Mueller Water Products - Earnings Call - Q1 2013

Transcript

Speaker 0

Good morning and thank you all for standing by. This is the conference coordinator. All lines will be placed on listen only until we're ready for the question and answer session of today's call. This call is also being recorded. If you have any objections, please disconnect at this time.

I would now like to introduce your speaker, Ms. Marty Zacchus. You may begin, ma'am. Thank you. Thank you, Lori, and good morning, everyone.

Welcome to Mueller Water Products twenty thirteen first quarter conference call. We issued our press release reporting results of operations for the quarter ended December 3132 yesterday afternoon. A copy of it is available on our website, muellerwaterproducts.com. Mueller Water Products had 157,500,000.0 shares outstanding at December 3132. Discussing the first quarter's results this morning are Greg Highland, our Chairman, President and CEO and Evan Hart, our CFO.

This morning's call is being recorded and webcast live on the Internet. We have also posted slides on our website to help illustrate the quarter's results as well as to address forward looking statements and our non GAAP disclosure requirements. At this time, please refer to slide two. 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. As required by Regulation G, reconciliations between non GAAP and GAAP financial measures are included in the supplemental information within our press release and on our website.

Slide three addresses our forward looking statements. 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 two and three in their entirety. During this call, all references to a specific year or quarter refer to our fiscal year, which 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 thirty days after the call at 6045. The archived webcast and the corresponding slides will be available for at least ninety days in the Investor Relations section of our Web site. In addition, we will furnish a copy of our prepared remarks on Form eight ks later this morning. After the prepared remarks, we will open the call to questions. I'll now turn the call

Speaker 1

over to Greg. Thanks, Marty. Thank you for joining us today as we discuss our results for the twenty thirteen first quarter. I'll begin my remarks with a brief overview of the quarter followed by Evan's detailed financial report, which covers key drivers affecting our businesses. After that, I will follow with additional comments on our recent results and our end markets as well as our outlook for the second quarter.

Our consolidated performance improved again in the first quarter as demonstrated by a 13.8% increase in net sales and a 20.6% increase in adjusted operating income. Shipments of Mueller's valve, hydrants and brass products increased in the quarter year over year, which we believe was due to continued improvement in both the municipal and residential construction markets. Net sales of Mueller Company's newer technology products and services more than doubled in the quarter on a year over year basis demonstrating the traction we believe these products and services are gaining in the marketplace. In fact, over half of the $23,000,000 net sales increase at Mueller Company was attributable to our metering products. Although Mueller Company's newer technology products and services negatively impacted its adjusted operating income margin in the quarter, the incremental margin from increased net sales was encouraging and we believe there is room for further improvement, especially as deployment of our AMI systems grow.

Anvil's net sales were also up year over year. However, as we expected, adjusted operating income was negatively impacted by higher per unit overhead costs due to lower production during the 2012. Overall, results for the quarter were about as we expected and we look forward to our performance improving further over the remainder of the year as our end markets are expected to continue to recover. I'll now turn the call over to Greg. Evan?

Speaker 2

Thanks Greg and good morning everyone. I'll first review the consolidated results and then discuss segment performance. Consolidated net sales for the twenty thirteen first quarter of $245,100,000 increased $29,700,000 or 13.8% from the twenty twelve first quarter's net sales of $215,400,000 due to higher shipment volumes, most of which came from Mueller Company. Consolidated gross profit was $57,100,000 for the twenty thirteen first quarter compared to $52,800,000 for the twenty twelve first quarter. This improvement was driven primarily by higher shipment volumes, higher sales prices and lower raw material costs, partially offset by higher per unit overhead costs.

Consolidated selling, general and administrative expenses as a percentage of net sales declined to 20.2% in the twenty thirteen first quarter from 21.6% in the twenty twelve first quarter. Selling, general and administrative expenses were $49,500,000 for the twenty thirteen first quarter compared to $46,500,000 for the twenty twelve first quarter. Adjusted operating income for the twenty thirteen first quarter increased 20.6% to $7,600,000 from adjusted operating income of $6,300,000 for the twenty twelve first quarter. This increase was driven primarily by higher shipment volumes, higher sales prices and lower raw material cost. These improvements primarily at Mueller Company were partially offset by higher expected per unit overhead cost at Anvil.

