Mueller Water Products - Earnings Call - Q4 2016

Transcript

Speaker 0

Welcome and thank you for standing by. At this time, all participants are in a listen only mode. This call is being recorded. If you have any objections, you may disconnect at this point. Your host today is Mrs.

Marty Sakas. Ma'am, you may begin.

Speaker 1

Good morning, everyone. Welcome to Mueller Water Products twenty sixteen fourth quarter conference call. We issued our press release reporting results of operations for the quarter and full year ended September 3036, yesterday afternoon. A copy of it is available on our website, muellerwaterproducts.com. Discussing the fourth quarter and full year results this morning are Greg Hylin, 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 and full year's results as well as to address forward looking statements and our non GAAP performance and liquidity measures. 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. Reconciliations between GAAP and non GAAP performance and liquidity measures are included in the supplemental information within our press release and on our website.

Slide three 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 two and three 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 thirty days after the call at +1 6038. The archived webcast and corresponding slides will be available for at least ninety days in the Investor Relations section of our website. 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 over to Greg.

Thanks, Marty.

Speaker 2

Thank you for joining us today as we discuss our results for the twenty sixteen fourth quarter and full year. I'll begin with a brief overview followed by Evan's more detailed financial report. We are pleased that we continued to see margin expansion in all three of our businesses, which contributed to a 7.6% increase in adjusted operating income in the fourth quarter and which more than offset the impact of a slight decrease in revenue. For Mueller Water Products, adjusted EBITDA margin for the twenty sixteen fourth quarter improved 120 basis points to 20.4% and our adjusted EBITDA for the year increased to $198,100,000 Free cash flow was $105,700,000 for the year or 132% of adjusted net income. Mueller Company's domestic sales of valves, hydrants and brass products increased 4.4 in the fourth quarter year over year.

This growth was not enough to offset the expected sales decline of our Henry Pratt water treatment valves. Mueller Company again had strong margin improvement with adjusted EBITDA margin improving 150 basis points to 30.3%. Anvil's net sales for the twenty sixteen fourth quarter decreased 7.3% due to lower shipment volumes into the mechanical and oil and gas markets. Despite lower net sales, Anvil's adjusted EBITDA margin increased 90 basis points this quarter. Mueller Technologies showed meaningful operating improvement in the fourth quarter on essentially flat year over year net sales.

Favorable product mix contributed to this improvement. For Mueller Water Products, we again improved our adjusted operating performance in 2016, representing the seventh consecutive year of operating margin expansion. Our 2016 adjusted net income improved nearly 25% compared to the prior year and 2016 adjusted EBITDA margins was the highest in our history. We ended the year with net debt leverage down to 1.5 times. Adjusted net income per share for the quarter was up 21.4% to zero one seven dollars versus $0.14 a year ago.

For the full year, adjusted net income per share increased 25% to $0.49 compared to $0.39 last year. As we look to 2017, we expect continued growth in our key end markets. As capacity utilization increases, we believe operating leverage will continue to be strong in all three businesses. I will provide additional comments on the quarter's results and developments in our end markets as well as our outlook for the 2017 full year and first quarter later in the call. With that, I'll turn the call over to Evan.

Speaker 3

Thanks, Greg, and good morning, everyone. I'll first review our fourth quarter consolidated financial results and then discuss segment performance. Twenty sixteen fourth quarter net sales decreased $8,900,000 or 2.9% to $302,500,000 compared with $311,400,000 last year primarily due to lower shipment volumes at Anvil. Gross profit improved $103,600,000 for the twenty sixteen fourth quarter from $97,700,000 last year. Gross margin increased two eighty basis points to 34.2% from 31.4% in 2015.

Selling, general and administrative expenses were $55,200,000 in the quarter compared with $52,700,000 last year. The increase was due primarily to personnel related expenses. Adjusted operating income for the twenty sixteen fourth quarter increased 7.6% or $3,400,000 to $48,400,000 as compared with $45,000,000 last year. Operating performance improved at Mueller Company, Anvil and Mueller Technologies. Adjusted EBITDA for the twenty sixteen fourth quarter increased to $61,800,000 compared with $59,900,000 last year.

