Mueller Water Products Inc (MWA) 2014 Q2 法說會逐字稿

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

Thank you, Laurel, and good morning, everyone. Welcome to Mueller Water Products 2014 second quarter conference call. We issued our press release reporting results of operations for the quarter ended March 31, 2014, yesterday afternoon. A copy of it is available on our website, muellerwaterproducts.com. Mueller Water Products had 159.3 million shares outstanding at March 31, 2014.

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 to help illustrate the quarter's results as well as to address forward-looking statements and our non-GAAP disclosure requirements. At this time, please refer to Slide 2.

This slide identifies certain non-GAAP 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 information to investors. Reconciliations between GAAP and non-GAAP financial measures are include in the supplemental information within our press release and on our website.

Slide 3 addresses 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 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 1-866-418-8386. The archived webcast to 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. Thank you for joining us today as we discuss our results for the 2014 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. I will then provide additional comments on the quarter's results and developments in our end markets as well as our outlook for 2014.

We are pleased with 13.4% year-over-year improvement in our adjusted operating income during the second quarter, especially given adverse weather effects experienced in many parts of the United States. Mueller Company's net sales increased 1.7% year-over-year. Domestic orders for valves, hydrants, and brass products grew over 20% in the second quarter which we believe reflects a continued strength of our key end markets.

Most of this increase in orders is not reflected in the quarter's shipments due to the timing of Mueller Company's price increase this year compared to last year and, to some extent, the harsh winter weather. Mueller Company's adjusted operating income increased 18.3% year-over-year in the quarter with improvement across all product lines. I'll provide more detail later in the call.

Although Anvil's net sales increased slightly, its adjusted operating income declined 6.5% and its adjusted operating margin decreased 80 basis points to 8.9% due primarily to operating challenges during the quarter at its largest manufacturing facility. Overall, we continue to believe consolidated results for the balance of 2014 will continue to improve year over year, primarily due to expected growth in most of our key end markets and the benefits of stronger operating leverage, particularly at Mueller Company. With that, I'll turn the call over to Evan for a detailed discussion of our financial results for the quarter.

Thanks, Greg, and good morning, everyone. I'll first review our second quarter consolidated financial results and then discuss segment performance.

Net sales for the 2014 second quarter of $288.1 million increased $5 million or 1.8% from the 2013 second quarter net sales of $283.1 million due primarily to higher prices and higher shipment volumes. Gross profit increased 6.3% to $82.2 million for the 2014 second quarter compared to $77.3 million for the 2013 second quarter. Gross profit margin of 28.5% in the 2014 second quarter increased 120 basis points from 27.3% in the 2013 second quarter. This improvement was driven primarily by higher sales prices and higher shipment volumes.

Selling, general, and administrative expenses 18.8% of net sales in the 2014 second quarter as compared with 18.6% in the 2013 second quarter. Selling, general, and administrative expenses for the 2014 second quarter were $54.2 million as compared with $52.6 million in the 2013 second quarter.

This year, expenses associated with liabilities related to the Company's former US pipe business and retained by the Company are now being included in continuing operations whereas a year ago they were included in discontinued operations. The increase in SG&A is primarily related to these expenses. We believe most of these expenses will decline over time.

Operating income for the 2014 second quarter increased 13.4% to $28 million as compared with $24.7 million for the 2013 second quarter. This increase was due primarily to higher sales prices and higher shipment volumes. Adjusted operating margin also improved 100 basis points to 9.7%.

Adjusted EBITDA for the 2014 second quarter increased to $41.8 million as compared with $39.7 million for the 2013 second quarter. Adjusted EBITDA for the trailing 12 months was $166.5 million. Interest expense net for the 2014 second quarter declined $300,000 to $12.5 million as compared with $12.8 million in the 2013 second quarter due to a lower level of total debt outstanding.

During the 2014 second quarter, income tax expense was $3.1 million on income before income taxes of $12.8 million resulting in an effective income tax rate of 24.2%. Income tax expense for the 2014 second quarter included a benefit of $2 million from an adjustment of deferred state and local income taxes. The effective income tax rate was 24.8% in the second quarter of 2013

Adjusted net income per diluted share for the 2014 second quarter was $0.07 as compared with an adjusted net income per diluted share for the 2013 second quarter of $0.05. There was a weighted average of 161.9 million diluted shares of our common stock outstanding for the 2014 second quarter compared to a weighted average of 160 million diluted shares outstanding for the 2013 second quarter. I'll now move on to segment performance and begin with Mueller Company.

Net sales for the 2014 second quarter increased 1.7% to $191.3 million as compared with $188.1 million for the 2013 second quarter. This increase was due primarily to higher prices and a favorable mix, partially offset by unfavorable Canadian currency exchange rates. Adjusted operating income for the 2014 second quarter improved 18.3% to $27.8 million as compared with $23.5 million for the 2013 second quarter. This increase was due primarily to higher prices and favorable mix.

