Mueller Water Products Inc (MWA) 2012 Q2 法說會逐字稿

Very good. Thank you, Laurel. Good morning, everyone. Welcome to Mueller Water Products Fiscal 2012 Second Quarter Conference Call. We issued our press release reporting results of operations for the quarter ended March 31, 2012 yesterday afternoon. A copy of it is available on our website, muellerwaterproducts.com.

Mueller Water Products had approximately 156.7 million shares outstanding at March 31, 2012. Discussing the second quarter's results this morning are Greg Hyland, our Chairman, President and CEO; and Evan Hart, our CFO.

This morning's call is being recorded and webcast live on the Internet. We have also posted slides on our website, which were available to help illustrate the quarter's results as well as to address our Safe Harbor disclosure statement and our non-GAAP disclosure requirements.

At this time, please refer to slide 2. This slide identifies certain non-GAAP financial measures that we reference in our press release, on our slides and on this call, and discloses the reasons why we believe that these measures provide useful information to investors. As required by Regulation G, reconciliations between non-GAAP and GAAP financial measures are included in the supplemental information within our press release and on our website. Slide 3 is our Safe Harbor disclosure statement addressing forward-looking statements. This slide includes cautionary statements identifying important factors that could cause actual results to differ materially from those included in the forward-looking statements, as well as specific examples of forward-looking statements.

Please take note of slides 2 and 3 in their entirety. During this call, all references to a specific year or quarter refer to our fiscal year, which ends on September 30, unless specified otherwise. As previously announced, we sold US Pipe effective April 1, 2012. US Pipe's operating results have been reclassified as discontinued operations, and its assets and liabilities have been reclassified as held for sale for all periods presented. The operating results presented for US Pipe do not reflect what they would have been had US Pipe not been classified as held for sale. The year-over-year comparisons of consolidated operating results discussed on this call represent our continuing operations.

The archived webcast and the corresponding slides will be available for at least 90 days in the Investor Relations section of our website. In addition, we will furnish a copy of our prepared remarks on Form 8-K later this morning. After the prepared remarks, we will open the call to questions. I'll now turn the call over to Greg.

Thanks, Martie. We appreciate you joining us today as we discuss our results for the 2012 second quarter. I'll begin with a brief overview of the quarter followed by Evan's detailed financial report, which covers key drivers affecting our businesses. After that I will follow with additional comments on our recent results as well as our outlook for the third quarter.

Since our last conference call, we have taken several significant steps to strengthen the Company. We completed the sale of US Pipe and reduced our total debt outstanding and net debt leverage.

As we have mentioned before, the sale of US Pipe enables us to focus on Mueller Company's higher-margin base business as well as our newer technology businesses, Mueller Systems and Echologics. Both net sales and adjusted operating income at Mueller Company's base business grew in the second quarter. Net sales grew 2.4% and adjusted operating income for the base business, which excludes Mueller Systems and Echologics, grew 10.7% driven primarily by growth in domestic valve and hydrant units.

Additionally, Mueller Systems and Echologics continued to gain traction in the marketplace with net sales growth of 22.3% year-over-year. We are still in the investment phase with these businesses, which, as expected, negatively impacted Mueller Company's overall results in the quarter.

I'll discuss these investments and the growth opportunities later in the call.

Anvil again delivered solid year-over-year growth with net sales up 12% and adjusted operating income up 45% driven primarily by our energy and fire protection businesses. This is Anvil's seventh consecutive quarter of increased operating income on a year-over-year basis.

We believe the combination of the steps we have taken to strengthen the companies and what appears to be improving end market dynamics position us well for future profitable growth.

I will now turn the call over to Evan who will provide more details on our second quarter financial results.

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

Consolidated net sales for the 2012 second quarter of $251.5 million increased $16 million, or 6.8% from the 2011 second quarter net sales of $235.5 million. Net sales increased due to higher shipment volumes and higher prices at both Mueller Company and Anvil.

Consolidated gross profit of $62.1 million for the 2012 second quarter improved from gross profit of $58.1 million for the 2011 second quarter. Gross profit for the 2012 second quarter was positively impacted primarily by higher shipment volumes and higher sales prices.

Consolidated selling, general, and administrative expenses of $50.6 million for the 2012 second quarter compared to $47.2 million for the 2011 second quarter. Selling, general, and administrative expenses as a percentage of net sales were essentially flat year-over-year.

