Mueller Water Products Inc (MWA) 2015 Q1 法說會逐字稿

Welcome, and thank you all for standing by.

(Operator Instructions)

This call is being recorded. If you have any objections, you may disconnect at this point. Now, I will turn the meeting over to your host, Ms. Martie Zakas. Ma'am, you may begin.

Thank you. Good morning, everyone. Welcome to Mueller Water Products' 2015 first-quarter conference call. We issued our press release reporting of operations for the quarter ended December 31, 2014 yesterday afternoon. A copy of it is available on our website, muellerwaterproducts.com. Mueller Water Products had 160.6 million shares of common stock outstanding at December 31, 2014. Discussing the first-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 on and 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.

A replay of this morning's call will be available for 30 days after the call at 1-800-396-1242. 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'll now turn the call over to Greg.

Thanks, Martie. Thanks for joining us today as we discuss our results for the 2015 first quarter. I'll begin with a brief overview of the quarter, followed by Evan's detailed financial report. I will then provide additional comments on the quarter's results and developments in our end markets, as well as our outlook for the 2015 second quarter and the full year.

Mueller Company's adjust operating income increase 10%, primarily attributable to the 11% increase in domestic shipments of valves and hydrants. We believe this growth came from solid demand from the municipal market, as well as from growth in some residential markets. Anvil's net sales grew 5.1% in the first quarter, with growth across its end markets.

During the quarter, we prepaid our long term debt, entered into a new $500 million senior secured term loan, and reduced our debt outstanding. Thereby lowering our interest rates, and improving our financial flexibility. We continue to believe consolidated operating results for the full year will improve year over year, due to expected growth in most of our key end markets, lower interest expense, and the benefits of operating leverage. With that, I'll turn the call over to Evan.

Thanks, Greg, and good morning, everyone. I'll first review our first-quarter consolidated financial results, and then discuss segment performance. Net sales for the 2015 first quarter of $261.8 million increased $4.4 million or 1.7% from the 2014 first-quarter net sales of $257.4 million. Due to higher shipment volumes and involved pricing, partially offset by unfavorable Canadian currency translation effects. Gross profit increased 6.3% to $71.3 million for the 2015 first quarter, compared to $67.1 million for the 2014 first quarter. This increase was due to a higher margin product mix at Mueller Company, and higher sales prices. Gross margin of 27.2% in the 2015 first quarter increased 110 basis points from 26.1% in the 2014 first quarter.

Selling, general and administrative expenses were $55 million in the 2015 first quarter, or 21% of net sales. Adjusted operating income for the 2015 first quarter increased 15.6% to $16.3 million, as compared with $14.1 million for the 2014 first quarter. This increase was due to a higher margin product mix at Mueller Company, and higher sales pricing. Adjusted operating margin also improved 70 basis points, to 6.2%. Adjusted EBITDA for the 2015 first quarter increased 6.3% to $30.6 million, as compared with $28.8 million for the 2014 first quarter. Trailing 12 months adjusted EBITDA was $185.7 million.

I will note that this quarter's reported results include additional expenses, primarily associated with our debt refinancing and the closure of a manufacturing facility in Canada. These expenses totaled $39.5 million pretax, or $0.16 per share. In November, we prepaid our long-term debt, entered into a new $500 million senior secured term loan maturing in 2021, and reduced our debt outstanding. These actions improved our financial flexibility, and lowered our interest rates. The pretax refinancing expenses of $31.3 million included the premium paid for the early extinguishment of debt, and the write-off of associated deferred finance expenses.

During the quarter, we closed a small foundry in Canada that primarily produced commodity municipal castings and had faced strong competition from imports. We also sold certain other related assets, resulting in a pretax loss of $7.2 million. Of this amount, $2.6 million was non-cash. And ultimately, we expect this transaction to be cash flow positive, subject to our estimated costs associated with the closure of the facility and the sale of remaining assets. This facility generated net sales of $11.5 million in 2014, but had an operating income loss of about $2 million.

Interest expense declined this quarter, due to lower interest rates and lower amounts of debt outstanding. Interest expense net for the 2015 first quarter declined $3.2 million to $9.4 million, as compared with $12.6 million for the 2014 first quarter. There was an income tax benefit for the 2015 first quarter of $12.4 million on a loss before income taxes of $32.6 million, resulting in an effective income tax rate of 38%.

Net loss per diluted share for the 2015 first quarter was $0.13. However, excluding the one-time items just discussed, adjusted net income per diluted share for the 2015 first quarter improved to $0.03 from $0.01 in the 2014 first quarter. There was a weighted average of 163.1 million shares of our common stock outstanding for the 2015 first quarter adjusted results, compared with 161.7 million shares outstanding for the 2014 first quarter.

I'll now move on to segment performance, and begin with Mueller Company. Net sales for the 2015 first quarter were relatively flat at $164.7 million as compared with $165 million for the 2014 first quarter. Mueller Base, which excludes metering products and leak detection saw an increase in domestic shipments of approximately 9%, which was led by about 11% increase in valves and hydrant sales. This was offset primary by lower shipment volumes of metering products, lower exports, and unfavorable Canadian currency translation effects.

