Mueller Water Products Inc (MWA) 2014 Q3 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. Good morning everyone, welcome to Mueller Water Products' 2014 third quarter conference call.

We issued our press release reporting results of operations for the quarter ended June 30, 2014, yesterday afternoon. A copy of it is available on our website, muellerwaterproducts.com.

Mueller Water Products had 159.7 million shares of common stock outstanding at June 30, 2014. Discussing the third 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 information to investors. Reconciliations between GAAP and Non-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 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, unless specified otherwise, refer to our fiscal year. Our fiscal year ends on September 30. 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 and 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. Thank you for joining us today as we discuss our results for the 2014 third quarter.

I will 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 2014 fourth quarter.

We are pleased with our improved overall performance in the third quarter with year-over-year growth in net sales, net income per diluted share, and free cash flow, as well as a 27% increase in operating income. Mueller Company's net sales increased 7% in the quarter driven primarily by domestic shipments of valves, hydrants, and brass products which were up 28%.

The increase in shipments was the primary driver of Mueller Company's adjusted operating income growth of 39.5% in the quarter, to its highest adjusted operating income level since the second quarter of 2007. Anvil's net sales increased 4% in the quarter to the highest level since the fourth quarter of 2009.

Anvil's adjusted operating income declined in the quarter primarily attributable to the approximately $3.5 million third quarter impact of operational inefficiencies that occurred during the second quarter at Anvil's largest manufacturing facility. These inefficiencies have been resolved as we discussed on our second quarter conference call. Excluding these inefficiencies, Anvil's adjusted operating margin in this quarter would have been roughly equivalent to that of last year.

With our improved operating performance and free cash flow generation, our net-debt leverage declined to 2.6 times at the end of the third quarter. We also recently announced the redemption of $55 million principle amount of our senior subordinated notes, which will reduce our annual interest expense by about $4 million.

We continue to believe consolidated results for the 2014 fourth quarter will improve year-over-year primarily due to expected ongoing growth in 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 third quarter consolidated financial results and then discuss segment performance.

Net sales for the 2014 third quarter of $318.5 million increased $19.1 million or 6.4% from the 2013 third quarter net sales of $299.4 million due primarily to higher shipment volumes at both Mueller Company and Anvil. Gross profit increased 8.1% to $97.3 million for the 2014 third quarter, compared to $90 million for the 2013 third quarter. This improvement was driven primarily by higher shipment volumes and higher sales prices.

Gross profit margin 30.5% in the 2014 third quarter, increased 40 basis points from 30.1% in the 2013 third quarter. Selling, general, and administrative expenses as a percentage of net sales improved to 17.4% in the 2014 third quarter as compared with 19% in the 2013 third quarter. Selling, general, and administrative expenses for the 2014 third quarter were $55.3 million, down from $56.9 million in the 2013 third quarter.

Adjusted operating income for the 2014 third quarter increased 26.9% to $42 million as compared with $33.1 million for the 2013 third quarter. This increase was due primarily to higher shipment volumes and higher sales prices.

Adjusted operating margin also improved 210 basis points to 13.2%. Higher shipment volumes were the biggest contributor to this improvement.

Adjusted EBITDA for the 2014 third quarter increased 17.4% to $56 million as compared with $47.7 million for the 2013 third quarter. Adjusted EBITDA for the trailing 12 months was $174.8 million, the highest in more than five years.

Interest expense net for the 2014 third quarter, declined $200,000 to $12.5 million as compared with $12.7 million in the 2013 third quarter. During the 2014 third quarter, income tax expense was $10.8 million on income before income taxes, of $29.3 million, resulting in an effective income tax rate of 36.9%.

The 2014 third quarter expense was reduced by $1.1 million related to a deferred tax asset valuation allowance adjustment. Excluding this adjustment, net income per diluted share would have remained at $0.11 and the effective income tax rate for the 2014 third quarter would have been 40.6%.

Adjusted income from continuing operations per diluted share for the 2014 third quarter, improved to $0.11 from an adjusted income from continuing operations per diluted share for the 2013 third quarter of $0.08. There was a weighted average of 162.2 million diluted shares of our common stock outstanding for the 2014 third quarter, compared to a weighted average of 160.7 million diluted shares outstanding for the 2013 third quarter.

I'll now move on to segment performance and begin with Mueller Company. Net sales for the 2014 third quarter increased 7.4% to $214 million as compared with $199.3 million for the 2013 third quarter. This increase was due primarily to higher domestic shipment volumes of valves, hydrants, and brass products and higher prices.

The quarter was affected by unfavorable Canadian currency exchange rates. Absent those unfavorable currency exchange rates, the net sales increase at Mueller Company would have been 8.2%.

Adjusted operating income for the 2014 third quarter, improved 39.5% to $42.4 million as compared with $30.4 million for the 2013 third quarter. Adjusted operating income improved $12 million due primarily to higher domestic shipments of valves, hydrants, and brass products, and higher sales prices. Adjusted operating margin for the 2014 third quarter improved 450 basis points to 19.8% as compared with 15.3% in the 2013 third quarter.

Adjusted EBITDA for the 2014 third quarter increased to $52.8 million as compared with $41.3 million for the 2013 third quarter. Adjusted EBITDA margin for the quarter increased 400 basis points to 24.7%.

