Mueller Water Products Inc (MWA) 2009 Q1 法說會逐字稿

Good morning, and welcome to the Mueller Water Products conference call. (Operator Instructions). At this time, I will turn the call over to Ms. Martie Zakas. Ma'am, you may begin.

Good morning everyone, and thank you for joining us today as we discuss Mueller Water Products' results for the 2009 first quarter.

We issued our press release reporting results of operations for the three months ended December 31, 2008 yesterday afternoon, and a copy of it is available on our website.

Mueller Water Products had 115.5 million shares outstanding as of December 31, 2008. Last week, we announced that stockholders approved a proposal to convert the Series B common stock into the Series A common stock. As a result of the conversion, each outstanding share of Series B common stock has been converted into one share of Series A common stock. Trading of the Series B common stock on the New York Stock Exchange ceased prior to the open of trading on January 29, 2009. We believe this conversion will simplify the Company's capital structure and enhance liquidity.

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-financial measures which are derived from GAAP financial measures. These non-GAAP measures are provided because we believe they are used 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 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 statements. Please see our Form 10-K for the fiscal year ended September 30, 2008 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're presenting this morning will be available in the investor relations section of our website at www.MuellerWaterProducts.com for at least 90 days after the presentation. The slides related to this morning's call are 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.

After the prepared remarks, we will open the call to questions from our dial-in participants. I will 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 first-quarter fiscal 2009. I will begin today with a brief overview of the quarter. Evan Hart will then follow up with a detailed financial report, after which I will update you on key drivers influencing our business, our outlook for the second quarter, as well as how we're managing through this economic downturn. We will then open up the call for your questions.

Net sales for the 2009 first quarter were $367.7 million. Adjusted income from operations in the first quarter was $12.7 million, and adjusted net loss was $0.00 per diluted share. Adjusted operating income margin in the first quarter was 3.5%, and adjusted EBITDA margin was 9.7% for the quarter. Excluded from these results is an estimated goodwill impairment charge of $400 million, which Evan will discuss in detail.

As we discussed on our last conference call, bookings declined in September and October, and that trend continued throughout the quarter. Volume was down $80 million with shipments of our core water infrastructure products down between 30% and 40% year over year. We believe a sharp decline in municipal spending coupled with continued distributor destocking were the primary drivers of this drop-off.

If you recall, municipal spending had been growing prior to September. However, a liquidity crisis, municipal budget shortfalls, and uncertainties surrounding the proposed federal stimulus bill all factored into the decline in municipal spending. I will talk more about our markets later in the call.

During the quarter, we implemented further action to respond to this current fall in market conditions by reducing headcount and cutting production. Until we see improvement in our markets, we will manage our controllable expenses and match our production to demand.

We did see several positives during the quarter. We continued to see the benefits of the price increases realized during the second half of fiscal 2008 and saw a significant decrease in the purchase price of our key raw materials. We will cover this in more detail later in the call.

I will now turn the call over to Evan Hart, who will discuss our financial results including our debt and liquidity position. I will then come back and provide an outlook for the second quarter and second half of fiscal 2009.

Good morning, everyone. I will now provide a more in-depth review of the financials. I will first review the consolidated results and then turn to segment performance. The results I will be discussing exclude the impact of the first-quarter 2009 goodwill non-cash charge, which I will discuss after presenting segment performance.

Consolidated net sales of $367.7 million in the 2009 first quarter decreased $44.6 million year over year. Net sales decreased due to lower shipment volumes of $80 million across all of our business segments and $8.4 million in unfavorable Canadian currency exchange rates, which were partially offset by $43.8 million of price increases implemented in fiscal 2008.

Gross profit was $75 million in the 2009 first quarter, a decrease of $19.4 million compared to $94.4 million in the 2008 first quarter. Gross margin was 20.4% compared to 22.9% in the prior-year period. Gross profit decreased primarily due to higher raw material costs of $40 million, lower volume of $27.9 million, and $1.1 million due to unfavorable Canadian currency exchange rate. This was partially offset by higher sales pricing of $43.8 million and cost savings of $10 million.

Adjusted income from operations for the quarter of $12.7 million decreased $19.9 million from the prior-year period of $32.6 million. 2009 first-quarter adjusted income from operations was negatively impacted by higher raw material costs and lower shipment volumes, partially offset by higher sales pricing, operating cost savings, and a $3.5 million gain on the sale of a building.

First-quarter 2009 adjusted operating income and adjusted EBITDA margins of 3.5% and 9.7%, respectively, compare with a 2008 first-quarter margin of 7.9% and 13.6%, respectively.

Selling, general and administrative expenses were $62.3 million in the 2009 first quarter compared with $61.8 million in the 2008 first quarter.

Interest expense, net of interest income, declined $1.9 million to $17.3 million in the 2009 first quarter compared to $19.2 million in the 2008 first quarter.

Gross interest expense totaled $18.1 million in the 2009 quarter compared with $20.6 million in the prior-year quarter. Gross and net interest expense was down year over year due to lower interest rates and lower average net debt outstanding.

In the 2009 first quarter, the total income tax benefit of $2.9 million included a $1.2 million adjustment to the valuation allowance related to nondeductible compensation. The income tax benefit also included $400,000 principally related to legacy state income tax matters that have effectively been resolved. There was no income tax benefit related to the goodwill impairment charge. Excluding these items, the effective income tax rate was comparable to the 2008 first quarter.

Adjusted net loss per diluted share was $0.00 in the 2009 first quarter compared to $0.07 per share in the first-quarter 2008, which excludes $0.08 per share of restructuring charges associated with the Burlington closure.

