Mueller Water Products Inc (MWA) 2017 Q1 法說會逐字稿

Welcome and thank you for standing by.

(Operator Instructions)

This call is being recorded. If you have any objections, you may disconnect at this point.

I would like to turn the call over to Ms. Martie Zakas. Ma'am, you may begin.

Good morning, everyone. Welcome to Mueller Water Products' 2017 first-quarter conference call. We issued our press results reporting results of operations for the quarter ended December 31, 2016 yesterday afternoon. A copy of it is available on our website on muellerwaterproducts.com. Discussing the first quarter's results this morning are Scott Hall, our President and CEO, and Evan Hart, our CFO. This morning's call is being recorded and webcast live on the Internet.

We have also posted slides on our website to help illustrate the quarter's results as well as to address forward-looking statements and our non-GAAP disclosure requirements. At this time, please refer to slide 2. This slide identifies certain non-GAAP 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 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.

We sold our Anvil business in January 2017. As a result, Anvil's operating results for all prior periods have been reclassified as discontinued operations. This quarter's earnings release contains reclassified 2016 results for the first quarter. We will make available to you the reclassified results for the remaining quarters of 2016 and the full year by February 15. During this call, all references to a specific year or quarter unless specified otherwise refer to our fiscal year, which ends on September 30.

A replay of this morning's call will be available for 30 days after the call at 1-888-566-0639. 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. I am now pleased to introduce you to Scott Hall, our new President & Chief Executive Officer.

Thanks, Martie. First off, please allow me a couple minutes to talk to you all about Mueller Water Products and why I thought it would be a great opportunity to join a great team. I've watched Mueller Water Products in the water infrastructure space for some time. I believe that the Company is uniquely positioned with its strong customer presence and distributor relationships to drive impressive long-term growth.

I believe over the last several years, the Mueller Water Products' team has strengthened the balance sheet through a combination of manufacturing excellence and strategic divestitures and has positioned the Company for a future with the financial flexibility and resources to be a force in the water infrastructure market.

In particular, the Anvil sale takes our net debt position to near zero, which gives us tremendous flexibility to pursue acquisitions and invest in organic development opportunities. That flexibility when combined with the backdrop of an old leaky infrastructure in municipality, the realities of water scarcity, and the monitoring imperatives from both water security and water quality points of view makes the water space one of the great market growth opportunities on the investment horizon.

I believe Mueller Water Products' brands, products, channel presence, relationships and strategy all lend themselves to this Company at this time being a great opportunity for me personally and for our shareholders. I have been encouraged by what I have found during my first two weeks. There is a solid team in place and the purpose and mission of the team is customer and product focused, both necessary for future sales success. The Singer acquisition is a clear signal from the Board and the team that they support expanding the product offerings with both a robust product development process and through acquisitions.

Finally, let me say that I'm looking forward to meeting and working with you all. I believe that we have in front of us a great growth opportunity. I look forward to talking with you and sharing a very compelling growth story.

Now onto the quarter. Before I hand it off to Evan, we are pleased to report on a good quarter, highlighted by solid execution by our manufacturing team, delivering year-over-year margin improvement at Mueller Co and by our sales team delivering impressive growth at Mueller Technologies. The end result, we delivered a solid quarter with 3% overall top line growth and 25% adjusted operating income improvement. For more color and detail on the quarter, let me turn it over to Evan.

Thanks, Scott. Good morning, everyone. I'll first review our first-quarter consolidated financial results and then discuss segment performance. As a reminder, I will only be discussing results from continuing operations.

Increased shipment volumes at both Mueller Company and Mueller Technologies delivered net sales for the 2017 first quarter of $167.2 million, an increase of $4.1 million or 2.5% from 2016 first quarter net sales of $163.1 million. Next, gross profit improved at both Mueller Company and Mueller Technologies and was $51.7 million for the 2017 first quarter compared with $47.6 million for the 2016 first quarter.

Gross margin increased 170 basis points to 30.9% in the 2017 first quarter, from 29.2% in the 2016 first quarter. Selling, general and administrative expenses were higher year-over-year due primarily to personnel related expenses. Selling, general and administrative expenses were $36.5 million in the 2017 first quarter compared with $35.4 million in the 2016 first quarter. SG&A expenses as a percent of net sales were 21.8%, essentially flat with 21.7% of net sales in the prior year.