Adjusted operating income of $17.6 million for the 2015 first quarter improved 10% from $16 million in 2014. Adjusted operating income improved $1.6 million, due primarily to higher domestic shipment volumes of valves and hydrants. Adjusted operating margin of 10.7% for the 2015 first quarter improved 100 basis points from 9.7% in 2014. Adjusted EBITDA for the 2015 first quarter increased to $28.2 million, as compared with $27.1 million for the 2014 first quarter. Adjust EBITDA margin for the quarter increased 70 basis points to 17.1%.

I'll now turn to Anvil. Net sales for the 2015 first quarter increased 5.1% to $97.1 million, as compared with $92.4 million from the 2014 first quarter. The increase in net sales resulted primarily from higher shipment volumes and improved pricing. For the quarter, Anvil's net sales into the energy market grew about 14%. However, we started to see a fall off in mid-December. Shipments of mechanical and fire protection products grew by about 3%, driven by non-residential construction.

Adjusted operating income for the 2015 first quarter was $7.2 million, as compared with $7.3 million for the 2014 first quarter. Adjusted operating margin decreased to 7.4% from 7.9% for the 2014 first quarter. The decrease in adjusted operating income and adjusted operating margin resulted from the benefits of higher shipment volumes and improved sales pricing, offset by higher manufacturing and other costs. Manufacturing costs were higher year over year as the result of a maintenance shutdown at Anvil's largest plant in August. We have historically shut down this plant in August to perform maintenance, but did not do so in August 2013.

These overhead costs negatively impacted our first-quarter margins as compared to the 2014 first quarter. We included these higher costs for the quarter in the outlook we provided on our last call. Additionally, we incurred a $200,000 non-cash write-off related to selling an idle building. And experienced some higher freight costs associated with disruptions at US West Coast Ports related to their labor dispute. Adjusted EBITDA for the 2015 first quarter was $10.8 million flat with 2014. Adjusted EBITDA margin for the 2015 first quarter was 11.1%. Corporate expenses for the 2015 first quarter were $8.5 million, compared with $9.2 million for the 2014 first quarter.

Turning now to a discussion of our liquidity. Free-cash flow, which is cash flows from operating activities less capital expenditures, was negative $34.3 million for the 2015 first quarter, compared to negative $11.3 million for the 2014 first quarter. The year-over-year change was driven primarily by an increase in inventory in an effort to spread production more evenly between periods in anticipation of the upcoming construction season, and timing of receives and disbursements. Given the seasonality of our business, the first half of the year is typically negative from a free cash flow perspective.

This quarter, we built more inventory at Mueller Company in advance of the price increase in order to level out our plant production. Which we expect will lead to improved efficiencies in the second quarter by reducing the need to work overtime. Additionally, we improved a measure of working capital efficiency by 100 basis points year over year, as evaluated by trailing four quarter average accounts receivable, inventory, and accounts payable as a percent of net sales.

At December 31, 2014, total debt was comprised of a $497.5 million senior secured term loan due 2021, and $2.1 million of other. The term loan accrues interest at a floating rate equal to LIBOR subject to a floor of 75 basis point plus 325 basis points. Net debt leverage was 2.4 times at December 31, 2014. Using December 31, 2014 data, we had $138.3 million of excess availability under our asset-based credit agreement. I'll now turn the call back to Greg.

Thanks, Evan. I'll now elaborate on our 2015 first-quarter results and end markets, review our outlook for the second quarter, and provide an update to our general overview for the full year. I'll begin with Mueller Company.

There were a number of moving parts at Mueller Company this quarter. Both relative to year-over-year comparisons, and to the outlook we provided last quarter. Net sales at our base, which excludes metering products and leak detection, were up 5%. Domestic shipments of valves and hydrants, however, were up about 11% year over year, while shipments of brass products were essentially flat. We also saw growth in valves and hydrant shipments in Canada, although we were affected by unfavorable Canadian currency exchange rates. We saw a decline in export shipments of approximately $2.5 million. Sales of our water treatment valves were up slightly year over year.

Turning to our metering products, year-over-year net sales declined $7.6 million. This business had a difficult comparison in the first quarter, since we shipped the majority of the large Jackson, Mississippi project in the first two quarters of 2014. In addition, we were unable to ship about $2 million of meters and radios this quarter, due to a delay in receiving components from a supplier.

When we look at net sales this quarter, relative to our expectations, we had a shortfall in two additional areas. Even though Mueller Company's domestic values, hydrants and brass products increased about 9% year over year, the growth was less than we expected, particularly in our western region. While shipments in this region grew roughly 5%, the growth rate was well below our expectations and what we have recently experienced. We think the slowdown in growth in our western region was primarily due to a decline in the growth rate of residential construction.