I will now move on to segment performance. Net sales for the Mueller Co. segment were $119.6 million in the 2009 first quarter compared to $161.6 million in the prior-year quarter. Lower shipment volumes of $49 million and $1.8 million of unfavorable Canadian foreign currency exchange rates were partially offset by higher pricing of $8.8 million. Unit shipment volumes of iron gate valves, hydrants, and brass service products declined about 40% in the quarter.

Adjusted income from operations of $8.5 million and adjusted EBITDA of $20.8 million in the 2009 first quarter compared to income from operations of $24.8 million and EBITDA of $37.4 million in the 2008 first quarter. Adjusted income from operations was reduced by $21.2 million due to lower shipment volumes, $6.1 million of higher cost of raw materials, and $500,000 of unfavorable Canadian foreign currency exchange rates. This was partially offset by operating cost reductions of $4.6 million and higher sales pricings of $8.8 million.

Net sales in the US Pipe segment increased in the 2009 first quarter to $115.7 million from $110.7 million in the prior-year quarter. The sales increase was attributable to $22.8 million of higher pricing partially offset by $17.8 million of lower volume of ductile iron pipe shipment.

In the 2009 first quarter, adjusted loss from operations was $6.5 million and adjusted EBITDA loss was $400,000. These results compare to adjusted income from operations of $900,000 and adjusted EBITDA of $6.8 million in the 2008 first quarter.

The 2009 first-quarter results were negatively impacted by increased raw material costs of $30.4 million and $4.7 million related to lower shipment volumes. These items were partially offset by operating cost savings of $4.4 million and higher sales pricing. The higher sales pricing of $22.8 million did not cover the higher raw material costs of $30.4 million in the quarter.

Net sales in the Anvil segment were $132.4 million in the 2009 first quarter compared to $140 million in the prior-year quarter. The net sales decline was driven by $13.2 million of lower shipment volumes and $6.6 million due to unfavorable Canadian currency exchange rates. This decline was partially offset by higher sales pricing of $12.2 million.

Income from operations of $21.3 million and EBITDA of $25.5 million in the 2009 first quarter compared to income from operations of $15.9 million and EBITDA of $20.9 million in the 2008 first quarter. Income from operations increased principally due to higher sales pricing, a $3.5 million gain on the sale of a building, and cost savings of $1 million. 2009 first-quarter results were reduced principally by higher raw material costs of $3.5 million and under-absorbed overhead of $4.7 million.

Free cash flow, which is cash provided by operating activities less capital expenditures, was a use of $27.9 million in the first-quarter 2009. This compares to cash generation of $39.1 million for the first-quarter 2008. The decline in cash flow was primarily attributable to the $87.6 million reduction of payables and accrued expenses.

At December 31, 2008, net debt totaled $937.2 million, which is total debt of $1.089 billion less cash on hand of $151.8 million. Total debt at December 31, 2008 was comprised of our $420 million senior subordinated notes at a fixed rate of 7 and 3/8 percent, $141.6 million of term A debt at LIBOR plus 150 basis points, $525.4 million of term B debt at LIBOR plus 175 basis points, and $2 million of capital leases and other.

As we noted last quarter, we have interest rate swap agreements that effectively convert floating-rate debt into fixed-rate debt. As a result of these swaps, at least 67% of our total debt will bear interest at fixed rates through May 2012. The estimated average all-in fixed rate on the swap portion of term debt is currently 6.1% and is expected to remain under 6.8% until the final swap agreements mature in fiscal 2012.

During the quarter, we repurchased $5 million principal amount of senior subordinated notes at a discount, which generated a gain of $1.5 million. Our scheduled principal repayments are minimal over the next three fiscal years, with $8.9 million due over the remainder of 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 2012, when our term A debt matures.

At the end of the first quarter, our leverage ratio, which is net debt to EBITDA, was 3.72 times below the maximum leverage ratio of five 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 3.66 times at December 31, 2008, above the minimum interest coverage of 2.5 times.

We anticipate that our existing cash, cash equivalents, and borrowing capacity combined with our expected operating cash flows will be sufficient to meet our anticipated operating expenses, capital expenditures, pension contributions, and scheduled debt service obligations as they become due for at least the next 12 months.

As a result of the significant deterioration of equity markets in fiscal first-quarter 2009, we evaluated our goodwill and other indefinite-lived intangible assets for possible impairment. Due to higher discount rates, we determined that our goodwill was impaired and reported an estimated impairment charge of $400 million. The final impairment analysis requires a fair value of determination of our recorded and unrecorded assets and liabilities, and the determination of these fair values has not been completed at this time.

Any revision to the estimated impairment charge will be recorded during the 2009 second quarter and is expected not to exceed an additional $200 million. The impairment charge is a non-cash item and does not impact our normal business operation. Further, this charge is excluded from all of our financial results in evaluating financial covenants under our debt agreements.

I will now turn the call back over to Greg.

Thanks, Evan. As we said on the last conference call, we expected this to be a tough quarter. The peak prices that we paid for raw materials in fiscal 2008 impacted cost of goods sold, especially at US Pipe. As we entered the quarter, we experienced a significant drop-off in bookings at US pipe and Mueller Co., with no improvement throughout the quarter.

Certainly, we were impacted by the continual deterioration in the residential construction market, but we believe the biggest impact was driven by a falloff in municipal spending which also drove our distributors to aggressively reduce their inventories. As I mentioned earlier, we believe public spending for our water infrastructure product had been growing about 10% per year prior to September. However, the liquidity crisis and municipal budget shortfalls contributed to the decline in municipal spending.

We also believe the uncertainty surrounding the proposed stimulus bill has caused municipalities in general to delay projects until they have a better understanding of what federal monies could become available to them.

We also saw a softening in demand for Anvil products towards the end of the quarter, as we are beginning to feel the downturn in spending in nonresidential construction.