Adjusted operating margins for the 2014 second quarter improved 200 basis points to 14.5% as compared with 12.5% in the 2013 second quarter. As we discussed last quarter, we have changed the manufacturing process for certain sizes of our iron gate valves. This change result in a $1.5 million non-cash write-down of some of our equipment and is expected to deliver cost savings which will generate less than a one-year payback. Adjustments to operating income include this $1.5 million non-cash charge.

Adjusted EBITDA for the 2014 second quarter increased to $37.9 million as compared with $34.9 million for the 2013 second quarter. Adjusted EBITDA margin for the quarter increased 120 basis points to 19.8%. Mueller systems net sales for the 2014 second quarter were essentially flat year-over-year. However, operating income improved and was positive this quarter. I'll now turn to Anvil.

Net sales for the 2014 second quarter increased 1.9% to $96.8 million as compared with $95 million for the 2013 second quarter. The increased resulted primarily from higher shipment volumes, particularly to the oil and gas market. Adjusted operating income for the 2014 second quarter declined 6.5% to $8.6 million as compared with $9.2 million for the 2013 second quarter.

Anvil's adjusted operating margin decreased 80 basis points to 8.9% as compared with 9.7% for the 2013 second quarter. Adjustments to Anvil's operating income include a $1 million reserve for the estimated cost for us to withdraw from the only multi-employer pension plan in which the Company had participated.

During the quarter, Anvil's largest manufacturing facility experienced production issues related to unplanned outages of its melting and heat-treating operations. These issues created a number of inefficiencies. The impact was further exacerbated by an ERPC implementation that was completed at this facility during the quarter. We believe the operating issues are behind us, but they adversely impacted Anvil's second quarter results and due to higher costs in inventory associated with the inefficiencies, they will adversely impact the third quarter.

Adjusted EBITDA for the 2014 second quarter decreased to $12.2 million as compared with $12.7 million for the 2013 second quarter. Adjusted EBITDA margin for the quarter was 12.6%.

Turning now to a discussion of our liquidity. Free cash flow, which is cash flow from operating activity plus capital expenditures $600,000 for the 2014 second quarter compared to negative $12.9 million for the 2013 second quarter. We continue to expect 2014 full-year free cash flow to be stronger than 2013 driven primarily by better operating results.

At March 31, 2014, total debt was $600.6 million and included $420 million of 7-3/8% senior subordinated notes due 2017, $178.1 million of 8-3/4% senior unsecured notes due 2020 and $2.5 million of other. The net debt leverage was three times at March 31, 2014. Using March 31, 2014, data, we had $171.4 million of excess availability under our asset-base credit agreement. I'll now turn the call back over to Greg.

Thanks, Evan. I'll now elaborate on our 2014 second quarter and end market to provide an outlook for the third quarter and comment on 2014 expected performance. I'll begin with Mueller Company.

Overall, Mueller Company net sales during the quarter grew 1.7% year over year. Net sales from our quarter domestic iron gate valve, hydrants, and brass products grew 7%. As we discussed last quarter, we expected that several factors would impact shipping comparisons during the second quarter.

Specifically, we noted the price increase on valves and hydrants compared to the timing of last year's price increase and we would have three fewer weeks this year than last year to ship the orders received before the price increase. We also mentioned that severe winter weather could affect the timing of shipments. We believe these factors contributed to domestic unit shipments per valve being up only 1% and hydrant shipments up 5%.

Net sales growth in Mueller Company this quarter was also impacted by declines in areas outside of our core valve, hydrant, and brass products. Net sales declined $1.3 million for our Pratt product line as we have not yet seen a rebound in spending for water treatment facilities. Net sales from Mueller Canada declined $1.5 million, primarily due to foreign exchange, and international sales declined $1.5 million.

Net sales of metering systems were essentially flat from last year and sequentially. We believe demand for our core valve, hydrant, and brass products was much stronger than our shipments than the second quarter may indicate. For example, domestic unit orders for iron [gate] valves during the quarter were up 23% year over year and hydrants were up 20%. We were encouraged by the year-over-year growth in orders from distributors ahead of our price increase which we believe suggests a positive outlook as we enter the construction season.

Additionally, even though we have said in the past the backlog for vales and hydrants is generally not meaningfully metric, since these products typically ship within three weeks we note the backlog nearly doubled in the quarter year over year. Given everything we saw in the second quarter, we think the growth in backlog further supports our and our distributor's beliefs that market demand continues to grow.