Mueller Systems net sales for the 2014 third quarter were essentially flat year-over-year, but it was profitable for the quarter. The profitability improvement was largely due to a favorable product mix and the benefits of lower cost.

I'll now turn to Anvil. Net sales for the 2014 third quarter increased 4.4% to $104.5 million as compared with $100.1 million for the 2013 third quarter. The increase resulted primarily from higher shipment volumes, particularly to the oil and gas, commercial, and industrial markets.

Adjusted operating income for the 2014 third quarter declined 22.8% to $9.5 million, as compared with $12.3 million for the 2013 third quarter. Anvil's adjusted operating margin decreased to 9.1% from 12.3% for the 2013 third quarter. The decrease in adjusted operating income and adjusted operating margin resulted primarily from higher costs associated with operational inefficiencies during the second quarter at Anvil's largest manufacturing facility.

Adjusted EBITDA for the 2014 third quarter decreased to $13 million as compared with $15.9 million for the 2013 third quarter. Adjusted EBITDA margin for the quarter was 12.4%.

Turning now to a discussion of our liquidity. free cash flow, which is cash flows from operating activity less expenditures, was $46.2 million for the 2014 third quarter compared to $37.4 million for the 2013 third quarter. We believe 2014 full-year free cash flow, will be up at least 15% over prior year, driven primarily by improved operating results.

At June 30, 2014, total debt was $600.8 million and included $420 million of 7.375% senior subordinated notes due 2017, $178.2 million of 8.75% senior unsecured notes due 2020, and $2.6 million of other. Net debt leverage was 2.6 times at June 30, 2014.

Using June 30, 2014 data, we had $161.5 million of excess availability under asset-based credit agreement. As Greg mentioned, we announced last week that we will be redeeming $55 million, principal amount, of our senior subordinated notes on August 29. The redemption price is 101.229% of the principal amount, which is the current call price.

We expect to recognize a loss of approximately $1 million on the redemption in the fourth quarter. Assuming the redemption of these notes, our total debt outstanding would be $545.8 million. We expect the redemption to yield annual interest savings of about $4 million.

I will now turn the call back to Greg.

Thanks, Evan. I will now elaborate on our 2014 third quarter results and end markets, and provide an outlook for the fourth quarter. I'll begin with Mueller Company.

Mueller Company had a solid quarter with overall net sales up 7.4% year-over-year. It was Mueller Company's best performance from the standpoint of adjusted operating income, adjusted operating margin, and adjusted EBITDA margin combined since 2008.

At base, Mueller Company, which excludes our newer technology products and services, net sales grew approximately 9%. To really understand the drivers of base Mueller Company, net sales growth, we have to look at what happened in several of our addressed markets.

Strong growth in municipal spending and residential construction were the key drivers of the 28% year-over-year increase in net sales of our domestic iron gate valves, hydrants, and brass products. Certainly a portion of this growth was related to the difference in timing of our price increase this year on valves and hydrants, compared to the timing of our price increase last year. As well as the subsequent backlog we had coming into the quarter.

We believe that looking at year-over-year domestic shipments for valves, hydrants and brass products for the second and third quarters adjusts for the difference in timing of the price increase and gives us a better idea of what is happening in our end markets. Shipments of those products in the second and third quarters were up a strong 18% year-over-year.

We believe the end-market growth came from both the municipal and residential markets, with roughly 2/3 of this growth coming from municipal spending. We experienced 13% sales growth in Canada, excluding the negative impact of unfavorable currency exchange rates.

We expected a decline in our shipments to the water treatment market this quarter, and pointed it out on our last conference call. Net sales at our Pratt business were down roughly 20% or $6.5 million in the quarter.

Additionally, although international sales of valves and hydrants are only a small portion of Mueller Company's net sales, international net sales were down about $3 million year-over-year. Our international business tends to be project based and can fluctuate from quarter-to-quarter.

Net sales of our metering products and systems were essentially flat year-over-year. As a reminder, there is a degree of lumpiness in Mueller Systems' shipments given the project oriented nature of this business.

The size of the projects we are competing for is increasing. And we are also seeing longer lead times before orders are awarded, especially as municipalities contemplate migrating to advanced metering infrastructure systems. We continue to invest in this part of our business to further differentiate our solutions, particularly in the area of leak detection.

Echologics' net sales were up almost 20% year-over-year. Mueller Company's overall adjusted operating income grew by 39.5% in the third quarter year-over-year. The strong operating income growth is attributable to the growth we saw in our domestic valves and hydrants, which as you know, are our higher-margin products, increased operating leverage, as well as improved performance at Mueller Systems.

While net sales were essentially flat at Mueller Systems, the business was profitable and adjusted operating income improved about $1.5 million year-over-year due to a favorable mix and lower costs. Anvil's net sales during the quarter grew year-over-year with improvement across the mechanical market, which is largely heating, ventilating, and air-conditioning applications, into the non-residential market.

The energy market also continued to remain strong with net sales up 7%. Additionally, we saw strong improvement in Canada.