Adjusted EBITDA for the twenty thirteen first quarter increased to $22,400,000 from $21,300,000 for the twenty twelve first quarter. Interest expense net decreased $2,100,000 in the twenty thirteen first quarter due to $1,400,000 of non cash costs for terminated swap contracts in 2012 and $700,000 due primarily to lower levels of total debt outstanding in 2013. Subsequent to the end of the first quarter, we announced our intention to redeem an additional $22,500,000 of our 8.75% notes. The redemption date is February 2233. The twenty thirteen first quarter income tax benefit was 1,600,000 on a pretax loss of $6,600,000 or an effective income tax rate of 24.2%.

The twenty thirteen first quarter benefit was reduced by $800,000 related to a deferred tax asset valuation allowance adjustment. Excluding this adjustment, the effective tax rate for the twenty thirteen first quarter would have been 36.4%. Net operating loss carry forwards remain available to offset future taxable earnings. Adjusted net loss per diluted share for the twenty thirteen first quarter was $02 compared to adjusted net loss per diluted share for the twenty twelve first quarter of $04 an improvement of $02 I'll now walk you through the after tax adjustments for both the 2013 and twenty twelve first quarters. The twenty thirteen first quarter adjusted results exclude the income from discontinued operations of $12,000,000 the deferred tax valuation allowance of $800,000 and restructuring expenses of $400,000 The twenty twelve first quarter adjusted results exclude the loss from discontinued operations of $5,400,000 terminated interest rate swap cost of $800,000 and restructuring expenses of $200,000 There was a weighted average of 159,200,000.0 diluted shares of our common stock outstanding for the twenty thirteen first quarter compared to a weighted average of 156,000,000 diluted shares outstanding for the twenty twelve first quarter.

I'll now move on to segment performance and begin with Mueller Company. Net sales for the twenty thirteen first quarter increased 18% to $151,100,000 from net sales of 128,100,000.0 for the twenty twelve first quarter. This increase was due primarily to higher shipment volumes across most of Mural Company's products, especially metering, valves, hydrants and brass products. Sales of the newer technology products and services more than doubled this quarter compared to last year and accounted for more than half of the net sales growth in the twenty thirteen first quarter. Adjusted operating income for the twenty thirteen first quarter improved 72.5% to $8,800,000 from adjusted operating income of $5,100,000 for the twenty twelve first quarter.

Adjusted operating income margin for the twenty thirteen first quarter improved 180 basis points to 5.8% from adjusted operating income margin for the twenty twelve first quarter of 4%. Net sales of our newer technology products and services demonstrated strong growth this quarter more than doubling on basis. Additionally, the operating performance of these products and services improved meaningfully versus the prior year and is approaching breakeven. As a result, the negative margin impact at Mueller Company from these products and services was down substantially from previous quarters to 190 basis points this quarter. The performance of base Mueller Company was mixed with strong performance year over year for valves, hydrants and brass service products, partially offset by weaker performance from Henry Pratt's water treatment plant valves.

I'll now turn to Anvil. Net sales for the twenty thirteen first quarter increased 7.7% to $94,000,000 compared to net sales of $87,300,000 for the twenty twelve first quarter. The increase resulted primarily from higher shipment volumes across most of Anvil's end markets. Anvil's net sales to the fire protection and mechanical markets improved over last year, while net sales to the oil and gas market, which accounts for approximately 20% of Anvil's net sales had minimal growth after exhibiting strong growth in 2012. Adjusted operating income for the twenty thirteen first quarter was $5,900,000 compared to adjusted operating income for the twenty twelve first quarter of $7,800,000 As anticipated, adjusted operating income declined due to lower production levels in the twenty twelve second half.

This caused higher per unit overhead cost in inventory, which impacted operating results in this quarter. As a reminder, we use the FIFO method of inventory accounting. Adjusted EBITDA for the twenty thirteen fourth quarter was $9,400,000 compared to adjusted EBITDA for the twenty twelve first quarter of $11,400,000 Turning now to our discussion of our liquidity. Free cash flow, which is cash flows from operating activities less capital expenditures was negative $5,600,000 for the twenty thirteen first quarter compared to a positive $6,600,000 for the twenty twelve first quarter. We continue to focus on managing working capital and for the twenty thirteen first quarter trailing four quarter average receivables, inventory and accounts payable as a percentage of net sales improved two twenty basis points from the twenty twelve first quarter.

