Mueller Water Products Inc (MWA) 2009 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 call. At this time, I will turn the call over to Ms. Zakas. Ma'am, you may begin.

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

We issued our press release reporting results of operations for the three months ended June 30, 2009 yesterday afternoon. A copy of it is available on our website.

Mueller Water Products had approximately 116.5 million shares outstanding at June 30, 2009. With us on the call this morning are Greg Hyland, our Chairman, President and CEO; and Evan Hart, our CFO.

We reference certain non-GAAP financial measures in our press release and on this call. These non-GAAP measures derived from GAAP financial measures and are provided because 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. These non-GAAP measures have limitations and reconciliations between non-GAAP and GAAP financial measures are included in the supplemental information within our press release.

This morning we will refer to adjusted net loss, adjusted EPS and adjusted EBITDA, all of which exclude the impairment and restructuring charges and the effect of debt related transactions in fiscal 2009 and 2008. We will also refer to free cash flow.

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 in the future tense or containing words such as expect, believe, anticipate and project or similar words derived from those words 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 and our Form 10-Q for the quarter ended March 31, 2009 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. The slides related to this morning's call are available to help illustrate the quarter's results.

In addition, we will file a copy of this morning's call 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 2009 fiscal third quarter.

I will begin today with a brief overview of the quarter. Evan Hart will then provide a detailed financial report, after which I will update you on key drivers influencing our business and our outlook. We will then open up the call for your questions.

While our end markets remain challenged, we accomplished several of our key initiatives in the third quarter. We executed well on a number of our cost containment initiatives with $22.9 million in year-over-year cost savings during the quarter. Our employees continue to find additional opportunities to reduce costs while making sure we maintain our high standards for quality and service.

We continued to generate free cash flow with $65.4 million of free cash flow in the quarter or $0.56 per share. We reduced our leverage by paying down $126.5 million of our debt.

We also successfully amended our 2007 credit agreement which provides us with greater maintenance covenants flexibility. Our end markets still face difficult conditions but we saw some positive signs that reinforced our belief that the water infrastructure market has stabilized as we discussed in our second-quarter call.

We saw the expected seasonal uptick in the third quarter particularly in Mueller Co. Furthermore, the seasonal uptick allowed us to increase production at both Mueller Co. and US Pipe which should benefit future quarters especially as it will reduce our underabsorbed overhead costs. Additionally, US Pipe benefited from lower raw material costs which are now beginning to flow through our cost of goods sold.

I'll now turn the call over to Evan Hart who will discuss our financial results. I will then come back to provide an outlook for the fourth quarter of fiscal 2009.

Good morning, everyone. I'll first review the consolidated results and then discuss segment performance.

Consolidated net sales of $363.2 million in the 2009 third quarter decreased $165.3 million year-over-year. Net sales decreased due to lower shipment volumes of $176 million across all business segments and $9.3 million due to unfavorable Canadian currency exchange rates.

These decreases were partially offset by $20 million of price increases, mostly from our Mueller Co. and Anvil segment, implemented primarily in the first three quarters of fiscal 2008. Gross profit was $57.8 million in the 2009 third quarter, a decrease of $65.6 million compared $123.4 million in the 2008 third quarter.

Gross margin was 15.9% compared to 23.3% in the prior year period. Gross profit decreased primarily due to lower volumes of $53.3 million, $38.2 million due to underabsorbed overhead from lower production and higher raw material costs of $8.5 million. Gross profit declines were partially offset by higher sales pricing of $20 million and manufacturing cost savings of $11.8 million.

Adjusted loss from operations for the quarter of $4.6 million decreased $58.4 million from the prior year period adjusted income from operations of $53.8 million. 2009 third quarter loss from operations was negatively impacted by lower shipment volumes of $53.3 million, underabsorbed overhead of $38.2 million and higher raw material costs of $8.5 million primarily from Mueller Co. and Anvil. This was partially offset by higher sales pricing of $20 million, manufacturing cost savings of $11.8 million; and reduced selling, general and administrative expenses of $7.2 million.

Third quarter 2009 adjusted operating loss and adjusted EBITDA margins were negative 1.3% and positive 4.7% respectively. These compare with the 2008 third quarter adjusted operating income margin of 10.2% and adjusted EBITDA margin of 14.5%.

Selling, general and administrative expenses were $62.4 million in the 2009 third quarter compared with $69.6 million in the 2008 third quarter. This decline was the result of cost saving actions and lower shipment volumes. 2009 third quarter SG&A expenses also included $3.9 million of bad debt expense related to a specific customer.

Interest expense net of interest income declined $300,000 to $17.2 million in the 2009 third quarter compared to $17.5 million in the 2008 third quarter. Gross interest expense totaled $17.5 million in the 2009 third quarter compared with $18.4 million in the prior year quarter. Gross and net interest expenses were down year over year due to lower interest rates and lower average net debt outstanding.

Our effective income tax rate for the three months ended June 30, 2009 was 32.1%. Nondeductible items reduced the tax benefit attributed to our loss before income taxes which lowered the effective rate compared to the 35% federal statutory rate.