As we discussed earlier, Anvil's adjusted operating income declined year-over-year, primarily due to operational issues in the second quarter at its largest plant. Excluding the operational inefficiencies, adjusted operating margin would have been comparable to last year.

Turning now to our outlook for the 2014 fourth quarter, I'll start with Mueller Company. Overall for the fourth quarter, we expect to continue to see growth at base Mueller Company driven by demand from both residential construction and municipal spending.

Recently, momentum in the growth of the housing recovery has slowed. However, we still believe that, with land lot development, we are benefiting from growth in residential construction. We also believe that we will see strong demand for our products during the fourth quarter, driven by municipal spending. Municipal demand has held up well throughout the year.

Distributor inventory levels declined during the quarter and were relatively flat year-over-year. Based on the orders we received in July, we believe distributors remain optimistic relative to end-market demand. We believe we will see solid growth in base Mueller Company's net sales for the fourth quarter.

For metering systems, we expect to see year-over-year net sales growth of around 20%, based on the timing of our backlog and expected orders. We expect to see strong net sales growth from Echologics, as this business continues to gain momentum in the marketplace.

Considering all these factors, we expect Mueller Company's net sales percentage growth to be around 10% in the fourth quarter. We expect both Mueller Company's adjusted operating income to improve, and for adjusted operating margin to expand in the fourth quarter year-over-year. However, the rate of growth is expected to be lower than in the third quarter.

This improvement will primarily be driven by an increase in shipments we expect for our core products, as well as continued improvement in our metering systems, and leak detection, and pipe condition assessment businesses. We believe our metering systems, and leak detection, and pipe condition assessment business will be about break-even for 2014.

We expect Anvil's fourth quarter net sales percentage growth will be up low single digits year-over-year, primarily driven by improvement in its addressed oil and gas market. With the operational issues behind us, we expect Anvil's adjusted operating income to improve over the third quarter and be slightly up on a year-over-year basis.

For Mueller Water Products as a whole, we believe the 2014 fourth quarter net sales percentage growth will increase the high single digits year-over-year, driven primarily by performance at Mueller Company. We expect solid increases in our 2014 fourth quarter adjusted operating income as well as expansion in adjusted operating margin year-over-year.

Other 2014 key variables include corporate expenses are expected to be $35 million to $37 million. Depreciation and amortization is expected to be $56 million to $57 million, and interest expense is expected to be about $50 million.

Our adjusted effective income tax rate is expected to be 37% to 39%. Capital expenditures are expected to be $35 million to $36 million. For 2014, we continue to expect free cash flow to be stronger than in 2013 driven primarily by improved 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.

In total, we think the free cash flow will be up at least 15% for the year. And finally, we have been especially pleased with the momentum we have been seeing for our leak detection, and pipe condition assessment offerings, both domestically and internationally. During the quarter, we were awarded contracts to provide leak detection products and services by the Singapore Public Utilities Board and Severn Trent in the UK.

In the US, we have been engaged to provide condition-assessment products and service for Baltimore, Boston, and Suburban Washington, D.C. We have also been providing leak detection services to several other US municipalities including New Orleans; Springfield, Massachusetts; and Las Vegas. Interestingly, water utilities and municipalities are identifying leak detection and water loss management as a cost-effective solution to several of their most pressing challenges.

During the third quarter, we announced commercial availability of fixed leak detection solutions designed to accurately detect and monitor leaks in both water transmission and distribution mains remotely on a 24/7 basis. We believe integrating Echologics' proprietary fixed leak detection technologies with Mueller Systems AMI system will allow us to offer North American utilities additional ROI and accelerated payback on the installation of AMI systems for metering.

Outside North America, we believe that Echologics' fixed leak detection solutions will provide us with a highly-scalable business model. Given the strengths of the technologies we have developed, we believe there is tremendous opportunity for Mueller Water Products to assume a global leadership position in this area.

While we expect that larger-scale adoption of these technologies will involve multiple benchmarking and pilot projects over the near-term, our technologies are generating a lot of interest and should help differentiate us in the marketplace. We believe that the long term prospects are very encouraging.

With that, operator, I'll open this call up for questions.

Thank you.

(Operator Instructions)

Our first question today comes from Mike Wood. Sir your line is open, and please state your affiliation.

Hi, Mike Wood at Macquarie.

Hi, Mike.

Thanks for taking the question. In Anvil, excluding the resolved manufacturing inefficiency that you called out, there still wasn't leverage on the volume growth. Was this a mix issue? And can you just talk through if oil and gas industrial markets have different margin profiles compared to commercial?

You know, Mike, they're really not that significantly different. It can vary project by project by project. But again, if we look at our volume, and the net increase in volume on Anvil, we think that converted at about a 32% rate. So that's pretty much in the range that we would expect.

Okay, got it. And also on the bond redemption, just curious how you came up with the $55 million on the 7 3/8%? Why not more and is there the ability to call and re-fi the remainder at more attractive rates?

Mike, I will ask Evan to address that.

Mike, as you know, we have a $65 million restricted payment basket available to redeem the subordinated notes. We chose $55 million just to have a little remaining under the RP basket. That was really the only decision, just not to fully utilize the RP basket before the senior notes mature and are callable, September 1, 2015. Yes, we always evaluate our cash position and the capital structure and assess any opportunities for refinancing.