At December 3132, total debt was $623,000,000 down 55,500,000 from a year ago. Total debt outstanding included $420,000,000 of 7.75% senior subordinated notes due 2017, dollars 200,000,000 of 8.75% senior unsecured notes due $20.20 and $3,000,000 of other. Net debt leverage was 4.3 times as of December 3132. Using December 3132 data, we had $122,100,000 of excess availability under our asset based credit agreement. I'll now turn

Speaker 1

the call back to Greg. Thanks, Evan. I'll now elaborate on our twenty thirteen first quarter performance and end markets and provide an outlook for our second quarter. I'll begin with Mueller Company. Mueller Company performed about as we expected this quarter with stronger performance across all products and services with the exception of our Henry Pratt product line.

We are pleased with the net sales growth at Mueller Company in the quarter. Shipments of domestic valves, hydrants and brass products in both dollars and units were up. We believe demand for Mueller Company's products benefited from increased spending by municipal water systems and that we saw some growth in demand from new residential construction projects. Our domestic unit booking activity in the first quarter for Mueller Company's valve, hydrant and brass products increased 8%, 1015% respectively year over year. We also believe the distributor inventories at the end of the first quarter were flat from both previous quarter and year over year.

Our metering products continue to make good progress with net sales and bookings more than doubling year over year during the quarter. These products are certainly gaining traction as more than 50% of Mueller Company's net sales increase in the quarter came from our meter products. During the quarter, year over year adjusted operating income margin at Mueller Company expanded by 180 basis points, driven by the improved performance of our newer technology products as well as the growth of our core valve, hydrants and brass products. As we look at the margins for the products manufactured at our hydrant valve and brass product facilities, we note that they expanded about 200 basis points year over year. The one product category that declined year over year is Henry Pratt valve.

Henry Pratt accounts for approximately 15% of Mueller Company's net sales. This quarter was impacted to a greater extent primarily by the mix of products as compared to the previous year. However, we believe we should see improved performance beginning in the second quarter since both bookings and backlog increased during the quarter. As Evan discussed, Anvil performed as we expected. Anvil saw net sales growth in most of its end markets.

As we mentioned on our fourth quarter call, we expected Anvil's adjusted operating income to decline year over year. Anvil experienced higher per unit overhead costs due to lower production in the 2012. This impacted first quarter financials. Higher volume and higher sales pricing offset a portion of those costs. Before I turn to our outlook for the second quarter, I'll discuss what we are seeing with some of the macro drivers in our end markets.

Most of the recent macroeconomic data has been positive and we believe our water infrastructure markets continue to improve. The general municipal spending environment continues to show improvement as tax receipts have grown and the financing market remains favorable. According to the U. S. Census Bureau, state and local seasonally adjusted tax receipts grew at 3.9% year over year for the period ending September 3032 and were up to the June.

And on the municipal bond front, rates are still very attractive from a historical perspective. The CPI for water and sewage maintenance rates increased by an annualized rate of 6.7% in December compared to the prior year, exceeding that of all other utilities and the CPI as a whole. Finally, the housing market continues to be a bright spot in the economy. December housing starts of 954,000 units was the highest level since June 2008. This represented the fourth consecutive month of greater than 800,000 units on a seasonally adjusted annualized base.

Furthermore, December single family starts of 616,000 units were above 500,000 units for the ninth consecutive month and represents the strongest reading since June 2008. As a potential future indicator, December housing permits were above 900,000 units for the second consecutive month and represented the highest reading since July 2008. Total permits grew 29 over last year, while single family permits reached their highest level since June 2008 and grew 27% over last year. Also new and existing home inventories held for sale have continued to decline from all time highs during the financial crisis both well within historical normal levels. Household formation growth for the last twelve months has averaged $1,400,000 which is another positive sign for the housing market.