In addition, we had expected our export shipments to grow year over year in the first quarter, but exports actually declined. A significant portion of the year-over-year decline and the shortfall to our expectations is attributable to delayed orders of valves and hydrants for refineries in the Middle East. We now believe these orders could be pushed out beyond 2015. The bulk of the shortfall from our expected net sales growth in the first quarter was caused by this falloff in export shipments and the slow down in our western region. In addition, we believe distributor inventories during the quarter declined sequentially, and were flat to slightly down year over year.

Mueller Company's overall adjusted operating income grew 10% in the first quarter year over year. This growth was attributable primarily to higher domestic sales volumes of valves and hydrants, and increased pricing. Anvil's net sales growth of 5.1% in the first quarter benefited from strong growth in the energy market, and to a lesser extent, growth in demand from non-residential construction. Despite solid net sales growth, Anvil's adjusted operating income was essentially flat year over year, due to a number of items Evan discussed.

Turning now to our outlook for the 2015 second quarter. I'll start with Mueller Company. We expect mid single-digit net sales percentage growth for our base business. Driven primarily by domestic demand for our valves, hydrants and brass products from both residential construction, and municipal spending. In early January, we announced a price increase on iron gate valves, hydrants and Pratt valves that will be effective February 13th. The effective date of the price increase is essentially the same as last year. Net sales growth in domestic valves, hydrants, and brass products is expected to be partially offset by a net sales decline in exports, and in Canada.

For our metering products, we expect year-over-year net sales to decline again. Due largely to the tough comparison we have, relative to the timing of the shipments for the Jackson, Mississippi project last year, and the timing of deliveries of our backlog that are heavily weighted towards the second half of the year. As a result of these factors, we believe Mueller Company's sales second-quarter net sales will be flat with the prior year.

We expect Mueller Company's adjusted operating income and adjusted operating margin to also be flat in the second quarter year over year. We expect to see increased operating income from our domestic valves, hydrants and brass products. But this higher operating income will be offset by lower shipments of metering products. In addition, as we mentioned during our last conference call, we have elected to increase our investments in technology and business development in leak detection. We expect to be negatively impacted by about $5 million for the full year in connection with these investments, some of these higher costs will ramp up in the second quarter.

Moving to Anvil. We anticipate second-quarter net sales will decline year over year, based in large part on our run rate of oil and gas orders over the last six weeks. We do not believe the growth that we will expect to see in our non-residential construction markets will offset the net sales decline from oil and gas. While Anvil's adjusted operating income is expected to be slightly down, we believe our adjusted operating margin will be close to what we achieved in the second quarter last year. Even though we generally achieve higher margins on our oil and gas products, because they are manufactured domestically, we expect to make up some of the shortfall with manufacturing efficiency improvements.

For Mueller Water Products, we expect adjusted pretax income in the second quarter to improve largely due to our lower interest expense. As just discussed with the puts and takes in our various businesses, we believe consolidated results will show about flat year-over-year net sales, adjusted operating income, and adjusted operating margin.

I will now provide an update on our general overview for 2015. As we said on our last call, we expect continued net sales growth at Mueller Company, driven primarily by both the residential construction, and municipal end markets. I'll start with our base business, which excludes metering products and leak detection. We continue to expect year-over-year net sales for our base business to increase in a range comparable to the 7.3% growth we saw in 2014. We expect this growth to be driven by demand in our residential and municipal end markets. Additionally, we anticipate higher growth rates in the second half of the year relative to the first half.

Looking at our quote activity, quotations in the first quarter were up 16% in number of quotes and 30% in dollars. Quotation activity was primarily driven by several large municipal projects. We view this quote activity as an indicator of the direction of future municipal demand, which we think indicates ongoing growth. Economic forecasts for growth in housing starts in calendar 2015 are now about 15%. This growth rate is slightly lower than what was forecast several months ago, but still much higher than the 8.7% growth in calendar 2014 and the 6% growth for the quarter ended in December.

We expect greater growth and demand for our products coming from the residential construction market in the second half of our year, than what we expect to see in the first half. For our domestic valves, hydrants and brass products, we expect our growth rate for the first half of the year to be about 9%. Given the outlook for growth in residential construction and continued strong and municipal spending, we expect to see a slightly higher year-over-year growth rate in the second half of the year.

For our international sales, keep in mind that this business tends to be project based. We believe our export shipments will be up in the second half of the year, as compared with the first half. Finally, we expect net sales of Pratt to increase in the second half of the year compared with the first half. Driven by growth in water distribution pipeline work, and plant projects.

For metering products, we continue to believe that 2015 net sales will be essentially flat with 2014. We mentioned last quarter that we had outstanding quotations on some large metering projects, and that we expected to win a portion of these. We are encouraged by the progress we made in the first quarter, and we continue to expect to win some of these larger orders over the next several quarters. Bookings for our metering products were up 24% year over year in the first quarter. Our backlog has grown nearly 80% since the end of 2014, and we expect it to continue to grow in the second quarter. As we look at our full year forecast, shipments are heavily weighted towards the second half of the year given the scheduled shipment dates in our backlog, as well as anticipated future orders.