Okay, thank you.

Thanks, Mike.

Our next question comes from Kevin Maczka. Your line is open, please state your affiliation.

Thanks, good morning, BB&T Capital Markets.

Morning, Kevin.

Good morning. First question, it sounds like volume was the biggest driver of the strong margin performance in Mueller Co. I'm wondering if you can address capacity utilization both there and in Anvil? Where are we now?

Yes, Mike, when we look at our -- Kevin, yes, when we look at our capacity utilization, we estimate probably in this third quarter, at our valve plant, we were up at 75%, maybe even close to 80% capacity utilization, albeit that's on two shifts. We were a little less capacity utilization at our hydro plant, probably a little more in the 60% to 65% range. So overall, we're going to say, we think at Mueller probably we were still under 70% in total and Anvil slightly under 75%, we think probably between 65% and 70%. So we still have a long way, a lot of capacity left. Again, as I said, on some of these plants, it was only on a two-shift basis so we certainly have the availability to add a third shift if needed.

Got it. And then, am I correct in that, you are saying volume was the bigger driver here than the price increase? Do you expect more benefit from the price increase in Q4 and into the new year?

When we look at Mueller Company on the 450 basis points margin improvement, about 100 of those basis points improvement came from pricing. The rest of it came from volume and, pretty importantly, mix. You know, because as we said, we saw very nice growth in domestic valves and hydrants and, of course, as you know, they're our highest-margin products. In this quarter that when we moved a year ago, the market, our distributor started bringing in no-lead brass for our brass products. We anniversaried that this quarter, so we may have seen a little benefit in that pricing, but we won't expect to see that kind of benefit going forward. So in total, of our 450 basis points improvement, we think about 350 basis points were related both to volume and mix, and then about 100 basis points to price.

Got it. And then just finally for me, Greg, can you just say a little bit more about the muni markets and the resi markets? I think you said the distributor inventory was low, the orders suggest optimism there.

Yes.

There had been some slowing in the land development. I guess, have you seen that in your business yet?

You know, very difficult for us, Kevin, to differentiate and find that. We saw nice growth. We clearly believe that a greater percentage of our growth, as we stated, is coming from municipal spending. We have seen some pretty strong pockets of, I think, repair and replacement work that probably had been pent-up demand and delayed.

I will note that if when we look at our domestic sales regions, our shipment growth in valves, and hydrants, and brass products were anywhere from 20% to 40%. And the region that only grew 20%, the western region, actually probably a year ago was seeing more growth in housing. So if anything, we may be seeing, regionally, a little bit of an impact in the west but I think right now, it's difficult for us to be able to say we're seeing a significant drop off from residential construction and we're pretty convinced we're seeing nice growth coming from municipal spending.

Okay, great, that's helpful. I'll get back in line. Thank you.

Thanks, Kevin.

Our next question come from Seth Weber. Your line is open, please state your affiliation.

Hey, good morning, it's RBC.

Good morning.

Hi. On the Systems and Echologics business, I just want to make sure I'm -- you know, my math is correct. If revenue was about flat for the third quarter, and fourth quarter you're saying up 20%, that puts the full year sort of high single-digits?

Yes.

That's right.

Which I think previously you had talked about, kind of, a little under 20%. So did something get pushed out or is there something going on there?

Yes, I'll tell you, Seth, probably the biggest impact that we're seeing certainly in our Mueller Systems is a slow down in order intake from our largest customers. When we look at this quarter, orders and shipments were below our expectations there. We were expecting a significant pick-up in orders as we entered the construction season. We didn't see the increase that we expected. Primarily, we believe our customer there is reducing its meter inventory this year, impacted our third quarter and has caused us to lower our fourth quarter expectation. So, when we look for the year, we expect probably our orders and shipments will be down anywhere from 25% to 30% from what we saw last year from our largest water Meter customer.

Meters are not going to any other meter manufacturer. They shared with us that they're looking to bring down some inventory this year, which leads us to believe that we'll see the pick-up next year, but if you look at the biggest impact to our growth rate in the Meter side has been, I would say, the reduced orders that we've seen from our largest Meter customer. In addition, as we said in our prepared remarks, our quotation activity is at a nice level. Our backlog is actually up $5 million at the end of the third quarter at Mueller Systems year-over-year, but we are seeing a longer decision time relative to AMI systems. But by far the biggest impact has been the, I think, the 25% to 30% reduction on a year-over-year basis in Meter activity from our largest customer.

Okay, that's very helpful. Thanks, Greg.

You know, Evan, can you just, any additional help on the profitability of the Systems and Echologics business? You said it was about $1.5 million delta year-over-year, but can you talk about whether it changed sequentially at all? It looks like it may have, the profitability may have come down a little bit sequentially. Is that the right way to think about it or that's not correct?

Yes, that's certainly an improvement year-over-year, about $1.5 million, you know, attributable to lower costs, and the favorable product mix that we saw during the quarter. And then if you look at, sequentially, I would say about $1 million higher on a sequential basis.

Okay. That's great. Okay. And is that where most of the SG&A -- so your SG&A was really good. I mean it was better than we were expecting. Is that where you're seeing the reductions come out of? Maybe, can you just talk about SG&A going forward, how we should be thinking about that? Because, it did come down year-over-year and it was frankly better than what we were looking for.