Adjusted operating income for the 2017 first quarter increased $3 million to $15.2 million, compared with $12.2 million for the 2016 first quarter. Mueller Company improved its operating performance by $2.2 million or 9.2%. Mueller Technologies improved by $1.1 million or about 33%.

Adjusted EBITDA for the 2017 first quarter increased to $25.5 million compared with $21.8 million for the 2016 first quarter. For the trailing 12-months, adjusted EBITDA was $159.9 million or 19.9% of net sales.

Interest expense net for the 2017 first quarter increased $300,000 to $6.4 million compared with $6.1 million for the 2016 first quarter. Income tax expense for the 2017 first quarter of $2.1 million was 28% of income before income taxes, which is fairly comparable to 24.5% last year. Adjusted income from continuing operations per diluted share increased to $0.04 for the 2017 first quarter compared with $0.03 in the 2016 first quarter.

I'll now move on to segment performance beginning with Mueller Company. Net sales for the 2017 first quarter increased 1.1% compared with the 2016 first quarter. Domestic sales growth was partially offset by lower sales outside the United States. We experienced strong improvement in adjusted operating income largely due to higher volume, operating efficiencies, and other manufacturing cost savings. Adjusted operating income for the 2017 first quarter increased 9.2% to $26.2 million compared with $24 million for the 2016 first quarter.

Adjusted operating margin for the 2017 first quarter improved 130 basis points to 17.9% as compared with 16.6% for the 2016 first quarter. Adjusted EBITDA for the 2017 first quarter increased to $35.2 million compared with $32.4 million for the 2016 first quarter. Adjusted EBITDA margin for the quarter increased 170 basis points to 24.1% from 22.4% last year.

Now Mueller Technologies. Net sales for the 2017 first quarter increased 13.6% to $20.9 million compared with $18.4 million for the 2016 first quarter, primarily due to higher AMI shipments. Operating performance at Mueller Technologies improved again this quarter by $1.1 million. Adjusted operating loss for the 2017 first quarter was $2.2 million compared with a loss of $3.3 million for the 2016 first quarter. Adjusted operating performance improved at both Mueller Systems and Echologics, largely due to higher shipment volumes and lower SG&A expenses.

Now turning to a discussion of Mueller Water Products liquidity. Free cash flow, which is cash flows from operating activities of continuing operations less capital expenditures, was negative $24.1 million for the 2017 first quarter compared with negative $13 million for the 2016 first quarter. Although free cash flow was lower this quarter largely due to tax payments in the quarter, we expect full-year free cash flow to be higher than adjusted income from continuing operations in 2017.

At December 31, 2016, total debt was comprised of $482.3 million senior secured term loan due November 2021 and $1.3 million of other. The term loan accrues interest at a floating rate equal to LIBOR subject to a floor of 75 basis points plus a margin of 325 basis points. Subsequent to the sale of Anvil net debt is near zero and our excess availability under the ABL agreement was about $91 million. I'll now turn the call back to Scott.

Thanks, Evan. I'd like to provide a few additional comments on our 2017 first-quart results and end markets and then discuss our outlook for the second quarter and full year. First, Mueller Company. As Evan mentioned, we again delivered excellent operating performance at Mueller Company. Operating efficiencies and productivity improvements drove 130 basis point improvement in adjusted operating margin in the first quarter.

Looking at our latest 12 months, Mueller Company's adjusted EBITDA margin was 27.8% or 130 basis point improvement from the prior trailing 12-month period. Mueller Company's first-quarter domestic net sales grew a modest 2%, primarily due to a less favorable mix of products. We also believe that the new administration's promise to increase funding for infrastructure has impacted the timing of municipal spending in some parts of the country.

As we look at our municipal and residential end markets, all indications to us are that the fundamentals for a healthy demand environment remain very good. At Mueller Technologies, the first quarter's 14% net sales growth was driven by increased AMI shipments at Mueller Systems. AMI shipments now represent about half of Mueller Systems net sales. Both Mueller Systems and Echologics continue to win new business.