End-market demand is by far our biggest challenge. We were pleased during the first quarter that we were able to maintain price increases realized in the second half of fiscal 2008. In the first quarter of 2009, price per ton of ductile iron pipe was 5.4% higher than the previous quarter and 37% higher than the first-quarter 2008. The prices per valves and hydrants were 13.3% higher than the first-quarter 2008.

We also saw the average price of most of our raw materials decline in the quarter. For example, scrap steel at US pipe declined 49% from the average we paid in fiscal 2008 and 63% from the peak. For Mueller Co., purchases of scrap steel declined sharply during the quarter, with prices falling 51% below the peak price paid in July of 2008. Brass ingots declined 34% from the 2008 average and 36% from the peak.

We expect the lower purchase price of raw materials in all of our businesses to begin flowing through cost of goods sold starting in the second quarter.

During the last four months, we continued to be aggressive in responding to the falloff in demand. We froze salary increases for all salaried employees. We reduced headcount by 527, or about 8% of our workforce. In addition, we modified our production schedule, removing 155 production days, or about 20% of the available days. Overall, in the quarter these actions as well as the carryover benefits from past actions resulted in approximately $10 million in cost saving.

Although our operations took significant steps to match production to an extraordinary drop in demand, we will need to take further actions in the second quarter.

As we look to the second quarter, we expect shipment, margins, and earnings to be down from the first quarter of this year. As you know, the second quarter is historically our lowest shipment quarter due to the seasonality of our water infrastructure business. We believe that we will have an even greater drop-off year over year in second-quarter 2009 revenues than we did in the first-quarter fiscal-year 2009. We also expect that revenues will be down sequentially.

Let me provide you some insights into trends we are seeing. Bookings in January for our Mueller Co. valve, hydrants, and brass products were less than any month of the previous quarter and down significantly from January a year ago. Bookings for US pipe were down in January from what we saw in the first quarter and down substantially from January a year ago.

We believe there were a number of factors that contributed to this decline. First, we think that municipalities are continuing to delay all possible projects. Secondly, while we believe most distributor destocking has taken place, we expect they will not place any inventory orders until we enter the construction season and they see a pickup in demand. Finally, we have traditionally implemented a February 1 price increase on our Mueller Co. valves and hydrants. We did not implement that annual increase this year due to the multiple price increases we implemented in 2008.

As I mentioned earlier, we did see a drop-off in Anvil orders in December. While we are not experiencing the same level of decline in the nonresidential construction market as we are in the municipal and residential construction markets, we expect Anvil shipments will be down from second quarter of the prior year and sequentially from last quarter.

On the operating income side we expect the -- be impacted not only by the lower shipment volumes, by also the cost of under-absorbed overhead as a result of reduced production levels in first-quarter 2009. As a reminder, we used the FIFO method of accounting. We expect the benefit of the lower raw material purchase prices we paid in the first quarter to be more than offset by under under-absorbed overhead.

In summary, for the second quarter we expect revenues will be down on a year over year basis and less than first-quarter revenues. The cost associated with under-absorbed overhead driven by the reduced production in the first quarter will have a significant negative impact on cost of goods sold, particularly in Mueller Co. and US pipe. While raw material costs will be down nicely from the first quarter, the cost of under-absorbed overhead will more than offset any of this benefit.

Again, we expect revenues, adjusted margins, and adjusted earnings per share to be down from fiscal quarter 2009 results.

As we look to the second half of our fiscal year, the outlook for residential and nonresidential construction has deteriorated over the last 90 days. Based on the most recent forecast for calendar 2009, housing starts are projected to drop between 20% and 36%, and nonresidential construction spending to drop 8% to 10%.

The outlook for municipal spending is more difficult to assess. Public sector demand for our products depends on many factors, but we believe in this environment credit availability and relative interest rates, municipalities understanding what monies they will or will not get from the proposed stimulus bill, and the overall financial health of the municipalities will have the biggest impact.

Once we begin to see a rebound in municipal spending, we expect our distributors will also increase their inventory levels. However, we do not expect this will happen until we get into the construction season.

One of our primary objectives continues to be maintaining strong free cash flow. As Evan mentioned earlier, we experienced a (inaudible) of cash in the first quarter primarily due to a combined $88 million drop in payables and accrued expenses.

There was also an increase in inventories, which was principally due to under-absorbed overhead associated with reduced production, which was capitalized in inventory, as well as a drop-off in December shipments. We plan to bring down inventories throughout the year. In order to accomplish this, we will scale back production as needed, which may result in additional under-absorbed overhead.

In addition, we are tightly managing capital expenditures, which we now project to be in the range of $40 million to $50 million.

We expect to generate positive free cash flow for the full year.

Other key variables for fiscal 2009 are corporate spending, estimated to be between $42 million and $44 million, our tax rate is expected to be between 39% and 41%. We estimate 2009 net interest expense to be within the range of $68 million to $71 million.

What we want you to take away from today's conference call is that we are dealing with a very challenging economic environment. We believe we have taken the difficult and necessary steps, and will continue to do so. We will continue to focus on generating free cash flow and managing our controllable expenses while maintaining our quality, reputation of our brand, and service levels to our customers.

With that, we'll open up our call to questions.

(Operator Instructions). Kevin Maczka.

Kevin Maczka, BB&T Capital Markets. Greg, I'm wondering if you can say a little bit more about the channel inventory situation? You've got orders trending down 30% to 40%, and it sounds like you're kind of the implying that you're not going to see any uptick until we get into the spring construction season. What does that inventory channel look like? Is that destocking still a big part of that, where your distributors are still working down inventories, or has that played out and they are just not ordering yet at this point?

