February would not offset the impact of raw material costs on a year-over-year basis.

Okay and that 5% price increase that went in February 1, you've realized 100 basis points of it so far. Is that because of timing or is it -- and would you expect to actually recover the next four points, or indeed are you getting pushed back in the market where you will likely back off of the four or five points and end up netting something less than that?

Yes. I think that it's a combination of timing and probably, up front, maybe a little back off. However, I think with this next round of price increases, the 15% that we announced on the valves and hydrants and we had competitors announce similar price increases, that I think that that makes us very confident that we'll get that full 5% and then, of course, get some of the 15%. So, I think what's happened on this last round of price increases gives us, as I said, confidence that we'll be achieving all of the first price increase and we would expect to get some of the second.

And this may be the same question a different way than what you just stated; but so, if you are not entirely successful on the first round of pricing, with the next round of pricing does that at least account for what you expect to fall short on the first round of pricing?

No, not necessarily. I think if you look at -- our second round of pricing was really just focused on what we've seen happen on raw material costs. So we were -- I think, if we look back and hindsight's 20/20, we should have gone out with a higher than a 5% price increase effective February 1. But I don't think even at the time, certainly at the time we announced that price increase, that we had any expectations that we would see in a two-month period the rapid increase on raw material costs. So, our 15% was really focused on what we saw happening to raw material costs and our belief it was justified. And, in fact, on this 15% we were the price leader on the 5% price increase we announced in February. It was actually one of our competitors that led this second round of price increases of 15%, so we followed on the 15%.

And if you're not successful entirely on the February 1 price increase, and this is just a third way of putting it, I guess what I'm trying to determine is, must you be successful fully in the first and second round of price increases at Mueller to be made whole, or is there a cushion built in to those?

If we would achieve both those price increases, we would more than offset rising raw material costs based on where raw material costs are today.

Okay, and then U.S. Pipe, it looks like it barely achieved any positive price in the quarter. So, the 15% that was put in, in January, I would have thought would have already been flowing substantially during this quarter. Again, can you give us some more color on the timing of that increase and then, again, if you're not fully successful on both rounds of price increases there, where do you stand relative to raw materials today?

Actually, on our last conference call we said that we would not see any impact of that January 25 price increase. Typically, we run with about a six- or seven-week backlog in U.S. Pipe, so when we announced that price increase, our shipments, both of our shipments for Q2 were already scheduled. What we have seen to date in our backlog in April is that of that 15% we're up about -- we're seeing about 500 basis points. So in our backlog, we've achieved about a third of that price increase.

And Mike, so that's a combination of timing, too, because there were quotations outstanding. When we announced that price, our distributors had quotations outstanding, we had quotations outstanding, where we honored the price that we had quoted at the time that we issued the quote. So that's also timing. A little push-back, I think, in the marketplace also. But again, I would say that with this next round -- with this latest round of price increases, and we did take the lead on this 10% but out competitors -- but as I said the competitors announced similar price increases. I think that gives us a lot more confidence that we should achieve most, if not all, of that initial price increase and we are hopeful that we will get some of this second price increase, too.

Again, it's the same situation. If based on where raw material costs are today, if we would achieve both those price increases, we would more than offset the raw material costs. I think right now that we can say that I think we're reasonable confident that we'll achieve the 15% that we announced in January, and are hopeful on the other 10%. Because again, our competitors are faced with the same rising raw material costs. The only thing that could possibly differ between us, if they have an expectation that scrap is going down, they may react a little differently. Right now, we have no expectation that the cost of scrap is going down, so we're going to be very disciplined on our pricing.

And, in the valve and hydrant business, the 17.6% decline there this quarter, can you give us a sense of what you believe repair and replacement was up this quarter, and was it sequentially softer?

You know, that is -- on a quarter-to-quarter basis, that is hard for us to tell to be able to determine that. As I said, those orders come through our distributors. I can tell you that as I said earlier that we had a $27 million decline year-over-year in January, and what that told us certainly was our distributors were ordering less before the price was in effect than they did a year ago. We think two factors; one was certainly the weaker market, but two, I think they elected to say instead of protecting that price they were just going to manage their working capital a little closer and wait until the construction season just to see to what extent demand would rebound in the construction season.