To put this into perspective, household formation in 02/2010 averaged 350,000 and the long term average is 1,100,000. Although the housing recovery appears to be continuing to gain momentum, we still expect to experience somewhat of a lag relative to the growth in housing starts as the industry continues to work through existing finished lot inventory. As we have mentioned before, we need to see not just growth in community counts from builders, but development of raw land, which is still in the early phases of recovery. According to Ivy Zelman and Associates, there is evidence of mothballed communities, primarily in A and B locations coming back online in areas such as California, Florida and Phoenix. There is also some evidence of builders demand for raw land increasing and development activity also increasing, particularly in areas such as Washington D.

C, San Francisco, Houston, San Diego and Phoenix. We believe that we are still seeing a lag period for the sale of certain of our products into residential construction, but the lag period continues to decline and we are seeing some pockets of growth. It is important to note that improving housing construction ultimately helps bolster the health of municipalities as local governments benefit from increased property taxes as well as connection fees and other ancillary fees associated with residential construction. Turning now to our outlook for the second quarter. On a year over year basis for the second quarter, we expect Mueller Company's net sales to increase primarily due to volume growth in our core valves, hydrants and brass products and significantly higher net sales of our metering products.

The metering backlog was up over 70% at the December as compared to a year ago. In total, we expect adjusted operating income from Mueller Co. To nearly double year over year with improved performance across all of our product categories. At Anvil, we expect a slight decrease in shipment volumes in the second quarter year over year as we face some softness in our end markets, primarily the oil and gas market. We believe this reduced volume will result in lower year over year operating income.

Additionally, we expect the remainder of a higher per unit overhead cost in inventory related to second half production last year to flow through the income statement this quarter. Therefore, we expect to see a year over year decline in Anvil's adjusted operating income. For the company as a whole, we believe that twenty twelve second quarter net sales will increase year over year attributable to volume increases at Mueller Company. We expect adjusted income from operations to increase substantially year over year. Overall, we think the signs we are seeing in our water markets are mostly positive reinforcing the outlook we provided last quarter.

Raw material costs remain relatively stable and we expect that average cost for 2012 could be slightly below those I'm sorry, that average cost for 2013 could be slightly below those of 2012. Other key variables for 2013 are as follows: corporate spending is estimated to be 30,000,000 to $32,000,000 depreciation and amortization is estimated to be 60,000,000 to $62,000,000 and interest expense is estimated to be 51,000,000 to $53,000,000 Our adjusted effective income tax rate is expected to be between 3740% for the full year. Capital expenditures are expected to be between 30,000,000 and $34,000,000 For the full year 2013, we expect free cash flow to be stronger than 2012. Most of our improved free cash flow generation is expected to come from improved operating results. Additionally, we expect cash income taxes to be minimal this year based on our net operating loss carry forward position.

At this time, we contemplate only making minimal cash contributions to our pension plans in 2013. In summary, we feel we are well positioned to benefit from recovery in residential construction and municipal water spending, both of which we believe are healthier today than they were a year ago. We also believe operating margins will continue to be positively impacted in the future by the efficiencies generated from our lean manufacturing achievements and as we experience higher levels of capacity utilization. Additionally, we believe we will benefit from the investments we have made in our metering systems and leak detection products and services as these markets continue to grow. With that, I will open this call for your questions.

Speaker 0

Thank you. Our first question comes from Kevin Masca. Please state your company name.

Speaker 3

Good morning, BB and T Capital Markets. Good morning, Kevin. Morning. Greg, first question, so a lot of talk about the housing upturn of course. And now that you're clearly seeing that you've got the business reconfigured as a two segment business.

I think you said in twenty twelve fiscal twenty twelve that was about 5% of your total revenue, so about $50,000,000 So it starts to double or even triple and get to the $1.1 or $1.5 type of range and I understand there's a lag there, but should we be thinking about your business, your housing business moving in lockstep with that or is there something that would allow that to grow much faster maybe than the underlying market?

Speaker 1

Kevin, good question. I think that we do as we've said, it's difficult for us to exactly know on the lag on what time period. I think we are very comfortable right now. I'm saying that inventory loss have been absorbed and we think that our estimate now is the lag that the lag is now less than twelve months. But that's a good question and I think we would have to wait and see.

