Mueller Water Products Inc (MWA) 2008 Q3 法說會逐字稿

Good morning and thank you all for patiently holding. I would like to remind all parties that your lines are on a listen-only mode until the question-and-answer segment of today's conference call. I will now turn the call over to Ms. Martie Zakas. Ma'am, you may begin.

Thank you, Laurel. Good morning, everyone, and thank you for joining us today as we discuss Mueller Water Products' results for the 2008 third quarter. We issued our press release reporting earnings for the three months ended June 30, 2008 yesterday afternoon, and a copy of it is available on our website. Slides related to this morning's call are also available on the website to help illustrate the quarter's results. In addition, we will be filing a copy of this morning's call's prepared remarks on Form 8-K.

Mueller Water Products had 115.4 million shares outstanding as of June 30, 2008, which is comprised of 85.8 million series B shares and 29.6 million series A shares, which are both traded on the New York Stock Exchange.

With us on the call this morning are Greg Hyland, our Chairman, President, and CEO, and Evan Hart, 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 they are used as the standard metric by the financial community. We believe these measures will assist in assessing the Company's underlying performance for the periods being reported. There are limitations to these non-GAAP measures, and reconciliations between GAAP and non-GAAP financial measures are included in the supplemental information within our earnings 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 statements. Please see our Form 10-K for the fiscal year ended September 30, 2007, as supplemented by our quarterly reports on Form 10-Q for a discussion of these risks.

This morning's call is being recorded and webcast live on the Internet. The archived webcast, along with the corresponding slides we are presenting this morning, will be available in the Investor Relations section of our website, www.muellerwaterproducts.com for at least 90 days after the presentation.

After the prepared remarks we will open the call for 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 third quarter of fiscal 2008. I'll begin today with a brief overview of the quarter. Evan Hart will then follow up with a detailed financial report, after which I'll update you on key drivers influencing our business, our outlook for the fourth quarter, and our strategy. We will then open the call up for your questions.

Net sales for the 2008 third quarter increased 5.2% to $528.5 million. Income from operations was $53.6 million and net income was $20.3 million, or $0.18 per diluted share. The operating income margin was 10.1% and adjusted EBITDA margin was 14.5% for the quarter.

During the third quarter we were encouraged by some of what we saw. Notably, steps we have taken have resulted in several positives in the quarter. We began to realize the results of our recently announced price increases. We continued to benefit from our aggressive cost reduction actions. And we enhanced free cash flow through our various working capital initiatives. Overall, we were pleased with our third-quarter results, but remain cautious about the near-term economic environment, given the increasing cost of raw materials and the weak residential construction market. I'll discuss both of these later in the call.

We also experienced a modest increase in year-over-year shipment volumes for the Company as a whole. This is the first quarter in the last six quarters in which shipment volumes have not declined on a year-over-year basis. We believe two primary factors may have contributed to this quarter's shipments -- lower distributor inventory levels and announced price increases. As we discussed on our last conference call, we believe that distributors may have more tightly managed their inventory levels during our second quarter. In our third quarter we entered the construction season and saw an influx of orders in April, which could have been due to lower inventory levels maintained by our distributors.

Additionally during the quarter, distributors may have placed orders in advance of the effective dates of the announced price increases for ductile iron pipe, valves, hydrants, brass service products, and Anvil products.

We also saw the continued benefit of the cost reduction and saving initiatives that we have been implementing for the past 24 months. Cash flow remains strong. Net debt declined $130.2million, or 12% to $954.8 million at June 30, 2008, compared to $1.085 billion at June 30, 2007.

I'll now turn the call over to Evan Hart, who will discuss our financial results for the third quarter in more detail.

Thanks, Greg. I'll start by reviewing the consolidated results and then discuss segment performance. Consolidated net sales of $528.5 million in the 2008 third quarter increased $26 million year over year due to $17.6 million of higher pricing across all business segments, volume increases at both U.S. Pipe and Anvil, and a $5.7 million favorable impact of Canadian currency exchange rates. Gross profit was $123.4 million in the 2008 third quarter, an increase of $3.9 million, compared to $119.5 million in the 2007 third quarter. Gross margin was 23.3% compared to 23.8% in the prior-year period.

Sales price increases of $17.6 million offset higher costs of raw materials and purchased components of $17.6 million. The increase in gross profit was principally due to cost reductions of $11.5 million and other savings which more than offset $9.5 million of under-absorbed overhead resulting from lower production levels.

Income from operations was $53.6 million compared to $57.4 million in the 2007 third quarter. Third quarter 2008 operating income and adjusted EBITDA margins of 10.1% and 14.5%, respectively, compare with the 2007 third quarter margins of 11.4% and 16.6%, respectively. The margin declines were principally from under-absorbed overhead, higher selling, general and administrative expenses, and higher raw material costs, partially offset by cost savings. Higher pricing only offset the dollar increase in raw materials which resulted in lower margins.

Selling, general and administrative expenses were $69.6 million in the 2008 third quarter, compared with $62.1 million in the 2007 third quarter. The year-over-year increase is largely attributable to higher sales commissions and distribution costs of $2.9 million and severance and other increased employee-related costs of $1.3 million. Also, the 2007 third quarter included a positive adjustment of $1.5 million, primarily for employee medical cost trends.

Interest expense net of interest income declined $5.8 million to $17.5 million in the 2008 third quarter, compared to $23.3 million in the 2007 third quarter. Gross interest expense totaled $18.4 million in the 2008 quarter, compared with $23.9 million in the prior-year quarter. Interest expense in the prior-year third quarter included a $1.7 million charge related to an interest rate swap adjustment. Gross and net interest expense were down year over year due to lower interest rates and lower average net debt outstanding.