Mueller Company's adjusted operating income grew by 18.3% in the second quarter year-over-year. Despite net sales decline, adjusted operating income at Pratt increased $1.6 million or 43% during the quarter year-over-year and Mueller Canada increased by $300,000 after the foreign exchange impact. Adjusted operating income for our metering systems improved by about $1 million year over year and Mueller systems was profitable for the quarter.

Anvil's net sales during the quarter improved slightly year over year with the improvement primarily in the oil and gas market where shipments were up by about 10%. Net sales to the non-residential construction markets were essentially flat during the quarter. As Evan mentioned, in spite of the improvement in net sales, Anvil's adjusted operating income declined year over year, primarily due to operational issues at its largest plant. Production was interrupted at both the melting and heat-treating operations, which required unscheduled maintenance.

Even though Anvil met its shipment obligations, it was inefficient doing so and incurred higher costs. Additionally, the situation was magnified by the implementation during the quarter of a new ERP system. We believe these factors impacted adjusted operating margin by about 130 basis points in the quarter.

Turning now to our outlook for the 2014 third quarter. I'll start with Mueller Company. Overall, we believe the fundamentals in our addressed markets remain strong as we entered the third quarter. Demand for our core valves, hydrants, and brass products driven by both residential construction and municipal spending is expected to be up nicely. As we just discussed, we saw order dollars for our domestic valves, hydrants, and brass products increase more than 20% in the second quarter.

We believe these products will ship during the third quarter and we expect to see strong year-over-year growth in the Mueller Company core valve, hydrant, and brass business. We believe some of the growth in Mueller Company's core products will be offset by lower sales of Pratt in the third quarter year over year where we are continuing to see the water treatment market. Pratt, however, is beginning to see an increase in (inaudible), and its backlog has grown throughout fiscal years. We do not expect to ship the recent projects we have received in 2014.

For metering systems, we expect to see year-over-year net sales growth in the mid-single year digits based on the timing of our backlog and expected order activity. Considering all these factors, we expect Mueller Company's net sales to increase in the low double digits in the third quarter.

We expect both Mueller Company's adjusted operating income to improve and adjusted operating margin to expand significantly in the third quarter year over year. This improvement will primarily be driven by the increase in shipments expected from our core products as well as continued improvement in our metering systems and leak detection business.

As I mentioned earlier, even as Pratt sales expected to decline year-over-year, operating income is expected to be essentially flat as margins are expected to continue to improve in that business. We believe Anvil's third quarter net sales will be up low single digits year over year, driven primarily by improvements in its addressed oil and gas markets.

Earlier, we mentioned operational issues at Anvil's largest plant. We expect these additional costs will reduce third quarter operating income by $3.5 million. As a result, we expect Anvil's adjusted operating income to decline year-over-year and to be essentially flat sequentially.

For Mueller Water Products as a whole, we believe 2014 third quarter net sales will increase in the high single digits year-over-year driven by performance at Mueller Company. We expect solid increase in our 2014 third quarter adjusted operating income as well as expansion in adjusted operating margin year-over-year. I will now take a moment and talk about our expectations for full year 2014.

As we said on our last call, overall for the Mueller Company-based business, which excludes our metering and leak detection products and services, we expect the year-over-year net sales growth rate to be in the high single digits. In 2013, net sales of our metering products and services grew by approximately 50% year-over-year. We expect to continue to see nice growth in 2014 but expect the growth rate to be less than half the 2013 rate based on a delivery schedule of our current backlog and anticipated timing of new projects.

In total, our outlook for 2014 net sales growth for Mueller Company remains substantially the same, with the exception that we now believe the growth in our metering business will be slightly less than 20%. The rate of growth in net sales in 2014 for Mueller Company is expected to be in the low double digits but could be slightly less than last year based on our performance to date. We expect Mueller Company's adjusted operating income and adjusted operating margins to improve over 2013. We also believe our metering and leak detection products and services will be profitable for 2014.

For Anvil, year-over-year net sales are expected to grow in the low to mid single-digit rate based on current expectation of increased demand in our oil and gas and non-residential construction [end] markets in the second half of the year. Adjusted operating income and adjusted operating margins are expected to contract primarily as a result of the costs associate with the operational issues we addressed earlier on the call.

Other 2014 key variables include corporate spending is expected to be $35 million to $37 million, depreciation and amortization is expected to be $57 million to $59 million, and interest expense is expected to be about $50 million based on current debt outstanding. Our adjusted effective income tax rate is expected to be 36% to 39%, capital expenditures are expected to be $34 million to $36 million. For 2014, we continue to 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 operating loss carry-forwards. We also expect to make only minimal cash contributions to our pension plans in 2014.

For the full year, our consolidated earnings outlook remains for Mueller Water Products remains about the same as we provided on the last conference call with the exception of the expenses associate with the inefficiencies at Anvil that we addressed earlier on this call.

