Mueller Water Products Inc (MWA) 2013 Q4 法說會逐字稿

Welcome and thank you for holding. I would like to remind all parties that your lines are on a listen only mode until the question and answer session of today's conference.

Also, this call is being recorded. If you have any objections, please disconnect at this time. I will now turn the call over to Ms. Martie Zakas. Ma'am, you may begin.

Very good, thank you, and good morning, everyone. Welcome to Mueller Water Products 2013 fourth quarter conference call. We issued our press release reporting results of operations for the quarter and year ended September 30, 2013, yesterday afternoon. A copy of it is available on our website, muellerwaterproducts.com. Mueller Water Products had 158.2 million shares outstanding at September 30, 2013. Discussing the fourth 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 to help illustrate the quarter's results as well as to address forward-looking statements and our non-GAAP disclosure requirement.

At this time, please refer to slide 2. This slide identifies certain non-GAAP financial measures referenced in our press release, on our slides, and on this call and discloses the reasons why we believe that these measures provide useful and for information to investors. Reconciliations between non-GAAP and GAAP financial measures are included in the supplemental information within our press release and on our website. Slide 3 addresses our forward-looking statements made on this call. This slide includes cautionary information 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 review 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. All operating results discussed in these prepared remarks are from continuing operations unless specified otherwise. A replay of this morning's call will be available for 30 days after the call at 1-866-470-7045. 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 will now turn the call over to Greg.

Thanks, Martie. And thank you for joining us today as we discuss our results for the 2013 fourth quarter and full year. I'll begin with a brief overview of the quarter followed by Evan's detailed financial report which covers key drivers affecting our businesses. I will then provide additional comments on the quarter's results and developments in our end markets as well as our outlook for the first quarter and for full-year 2014.

We are pleased with our overall fourth quarter results, particularly the 47% year-over-year increase in adjusted operating income and the 27% improvement in adjusted EBITDA. Mueller Company continues to benefit from improved operating leverage and the ongoing recovery of its end markets, especially residential construction in certain regions of the country. Mueller Company continues to see growth in domestic shipments of valves, hydrants, and brass products during the fourth quarter, and this strong mix contributed to the segment's 40% year-over-year increase in adjusted operating income and the 430 basis points improvement in adjusted operating margin to 15.8%. Domestic dollar shipments of valves, hydrants, and brass products increased 13.7% during the quarter year over year.

Anvil had a strong quarter, with net sales up 8.8% and adjusted operating income up 30% year over year. 2013 was a year of strong performance for Mueller Water Products, as evidenced by year-over-year net sales growth of 9.5% and adjusted operating income growth of 48%. Free cash flow generation of $78.5 million, an increase of $33.1 million and a reduction of net debt leverage to three times. Our 2013 performance reflects the ongoing operating improvements we have made over recent years, as well as the benefits we have realized from improving end markets. I will now turn the call over to Evan.

Thanks, Greg, and good morning, everyone. I'll first review our fourth quarter consolidated financial results and then discuss segment performance. Net sales for the 2013 fourth quarter of $293.2 million increased $12.1 million or 4.3% from the 2012 fourth quarter net sales of $281.1 million due primarily to higher shipment volumes and higher prices. Gross profit improved 15.9% to $88.8 million for the 2013 fourth quarter compared to $76.6 million for the 2012 fourth quarter. Gross profit margin of 30.3% improved 300 basis points from 27.3%, representing our best performance since the fourth quarter of 2008. This improvement was driven primarily by higher shipment volumes and higher sales prices.

Selling, general, and administrative expense of as a percent of net sales declined to 18.9% for the 2013 fourth quarter from 19.2% for the 2012 fourth quarter. Selling, general, and administrative expenses were $55.4 million for the 2013 fourth quarter, compared to $53.9 million for the 2012 fourth quarter. Adjusted operating income for the 2013 fourth quarter increased 48.7% to $33.4 million from adjusted operating income of $22.7 million for the 2012 fourth quarter. This increase was driven primarily by higher shipment volumes and higher sales prices. Adjusted EBITDA for the 2013 fourth quarter increased to $48.2 million from $38.1 million for the 2012 fourth quarter. 2013 adjusted EBITDA was $158 million, an improvement of $30.5 million or 24% from year ago. Interest expense net for the 2013 fourth quarter declined $400,000 to $12.7 million from $13.1 million for the 2012 fourth quarter, excluding $700,000 of non-cash costs for terminated interest rate swap contracts for the 2012 fourth quarter. This decrease was due to lower levels of total debt outstanding.

For 2013, interest expense declined $3.2 million, excluding terminated interest rate swap contracts of $5 million in 2012. During the 2013 fourth quarter, income tax expense was $3.7 million on pre-tax income of $20.5 million, resulting in an effective income tax rate of 18%. The 2013 fourth quarter expense was reduced by $4.4 million related to a deferred tax asset valuation allowance adjustment. Excluding this adjustment, the effective tax rate for the 2013 fourth quarter was 39.5%. Adjusted net income per diluted share for the 2013 fourth quarter was $0.08 compared to adjusted net income per diluted share for the 2012 fourth quarter of $0.03, an improvement of $0.05. I will now walk you through the after-tax adjustments for both the 2013 and 2012 fourth quarters. 2013 diluted EPS from continuing operations of $0.10 was adjusted by the following items -- restructuring expenses of $100,000 offset by deferred tax asset valuation allowance adjustment benefit of $4.4 million.