Currently, we expect shipments to be up more than 20% year over year during the second half of the year. Although we expect net sales of our metering products to be flat in 2015, based on our current backlog and project pipeline, we believe adjusted operating income will again improve on a year-over-year basis. We expect this improved performance will come from cost saving initiatives, as well as from an improved mix weighted towards the second half of the year.

As we mentioned on the last call, we are bullish about the future potential of our leak detention offering. We are investing in further developing our technology, especially with an eye on international markets. During the first quarter, we continued to gain traction in both domestic and international sales as well as in quoting activity. On a year-over-year basis, our sales funnel essentially doubled. Though we expect to see significant sales growth during the year, as we guided on our last call, we expect to be negatively impacted by about $5 million for the year, related to the investments in technology and business development activity.

Based on the current outlook for housing and municipal spending, we expect Mueller Company's year-over-year net sales growth in 2015 to be in a range comparable to the 7.4% growth we saw in 2014. We expect Mueller Company's adjusted operating income and adjusting operating margin to increase in 2015 compared with 2014. Again, weighted towards the second half of the year.

Turning to Anvil, some leading indicators related to non-residential construction are positive. For example, the architectural billing index for December remained above 50. As a reminder, in 2014, about 75% of Anvil's business was driven by non-residential construction spending. However, our outlook for Anvil has changed since our last earnings call due to its exposure to the oil and gas markets. As you know, these markets accounted for about 20% of net sales in 2014.

As we mentioned earlier, we actually saw about a 14% year-over-year increase in net sales for the oil and gas markets in the first quarter. However, beginning in the second half of December and continuing into January, we saw our orders on a year-over-year basis drop about 25%. If we continue to see deterioration in our oil and gas business of this magnitude for the rest of our fiscal year, we do not believe that growth in our non-residential construction market would offset the decline in oil and gas sales. Taking this all into account, we expect Anvil's net sales could be down in 2015 on a year-over-year basis.

In total, we think adjusted operating income could be flat or slightly down year over year. Excluding the $2.5 million gain that we experienced in the fourth quarter of 2014 with the sale of Anvil's Bloomington, Minnesota facility. We believe that an improvement in manufacturing efficiencies will partially offset the difference in margins between the sales of our domestically produced oil and gas products and our non-residential construction products. Though we continue to see a growing trend in the non-residential construction market to purchase our importer products.

For Mueller Water Products as a whole in 2015, we expect net sales growth in the mid single-digits. Additionally, with increased production in shipment volumes at Mueller Company, we expect the benefits of continued operating leverage to result in adjusted operating income growth and adjusted operating margin expansion.

Other 2015 key variables include corporate expenses are expected to be $34 million to $36 million. Depreciation and amortization is expected to be $58 million to $60 million, and interest expense is expected to be about $27 million. We expect our adjusted effective income tax rate to be 37% to 39%. Capital expenditures are expected to be $36 million to $38 million. For 2015, we expect free cash flow to be driven primarily by improved operating results, offset by cash income tax payments as we have substantially exhausted our federal NOLs. We expect 2015 income tax payments to approximate our reported income tax expense for the year. We also expect to make only minimal cash contributions to our pension plans in 2015. As a reminder, our target is for free cash flow to exceed adjusted net income.

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

Thank you.

(Operator Instructions)

Our first question coming from the line of Mike Wood of Macquarie Security Groups. Sir, your line is open.

Hello, thanks so much for all the detail. You actually got to most of my questions in your prepared remarks. First, just let me ask about the $5 million investment that you were talking about in the systems business. Is that primarily related to leak detection, and can you give us any update in terms of progress on penetrating the UK market there?

Yes, Mike, that is all related to leak detection. And we said on our last call that as our -- the technology that we introduced last year in the US and the results from the pilots we got very, very excited. Certainly, about the pick leak detection that we had been working on, and our customers have been excited about it. And so we're continuing to invest to expand our capabilities in that area. To really -- just to go after the US market to be able to offer it not only over RF systems, but over cellular systems. If the utility decides to buy our fixed leak detection only, and not couple the decision with an RF AMI system.

We have, in the last several weeks, actually submitted several quotations in the UK. We would expect some decisions be made, probably over the next three or four months, but we have had indications that they will start piloting our technology, probably within the next several months. And as I said, the quotations put us in a position to potentially benefit from much larger orders down the road.

Great. And then would the oil and gas headwinds in Anvil and just general currency headwinds, do you have any contingency planning or additional restructuring that you may embark on if the headwind increases?

That's a difficult one. Because when we look at our SG&A in our oil and gas business, we really have a limited sales force there. Our products go 100% through distributors that are located in the oil patch. I think our salespeople do a good job of not only interacting with our distributors but the end users, and we wouldn't want to lose that touch point.

From a manufacturing standpoint, those products are manufactured at facilities where we manufacture our other products. So we don't have an opportunity to actually close any manufacturing facility. So we'll have the opportunity probably to reduce some manufacturing overhead, obviously direct costs will be reduced. But relative to what I would call any real restructuring activity, I think we're really limited.