Adjusted net loss per share was $0.13 in the 2009 third quarter compared to adjusted net income per share of $0.18 in the 2008 third quarter. The 2009 adjusted third quarter results excluded $0.04 per share related to restructuring charges and a write-off of deferred financing fees. 2009 third quarter results also included $3.9 million of bad debt expense related to a specific customer.

I'll now move on to segment performance. Net sales for the Mueller Co. segment where $154.6 million in the 2009 third quarter compared to $203 million in the prior year quarter. Lower shipment volumes of $55.5 million and $3.3 million of unfavorable Canadian currency exchange rates were partially offset by higher pricing of $10.4 million.

Unit shipment volumes of iron gate valves, fire hydrants and brass service products declined about 35% in the quarter. Adjusted income from operations of $13.6 million and adjusted EBITDA of $26.3 million in the 2009 third quarter compared to income from operations of $44.4 million and EBITDA of $52.7 million in the 2008 third quarter.

Adjusted income from operations decreased $21.6 million due to lower shipment volumes of $18.1 million due to underabsorbed overhead from lower production. Income from operations was also impacted by $5.7 million of higher raw material costs and $900,000 of bad debt expense related to a specific customer.

The decrease was partially offset by $10.4 million of higher sales (technical difficulty) $5.8 million of manufacturing cost savings and $2.2 million of reduced other, selling, general and administrative expenses. These results excluded $700,000 of restructuring charges for the 2009 third quarter.

Net sales for the US Pipe segment were $96.7 million in the 2009 third quarter compared to $167.7 million in the prior year quarter. The net sales decrease was primarily attributable to $70.1 million of lower shipment volumes and $900,000 of lower prices.

In the 2009 third quarter, adjusted loss from operations was $16.8 million and adjusted EBITDA was a loss of $12.5 million. These results compare to adjusted income from operations of $3.1 million and adjusted EBITDA of $8.5 million in the 2008 third quarter.

The 2009 third quarter results were negatively impacted by $17.9 million due to lower shipment volumes, $8.8 million of underabsorbed overhead from lower production and $3 million of bad debt expense related to a specific customer. The decrease was partially offset by $4.2 million of manufacturing cost savings; $2.6 million of lower other, selling, general and administrative expenses; and $1.2 million of lower raw material costs. These results excluded $1.5 million and $200,000 in restructuring charges in the 2009 and 2008 third quarters respectively.

Net sales for the Anvil segment were $111.9 million in the 2009 third quarter compared to $157.8 million in the prior year quarter. The net sales decline was driven primarily by $50.4 million of lower shipment volumes and $6 million of unfavorable Canadian currency exchange rates. This decline was partially offset by higher sales pricing of $10.5 million.

Adjusted income from operations of $6.7 million and adjusted EBITDA of $11.1 million in the 2009 third quarter compared to income from operations of $21.9 million and EBITDA of $26.9 million in the 2008 third quarter. Income from operations decreased principally due to lower shipment volumes of $13.8 million and $11.3 million to due to underabsorbed overhead from lower production.

Adjusted income from operations was also impacted by higher raw material costs of $4 million. These items were partially offset by higher sales pricing of $10.5 million; lower selling, general and administrative expenses of $2.7 million; and manufacturing cost savings of $1.8 million. These results excluded $1.7 million of restructuring charges in the 2009 third quarter.

Free cash flow, which is cash provided by operating activities less capital expenditures, was $65.4 million in the 2009 third quarter. This compares to free cash flow of $21.7 million for the 2008 third quarter.

The increase in free cash flow was primarily attributable to working capital management principally due to lower inventories as well as lower capital expenditures. Free cash flow was $45.6 million year-to-date. At June 30, 2009 net debt totaled $881.1 million which is total debt of $961.2 million less cash of $80.1 million.

Total debt at June 30, 2009 was comprised of our $420 million senior subordinated notes at a fixed rate of 7 3/8%, $115.1 million of Term A debt at LIBOR plus 550 basis points, $424.3 million of Term B debt at LIBOR plus 550 basis points and $1.8 million of capital leases and other debt.

Our near-term scheduled principal repayments were minimal with $4.9 million due in the remainder of fiscal 2009 and $19.3 million and $19.2 million due in each of fiscal 2010 and 2011, respectively. Our first significant debt repayments are not scheduled until May 2012 when our Term A debt matures.

During June 2009, we amended our 2007 credit agreement which provides more financial covenant flexibility and among other things, resulted in increased interest rates and new financial covenants. We repaid $100 million of borrowings under the agreement in connection with the amendment and we subsequently prepaid another $25 million.

In connection with this amendment, we incurred a loss on early extinguishment of debt of $2.3 million. Borrowings under the amended 2007 credit agreement bear interest at a floating rate equal to LIBOR plus a margin ranging from 500 to 600 basis points depending on our consolidated senior secured first lien leverage ratio as defined in the amended 2007 credit agreement. At June 30, 2009 the applicable margin was 550 basis points.

As of June 30, 2009 our trailing four-quarter EBITDA for credit agreement covenant purposes was $158.9 million. We anticipate that our existing cash, cash equivalents and borrowing capacity combined with our expected operating cash flows will be sufficient to meet our anticipated operating expenses, capital expenditures, pension contributions and scheduled debt service obligations as they become due.