Before we open it up for questions, there is one legislative development I would like to address. As those of you who follow our industry know, the newly-enacted by American requirements contained in Congress' most recent appropriation Bill require that American Iron and Steel, known as AIS, be used in water and wastewater projects funded by EPA state-revolving loan funds. Although it is still early, and like the rest of the industry, we are still working our way through the EPA's recently released guidance on the AIS requirements, we do not have any concerns with meeting the requirements or anticipate any long-term impact on demand for our product.

That said, we have seen in the past where new legislative requirements can create a period of confusion that disrupts buying patterns or cause some delays in projects. To date, we have not seen delays in projects or other adverse impacts in the market attributable to the new requirements. So, the bottom line is we feel good where we are right now and we believe we have the production capability here in the United States to address the new AIS requirements with little, if any, disruptions to our customers. With that, Operator, we'll open it up to questions.

Thank you.

(Operator Instructions)

Our first question today comes from Mike Wood. Your line is open.

Hi, guys. This is Adam in for Mike Wood at Macquarie. Quick question. Do you guys still expect to recognize the $6 million to $7 million in shipments in 3Q that were pushed out given the timing of the price increase?

Yes, we would expect, Adam, those would, that would flow into Q3. As I said, we went into our third quarter this year with significantly higher backlog in valves and hydrants. Certainly some of that backlog is due to the timing difference to the price increase last year and this year. So yes, we would expect that $6 million to $7 million would probably ship early in our third quarter.

Okay, great. And then just on the Mueller Company side, really strong incremental margins. Did you see a benefit in 2Q from the price increase that you had enacted on the lead-free hydrants?

Adam, maybe to some extent but that wasn't the key driver I think of the strong conversion margins in Mueller Co. We benefited from improved performance and a more favorable mix actually with our metering systems. Revenues were essentially flat but operating income improved about $1 million.

So, certainly our performance at Mueller systems was a strong contributor to conversion. And as I talked, revenues for our Pratt product line and we're down about $1.4 million year over year, but operating income for Pratt was up $1.6 million.

So those two, both our Mueller Systems and Pratt, contributed very nicely to the conversion margin. And then I think then in addition to that we did benefit from higher prices, particularly a shipment of our lead-free brass products have grown significantly and now account for a vast majority of brass sales. And I think as well as higher sales prices of valves and hydrants. So, I think there were a number of factors that contributed to the strong conversion margin at Mueller.

Great, thanks a lot.

Thank you.

Our next question comes from Michael Gaugler. Your line is open.

Good morning, everyone.

Good morning, Michael.

Please state your company name as well.

Brean Capital. Taking a look at the balance sheet, I've noticed you've been sitting around $600 million in debt or so now for six or so quarters. Cash has been kind of building up a bit and now you're coming into a seasonally strong free cash flow period. I'm wondering what your thoughts are in terms of what you're going to do with the cash here in the next couple of quarters?

Yes, Mike. I'll let Evan go into a little more detail here. Our leverage -- net debt leverage is three times, you pointed out, and certainly as we get into the stronger -- get into the construction season, we would think that would continue to improve. We've been pretty consistent the last several years in saying that we would -- that we're still focused on bringing down debt, our overall debt, so that our objective was to get our net-debt leverage below 3 and once we got below 3, then we would look to have a little more flexibility. We are somewhat constrained on what we can do, and I'll ask Evan to go into some of that.

Yes, our flexibility with respect to debt retirement, share repurchase, and dividends is somewhat limited as long as we have 8-3/4% notes outstanding. And as a reminder, they're not callable at a predetermined price until September 2015. We do, however, have a restricted payment basket of about $65 million which can be used to repurchase sub notes, the 7-3/8% notes or for share purchases or dividends above $15 million annually.

Obviously other potential uses of free cash flow could include acquisitions, but certainly over the past several years, as you know, debt retirement has been a key focus. We continually monitor -- our Board continually monitors our cash position, evaluate our capital structure and all alternatives to determine the overall best allocation of capital resources.

So, Michael, it's a good question and we do think that we will certainly continue to generate the cash flow buildup. We'll look to see what we can do on debt retirement side. We're somewhat limited on what we can do on any stock buy back or additional dividends. So that September date of 2015 really is a key milestone for us in terms of giving us a lot more flexibility on what we can do with cash.

Greg, do you have any windows opening between now and September 2015 on the 8-3/4% where you could still pay off some of it?

We do not. In the past, we had three windows of a certain feature where we could retire about 10%, but that has expired so we do not have windows there, and we did take advantage of a couple of those windows and retired right around a little over $45 million of that debt under that certain feature.

Okay, that's all I had. Thanks.

Thank you, Michael.

Our next question comes from Jerry Revich. Your line is open. Please state your company name.

Good morning.

Good morning, Jerry.