Adjusted operating income for the 2012 second quarter of $11.5 million improved from $10.9 million for the 2011 second quarter driven by the higher shipment volumes and higher sales prices.

Adjusted EBITDA was essentially flat year-over-year.

Interest expense, net for the 2012 second quarter, was $15.6 million, which included $1.6 million of noncash cost for terminated interest rate swap contracts compared to $16.3 million for the 2011 second quarter, which included $2 million for such contracts. Although these contracts were terminated prior to 2011, the related costs are being amortized over the original term of the swap contracts. Interest expense, excluding the terminated swap contract costs, declined $300,000 year-over-year.

During the 2012 second quarter, we reported income tax expense of $3.9 million on the pretax loss from continuing operations. This expense consists principally of a tax benefit of $2 million, or an effective tax benefit rate of 40%, which was more than offset by a $5.9 million valuation allowance charge related to deferred tax assets at September 30, 2011.

Overall, we recorded $34.4 million in valuation allowance charges during the 2012 second quarter. Although all of the valuation allowance charges are primarily due to operating losses from discontinued operations, GAAP requires allocating a $5.9 million valuation allowance charge to continuing operations. Our net operating loss carryforwards remain available to offset future taxable earnings.

Adjusted net loss per share of $0.01 for the 2012 second quarter improved from adjusted net loss per share of $0.02 for the 2011 second quarter. The 2012 second quarter adjusted results exclude the after-tax loss of discontinued operations of $100.9 million, a valuation allowance charge included in continuing operations of $5.9 million, after-tax interest rate swap costs of $1 million, and after-tax restructuring expenses of $600,000.

The 2011 second quarter adjusted result excluded an after-tax loss of discontinued operations of $8.3 million, after-tax interest rate swap costs of $1.2 million, and after-tax restructuring expenses of $700,000.

There was a weighted average of 156.5 million shares of our common stock outstanding for the 2012 second quarter compared to a weighted average of 155.4 million shares outstanding for the 2011 second quarter.

I'll now move on to segment performance and begin with Mueller Company. Mueller Company's net sales for the 2012 second quarter of $154.5 million increased 3.8% from the 2011 second quarter of $148.9 million. Net sales grew due to higher shipment volumes and higher prices in both the base business as well as at Mueller Systems and Echologics.

The increase in shipment volumes in Mueller Company's base business was primarily due to higher shipments of domestic valves and hydrants. Domestic units of valves increased 3.5%, and hydrants increased 2.1% in the second quarter on a year-over-year basis.

While net sales in Canada were down approximately 12%, or $2 million, on a year-over-year basis, we expect that year-over-year comparisons from our Canadian operations should ease as the Canadian stimulus program was completed in mid-2011.

Adjusted operating income for the 2012 second quarter was $9 million compared to adjusted operating income for the 2011 second quarter of $10.5 million. However, base business adjusted operating income improved 10.7% from the 2011 second quarter and adjusted operating margin improved as well.

Expenses associated with the rampup of operations at both Mueller Systems and Echologics reduced the adjusted operating margin at Mueller Company by 440 basis points.

I'll now turn to Anvil, where we reported our seventh consecutive year-over-year quarterly increase in adjusted operating income.

Net sales for the 2012 second quarter increased 12% at $97 million from $86.6 million in the second quarter of 2011. Net sales increased due to higher shipment volumes and higher prices. Net sales were higher across all our businesses, especially fire protection and oil and gas.

Adjusted operating income increased 44.9% to $10 million in the 2012 second quarter from $6.9 million in the 2011 second quarter.

Adjusted operating margin for the 2012 second quarter was 10.3%, which is a 230 basis point improvement over the 2011 second quarter adjusted operating margin of 8%.

Higher shipment volumes and higher sales prices helped drive the adjusted operating margin improvement.

For the 2012 second quarter, Anvil improved both its adjusted EBITDA and adjusted EBITDA margin year-over-year. Adjusted EBITDA increased to $13.5 million or an adjusted EBITDA margin of 13.9% for the 2012 second quarter compared to adjusted EBITDA of $10.4 million or an adjusted EBITDA margin of 12% for the 2011 second quarter.

Discontinued operations for the 2012 second quarter included a pretax loss of $116.5 million for the sale of US Pipe. US Pipe's net sales and operating loss were $100.9 million and $2.8 million, respectively, for the 2012 second quarter. As a reminder, the operating loss presented for US Pipe does not reflect what it would have been had US Pipe not been classified as held for sale.