During the 2009 third quarter, the Company incurred $3.9 million of cash restructuring charges primarily related to headcount reductions. Restructuring charges were $700,000 at Mueller Co., $1.5 million at US Pipe, and $1.7 million at Anvil. I will now turn the call back to Greg.

Thanks, Evan. As I mentioned at the beginning of the call, our end markets remained challenged in the third quarter which impacted our results. Even so, we accomplished several of our key initiatives.

The biggest factors negatively impacting our third quarter results were the decline in shipment volume on a year-over-year basis in all of our end markets and unabsorbed overhead associated with lower production volume. Shipments for our Mueller branded fire hydrants, valves and brass products during the third quarter dropped about 35% and that's when our pipe shipments dropped 46% year-over-year.

We believe the drop-off in end market demand which was caused by the ongoing weakness in residential construction and municipal spending contributed to this year-over-year volume decline in our water infrastructure business. Additionally, we saw unprecedented increases in raw material costs last year which prompted us to implement an additional round of price increases during the fiscal third quarter of 2008.

We believe our distributors pulled forward orders from the fiscal fourth quarter 2008 in advance of these price increases, resulting in higher shipments in the third quarter last year. Anvil's net sales declined 25% year-over-year excluding exchange rate differences caused by an accelerated drop-off in spending on non-residential construction as well as in the oil and gas markets in the third quarter of 2009.

During the quarter, we announced the closure of two smaller manufacturing facilities and three distribution warehouses. We believe that annualized savings from these actions will be about $5 million. We should begin to realize these savings in the fiscal fourth quarter and expect those savings to be about $700,000.

Total inventories dropped $74.8 million in the third quarter on a sequential basis. The drop in production in the second quarter has helped drive these lower inventory levels, increased underabsorbed overhead. The cost of this underabsorbed overhead negatively impacted our third quarter earnings.

In the third quarter, underabsorbed overhead costs increased $38.2 million year-over-year and $8.1 million sequentially. With respect to pricing, Mueller Co. and Anvil benefited from higher pricing year-over-year in the third quarter while US Pipe's pricing was essentially flat.

Sales prices for valves and hydrants averaged 7 to 9% higher year-over-year and prices for Anvil products averaged about 7% higher. A significant impact on the quarter however was a sequential decline in pricing at US Pipe.

The average price per ton declined each month during the quarter and in total, US Pipe pricing was $10 million lower in the third quarter as compared to the second quarter. Higher prices for the quarter once again covered raw material cost increases at Mueller Co. and Anvil. US Pipe had moderately lower raw material costs year over year.

We continue to tightly manage our overall cost structure. Total manufacturing costs and SG&A expenses were $22.9 million lower in the third quarter year over year.

However, the benefit of these lower costs was reduced by $3.9 million of bad debt expense related to a specific customer. We lowered headcount by an additional 100 positions in the third quarter from the second quarter.

Year to date in fiscal 2009, we have reduced our workforce by 17%. During the second quarter, we reduced capacity at our North Birmingham ductile iron pipe manufacturing facility by 50% resulting in savings of $3.4 million in the third quarter.

I'll now turn to our fourth-quarter outlook for each of our three segments and then the Company as a whole. Municipal spending and residential construction significantly impact two of our segments, Mueller Co. and US Pipe. Before discussing developments in both segments, let me update you on what we believe is happening in both end markets.

As background on municipal spending, we estimate that prior to September 2008, demand from this segment was growing at about 10% annually. However, we believe that municipal spending became paralyzed in the fall of 2008.

Initially it stalled due to the liquidity crisis including a closed municipal bond market. Then we believe most activity was frozen when the possibility of a stimulus package was first announced and it remained so even after the American Reinvestment and Recovery Act was signed into law in February primarily due to confusion over certain provisions.

In March and again in May, the EPA provided some needed clarity concerning implementation of the Buy American clause that was a primary source of confusion. Stimulus package funds for drinking water projects are slowly working their way into the marketplace.

However, the Congressional Budget Office estimates that water funding will get into the marketplace more slowly than funding for other infrastructure projects. The CBO has stated that only 4% of funding for water projects is estimated to be spent in the first year compared to 27% for highway projects. As you know, the stimulus bill mandates that the approved funds be spent within two years.

As an early sign that more funds may be coming into the marketplace, our tons quoted for ductile iron pipe public bids increased modestly in the third quarter year-over-year after being flat in the second quarter and down for the previous five quarters. We quoted more stimulus related jobs in July over June and there seems to be more projects available for quotation.

But we have not yet seen those quotes translate into shipments. We still expect shipments for stimulus related projects to be minimal in the fourth quarter and expect activity to ramp up in the first half of fiscal 2010.

Some non-stimulus funded projects that were previously delayed have begun to receive funding and we expect this number to increase in the coming months. As we mentioned last quarter, we believe demand for our products in residential construction has hit bottom.

Housing starts have increased slightly but levels are still only about 40% of the last 50 year average. We believe shipments for residential construction in third quarter were minimal and will remain so in the fourth quarter. Now, let's turn to Mueller Co. specifically.