2012 diluted EPS from continuing operations of $0.03 was adjusted by the following items -- restructuring expenses of $500,000 and terminated interest rate swap contract cost of $400,000. It was a weighted average of 161.2 million diluted shares of our common stock outstanding for the 2013 fourth quarter compared to a weighted average of 158.5 million diluted shares outstanding for the 2012 fourth quarter. I will now move on to segment performance and begin with Mueller Company. Net sales for the 2013 fourth quarter increased 2% to $191 million from net sales of $187.2 million for the 2012 fourth quarter. This increase was due primarily to higher domestic shipment volumes of valves, hydrants, and brass products, partially offset by lower shipments of metering products and shipments to Canada.

Adjusted operating income for the 2013 fourth quarter improved 40% to $30.1 million from adjusted operating income of $21.5 million for the 2012 fourth quarter. Adjusted operating margin for the 2013 fourth quarter improved 430 basis points at 15.8% from adjusted operating margin for the 2012 fourth quarter of 11.5%. We benefited from increased volumes and more specifically, a richer mix of our valves, hydrants, and brass products, higher sales prices, and lower cost. Adjusted EBITDA for the 2013 fourth quarter grew to $41.2 million compared to adjusted EBITDA for the 2012 fourth quarter of $33.1 million.

I will now turn to Anvil. Net sales for the 2013 fourth quarter increased 8.8% to $102.2 million, compared to net sales of $93.9 million for the 2012 fourth quarter. The increase resulted primarily from higher shipment volumes across most of our product lines. Adjusted operating income for the 2013 fourth quarter improved 33% to $13.2 million compared to adjusted operating income for the 2012 fourth quarter of $9.9 million. Anvil's adjusted operating in for the 2013 fourth quarter improved 210 basis points to 12.6% from 10.5% for the 2012 fourth quarter. Adjusted EBITDA for the 2013 fourth quarter increased 22% to $16.5 million compared to adjusted EBITDA for the 2012 fourth quarter of $13.5 million.

Turning now to a discussion of our liquidity. Free cash flow, which is cash flows from operating activities less capital expenditures, was $58.7 million for the 2013 fourth quarter compared to $40.4 million for the 2012 fourth quarter. The increase was driven by both growth in operating income and improved working capital management. For the full year 2013, free cash flow was $78.5 million compared to $45.4 million in 2012. Additionally, we improved the measure of working capital efficiency by 110 basis points year over year as evaluated by trailing fourth quarter average accounts receivable, inventory, and accounts payable as a percent of net sales.

At September 30, 2013, total debt was $600.8 million, down $22 million from year ago. Total debt outstanding included $420 million of 7 3/8% senior subordinated notes due 2017, $178 million of 8 3/4% senior unsecured notes due 2020, and $2.8 million of other. Net debt leverage declined to three times at September 30, 2013, due to improved operating performance and free cash flow generation. Using September 30, 2013 data, we had $159.4 million of excess availability under our credit agreement. I'm also pleased to remind you that during the quarter, Moody's raised its corporate credit rating on Mueller Water Products to B2 with a stable outlook from B3 with a positive outlook. I will now turn the call back to Greg.

Thanks, Evan. I will now elaborate on our 2013 fourth-quarter and full-year performance and end markets and provide an outlook for the first quarter and full year 2014. I'll begin with Mueller Company. We continued to see strong growth in domestic demand for our valves, hydrants, and brass products. As I mentioned earlier, domestic dollar shipments for these products during the fourth quarter grew 13.7% year over year. We believe this increase was driven primarily by residential construction growth, although we also saw some positive activity in municipal spending.

Year-over-year sales of metering products declined in the fourth quarter, although going into the quarter we had expected sales to increase modestly. First, orders from our largest meter customer declined year over year which we believe was due to scheduling. Second, sales were lower than expected due to the timing of a major order. During the quarter, we received an order from Jackson, Mississippi, for 65,000 units, a substantial majority of which was for our remote disconnect meter and for our two-way AMI system. This was the largest single order that Mueller Systems had received. We originally expected to receive this order earlier such that we could start shipping during the fourth quarter. Instead, given the timing of the order, we expect these units to begin shipping later during our first quarter of 2014 and to continue throughout calendar 2014.

Sales to Canada were down year over year as we saw a fall off in demand due to a market that remains soft. We were also negatively impacted by a weaker Canadian dollar. While Mueller Company net sales during the quarter grew only 2% year over year, demand from our core domestic markets remained strong. Anvil also had a very good quarter. They saw a nice pickup in activity for their products with net sales growing just under 9% which also benefited from higher prices. Adjusted operating income grew by 30% and adjusted operating margin expanded by 210 basis points to 12.6%. This is the highest margin Anvil has achieved since the first quarter of 2009.