Kevin, our best market intelligence leads us to believe that most of the destocking has occurred. I think that as I said in our prepared comments, that there was a very aggressive take-down starting in September. So our belief is that we just won't see orders from the replenishment of that inventory.

Typically, as we get into the end of Q2 -- and past years -- distributors would start bringing in some inventory to be prepared for the construction season. We think this year, as I said, that we won't see distributors bringing back -- or bringing up their inventories until we get into the construction season and they see the pickup.

So I think it's the latter that you pointed out. We think we've seen most of the destocking. At this point, though, we are just -- we don't expect to see, especially in the second quarter, any orders to start bringing up inventories.

Then switching over to the debt covenant slide, you showed on the slide that you are well below your covenants, but I think you've said in the past you have an EBITDA number of around $180 million or so for the full-year '09 that you need to hit to not have those covenants become an issue. I guess with running at a run rate in Q1 well below that and looking at Q2 maybe even lower, I guess can you just comment on your outlook there, Greg?

Sure. Kevin, as you pointed out, actually at the end of December, our trailing four-quarter EBITDA for bank covenant purposes was almost $252 million -- because I think it's important to point out that the EBITDA that we report is not necessarily EBITDA that is used for bank covenant purposes, because we are allowed to add back certain items. So actually, in our first quarter, for bank covenant purposes, are EBITDA was about $40 million.

But at current net debt levels, we need minimum trailing four-quarter EBITDA of about $187 million. Of course that is calculated as defined by our credit agreement. We monitor these covenants closely. We've been taking aggressive actions to reduce our controllable expenses with workforce reductions and plant shutdowns. We are also focused on managing our working capital and generating free cash flow, which helps to lower our net debt.

So we will continue to take the steps necessary to meet our debt covenant obligations. At this point we are in compliance with our debt covenants, and we anticipate maintaining such compliance.

Okay. And if I could, just one more, Greg, and then I will hop back in line. You talked about taking some more actions on the cost side in Q2. With the Burlington (technical difficulty) things like that.

Kevin, the -- I think relative that -- we don't see on the horizon any plant closures or exiting any of our plants. I know that we've talked about this in the past. You're right. If you look in the last two, two and a half years, we've closed five manufacturing facilities. So we are really down to our core operations, and I think they are very efficient operations. So it would be difficult for us to -- I would say in the short term, in a 6-, 8-, 10-month period -- to take down any further plants.

I think it will be a -- more of a continuation. As I mentioned, we froze -- we implemented a salary freeze in the first quarter, in addition to the reduction in workforce. So it will be more in line I think with those types of actions. We are reviewing the specific situation at each of our facilities. I think we will make additional announcements as specific plans are developed, but of course we will always be very sensitive to make sure that our employees are well informed in the process.

Christopher Glynn.

Chris Glynn from Oppenheimer. Good morning. Just wondering on the -- kind of the price/cost movement. I know you don't have a crystal ball, but would we assume maybe that the price stickiness at Mueller Co. would be pretty safe?

You know, Chris, as we look in -- we've never experienced a decline, and I think especially in a four-month period, as we have seen in these last four months. And yet as I said, we were pleased at our pricing on both Mueller and US pipe, that we realized the price increases that we realized in the second half of the year.

So as you said in your -- as you started off your question, one never knows in this environment. But I would say right now that we are reasonably confident, but certainly we appreciate that in a recession it can be more challenging to maintain price.

Okay. And then in some sense or fashion can you kind of talk about the dollar impact of the benefits from cheaper raw materials by -- in the second quarter relative to the first? And then relative to that into the second half?

Yes. When -- and I can give you an estimate. Certainly it's going to -- it will depend on what shipments end up being. But we think that we could see potentially as much as a $20 million reduction in raw material prices. Oh, let me -- I'm sorry. Let me rephrase that -- in raw material costs flowing through our cost of goods sold versus what we experienced in the first quarter.

I think that probably what we would see -- we will see our biggest sequential quarter over quarter benefit in the second quarter, because in the first quarter we had our peak prices flowing through. But we wouldn't expect to see the -- we wouldn't expect to see that kind of reduction on a sequential basis occurring in the second half of the year. But I think that we would be comfortable in saying that we could see at least half of that again in the second half of the year.

Thanks. That's very helpful. And the $10 million in annualized cost savings from the 1Q cost actions, I take that that's annualized. Correct me if I'm wrong. And then was there an expense into segments associated with those actions?

Evan, why don't you handle that one?

Yes -- this is Evan. We did have $10 million in the quarter of cost savings, and that's related to our lean Six Sigma and manufacturing efficiencies of about $4.8 million, $2.8 million related to Burlington, $1.5 million in headcount reduction, and about $0.5 million of other savings. And those savings we expect are in the quarter, and that's kind of the recap of those.

Mike Schneider.

Hi. It's Mike Schneider from Robert Baird. Evan, I'm sorry; just a follow-up. So the $10 million in savings you just ran through, that's an annualized number? Or that was quarterly savings?

That's quarterly savings. And to clarify as well, we had severance costs in the quarter of roughly $400,000 related to some of those segments.

Then, just switching gears. So thank you very much for the raw materials information, Greg. The flip side of this now is you are clearly indicating that the incremental costs of under-absorption in the second quarter will be greater than that $20 million in cost savings on raw materials. Can you ballpark what you think the incremental cost of -- or sequential cost of under-absorption would be, Q2 versus Q1?

Yes, Mike. As I said, we think that we will more than offset that, and I think it could be as much as a $2 million higher of unabsorbed overhead costs than the raw material savings.

But only $2 million? I guess that's surprisingly small to me.

And Mike, just to clarify, you were talking about on a sequential basis --

Yes.