Thanks so much.

Thank you, Mike.

Thank you. Our next question coming from Kevin Maczka of BB&T Capital Markets. Sir, your line is open.

Thanks. Good morning.

Morning, Kevin.

I guess, can we just touch on Mueller Co? So we had a couple of things surprise us here in the quarter with the Mid East refinery delays, and the resi business out West. And it looks like from your guide, we're shaping up in terms of total Mueller Co to be flat in the first half. But, Greg, if I heard you right, you're still thinking maybe 7% plus for the year. So a really back end loaded strong second half.

I'm just wondering, can you say a little about the more about your confidence level, your visibility, your forecasting ability? What gives you the confidence to keep that target after a flat first half?

Yes, Kevin, excellent question. And let me break it down into components. When we look at our valves and hydrants and brass products for the first half of the year, we think on a year-over-year basis they're going to grow close to 9%. When we look at the second half of the year, that we think that will grow, we would expect that to grow at least slightly -- at a slightly greater amount, driven by our expectations for growth in residential construction. And our expectations that we're going to continue to see a solid municipal market.

Our grow -- I think our expectations relative to the residential construction market are really driven by, I would say, the consensus or the midpoint of housing forecasts of a 15% growth year over year. And as we said in our prepared remarks, in 2014, that grew less than 9%. And in the quarter just ended in December, that grew about 6%. So in order to hit -- to have calendar year 2015 to be at a 15% rate, we're going to have to -- we would have to see a pick-up in residential construction. And certainly, that expected pick up is built into the outlook that we just presented. So, I would say that where could we be vulnerable? Where could we be vulnerable in our current outlook? That is if we don't see residential construction growing at or near that 15%, we could certainly have some vulnerability in our most profitable products at Mueller.

If we look at the macro environment relative to residential construction, it certainly looks like those variables support the expectation of a 15% growth rate. Job growth is accelerating, there seems to be higher consumer confidence, household formation has increased dramatically in the recent months, and interest rates remain historically low. So that would certainly support an expectation of higher residential growth.

When we talk about a solid -- municipal spending remaining solid, we referenced that we saw a nice increase in the number of quotes we issued in the first quarter. About 16% in terms of the number of quotes, about a 30% increase in the dollar value. Most of that was driven by larger municipal projects. That gives us some insight to -- at least we think that there's some bullishness around the municipal spending. And also, we saw that some of these projects tended to be transmission work related, and distribution work usually follows the transmission. So when we look at core Mueller, and I'll say our valves, hydrants, and brass products, 9% growth in the first half of the year. We're expecting 9% growth in the first half of year, slightly higher in the second half. Those are obviously the products that generate our highest margin, and we have the greatest conversion margin.

Now, when we look at Mueller Co exports, our export business, when I look at the last 18 months, a lot had been influenced by shipments as we referenced to refineries in the Middle East. They had a change, I would say, probably the last, six, seven, eight months ago in their specifications to make sure that their valves and hydrants could handle sea water, as well as clean water. We had to make a change to the internals in those products to be able to not only handle clean water, but sea water. We've made those changes. So we're going to go through a period where they come over and test the product and inspect the product. And that's why we say, hey, we think that exports could shift into 2016.

However, we have seen an uptick, I would say in the last 12 months in our quotation activity on infrastructure projects in the Middle East. And right now, as we look at both our backlog and expected wins, we expect to see a pickup in our export activity in the second half of the year, as compared to the first half of the year. Albeit, I think it's important to point out that we don't earn near the same margins on the export business as we do on domestic valve hydrants and brass products.

Our Pratt business, more project-oriented. As we look at our backlog, we see the second half of the year growing at a much greater rate this year at Pratt. Greater than what we see in the first half, and greater on a year-over-year basis. And then finally, if you look at probably the biggest impact will be our expectation that our metering sales will grow 20% year over year. And that again, is weighted to orders that we have on our backlog, orders that we expect to receive. And so when we put those together, we do see an uptick in the second half. If you were to ask me, what is the biggest concern at this point? I would say it is, if we don't see a growth rate in residential construction that drives lot development at or near the 15% growth, then I think our second half forecast and the full year outlook could be vulnerable.

Got it, Greg. That's all very helpful. I appreciate all the detail there. Can I just ask one more about price costs, and then I'll jump off?

Sure.

More price increases coming in February, presumably the input cost side is under control and maybe even increasingly favorable. Can you just address that and how does that effect your guidance?

Yes, I think relative to input costs, Kevin, I think under control is a good way to put it. I think that when we look at our overhead cost per unit sale, we expect that to come down as our capacity utilization and our manufacturing -- and it increases. I think we have a little bit of a mix, we're a little mixed on the raw materials side. I think when we look at brass ingot and when we look at our scrap steel purchases, we think that we will get a tailwind from those components. But we are seeing an increase in components that we source, especially those from China, given where they were 12 months ago.