Now turning to what we expect to see for the full year 2014, I will begin with Mueller Company. We expect continued growth in net sales at Mueller Company driven primarily by the residential construction market. Housing starts are forecasted to grow between 22% and 24% in calendar 2014 from 2013. As you know, development of raw land for residential construction is the greatest driver of demand for our products. According to recent surveys by Ivy Zelman & Associates, growth in demand for land and lots has moderated slightly after recently hitting record highs. But growth remains robust. The CPI for water and sewage maintenance increased around 6% for the last 12 months ended August 2013.

Rising water rates are a significant source of funds from municipalities to drive capital projects. Water rate increases have far outpaced those of other utilities over the last several years. Overall, municipal bond financing was down through the first on months of calendar 2013, primarily due to higher rates. However, while refinancing activity was down, new money issuance was up about 8%. On the municipal budget front, state and local seasonally adjusted tax receipts continue to increase and hit new highs, and municipalities overall are in a better fiscal shape than they have been over the last several years. All in all, based on discussions with our customers and distributors, we expect to see modest growth in demand from municipal repair and replacement projects in 2014.

Overall, for the Mueller Company base business, which excludes our metering and leak detection products and services, we expect year-over-year net sales to increase over 2013 and to grow in the high-single digits. We believe our metering business is stronger today than it was a year ago. For example, over the last two months we were awarded three projects totaling approximately $30 million. These include orders for our meters and either our one-way or two-way AMI technology offerings. Not only is our business stronger due to the increased volume, but also we believe due to a product mix more heavily weighted towards our higher technology products. We expect most of these meters to ship in the second half of 2014 with a lesser amount scheduled for 2015. Of course, construction delays and other external factors could cause the timing of shipments to shift. While we expect nice year-over-year net sales growth in our metering products in 2014, growth is expected to be well below the roughly 50% year-over-year growth we realized in 2013.

In total, for Mueller Company, 2014 net sales growth should be comparable to 2013 based on the current outlook for housing, continued growth in municipal spending, and continued adoption of smart meter technology. On the production side, we expect to continue to see the benefits of LEAN manufacturing and other productivity improvements. With increased production and shipment volumes, we should see the benefits of stronger operating leverage resulting in year-over-year margin expansion. Material costs have been stable recently and we expect that average costs for 2014 will be slightly lower than in 2013 as we have seen a modest decline in prices during the year. As a result, we expect Mueller Company's adjusted operating income and adjusted operating income margin to improve over 2013. We also believe our metering and leak detection products and services will be profitable for 2014, weighted towards the second half of the year.

Now I will turn to Anvil. We expect Anvil to see slightly higher shipment volumes in 2014. The architectural billing index was about 50 for 11 of the last 12 months and any score above 50 suggests an increase in billing. In addition, most economic forecasts call for a modest growth in nonresidential construction spending. We have recently seen a slight increase in activity and believe this momentum will carry through 2014. Spending in the oil and gas markets is expected to increase in response to expanding production. We expect the benefits of LEAN manufacturing and other productivity improvements at Anvil to at least offset inflationary increases in production costs. Overall, year-over-year net sales were expected to grow in the low- to mid-single-digit range and adjusted operating income margins could expand slightly.

Other 2014 key variables include corporate spending is expected to be $32 million to $34 million, depreciation and amortization is expected to be $57 million to $60 million, and interest expense is expected to be about $51 million based on our current debt outstanding. Our adjusted effective income tax rate is expected to be 37% to 40%, capital expenditures are expected to be $34 million to $36 million. For 2014, we expect free cash flow to be stronger than in 2013, driven primarily by better operating results. Additionally, we expect cash income taxes to be minimal in 2014 as we continue to benefit from utilization of net of operating loss carry forward. We also expect to make only minimal cash contributions to our pension plan in 2014.

Turning now to our outlook for the first quarter. We expect Mueller Company's first quarter net sales to increase year over year in the high-single digits. We expect Mueller Company's adjusted operating income and adjusted operating income margin for the first quarter to improve year over year. Please note that Mueller Company's conversion margins are typically lowest in the first quarter due to the seasonality of our business and the reduced workdays that result from scheduled holiday plant shutdowns. At Anvil, first-quarter net sales should be modestly higher year over year. We believe Anvil will benefit from lower year-over-year per unit overhead cost. This coupled with an increase in volume should contribute to higher adjusted operating income and a higher adjusted operating income margin.