Because that's how I answered the raw materials. On a sequential basis.

All right. But again, that seems surprisingly small even on a sequential basis. From that can we deduce that because you took so many man-hours out in Q1 -- and production hours out in Q1 -- that indeed, there -- it's -- I don't know if "impossible" is the right word, but it's difficult to take many more hours out than you did in Q1?

No, actually we would probably expect to take out more hours in Q2, because as we -- as Evan was reviewing the cash flow, we did have a slight increase in inventories. And certainly our objective, as we've said a number -- many -- a number of times, is to match production with demand and not to have inventories grow.

In fact we would like to have a continual decline, gradual decline in inventories. So -- and as we also said that we expect revenues and orders to be down in Q2 from Q1. So with that coupled -- those two coupled together, that we expect that actually production would probably be less in Q2 than Q1.

I guess -- I know this is qualitative. It just surprises me that if the range of under-absorption is $22 million, $23 million sequentially, I would have almost expected the number to be much higher. But because, as you say, revenue is going to be down sequentially, your production days will be down sequentially because of that, and compounded by the fact that you want to reduce inventory in dollars. But it just -- a reaction more than anything.

Yes. Well, Mike, again, I would point out the lag, we are on a FIFO basis, so it lags. So what we experienced in the last quarter flows through this quarter.

Right, right. Okay. And I guess at Mueller, the pricing contribution -- you outlined in the press release the exact dollars contributed by the increase in pricing. But when you take it as a percent of sales, the contribution of pricing in Mueller actually was smaller in Q1 then in Q4. I'm wondering -- if you have the numbers top of mind -- just why pricing would've contributed 7 points in Q4 and then only about 5.5 in Q1.

It's because we -- our biggest drop-off in shipments in Q1 were our in valve and hydrant products. And of course, that was the product line where we had our -- the significant price increases. So if you look in Q4, we had nice shipments of valves and hydrants. We had the drop-off in Q1 of those particular products of over 40%. So it was a mix that was influencing that pricing difference.

Got it. That's very helpful. Then back to inventory then, on those lines, can you quantify just what unit inventory looks like, either year over year or sequentially, even though the dollars are up slightly?

Yes. Unit is -- unit inventory is reasonably flat to down slightly because of, as I said, that we had -- the unabsorbed overhead bumped up inventory, as did what happened to currency valuation. So from a unit standpoint, we did not see the increase that would be indicated by looking at a dollar volume, but it was not, as I say, significantly below where we were in the fourth quarter, but yet shipments and orders were. So relative to I think current market demand, we would say inventory is higher than we would want it to be.

And in US pipe, the volumes you -- as a percent, again, volumes were down about 16%, but yet you've talked about declines as much as 46% in October. Again, just relative to my expectations, I would've expected US pipe volumes to be down far greater, to the tune of 30%, 40%, given that orders have been running at that rate. Can you explain the discrepancy there?

Yes. Shipments on a tonnage basis were down about 27.4% for Pipe on a (multiple speakers)

But on a dollar basis were only down 16%?

Right -- because of the pricing.

Got it. So I was mixing pricing and tonnage. So when you talk about orders being down, you were speaking more in tonnage terms, not dollars?

Yes, tonnage terms, yes.

Okay. And then, just pricing. It's been encouraging to see pricing hold in across this industry even in this tough market. Can you focus specifically though just on project quotes for municipal projects? I know there's probably not many occurring right now, but what does pricing look like in that narrow niche?

Well, I think you may have answered the question right up front. I wish we would've -- we would be seeing enough quotes to be able to get a good handle on that. I would still say, Mike, from what we're seeing that we're confident in that the pricing, the price increases realized the second half are I would say pretty much holding.

Okay. And then final question -- and a focus I think of a lot of people. The covenants again. Greg, you made the statement that you anticipate remaining in compliance. From that, I guess I just want to understand your view of fiscal 2009 here. Even with the -- I guess the hole we're starting in during Q1 and Q2, what does it take in the second half for you to remain in compliance with the leverage ratio covenant? And by that I mean, do we need to see an acceleration in market demand? Do we need to see distributor restocking? Just give us your sensitivity analysis.

Yes, Mike. There's obviously two variables that affect our meeting our covenants. On the demand side, we expect and we would need to see our traditional seasonality. And we have seen nothing that would lead us to believe that we won't see the traditional seasonality. In fact, we've seen -- there is some data that says that the drop-off in state and local government spending in the last quarter was the biggest percentage drop-off in at least 50 years, if not longer (technical difficulty) because the data we looked at went back only 50 years.

So that would lead us to believe -- that certainly helps explain what we saw in this quarter, but also gives us some hope that we will see the seasonality, because we know that that level of spending can't be made -- can't continue for that length of time.

So certainly we would need to see I would say the traditional seasonality in our business. Secondly, I think that the pickup, as you referenced, the pickup in distributor -- re-bringing their inventories, I think that would certainly be a plus. I think that we would expect that that will add to probably magnifying this year shipments in the second half of the year versus the first half of the year.

Now, relative to the other part of that -- certainly in that equation -- is where our net debt is. And we are focused on managing working capital, generating free cash flow, and that helps lower our net debt. So it's a -- certainly on the demand side, it's -- we need to see the typical seasonality. And we will continue to do -- I think continue to make progress in lowering net debt.

Then, final question. I apologize. The new Pipe plant, can you give us some just analysis of where you are relative to your expectations on tons per day or man-hours per ton, any of those type of metrics to give us some sense that indeed that plant is on-track relative to your expectations in the early ramp?

Yes. I would say that the efficiencies that we saw or the production that we saw in November/December gives us comfort that we are meeting the productivity that we expected out of that plant. Our only issue now is of course -- is that the production was so low that we're not getting to see the benefit of those efficiencies because of the reduced production and reduced demand.