That's a preamble to say that when look down, we were down in every one of our regions year-over-year, sales regions. We were down a lot less in our Northeast region, and again, our Northeast region is more closely aligned by repair and replacement. So, I think for right now it's still tough for us to tell on a quarterly basis exactly what happened to our shipments on the repair and replacement side.

Okay, thank you. I'll get back in line. I appreciate it.

Thanks, Mike.

Thank you. Our next question is from Kevin Maczka. You may ask your question and please state your company name.

Good morning, BB&T Capital Markets.

Morning, Kevin.

Good morning. Greg, how much share loss have you experienced, because it seems like you've been pushing the lever pretty hard on pricing and, in some cases it has stuck, in other cases it has not and you've even had to rescind price increases? So, with your volumes down so much, how much of that is related to share loss?

Kevin, we get industry data, obviously trade association data every month on our valves, our hydrants and our pipe products. And actually, our market shares we are up 1%, down 2% and flat, and I'm not given you exactly what products because that could be sensitive, competitive information. But what it is to say in total is market shares are remaining stable.

Okay. Just let me switch over to the municipal side if I could? It looks like a pretty dramatic change in some of your distributors' behavior and in some of the municipal spending commentary that you gave in your prepared remarks. I guess my question is, when you look at the channel inventory with your distributors and maybe what some of that pipeline looks like, how do you view the channel inventory situation?

Prior to our February 1 price increase, or first of all, there is very little ductile iron pipe in our distributors' inventory, if any. They're just not equipped to handle ductile iron pipe. So even though we may bill the distributor and the distributor invoices the end user, we'll ship direct to jobsite. So, when we talk about inventory, we're talking primarily valves, hydrants and brass products.

Prior to our February 1 price increase, we were pretty comfortable that our distributors' inventories were in line, because they had brought down inventories pretty significantly throughout 2007. We will typically see a little blip in their inventories in February and March as we ship the products on the orders that they brought forward to put the orders in before the price increase. As we said, January is typically our largest order month for our valves and hydrants, and it was again this fiscal year.

So I think there's a little bit of a blip, but we don't believe that there is a big, a large amount of inventory out there that is slow moving. We think that they took those down pretty significantly in 2007. Relative, and I don't want -- certainly, we've been trying to give as much insight as we can. One of our best indicators that we have internally is our quotation activity, as we said, to public works and we do have a better line of sight on our ductile iron pipe products. As we said, we're not ready to conclude that that's a trend, that 20%. Other though, it's one that we need to on a year-over-year basis to see that decline to be aware of.

So, I think to summarize, that yes, there's a little blip in our distributors' inventory now as we ship the orders that they placed in January before the price increase was in effect. But we don't right now see what we would say is a significantly overstock situation in the channel.

Okay and then just finally, if I could, on your slide on the uses of cash you give five items there. The first three you're doing; the second two you're not. And I guess my question as it relates to the buybacks, but more importantly the acquisition front, is this a case where to consider something like that you have a certain idea in mind of your balance sheet of improvement you'd like to see there before you could tackle something like that? Or, is it more a case that there's just so much going on in your current business now that tackling any kind of acquisition would be just too much of a distraction right now?

You know, Kevin, I would have to say it's a combination of all the above. Certainly, I think that we would be very prudent on any acquisition, but then again there are certain acquisitions that have such a strong strategic fit and, essentially, how we think that the market will play out over the long term. But if they would become available we would have to look very closely. But I think it's safe to say that we will be very disciplined and take into account certainly the condition of our balance sheet, as well as the potential target. So, I know that that's not specific, but it would all depend on what would be the acquisition target and the factors at the time. But certainly, I would say that we think it's very prudent for us to be very disciplined.

Okay, that's fair. Great. Thank you.

Thanks, Kevin.

Thank you. Our next question is from Brent Thielman. You may ask your question and please state your company name.

Good morning, Brent Thielman with D.A. Davidson.

Hi, Brent.