Our effective tax rate was 43.8% in the 2008 third quarter, compared with 43.5% in the 2007 third quarter. During the quarter we had a discrete net adjustment of approximately $1 million, which increased the provision for income taxes. The largest component resulted from a true-up of a consolidated tax return filed by Walter Industries for periods prior to the spin off of Mueller Water Products in December 2006. As we look forward to the full year, we currently expect the effective tax rate to be 42 to 43%, including these items.

Net income per diluted share was $0.18 in the 2008 third quarter. This compares with $0.17 in the 2007 third quarter, when adjusted to exclude the loss on early extinguishment of debt of $0.18 per share.

I'll now move on to segment performance. Net sales for the Mueller Company segment were $203 million in the 2008 third quarter, compared to $203.1 million in the prior-year quarter. Net sales were essentially flat, as sales price increases of $4.8 million and a $2.4 million of favorable impact of Canadian currency exchange rates basically offset lower volumes of $7.3 million.

Unit shipment volumes of iron gate valves declined 1%, hydrants declined 8%, and brass service products declined 32% in the quarter, primarily due to the soft market associated with the continued downturn in residential construction.

Income from operations of $40.4 million and EBITDA of $52.7 million in the 2008 third quarter compared to income from operations of $41.5 million and EBITDA of $54.7 million in the 2007 third quarter. Higher costs of raw materials and purchase components of $5.3 million were partially offset by sales price increases of $4.8 million. Volume declines reduced profits by approximately $2.8 million. Cost reductions of $3.2 million, the favorable impact of Canadian currency exchange rates, and other net savings more than offset the negative impact of under-absorbed overhead and increased SG&A.

Net sales in the U.S. Pipe segment of $167.7 million in the 2008 third quarter increased from $153.3 million in the prior-year quarter. The increase was due to higher sales prices of $8 million and higher shipment volumes of $6.4 million. In the 2008 third quarter, income from operations was $2.9 million, and adjusted EBITDA was $8.5 million. These results compared to income from operations of $8.9 million and EBITDA of $15.2 million in the 2007 third quarter. The 2008 third quarter operating income was negatively impacted by $12.2 million of higher raw material costs, partially offset by sales prices of $8 million. Cost reductions of $4.9 million realized during the quarter and higher shipment volumes of $2 million partially offset the negative impact of under-absorbed overhead of $4.5 million, $1.4 million of start-up costs associated with the new ductile iron pipe manufacturing facility, and a $3.4 million provision for warranty-related expenditures.

Net sales in the Anvil segment increased 8% to $157.8 million in the 2008 third quarter, compared to $146.1 million in the prior-year quarter. The net sales increase was driven by sales price increases of $4.8 million, increased volume of $3.6 million, and the favorable impact of Canadian currency exchange rates of $3.3 million. Both income from operations of $21.9 million and EBITDA of $26.9 million in the 2008 third quarter increased over 2007 third-quarter income from operations and EBITDA, which were $17.4 million and $23.2 million, respectively. The increase in the2008 third-quarter operating income was primarily driven by sales price increases of $4.8 million, higher shipment volumes of $1.0 million, and cost reductions, which were partially offset by under-absorbed overhead, higher selling commissions, and ongoing administrative expenses largely associated with the separation of Anvil's manufacturing and distribution operation in Canada.

On a fiscal year-to-date basis, free cash flow, which is cash provided by operating activities less capital expenditures, amounted to $45.1 million in 2008. This is comparable to free cash flow for year-to-date fiscal 2007, excluding the impact of debt refinancing.

Earlier in the call, Greg mentioned the 12% decrease in net debt over the past 12 months. At June 30, 2008, net debt totaled $954.8 million, which is total debt of $1.0967 billion less cash on hand of $141.9 million. Total debt at June 30, 2008 was comprised of our $425 million senior subordinated notes at a fixed rate of 7.375%; $146.6 million of term A debt, currently at LIBOR plus 150 basis points; $528.1 million of term B debt at LIBOR plus 175 basis points; and $2 million of capital leases.

During the quarter we took advantage of the current low interest rate environment to swap portions of our variable LIBOR-based debt into fixed LIBOR rates. As a result, 82% of total debt outstanding is now fixed rate, and 18% is variable rate. Our fixed-rate debt is currently comprised of the $425 million senior subordinated notes and $475 million of term debt.

During June we entered into additional interest rate swap agreements that converted floating rate debt to fixed-rate debt. As a result of the new interest rate swaps, at least 70% of our total debt will bear interest at fixed rates through May 2012. The estimated all-in fixed rate from the swapped portion of term debt is currently 6.1% and it is expected to remain under 6.8% until the final swap agreements mature in fiscal 2012. Our scheduled principal repayments are minimal over the next three fiscal years, with $8.8 million due in fiscal 2009 and $19.5 million due in each of fiscal 2010 and 2011. Our first significant debt repayments of $115.1 million are not scheduled until fiscal 2012 when our term A debt matures.

We are well within our maintenance debt covenants. Our leverage ratio, which is net-net to EBITDA, was 3.5 times at June 30, 2008, well below the current maximum leverage ratio of 5.2 times. This maximum leverage ratio gradually scales down to 4.5 times in fiscal 2011. Our only other maintenance covenant is interest coverage, which was 3.7 times at June 30, 2008, well above the minimum interest coverage of 2.5 times.

We will continue to manage our capital structure and we believe that we have sufficient liquidity through cash on hand, future free cash flow generation, and availability under our credit facility to meet our foreseeable needs.