And 2016 adjusted EBITDA was $198,100,000 Interest expense net for the twenty sixteen fourth quarter was $5,600,000 down from $5,800,000 last year. For 2016, interest expense net was $23,600,000 the lowest in our history. For the twenty sixteen fourth quarter, income tax expense of $14,600,000 was 35.5% of income before income taxes. Adjusted net income per share improved to $0.17 for the twenty sixteen fourth quarter compared with $0.14 last year. I'll now move on to segment performance beginning with Mueller Company.

Net sales for the twenty sixteen fourth quarter of $190,100,000 decreased $1,900,000 as compared with $192,000,000 last year. Domestic shipments of valves, hydrants and brass products increased 4.4%, but were more than offset by lower shipments of water treatment valves at Henry Pratt. We experienced strong improvement in adjusted operating income in the twenty sixteen fourth quarter, largely due to favorable product mix, lower raw material cost and other cost savings. Adjusted operating income improved 7.2% to 48,900,000 as compared with $45,600,000 last year. Adjusted operating margin improved 190 basis points to 25.7% as compared with 23.8% last year.

Adjusted EBITDA for the twenty sixteen fourth quarter increased to $57,600,000 compared with $55,300,000 last year and adjusted EBITDA margin increased 150 basis points to 30.3% from 28.8% last year. The twenty sixteen fourth quarter was the seventeenth consecutive quarter where Mueller Company increased year over year adjusted operating income and adjusted operating margin. Continuing with Anvil. Net sales decreased 7.3% to $86,900,000 for the twenty sixteen fourth quarter compared with $93,700,000 last year. Lower shipment volumes primarily of mechanical and oil and gas products were partially offset by increased sales of fire protection products.

Operating efficiencies and other cost savings more than offset the impact of lower net sales and adjusted operating income improved to $9,500,000 as compared with $8,900,000 last year. And now concluding with Mueller Technologies. Net sales for the twenty sixteen fourth quarter were essentially flat year over year. Shipments of our higher margin AMI products increased $3,100,000 or 42% year over year, but were more than offset by lower AMR shipments. AMI shipments represented almost 50% of Mueller Systems' total net sales in the quarter.

For the twenty sixteen fourth quarter, Muir Technologies adjusted operating loss improved $1,300,000 despite essentially flat sales and adjusted operating margin improved 500 basis points due to favorable mix and lower overhead cost. Now turning to a discussion of our liquidity. Free cash flow, which is cash flows from operating activities less capital expenditures, was $54,700,000 for the twenty sixteen fourth quarter. Free cash flow for the full year was $161,100,000 higher year over year. At September 3036, total debt was comprised of a $483,100,000 senior secured term loan through November 2021 and $2,000,000 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 three twenty five basis points. In April 2014, we entered into interest rate swap contracts that effectively fixed the interest rate on $150,000,000 of term loan borrowings at 5.6% from September 3036 through 09/30/2021. Our excess availability under the ABL agreement was $169,000,000 Net debt leverage improved to 1.5 times at September 3036. I'll now turn the call back to Greg.

Speaker 2

Thanks, Evan. I'll now comment further on our twenty sixteen fourth quarter results and end markets and provide an overview of our expectations and outlook for the 2017 full year and first quarter, beginning with Mueller Company. While Mueller Company's domestic sales of valves, hydrants and brass products grew 4.4% year over year, this was below our expectations. We saw a nice growth in orders in the third quarter and that continued in July. However, we did see orders slow down in August through mid September.

Orders rebounded somewhat at the September. Even though we had an easier comparison during this time period from a year ago because of the weather issues in May and June 2015, in retrospect, we believe our distributors were building inventory in the third quarter and early in the fourth quarter and as a result, slowed down their ordering in August and most of September. In addition, I would again point out, as we discussed on our last call, we had a very difficult comparison for product line revenue this quarter. As we have mentioned a number of times, Pratt plant work is project driven and is subject to significant swings. The fourth quarter last year was our best quarter in several years.

Pratt sales were down 16% this quarter. However, our backlog grew and is up entering 2017. Despite slightly lower net sales, Mueller Company's adjusted operating income improved in the fourth quarter benefiting from favorable product mix, ongoing cost saving initiatives and lower raw material costs. The twenty sixteen fourth quarter is the seventeenth consecutive quarter where Mueller Company increased year over year adjusted operating income and adjusted operating margin. For the full year 2016, Mueller Company's adjusted operating income increased 11.7%.