I'm just curious, maybe just turning to Anvil for a little bit. Can you talk a little bit about the demand environment there and sort of maybe some clarification on what supports your outlook for a slight improvement in the second half for that business?

Yes. Again, I know we discussed this. Where we fall in the construction cycle, and again it's when those -- when the buildings are maybe two-thirds of the way complete when we'll start seeing our products being installed in HVAC systems' fire protection. When we look and see the backlog of I would say projects that are existing, that we think for the next six months that the demand should be sufficient to where we won't see the impact of potentially of what may happen in '09 and 2010. Certainly, I think that some of the forecasts that we're seeing -- though some of the forecasts are still projecting not only growth this year but a slight growth for next year -- I think where, again, where we fall in the construction cycle that what's driving demand for our products is the backlog or the big increase, I think, in investment that we saw over the last 18 months.

Okay, that's great. And then, you've talked about the U.S. Pipe quotation activity, and I'm just maybe curious of your thoughts, but do you have any sense of how much of an impact higher construction material cost is having on public sector demand?

You know, that is a -- we probably can't say that we're absolutely -- demand for our products are an elastic. But again, when pipes need to be replaced, they need to be replaced. So, we might be very well on what's happening in the general inflation area environment. We're finding some municipalities, or water systems, saying that if there's a project that can be postponed they might very well be doing that. I don't think that we can point to that specifically for an impact of our quotation in the second quarter. I think we won't have better insight on that probably for at least another couple of more months.

But again, when the pipes need to be repaired, they need to repair them. So, I think it's too soon for us to say that the increase in raw material costs and what we're doing to pricing is having much of a significant impact on these projects. And again, it's important to point out, probably the largest dollar item, or largest expenditure on these projects is still on labor. So, it is not as much on material as it is on labor.

Okay, I appreciate that. And then there's one final question. With the new facility, the new ductile iron pipe facility at [Bessemer], I mean can you remind me if any, will this facility help you reduce your dependency on scrap?

In a round about -- not directly. The biggest savings we'll generate from the automated plant for U.S. Pipe will be a reduction in labor costs. We'll take it from about four man hours per ton to two. Where we will see a pickup is that we will have less of a scrap rate. With the controls on the new equipment that we're installing, that we expect that our good tons of pipe produced the first time will go up significantly, and that should help us on our scrap rate. Though, when I say that, it will just be a marginal improvement, because anything that we scrap on our ductile iron pipe business we put it back into the furnaces and re-melt it. So no, I would say it really won't help us too much on scrap. The big savings will be on the reduction in man hours per ton on the labor side, as well as probably allow us to carry less inventory.

Okay. Thanks a lot, guys.

Yes.

Thank you. Our next question is from Matthew Arnis. You may ask your question and please state your company name.

Morning, just a couple of quick questions. Can you take us through what happened in the Canadian operations on the SG&A line and how that is expected to progress through the year?

Well, the SG&A we talked about there was one distributor customer that ran into financial difficulty, so there's a $1.1 million write-off during the quarter that impacted that. We're reorganizing the Anvil Canadian operations to structurally split the manufacturing from the distribution and that added $1 million to the SG&A line this quarter, and we had that in the first quarter as well. And then, just the movement in the Canadian dollar year-over-year impacted the rest. Last year, there was a bit of a gain.

There's a pay-down of an inter-Company note that triggered a gain last year, so that impacted the Delta. Just the inflationary effect, you know the Canadian dollar year-over-year strengthened 10% versus the U.S. dollar, so that inflated the SG&A of our Canadian operations. That's largely 75/80% of the impact of the SG&A growth.

Right, and can you say just quickly on a sequential basis how much of the increase in SG&A was seasonal versus these other factors?

Other than that comparative impact on that [FX] settlement gained last year, which is like $700,000, it's all pretty much a run rate.

So when I think about, I mean obviously fourth quarter at 61 -- I'm sorry first quarter at 61 was lower than run rate. This feels higher than run rate. Is it more in that or is it a percentage of sales basis? Can you kind of give a sense of what the normalized run rate should actually be?