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

Thanks, Evan. As I said in my introduction, we have begun to realize higher pricing across most of our products in connection with the price increases we have implemented since January of 2008. For example, we have realized a cumulative price increase of about 24% on ductile iron pipe since the second quarter. Most of the price increases were realized later in the quarter, with more than half of the increase reflected in our July backlog. Within Mueller Company, the average cumulative sales price increases in our backlog were between 12 and 14% for valves and hydrants, and the sales price increase was 9% for brass service products. Most of these price increases are reflected in our July backlog.

During the third quarter, sales price increases just covered our higher raw material costs for the Company as a whole. However, within U.S. Pipe and Mueller Company we did not cover the higher cost of raw materials with the price increases realized as of June 30th.

For U.S. Pipe, even with the price increases we have implemented to date, we do not expect to cover the higher raw material cost of sales in the fourth quarter. As you know, scrap steel is the largest component of U.S. Pipe's cost of sales. We anticipate that the cost per ton of scrap that will flow through U.S. Pipe's income statement in the fourth quarter will be up over 60% from the second quarter. Now, total raw material cost through the first nine months of fiscal 2008 were approximately 47% of U.S. Pipe's cost of sales versus 33% in fiscal 2007.

We have just announced another 10.5% price increase for ductile iron pipe that will be effective August 18th. We do not expect to realize any of the benefits of this price increase until our first quarter of 2009. This price increase is needed to insure that we at least cover higher raw material costs in fiscal 2009. And this of course depends on both the price realization that we achieve in the marketplace as well as the ongoing cost of scrap steel.

Within Mueller Company we believe that the price increases implemented to date should at least cover our higher raw material costs in the fourth quarter, and could contribute to profits.

Anvil price increases more than covered higher raw material costs for the third quarter, and we expect this to continue in the fourth quarter. The increased raw materials cost for Anvil's recent purchases remain in inventory because of the pace of inventory turns in this segment. Anvil's cost of sales should begin to reflect these escalated raw material costs in the first quarter of fiscal 2009 as this inventory is shipped.

Other drivers that could impact first quarter net sales include residential construction, distributors' buying patterns, and municipal spending. Housing starts were down 30.6% for third quarter of 2008 versus the prior-year period. The extent and length of the downturn is still uncertain, as is the timing of the eventual recovery of the market. During the last three months the most recent Consensus Blue Chip Economics Indicators forecast on housing starts for 2008 dropped again from 980,000 units to 960,000 units.

In looking at our shipments and order trends, we believe we are seeing some growth in municipal spending. It is hard, however, to assess if the general uncertainty of the economy will affect municipal spending in the near term. We should note that, compared to prior-year periods, ductile iron pipe quotations for public works in terms of tons were down for the quarter, and are down 4% year to date. However, we remain confident that the need exists and the long-term prospects for water infrastructure investment by municipalities remains encouraging.

As we said earlier, we believe distributors placed orders in the third quarter in advance of the effective date of price increases. Fourth-quarter volume is expected to be impacted by the decline in residential construction and by this pull-forward of shipments into the third quarters for both U.S. Pipe and Mueller Company. We expect the net effect of lower residential construction, municipal spending levels, and distributor buying patterns to result in a decline in fourth-quarter volume both on a sequential and year-over-year basis.

As we previously discussed, revenues remained strong for our Anvil business, although there is some question about future level of activity in the commercial construction sector, based on where demand for our product falls in the construction cycle, our outlook for this segment remains stable for the remainder of the fiscal year.

In addition to the effects of price increases and volume changes, profitability in the fourth quarter will be impacted by the increasing costs of raw materials and the benefits from cost [reached] savings. The rising cost of raw materials continued to be a major variable to our profitability.

As I just discussed, scrap in U.S. Pipe's cost of sales is expected to be up over 60% in the fourth quarter from the second quarter, and the price we pay for scrap continues to escalate. In July U.S. Pipe paid $533 per ton for scrap steel. This is an 8% increase from April and a 134% increase from what we paid in July of 2007, and is greater than the cost of scrap that we expect to be reflected in U.S. Pipe's cost of sales in the fourth quarter.

Mueller Company's scrap purchase prices have also increased. On a blended basis they increased 24% to $699 per ton from April to July. July purchase prices for Mueller Co. was 59% higher than what we paid in July of 2007. Brass ingots increased from $2.64 per pound in January to $3.10 per pound in July, and is essentially flat since April.

During the third quarter we achieved $11.5 million of operating cost savings year over year, which included savings associated with the closure of the Burlington manufacturing operation, as well as ongoing lean manufacturing efficiencies and the headcount reductions we mentioned last quarter.

As you will recall we had always projected to begin production at our automated ductile iron pipe manufacturing facility late in the first quarter of fiscal 2009. However, we are doing our best to accelerate the start-up of the operation. We now expect to produce our first order of ductile iron pipe at this facility by the end of the fourth quarter of fiscal 2008, approximately three months ahead of schedule. We expect to begin to realize the full benefits of this lower-cost process in the second half of fiscal 2009 after a period of production start-up and the refinement of manufacturing processes.

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

One of our primary objectives is maintaining strong free cash flow. As Evan discussed earlier, free cash flow in the first nine months of fiscal 2008 was $45.1 million, which is 128% of adjusted net income. 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 based on improving working capital.

Other key variables for 2008 are corporate spending, estimated to be approximately $39 million. Our tax rate is expected to be approximately 42 to 43%. We estimate 2008 net interest expense to be within the range of $73 million to $74 million, and we expect capital expenditures to be within the range of $80 million to $85 million.