It's Goldman Sachs. I'm wondering if you gentlemen can talk about the cadence of orders at Mueller Co over the course of the quarter? I appreciate the fact that you've got the price increase timing in there. But I'm wondering if you can just help us get a broad sense of whether demand accelerator over the course of the quarter, as we seem to have heard from a couple of construction materials companies. Wondering if you're seeing the same underlying trend as the weather improved, particularly into March projects really accelerated. Can you just give us a sense, if you can, that would be helpful?

We were probably not consistent with others because of time of our increase. If you look at last year, we said our price increase was in the third week of January, this year the second week of February.

So, for us to do a valid analysis, we took the January/February time period of last year versus the January/February time period of this year. And if you look, for instance, at our valves and hydrants, our orders during those -- that time period, our orders were up 25% on valves and hydrants on a year-over-year basis. So, clearly we saw our distributor deciding to buy more ahead of the price increase than they did last year, which we think reflects they're bullish on projects when we get in construction season.

We did see, however, since we saw such a nice growth in orders in January and February, we expected that March would fall off year over year and in fact we were pleasantly surprised that our March orders actually grew this year over March orders for Mueller Co. So, in a way we may have seen that same phenomena. It was just somewhat distorted because of the timing of the price increase and of course with our distributors, they have to get their orders before the price increase goes into effect to protect that pricing.

Okay, thank you. Greg, would you be willing to comment how April is stacking up as well since that's a little further out from the price increase? Maybe we can get --

Yes, yes. I would say right now April is pretty consistent with the outlook we've been giving.

Okay, and then in terms of the industry's shift towards the lead-free products, can you give us a sense for whether there's scope for additional products to potentially shift over as well? Where are we in that process, broadly beyond brass products?

Good question, Jerry. I'll tell you, with the -- what happened in the industry in October of last year, when the EPA made a preliminary decision that that legislation would apply to component in a hydrant and subsequently came back and said reverse that decision, but I think that in a way implied that they would prefer if municipalities would eventually switch to non-leaded components. At least in our products where we compete, I think they have pretty much covered -- we're now covered all the products that can be affected.

I'm sure we can always be surprised but I think we're covered now. So clearly brass products in January of this year contained no lead. The industry made that because we had three years to be prepared, so that was a pretty smooth transition. As I said, the hydrants caught us by surprise. I think there is a plan going forward there. Our expectations are that probably by the end of the year, most, if not all, hydrants will contain components that are no lead. However, the industry can work off its existing inventory. And then from there, I think we're pretty well covered.

So on the hydrant side, at this point what you shipped in the quarter what proportion was non-lead?

By far, the vast majority was non-lead, but we did use this as an opportunity to take down our inventory, get rid of our inventory of any leaded components. So, going forward we will only be manufacturing and shipping non-lead.

I would suspect that there's probably still some distributors that have leaded components in inventory and for sure some of our end users have in their inventory those with leaded components. But, as said, I would expect looking at the calendar year that most of those will have gone through the system.

Okay, thank you. And, Evan, can you just step us through where we are in the ERP rollout. Are there any additional plant scheduled to move forward? Could you just give us a sense for how that process is going outside of what happened this quarter?

Sure. We're 12 months into the new ERP implementation system at our Anvil business and we did implement at the largest facility in January. We experienced normal startup issues during implementation at other locations, but experienced no significant impact on operating results. What we're doing here is Anvil has been operating on a number of systems and we're bringing that down into one to add efficiency overall. But for the largest facility, it's complete, but it did exacerbate the operational challenges that we experienced in the second quarter.

Jerry, in fact let me go a little further because I don't want anyone to be confused. As Evan pointed out, probably the results at Anvil in the quarter maybe somewhat exacerbated by the ERP implementation, but that really didn't cause our issues.

We had two primary issues and probably both of them fall in the category of preventive maintenance. We lost an [ellein] oven for a month. Our plant management there thought that this oven could continue operating until the next scheduled maintenance period and it couldn't.

The other issue is one of our melting furnaces where we had a thin spot in the furnace lining, we actually burned a hole in the furnace and that was a several-week repair. And probably what impacted us most is that we're somewhat unique, Anvil at this facility is somewhat unique since we run several types of iron at this facility.

Generally, our furnaces are dedicated to a single type of iron, so once we lost this melting furnaces, we had to utilize furnaces that were dedicated to other types of iron. So, in order to do that, that when we switched from one type of iron to another, we had to shut down the furnace, clean it out completely before we could begin melting another type of iron.

We incurred a lot of inefficiencies over time. We said that hit us for about $1.3 million margin impact on Anvil in the second quarter. As I said in my prepared remarks, it's about $3.5 million we expect inventory now that will hit us in the third quarter. That will be behind us then, but we did everything necessary to make sure that we didn't miss any of our shipment obligations to our customers.