Ryan Connors.

Sure. It's Ryan Connors, Boenning & Scattergood [Securities]. Good morning. I had a couple of things here, but a lot of it's been covered -- and you've been very thorough. But I wonder if you could drill your raw material and input cost discussion down to Anvil in particular. It obviously -- if my records are correct, this was the first quarter on record that Anvil is the biggest segment of the Company from a revenue standpoint.

My understanding of their raw material mix is that there's more copper and brass ingot in there. I thought maybe raw materials might even be a tailwind, and was surprised to see it was actually a margin headwind. So if you could just drill that raw material discussion down to Anvil in terms of what the impact was on the quarter and then what your outlook is in terms of going forward, in terms of the input costs as a headwind or tailwind in that segment.

Yes. Anvil -- again, and I will go back to an earlier answer. That we use the FIFO method of accounting, and Anvil's inventory turns are less than Mueller and Pipe. So actually what was flowing through cost of goods sold for Anvil were the raw materials that we purchased in the summer. So -- and of course if you recall that that almost was at peak price -- or even not quite at peak price -- peak pricing, so costs were still going up. So that contributed to the -- I would say to the primary headwind this quarter for Anvil on the raw materials side.

We do believe sequentially though, it -- so then in Q2, that raw materials will be -- or raw material costs will be slightly better. But since we turn inventory lower in this business, we will still have some of that peak -- some of those higher costs flowing through cost of goods sold. So we would really expect to see the benefit at Anvil of lower raw material costs in Q3 and Q4.

That's great. Thanks for that. And then I just had a bigger-picture question, Greg, from a competitive standpoint. We spend a lot of time talking to utility operating managers trying to get a better feel of what they're doing, and a lot of them are talking about looking more closely at things like leak detection technology that they believe can enable them to spend more wisely in terms of -- especially in the rehabilitation aspect -- rather than wholesale replacement of water mains, to sort of do a real targeted leak detection program.

And so I'm wondering to what extent -- just on two fronts -- that's been a factor, that type of redeployment of those limited CapEx dollars has been a factor in the weakness? And then just from a longer-term perspective, how you view leak detection and asset management as a competitive or substitute threat to your products?

That's a good question. I think in the short term that has not been -- really has not been much of an impact. I think the biggest impact has been that the municipalities I think have tried to cut back spending every possible way.

Again, I can't overemphasize also, I think what we've seen in the past quarter is the uncertainty in the stimulus bill. We know there's one city -- has a project ready to go, had it ready to go, a 54-inch pipeline. We were going to participate in that project, and several weeks ago word came back that they're putting it on hold until they know exactly if they're going to get federal money. I think that's an example of some of the turmoil we're seeing in the marketplace.

So I don't think there has been any reduction in our volume, in our -- in demand for our products from using alternative methods to stop a leak. I will say that probably more of the repairs that you are referencing are used in wastewater than in drinking water. But then I would say even long term, I don't (technical difficulty) have a big impact.

And the primary -- I think the primary driver of that is that if you look at a lot of the pipe that will need to be replaced, it's been in the ground 75, 80, 85 years. They were installed in a time when population was a lot less than what it is today. So the municipalities and the water utilities that we talk to, they say that there is a definite need when it comes time to replace that pipe to replace it with larger-diameter pipe because they need greater volumes of water. That makes their system much more efficient. It saves energy on the pumping side. Also it makes them less susceptible to blowing out a pipe because they're not trying to put more volume through the pipe then the diameter would dictate.

So I think on a short-term basis, a municipality or water utility may find that if they go in and make a temporary patch, that we may see that picking up in the short term. But I don't think it has a long-term impact, because I think, again, the need to replace the existing pipe with larger-diameter pipe because greater volumes of water are needed, will be the deciding factor.

Great to get your perspective there. Thanks for your time.

Michael Gaugler.

Brean Murray, Carret. Greg, I was wondering if you can give us a little bit more color on what you're seeing in the end markets that your Anvil products go into, if there's a particular area there that causes you concern?

You know, Michael I would say it's more in -- it's more in general. We have -- there are still some regions -- actually United States -- where activity is holding up pretty well on the commercial construction side. I think that as we look at it, maybe our fire protection business could be a little slower than the mechanical side, which is tied into HVAC, because there could be a little more -- some replacement there.

But I would say there's not one area more than another. And some of our products -- though it's not a big -- we have some specialty products such as engineered hangers that will go into power plants and so on, and that business has remained pretty strong. So when we talked about -- we would expect to see a drop-off in Anvil, but not to the same extent as the other businesses. And we've even -- have some -- I'd say some bright spots regionally.

The balance of my questions have been answered. So, thanks.

Joel Tiss.

Buckingham Research. You've definitely done a good job answering all of the questions. I just have one. Can you talk a little bit about potential for the -- some of the distribution channels to be waiting for lower prices to come through? And sort of in the same thought, what a second half of 2009 year over year -- it sounds like the pricing increases are going to start to wane. Do you think that's keeping some additional pressure on the channel or causing some of those people to wait a little bit?

Good questions. I think it would be hard for me to answer that with any certainty. But I don't believe that that is the driving factor. I just think it's they are improving their liquidity. They are focusing on it. Getting their inventories just to I think historically low levels and waiting for demand.

So I'm not so sure they're necessarily waiting for lower prices. Quite frankly, our distributors like to see us put in price increases because that just -- that falls more to their bottom line.

Relative to the second half of the year -- and I'm sorry, Joe, maybe if you could -- relative to the second half of the year, if you could ask that question again.

Well it just seems like you're going to anniversary your price increases.