I think that we would be comfortable in saying that when we get through this lag period that we would grow in lockstep. I think whether or not we would grow at faster rate, I think would depend on how quickly developers go in and develop raw land. And I think we saw in the past cycle during the boom period, I think that they were very aggressive in going out and developing raw land. I would expect this time around initially they would be more cautious. But I think that as the rebound continues to gain traction, I think we could see even a little greater pent up demand because then we could see them perhaps developing raw land at a faster rate.

But I think where we sit here today, I think we would be more comfortable thinking of it in terms that we would probably be in lockstep. Got it. And then

Speaker 3

Greg on the margin side, I know we probably shouldn't get too bogged down in any given quarter on incrementals because there can be issues with absorption and things like that that we had in Q1. But can you just refresh us now that again that you're into the recovery, you've done a lot of restructuring that's in the past mostly, you have ongoing lean and productivity initiatives all the time. On the incremental margin side, as we're into the recovery, should we still be thinking about kind of 35% in Mueller Co. And 25% in Anvil or maybe are those better than that as we really get into it?

Speaker 1

No. I would think on average that would be the overall I think improvement Kevin that we would expect. It could be adjusted. If our valve and hybrid business start growing faster, I think that incremental margin rate would be a be a little better. But I think if you look at it on this quarter that when you look at the incremental improvement, we saw as we mentioned in our prepared remarks, only over half of our sales growth came from our newer technology in the Mueller Company segment, over half our sales growth came from newer technology products, which currently have negative margins.

But however, when you look at that on a conversion that for instance our Mueller systems operating income improved over improved about $2,700,000 So it will depend on the mix. But as we made comment in our prepared remarks, in the first quarter, our valve and hybrid brass product manufacturing facilities operating margins improved 200 basis points on a over the prior year and we only utilized 40% for about 48% of our capacity at those facilities. That albeit that's up from about 40%, 42% in the first quarter a year ago. So as we go up the capacity utilization curve later in the as our season as we go through our seasonal period where we see some increased demand, we would again think that the conversion rate could be higher than that 3540% range. But for an annual from an annual conversion rate, I think we're still comfortable that that's the range.

Speaker 3

Okay. And then but in Anvil, it sounds like near term maybe we're still less than that because you've still got some of this high cost inventory running through in Q2.

Speaker 1

Yes. I think in Q2 that that should be that will flow through in Q2 and then we'll be back to what we see in market demand. And as we said, I think when we look at Q2 for Anvil, we are we do expect to see a little softer demand from primarily from the oil and gas market. But I want to point out that in 2012 that group that we saw some very nice year over year growth rates in 2012. So what we're seeing is really a slowdown of growth from what was a nice spike in 2012.

And as we look at it today, we think towards the second half of our fiscal year that we should start seeing some increased spending in the oil and gas market. So I think that as we look at it now, we think that's more a one quarter issue for Anvil and we expect to see the third and fourth quarter if the oil and gas market improves as I think the analysts are now are expecting that we should see that pick up in the second half of the year.

Speaker 3

And just finally from me, Greg, what would trigger that in the second half? What would for your business not oil and gas broadly, but for your oil and gas business, what would trigger that that would make second half so much better than first?

Speaker 1

Increased production. And so certainly we follow what's happening to the rig count and the expectation of the rig count growing which is increased production. Our product go on tank farms, different tanks and so that the storage equipment that will typically grow as production grows.

Speaker 0

Our next question comes from Ryan Connors. Please state your company name.

Speaker 4

It's Johnny Montgomery. Had a couple of first off, Greg, if you could just clarify your Mueller Co. Top line You mentioned up, but was that a is that a year over year sequential

Speaker 1

comment? Yes, yes. Comments were really on year over year and naturally on the seasonality of the business, we would expect to see an increase in the second quarter. We did have in the on January 23, a price increase on our valves and hydrants as we had in most previous years. So what we typically see Ryan is distributors pulling orders forward ahead of that price increase and that's probably the biggest contributor to our uptick sequentially in second quarter versus first quarter.

But my comments in the prepared section were on a year over year basis.