Thank you.

As Evan said, we have a little bit to go on the ERP implementation. We've been implementing it before and really didn't impact the quarter. I don't think it would have had as much of an impact this quarter if we didn't have those furnace issues.

Okay, thank you very much.

Our next question comes from Ryan Connors.

Thank you. The firm is Janney Montgomery. I wanted to drill down on this issue of distributor restocking, Greg. You've kind of referred to it a few times. I kind of wanted to get your sense because if it is in fact an increased confidence in the rebuilding inventory, I think it's pretty powerful signal for the end market. So, can you just give us a little more color there on how much you really think that is an indicator of sentiment rather than noise around the price increase and also whether -- are there any regional dynamics and differences there?

Yes, yes. One, we do think it's certainly a positive indicator and we base that on, as I referenced a little earlier, that we thought 25% growth year-over-year in valves and the hydrants tied into that timing of the price increase. We saw orders from distributors mixed price increase bringing orders forward that we hadn't seen in the past. So, that certainly told us they were feeling a lot more bullish.

Our distributors, when we go across the country, are generally bullish. They've shared with us, in fact, when we look, entering this quarter that our distributors -- our inventories at our distributors in absolute dollars have increased, and -- but we see really no, we'll say no issues with too much being in inventory because they fully expect to turn it. In fact, a number of our distributors when we followed up on the orders that they pulled forward, that we already have projects down the road in our backlog that we will use be using these for.

So, it was a very -- right now we're saying it's a very positive indicator from indication from our distributors as they're bullish, both from the context of they're willing to up the amount of inventory that they're carrying, and this is probably the first time certainly in several years we've seen that, and their belief that they'll reach the turns that they expect.

Relative to what's happened regionally, I would say that we saw almost across the country distributors increasing inventory with perhaps less so in the northeast and again we think that that was related to weather and our distributors in our field sales force tell us that they do expect that business is going to pick up. But as I say that, we've even seen April in the northeast start off a little slowly and what's coming back to us is that it's still weather-related. So, I think that -- we were very pleased.

I think we said on our last call that we'll have a pretty good idea on how sustainable or how strong the recovery is based on the kind of orders or the order growth we see placed ahead of the price increase and, as I said, we were pretty pleased when we saw in that January-February time frame on a year-over-year basis orders up 25% and again seeing orders from distributors being pulled forward that we haven't seen in the last couple of years.

Great. And then over on to the metering business, Greg. That business has been coming back. You said the outlook there is positive. Can you give us an idea specifically what types of customers and what types of products, whether it's advanced AMR stuff or whether it's more of the basic flow measurement? Because you had the major customer win last year and I guess what we've seen since then is a lot of small fish. So can you give us some color around exactly what those deals look like?

Yes. I would say we're still dealing with the smaller utilities and still looking at the -- we're seeing from a quotation standpoint, we're quoting much more AMI business. I don't know if maybe that's indicative of this market as we're positioned. We think it's both where we're positioned in that market as well as growth in AMI. But we expect probably in the next, I would say within the next quarter, to be addressing some pretty large quotations to larger cities, so larger municipalities.

So, I would say probably right now what we're seeing is probably consistent with what we have seen over the last 12 months. A greater percentage of our quotations geared towards AMI, probably it's still -- we're still dealing with the midsize, with smaller size municipalities, but expect to start making some quotations in the next quarter to some larger cities.

Great. And then last question for me is more for Evan. Following up on the balance sheet discussion. As you have discussions with the rating agencies and so forth, I would imagine they're pretty happy with where the Company has come from a leverage standpoint and from a fundamental profitability standpoint. Is there -- can you update us there where the latest outlooks are and how those discussions have progressing and what do you think there's any positive trajectory there?

Well, certainly as you know, last year we had improvement in ratings from both S&P and Moody's and we have frequent conversations with rating agencies. I really can't project exactly where we'll go from here. But certainly as you saw last year and from the commentary both from our net debt leverage as well as our improving EBITDA position, I would say they have been fairly pleased.

Great. Thanks for your time.

Thank you.

Our next question comes from Nick Prendergast. Please state your company name.

Hi, it's BB&T Capital Markets. I just want to make sure I'm absolutely clear on these Anvil inefficiencies and how much flow is in Q3. In your prepared remarks my takeaway was it's going to be a $3.5 million headwind to Anvil's EBIT in Q3. Am I understanding that correctly because I think you mentioned inventory in the Q&A?

Yes, yes. Yes, Nick, that's absolutely right. What happens, we saw in the second quarter an impact of 1.3. Those inefficiencies go into inventory and hit the P&L as inventory turns, so the bulk of the inefficiencies will hit us in Q3, and we're estimating that it's $3.5 million. So in total between the second and third quarter, it's around a $5 million impact.