Joel, you're right. That's exactly right. I think when we start getting into Q4, if we implement no further price increases before then, that we will be pretty flat year over year, because most of the price increases that we implemented last year were implemented before we got into the fourth quarter, and I think we've started seeing that pricing in the fourth quarter. So you are right that we would expect to see positive contribution from price increases that we implemented last year through the third quarter. But I think it will be flat in Q4.

And then as long as you are here, do you think -- including sort of guessing -- that maybe you will be a little bit below breakeven in the second quarter? Do you think it's crazy to think that if we don't see any economic rebound and we don't see any impact of stimulus, with all else being -- trending the way it is trending, that you guys could be close to breakeven for the year?

You know, as again -- and this probably ties into the way I answered a question a little earlier. We're still confident that we will see the seasonal uptick in demand, and so as we look at the second half, we think that clearly that the demand and volumes will be up in Q3/Q4 versus Q2.

And I think -- again, I think we are in a period where municipalities have cut back spending so significantly and so dramatically in the last three months, and probably I would say in the early part -- and probably through most of this quarter, that they are at the point where they have to -- they will have to spend money . So we think clearly that Q2 will be the low point for us.

Brent Thielman.

Yes. This is Brent Thielman, DA Davidson. Greg, just on some of your competitors I guess for both Mueller Co. and the US Pipe, can you just discuss a little did what you're seeing on the pricing standpoint from some of those companies?

Yes. So far we have seen I think prices -- the price increases that were implemented in the second half of the year pretty much holding. And again, I think it gets down to that, one, we fought so hard for those prices, two, that we were all so far behind the curve in what was happening to raw materials that we needed those (technical difficulty) price increases -- those price increases. So right now, the best that we can see is that pricing is reasonably stable relative to the price increases that were implemented in the second half of the year.

And again, as I said a little earlier, that clearly in a recession that our confidence may be a little less than it -- I would say it has been in the past. But right now we haven't seen any dramatic what -- I would say -- shift.

That's helpful. Then I guess you've seen input costs for some of the alternative products, particularly plastics have pulled back pretty dramatically. Can you discuss your ability or likewise inability to maintain prices for ductile iron pipe if we begin to see some real pricing scale-backs for those types of products?

Yes. I think that certainly on some projects or some instances, it could be a factor, but I think generally it's less of a factor. And that gets back to that we think a lot of the market that -- the market share -- ductile iron pipe has lost a lot of market share over the last 15, 20 years to plastic pipe in the smaller-diameter sizes where there's lower pressures. So I think incrementally there's not that much more to lose, and I think that again when you look at where a lot of our pipe is being used, it's where the engineers and municipalities would prefer to use ductile iron pipe because there is greater volume of water going through at higher pressure.

Now, that doesn't mean in -- of course, that doesn't mean that in some instance we may find a municipality that says, I'm absolutely -- got to save money here, so I'm going to go ahead and put in some plastic pipe. But I don't think we will see that on a wholesale basis. I think again where ductile iron pipe is used today, it is primarily because the engineers only have confidence in ductile iron pipe.

Very helpful. Then lastly, just do you have any sense geographically where you're sort of seeing the biggest pressures in municipal spending, or is it a kind of all across the board?

Interesting question. When you look at this time a year ago, we were seeing drop-offs -- especially in our Mueller orders, we were seeing drop-offs in the West, in the South where there was -- where clearly the housing residential construction was falling off. We saw a big impact in our orders in those regions. But we actually in the Northwest and the Midwest, orders were up.

This past quarter, orders were down in every region for Mueller branded products. And interestingly, pretty much about the same amount -- a little more in the West which continues to demonstrate what's happening in the housing market there. But it's pretty much consistent across all regions, which led us to conclude that our biggest impact on our biggest impact business today is what I would say is almost a freeze in municipal spending.

Debra Coy.

Deborah Cole, Janney Montgomery Scott. Greg, the hardest thing to understand is -- it sounds like you are saying as well -- is really the sense of when and how spending can pick up in the municipal market. A couple of the things we're looking at is the bond market -- the municipal bond market does seem to have unfrozen somewhat. Hopefully that will help.

I'm wondering what your sense is of how the stimulus spending will play through. Obviously we don't have a final bill yet, but we assume we get one. We assume we get additional funds related to the state revolving fund programs. But what are you hearing from your clients in terms of the timing of -- if we do get incremental money, when they expect to actually see it? My concern is that it's going to take a while to actually flow through to the end market.

Yes, Debra. I think that's a good point. I do think that there are some projects ready to go, because I think they were projects that were already -- I think that they were ready to pull the pin or in essence start, and they had put them on hold to see if they were going to get federal money.

You know, I think we could benefit in several ways. But I think, as you point out, it's a moving target that -- I think that prior -- the stimulus bill that was approved by the House had roughly $9 million, $9.5 million -- $3.5 million for drinking water, $6 million for wastewater.

Right.

I mean just to point out I think what a moving target it is, I know we understand just yesterday Senators Feinstein and Murray (technical difficulty) [minutes] that proposed an additional (technical difficulty) $7 billion for water infrastructure.

That's right. But it was shot down.

Yes. I think it was shot down on a -- I don't think it's dead. I think that -- but the hill may be a little steeper for it to climb. But I -- to put it this way, we don't think that the amount of money that's been talked about his going to move the needle that much. It's not going to be a windfall.

Agreed.

But I think what it will do -- and as I think once municipalities are aware that this money is going to be available for them that it could free of capital for them to start spending capital that I think is just absolutely frozen right now. So I think that that's where we might see the initial benefits. I think it will be six to eight months before we would see any direct benefit from the package itself on spending for water infrastructure.