We will continue to evaluate the repayment of debt and the repurchase of stock on an ongoing basis, but for now we believe we should preserve the flexibility our current liquidity affords. Given the volatility in today's economy we believe this is the most prudent course.

To recap -- we saw several positives in the third quarter that were a direct result of steps we have taken. We began to realize the results of our recently-announced price increases. We continue to benefit from our aggressive cost reduction actions, and we enhanced free cash flow through our various working capital initiatives.

We remain cautious about the near-term economic environment, given the increasing cost of raw materials and weak residential construction market, but are confident of our ability to manage through these challenging conditions. We will take necessary actions to recover higher raw material costs and focus on cost reduction initiatives. We also believe the long-term prospects for the water infrastructure market are good and that we are well positioned to capitalize on growth opportunities.

With that, I'll open it up for questions.

(OPERATOR INSTRUCTIONS.) Mike Schneider; Robert W. Baird.

Greg, maybe first we can start with just the general revenue comments for the second half. Last quarter you had somewhat backed away from, based on market conditions, the ability to hold sales flat in the second half versus the first half. This quarter you did show $20-something million increase year over year. From that, have you revised your thoughts now on Q4 revenue? And, based on the volume of your clients, would you still expect revenue to be down then?

You know, Mike, that's a good question. And I think after seeing the results of the third quarter I think that right now that we would say that we expect revenues for total Mueller Water Products to be up slightly in the second half. And I think what primarily would be reflected is -- the comments that I made in our prepared presentation here is that when we entered the third quarter we saw an uptick in April orders. And we think primarily because our distributors managed their inventories so tightly in Q2 that, when we entered the construction season, they had to I would say almost probably rebalance or increase their inventory levels.

So I think that what we ended up seeing was in a, we'll say normal year, for the last several years, orders that we would have seen in Q2, probably in the January time frame, we saw in April. So I think that probably that will contribute to now slightly higher shipments in the second half this year versus second half of last year.

Okay. And then, sticking with U.S. Pipe for a minute, you mentioned that the cumulative price increase now has been 24% in U.S. Pipe, half of which is reflected in the July backlog. I'm curious, though -- the last price increase that went into effect, well the first one I guess, was on January 15th. That was 15%.

Yes.

And you had mentioned that that would generally benefit the fiscal third quarter.

Right.

And if I look at the fiscal third-quarter numbers you've disclosed, it looks like there was, in U.S. Pipe, a 4.7% price benefit. How do we reconcile that 4.7 points with the 15% that was issued back on January 15th?

You know, Mike, I think you may be looking at that on a year-over-basis.

Yes.

Yes. Actually, last July our average price per ton, and I have the July but it was around -- we were over $900 in the third quarter per ton last year. In January of this year that was around $880. So actually what happened in I'd say the last six months, or certainly the last quarter of our fiscal 2007 and first quarter of 2008, prices actually dropped in the marketplace. So when you look at our price increase that we announced, 15%, that was on probably I would say a price per ton that was already $40 less than what we were seeing in the third quarter last year.

Okay. So in other words, the 4.7 points, would you believe that is almost full realization of the first round of pricing?

No. I think that when you look at our shipments in the third quarter, that we think that we got probably a total of -- I mentioned that we have in our backlog about 24 percentage points. I think we got around 10 percentage points in Q3 over our Q2 average selling price. And therefore, we think we probably have another 14 percentage points in our backlog that we should see in Q4.

And will Q4 then, that 14 points, will that fully reflect the 10% price increase that you put into effect on April 25th?

Well, if you look at our combined pricing increases, so the 15% and the 10%, we will be at about 90% of those combined price increases. So if you take the 15 times another 10, that's a total of about 26, between 26 and 27%. We'll be at 24%. So we're about -- we'll have about 90% of those combined price increases.

Okay, but to be clear --

Of the July backlog.

Right. Okay. Impressive. And then to be clear, because materials have since sequentially risen again, you need this additional 10 points that you're putting into effect August 18th?

Yes. As we look at it, we need most of that to be able to recover what's happened to us on raw material costs for U.S. Pipe.

Okay. And if you'll bear with me a moment on margins in U.S. Pipe, you mentioned you go through the under-absorption impact. You go through the net price and cost impact. And if one is about 270 basis points of hit during the quarter, the price cost gap is 200 basis points. So with that, if I add that to this quarter's margins, assuming again normalized volumes, you're about 7% already. On top of that, I'm curious -- you mentioned in the slides for the first time that there was $1.4 million in start-up costs, and $3.4 million in warranty costs. Were those included in some of the expenses you cited in the release or are those separate?

They were included in some of the expenses in the release.

Okay. So those would be embedded in the under-absorption hit?

Actually they would be in an area that is not related to production cost savings, but it is in other areas. But you would see that reflected actually in the margins.

Okay. And then those costs, the $1.4 million, where does that amount head from here and when does it actually go to zero? And then secondly, the warranty expenses -- is that a one-time adjustment or is this something that continues?

Yes. We expect the warranty adjustments, to the best of our knowledge right now, that that's a one-time. We would expect probably to see similar start-up costs in Q4, I mean the cost in Q4, primarily because, as I said, we expect to ship our first orders in Q4. But we'll probably be less than 10,000 tons. So in essence we have a cost that we are absorbing in the start-up of that facility with very little shipments against it. When we get to Q1 of fiscal 2009 our shipments then should absorb and more offset that. So I would say it's still ahead of us in Q4, and I would say I would expect that we'll probably see about the same kind of cost hit.