Okay. And then since that's [rolling in] inventory, is that mostly COGS then?

Yes, that's cost of goods sold. We're on the FICO method of accounting, so effectively it goes into the per unit cost of your inventory and then flows out based on inventory turns. So, as Greg mentioned, that will kind of flow through the income statement, that impact of about $3.5 million in the third quarter.

Got it, got it. And then you noted the adverse weather impacts in Q2. Did you quantify that?

No, we didn't. We just don't know how to quantify it. We had distributors that were shut down for a couple days -- a couple days at a time. We know that there were a lot of areas that we just weren't able to do work outside. So, we really don't know what the impact was, though clearly, though, we know that our shipments were reduced as a result of it.

That's fair, that's fair. And then finally, it sounds like you're actually expecting a little bit of lift in non-res construction in the second half. Is that true? And then I guess what gives you confidence that that may occur?

We said that last -- we mentioned that in the last quarter and we thought that we might see in it the second half of the year. We're hearing discussion in the marketplace that -- more talk about project activity but we're not seeing it yet. So I think that we're probably making those comments a little on the come.

If you look at the AVI index, it's bumping up and down, one month it's above 150 which indicates it's positive territory, next month it's below 50, and so on. So we think it's certainly mix. We haven't seen any growth in the first half of the year. We may see modest growth in the second half of the year, but I would say that we're not saying that with a lot of confidence.

Got it. Okay. That's it for me. Appreciate it. Thank you.

Next question comes from Seth Weber. Your line is open. Please state your company name.

Hey, good morning. It's RBC.

Good morning, Seth.

Good morning. So, just going back to the Anvil production hiccups. Mueller historically has been a company with relatively low CapEx. Does this suggest that we need to start raising maintenance CapEx here going forward to prevent some of these issues that might occur?

No, Seth. We were all over that, as you would expect, and we looked at it and we start looking on a year-over-year basis, total maintenance spending at this facility to try to determine if, in fact, that is what was happening and it's not. We found that the number of people dedicated to maintenance, the spending on maintenance was consistent year-over-year.

I think what happened was the plant management on the one furnace thought they could wait until the next scheduled outage and, as I said, they didn't. And the thin lining spot that -- it's unusual but not necessarily uncommon. That's a very good question. We looked at the -- we had that very same question and not so much on the capital, it would have been an expense issue, but we looked in the -- nothing unusual at this plant in terms of maintenance expense dollars over the last couple of years.

That's very helpful, thanks. Maybe just switching gears to the Mueller Co business.

On the residential side, we're starting to hear some mixed messaging around new housing development. I'm wondering, are you still seeing an uptick in raw land development? How should we -- how are you thinking about the residential market this year or into next year?

Right now, our outlook and certainly we pay close attention, and we've seen some of the analysts becoming a little less bullish. But we have not seen anything that alters the outlook we're providing for the last six months. We think that what supports our outlook is development of raw land.

We just had some of our distributors report some developments going in their territory and the size of development, they said, goes back to the time of 2005-2006 when that industry was booming. So, right now it looks like land development supports our expectations and outlook for the year. But our antenna is certainly up based on some of the reductions in forecast over the last couple of months.

Right. Okay. If I could just slide one more in.

I think after the last quarter we had talked about MS&E growth of about 25% for 2014. It sounds like maybe that's going to be a little bit below 20% this year. Is that -- I know this is a business that's hard to handicap and did something just slide around on you? Did something get pushed out? Or is there --?

We've adjusted that outlook a little bit. When we look at and we meet pretty regularly, as you would expect, with our largest customer in that business. The current outlook is that our largest customer believes that they will be installing fewer meters this year than what they did last year. So probably the biggest impact or the biggest driver of our bringing down the outlook a little bit is reduced expectations from our largest customer.

So, I think other than that the market and orders are playing out as we expect. On our Jackson, Mississippi, the biggest orders we have in our backlog through six months we've shipped about 50% of that and still expect to be able to ship the remaining the second half of the year. So, we're making a slight adjustment in orders we expect to see from our largest customer.

Okay. That's very helpful. Thank you, Greg.

Thanks, Seth.

Next we have Kevin Bennett of Sterne, Agee.

Good morning, everybody. Greg, two questions for me. First, was wondering if you've seen any impact from high raw material costs and how that's going to play through as we go throughout the year or if it's still kind of benign?

Yes, I think that we would put it in the benign category. We have seen maybe a little movement on brass and a little movement on scrap, but right now, nothing I would say that's material. And as we look over the next, the remainder of our fiscal year, we don't think that we will see much of a negative impact, if any at all, from higher raw material costs.