As we look at the fourth quarter in our Mueller Co. business, we are encouraged by some of the trends that we saw in the third quarter. July bookings were comparable to June bookings, an indication that the third quarter seasonal uptick may be continuing in the fourth quarter.

The uptick in orders relates more to day-to-day maintenance and repair activity than to stimulus related projects. As I just mentioned, we don't expect to begin seeing shipments for those projects until the end of the fourth quarter at the earliest.

Mueller Co. saw a significant increase in the number of expedited orders in the third quarter. These expedited orders reconfirm our belief that our distributors have completed their de-stocking and we believe they will continue to maintain these lower inventory levels.

The combination of pent-up demand for our products for repair projects and the lower distributor inventory levels have led to these expedited requests. Even with our reduced inventories, we have filled these requests and maintained our service levels.

Pricing for our valves and hydrants has been stable as we have held onto most of our realized 2008 price increases. Most of these price increases occurred more than one year ago and we did not implement any additional increases in 2009. Therefore, we don't expect to have any favorable pricing in the fourth quarter year over year.

We increased production in the third quarter due to the seasonal uptick in demand. For example, our valve, fire hydrant and brass manufacturing facilities had no down days in the third quarter as we're currently configured, while they operated only 66% of the available days in the second quarter.

The increase in production enabled us to recall some of our hourly employees at these facilities. With this increased production, our underabsorbed overhead expenses will be less on a sequential basis although we will still feel a year-over-year impact.

During the fourth quarter at Mueller Co. we also expect to benefit from lower raw material costs rolling through cost of goods sold. We also expect to see increased capacity utilization in the fourth quarter compared to the third quarter which will lessen our underabsorbed overhead burden in future quarters.

We expect higher operating income margin because we will have less underabsorbed overhead costs and lower raw material costs. Turning now to US Pipe.

Many of the factors impacting US Pipe's business such as municipal spending and residential construction are similar to those impacting Mueller Co. But some of the near-term dynamics are different.

Orders for ductile iron pipe tend to be driven by more large projects with longer lead times than by ongoing repair and maintenance which is benefiting Mueller Co. This is one reason why unit shipments grew at a sequential rate of 22% at US Pipe compared to 39% at Mueller Co.

Prices at US Pipe continued to deteriorate in the third quarter with the average price per ton for ductile iron pipe decreasing 15% in the third quarter from the second quarter. US Pipe announced a price increase of 11% effective June 1 and a second price increase of 10% effective on August 1.

These price increases are necessary but could be difficult to fully realize in the current environment. As the environment improves, we should see some realization of these price increases but we don't expect these price increases to have an impact on fourth-quarter results.

In fact, we expect to see continued pressure on pricing at US Pipe in the fourth quarter. The impact on future quarters remains to be seen.

The lower per unit cost of raw materials flowing through our cost of goods sold is benefiting US Pipe and we expect average raw material costs and cost of goods sold will decline even further in the fourth quarter.

Capacity utilization at US Pipe increased somewhat during our third quarter with fewer down days than we had in the second quarter. We expect this increased production to lead to lower underabsorbed overhead costs relative to the third quarter although we still expect to incur higher underabsorbed overhead costs on a year-over-year basis. We expect US Pipe to continue to be in an operating loss position in the fourth quarter although somewhat improved from last quarter.

Turning to Anvil's fourth quarter, we believe non-residential construction will be down on a year-over-year basis. Economic forecasts from Ivy Zelman and McGraw-Hill Dawes project a 20% decline in non-residential construction spending for the calendar year.

In addition, spending in the US oil and gas production markets remain depressed. Most of the price increases we implemented at Anvil in fiscal 2008 are more than one year old. But we do expect to see the benefit on a year-over-year basis of some select price increases we implemented in the fourth quarter fiscal 2008 and first quarter fiscal 2009.

Until we see improvement in non-residential construction, we expect Anvil to continue to operate at lower capacity. This will contribute to higher levels of underabsorbed overhead both sequentially and year over year.

We continue to manage aggressively our controllable costs, reducing 97 positions in the third quarter. We expect Anvil to remain profitable in the fourth quarter.

Based on the margin improvement we expect to see at Mueller Co., on a consolidated basis we believe income from operations will be slightly positive in the fourth quarter. We continue to tightly manage capital expenditures which we now project to be in the range of 40 to $42 million for fiscal 2009.

As a reminder, our amended credit limit capital expenditures for the second half of fiscal 2009 to $25 million. As we discussed on a consolidated basis, we had strong free cash flow for both the third quarter and year-to-date.

All three segments had positive cash flow year-to-date. We expect to generate positive free cash flow for fiscal 2009.

Other key variables for fiscal 2009 are corporate spending, estimated to be between 36 and $38 million. Our effective income tax rate excluding goodwill impairments is estimated to be approximately 34% for the fourth quarter and 38% for the full year. We estimate fourth-quarter net interest to be within the range of 21 to $23 million.

In summary, we believe our water infrastructure markets continue to stabilize and are showing early signs of recovery. Year-over-year comparisons are difficult and we still expect a slow recovery. However, we believe we may see modest sequential growth.