For Mueller Water Products as a whole, we believe first-quarter net sales will increase year over year primarily due to volume increases at both Mueller Company and Anvil. We expect solid increases and adjusted operating income year over year and to see an improvement in our adjusted operating margin. As we reflect on 2013, we are pleased with net sales growth of 9.5%, conversion margin on net sales growth of almost 33%, and improvement in adjusted net income per share to $0.18 from $0.04. We also generated free cash flow of $78.5 million and importantly, reduced our net debt leverage to 3 times at September 30, 2013 from 4.2 times at September 30, 2012. We also improved our receivables, inventory, and accounts payable as a percent of net sales by 110 basis points. Our focus on safety, LEAN manufacturing, and operating efficiencies continue to yield positive results. Most recently, our Albertville, Alabama hydrant plant earned OSHA's prestigious Voluntary Protection Program Star status. This award recognizes work locations for their commitment to workplace safety. Albertville is one of only six foundries in the United States and the only one in the Southeast to currently hold Star status.

Net sales of our metering and leak detection products and services group 55% year over year in 2013 and represented about 13% of Mueller Company's net sales. Their operating loss improved by about $8 million. Importantly, we continue to gain new customers. We also developed and announced a number of new offerings including fixed leak detection products for both distribution and transmission pipelines, which we believe will provide our customers solutions to more efficiently manage their operations and prioritize capital spending. With that, I will open this call for your questions.

(Operator Instructions)

Our first question comes from Kevin Maczka. Your line is open and please state your company name.

Thanks, good morning. BB&T Capital Markets. First, Greg, on the Mueller Systems, I think I missed last part of your comment there. Your expectation for 2014, you're not going to see the same 50% type growth again in 2014, but with the projects that -- in the wings that you've recently had, are you still expecting that to be flat or are you still expecting double-digit growth there? I missed that part of your comment.

Yes, no, Kevin, we would still expect double-digit growth. In fact, I know in our investor presentation, we believe we say over the next couple years we would expect to see a 20% year-over-year growth so we are still comfortable in seeing at least a 20% year-over-year growth. What we expect to happen in this business over time is that we are selling fewer and fewer mechanical meters, more meters with AMI, with the AMI either one-way or two-way system. So yes, we still expect to same year-over-year growth and we are comfortable with saying that we would expect to see at least 20% year-over-year growth. But we will have a much more favorable mix due to this -- we are selling more of our technology products.

Got it. And do you have that comfort and the 20% this year in 2014 because of the recent wins that you've already got in your pocket or is it that plus the bidding you still quite active and you feel pretty good about further wins?

I'd say it is certainly a combination of both. The recent wins certainly helps our backlog and as we said, most of those are scheduled to ship in 2014. But I would say right now that we have a still pretty good funnel of quotations outstanding or projects that we would expect to quote in 2014 that we would hope to turn to orders and shipments so it is a combination of both. But I think we will see the activity in our wins for the last couple months. It certainly solidifies our confidence of being able to deliver that 20%-plus growth year over year.

Got it. Can I just ask a question on Mueller Co margins which were very strong in the quarter? It looks like for total segment revenue was up $4 million but profit was up $9 million and if I back out Mueller Systems, it seems like the incremental there was about 50%. Now I know you've got some products that you say can do 50%, things like belts and hydrants, but that's not the normal mix or the normal trajectory for the whole segment. Can you just talk about that? What other, beyond pricing and volume that we know about, were there other productivity initiatives that really drove that better than we might have thought?

Yes. And you hit the -- the primary contributing factor was the rich mix we had. Certainly our valves, hydrants, and brass products, we are seeing nice conversion on brass products as we moved to no-lead brass. That actually has been a boost to our margins if you look at where those margins were historically. In those products, our shipments grew about 40% and as we look at our valves and hydrants given the capacity utilization, some of our efficiency improvements, conversion margins for fourth quarter for valves and hydrants were just almost 60%. So again, we had very good performance at our plants and a very rich mix.

We also benefited a little more too from -- you've heard us mention our focus on LEAN initiatives the last few years and that we get many benefits on the cost side, working capital management, but also one of the benefits is that we are making our processes safer. I think a good example of that is the VPP Star that I mentioned in our prepared remarks recently awarded to Albertville location. When you look at foundries, foundries are inherently dangerous but I think as a result of our focus the last several years, we've seen a significant improvement in our safety results and we also saw a benefit in the fourth quarter on a very nice reduction in our workers compensation cost.

I think that the primary driver was the rich mix, the increased capacity utilization especially in our valves and hydrant product area, but we did see some benefits from other sides. And one of the ones that we specifically saw in the fourth quarter was lower workmen's compensation cost and this all combined to contribute to a very strong conversion margin.

Okay. So since you mentioned it, Greg, what was capacity utilization in Mueller Co in Q4 and given everything you just said about the improvements made, should we still be thinking about Mueller Co ex Mueller Systems as kind of a 35% incremental margin on volume growth going forward?

Kevin, I think that we are comfortable with having, at least on the Mueller base, of at least of 35% -- a conversion margin or possibly a little better. Our capital -- our capacity utilization rate for the fourth quarter were about for Mueller Co were about 70% and actually since you bought it up, talking about looking at our base business, if you look for our Mueller Co business in fiscal year 2013, so if we again subtract our metering and leak detection business, EBITDA margins for the full year were 22.5%. We've said when we get to 1.1 million, 1.2 million housing starts that we think that our base Mueller business can get back in the 25% range. We are very comfortable given the capacity utilization we were this year and being able to generate EBITDA margins in that portion of our business at the 22.5%.