Speaker 4

Okay. And then I just want to talk a little bit, kind of structurally about the Mueller Co. Business lines. And obviously, you made a decision to exit pipe and my perception of that was it was in part at least due to a conclusion that the industry supply and demand dynamics were not to your liking there. So can you talk at all about I mean you talk about being at forty eight percent capacity utilization today the valve and hydrant side.

Do you have a feel for where the broader industry is today, whether it's at or below where you all are and how you feel about the general capacity situation of that industry right now and go kind of dovetailing into the prior question on incremental margin opportunity?

Speaker 1

Yes. I would think that they were all probably about the same capacity utilization rate. And when I say 48%, it's important to point out that was in the first quarter. And certainly, because of this is the first quarter is our down season. If you look at last year, we were about on the valves and the hydrant plant, we were about 40% capacity utilization and we're pretty close to 60% capacity utilization for the full year.

So as we go through the year, we'll expect to see that capacity utilization increase. And based on our outlook today, is consistent with the outlook that we provided in the first quarter, we do expect to see greater demand in 2013. So we would expect on an annual basis to certainly be above that 60% capacity utilization. So I do think that given today's level of demand, there is some excess capacity. That being said, I think that we're operating we would expect in 2013 to be operating significantly higher capacity rate than we did in 2009 and 2011.

But so as we go up that capacity, think it goes back to Kevin's earlier question, when we see growth in demand for our products and lockstep with residential construction, we think we can clearly see getting to 70%, 75% capacity utilization. And again, we think as we increase our capacity utilization that we will convert that and see margin growth. When we look again and I mentioned this earlier at our first quarter, at our plants we manufacture our valve hydrants and brass products on a year over year basis, we were up 200 basis points of margin. Certainly, what helped that margin improvement was some increased capacity utilization as well as higher pricing and lower raw material costs. But yes, I think that we expect to see our overall capacity utilization be above the 60% on an annual basis above the 60% rate that we were in 2012.

And as that capacity utilization increases, obviously, we expect to see that lower per unit overhead costs which will improve our margins.

Speaker 4

Okay, great. And then one other question on the sort of the system side. Congratulations there on the success you've been having. It's pretty impressive. I mean, can you talk about the levers that you're having success in pulling in order to grow that side of the business, particularly on the metering side?

I mean, obviously, that's a fairly mature market. So can you just discuss your marketing strategy and how you're managing to make headway against some of the larger incumbent players that obviously have pretty good relationships and installed bases and pretty decent offerings in their own right?

Speaker 1

Yes. And there's no question that the I think the leading meter manufacturers in this market are very strong and have very good products and have very good customer relations. Where we're seeing our growth is certainly our concept, our AMI technology on the two way mesh technology, there are certain applications where the two way mesh technology is a much better selection than some of the alternative choices. I think that certainly helps us even where we're selling AMR, the utilities that we're talking to like our AMI and like that we can offer them the ability to start with AMR, but then to eventually convert to our AMI system. That's certainly I think number one.

Number two, we are finding some municipalities and utilities that like our composite meter and like the fact that we have metal threads on the composite meter and that is a patented design. Number three, that as we talk to some utilities, they like the fact that we are working on trying to incorporate leak detection into the AMI system. That was one of the drivers several years ago for our acquiring the leak detection. One, there is a market for leak detection, but I think all of us that are in the market today are in the early stages of developing demand for leak detection. But two, what we saw was an opportunity to merge the leak detection technology into our AMI systems.

And while we're still in the development phase, we've been able to expose some of our ideas to some of our customers and some of the end users and they find that future potential to be very attractive. So I think that and then I think Ryan, fourth thing probably the fourth contributor is that I think we're solving some of providing some solutions to end users, especially when I'm talking about AMI systems by being able to incorporate our existing products into the solution. And we've talked to several months about eighteen months ago, we introduced putting the receiver for an AMI system in a hydrant. So these are assets that the end user already owns. And then we believe that there is other future functionality by having that receiver in the hydrant that that end user will be able to benefit from.