Demand from residential construction will likely require a longer recovery period. Non-residential construction, the primary end market for our Anvil products, is forecasted to decline further in calendar 2009 and 2010. We will continue to reduce capacity and manage our controllable costs in this business segment accordingly.

We continue to see the effect of decrimental margins in the third quarter. With our cost reduction actions and increased production, due to the seasonal uptick in orders that continued in July, we expect to see improved operating leverage contribution in the fourth quarter especially in our Mueller Co. business. Additionally, fourth-quarter results should benefit from lower raw material costs.

Our primary focus remains generating positive free cash flow, reducing our debt and managing our controllable expenses while maintaining our quality, best-in-class products position, the reputation of our brands and service to our customers. As a reminder, remarks from this morning's call are being filed on Form 8-K.

With that, I will open it up for questions.

(Operator Instructions) Kevin Maczka.

Kevin Maczka, BB&T Capital Markets. Good morning.

Greg, I guess first on stimulus, so you're not seeing many shipments yet, you won't see many more in Q4. But you are bidding on more and more of it all the time.

So my question is we're hearing in many cases about these bids being very competitive and maybe pricing and margins on those bids not being quite what you would want them to be. Could you just comment on what you are seeing there?

Yes, Kevin, I think that certainly we have seen a bit of an uptick in July from what we quoted on June. I will be honest, very few of those have been awarded. So it would be difficult to absolutely confirm what you are seeing.

I would say the trends are probably pretty consistent with -- as we discuss what we're seeing overall with our business. I would say that on the pipe side, I think we would see that perhaps being a little more competitive and a little more pricing pressure than what we would see on the valve and hydrant inside.

Again, that's because sometimes the specification position and so on. But I would say that right now we haven't seen a significant change in the prices we are quoting versus what we have been realizing I would say in the third quarter.

And then seasonality, Greg. It's been a couple of years since you have had a normal year, I guess. But you had your normal seasonal uptick especially at Mueller in Q3. Can you just remind us what normal seasonality is and are you still expecting that this year at least at Mueller and US Pipe even if Anvil maybe will continue to sequentially decline?

Kevin, good question and you are right the way you started your question talking about we haven't had a normal couple of years especially when you realize in the third quarter last year we had some significant price increases on valves and hydrants and brass products and on US Pipe are typical relative to shipments. If you look at 2007, about 47% of our shipments were in the first half of the year, 53% in the second half.

That changed a little bit in 2008 primarily because we had less pull forward on our price increase that we announced in February of 2008 for valves and hydrants. So we had about 45% of our sales in the first half of 2008 with 55% in the second half.

We think this year we are going to have a stronger -- probably more sales in the second half of the year than in the first half of the year. In fact when we look at shipments for Mueller Co. orders in the third quarter, they were up on a weighted average about 39% for our core products over the second quarter. And if you look at last year, they were only up 18% in the third quarter over the second quarter.

So I think that number is being influenced by timing of price increases but I think that we will see the uptick obviously in the second half of the year. I think as we look at it now, we will see a greater percentage of our sales in the second half of the year versus the first half.

And if we look at our Mueller Co. business and our US Pipe, the orders that we saw in July pretty much continued -- for Mueller -- continued pretty much at the same rate that we saw in the third quarter. And for Pipe, we saw July was continuing at the same rate that we saw in June and it wasn't really until June of this year we saw the uptick in orders at Pipe. So I think as we look at it right now, that we will see I think greater seasonality this year with a greater percentage of our shipments in the second half.

Okay, great. And just one clarification, Greg. So those numbers you just gave, that's relevant to the total Company, not just Mueller Co.?

Yes, that is the total Company.

And then Anvil, you expect that to sequentially continue to decline in terms of absolute dollars of revenue based on your commentary about the commercial construction markets?

You know, Kevin, there is a bit of seasonality sometime in the construction market. I think that we could see it decline slightly. I would say we would see it anywhere from being flat to declining slightly in Q4 over Q3.

Mike Schneider.

It's Mike Schneider from Robert Baird. Maybe we could focus just on some of the sequential trends within both raw materials and overhead absorption.

So raw material headwind is going to fade sequentially. Can you give us a sense of where the lines cross and just how much progress you make alone just from Q3 to Q4? I believe this quarter, raw materials were a $9.7 million incremental expense year-over-year. If you could use that as the starting point, that would be helpful.

Yes, Mike; you're right. There was an incremental hit. When we look at our Q4, we expect that raw material costs will be less and we will benefit and we expect that we will benefit in both Mueller and Pipe, Pipe for sure.

On magnitude, we will be positive and we think that we will see anywhere from -- I would say anywhere from 12 to $15 million lower raw material costs on a year-over-year basis.

12 to $15 million. So in other words, Q3 was $9.7 million higher and Q4 will be 12 to $15 million lower?

Yes, I think that's what we think right now. We have an inventory that will flow through. We think it will be in that direction.

Okay and then similar type of analysis just on overhead absorption. So I appreciate you're taking huge inventory out and obviously volumes are down hard.

Overhead absorption was a $38 million again headwind this quarter. Similar type of question. If this run rate of sales continues and your production days rise, as I believe they are both at Mueller and US Pipe, what does that number look like in Q4? I imagine it starts to fall precipitously.