During the 2012 second quarter we reported an income tax benefit of $47.1 million on the pretax losses from the discontinued operations and $28.5 million of evaluation allowance charge.

On April 2, 2012, we received cash proceeds of $94 million from the divestiture of US Pipe subject to future adjustments.

Turning now to a discussion of our liquidity -- free cash flow, which is cash flows from continuing operations from operating activity less capital expenditures was $5.1 million for the 2012 second quarter compared to a negative $24.5 million for the 2011 second quarter.

Year-over-year increase in free cash flow was primarily related to the timing of disbursement an income tax refund we received in the 2012 second quarter and an additional [pitch-in] contribution made in the 2011 second quarter.

At March 31, 2012, total debt was $692.5 million and included $420 million of 7.375% senior subordinated notes due 2017; $221.9 million of 8.75% senior unsecured notes due 2020; $48 million drawn under our asset-based credit agreement; and $2.6 million of other.

As of March 31, 2012, we had $89.1 million of excess availability under our asset-based credit agreement, which now excludes US Pipe. However, subsequent to the end of the second quarter, we repaid the $48 million outstanding at March 31, 2012, under the asset-based credit agreement. We also announced the redemption of $22.5 million in principal amount of our eight and three-quarter percent senior unsecured notes on May 18, 2012.

Debt extinguishment charges associated with this redemption will be approximately $1.5 million in the 2012 third quarter.

We reduced net debt leverage from 6.7 at December 31, 2011, to 4.8 at March 31, 2012 on a pro forma basis for the divestiture of US Pipe.

I'll now turn the call back to Greg.

Thanks, Evan. I'll now elaborate a little more on our 2012 second quarter performance and end markets and then provide an outlook for our third quarter. I'll begin with Mueller Company.

We are pleased with the net sales growth in Mueller Company's base business where both orders and shipments of domestic valves and hydrants were up year-over-year. Certainly, we believe that our results benefited from a warmer winter this year. We are uncertain of the extent to which the increased activity was simply due to an earlier start for the construction fees. However, we saw a number of encouraging signs that could indicate our end markets are possibly improving.

As you may remember, we increased prices on valves and hydrants effective in February. Distributors pulled forward orders ahead of the price increase, as they did last year. However, this year a number of distributors have been expediting delivery while a year ago they were asking us to delay shipments.

We also believe the distributor inventories at the end of the second quarter were flat and, in some cases, down from the previous year.

Our quotation activity in the second quarter for Mueller Company's base business was up more than 40% in the number of quotations and up more than 100% in dollars quoted year-over-year.

We are also beginning to see quarter activity on some municipal projects that have been on hold for the last several years. Both shipments and orders at our Henry Pratt business, which primarily consists of valves used in water treatment facilities, were down year-over-year as net sales declined 12%.

As a reminder, this business typically accounts for a little more than 10% of Mueller Company's net sales, and market demand for the products generally lags the rest of Mueller Company's business by about a year.

We should note the quotations in the quarter were up about 16%, which is the first increase since the third quarter of 2010.

Net sales at Mueller Systems and Echologics grew 22% in the second quarter year-over-year as both businesses continued to add new customers.

At Mueller Systems, we continue to gain traction in the marketplace. Our net sales in the quarter were up almost 20% year-over-year, and our backlog increased around 40% from the same period last year. However, the financial performance at Mueller Systems negatively impacted the overall financial performance of Mueller Company. We are still in the investment phase and during the quarter these investments included costs associated with building production capabilities.

We are currently engaged in pursuing several large opportunities that we believe are likely to turn into shipments in the second half of the year. We also are continuing to invest in new product development. We expect to see the benefits of these new product investments in later years.

We are in the early phase of introducing our Echologics leak detection and pipe condition assessment technologies to the marketplace and are currently conducting pilots with a number of customers as we pursue long-term opportunities.

For example, we recently announced agreements with the cities of Tampa and Las Vegas. The investments we made in the quarter in Echologics are associated with introducing its technologies and building its field service and engineering organizations.

The interest in leak detection and pipe condition assessment services is growing as municipalities have struggled to maintain an aging water infrastructure as it helps them prioritize their capital spending.

As Evan discussed, Anvil had another solid quarter. Most of its addressed markets are relatively stable, with the oil and gas markets, which accounted for approximately 20% of Anvil sales remaining strong, although the year-over-year comparisons will begin to get tougher.