But again, I think that we've seen projects being put on hold while Congress debates, and I think that once there is some certainty, some understanding by the municipalities, I think that's going to help to free up some of these budgets, and -- but I think -- back to your point -- the direct money that will be available for water infrastructure -- I agree. I don't think that will start working its way through to at least six to eight months, but I think just, one, removing the uncertainty, and two, once municipalities know that some money is coming, could be a benefit in I think thawing out the freeze that we're seeing now.

That's helpful. Just one related last question. Just thinking about this historically, certainly I don't believe that we have seen water infrastructure spending drop-off anywhere like 30% or 40% in any historical recession. It's certainly not been that kind of a deep-cycle market. It's been much more of a flattening to maybe a temporary modest decline. What is your sense of sort of a realistic recession outlook, temporary stimulus delays aside?

Well again, we've been looking at some numbers, and the one particular set of numbers we were looking at, going back to 1960, prior to this quarter, I think there were only two or three quarters where local government or state government actually declined -- I mean actually went -- did not grow somewhat. And this quarter was just a dramatic fall, and in -- well into negative territory on a quarter over quarter basis. So I think it would be a mistake -- or we could be making a mistake if we extrapolate what happened the last three, four months and say that will continue the next three or four quarters.

So I believe that there has been such a significant cutback in government spending in all areas, that we will see some rebounds, because we just -- I don't think that we can see -- that they can continue at that rate.

We have an example of -- we have a blanket order for a city where they are on a program where they are continuing to replace hydrants. We did not ship one hydrant in the last four months to that city, which is unheard of, because they put a hold.

We have another where were the water system signed off on a project to spend $4 million on gate valves. We were going to get that order, and city council said no -- in that particular instance. And that water system came back and said that that's the first time. Usually it was always -- been rubber stamped.

So I know I -- it's a long-winded answer to your question, but no, we don't think that we will see probably a double-digit or an off-the-chart rebound. But we do expect that it will pick up somewhat, because we -- to the best of our knowledge -- think local governments have cut back spending so dramatically.

That's helpful. I do have one very last question. I know the call has run long. But just your sense as we go through this unprecedented period kind of how your competitors are surviving. In other words, you obviously have debt issues that you're dealing with. Kind of their liquidity situation -- if you have any sense of that -- and really trying to understand when we all come out of this at some point in the next year or so, what's -- will there be any changes to the competitive landscape? Do you have any opportunities here to take some share? Or do you think everybody kind of ends up in the same positions when we come out of this cycle?

That's a great question. We've been asking that question a lot of ourselves. As we look at it, we think that our competitors are sufficiently strong that they can weather this storm. As you know and we've pointed out in our investor presentation, if you look at this industry in this market segment, it's been pretty stable for 60, 70 years when you look at the brand names, you look at the manufacturers. So I think --

It's a small group.

Yes -- as we look at it, that we think probably there certainly -- the data that we get from our trade associations would indicate there's been no significant -- we have not -- our market share has stayed the same. I don't know maybe what's happened between or among our other competitors. But I get the sense that we'll all survive and probably will be stronger, because we know that our competitors have been closing manufacturing facilities.

I know that Griffin announced several months ago that they closed their manufacturing facility in New Jersey. So I do think that our best guess is that everyone will survive, and we'll be stronger when we come out of this.

Matt Vittorioso.

Barclays Capital. Just real quick -- and I don't know if you've touched on this, but could you comment on your availability or ability to continue to repurchase your bonds, and what your thoughts are on that going forward?

Yes, Matt. When you look at that, we said in our last conference call, and when we talked about uses of cash, that that certainly in an [item] (technical difficulty) that we look at. We did this -- as you saw this quarter, we did purchase some, and because we saw it was advantageous to do so. Our bonds are very thinly traded, but we will always be -- we're confident in our cash position. We expect to -- as I said earlier in our prepared comments, we expect to generate positive free cash flow through the year. So we will always look at and make decisions on what the best opportunity is and what makes the most sense.

And what does your -- does your bank debt limit how much you can do there? Is there a certain size of a basket that limits how far you can go with the bond buyback?

I'll ask Evan to (multiple speakers) that.

Yes, there is a basket for that. But I think it goes up to around the $50 million mark.

Great. And then just real quick, just to put a little more color around working capital and free cash flow in the year, how should we be -- last year you were able to turn that into a slight source for the full fiscal year. Given the start to this fiscal year, how should we be thinking about working capital? Where can you get that back to over the course of the rest of the year?

Yes. Over the coming year with the inventory plans that we have and as we look out, we project that we will have a source of cash for working capital for fiscal year 2009.

So you're going to turn that all the way back to a source. Great. Thank you very much.

Brad Levie.

I was just about to ask the bond buyback basket question. So of the $50 million, to just refine that a little bit, have buybacks to this point eroded that basket? And how much is left in it?

To date we've purchased about $5 million. As Greg mentioned, our bonds are thinly traded, but we look at selective opportunities. And we were able to retire $5 million of debt in the quarter with generating a gain of $1.5 million. And that $5 million would go against the basket.

So that means there's $45 million left in the basket. And if earnings kind of continue in the direction they are going, is there a possibility that basket could get curtailed?

There's a possibility, but at this time we don't anticipate that.

Okay. And you've got about $45 million more room; right?

Right, right.

That does conclude the question-and-answer segment of today's call.

Well, everyone, thanks very much for your continued interest in Meuller Water Products. I think probably, again, the best way for me to summarize is that obviously, we are in a very challenging economy. But we are -- made the tough decisions. We will continue to do so, manage our business, and to make sure that we address these conditions.

So again, thanks for your interest.

That does conclude today's conference. Thank you all for participating. You may disconnect at this time.