You know, it will start to fall on a year-over-year basis. But if you look at the environment that we saw a year ago, we didn't really see the drop-off in orders -- the real drop-off until September.

So we were still producing at a pretty reasonable rate in the fourth quarter. So we were absorbing overhead at a pretty reasonable rate in Q4 last year.

So on a year-over-year basis, we do -- we expect that it could be down -- maybe the underabsorbed overhead could be down anywhere from 15 to 18%. But on a sequential basis, we do think as we said in our prepared remarks, we think that we will actually see positive overhead absorption in Q4 where it still was negative in Q3 over Q2.

Okay, that's another major swing. Okay. And then SG&A, I guess I realize you took additional actions in Q3.

But SG&A just in dollars is down only 16% year-over-year. Yet sales are down 31. Can you explain just the disconnect there?

I realize headcount is down 17% but it seems like that has all come out of production or mostly out of production. Are there additional efforts to reduce SG&A spending?

I will let Evan go into some of that detail. But also when you're looking at SG&A year over year, the $3.9 million which was a onetime -- we think a onetime write-off for the distributor, that certainly shows up in SG&A. So (multiple speakers)

I have excluded that. So SG&A even adjusting for that is down $11.8 million which is only 16% again versus a sales decline of 31 and I imagine commissions are variable. So I guess it's a little bit surprising that number isn't down more.

Yes, that's right Mike. What's playing into the decline, the $16 million year-over-year decline on a year-to-date basis with Premiere are about $7.2 million in the third quarter. I mean that's headcount reduction actions that we have taken throughout the past couple quarters, as well some reduction in professional fees and other items.

Certainly you referenced commissions. That's down as well.

But the way we look at it, SG&A, about 75% of that is fixed. And so some of the costs that we have taken out to date are structural in nature, are fixed in nature, maybe roughly about half.

But we are still continuing to refine and fine tune our SG&A expenditures and we will be looking at that going forward. I will indicate that some of our reductions at US Pipe, that was at the end of June. So we're just now starting to realize some of the benefits. So there will be some other benefits in cost savings that we will be experiencing in the SG&A line.

Okay and then just final question and I'll get back in line. On pricing at US Pipe, you mentioned the 11% increase and then subsequent 10% increase. It's my understanding your two competitors have gone out with similar cumulative amounts of 20 to 30%.

Is that accurate? And two, just what has been the early response? Because it's obviously a little suspect to investors that in this market, a 20 to 30% price increase is even viable.

Mike, you're right. I think our competitors are in the same situation of needing to implement some price increases.

Probably too soon to tell as we said that we don't expect to see any benefit of this in Q4. But I think that we do expect to see some signs that scrap steel prices could be going up and I think we are trying to get a bit ahead of the curve.

So I think we're just in a wait-and-see mode. But obviously as you can see by the results for the pipe business the last couple quarters that a price increase we believe is obviously needed and justified. But I think we're just going to wait and see to see what will actually happen and we probably won't see that until we get into the first quarter of our fiscal year.

Keith Hughes.

Keith Hughes, SunTrust Robinson Humphrey. The pricing actions taken in US Pipe, is that more a reaction to what's coming in on your inputs or the sequential pricing you lost which you highlighted in the prepared comments?

Keith, good question. I think a little bit of both. We do think that if you look at our last purchase for scrap at US Pipe in June was about 204, $205 a ton.

Now that is up from April which was $159 a ton though I think that April was more of an anomaly. I think as we look out at the next couple of quarters, at least the next quarter, we think that that could be up to $240.

July approached that level and we think we might see that for the next couple of months. So first of all, it's in anticipation of some higher scrap steel costs. Secondly it's also, as you point out, to try to get back to some of the prices that we saw four or five months ago.

With the increases you announced in the months you highlighted earlier, I understand this takes a while to get through. But it seems as though if it were successful, you would feel at least some impact in fiscal fourth quarter. Why is that not the case?

Well I think that when you look at the --- with price increase in June, we potentially could see I think a benefit in higher prices in Q4 than what we actually realized in June. But we think we'll probably overall still see lower prices in the fourth quarter on average than we saw on average in Q3 because April, we saw a big drop in our pricing between April and June.

In fact, it was probably 8, 9, 10% in that range drop between April and June. So we think with this price increase, we will see -- we hope to see slightly higher prices than what we saw in June but we still think that we will be below on a quarterly average basis in Q4 what we realized in Q3.

On the inventory, inventory has declined since the end of the previous year. But sales have come down a lot faster.

Are you keeping inventory in house for this stimulus demand whenever -- and it will materialize -- but whenever it materializes? Or are we going to have to see more even -- potentially even greater capacity reductions to bring down inventory?

No, I will tell you where we are, Keith. We had a very big drop in inventory especially this quarter. In fact if you look at the inventory drop, a lot of it -- most of it was in Q3.

And as I referenced I think a little earlier when talking to -- answering one of the previous questions, actually this time last year we had not really brought down any production. So that's when we really saw inventory build was going into the -- throughout the first quarter of fiscal 2009.