So as I said, I don't want to leave that we certainly have long way to go, but I believe that our end users are positively responding to some of the technology we have, but also I think that some of the technology that we're working on developing that can be incorporated in that meter system in the future. Even though we're taking a hit on the bottom line with those investments and we pointed those out in previous calls on product development and so on. So that was a very long winded answer and hopefully I addressed your question.

Speaker 4

Long winded, but very informative. Thanks for your time, Greg.

Speaker 1

Yes. Thank you, Ryan.

Speaker 0

Our next question comes from Jerry Revich. Please state your company name.

Speaker 5

Hi, good morning. It's Goldman Sachs. Hey, Good morning, Jerry. Hi. Greg or Evan, you mentioned you expect raw materials to be neutral this year.

Can you just talk about how much pricing was up in the first quarter in each of the businesses and just give us an update on the typical Mueller Co. Price increase, which I think generally kicks in Jan '1?

Speaker 1

Jerry. We said that we actually look now we think on a full year basis that we think our raw materials will be down slightly for the year. And we did have a benefit in both Buehler and Anvil from lower raw material costs year over year. We also in both businesses did see positive pricing on a year over year basis. So it was the as you recall that last year, especially on valves and hydrants, we had a price increase in early February.

So we're getting on a year over year basis, the benefit of that price increase that we implemented in February. I just mentioned that we had another price increase on January 23 on valves and hydrants and we won't see any benefit in the second quarter from that price increase or very little if any because of the pull forward that our distributors to beat that price increase gave us orders in advance of that price increase. But when we ship those in the second quarter and early third quarter, we think we will get to this price increase in the third and fourth quarter. So on a year over year basis, both businesses we continue to see a positive contribution from pricing in addition to slightly lower raw material costs.

Speaker 5

And thanks for the color, Greg, again. And the extent of the price increases on a weighted average across the portfolio, can you help us get a sense?

Speaker 1

Yes. We had if you look at the Mueller business, we had about a 7% we had a 7% price increase on about 50% of our volume.

Speaker 5

That's perfect. And Evan, I'm wondering if you could

Speaker 1

just Yes. Jerry, and I do want to point out and we've discussed this many times in the past that that 7% we typically expect to realize I'd say 50% to 60% of that price increase.

Speaker 5

Okay, great. And just a clarification Evan on the prior comments on Mueller system profitability on or Mueller Co. Profitability on the base business. So your total Mueller Co. EBIT was up $2,700,000 And I guess if Mueller Co.

Legacy business had 200 basis points better margins that accounts for all of the $2,700,000 profit improvement, which I think implies Mueller Systems losses were about equal in the first quarter of this year to the first quarter last year on more than double the sales level. So I'm wondering if you could just calibrate that for us or just clarify that.

Speaker 1

Jerry, this is Greg. Let me take that for you. When we talked about 200 basis points improvement in margin that was on our core valve hydrant and brass products, the products that come out of those manufacturing facilities. We did mention that the performance at our Henry Pratt product line that did roll up under Mueller negatively impacted results due largely to the mix of products sold this quarter as compared to the 2012. Our butterfly valve primarily it's butterfly valves and plug valves under the Henry Pratt brand name.

They generally account for about 15% of Mueller Company's revenue. Our operating income on those products were down about $2,500,000 year over year, I would say on relatively similar sales. This is a product line where we would expect to realize operating income margins anywhere between 1113% and we just barely broke even this quarter on these group of products. We had a few contributing items to performance. First, as I we mentioned a weak mix of products.

There's a margin difference between our large diameter butterfly valve installed in transmission pipeline versus our small diameter butterfly valve which are installed in distribution pipeline. Our mix this quarter was heavily skewed to smaller diameter butterfly valve. So in addition, we had a concentration of events that happened to fall in this quarter that also impacted operating income. For instance, we allowed the distributor return some valves, we replaced some valves that were installed several other items. I would say that these are normal business items, but I think unusually concentrated in one quarter.

All in all, these events, I would not call these events significant, but given that our first quarter of Mueller Company can be the weakest seasonally, the impact is a little more pronounced. So Pratt's performance this quarter, I think, masked the expansion in the rest of Mueller Company. So we did have an expansion on our valve, hygienic, the brass product. We did have an expansion of our Mueller systems. We had a $2,500,000 negative hit on a year over year basis from our Pratt business.