When we're talking about Pipe, as we look at it, we still think we have at least a couple of tough quarters ahead. One, as we've been talking, we have to offset higher raw material costs. And we've had a dramatic increase, as we've talked about on the last few calls, on the raw material costs and not been able to offset them. And we still have higher costs in inventory that are going to flow through the Pipe P&L in the next several quarters. As I said, raw material costs are now 47% of costs of goods sold, up from 33% in fiscal 2007. We expect that probably by the end of the year that could be 50% of our cost of goods sold, just being raw material costs. So you're right; we need that additional 10.5% increase, most of that, to offset it. But as we look at the next couple of quarters, I think that we'll still have some tough quarters of Pipe.

Okay. And then final question and I'll get back in line. Excuse me. The $3.1 million in operating income you reported in Pipe, then really if we add back the $3.4 million was more than double what you reported?

Looking at as a one-time expense, that's right.

So margins, instead of 1.8 were actually 3.8 or 3.9?

You could add that -- adding that way, yes.

And you're definitely not whole on raw materials yet? You're still almost near 4%.

Yes. And I think that, as I just said, that raw materials could even be a bigger hit in the fourth quarter, primarily because if you look we've done a good job of reducing inventory in our U.S. Pipe business. And it's not completely reflected when you look on the balance sheet because the higher cost of raw materials that are there, but in terms of tons, we've taken our inventory down about 45% the last quarter. As we do that, accounting on a FIFO basis, the increase in raw material cost we've seen the last couple quarters that have been in inventory will flow through in Q4.

Okay. Thank you again. I'll get back in line.

Keith Hughes; SunTrust Robinson Humphrey.

I just wanted to clarify something from the previous question. Your expectation is the sales in the second half of fiscal '08 will be slightly ahead of the second half of fiscal '07. Is that correct?

Yes. That's right, Keith, on a sales-dollar basis.

On a sales-dollar basis. Okay. Now you talked about several things that helped volume in the quarter. Was the pre-buy aspect, was that a bigger impact in the U.S. Pipe segment versus the Mueller segment?

It's tough to say. I think it was a benefit for both. And it's hard to say which is -- certainly with Mueller, with most of our business going through distributors, it's easier for distributors to bump up and bring orders ahead. And they'll just bring it into inventory. With pipe, as we've talked in the past, most of our distributors do not inventory pipe. But our U.S. Pipe people reported that there was projects in planning stage, or before they'd actually begun, that they brought in the pipe and just put it on the ground. So it would be hard to say which benefited, but certainly both businesses benefited.

Okay. You highlighted for us another price increase coming in U.S. Pipe. If there are further increases in scrap steel prices, which some fear, that would necessitate more pricing action. Is that correct?

For -- I'm sorry, Keith.

Let me ask it this way. The price --

For U.S. Pipe and Mueller, or --?

Yes. I guess that would be right, [enterprise-wide.] I guess the point is, the price increases that are coming in the near term, that is still an attempt to catch up with where steel prices are currently. Is that correct?

Certainly, yes. Certainly for U.S. Pipe. On Mueller, even though we're seeing certainly higher prices of scrap steel, raw materials for that business is only running about 11.5% of cost of goods sold. So that has a much less of an impact as it does on U.S. Pipe. But certainly that's the case for U.S. Pipe.

Okay. And could you remind us again, with the new plant coming on line little sooner than expected, have you put a updated number on potential cost savings from that facility once it's fully in production later in fiscal '09?

Yes. We said that there's a three-year payback on that facility. And we've said that facility will cost us $45 million to $50 million in capital. In fact I said we expect less than a three-year payback. And right now we would be forecasting that on the tons that we manufacture in that facility we would probably have at least a 15% reduction in our cost per ton. So if you look at the $45 million to $50 million capital expense, and then probably some of the start-up costs to pay back, we're still confident we'll pay back that in three years. So when it's fully operational, we would think a $20 million savings per year is certainly what we're targeting.

Okay. Final question -- on the dual-class share structure, any potential changes coming to that in the future?

You know, Keith, good question. We've talked about this with a number of our investors and our analysts. And the IRS has no hard and fast rules, but generally what we have seen, that any companies in the past have had this structure, is that the earliest we'd see anyone collapse these has been 26 months. In December it will be 24 months since our spend, so we're certainly getting into the period where we think that it's very reasonable that we will be able to do this. And we think that it makes sense. We think our shareholders want it. But certainly, to point out that both classes of shareholders have to vote for it. But at the end of this year we will reach that time period that we think will give us the flexibility to move forward on this.

All right. Thank you.

Kevin Maczka; BB&T Capital Markets.

Just another question on volumes if I could. You gave some nice color on your Q4 expectations. But I'm wondering if you look out beyond that, look at '09, if you've got a housing environment that's still weak, a commercial construction market that is okay but slowing, and I think you commented that the muni marketplace you're still seeing some growth there, but maybe quotation activity isn't quite as strong, I guess. And you blend all that together. Can you give a little bit of color around your expectations for '09 volumes?

Yes, Kevin, and this is very preliminary. We're still going through putting together our '09 plan. We've always said in the past that in the residential construction market that we are going to lead going down because it's not the construction of an individual house that really drives demand for our product. It is when the development goes in. And though we cannot find specific data, that we think it's very reasonable to expect that this was the first area that builders cut back, and new developers. So I would think when we get in the early -- at least by 2009 on a comparable basis, that it won't drop any further -- for us. Housing starts I think we're seeing some forecasts that are saying housing starts could still continue to drop in 2009. But we would think when we get into 2009, at least by mid-2009, and perhaps sooner on the residential construction side, that on a year-over-year comparison that we won't see any further drops.