We expect that we will still see a continued drop in inventory in our fourth quarter but nowhere near the magnitude that we saw in the third quarter and therefore that more of our shipments in the fourth quarter will come from actual production rather than out of inventory. And that's what leads us to be optimistic that we will see at least sequentially some positive impact of the overhead absorption.

So back to your point that we will continue to bring down inventory nowhere near what we saw in Q3. So actually the order intake and the subsequent production will be positive for us in terms of overhead absorption.

But your inventory is only down about 13% year-over-year, sales are down 30%. As we stand today, are you not carrying too much of some items?

A good portion of what's in inventory is some of that unabsorbed overhead. So that unabsorbed overhead obviously will be coming out and we still expect Q4 inventory to be down another $30 million. But back to your point that we still expect to see inventory decline in the next year or so but it will be on I think a much more gradual basis than what we saw in Q3.

Ryan Connors.

The company is Boenning and Scattergood. I had a question. First off on this issue of the bad debt expense for the individual customer in US Pipe, can you expand on that a little bit, in particular just talk about what the circumstances were behind that and whether it is truly a one-off or whether there might be other customers out there like that given obviously the stress that municipalities are under in terms of fiscal situations.

Yes, Ryan. This particular instance, we think it was a one-off. In fact if you look at our bad debt expenses for this quarter, they are a factor of four greater than what we have seen in the last eight to 10 quarters.

And I would say that we were a bit surprised with this in this particular instance especially with the timing. This potential issue surfaced I would say a little less than a year ago.

We immediately put this distributor on COD and we developed a payment plan. The distributor was current with his payments on that plan. However, about three weeks ago, three, four weeks ago; the bank pulled his line of credit, leaving us no options but to take the bad debt write-off in this third quarter. But I will let Evan give a little more color as to I would say our overall position on our Accounts Receivable.

Ryan, we continually monitor our receivables portfolio and we looked at DSO and our overall agings. And I would say in general, those are stable and we do feel that this is a one-off. We feel that our reserves are sufficient for bad debt and we were just a little surprised with this particular customer.

So this would be a little bit more isolated. But we are always monitoring and proactively looking at our overall credit exposure and don't really feel that there are any other issues that we foresee at this point in time out there.

That's very helpful. And just from a bigger picture perspective, Greg, obviously cutting back on capacity on fixed costs is the right thing to do in this environment. You mentioned another 50% reduction in the North Birmingham facility.

But just looking out, obviously you're also talking about the markets beginning to stabilize, housing starting to get better etc. Can you just talk to us about how you make sure you don't cut so aggressively that you are not able to react and participate fully in a recovery in terms of cutting too close to the bone?

Sure, Ryan; good question. We look forward to that challenge. If you look at our first option -- we actually in the third quarter needed to work some overtime at Mueller Co. as we saw the uptick in orders. And in fact, that is our first reaction.

We would work overtime until we get comfortable that the increase in volume that we are seeing is somewhat sustainable. We concluded that it was and in fact late in the third quarter and in the fourth quarter, we brought back employees at our Decatur, Albertville and Chattanooga plants.

Those are the three plants we manufacture our valve, hydrants and our brass products. So certainly we can work overtime. We can bring back -- we had I would say a pretty good success, pretty good success and the number of employees that came back, that's always a variable when you go through a layoff, how many employees will actually return when you need them to come back. We were pleased with the number of employees that came back.

And then we can add other shifts. So we have I think significant capacity to be able to respond. The key would be bringing back our employees. And again at US Pipe where we talked about taking 50% out of our capacity at North Birmingham; this past quarter at US Pipe, we still operated in total slightly under 50% of our total capacity.

So we have a lot of room and what our first action and just to summarize, would work overtime. We would bring back additional employees and then we could go to another shift. So we have for the foreseeable future, we really have no capacity constraints.

That's very helpful. Thanks for your time today.

Brent Thielman.

D.A. Davidson, good morning. I guess just a clarification on a previous question on SG&A. I think in Q3 if you backed out the restructuring -- or excuse me -- the bad debt expense, [you're sort of stuck] $60 million level. Is that an appropriate run rate to think about for Q4?

I would say, yes, using that would be reasonable.

And then Greg, you referenced some larger projects in US Pipe that you are sort of quoting for and I'm just curious maybe you could provide a little bit more specifics in terms of what you are seeing there?

Yes; and, Brent, I would say that what we saw is -- and I referenced our public bids, and public bids at our US Pipe business is primarily driven by municipal spending. I would say we did not see a significant uptick on year-over-year but it was an uptick. And as I referenced, we were flat last quarter and the previous five quarters, it was down.

So I would just say we're seeing a little -- I don't want anyone to interpret what we're saying is [to avoid it] that we're quoting on a lot of major projects, a lot of pipe projects. We are just seeing a little improvement and I think that we will continue to see that over the next few quarters.

In fact, we just saw a figure that was published that of the $6 billion that was approved for water and wastewater, only about $30 million has made its way into the marketplace. So that's obviously out in front of us and -- but I would say that we are just in the very early stages of seeing some greater quotation rates at our Pipe business.