And so when we look at the price increase of Pratt, that price increase is very important to offset the higher components costs that we're seeing from China. Since a lot of our components and even machining of our valve bodies is done in China, and then come to Pratt for assembly. So all in all, I would say it should tend to be a bit of a tailwind. But we are seeing, on the material side, there's offsets from the lower scrap steel and brass ingot costs relative to source components, especially those coming from China versus what the our costs were a year ago.

Okay, great. Thank you.

Yes, thank you.

Thank you. Our next question coming from Brent Thielman of D.A. Davidson. Sir, your line is open.

Good morning.

Morning, Brent.

Good, good. Greg, is there anything specifically you're looking at as it relates to infrastructure proposals out of Washington that you think might be significant to the Company?

Brent, certainly, what's coming out of Washington, one would have to classify as very positive. I think the question is timing and the overall bureaucracy. Certainly, I think that when you look at the state revolving funds, I think that over $2.3 billion was allocated by the federal government, which is up from where it has been. And that seems that a majority of that -- well, less than half of that for drinking water, but almost $1.5 billion of that for allocated for clean water.

So certainly, I think rebuild America. There's a discussion there to invest $1 trillion over five years, who knows where that will go. But I think even out of Washington, as you mentioned, there's bipartisan support for the Sustainable Water Infrastructure Investment Act. So, I would say that what we're seeing out of Washington is positive. I can't say that we'll see much of an impact in 2015, other than I think the increase in state revolving funds. I think that that increase should flow through into the market.

Sure. Okay, that's helpful. And then, what do you expect your overall sales exposure is going to be in Canada going forward, since it sounds like you've kind of scaled back the business?

Yes. Actually, we only scaled back -- as we said, we had, I think, last year it was somewhere around $11 million of sales of municipal castings. So we're talking a real commodity product. It has been a legacy business for us. And I'd say up until a couple years ago, it was a pretty reasonable business for us, because there was a tendency to buy locally. Over the last couple years, we've seen a trend that exports take some of that market. So we've, as we discussed, we elected to exit that business.

We lost about $2 million at the OI line last year. And the sale of those products are completely unrelated to our valve, hydrants, and brass products, and any of our other products. Different buyers, different distribution. So relative to our cutting back our investment in Canada, we don't believe it really will have any impact on the rest of our business. Now, was that your question?

I think that hits it, Greg. Yes, I guess one more on that. Are you continuing to focus on pushing some of the technology products up into that region as well?

Yes, we are. We have pilots ongoing with several of the major water systems there, but it's more on the leak detection side, really, not on the metering side.

Okay. Great, thank you.

Thanks.

Thank you. Our next question is from Kevin Bennett of Stern Agee.

Good morning, everybody.

Good morning, Kevin.

Two questions, Greg. First, if we can talk housing for a second. You mentioned some of the headwinds out West that you saw late in the quarter.

I'm wondering if you could talk about the other regions? And I guess more specifically, in terms of new community development, what you're seeing on that front?

Yes, when we made our comments about the West, as we've said, we were surprised. Because for the last four quarters, we received very, very nice growth out of the West. And this quarter, we saw 5% growth. So, we really did a deep dive and said, okay, on a year-over-year basis, where are we seeing the real difference? And we were able to identify over a year ago some pretty nice shipments that we made to our distributors that were specifically earmarked for different housing developments that were being developed -- going through the development process at that time. So that is why we, Kevin, that is why we were saying that, hey, we think this downturn from our on a year-over-year basis and from our expectations has been a slowdown from residential construction.

Relative to community counts, I think the community counts continue to move, continue to grow and move in a positive direction. We continue to see, I think, the statistics would indicate that land development continues to grow. Albeit, at a slower growth rate than what maybe we were seeing several quarters ago. So, and I think that's what's supporting our outlook of why we think in the second half of the year we're going to see the uptick in further growth coming from residential construction. But when I answered the earlier question that Kevin asked, if one were to ask us right now, what's the vulnerability in our forecast? It may be, are we going to see that kind of growth rate?

Certainly, that makes sense. Thanks for that. And then lastly, Greg, and I guess Evan. Now that you guys have some financial flexibility, can you talk about your capital allocation plans going forward? Should we look for a dividend hike, or a buyback, or M&A, or what are you thinking about on that front?

Yes, again, Kevin, good question. We do have the flexibility. When we look at our Board -- with our Board, we look at all the different options. I would say right now, that our first priority would be, is there an opportunity for us to grow our business? And we've said in the past when we look on the acquisition side, if there's acquisitions it would strengthen our position water infrastructure, or add to our technology, that we would look very seriously. So we have flexibility. We're looking -- I'd say, we look at all options. I would say as we look to the immediate future, our priority would be, are there opportunities for us to grow the business?

Okay. Thanks, Greg. Appreciate it.

Thank you.

Thank you. Our next question is from Seth Weber of RBC Capital Markets. Your line is open.

Hey, good morning. This is actually Daniel Palter on for Seth. So, going to your revised guidance for 2015, what's your level of comfort with the incremental expectation? You guys have talked in the past about Anvil around 25%, and Mueller around 35%. Should we still expect that for this year, or what are you thinking?