Commercial construction, again where we fall in the cycle, I think that certainly, as I said on our prepared remarks, that the fourth quarter was stable. I think we feel probably reasonably comfortable to think that our volumes will be stable at least through this calendar year, so and through the first quarter of 2009. But then we'll be getting some further insight there.

Municipal spending I think is the one variable. We have seen year to date some year-over-year growth. Our order trends, our shipment trends, would indicate that, based on some year-over-year results from the different regions, our different sales regions. In fact, when we look at year to date, our orders are actually up in the Mueller businesses and our Northeast and Central regions on a year-over-year basis. Those are regions that have been less driven by residential construction, more by municipal spending.

But we have seen some instances of projects that were budgeted at the municipalities and when the actual costs were coming in, or actually quoted, that they were so far in excess of what was budgeted that the municipalities have pulled those back. And we're not talking only what's happened to ductile iron pipe, but just about every commodity that probably is going into that project is up significantly in the last six months due to the inflation we're seeing in so many commodities. We don't think those will be cancelled, but we do think that they'll be pulled back as the municipality looks at their budget and how they'll fund it.

So looking at 2009, I think we expect at least for half of the year still to see a stable commercial construction market, that we think that we'll reach a point in 2009 where our comparables from residential construction, that we don't see any further decline. And municipal spending I think at this point still remains a variable to be seen.

Okay, great. And if I could just ask one more on visibility in general, both on the municipal side and your business in general. I'm sure those pre-buys ahead of the price increases must have caught you somewhat by surprise, and I'm just wondering what kind of visibility you have. Can you look out a quarter or more? Or is more measured in weeks?

That's tough to measure. It didn't catch us too much by surprise, because generally that is the pattern. And I think this go-around that distributors knew that these price increases were going to stick because of what was happening in commodity pricing. So I think that that certainly contributed. I think maybe in our February price increase that there was still some question, are these prices going to stick? I think when we got to April, and again what was happening to scrap steel and other commodities, that they knew that these were necessary.

It's difficult to say how much, what was pulled forward. We do get some insight from our July orders. For instance, on our Mueller branded products, so our valves and our hydrants and our brass products, on a dollar basis July year over year -- July orders this year were down about 28 to 29%. And that's on a higher dollar because our pricing's higher now than it was a year ago. Certainly residential construction could have contributed to that. But I think that probably as much as anything was the pull-forward from July, August orders into late May, early June. That was a total of a little over about $10 million to $11 million. And even on the U.S. Pipe side, that if you look on a July-over-July basis our tonnage was down about 15, 16%.

So I'm sorry; it's difficult to give an exact dollar number of what was pulled forward, but if you look at the magnitude on a year-over-year basis, our July orders for our Mueller brand of products down about $10 million. We'll probably still see a fall-off in August for that, for the pull-forward. Hopefully when we get into September then we'll be seeing orders that reflect demand.

Okay, great. Great color. Thank you.

Seth Weber; Banc of America.

Greg, just following up on your last comment, can you give us similar color on what orders looked like in May and June I mean, it sounded like April was real strong. Did the quarter kind of taper down from the strong April into May, June and then July again?

Well, we saw a strong April across the U.S. Pipe and Mueller, and then a real jump, Seth, in essentially Mueller in the last week in May and the first, say, first ten days in June. And again, when you think about it, our distributors, when they pull forward orders, generally that's for products that they don't have an immediate need. So they wait until that very last possible moment to place the orders in advance of the price increase. But certainly May was our largest order month by quite a bit for Mueller. In fact, it was two times greater, double, than what April was for Mueller. So clearly that's the pull-forward.

And on Pipe it was a little more evenly distributed across the quarters because the Pipe price increase went into effect a little sooner than the Mueller.

Okay. Great. Thanks for that.

Let me -- I'll give you a little more color on the Pipe. Pipe actually was -- April and May was the two big orders and it did drop off quite a bit in June.

Okay. And then, so just to recall, so you had a 15% price increase on the valves effective June 2nd.

Yes.

And then I think 12% on brass May lst. Can you give us some color as to how much of that you're actually recognizing? Last quarter you talked about it; you gave us some color in terms of basis points as a percentage -- relative to the actual increase.

Yes. If you look at our shipments, and I said in the prepared comments, that if you look at our July backlog for valves and hydrants, we say we probably have 12 to 14 percentage points. So if you look at our combined price increases of a 5% February lst, an additional 15%, if we were able to achieve all of that our prices would have been up about 21% from the price that we would have had for that product in January. And our backlog is up about 12, as I said, 12 to 14%. I think in our valves and hydrants we probably realized about 4 percentage points. So we still have anywhere to 8 to 10 percentage points benefit in Q4 that's in our backlog.

On the brass products, we saw again probably about -- of the 12 percentage points, we have 9 percentage points in our backlog of which we saw probably about 3 percentage points in Q3. So we'll probably have another 6 percentage points to realize in Q4. And hopefully that's clear, because I even get confused going through that. But hopefully that gives a sense.

Yes, that's helpful. And are your competitors matching these prices? Or what's the environment look like out there?

From what we've seen in the marketplace, the fact that we were able to realize these price increases I think gives us confidence that our competitors are also increasing those prices. And of course from a price announcement we know that they have announced similar price increases.

Okay. And then lastly, if you could just drill down a little bit on your comment about the Mueller top line being up a little bit year over year for the second half. I get that volumes are under pressure a little bit, but given the price increases it just seems hard to reconcile. It seems like that number should be a little bit stronger in the fourth quarter than maybe what you're suggesting. Or am I missing something?