Before I turn to our outlook for the third quarter, I'll discuss what we are seeing with some of the macro drivers in our end markets. As we have discussed, before we believe -- as we have discussed before, we believe our water infrastructure markets have essentially hit bottom. This year's construction season is off to a favorable start.

The general municipal spending environment continues to improve, although budget pressures and economic uncertainty persists.

State and local receipts grew at over 4% year-over-year for the third consecutive quarter in the latest 12 months as of December 31st. While both are showing improving trends, state tax receipt improvements is much stronger than local.

On the municipal bond front, rates are still very attractive from a historical perspective and year-to-date issuance is up 76%.

Finally, the housing market appears to be stabilizing. Housing starts in March represented the seventh consecutive month of greater than 600,000 units on a seasonally adjusted annualized basis. March was the first time there have been five consecutive months of higher than 650,000 starts since November 2008.

Furthermore, March single-family starts were above $450,000 units for the fourth consecutive month. As a potential future indicator, February and March housing permits were the two strongest months since October 2008. An improving housing market should also help bolster the municipal market as local governments benefit from increased property taxes as well as connection fees and other ancillary fees associated with residential construction.

Overall, while we think it is premature to conclude that we are going to see real near-term growth in our end markets, the signs we are seeing are the most positive ones we've seen in the last couple of years. We believe that our end markets certainly have stabilized, and there is less uncertainty today.

Turning now to our outlook for the third quarter. On a year-over-year basis for the third quarter, we expect Mueller Company's net sales to increase due to modest volume growth and higher prices in our base business and significant net sales growth in Mueller Systems and Echologics.

Generally, raw material costs continue to be relatively stable year-over-year. Mueller Systems and Echologics will continue to negatively impact Mueller Company's overall performance in the third quarter. Our previous expectations for these businesses to be profitable in the second half of the year now appears to be entirely dependent on the timing of anticipated orders.

In any event, we do expect an improved performance for these businesses in the second half of the year compared to the prior-year period in the first half of this year. We also expect the year-over-year negative impact on Mueller Company's margins due to these businesses to be less in the third quarter than it was in the second quarter.

We expect adjusted operating income from Mueller Company to be slightly higher benefiting from the positive operating leverage from our base business, partially offset by the continued investment in Mueller Systems and Echologics.

Now I'll turn to Anvil.

We expect to see slightly higher shipment volumes in the 2012 third quarter year-over-year. We also expect to benefit from higher pricing. However, we are entering a period of tougher year-over-year comparisons in our addressed oil and gas markets as a result of the strong demand we began to see starting in the third quarter last year.

Generally, raw material costs are expected to be relatively stable. In total, we expect to see a slight improvement in Anvil's net sales and adjusted operating income.

I'll now discuss some other key variables for 2012.

Our corporate expenses are estimated to be between $27 million and $29 million this year. Our corporate expenses have been declining since 2008 and are expected to be down from the 2011 expenses of $31.9 million.

For the second half of the year, depreciation and amortization is expected to be approximately $31 million, and interest expense is expected to be $29 million to $31 million, which includes $2 million of noncash interest expense associated with the terminated swap contracts.

Our effective income tax rate for the second half of 2012 is expected to be between 38% and 42%. Capital expenditures are estimated to be between $26 million and $30 million for the full year.

We expect 2012 free cash flow from continuing operations to be higher than the preliminary reclassified free cash flow estimates of $30 million for 2011 due primarily to improved operating results.

We continue to improve our working capital efficiencies. For example, inventory turns for the 12 months ended March 31, 2012, improved about a half a turn from the comparable prior-year period. Additionally, we believe inventory turns will continue to improve over the remainder of 2012.

Furthermore, for the latest 12 months, average receivables, inventory, and accounts payable as a percentage of net sales decreased about 170 basis points from a year ago.

We have long said that Mueller Water Products is well positioned for growth when our end markets rebound. We have streamlined our manufacturing operations, strengthened our financial positions and invested in new product development. Consequently, we are a leaner, more flexible, and more innovative company than before.

We are also investing in emerging technologies such as advanced meter infrastructure, leak detection, and pipe condition assessment to ensure that we remain a value partner for all aspects of municipalities' water management programs.

Municipalities and water utilities continue to balance the need to repair and replace an aging water infrastructure with budget and customer service considerations. We believe the combination of our infrastructure expertise, innovative technology, and longstanding relationships with distributors and end users is unmatched in the industry, and we are leveraging all three to help our customers increased operational efficiencies, improve customer service, and better manage the distribution and use of water.