At the end of the first quarter, Mueller Systems' backlog was up $10.4 million or about 70% from the prior year due to AMI bookings. As a reminder, larger AMI projects are often deployed over several years.

Echologics added $5.1 million of projects under contract, an increase of $1.4 million compared with the first quarter last year. Mueller Technologies' adjusted operating loss of $2.2 million for the first quarter was an improvement of $1.1 million from the prior year, due to higher shipment volumes, a more favorable mix and some cost savings.

I will now discuss our outlook for the 2017 second quarter and begin with Mueller Company. Mueller Company announced valve and hydrant price increases for both the US and Canadian markets. The 7% increase in the US was effective for orders placed after February 17. The 10% increase in Canada is effective for orders placed after February 1.

Last year in the US, we saw a significant pull-forward of orders ahead of the price increase. We shipped a large number of these orders in the second quarter. This year, we anticipate a similar pull-forward of orders and about the same number of shipments.

As we explained in last year's second-quarter call, shipments are restricted by distributor inventory limits. We expect distribution to carry about the same amount of inventory as last year. With this in mind, we expect Mueller Company's percentage sales growth to be in the low single-digits. We also expect Mueller Company's adjusted operating income and margin to again improve year-over-year due to higher volumes and cost savings.

At Mueller Technologies, net sales for the second quarter is expected to be up about 15% compared with the prior year, primarily from growth in AMI systems and fixed leak detection projects. We expect Mueller Technologies' second-quarter adjusted operating performance to again improve year-over-year, with expected increases in shipments, favorable product mix and ongoing cost savings. We expect that this performance improvement will be comparable to first-quarter performance.

We expect 2017 full-year net sales growth at Mueller Company to be in the mid single-digits. Driven primarily by increased domestic shipments of valves, hydrants and brass products, we expect 2017 adjusted operating income and adjusted operating margin to improve commensurate with the organic sales growth.

We expect the net sales growth at Mueller Technologies to be about 15% compared with last year. We expect operating results to continue to benefit from both increased sales of higher margin products and cost savings. We expect adjusted operating performance at Mueller Technologies to improve about $10 million on a year-over-year basis.

For Mueller Water Products, as a whole for the full year, we continue to expect both residential construction and municipal spending to drive higher demand for our products and services. Consequently, we have now changed our full-year outlook from Mueller Water Products. We expect net sales percentage growth in the mid single-digits.

Other full-year key variables include: corporate expenses, which are as expected to be $33 million to $36 million; depreciation and amortization, which is expected to be $42 million to $44 million; and interest expense, which is expected to be $24 million to $26 million. We expect our adjusted effective income tax rate to be around 36% and capital expenditures to be between $30 million and $34 million for the full year.

Finally, we expect 2017 free cash flow to be driven by improved operating results and an improvement in working capital. Our target is for free cash flow to exceed adjusted income from continuing operations.

On Monday this week, we announced that we agreed to acquire Singer Valve, a manufacturer of automatic control valves, for approximately $26 million. Singer Valve offers engineered products for pressure management within waterworks. It also manufactures similar valves used in industrial, commercial and fire protection applications. Once the transaction has closed, Singer Valve will become part of Mueller Company.

This acquisition is an example of a small strategic transaction that allows us to expand our position as a leading water infrastructure Company. We think there is a great opportunity for growth especially in the areas of pressure monitoring, pressure management and non-revenue water remediation.

The addition of Singer Valve broadens our portfolio of products and enhances the value we offer our customers, especially in areas of managing pressure and extending the life of water assets. Singer had net sales of approximately $50 million in calendar 2016. The transaction is expected to close during our second quarter and is not expected to be significant to EPS in 2017.

As we noted on our press release on the divestiture of Anvil, we are now a pure-play water infrastructure Company that is positioned to take advantage of significant opportunities in the industry. We intend to deliver superior long-term value to stockholders through: investing organically in our business, whether in product development or capital equipment; making acquisitions in adjacent areas to our core business, which provide either channel, technology or product line expansion; and by returning capital directly to stockholders. As an example of returning capital directly to stockholders, in conjunction with the sale of Anvil, we increased our quarterly dividend by 33% to $0.04 a share.