I don't want to be misleading on our conversion margins because that can vary by quarter. For instance, we pointed out in the first quarter, our first quarter is typically our lowest conversion margins because we will have plant shutdowns around the holiday. But when we look around the holidays, but when we look on average I think that we are very comfortable with saying that that business should be able to achieve at least a minimum of 35% conversion margin.

Okay, great. Congratulations on the quarter and the year.

Thanks, Kevin.

Our next question comes from Mike Wood. Your line is open and please state your company name.

Hi, Macquarie Capital. Thank you. In your initial 2014 comments, you talked about comparable growth overall in the Mueller Co base business, so you also mentioned some strength in residential. I'm curious kind of what you think at the current 900,000 plus housing starts, the appropriate infrastructure spend from Mueller standpoint would be on your products next year and how that compares to where you are now. Basically, it seems like you are implying some growth in residential but not necessarily that large an acceleration in the resi growth.

Mike, thanks. I will say that we are very positive and I would say approaching bullish for what we think housing starts will mean for us next year. I will say the one piece of data that we are missing, certainly, is that on housing starts this year, how much new or raw land needed to be developed to support that housing start number. We believe that certainly that excess inventory of developed land that existed has been effectively worked through in most regions of the country, so we do believe that future demand for lot development will be somewhat commensurate with a need for housing starts.

But I would say that that is the lack of data, at least for us, we are unable to get that data so that I would say colors a little bit, effects a little bit our expectations for next year because we do think there may be some part, some regions of the US that may still have excess developed lots but certainly as I said, we are much more bullish. We believe that a lot of excess developed lots were absorbed this year and I'd say that maybe our outlook has just a bit of caution until we can get a lot more comfortable as to how much raw developed land needs to be or how much raw land needs to be developed to support the housing start increase.

That's fair. And also I'd love your view in terms of the impact from interest rate increases on how it impacts the water utility customers that you serve from a municipality standpoint, the project ROEs, or how demand can fluctuate based on interest rate sensitivities.

Yes. I think that -- we certainly think that some projects could be impacted by the higher rates that they would have to pay in the bond market. Though again, I think on a micro level basis, our discussion with our customers and with our distributors indicates that the -- certainly support our expectation that we will see continued growth in municipal spending on repair and replacement. We referenced, of course, the continued increase in water rates and that's a major source of funding for water utilities. But the growth could be somewhat muted if we see the continued growth in interest rates because that there's no question that there are projects that are financed by our utilities going to the bond market.

Great. And finally can you just give us for the quarter the Mueller Systems Echologic sales number or drag on margin so we can figure out what the base business contributed?

Yes, if you look at the -- we think that the overall drag on margins for Mueller Co were about 400 basis points.

Thank you.

Thanks, Mike.

Next we have Michael Gaugler. Your line is open and please state your company name.

Brean Capital. Congrats on the quarter. A lot of my questions have already been answered but one I wanted to ask and I hope it is not too early to ask this question, but I'm wondering what you are thinking, Greg, on raw material costs and more specifically price increases for next year?

Yes, Mike, when we look at raw material costs, we think that they certainly have been stable and when we look all in all, we think in 2014 we may be able to see a little bit of a decrease in our overall material cost. That being said, we continue to see increases in other areas. We certainly see an increase in freight, continues to increase, our medical costs continue to increase, and so on. You are right, it is a little premature for us to make a decision or be able to announce exactly what we are going to do with pricing, but we take all those factors into account and we will probably be making a decision some time here in the next couple months and as to what we think we need to do with pricing. But I'd say that we think raw materials will be less, but we do expect to see other costs increasing.

All right. Thanks.

Thanks, Michael.

Next we have Seth Weber. Your line is open and please state your company name.

Good morning. It is RBC. I guess first I just want to clarify that I heard something correctly. Are you saying that the growth rate for the overall Mueller Co in 2014 -- fiscal 2014 will be similar to the growth rate for Mueller Co in 2013? Was that correct?

Yes. That's what I think we said that the overall growth rate will be the same, though the different segments in the business will grow a little differently. We said that we don't expect to see the same kind of growth rate that we saw in Mueller Systems and that we expect the Mueller base business to grow greater than what it did in 2013, and but it all sums up to we think about growth rates that are similar.

Something in the overall like a low-double-digit growth rate? Is that the right way to think about it?

We said high-single digits so it approaching I think that that high single-digit may be low double-digit in total.

Okay, great. Thank you. I wanted to focus on the free cash flow. Very strong generation in the quarter and the year and now you are talking about 2014 actually being better than 2013. Can you give us some color what you are planning to do with the free cash flow? What kind of opportunities you see out there and if whether it is organic growth or acquisitions or doing something with the capital structure? Any hints there?