With that, I will open this call for your questions.

Thank you. (Operator Instructions) Kevin Maczka, sir, your line is open and please state your company name.

Good morning. BB&T Capital Markets. Greg, I guess you're not disclosing quite as much in terms of the breakdown by segment and price in volume. I was wondering if you could say a little bit more about the pricing environment generally? With the conditions improving and volumes increasing, you've been able to take price increases even prior to that. But are you seeing any change in competitive behavior in the pricing dynamic more recently?

Kevin, I don't think we've seen much of a change. In both of our businesses, our price increases more than offset higher raw material costs. In the Anvil business, I think we're probably even a little ahead of where -- you know, I think raw materials, we got price increases in the marketplace very early there, and higher raw material costs, in a sense, are starting to catch up.

But we still, I think, in both businesses again this quarter, we were able to achieve higher pricing than the higher raw material costs. And I think that we feel confident that we'll be able to continue to maintain that relationship.

Okay, and then, Greg, you're, of course, talking more and more about Mueller Systems and Echologics as those become more important to you. Can you give us kind of an update in terms of sizing those businesses? Where they are today and the margin drag that we have there -- is that simply because these businesses aren't to scale yet, and you're making the investments to grow them? Or are you having to -- since this is a competitive market, are you having to kind of buy your way into the business, if you will, to win some of these first big contracts that you've won?

Kevin, great questions. Yes, when you look at our -- today, from a sales standpoint, those businesses are less than 10% of Mueller Company's total sales. The majority of what we are seeing relative to the -- I would say the drain on our performance -- is coming from investing in the businesses. And I'll give you some examples.

At Echologics we have something like 25 pilots in process today. Well, that requires that we had to fill [several] service organizations. We've been hiring our project managers for that business. We have been hiring -- continue to hire engineers on new product development. I don't think it's at all reflective of a pricing to buy our way in. It's more, I think, we're -- on the leak detection side, in the very early stages of introducing a new technology.

Acoustical leak detection has been around for a while, they're primarily used on distribution lines. We're using it on transmission lines where we think it has tremendous opportunity, and our customers are telling us they have tremendous opportunities.

But it's a very conservative customer base, and they're saying come in and prove it to us. So in the Echologics business, we're a lot in that phase of come in and prove it to us, and building the infrastructure to do that and supportive when we turn in to order.

When you look at Mueller Systems, I would not classify the drag as a pricing currently, but one a little bit of a mix. A year ago, that we signed an agreement -- a little over a year ago, we signed an agreement with Landis & Gyr to provide -- to sort electric meters from Landis and Gyr when we are going to those utilities that are buying both electric and water meters. We obviously get a much less of a markup on the electric meters because it truly is a pass-through for us.

When we look at our shipments for the first half of this year, of those orders we receive were both electric and water meters. A lot of what we have been shipping have been installed first, deployed first, have been the electric meters where we get very little markup.

The water meters, we expect we will be shipping most of those the second half of this year. So from that standpoint, I could say that -- you could say that it's more of a margin issue than buildup. But if you look at our other costs associated in the Mueller business, as I referenced on our prepared remarks, we had -- we incurred some costs associated with building up our production capabilities this past quarter for some orders that we expect to receive early in the third quarter and then shipping in the second half of the year. And we wanted to make sure we were ready to be able to meet those deliveries. So we went ahead, before we actually received the order, in anticipation of receiving those orders and started increasing our capability.

I will say that we are seeing some cost, and I wouldn't put this under the pricing category, but on -- and I think in any of new technology like this and especially on our two-way AMI, some of the systems that we have deployed in the last 12 months, we've had some field service work associated with those to do some fine-tuning in the field. And I think that that's maybe something that we learned, and there's a need for the field's fine-tuning and I think in the future we'll try to incorporate that in our pricing.

But I think, all in all, the primary negative drag that we're seeing from these businesses are associated with the buildup of capability and not really a pricing issue.

Got it, thanks, Greg -- very helpful. Just, finally, the businesses today you said are less than 10% of total Mueller Co. This may be hard to answer, I know this is evolving, but is there any way over the next couple of years you can kind of frame your expectations there? Should that become 20% or 30% or -- ?

Kevin, we do think it can become 30%. If we look in three or four years, if you look at our revenues we expect to generate from this business, maybe if you look four or five years, that we think that we could add $150 million to $170 million in revenue from where we are today. And I'd say maybe more in four or five years from now.