Additionally, I am pleased to announce today that we have entered into an agreement with a financial institution to repurchase $50 million of our common shares under an accelerated stock buyback program, which we expect to complete by the end of the third quarter.

Focusing on water infrastructure, water security and water asset management provides a myriad of opportunities. Whether it is new customers or new products, the opportunity set is compelling.

To realize our growth opportunities, we will be concentrating on three key initiatives: accelerating product development and innovation; driving manufacturing excellence; and expanding our portfolio in the water industry to address aging water infrastructure and help municipalities operate more efficiently.

Mueller has a long history of innovation. We are looking to continue that history, not only in Mueller Technologies as we have been doing, but also in Mueller Company. We are investing in research and development with the expectation that we will increase our pipeline of new products and bring those products to market much faster than we have in the past.

We will also continue to build on our strong lean manufacturing culture that has helped drive operating efficiencies and productivity improvements while being focused on the safety of our employees. In particular, each business will be expected to provide margin expansion from manufacturing efficiencies going forward.

We have an established track record for generating meaningful free cash flow, with a target of free cash flow exceeding our adjusted income from continuing operations. With our free cash flow generation capabilities and the proceeds from the divestiture of Anvil, we have the opportunity to implement various capital allocation initiatives.

I think the accelerated share repurchase program, the acquisition of Singer and the increase in our dividend demonstrate our ability to effectively deploy capital. Going forward, our capital allocation strategy will be focused on strengthening our position as a pure-play water infrastructure Company and adding long-term value for our stockholders.

With that as my summary, I'd like to open it up for questions.

(Operator Instructions)

Seth Weber, RBC Capital Markets.

Welcome, Scott.

Thank you. Good morning.

Scott, I wanted to get your view on the Technologies business, in particular, how you're thinking about balancing, growing that business, growing the top line versus attaining some sort of profitability level? Because that's been an area where it's been hard to handicap, frankly. And I think people would like to see some traction towards profitability there. So maybe just -- your big picture view on how you think about that business.

Okay. Well let me start by answering somewhat philosophically in that my experience with technology businesses is that you have to put meaningful amounts of investment upfront into the research and development to make sure you have some basis for differentiation. I don't want to get myself into a box because I haven't been there yet, but I also suspect that leads over into how they think about manufacturing and how they think about their cost structure on the plant floor.

I mean the reality is we're manufacturing meters. At the same time we're manufacturing meters, we need to continue to invest in the higher tech side of it, whether it be in the software side or certainly the leak detection side at Echologics. So they're two very different cultures.

So what I will be looking for is, I'll be looking for the base core manufacturing in meters to start to drive margin expansion through productivity projects by looking at the materials they're using, by looking at their labor content, by looking at their insourcing versus outsourcing activities and start to get meaningful productivity there. And at the same time try and take the parts of the business that I think we can differentiate ourselves on and continue to invest in them.

I like to say to people, go down the road five years in the technology business, kind of look back, tell me what you're known for and tell me how you're differentiated. Why do people buy your meters or your solutions instead of someone else's? Whatever those reasons are, you need to hold those at your core. You need to do those in-house. You need to make investments in those and the other things are kind of context and make sure you're not confusing the two.

As for the second part of your question, Seth. I was pleased -- it's only been two weeks. I was pleased to see the $1.1 million of improvement, but my expectation with Keith and his team is that we will be breakeven or slightly positive by the end of this year. Obviously, we would like it to be positive but I don't want to have people go in and just start cutting expenses to make it profitable, while it's still in this nascent development stage. I hope that answers the question.

Yes, that's very helpful. Thank you for all that color. I appreciate that. Then maybe just one for Evan. How are you thinking about the material cost environment, rising input costs, is that baked into your margin guidance for the year? I gather from your commentary about the first-quarter of profitability at Mueller, you didn't mention pricing. You sort of talked about volumes and efficiencies. Are you able to offset through a higher material cost with pricing in the current environment? Thank you.