Sure, I'll have Evan take that.

Certainly. When we look at our commercial margins for the base business, which excludes metering products and leak detection, we saw conversion margins of about 38% for our first quarter. And one variable that negatively impacted that conversion margin was about 800 basis points related to higher costs on components sourced from China by our Henry Pratt business. We had included that in the combines we provided last quarter.

So if you take that into effect, excluding this our Mueller Company base business conversion margin in the first quarter, it would have been around 46%, 47%. As you mentioned, we typically expect total Mueller Company conversion margins around 35% today, that's on average and can fluctuate from quarter to quarter based on the mix. And specifically, the mix of our higher margin valves and hydrants. So certainly, a base conversion margin fairly solid around 46%.

And then taking a look at Anvil conversion margins for the quarter, if you look at the volume, we saw conversion margins of around 30%. However, I cited in the prepared remarks, that we were negatively impacted -- some higher manufacturing costs -- due to a shut down. Excluding those costs and just taking a look at the business, we saw converse margins a little over 20% in the Anvil business, which is pretty close to our overall stated average of around 25%.

So for the year, would you still say 35% and around 25% for each of businesses?

That's right. When we look at full year, I would say that those conversion margins that we provide, we would see those, and certainly that's dependent upon the mix as we go forward. But we would expect conversion margins in that level.

Okay. Thanks. And another one, on the FX impact from the Canadian dollar, could you give an approximation of what the impact was on operating income from that?

Yes. Our currency exposure is primarily in Canada. And just a little bit on sizing, if you look for the quarter, our consolidated net sales growth would have been about 55 basis points higher or 2.5% excluding the unfavorable exchange rates. And adjusted operating income growth would have been 19% compared with 15.6%.

And in Mueller Company, our adjusted operating income would have improved about 12.5%, excluding the unfavorable exchange rates. So it's all in Canada. And I would say on the whole for the business from a revenue perspective, perspective impacted us a little under $1.5 million, and about $0.5 million on the operating income side.

Okay, great. Thanks, I'll leave it there.

Thank you. Our next question is coming from Noah Kaye of Northland Capital Markets. Your line is open.

Yes, good morning. The capacity utilization, you've given data on that in the past. Can you tell us what it was this past quarter?

Yes. We saw an increase in both Anvil and Mueller Co on a year-over-year basis. At Mueller Co, we're estimating a move from about 62% overall a year ago, up to about 67% this year in the first quarter. And Anvil about 70%.

Okay. And for Anvil, I imagine you have some pretty good visibility to the non-residential business, especially for large projects. How much are you expecting the non-residential construction portion of Anvil to grow this year?

Yes, that's a great question. Right now, as we look at it and it's pretty consistent with guidance we gave last quarter, we're looking for mid single-digit growth, around mid single-digit growth. If we look at our first quarter, we saw about 3% to 4% growth of our products going into fire protection and mechanical systems in non-res construction spending. As we look, we think that should maybe continue to increase slightly throughout the year. But as we look at where we fall in the construction cycle, I would say now, it would be difficult for us to guide any growth greater than that mid-single digits.

And just to follow up on that, where you fall in the construction cycle. By that, you mean you have some limit on visibility into the out quarters, or you're suggesting that that's fully baked into the year?

Yes, I think that that's fully baked into our year. As we've said, we expect that the construction we start seeing, I think, positive movement in about 12, 14 months ago. But we have to see foundations in place, structural steel, and some progress before our products get in probably about, I would say, mid-cycle of a construction project, depending on specifically what it is.

So I think that we're more -- we certainly are a little more back-end weighted. And possibly when we look at non-construction in what appears to be happening in that market, we may even see some of that increase flowing into our first quarter of our FY16, even though it would still be in calendar year 2015.

Great, great. And you mentioned, I think, a very substantial increase in the Mueller Systems backlog, I think you said 80%. Could you repeat that?

Yes. It was up 80%, albeit this on smaller numbers for Mueller Systems. But we saw a nice continued growth in our order. As we said, our orders were up on a year-over-year basis, 24% in the first quarter, the backlog growing. We said in the last call, and reiterated on this call, that in the last six months, we have seen requests for proposals from larger cities that I don't think have been around for the last couple years. We continued to make, I think, real progress on those in the past quarter. And we expect to win some of that business probably over the next several quarters. But yes, we're seeing positive activity in our, both in our order rate, our closure rate, the growth of our backlog. And that supports our expectation that on a year-over-year basis, our sales will grow about 20% year over year in the second half of the year.

Great. And would you be able to give us a backlog number?

Yes, our backlog is between right now it's about $16 million to $17 million.

Okay, great. Thank you so much.

Thank you.

And our next question is from Joe Giordano of Cowen. Your line is open.

Hello, guys. How are you doing. I'm just curious as how would you categorize -- how much could mix in terms of commercial -- residential construction help offset growth in the overall number that if it fails to meet up to 15%? Like if it shifted more towards single family than it was last year, but the overall growth rate was not as much. How much can be offset by mix?