Jerry Revich, please state your company name.

Hi, good morning. It's Goldman Sachs. Can you talk about the bookings activity in your oil and gas business? What was that like in the quarter and in the early part of April? And also just touch on what kind of end markets are we thinking about within oil and gas? If you can help us understand gas versus oil or any more granularity there that would be really helpful.

Yes, sure, Jerry. When we look at -- the comments that I made about tougher comparisons, when we look at our April, I think April was up a little but just slightly on the oil and gas side. If we look at still in the quarter we just completed, I think we were still seeing a 15% increase on year-over-year in that range -- year-over-year of orders.

Our products can go in either oil and gas, and I will say that we're not getting a breakdown from our distributors, whether it's going to -- is it oil or is it gas? But we manufacture the forged steel couplings that hold the smaller diameter pieces of pipe together. So we are downstream of the wellheads, and we have -- it can vary from quarter to quarter, but our products that we use in the oil patch of West Texas or it can be used in the fracking of the Marcellus Shale. But it is more -- it's agnostic as to either one. It goes into the couplings of the piping system.

And you've had excellent incremental margins in the segment over the past year. Should we look for the incremental margin profile to be different in the back half of the year as the oil and gas business slows? I guess, presumably that's a higher-margin business for you, but I'm wondering if you can give us some more context there?

Yes. We think the growth will slow, certainly not the business itself. And I would say that, really, our margins on this business are not significantly different than the other parts of our business. So we don't really think we'll see a margin impact.

Okay. And in terms of the Mueller Co restructuring charge in the quarter, can you talk about what part of the operation that's related to -- the payback period, et cetera?

Sure. Evan, I'll let you take that.

That's just some realignment of some very small facilities and some headcount reduction that we had. And those costs were in the quarter for activities that occurred in the quarter and we think that will be a very quick payback. But it's just primarily related to headcount reductions.

Okay. And are you open to talking about your material costs in the quarter by business as you were in the past? Or are you trying to move away from that level of disclosure?

Yes, sure. I think, Jerry, that we'll -- when -- they'll vary by quarter to quarter when it truly has a significant impact. We'll certainly point that out. But if we look in both businesses on a year-over-year basis -- for instance, if you look at our scrap costs that went through cost of goods sold in Mueller, it was less than a 2% difference from what we were paying on a year-over-year basis. Brass, actually, was down slightly a couple of percentage points, and the same was true at Anvil. So it was not a particularly -- did not have a particularly relevant impact on the operations when we look at this quarter.

But, certainly, I think when we see some very big movements, and it had a big impact year-over-year, we'll, certainly, I think, continue to point that out.

Anix Vyas, please state your company name, sir.

Hi, good morning, Gabelli & Company. I just wanted to follow up with the question that was asked earlier about the margins in Mueller Co. I think I got the answer, but I just wanted to flesh it out a little bit. So when I look at the margins, specifically the gross margin profile, it's significantly lower, and it seems like, Greg, you mentioned that it's potentially due to the pass through of the electric meters, but I just wanted to ask the question again in light of the gross margins and maybe you can comment on expectations, going forward, for the gross margin profile.

Yes, sure. Yes, and it was -- I don't want to mislead to say it was the electric margins. The electric meters, certainly, I think was an impact on our Mueller Systems business, but when we look at total Mueller Systems and Echologics, our newer technology businesses combined, they, as we pointed out, reduced our margins, operating income margins, at Mueller by 440 basis points. We also pointed out that while I think that these businesses will continue to be a drag, we think it will be less of a drag in the third and fourth quarter of this year because we expect to see some improvement as the volume increases in that business.

So when we look at our Mueller Company base business, our margins -- and we're calling base business everything excluding Mueller Systems and Echologics -- our margins in that business were up year-over-year, and we -- as we said, we expect overall improvement in operating income, a slight improvement in operating income year-over-year in this business in the third quarter, which would also support an improvement of margins in the third quarter also.

Seth Weber, please state your company name, sir.

Good morning, it's RBC. I just wanted to see if we could get a little bit more color on the pushout of the profitability for the emerging segments. Was that a function of the customer was pushing back or the product isn't ready? I'm just trying to understand where the dislocation came from this quarter?