But however, when we look at the Pratt products, we're still confident that for the full year, we'll have margins in the 11% to 13% range. So sorry if there was any confusion on those components. The valves and hydrants up 200 basis points year over year. Mueller Systems, for instance, 2,700,000.0 up year over year. That $2,700,000 was essentially offset by the $2,500,000 erosion on a year over year basis that we saw in our Pratt, Butterfly belt.

Speaker 5

Okay. Thank you for the color. That's helpful.

Speaker 0

Thank you. Our next question comes from Philip Volvichelli. Please state your company name.

Speaker 1

Good morning. It's Deutsche Bank. Good morning. I was just wondering if you guys could comment a little bit on the capital structure. I know that you have an ability to take out another 10% of your 8.75% notes at 1.03% in 2013 and your 7.38% are callable now, but the call price drops in June.

Would you guys consider redoing the majority of the cap structure considering how strong the bank debt market is or what are your thoughts with regard to that?

Speaker 2

Yes, we did just announce redemption for that 10% feature, the $22,500,000 of the 8.5% senior notes and that's effective February 22. And that will give us about another $2,000,000 in annualized interest savings. As well, you're correct, we have a $65,000,000 restricted payment basket for the subordinated notes, which we can repurchase at 103.168 beginning June 1. And I would say that we continue to evaluate other deleveraging opportunities as well as the capital structure and look at various scenarios in terms of refinancing. And certainly as we look at that there are many factors that come into play in the analysis and we would certainly communicate that if we were going to make any changes in the long term capital structure.

But certainly, we evaluate rates and other factors in terms of looking at the tranches of debt.

Speaker 1

That's great. And then with regard to acquisitions, clearly the housing market seems to be a tailwind for you guys and rig count, I guess, is plateauing, but there's still some opportunities out there. Have you guys looked at any acquisitions? Is that something that's core to the business with the free cash flow you'll generate in 'thirteen? Phil, think that thanks for that question.

Certainly, does look like versus where we have been for the last several years, our markets are could become a tailwind rather than a headwind. Our focus has been and I think we'll still continue to be reducing our leverage. We're down to our leverage in the first quarter was 4.3 times probably by a lot of measurements still high, but for those of you who've been following us for quite some time know that that's been a significant reduction. If we see a good strategic fit, I think we would evaluate it. Certainly interested in expanding in water infrastructure and particularly interested in emerging technologies within the water infrastructure.

So if there's anything that made sense to enhance our technology, market position on Mueller systems, our metering which is our metering business or our leak detection. I think we would look at that. We've also long expressed our interest in expanding internationally, say overall, we are still focused on improving our leverage. We think that that should come down pretty nicely over the next twelve months, eighteen months. But so we would consider acquisitions.

We believe they're value enhancing. But I would not say that we are on the acquisition trail. Our focus still remains bringing down our leverage. Understood. Thank you very much.

Good luck. Thank you. Thank

Speaker 0

you. And our last question comes from Please state your company name.

Speaker 1

D. A. Davidson. Good morning. Good morning, Brett.

Yes, I guess most of my questions have been asked. But on the municipal end market activity you're seeing, how much and I know it's difficult to given where you are between the distributors, but how much of what you're seeing are new projects which municipality might be developing via pipelines, treatment plants versus sort of the normal repair replacement projects for existing infrastructure in place? Yes. Brent, that is a good question. It's tough for us.

I would say that still the majority of the what we're seeing is still replacing existing. Though we are seeing we saw last year actually a little bit of a pickup in our gate valve demand going into new transmission lines and that should this year we should see then we should see the demand follow on for putting in new distribution lines off those new transmission lines. So I think that right now that we are seeing probably still the majority of our business repair, I'd say replace existing, but I think we're also seeing signs that new projects could be picking up momentum. But right now, it will be really hard for us to quantify that. Okay.

Thanks. Good luck. Thanks, Brent. Thank you. Well, hearing there are no more questions, that concludes today's call.

And I want to thank you all for your continued interest in Mueller Water Products and for joining us this morning.

Speaker 0

Thank you, Laurie. Thank you. That does conclude today's conference call. Thank you all for joining.