Yes, total SG&A moved from $56.9 million down to $55.3 million. About 19% of net sales last year to 17.4% of net sales this year, certainly there was some benefit coming from Mueller Systems as well. But if you look at on the overall, you know, in the quarter, we saw lower professional fees and some lower employee related expenses. Looking at year-to-date 2013 versus 2014, percentage of sales 19.2% last year, down to 18.8% this year. It's slightly up and that slight increase was due primarily to costs that were previously recorded as discontinued operations for the full year. But, you know, on the whole, we're seeing lower professional fees and lower employee related expenses.

Okay, terrific, thank you very much.

Thanks, Seth.

One moment. Our next question comes from Ryan Connors. The line is open, and please state your affiliation.

Hi, it's Janney Montgomery. Excuse me. I had a question, just, kind of, a big picture question for you in regards to, kind of, the margin profile at Mueller Company. Here we are back near the 20% level on an operating margin basis. I remember a couple years ago, Greg, you had been saying that business might be hard-pressed to get back above that 20% level as you moved into the next cycle, and here we are, almost there. Can you just give us your updated thinking on what is a good, normalized, mid-cycle margin level to think about for that business? You know, looking out a couple years, are we there or do you think there is more up side? What are your thoughts there?

Thanks for the question. You know, if I recall, we were probably saying about 18 month ago, two years ago, that we thought we could get to around 20% when we saw housing starts gain to 1.1 million or 1.2 million. You're right. We're getting there a little quicker. I think what we saw -- certainly what we saw this quarter was such a very strong mix from valves and hydrants, the growth as we said, that shipments grew 28% on a year-over-year basis, and when those products are our higher-margin products. But I think we would still feel comfortable with saying that the 20% margins, or EBIT margins, OI margins, or 25% to 26% EBITDA margins, when we get to the 1.1 million to the 1.2 million.

But I do think that we are seeing the benefits of our cost reduction activities that we have implemented over the last several years, both from what we have done on the capacity side, as well as what we're doing with lean. I think it's possible if we continue to see a mix of valves and hydrants as a percent of our total, like we did the last quarter, that we can be close to that 20%. And we do think that we will continue to see, when we look out in 2015, you know, further improvement in our Systems and Echologics. You know, I'm comfortable in saying that when we see 1.1 million, 1.2 million housing starts, we think that 20% is sustainable. But clearly I think that, from any given quarter, based on mix, we can hit the 20% where we are today given our less than 70% capacity utilization.

Great. Well, that covers the demand side nicely, Greg. I wonder if you could comment on the supply side industry-wise. What's happened in the last few years in terms of capacity? A lot of this industry is privately-held so it's tough for us to keep track of capacity, curtailments, and things like that. How is this capacity, industry-wide, structured today relative to the prior cycle? To your knowledge?

Yes, you know, Johnny, I think it's pretty similar. We're unaware of any significant reductions in capacity. I think as we went through this downturn, the valve and hydrants continued to remain profitable and generate positive cash flow. You know, certainly our history we know that the industry did take out capacity on the [Declar] pipe manufacturing side. But I would say on the valve and hydrant side, it remained pretty steady throughout this period.

Great. And then just a follow-up for you Evan, on the balance sheet side. Are there any additional near-term opportunities to take out additional debt, in particular, the 8 3/4% notes, callables, or are you restricted in what you can do there, in the near-term?

Well, the senior notes, the 8 3/4% notes, we can call those in September of 2015 at 104.375%. With respect to the subordinated notes, we do have $10 million remaining under our restricted payment basket. As I mentioned before, we utilized $55 million of the $65 million RP basket just to allow us to have a bit flexibility throughout the maturity of the senior notes. And the senior notes govern that subordinated note takeout, so that's the opportunity that we have currently.

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

Thank you.

Jerry Revich, your line is open. Please state your affiliation.

Good morning, it's Goldman Sachs.

Good morning, Jerry.

Good morning.

Can we just talk about the margin outlook for Mueller Co for the fourth quarter, as we think about the tail winds of volumes that are going to be better than 3Q if you hit your sales guidance? And then, we should see a greater improvement in Muller Systems in the fourth quarter, than in the third quarter, if the business is going to be profitable for the full year. So just circling back to guidance, why wouldn't the year-over-year margin improvement in Mueller Co be as good or better in the fourth quarter compared to what we saw in the third quarter?

Yes, Jerry, when we look at -- I'd say right now that we still have some questions about our overall volume at Mueller Systems. Right now, we said that we expect Mueller Systems to be, certainly be, break-even for the full year. But we still have some orders that we're not sure if they will book and ship in time, so certainly I think we took a little bit of a discount there. What we saw in the third quarter for Mueller, is probably higher overhead absorption than what we would expect to see in the fourth quarter. And that again comes from the timing of the orders that we got, ahead of the price increase that came in in mid-February. We put a lot of hours in manufacturing those in March, so we got some of the benefit of those increased orders in the end of the second quarter. But we also had more of that benefit coming into the third quarter.