I would take the first half to smooth out any aberrations from quarter to quarter and look at that as a half a year run rate.

Right. You talked very briefly about the -- not briefly but certainly at length about the year-over-year movement in margins. You kind of backed away from the improvement in margins and you now think margins are going to be weaker on a year-over-year basis. Can you talk if you roll forward on a sequential basis how you view the ability to stabilize your margins and what it would take to stabilize the margins based on where raw materials are today?

Our year-over-year impact as we said on margins, the biggest impacts were twofold. One is the decline in the volume and the higher raw material costs. And as Greg had mentioned in his prepared remarks and answering later questions, the ability to get the price increases that we have announced will help overcome the impact of what we're feeling with raw material. Volumes, obviously the volume is purely demand driven and a market recovery when those volumes come back on with all the cost savings that we're putting in place and lean manufacturing focus, we would expect that those margins will return. We'll have further margin expansion as we add volume.

Matthew, just to add a little more color to what Mike was saying, that yes, I think that that's the case. Certainly, our ability to achieve the price increases and what percent will have the biggest impact, but we would think with the seasonality of our business, as our production should pick up in the next several quarters, that sequentially we should see higher margins in Mueller-brand of products; our pipes and our Anvil business in the second half of the year.

Great. And the last question, can you just give a few brief comments on the health of demand currently? You mentioned in January down $27 million in the hydrant and valve business. Can you talk to what the Delta was in February and March? Did that narrow from a year-over-year basis?

It did. When we look at our -- essentially, we were talking specifically about our Mueller-brand of products. In March, we were flat year-over-year and just down slightly this February. So when we look on orders on a year-over-year basis, for this quarter the big drop-off was in January.

Great. Thank you very much.

Thank you.

Thank you. We have a follow-up question from Mike Schneider from Robert W. Baird. You may go ahead, sir.

Could you comment just on production levels in the second half? I know you've talked about inventory levels, but would you expect production levels to match your incoming orders and demand during the second half, or do you believe you've even got it ratcheted back just in anticipation or in an attempt to cut inventory internally?

You know, Mike, when we look at our production levels on what we would expect on a year-over-year basis, and I'll look again and I'll talk Mueller, we will see a bit of an up-tick in production in the third quarter over the second. But it will be still, I think, well below the production that we had in the third quarter of last year. We would expect in the fourth quarter that on a year-over-year basis our production could be comparable at Mueller.

In our pipe business, and that gets back again to the big reduction in inventory that we had in the third and fourth quarter of last year, on the pipe business that we'll see an up-tick in production in Q3; probably not equal to demand. Because if you recall, that when we closed Burlington, that we built a buffer inventory. The last thing we could have afforded to have done there was exit a plant in the Northeast and have any of our customer service fall down. So we built inventory and moved it up there in the distribution center to make sure that we did not fall down at all, and fortunately, we've kept all of our customers there and that seems to be going smoothly; that move. But I would think that we will be working down some inventory that we built on the pipe business. Though, we would still see on at least the second half of the year versus the first half of the year production pick up a bit.

Okay, and then as you look out into fiscal '09, Greg, and let's assume these markets, year-end markets go sideways during '09, and you begin to see the savings out of Burlington and many of the other moves you've made, just conceptually what do you think -- and I guess the key assumption is you get full price recovery here in the second half -- what do you think the run rate profitability of this business is today, either EBIT or EBITDA, just given the incredible changes that have gone on in this marketplace?

Mike, I won't be able to give you an exact number, but I will talk about -- I'll try to address the variables. First of all, that we think when housing bottoms and housing starts, and you know we went into this year -- in fact the last conference call we said that we still expect it to continue to decline in 2008, though I think that probably it's still declining at a faster rate than anyone expected. When housing starts at least to bottom out or stabilize, we'll lag that recovery. I know we've talked about that in the past, because it's the real development that drives demand for our products. But we would expect to see then still top-line growth coming from the repair and replacement sector. So I would think that once housing starts to bottom we would start seeing some top-line growth.