Yes. Thanks, Seth. I know we've had the opportunity to discuss this at a number of our investor conferences. I think we have discussed it in previous calls that when we look at our excess cash, our flexibility is somewhat limited. When we look in terms of debt retirement, share repurchase, or dividends because as long as our 8.75% notes are outstanding, we are limited by those indentures and just remind everyone they are not callable at a predetermined price until September of 2015. We do have a restricted payments basket of about $65 million which can be used to repurchase the 7 3/8% notes. We can use some of that per share repurchases or dividend payments, but obviously other potential uses of free cash flows could include acquisitions.

So right now, there is not a specific -- like I say, here's for the next 12 months here's specifically where our excess cash or the cash we are generating will go, but our Board does continually monitor our cash position and evaluates the capital structure and we are looking at -- we've always said that if we get our debt leverage down to three times or below three times, then we would be a -- I think have our eyes a little more open to look at potential acquisitions. So clearly I think that given where our debt leverage is, the cash that we have, it does give us some opportunities though in some areas as I just mentioned we are -- our flexibility is somewhat limited.

Okay. It is a nice change of pace relative to where you've come from. Just going back to the Systems and Echologics business, do you feel like that you are fully staffed? I know you have made some investments there to bring up sales staff and whatnot, but do you feel like with these additional revenues coming in that you really should start to see the profitability in that business? I know you talked about sort of second-half weighted, but are there incremental expenses that you think could delay that or do you feel like you are at where you need to be at this point for that business?

I think from a resources -- from a resource standpoint, I think we are staffed adequately. In fact, that probably hit us a little bit this quarter because we had resources more than what we needed, but by the anticipation of these orders coming in. I would say that yes, we should start seeing a much nicer conversion because of the higher volume and also the richer mix because it is more heavily weighted to our AMI technology or moving the way from the mechanical meters. If I were to say any area of where we may still have some additional incremental spending, it could be in R&D as we mentioned several times that in earlier this year, we've introduced Fixed Leak Detection for both transmission and distribution pipelines. We think that this technology has a great future.

But obviously, whenever in a pilot situation, we may learn some things about the technology that needs some tweaking and may need some continued research and development so we may have some expenses there. But I think all in all, relative from staffing in our plants, from our sales organization, and the rest of our resources needed to support the level of activity, I think we are pretty much where we need to be and we don't see the need to add a lot of costs.

Terrific. Thank you very much, guys.

Thanks, Seth.

Jerry Revich, your line is open and please state your company name.

Hello, good morning. It is Goldman Sachs. I'm wondering if you could talk about the extent of raw material tailwind you saw in Mueller Co and Anvil in the quarter, and also just calibrate us on your realized pricing that you delivered in the quarter at Mueller Co?

Yes, Jerry, I would say when we look at raw materials on a consolidated basis between the two businesses, we had a little bit of help, but not a significant amount. We may have on a year over year basis, certainly maybe 20, 30 basis points, so not a lot. We did have a -- more of a, I call it a tailwind from pricing. We saw both in Mueller and Anvil, we had higher year-over-year pricing.

Yes, and Jerry, for Mueller Company in particular, pricing counted for about 125 basis points or 35% of the margin improvement. And just as a reminder, we announced the last price increase on valves and hydrants back in January of 2013.

Okay. Perfect. Thank you for the context and Greg, you mentioned that there are going to be some costs that are inflationary for you in 2014 to 2013. Can you just flush that out a bit more? Most of us are of the impression that there aren't raw material part of the cost structure is really much more significant and I'm wondering if you would just flush that out for us the magnitude of cost increases from the other areas we should be thinking about.

Yes, as we've said, if you look at raw material costs and purchase components as a percent of cost of goods sold, that's in general around the 50% mark of costs and so that's certainly the most significant component. When we look at other cost increases, as Greg mentioned freight, we look at medical costs and other costs that go up. Some of those will be offset by the cost savings programs that we have. Our LEAN initiatives and those activities so on a net basis, some of that cost savings will neutralize those increased costs, but if you look at the entire cost structure for both Mueller Co and Anvil, 50% raw materials purchase components and as we said before, about 50% labor and the rest depreciation, amortization, and other cost.

Okay, thank you. And just broadly, you spoke about your expectations for the way residential plays out and flows to your business. Can you just talk about what non-res project bid activity is like and broader inquiry levels just for the non-res portion of your business?

Sure, Jerry. As we said, we saw an increase in activity, a slight increase in activity in the fourth quarter. We expect that to continue in 2014. I think that when we look at overall-- if we see overall Anvil revenues up maybe in the mid-single digits on a percentage basis, I think that that may be reflective of what we see in non-res construction spending. Certainly we referenced the ABI index being above 50 over 11 of the last 12 months, that would certainly imply that as those architects plans go into development that we should start seeing an uptick in 2014. So I think that we feel comfortable right now expecting a modest increase in non-res construction spending. And I think the recent activity that we have seen supports that view.

Okay. Thank you very much.

Thank you.

Brent Thielman, your line is open and please state your company name.