So probably the only real difference, when we think of it year-over-year -- sorry, sequentially in the quarter, is we probably got a benefit of more overhead absorption in the third quarter than what we expect to see in the fourth quarter. And also as I referenced a little earlier, relative to the inventorying the no-lead brass, anniversaring the no-lead brass price increase that we saw a little bit of benefit of that on a year-over-year basis in the third quarter. We won't see any of that benefit in the fourth quarter.

That's very clear. Thank you. Greg, on the pricing point with that leadless product benefit in total pricing was up 1%. You mentioned, as we think about fourth quarter, what's the pricing impact that we expect? So you're not going to get the leadless, but you're going to get a full quarter of better pricing. Can you just calibrate us there?

Yes, we do expect to see a contribution to overall margin improvement from pricing and probably slightly less than the 100 basis points that we saw in the third quarter.

Okay. And then, can you talk about the cadence of orders in Mueller Co over the course of the quarter? You mentioned dealers took down their inventories. Did that catch you by surprise? And if you're willing to touch on, what are trends in July that would be helpful?

Yes, we saw nice orders in -- nice year-over-year gain in orders in April. May and June we still saw orders up year-over-year, but that rate of increase declined. And what we believe happened, Jerry, was that, again, relative to the timing of our price increase, in March and April we shipped. In April, we made the last shipments of the orders that will pull forward. So probably coming into the end of April, our distributors were sitting with, we thought on average, of about 60 days inventory. Inventories came down nicely throughout the quarter, and as we said in our prepared remarks, at the end of our third quarter, they're flat. We think on average they're flat year-over-year.

We also mentioned in our prepared remarks that we saw a nice pick-up in orders in July. So what we think is that a number of these orders that we saw picking up in July were driven by our distributors' need to restock. So I think we got down to that where we may have expected some of those orders to be placed and shipped in June, and they happened to, you know, creep the way into July. So one month obviously doesn't make a quarter, but saw that our Mueller core orders were up about 15% in July year-over-year. So one, we think indicative of our distributors believing that the market -- they still expect to see nice market demand. Again it was in our valve and hydrant business. So, relative to the cadence, strong April on a year-over-year basis, saw that come down somewhat May and June, but right now seeing a -- at least in July, a nice uptick in July orders.

Thank you very much

Thanks, Jerry.

Next we have Brent Thielman. Your line is open, and please state your affiliation.

D.A. Davidson. Good morning.

Good morning, Brent.

Greg, just a clarification, did you say you expect Metering to be profitable in Q4?

Right now, we expect that they will be, Brent, break-even for the full year. And I think that our fourth quarter right now is dependent somewhat on the volume that we're -- that we book and ship. Even though our backlog is up about $5 million on a year-over-year basis, not all of that is scheduled to ship in the fourth quarter. So we are confident that Mueller Systems will be at least break even for the full year, based on the profitability that we saw in the second and third quarter. Right now, I think our fourth quarter is borderline relative to whether it will be profitable for the fourth quarter.

Got it. Okay. And then, Greg, what do you think caused your large customer in Metering to slow order intake this year?

I just think it was they took a good look at their inventory position in Metering, and thought that they could still meet their installation requirements this year and bring down that inventory. So I think that somewhat we're seeing somewhat of a movement on their part this year to bring it down. But as we look out, I think for the following years -- you know, in future years. That probably our demand and their installation schedule, so our shipments and their installation schedule, will be more closely aligned. And I think this year, we're just seeing where they're correcting and bringing down inventory.

Okay and then just, you know, a higher-level view of the technology businesses. Do they require significant capital from here in order to further increase your market share?

You know, Brent, as we sit here today, we don't think it requires a significant amount of capital. But as I said in our prepared remarks, we were really encouraged with a couple of our international wins this quarter. As we turn our attention more and more to the international opportunities, because we believe the leak-detection market is bigger outside the US. As we look at those opportunities, we'll make an assessment relative to, you know, potential capital needs. But I would say as we sit here today, a lot of our R&D spending for the product line that we had today, we've already incurred. But I think if we do see higher capital needs, it will be associated with a strategy to going after a larger percentage of the market and, more likely, that could be outside the US.

Interesting. Thank you.

Thanks, Brent.

Noah Kaye your line is open.

Yes, thanks. It's with Northland Capital Markets. Let me just pick up right there, actually. The comments you made earlier about seeing an improved margin mix shift in Metering systems, and talking, as you did, giving good color about leak detection demand. Can you help us understand a little bit what we could expect in terms of margin profiles going forward? In particular what you're seeing in terms of demand shifting to some extent, from AMR to AMI and the ability to potentially bundle that in some case with leak detection? How do you expect that to impact the margin shift going forward?

Yes, good question. Certainly, and I think we have been pretty consistent when talking about Mueller Systems, that we are in a transition period and moving more and more to AMI. We certainly saw that in our mix in the third quarter, because we shipped most of it, the Jackson, Mississippi order -- which was all AMI and additionally, were remote disconnect meters, we are our higher margin product. As we look out over the next couple of years, we expect that in the water meter market that AMI will grow at a much faster rate than AMR and certainly mechanical meters. We see projections where that may grow as much as 20% per year.