Joe, if -- certainly if we see a transition to more single-family homes, that's a plus for demand for our products. And so if you're saying that mix in terms of, hey, overall housing starts may not reach the 15% growth, but we see a greater percent of growth coming from single family. That certainly could offset a shortfall from the overall growth rate. Ask the question again. Because I'm not sure that I just addressed the question you asked.

No, that did it address it. Thank you. How large is your export business? You were talking about the Mid east component and stuff like that?

Yes, when you look at Mueller Co total, it's about 5%. I think it becomes probably more impactful when you're discussing perhaps year-over-year movement in a particular quarter.

Okay.

So that -- but it trends around 5%.

Okay. And then just last for me, how would you gauge your overall confidence level here versus where you were three months ago in terms of your outlook? I see what you said with the guidance, but how do you feel about your level of comfort now?

I would say we are just as comfortable with demand from municipal spending as we were last quarter. I would say that our outlook for Mueller Systems, we feel just as comfortable, given the order increase that we saw in the first quarter and the increase in our backlog. I would say that the fact that housing starts for the quarter ended in December were less than 7%, gives us maybe a little bit of pause. Saying gee, exiting the year at 7% and having a full year of 15% growth, that's certainly could be a little concerning. But again, when we go through the macro factors that we did, it certainly could support that type of growth. We announced our price increase on valves and hydrants in mid-February, we'll know exactly to what extent that this has been accepted by the marketplace, based on the number of orders that we've pulled forward. But we believe that -- but our competitors certainly appear to have followed.

I would say the other area that when you look at total Mueller Water products certainly have been the fall-off in energy and the oil and gas markets, and that's why we made the comments that we did. And that we said if you look at the last six months -- I mean, we're sitting here, and I imagine a lot of people are sitting and saying that what's really going to happen over the next 9 to12 months in the oil and gas business? It went -- in a very short time, it changed pretty dramatically. So all we can do is provide an outlook based on what we're seeing. And in the short-term, as I've said, for the last 6 weeks, we saw a downturn on year-over-year basis of about a 25% erosion in our fall-off in our orders from oil and gas. So, that certainly has changed from a quarter ago, and probably makes us, as we guided, feeling that Anvil's overall performance will be less than what we thought it would be a year ago.

So Joe, I don't know if that captures it all. But I'd say for the bulk of our business, we feel very comfortable, the bulk of our markets. Certainly, maybe a little question mark on the growth rate in residential construction. And oil and gas markets will negatively impact us.

Okay, great. Thanks for the color, guys.

Thank you.

Thank you. Our next question is from David Rose of Wedbush Securities. Sir, your line is open.

Good morning, and thank you for taking my call. I have a couple follow-ups, and I may be repetitive in that I was dropped. If I may ask, in terms of the oil and gas exposure. Can you break down downstream, midstream and upstream for us, and provide us a little bit more color from what you've seen historically? And maybe in terms of what's MRO, versus what's related to Cap Ex?

Yes. We are -- our products are production related and we're upstream. And we don't typically see a lot of MRO opportunity, because our products just don't -- they go into a process that don't wear out. We're providing couplings for piping systems, for tank batteries, and in gathering fields, and so-on. We have always found a good indicator for demand for our products is tied to the rig count. Because I think that certainly is a probably a good indicator of new production, and we follow very closely. So, we're really tied into that sector of the oil and gas market.

And then, in terms of your guidance for Canada and released FX, have you baked in this guidance as the stronger dollar, I'm assuming? Just to be clear?

Yes, we would have baked in the guidance on the stronger dollar. And but we also baked in, if you look at last year for the full year, we shipped about $3 million of Mueller valves to the oil sands. We go on fire protection systems. And right now, we don't think that business will repeat in 2015, given what's going on in the oil and gas business.

Okay. That's helpful. And then, just a couple quick ones on the SG&A bump, was some of that from the leak detection business? How much of it was from the investment in leak detection in this quarter?

When you take a look at SG&A, I would say that it was a small amount from some personal related expenses, just inflationary impacts. Some costs associated with a small acquisition, a line valve acquisition. And then we also had SG&A associated with the write-off of assets of a mirrored building, in our Anvil building, that we indicated on our prepared remarks, and just a bit on the investments related to our leak detection.

Okay. And then last one is, your comments have been pretty clear about you need a potential risk for your numbers in resi. Can you quantify a little bit what that would mean if resi grew at 7 or 10, versus 15, on a dollar basis? And then provide color as why not just assume a lower residential growth rate?

Yes, David, that would be something that we would really -- obviously, if we saw a decline, if growth was half of expectations, it would impact us. Right now, I really can't quantify what that impact would be. But certainly, it would be a fall-off in our valve and hydrant business, and which we've discussed a number of times, is our most profitable business.

Okay. Great, thank you very much.

Thank, David. Well, seeing that there are no additional questions, that concludes today's call. Thank you for your interest in Mueller Water Products, and for joining us this morning.

Thank you. And that concludes today's conference, thank you all for joining. You may now disconnect.