Hi, good morning. D.A. Davidson. Just a few follow-up questions. Greg, how much of a headwind was Canada this quarter and are you seeing any inflection there or does that persist based on your expectations for 2014?

If you look at, Brent, our revenues -- our sales were down somewhere between $3 million to $4 million on a year-over-year basis to Canada, a little bit of that was FX. But I think we are seeing the market has been soft the last couple quarters there. We've seen a dropoff in residential construction and I would just say municipal spending has been pretty spotty. So when we look at 2014, I think we believe we may see a little more activity in 2014 so we think that maybe more weighted to the second half of our fiscal year of 2014. But all in all, I think that Canada just seems to be bumping along for us.

Okay. And then on the tech division, you mentioned some of the recent orders. Could you comment on the backlog and where it sits today versus a year ago?

Yes. If you look at our backlog, our backlog is up probably around $15 million where we stand -- where we are here today, probably about $15 million higher than what we were a year ago.

Got it. Okay. And then are you seeing any changes in timeline from quotation to utilities to the order actually being awarded within that division?

We are. We are seeing it being pushed out because I think utilities are thinking more and more about AMI and I think that AMI is -- the consideration of AMI and their analysis as a business case for AMI is taking a much, much longer. In fact, the order that -- if you go back to 2013, what we kept saying that our belief based on our current outlook that Mueller Systems would be profitable by the end of the year. We expect that this order we announced for Jackson, Mississippi that we just received in September, we were probably expecting -- we were expecting to receive that four or five months ago.

So I think that's indicative of maybe a little bit of the complexity around AMI as a the business case and we are seeing it taking longer and it is impacting a little bit our ability to forecast because we expect an order to be placed at a certain time and we are seeing three, four months. They are being extended by three or four months to make that decision.

Okay. And then you mentioned capacity utilization at Mueller Co at 70%. Did you provide for Anvil?

Anvil still running probably around 65%.

And any benefits the margins from mix there? Or was it really just the volume growth?

I would say it was more volume growth and then we did have -- we did benefit some from higher pricing.

Okay. Thanks, guys.

Thanks, Brent.

Walt Liptak, your line is open. Please state your company name.

Hi, thanks. Global Hunter. Good morning, guys, and nice quarter. Most of my questions have already been asked but I've got two of them. Maybe I will go with the quickest one first. For 2014, I think you said corporate expenses of $32 million to $34 million?

Yes.

And this year you did $34 million. I wonder if you could just talk about why it is looking like a reduction and what the bonus comp metric might look like for 2014?

Sure. I will ask Evan to address that.

When you look at corporate expenses on a year-over-year basis for fiscal 2013 compared to fiscal 2012, they were just a bit higher there and that was primarily related to stock compensation mostly related to the increase in our stock price. And then when we look at 2014, we're always continual evaluating corporate expenses and managing those and so we are providing that general range of $32 million to $34 million, so I think overall 2014 compared to 2013 they will be similar in the same range but there could be some efficiencies that we gain during the year.

Okay. Good. And on the conversion margin, I wonder if you could just -- the margin conversion has been impressive and I just want to make sure that I caught all the numbers that you are talking about for overall and for the two segments.

Yes, Walt, when you look at our conversion margins, that was mentioned a little earlier. If you look at our Mueller business this quarter, we were approaching about 60% for valves and hydrants and had a very rich valves and hydrants mix. And generally when you start getting probably into the fourth quarter, we would expect to see those -- this quarter to be our highest conversion margin because we are getting the benefit of increased production in the third quarter in overhead absorption and some of that may roll into the fourth quarter, but the increased production in the fourth quarter that we really have strong, as I said, strong overhead absorption that reduces our overhead cost per unit and with the mix, so we were at about 60% conversion margins on valves and hydrants overall Mueller.

And if we look at Anvil, Anvil had a nice increase on pricing on a year-over-year basis, had a nice volume mix so conversion margins there were --

Conversion margins at Anvil were right around roughly 35% but what we have said on the long-term basis that the Anvil conversion margins would be in the 25% neighborhood and then overall for Mueller Company around 35%, but as Greg mentioned, our valves and hydrants in particular could be in the 50%-plus range.

Okay, good. With that said, is there a -- do the numbers work at some point with revenue going higher and leveraging the facility costs and all the other manufacturing costs that you get better leverage than that 35%, I guess as capacity utilization goes up?

Walt, I would think it will come in steps because at some point, we are not quite as efficient. For instance, when you need to add an additional shift. So we are seeing volume going up but when you add that additional shift, there may not be enough work to keep that shift fully utilized so you get some efficiencies there. But all in all, we would think that as our capacity utilization goes up, our overhead cost per unit should come down and should obviously drop to the bottom line.

Okay, great. Okay, thanks, guys.

Thanks, Walt.

Philip Volpicelli, your line is open and pleast state your company name.

Good morning. It is Phil Volpicelli from Deutsche Bank. Congrats on a good quarter. In regards to the restricted payments basket, I think for several quarters now you've mentioned $65 million but I believe there's a 50% net income builder. I'm wondering if the reason you keep mentioning $65 million is because the net losses you incurred during the downturn, you're still trying to offset those with a net income. Or at what point does that flip to being a positive contributor to that restricted payments basket?