Okay, that's great. And then one last question for me. On the leak detection business, which we haven't really talked about much. I know you've been doing a lot of pilot programs around the country and was wondering how those were going. When do you think we're really going to start to see the impact from this business on the P&L?

A lot of the pilot -- we're moving from the pilot phase into those turning into real orders. We've had a number of those, actually the last four or five months probably the one business that was impacted even more so in the last quarter was our leak detection business from the weather. But, no, when we look to the second half of the year, we think that we will see a very nice uptick in the project activity in our leak detection business.

You heard us talk in the past about we were in the pilot stage on our fixed transmission leak detection and distribution leak detection. That's moving nicely. We're getting closer to commercialization there. So I hope we're in a position in the next couple months actually to make a few announcements about some nice project work that we're winning at Mueller Systems.

That's great. Best of luck.

(inaudible).

Sorry. Yes, thank you.

Our next question comes from Walter Liptak.

Hi. Thanks, good morning.

Good morning.

Good morning.

I wanted to ask about the Mueller Co business and on the guidance. You talked a little bit about the third quarter operating profit and the margin. But given the strong leverage you have this quarter, I wonder if you can talk a little bit about what you're expecting from leverage for the third?

In total for Mueller Co we would expect leverage to be at least 35%. I think as we look out that we're very confident with the 35% and certainly if you look at the last couple of quarters, we have been doing better than that. So, we would expect it's reasonable for us to do better than the 35%.

We look like we should have a good valve and hydrant mix certainly given our increase in backlog. So, Walt, I would say that we would expect to be in the 40 plus range in our conversion margins for Mueller Co in the third quarter.

Okay. Great. Is there anything that we should be concerned about? You will shipping quite a bit of product. Are there capacity issues?

No, capacity, we're fine. We're working two shifts in our Chattanooga facility and our Albertville facility. As many of you know that probably a year ago and for quite some time we've been working only one shift, so we've been able to ramp up. We've been able to staff those shifts.

So, if we can dodge all of these tornadoes the next day because our plants happen to be in the path that they're projected, we feel pretty confident that from a manufacturing standpoint we have the capacity to be able to make the shipments.

Okay, got it. All right, let's hope so. Thanks.

Thanks.

Next we have David Rose. Your line is open. Please state your company name.

Good morning. Wedbush Securities. Most of my questions have been answered.

The last one, though, is if you could provide a little bit more color on the fire hydrant sale decline last quarter which I believe 13%. How do you think about what happened to those orders? Is that baked into your bookings numbers up over 20% for the period, do they go away, should they be higher?

Great question. Actually, the 13% -- I think the 13% you're referring to are decline in shipments.

Correct.

We actually -- we think that fall off or that occurred from mid October, probably end of October through November when we had all the conversation and disruption in the marketplace with discussion about lead-free hydrants. We actually saw our bookings pick up later in December.

We think we saw some of that shipment impact in the third -- or, in the second quarter here because if you recall we said on a year-over-year basis domestically our valve shipments grew 1% but hydrants grew 5%. So we think that so often valves and hydrants move in tandem. We think that the higher growth rate in shipments and hydrants this quarter was probably -- we were shipping some of those orders that were delayed, we didn't receive until the end of the first quarter. But we do think that also we still didn't see all of that flow through yet because of weather.

So I think that in the third quarter we do expect to see, from a shipment standpoint, we still expect that we will be shipping probably some of those orders that came in late December that were delayed during the uncertainty of the no-lead hydrants.

Okay. That's very helpful.

I hope I got your question there. I don't think it played too much in the increase that we saw in orders because we do believe we saw most of those orders come in at the end of our first quarter. But we do think we will still have some of those in our backlog to ship in the third quarter.

That does help. Thank you very much.

You're welcome. Thanks.

Next we have [Shawn Laundrak].

Hi. Good morning. This is Shawn Laundrak on for (inaudible) Deutsche Bank. How are you? Can you just remind me, please, the size of your price increases on which individual products and how much of that price increase was able to stick, please?

Yes. We increased our valves 7% in early February and our hydrants 5%, but the difference there was in December we had a price increase on hydrants as we switched to the unleaded components. So on valves up 7%, hydrants probably about the 8%, 9% range. Typically we expect to see 50% to 60% of that pricing stick.

Okay. So you said plus 5% on hydrants in early February, but then you said 8% to 9%. So, is that the compounded price increase considering December and February?

Yes, that includes, as I said, we had a price increase on hydrants in December when the industry, when we shipped from leaded components in the hydrants to unleaded components.

Right.

And that was a couple percentage points. So we, in February, had another price increase. So the combination of that price increase in December and the February price increase puts it in that 8% to 9% range.

Okay, great. That's all for me. Thank you very much.

Thank you.

At this time, I if no further questions.

Well, again, thank you all for your interest in Mueller Water Products.

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