Thanks, Seth. As you know, about 50% of our cost of goods sold is raw materials and purchased components. In 2016, we did have a nice tailwind from scrap steel and brass ingot costs. When I look at forecasts out for the balance of our FY17 and calendar 2017, scrap steel and brass ingot are expected to rise 7%, 8%. So we have incorporated that in our guidance as we look forward. And as you know, we have announced a price increase, as we mentioned in our prepared remarks, on our brass -- I mean our valve and hydrant products. So that should more than offset, we think, any expansion in raw material costs.

We also think it will give us good support for the price increase, as we start to see the upward pressure.

Sure. Okay. Thank you very much. Good luck, Scott.

Thank you very much.

Jim Giannakouros, Oppenheimer.

Welcome again, Scott. Looking forward to working with you as well. On the lower sales outside the US, can you remind us of sources of weakness specifically there? When you lap those -- meaning when should we be incorporating the notion of easier comps?

When we look at sales outside of the United States, we do have some international shipments in our Mueller Company business into the Middle East where American standards are utilized in the oilfields. I would say that's probably the biggest area where we saw a little bit of softness. I think as we look out to the balance of FY17, I think, we'll see that weakness moderate a bit when look at our comps compared to the previous year.

I think overall we see the weakness in the international markets, as we said, in the Middle East. But really when you take -- outside of Canada, the international sales are relatively small. The impact in the quarter was relatively de minimus as well I would say. I think the comp question actually gets to what has been a heating up municipal market. And the year-over-year increases have been relatively modest after what was a pretty good increase in municipality spending last year.

Got it. Canada specifically? I mean that -- how should we be thinking -- I mean it's been weak for several quarters now. On the comp basis, is that flattening out or are you still seeing a negative progression there?

Sales were down in the quarter, close to 5% year-over-year. I can tell you that the economy is so oil-driven that municipal spending it's almost -- the manufacturing sector is relatively small in Canada now. As goes the oil sands and the Newfoundland offshore oil, Sable Island oil, basically go to the economy and I think it's flattening out.

We believe it's flattening out because we've started to see some recovery in the oil sector and in the energy sector. That will be good for municipalities and industry pulp and paper and the like to start the investment cycle again. If we see the energy sector soften again and you see that oil price drop back into the 40s, I think it will continue to be soft. I think the comps will continue to be difficult.

All right, I appreciate that. One follow-up if I may on the muni side, you guys are signaling obviously North America all-in, in Mueller Co. strong solid tailwinds. How would you describe the spending environment over the last few months versus what you're expecting in the next few months? Do you see a pause or relative pause just given the new administration and uncertainties there? Or no, pretty steady as she goes?

Well, I think we were expecting more uplift through our Q1. I think the election kind of froze some municipal spending because certainly there was a lot of discussion around infrastructure spending. I'll be frank, I don't think Mr. Ryan helped us yesterday by saying they were going to push the infrastructure bill out into the spring. Because I think there are some municipalities that are wondering, is this going to be a step change in the funds available to municipalities for clean drinking water? Or is it just going to be an incremental increase over what has been in the federal programs in the past?

If it's going to be a step change, I think there is a lot of people that are pausing to see whether they would qualify and should they make their plans based on their current bond offering mentality or will there be more assistance from the federal government. So I think there has been a pause in Q2 somewhat. I kind of expect municipality in Q2 now to look similar to what it looked like in Q1, because there are some, let's call it, a pause -- your word, a pause going on in the market in the muni space.

I do believe though that the fundamentals about the lead content in water, the leaking infrastructure, the non-rev situation that many of the especially Northeastern and Midwestern large communities are facing, dictate that we're going to have to face into this problem as a country sooner rather than later. So while it may pause it for Q1 and Q2, everything I look at would indicate Q3, Q4 and beyond should be good healthy spending environments in our space.

Thank you.

Joe Giordano, Cowen and Company.

This is Tristan for Joe in today (inaudible). Scott, I had just a question for you to start, what are the top two, three things that excite you about Mueller? And then perhaps one thing that you would like to change or improve?