Seth, it's more of a -- we believed, for instance, we were going to receive the order in March, and now we think we'll get the order in May. It's more of a -- in one case, a large order that's just going through the system at our end user. In another case, the city council, we were informed that we were going to be awarded the contract, and the city council delayed their meeting for three weeks.

So that's what's been the bigger impact on us right now. It's not that we're losing orders that we expect to receive. I think it's just the timing of those orders working through the process at our customers, and then we're actually -- us actually getting awarded the order. So I think it's more of a timing on our customers' part. Our outlook hasn't changed relative to the orders we think we'll receive.

Okay, thank you. Changing gears a little bit -- another player -- not a competitor but another participant in the water infrastructure market recently talked about some issues with lead in some of their products, and they're starting to see more pushback. I know you guys have talked about this historically, but I was just wondering if you're seeing any kind of increase in attention on that and if you're taking any actions there?

Yes, yes, we have -- as you know, we have a brass product line under the Mueller brand name, and we've made some pretty significant investments -- probably started that process about four years ago to now where we manufacture low-lead brass for those products that meet all of the lead requirements. So that was a capital investment for us several years ago, and that adds some costs and, of course, we're trying to pass that along to the customer, I think, as our competitors are doing also.

Probably one of the most aggressive areas that we've focused on here, and one that gives us -- I think that we feel pretty bullish -- is several years ago we took the lead on the meter side of developing a composite meter, and we took that one step further, because I think the objection from the marketplace was their concern on cross-threading -- of putting metal threads into plastic threads or composite threads on the meter.

So we did some intellectual property work, and we think we have a pretty good patent on connecting metal threads to the composite body meter, which gives us, we think somewhat of an advantage in the marketplace. And some of the orders that I've referenced that we think that -- that we -- will be counting and start shipping the second half of the year will be for the composite meter.

So to answer your question -- yes, that I think we got out ahead of it several years ago in our brass products under the Mueller brand name. And, again, just to remind people, those are some of the small valves that actually are shut-off valves at the end of the property for an individual house where the water company can come in and shut off flow. Those are brass products. We manufacture those now in low-lead brass.

And on the meter side, as I said, that we think in the future a much greater percentage of our revenues and sales will be for our composite meter.

Okay, thank you, that's very helpful, Greg. And I guess just one last one for Evan. Can you maybe just talk about capital allocation now that the pipe business has been divested, and you have some runway there on the balance sheet?

Sure. As you saw, subsequent to the quarter, we've repaid $48 million under our ABL and also announced the redemption of 10% of the par value of our 8.75% notes. And, going forward, debt reduction continues to be a priority for us, and we have an additional 10% redemption option that we can put in play after September 1 of this year. And, as well, we have a $65 million general basket available for repurchase of notes, and beginning on June 1 of 2012, we can redeem the subordinated notes at just a little over 103.

So looking out, certainly debt reduction continues to be a focus, but we're still in the valuation phase as we move forward.

Yilma Abebe, please state your company name.

Good morning, JP Morgan. My question is on free cash flow. For the first half, can I confirm that I heard free cash flow for 2012 higher than $30 million? Did I hear that right?

We indicated that free cash flow for 2012, our projection is higher than the preliminary reclassified financial statement that we had last year, which was around $30 million. So it would be higher than that [mark], yes.

Okay, thank you for that.

And that's continuing -- free cash flow from continuing operations.

Yes, yes. And can you perhaps remind us on the seasonality of the free cash flow pro forma for the divestiture of your US Pipe? Is there any difference, or the so-called trends, is relevant?

I would say, overall, our first and second quarters, the non-construction fees and the net typically when we have lower free cash flow, second quarter in particular on an overall basis. But it can vary. But with the pipe divestiture, I would say that general trends will still be in place because Q3 and Q4 are the construction season, and that's when we typically have higher sales and activity in our Mueller Company business.

Okay, thanks for that. And then, finally, it looked like this quarter on the free cash flow front, there were some favorable timing-related issues. How should we think about these timing issues in this quarter and the following quarter?

This quarter we did receive, in free cash flow from continuing operations, we received an income tax refund of -- and also last year in the same quarter we had an additional amount of pension contributions that we made. So those can vary. The timing of that can vary from quarter to quarter, and so it did benefit the question. Both of those, I would say, in and around $15 million, and that can just be choppy as we go out, depending upon either refunds of taxes or pension contributions. But those were two items that did benefit us this year in the second quarter in free cash flow.

Todd Vencil, please state your company name.