Anvil, I think right now as we look going out, that's still a question mark, because commercial construction, I think that all the indicators are that we might start seeing a slowdown in commercial construction. And while we think we're solid for the second half of this year, that I think becomes a question for 2009. But, we've taken out a significant amount of fixed costs. The variable costs we've taken out. The 113 people that I referred to at our pipe plant that we took out the last four weeks, that was a change in our production philosophy going to a just-in-time, that we think that we'll be able to operate when demand comes back with those fewer people. So you're right, we'll get those cost benefits.

I have to say right now that the real variable for us is what's going to happen to raw material costs, and assuming that we can offset that, that I would expect then when we bottom out that we should start seeing margins improve when we get the benefits of all the fixed cost reduction and the change in processes. Right now, I think that to put an exact number on that, I think I'd like to just see a little more on what happens the next quarter or two. But I do think that we would obviously see an improvement because we have taken a lot of costs out of the business.

And I guess maybe a different way to phrase the question is, if you -- let's say we settle in at this $1.7 billion in revenue or thereabouts, do you think that the business stable at that revenue can re-achieve say the 11% operating margin range you were running in a couple of years ago because of the fundamental changes to the cost structure, or do you think $1.7 billion is just insufficient to reach that range?

I would feel confident -- I would expect that we could get to the 11%. When I think of the $1.7, the $1.8 billion range, that we have this quarter all the negative impact of reduced reduction in terms of unabsorbed overhead, we offset with cost reductions. So relative, we would lost the margin. We would have lost the absolute profit dollars on the reduced volume. And when you think about that, a year-over-year basis for us on our reduced volume cost us about $17 million on a year-over-year basis consolidated. We offset all of the impact of the reduced production, relative to unabsorbed overhead, we offset that with cost reductions.

So I think the only thing that ran away from us in the industry, I think, is what's happening to raw material costs and, as I said, we're running as fast as we can to try to recover those and taking the lead in the marketplace with the disciplined pricing. So I think relative to the reduction at a $1.7 billion level, I think we'll offset that overhead under-absorption with lower costs. So, I'm confident that the margins then, if we offset rise in raw material costs, that that 11% margin is very reasonable.

And the $17 million under-absorption?

That was not under-absorbed overhead. That was just the pure profit we lost on reduced volume.

Okay, so the equal amount was cost reductions. Though, would you characterize or could you characterize what amount of that would be fixed or structural reduction in cost versus just what I'll call variable cost reduction, whether it's overtime or temps, etc.

Yes, I can. About $3 million of our cost savings, $2.5 to $3 million were just pure headcount reduction. I think a lot of that was from process improvement. We had another $2 million from what I will say is lean fixed [sigma] improvements. And so, when I look at the bulk of our cost savings, I think, I know that they will repeat. But if you categorize, of course you categorize headcount and variables. If you look at that between fixed and variable the way you traditionally clarify it, we think that of our cost reductions this quarter probably around 30% came from the fixed side; 70% from the variable. But we think a good portion of those variable costs will not come back because they are the result of process improvements rather than just pure headcount reduction related to downturn in production.

Okay and final question, Mike, on the balance sheet, the Goodwill balance of over $1 billion now, have you done an analysis of that and are you comfortable that you don't need to do any reassessment of the value?

Well, we take a look at that each year and we look at that in the fourth quarter to assess the carrying value of that. With the downturn, we will probably just take a look at that a little sooner this year than the fourth quarter, but at this point in time we haven't made any conclusions with respect to the intangibles.

But just a further up on that, Mike, and that's obviously a very good question, insightful question, we had that discussion with our auditors just this past couple of weeks with our audit committee. And as Mike said, that we're confident in the business, they're confident in the business, but we'll do that evaluation probably in the next two or three months; two to three to four months.

Okay, thank you again.

Thank you. Okay, at this time we don't see any further questions. We do, Rob? All right, I think we have one more question?

One moment, please.

Yes.

Mr. Maloney, you may ask your question, please?

Okay, I may have been wrong and we don't have anymore questions. So again, thank you very much for your interest and we'll conclude our call.

Thank you. This concludes today's conference. Thank you for participating. You may disconnect at this time.