Okay and then I know you provided a little commentary on the scrap markets. I don't know if you can provide any more clarity there. Are you expecting big increases in terms of scrap pricing or sort of what are you seeing right now?

You know what? As we said and I would say there are -- the crystal ball here is cloudy -- that we paid in May and June on average about $205 a ton. July, we saw that bump up to about $240 a ton.

I think that is a combination of several factors. One, I think that probably a lot of the supply yards or the scrap yards have brought down their inventory. Two, probably supply for a time period has been reduced.

Certainly when automobiles aren't being manufactured, the scrap is generated just in the process of manufacturing or producing new automobiles is probably dried up. So that's contributed.

On the other hand, we are hopeful that the Clunkers for Cash, that we are going to turn a lot of that scrap into ductile iron pipe. So we're not necessarily sure what kind of impact that program may have. So we don't have a long runway on our visibility but we have seen, as I said, up about $240 a ton we paid in July versus the roughly $205 that we were paying in May and June.

I guess if you're paying $240 a ton in July, I think you referenced -- I mean I guess if you didn't get the price increases that you talked about in US Pipe but that pricing sort of stabilizes at current levels, is that going to be enough to cover your raw material costs if scrap indeed sort of stabilizes at these levels?

Yes, I think if it's stabilizes that and we get the pricing, I think that we will be reasonably -- that that pricing would cover that additional raw material cost, we think more than cover.

[Matt Vittorioso].

Barclays Capital. Just curious, I know you said you expect to be free cash flow positive for the year and you expect inventory to continue to come down, albeit at a slower pace. Do you expect to be free cash flow positive for the fourth quarter, just to clarify around that?

Evan, why don't you take that?

Well we do have in the fourth quarter a pension payment that we need to make which is in the magnitude of 19 to $21 million. Excluding that, we certainly believe it will be positive.

So where that comes out, I think where that eventual pension payment -- where it calculates to be could determine if we are cash flow positive or cash flow negative.

Yes, we are still refining our estimate on that but certainly excluding that payment, we would be positive.

That's helpful. And then just to clarify a little bit around the US Pipe business in Q4. I think your commentary was that you expect to see profitability slightly better than what we just saw in Q3.

Could you give us any more color on the magnitude? Is it just a slight improvement? The loss in Q3 was fairly deep. Are we making up some ground there getting back to profitability? Any color would be helpful.

Yes, we will see certainly some improvement. If you look at the bad debt write-offs that we referenced, it was $3.9 million in total, over -- about $3 million of that was at US pipe. So obviously we will see benefits there.

We will expect to see some higher volumes and some lower raw material costs as well as less of an impact on the unabsorbed overhead. So we will still be in a loss position but I think we may be more in the area somewhere between what we saw in the first quarter and second quarter.

Okay, that's great. Just high level, you did a good job of getting some flexibility on your covenants. Assuming you improve a bit on EBITDA here in Q4, what is your comfort level around the September quarter covenant? It seems like you'll have enough room but just any commentary would be helpful.

Certainly we renegotiated and amended the credit facility in June and we are in compliance and anticipate maintaining such compliance going forward. So I would say that for the September quarter end, obviously we had two quarters now, three quarters that have already been posted. So we feel that we will be in compliance.

Mike Schneider.

It's actually Mackay Shields, different [Mike Schneider]. Just a couple quick questions.

I guess as it relates to working capital, you talked a little bit more about inventory being a more gradual decline over the next few quarters. Could you just give a little bit more color on maybe what, given the current sales level and order levels, what you think your goals are and how much additional you might be able to take out over the next two to four quarters?

As I said a little earlier, we would expect to see inventory coming down I would say around another $30 million in our fourth quarter. And you're right, and then we expect to see a little more gradual -- it will decrease gradually.

We're running I think somewhere between three turns of the total Company give or take a half a turn. It varies by business unit. And again, given the dynamics of each business that -- we would expect that we will range between four turns and seven turns as our goal.

We think that US Pipe should be able to get to the seven turns. They're currently running just slightly under five I would say. I would put it almost at five times.

And I would say that right now our Anvil business given because we are in -- we also manage regional distribution warehouses, that we are running a little over two turns. But we think we can get that business to four. So we think that three on average, the three give or take a half turn, that we can get that in total to at least 5.5 turns per total company.

And then any more color on receivables as well? Any sort of anticipatory changes in terms -- and I guess you could maybe segue into payables as well.

Evan, I'll let you take that.

No anticipated changes in terms at this point in time. As I mentioned, our DSO is fairly stable and we will continue to monitor that going forward.

But I wouldn't say anything -- significant changes there. And with payables, we're always looking to improve [DTO]. In large part, changes in payables have been driven just by the low purchasing volumes that we have experienced over the past several quarters.

So there's some fine tuning and refinement there and I think we will see some marginal improvement. But it will be similar to the levels that we've experienced.

Okay and then just the last question, current availability under the revolver?

We have nothing drawn against our $200 million revolver.

Okay. Would be fully available given your inventory and receivable levels?

We do have letters of credit that are outstanding against the revolver, roughly around $40 million. But there is nothing withdrawn and it's fully available.

Thank you, appreciate it.

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

Well thank you for your continued interest in Mueller Water Products.

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