If we're able to win our share of those projects, then we will clearly see an improving margin profile because of the mix to AMI. We think that can be further enhanced by incorporating 24/7 distribution-leak detection, which will communicate over that same network that the meters are communicating over. As we said on our prepared remarks, we have just made that product commercially available. We have gone through some pilot systems, very encouraged with the result. So we do think that there is a significant opportunity for margin improvement, when we combine AMI Metering and add fixed leak detection to that same network.

We're not necessarily saying that we'll see a lot of that in 2015. I think we'll still be in the process of educating our customers. I think we'll probably still need to do a couple pilots, but as we look over the next several years, we do think there is a nice opportunity for margin expansion by certainly combining fixed distribution leak detection with AMI Metering solutions.

Right, and just as a follow-up, and thanks so much. I know you were active at Asian Utility Week. You're looking to international markets. You're generating very nice free cash flows now. How should we be thinking about the acquisition space, in particular the international acquisition opportunity? How are you looking at that these days?

Yes, I would say, on the acquisition front, we're certainly feeling a little more comfortable with our net debt leverage. As I said, we expect to see another strong quarter in free cash flow in our fourth quarter and overall free cash flow to be up at least 15% year-over-year. Evan talked a little bit of our flexibility with respect to debt retirement. But we continue to monitor our cash position, evaluate our capital structure. I think that, on the acquisition front, if we saw the right opportunity we would look very closely, and we'd be looking for anything, you know, certainly in our core water infrastructure business.

But I think more specifically that anything we could add to our technology on Smart Metering, on leak detection, that would be very high on our priority list. And when we look, as I mentioned earlier, when we look at leak detection and pipeline condition assessment, we have been in this business now for 2.5 to 3 years. We have coming up a learning curve. We're now learning more and more about not only the North American market, but the global market. We do see some really nice opportunities in the global market. So I would say that if we found a technology or a target that had a nice market position in leak detection outside the US, that I think that would be one that we would look very seriously, consider very seriously.

That's very helpful. Thank you so much.

Thank you.

Next we have Walter Liptak. Your line is open, and please name your affiliation.

Hi, thanks. Just wanted to ask a follow on to the comments on going global with some of the leak detection and other systems. Can you frame this for us a little bit better? Is this a new initiative? Does it require new sales people? Are there technology differences, costs, that may be impacting fourth quarter 2015?

Well, thanks. Yes. Good morning. Don't see really an impact on the fourth quarter. We'll assess, though we're assessing. I would say that it's probably a continuation of the initiatives that we've been starting for the last 12 months, but as we get more confident and encouraged about the technology we have developed, I think we could see that we add to our sales efforts internationally. Again as I mentioned, we had two nice awards this year -- I mean, sorry, this quarter.

We estimate that the international leak detection market today could be as much as 9 to 10 times larger than the North American market. It will be I think slower to develop. I think today, that we do have technologies that we can sell, and provide to our customers internationally. But as I referenced the 24/7 leak detection for mains in distribution, that communicates over a network that we've developed for our Smart Metering. To offer that technology outside the US, it would take some investment in developing the right communication system. We're not projecting right now that we have an increase in expenses for 2015 or 2016, but it's something that I think that we feel very comfortable to put together the plan to go after that market. And it could add in the, you know, next couple of years to our expenses to go after that market.

Okay, but it sound likes in 2015 it will just be international sales adds just some people. Is that right?

I would say for 2015, it will be difficult for us to have a system developed to go after a fixed communication, leak-detection network outside the US. But I think there is opportunity for us to pick up with some of our existing technology, and we could very well be adding to our sales efforts outside the US in 2015.

Okay, got it. Okay, thank you.

Thanks Walter.

David Rose. Your line is open, and please state your affiliation.

Wedbush Securities. Thank you for taking the call. A couple follow-up questions. On the SG&A reduction, you mentioned reduced professional fees. I'm assuming that doesn't go up again. Are there any other items that potentially could go up, is this temporary or permanent? And then maybe you can touch on the ERP implementation. I think you called it out, that it was somewhat of a head wind combine with the Anvil disruptions last quarter. Did you see much of that this quarter?

With respect to the ERP implementation at our Anvil business, we referenced that kind of in discussion around some of the operational inefficiencies, really just exacerbated as we were implementing the ERP at Columbia, our largest facility at that time. But the system is up and running at Columbia and running smoothly. We're about a year in to the overall ERP implementation and are continuing through some other locations, but we have our largest facility complete and that is running well.

With respect to the improvement in SG&A on a year-over-year basis from 19% of net sales last year to 17.4% of net sales this year, I referenced some lower professional fees and some employee-related costs that are down on a year-over-year basis. Certainly we're focusing on managing SG&A and lowering that overall percentage of net sales. We can be subject to certain fluctuations from time to time, depending upon certain initiatives and certain projects, but that is a focus and, you know, I don't see any significant, large-scale items that would move it significantly. Just normal fluctuations from quarter to quarter.

Okay, so this is sort of a trend line for now.

You know, for third quarter, I would say roughly a trend line, but certainly there's a bit of a seasonal nature to our business. So, you know, depending upon what can happen with the earnings and certain initiatives, you can see a little bit of volatility and a little bit of movement there. But I would say in this general range, yes, it would be roughly a trend line.