I'm sorry, Seth. Now when you said -- you mean the Mueller segment?

The Mueller -- I thought you said the Mueller segment revenue was --

I'm sorry. That's -- I'm sure Mike Schneider's still on -- I interpreted Michael Schneider's question being Mueller Water Products.

Oh, okay.

Sorry. So I was talking Mueller Water Products. For Mueller Company, specifically -- we do look, the second half of the year, we look as going to be pretty flat we think. Because we talk about volumes were down in the third quarter on a year-over-year basis. And we do expect volumes to be down in Q4.

Right. Okay. But that's for the segment you're talking about.

Yes. Mueller Company segment, we think that's probably going to be pretty flat year over year. Mueller Water Products in total we think will see a second half up slightly over second half last year.

Okay. That makes more sense. Thanks for the clarification. That was it. Thank you.

Brent Thielman; D.A. Davidson.

My questions have actually been answered. Thank you and congratulations.

Christopher Glynn; Oppenheimer & Co., Inc.

Did you say at Mueller Co. that raw materials are only at 11.5% of COGS?

Yes, that's right. Now, raw materials -- and I think that, Chris, it's important to point this out and some of our discussions in the past, would you look at it -- purchased parts are almost 45%. So we make a distinction in our 10-K that hopefully is not confusing, but when you look at the absolute scrap steel that we buy -- that's the biggest portion of raw material. If you look at raw materials, that's 10.5, but we have purchased parts are another 44.3, 44%. So hopefully that clears it a bit.

Yes. And would there be somewhat analogous inflationary pressures there?

Yes, but I don't think -- we're not seeing that to the same extent that we are in scrap steel. Scrap steel's been a real runaway. We are seeing inflationary pressures, because the purchased parts go all the way from fasteners to actuators. So it's quite a list of items. We are seeing inflation there, but it's nowhere near what we're seeing on scrap steel.

Okay. And then, trying to speak a little to the net price cost outlook. Maybe it came out and I missed it, but a lot of numbers going around. Looks like Mueller Co. will be positive on the price cost in the fourth quarter and then U.S. Pipe a little bit tougher. Would you expect the overall company a little bit ahead in the fourth quarter?

Right now that's tough to say based on what we realized on these price increases. But I think we're in a lot better position in Q4 to be in positive territory than Q3. Just as we said, we just broke even in Q3, and that was really on the strength of Anvil. Anvil, as I mentioned, because of inventory turns there, we still have a higher cost of raw materials in inventory now and we'll be getting our price increases a little sooner. But we're hopeful that as we look at it today for the total company that we may be in positive territory on pricing on a year-over-basis relative to raw material costs.

Okay. That's very helpful given the difficulties in a truly precise answer. And just going into the first quarter, sounds like that's when you'd expect Anvil COGS to have a little tougher dynamic. Net company, do you think you can kind of hold this parity/parity-plus in the first quarter?

I'll tell you what, it's tough to see. I think we know for sure what's coming through cost of goods sold. We have a pretty good idea of what's coming through cost of goods sold on Anvil, but we are still -- obviously first quarter will still be very influenced by what's continuing to happen to cost of scrap steel and what we see in the pricing environment. So right now I think that would be difficult for us to predict.

Okay, and then just lastly on Anvil. You've gotten ahead on the price, the costs still coming. Maybe you can have a further price increase to stay positive there?

Well, we have been -- I'll tell you that group has been very aggressive within -- leading in their marketplace. And that would certainly be an objective that we would hold out there. But we have been pretty aggressive, I would say, in Q2 and Q3 on price increases. And just depending on the product we've gone up anywhere from 10 to 25% on our products there.

Okay. And the reason you wouldn't be -- having that in guidance so you could stay ahead is just because it's too early to call?

Well, early to call and market acceptance, and so I think a variety of factors.

Okay. And then finally -- that might have been the second time I said that -- but I know it's difficult to isolate the pull-forward, but comments just around the hydrants business on potential pull-forward?

Again, when I look at hydrants on a July year-over-year basis, our July orders were down 20% this July versus July of last year on a dollar amount, and this is on a higher dollar. So I would think that we saw -- again, it's difficult to put an exact number, but I would say that probably hydrants were no different than valves. So I'll be able to probably answer the question a whole lot better at the end of the fourth quarter.

And higher dollar, you just mean price?

Yes. Yes. Yes, price.

Okay. Great. Thanks a lot.

Dori Konig; Lehman Brothers.

Can you guys please provide us with a little more color around the $5 million cost savings in the Mueller Co. segment, and how we should be thinking about the cost savings in this specific segment as we look into the fourth quarter of next year?

Sure. I'll ask Evan to address that.

Okay, thanks Greg. In the Mueller Company segment, the $5.1 million was broken down -- about $1.9 million was headcount related. The other component, about $3 million, was manufacturing efficiencies, manufacturing efficiencies such as scrap reduction, supply reduction and other lean manufacturing concepts. We estimate that these reductions are about 70% fixed and 30% variable in nature. So 70% will be ongoing savings as we continue. But once again, those savings are headcount and manufacturing efficiency related.

You know, Dori, I think it's important to point out that I think as we go forward, especially as we go through 2009, probably on a year-over-year basis that we'll see that cost savings on a year-over-year basis get smaller. Because it was about this time last year, and those that were on the call remember that we started taking some very, very aggressive actions in taking out costs, taking headcounts down. We're still seeing year-over-year benefit, but we expect going forward across the board that that benefit will get smaller.