Greg, talking around what you said about the valve and hydrant volumes this spring and what you said about distributor inventories -- what are you distributors telling you about their outlook. I mean, you made some positive comments, but on the residential construction side, what are those guys saying they're hearing from their customers?

Yes, Todd, good question. I think, overall, our distributors are more bullish now than they were a year ago, and I think there are a few sections -- I would not say many -- but a few sections of the country where our distributors are actually reporting that they're generating some valve and hydrant business from new housing developments.

Certainly, we're not projecting that this will be a significant uptick for us in 2012, but our distributors are telling is they're seeing some of the -- they're seeing in some locations, some opportunities. And as I said earlier, that they are reporting that we're getting some quotation activity and starting seeing projects they've been hold for the last two or three years. The last two or three years, we're seeing some activities on those.

So, all in all, our distributors are a lot more positive than they were a year ago. And I think that their hypothesis or what we're hearing is that a year ago that they thought that municipalities, because under the doom and gloom, got so conservative and cut so deeply that I think that their belief is they just can't continue at that low of a rate and maybe what we're seeing is that they're back to at least -- there's less panic than there was a year ago, and they're back to spending at least maybe a little closer to their normalized -- what they need -- what they need to do.

So -- but anecdotally, I would say that our distributors right now are more positive on the outlook for this year, the second half of the year, going into construction season, than they were a year ago.

That's great. Thanks for that. And just out of curiosity, can you -- are you at liberty to sort of talk about what sort of specific geographies they're seeing -- the uptick in community development or is it just sort of scattered?

I think it's scattered, but I would say that, again, it's probably a little more in our central region, which encompasses Texas and all -- so, again, I would think it's -- our -- Midwest, down in the Southwest, for sure.

Perfect. And then sort of the same question on the Anvil side. I mean, you had some great comments about oil and gas. Outside of oil and gas in the non-residential building side, what are you hearing there?

I would say it's moving slowly in the right direction. But we've seen a number of forecasts that are calling, maybe, for 4% or 5% growth in non-res construction spending this year. I would say that we have not yet seen those kind of growth rates, but I think that we've seen it pretty flat, but, again, I think our distributors are a little more bullish, and we could see some -- just some building of inventories there as the year moves along.

So certainly I would say that the oil and gas market has been a much stronger market than the non-residential construction. I don't think we -- we don't have a concern of seeing a potential fall-off in non-res construction. I think it's going to move slowly in the right direction.

Brent Thielman, please state your company name.

Yes, it's D.A. Davidson. Greg, I apologize, but you provided some metrics for Mueller's base business in terms of quotation activity. Could you give me those numbers again?

Yes. If you look on a year-over-year basis, our number of quotations were up 40%, and dollar volume was up slightly over 100%.

And, presumably, that's up from the first quarter as well?

Yes, it would be, for sure, just because of the seasonality of the business. If you look at sequentially on the number of quotes, we're up over 70% in this quarter versus our first quarter of our fiscal year.

Got you. And then can you remind me, is the majority of that municipal repair a replacement or sort of new subdivisions?

Yes, no, most of it would be the repair and replacement for municipalities. And, as I said, we may have had a smattering of some new housing developments, but I would still say that that's just crawling along but at least better than what it has been. And most of it has been, I guess, I would say, several of them were projects that have been on the books for a while that are finally coming to fruition.

Okay, and then switching to Anvil, I guess, as you begin to see more activity in markets outside of industrial, oil and gas, and, presumably, that's more non-residential buildings I'm talking about, but will that have an effect on the margin from a mixed perspective as this commercial cycle picks up?

Brent, I don't believe so. I think when you look at the margins that we get in our standard products versus the margins that we get on the oil and gas, they're pretty close to being in the same range. And I think where we will see a benefit, as that business picks up, we'll increase our capacity utilization, which should help to -- should help the overall performance of the business as we get the incremental margins flow through.

Seth Weber.

Seth Weber. Hi, just a quick follow-up. Sorry if you said this already, but what was the tax refund in the quarter that benefited in free cash flow?

The tax refund was around $8 million.

Okay, perfect, and that's factored into your $30 million-plus for the year?

That is correct.

And that does conclude the question-and-answer segment of our call. I'll now turn the call back over to our speakers.

Well, again, everyone thank you very much for your continued interest in Mueller Water Products, and hopefully we'll get a chance to see a number of you soon.

That does conclude today's presentation. Thank you all for joining. You may now disconnect.