That's correct. The general basket is $65 million and through the downturn, you are correct that the losses did build up and so we are at a negative position on the adder basket but over time as we generate positive net income and we move out depending upon those projections and then that will be an additional add to the basket.

Are you close to that flip point or are you still far away from that?

I would say that there is still a ways to go when you look at the overall complexion of the basket.

Great. And then in a second quarter, you mentioned that residential construction was about 5% of the total revenue and at peak it was 30% to 35%. Where are we now?

You know, when we look at residential construction, it is primarily at our Mueller Company business so we were running, we look at fiscal year 2012 when we were coming in at 2013, we were running probably a little south of the 10%. And today at Mueller Co, we are a little -- probably a little north of the 10%. So I think it is a little more accurate as we talk about it here looking at it in terms of Mueller Co so and we round these numbers off so we don't imply a level of precision we don't have. We are taking the best information that we have from our distributors and where it is going, but if you look at fiscal year 2012 probably we were a little bit under 5% for if you look at total Mueller Water Products. And today I would say we are somewhere between somewhere between 5% and 10% in total.

Great. Thank you. And then last one for me. There have been some articles about leak detection in oil and gas pipelines. Is that something that you guys can address with your technology products?

Not as we stand -- not as it stands today because is it a different medium and all of our algorithms are based on water as the medium. And it would take a lot of work for us to be able to have these work in -- to be able to work in oil and gas and I'm not sure how long it would take for us to get there, and we think there's so much opportunity on the water side. Of course, that's where we are focusing. Yes, our technology and our algorithms, like I said, are fine-tuned to water and would not be applicable the way they are today to the oil or gas market.

Great. Thank you.

Thank you.

David Rose, your line is open and please state your company name.

Wedbush Securities. Wanted to follow-up on some of the operating leverage questions. In the quarter, you mentioned that there is a benefit in the workers comp or your workers comp was lower than expected. Was this a one-time reversal of an accrual for workers comp or is this something ongoing?

Workers comp is evaluated -- an actuarial evaluation is done every year and then there are true-ups from that evaluation so it is based upon the entire portfolio of workers comp cases and projections, so there are adjustments periodically. This particular year, we did see a larger adjustment in Q4.

Okay. And can you quantify that a little bit? Is it something meaningful or is it just kind of a modest improvement?

I would say, in general, the benefit to the Mueller Company business in the quarter was somewhere around $1.7 million, in that general range.

Okay. And then the ongoing rate will be lower so you will still see a recurring benefit? Is that fair?

You know, slight. Certainly, as I mentioned that evaluation there are many factors come into play and sometimes there are periodic adjustments but and the base can adjust a little bit, but there's also other forward-looking factors that come into play there, so I wouldn't say that it would be a total resetting to that magnitude, but it could be a slight benefit as we go forward. But certainly over the long term, based upon all of the actions that we've taken in the safety area, we would continue to expect to see improvement in overall costs as we move down the road in subsequent years.

Okay then as a follow-up to some of your LEAN initiatives, and I appreciate that it is a journey, but are there any specific actions that you can highlight that should drive earnings or margins for next year?

I would say it is more general. Our focus has been on velocity and reducing our delivery lead times. We've mentioned in the past that our distributors, they continue to manage their inventories closer and they continue to rely on us to deliver the products quicker. So I think that we are certainly seeing some advantages on the cost side. Where I think we're seeing the more of the advantage is that our delivery cycle times are down that allow us to meet demand by carrying less inventory. And sometimes even demand a higher price for that quicker delivery. It would be difficult for me to point to any one or two specific areas. And I think you described it best, it is a journey and it impacts I think our overall processes.

Okay, great. Thank you and then the last question, if I may, is on leak detection. You've talked about the expanding this internationally, outside of North America. Can you update us on the progress and potential for acquisitions on that front as well?

Yes. We are still talking small numbers but we've seen very, very nice growth in Australia. We made an investment in that market and we saw our business more than double there in fiscal 2013. But again, that is -- we are still talking very small numbers. And I would say that if we look at the acquisition, we still think that there's more and more opportunity as we build our capability to address these markets and I would say that that would be an area that would get our attention if we saw an acquisition opportunity to increase our presence in international markets on the leak detection side. But there's nothing specific that we are looking at right now.

Okay, great. Thank you very much.

Thank you.

That was our final question so I will turn the call back over to Mr. Hyland for closing remarks.

Well again, we are -- as I said earlier, we are pleased with the performance in 2013 as we benefited clearly from improving markets but also with some of the improvements that we've made in our all businesses and processes. As we sit here today looking at our markets that we are encouraged by what we expect to see as continued growth in the housing market which will be the biggest driver of demand for our growth and again, the most recent advancement and orders that we've been able to win on our metering side puts us in a stronger position today so we are looking forward to 2014 and certainly appreciate your interest in the business.

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