Got you. Great. That's very helpful. Just on the free cash flow -- you guys generated some great free cash flow in the quarter and you guys are sitting on about $142 million in cash. Can you provide us with some color on your comfort level around the debt levels? And being that the bonds are trading in the low 80's, is that something you're looking at as a possibility of reducing?

Certainly we, as I said on our call, we're looking at not only buying back debt, we think that our price of our stock is certainly a compelling value. But again, I would reemphasize that, given the current volatility in the economy that we think we should at this time maintain the flexibility that the current liquidity offers us. But we certainly, again, as when we refinanced our debt in 2007 before the credit tightened and corporate interests costs increased -- we got some very favorable terms. But back to your point, we do continually monitor where our bonds are trading. And that's something that we analyze. And it is a distinct possibility that that would also be a compelling action for us.

Great, great. And then just one last question. On the working capital front, you guys did a great job managing that in the quarter and bringing it down as a percentage of sales. Going forward into the fourth quarter and into next year, how do we think about it?

Well, fourth quarter -- when you look at it, we had probably a jump in receivables at the end of the quarter. That was due to the timing of certainly the shipments, the orders -- Seth Weber's question on the timing of orders -- where we saw the big influx of orders in May. Lot of those shipped at the end of the quarter that resulted in receivables I think going up. Generally if we look in Q4 and Q1, our receivables come down. So as we look, I think, for at least the next quarter or the next quarter and a half, then I think that we should see very positive working capital, especially on the receivables side.

Right.

Great. Thank you very much.

Mike Schneider; Robert W. Baird.

Greg, maybe we could just circle back to the net effect of the pre-buy and then your comments about second-half revenue for the total company being up year over year. That seems like still a pretty significant statement, because it looks like that means fourth-quarter revenue is basically going to be flat or maybe slightly down. So despite the impact of the pre-buy, you've somewhat raised your expectations for revenue, and in particular, for the fourth quarter. What is running ahead of your plan in terms of revenue by segment to cause that net positive adjustment?

For the second half? Well, certainly I think that, Mike, when you look at it on a year-over-year basis we're expecting to see a nice bump-up in total on price. So again, as we said, I expect volume to be down, but when you look at the pricing that I think is in our backlog, as we talked about, we should see on a year-over-year basis a very positive contribution on the price side.

I think that, certainly -- and again I know I'm repeating myself -- the bump-up in April orders will certainly help us. But I think that when we look at where Anvil business is, that we think that there's a reasonable chance that the Anvil sales could be higher. I think that when we look at Mueller, and I answered this earlier, I think that we'll be at best flat. That could be down a bit. But if you look at what we have in pricing for Pipe, I think that that could be the contributor to get us up where we're very slightly ahead.

So that's what contributes to right now our expectations that we may be up slightly. Would I be surprised though if at the end of the quarter we were only flat? I wouldn't be surprised. So I'm hedging a little bit, but as we look at it right now, on the pricing that's in backlog, I think that that has a reasonable chance to get us to where we might overall see a slightly higher second half in total revenues for Mueller Water Products than what we saw second half of last year.

I guess what I'm asking, Greg, and this is somewhat convoluted, but the effect of the pre-buy was, in effect, adverse to you in revenue, because people are buying products at lower ASPs. And, as a result, Q4 suffers from lower volumes on that against those higher prices. So, despite that kind of adverse shift in your price mix, if you will, you've raised your second-half revenue expectations. And I'm just curious if indeed there's any product category or element to explain why in this type of market you're actually raising your revenue expectations?

Mike, you're right certainly about the pre-buy. What contributes a bit was probably the movement of orders that we would have typically seen at Mueller, I think in January, a [shift] in Q2, that we saw in April.

Got it.

So that -- I may have misspoke when I said the pre-buy. What I think more that I was referring to was the April jump, because I think the distributors went into the buying periods with inventories that were less than adequate because of their under-buying, or their under-ordering in Q2. However, I will say that I think -- I want to make sure that I temper when we say that the second half now higher than second half last year. It was more in response to what we said, and the question was, what we said last conference call, where we said that it would be below or flat. I think that now I would say flat to up slightly.

Yes. Fair enough. And then, just on production levels, so we understand the under-absorption effect here -- where do these lines cross on under-absorption in Mueller Co. and in the U.S. Pipe segment? When do you expect production levels to be up? Or what has to happen for those under-absorption dollar amounts to actually disappear?

On the U.S. Pipe, we will still be facing a year-over-year under-absorption -- and probably what's driving that more and I answered this a little earlier -- is that if you look at the last two quarters that we have almost taken our inventory in half, down in half, cut it by half. And yet in Q3 we shipped about 2,000 more tons in Q3 this year than we did last year. So a lot of that came out of inventory. So we reduced production. That under-production goes into inventory and then will impact us in Q4.

Actually, on the Mueller side we're hopeful that if we don't see a big drop-off, if the pull-forward wasn't greater than what we expect, that we may be in positive territory for Mueller on a year-over-year basis, primarily because, if you will recall last year, that we had an aggressive inventory takedown across the businesses, but primarily in Mueller. And we had about $5.5 million of under-absorption in Q4 last year due to that inventory takedown. That's behind us. So we think that there's a real possibility that we could be in positive territory on the Mueller side in Q4. But I think we're still a couple quarters away at U.S. Pipe.

Okay. Congratulations to you guys. I'm sure this hasn't been fun.

Well with that, we certainly appreciate everyone's joining us for the call and your questions and your continued interest in Mueller Water Products. And, again, thanks for joining us today.

That does conclude today's conference. Thank you all for participating.