Okay and then quickly, if you could, please. On Pratt, you called out some of the weakness before in some of the end markets of treatment, waste water treatment markets, and is there something, another dynamic within Pratt, some other end markets you want to call out? There is a small percentage goes into power.

Is there anything else that you see that's making it a little bit weaker? And do you see the outlook improving? Obviously, you called out MRO, but sort of bigger projects, do you seem them working through the pipeline?

Yes David, that's a good question and good insight. Actually, when you look on a year-over-year basis, some of our difficulty in comparison was that in the third quarter last year, we shipped over $2 million to a nuclear plant. Those are spotty and so on. So when we look at year-over-year basis, actually, our third quarter last year was among our highest for Pratt. Primarily because of the shipments to the power industry did -- and to the one nuclear plant, did bump up our shipments for the third quarter last year.

Actually, I'd say the trend we're seeing is more positive. Lately our quotation activity for the last six months has been up almost 12% on a year-over-year basis to treatment plant work. And in our orders we're up 10% in the third quarter on a year-over-year basis. So that added to our backlog. These can be, Pratt can be, certainly is our one business or one product offering, where delivery lead times are longer. These can be more associated with major projects and can be in our backlog for 12 to 14 months.

So I think we're in a period where we're seeing reduced water treatment work, but yet I would say the most recent indicators are positive, judging that from our quotation activity, and actual orders that we received in the third quarter. But it will always be, it will always be spotty relative when we do have a power plant work, and those tend to be nuclear, which also tend to be larger dollar volume projects.

Okay. Well, I appreciate that. And if I can slip one last one in. Did you see any pickup in inquiries after the pipe burst in Westwood, California? (multiple speakers)

Not yet. It's probably a little too soon, as its being digested. But I think this event highlights, we think, the potential damage and safety issues surrounding critical mains. And highlights some of the issues municipalities across the country face in managing the aging water infrastructure. When you look -- when I talk about our 24/7 leak detection or transmission, this is the exact type of application that we designed this for. To be able to, on a critical main, that a critical transmission pipeline where it's located and the volume of water going through it. That if it bursts like we saw in, out in Los Angeles, that, you know, life is in jeopardy, property is in jeopardy. So we designed it to be put on those kinds. Maybe we estimate for on the transmission side it may be 10% of all transmission lines would be candidate for this type of technology. But that's exactly the type of situation that we designed this technology.

We've gone through, as said, we've gone through the pilot stage. We're in the stage now of actually issuing some quotations. And the issue in Los Angeles obviously got so much publicity that we wouldn't be surprised if it heightened the interest in this leak detection technology.

Okay, great, thank you for the color. I appreciate it.

You're welcome. Thanks.

Our final question today come from Joe Giordano. Your line is open, and please state your affiliation.

Hi, it's Cowen and Company. Thanks everyone for taking the call.

Good morning.

Good morning. Just a quick one on Mueller Co, just to help bridge the gap a little bit. Shipment is up 28%, pricing adding about 100 BPs. I know the systems business was flat. Where were the other negative offsets to get to 7.4% for the year-on-year comp?

The way I look at it, Joe, I think it falls in two categories. One, going into the quarter, we would have expected to see an uptick in orders coming from our largest Meter customer, especially going into the construction season, and coming off a harsh winter. We did see sequentially a bit of an uptick, but not to the level we expected. That probably counted for even more than half of the shortfall from the 10%. The other came from, and I also mentioned this a little earlier, our distributors had, we think, about the end of April, 60 days in inventory as a result of our shipping the last orders from the pull forward, the price increase. They did bring those down throughout the quarter.

We saw restocking orders coming in July where we had a nice uptick in July. We would have thought maybe a few of those distributors would have placed some of those orders in June, and we would have shipped those in June. All in all, nothing that we saw that is a concern. Certainly we have adjusted our outlook relative to Mueller Systems for the third and fourth quarter based now on our expectations, orders from our largest Meter customer. And we think on the Mueller side we're still seeing, as we said in our prepared remarks, a nice demand both from municipal and residential construction.

Okay, great. So for systems on the Metering side, that's roughly about 15% of Mueller Co, right? How big is it, how big would you say the pipe condition assessment and leak detection business is right now?

Yes, if you look at the Mueller Systems as probably trending less than 10%. Our leak detection business is still running in the, say, the $12 million on annual basis, $12 million to $14 million in revenue. So obviously a small part of overall Mueller.

Okay and then last question, high-level. When we talk about the improvement in construction, we have seen a little bit recently, most of that growth has been in multi-family construction. So can you talk about how that shift impacts you guys, and your outlook going forward?

If we see a significant, you know, shift, we will still see a demand for valves and hydrants, but certainly not to the same extent as we would see on a development --where, you know, every, it can vary by locale. But where you may see a hydrant every 300 yards, and then valves associate with that hydrant down in the distribution line. So clearly on non-res construction, on multi-family there will be less demand for our products than there would be for single-family construction.

Okay, great. That does it for me, guys. Thanks very much.

Thank you, Joe.

That does end the Q&A session of today's conference.

Well, that concludes our call, today's call. Again, thank you for your interest in Mueller Water Products and for joining us this morning.

Thank you all for joining. You may now disconnect.