Well, I'm going to duck your second question because it's been two weeks and really what I want to do on the change improve front is, I want to get out into Chattanooga. I want to go to Albertville. I want to get Cleveland. I want to get to all of our facilities including Toronto. I want to meet the people. I want to see what we do well. It's the part I'm the most excited about to be quite honest with you.

So if you know anything about my background, you know I've been making stuff for 30-somthing-years and it excites me. I used to joke, I love the smell of cutting oil in the morning, machine shops and forges and boundaries. So that's what I want to get. When we get there, I'm sure we'll find areas for improvement but I'm looking forward to working with Greg Rogowski and Keith Belknap on setting the priorities for those manufacturing facilities.

I'm looking forward to engaging with the customers. I've known Mueller for many, many years. It's such a great brand, iconic brand in the industry. I think every city I've ever lived in has Mueller fire hydrants and gate valves. I knew it and I knew the space somewhat, so that excited me.

Great. Thanks.

I think though the thing that I want to say that excites me the most is, I think this team did a great job in the last 10 years taking a heavily levered Company, delevering it, driving great EBITDA. So, they got their manufacturing cash flows. Now we're at a point, we're at a nexus I believe where we have to stop thinking about the debt reduction and all of that and start finding now that we no longer have Anvil, we're in the water space. We've got an iconic brand. How do we grow from here? How do we become extraordinary, successful in a space that I think has tons of growth left in it? So that is probably what excites me the most.

Thanks. Then if I can just squeeze a quick second one on capital deployment. Is there a market with specific technology that you would like to focus on? I know you talked before about treatment. Is that still an option?

Yes. I think that we're going to be spending some time in the coming months looking at the three big segments, if you will. I think that whether it's drinking water, wastewater, sewage, water reclamation, water scarcity as a -- water reclamation as it relates to water scarcity I think are going to be huge investment opportunities for the world in general. I want to get our strategic thinking aligned with where we think the largest growth opportunities are going to be both in the short term, medium term, and long term.

I think we are very North American Centrex, so I want to understand is that by design? Is that by something that was just circumstance? Is that appropriate for us going forward?

So when you think about the strategic implications of what's happening in water and then what's happening from a geographic basis, those are areas that I think that Greg and Keith and I will sit down and hammer out the strategic framework for how we want to think about those things. And I expect to have that in that May, June timeframe completed so that we're in alignment of how we're going to go forward.

Thank you. Welcome and good luck.

Thank you.

Ryan Connors, Boenning & Scattergood.

I wanted to continue on the theme of capital deployment, Scott. My question is, why rush the buyback? I mean it seems like as you said, you're joining the Company at a potential inflection point. You've got a considerable war chest. Does the fact that the buyback's going to be accelerated -- I mean I recognize the desire to make a statement of value in the stock. But does that suggest that you want to do bolt-on deals rather than something transformational?

I mean certainly there are assets of scale out there where you could put that whole war chest to work if they were to come to market. So if you could just give us your thoughts on the buyback versus capital deployment and size of deals, whether you would be willing to go out and do something fairly sizable?

Well, let me say, the buyback, the dividend increase in the Springer Valve acquisition were all meant to display to the market that when we see opportunities and we see ways to create value for the shareholder, we're going to take them. And I don't want to be just like hoarding the cash. If we haven't got something better to do with it, obviously we have to return it to the shareholder.

With that said, absolutely transformational acquisitions are in the wheelhouse. Absolutely bull tongs are something we're going to look at. I started the 23, I think the Board meeting was the 25, where we approved a bunch of these things. I am completely comfortable that our war chest, after $50 million of the $250 million repurchase authorization, leaves us with more than enough cash and a strong enough future cash flow earning that we can do something transformational.

So I thought it was a token at $50 million but it preserved our powder to do something big if that's what we choose to do. But acquisitions for the sake of acquisitions, we're not going to do that. We want to -- as I said earlier, provide outstanding long-term value to our shareholders.

Got it. Understood. Thanks so much and good luck.

Thank you very much.

(Operator Instructions)

Well, thank you very much. I look forward to meeting you over the coming weeks and months and look forward to talking with you. We'll say goodbye for now. Thanks.

Thank you. That concludes today's conference. Thank you for participating. You may now disconnect.