This increase reflects not only a favorable mix, but also an improvement in operating performance. With our lean manufacturing initiatives, we continue to achieve efficiency improvements. Additionally, we have been making capital investments to introduce more automation into the manufacturing process. With the results we realized in 2016 and what we expect to achieve moving forward, we believe we are gaining benefits from both operating performance and operating leverage as capacity utilization increases, leading to margin expansion. Turning to Anvil.

End market demand for Anvil's products was mixed. As we expected, sales of our products to go directly into the oil and gas market were down year over year. Demand from our addressed industrial markets, especially those segments related to oil and gas, was also down. Sales of our fire protection products, however, were up approximately 5% year over year and accounted for about 25% of total sales. As we have discussed in the past, Anvil sales into the oil and gas market have closely correlated with The U.

S. Rig count. Current rig count has declined 28% from last year and is down 71% from two years ago. The active rig count has increased 16 out of the last eighteen weeks, which is a positive indicator. Also during the quarter, we announced that we will be closing Anvil's facility in Longview, Texas, which is dedicated to the manufacturing of products sold into the oil and gas market.

We will be consolidating those operations with Anvil's manufacturing facility in Houston. This move will not only reduce our fixed costs in the short term, but we expect to realize higher conversion margins when volume increases. We expect this consolidation to be completed by March 2017. Despite lower net sales, Anvil's adjusted operating income improved 6.7% and adjusted operating margin improved 140 basis points, driven by increased operating efficiencies and other cost reductions. Anvil's revenues declined 32,800,000 in 2016, largely attributable to sales of products into the oil and gas market, which are typically at a higher margin.

It is worth noting that even with this level of revenue decline, Anvil's adjusted operating income only declined $1,600,000 and its adjusted operating margin improved for the full year. Anvil's continued focus on operating efficiencies in its manufacturing plants, coupled with lower raw material costs and other cost savings, contributed to its ability to manage through a challenging end market environment. Mueller Technologies. Although Mueller Technologies fourth quarter net sales were essentially flat, we were pleased to see substantially higher sales of our fixed and mobile leak detection solutions and our AMI products. These increases were offset by a year over year decline in AMR sales, primarily to one customer as we have discussed in the past.

This is the last quarter where we will have this negative comparison. Mueller Technologies operating performance improved $1,300,000 compared to last year and its operating loss was $500,000 Mueller Systems was again profitable for the quarter. In June, we were awarded a project for an AMI system and meters for Lea County, Florida. Though we initially expected to begin making shipments for this project in the fourth quarter, we did not receive the contract until late October and will begin shipping for this project in the 2017. This 80,000 endpoint project is one of the larger AMI orders Mueller Systems has received and will be deployed over the next three years.

We entered 2017 with a strong backlog at Mueller Systems, especially for AMI products. The market remains in various stages of early adoption for some of our offerings, but the growth we continue to see in these businesses reinforces our strategic focus on higher margin technology products. Moving on to our outlook for fiscal twenty seventeen, I'll first discuss our key end markets, then review our growth and performance expectations for each of our segments. We expect our three primary end markets repair and replacement of water infrastructure, new water infrastructure driven by residential construction and non residential construction to grow in 2017. We expect the residential construction market to be the fastest growing of these market segments with a year over year increase in the high single digits.

We also expect low to mid single digit growth for both municipal spending and nonresidential construction. With regard to residential construction, blue chip economic indicators, which is a consensus of more than 50 economists, forecast an 8% growth in housing starts in calendar twenty seventeen. Also Zelman and Associates October land development survey indicated an improving sentiment for future land development among homebuilders and developers. The responses also indicated finished lots are down year over year, which we believe is a positive indicator for increased land development to meet expected housing demand. As you know, development of raw land for residential construction is a key driver of demand for our products.

On the municipal front, based on discussions with our customers and distributors, we expect to continue to see demand grow for repair and replacement of water infrastructure. State and local seasonally adjusted tax receipts continue to increase year over year as do water rates. CPI for water and sewage maintenance increased around 4% for the last twelve months ended September 2016. These are just some of the positive indicators we are seeing that should indicate increased municipal spending for water infrastructure projects. Current economic forecasts for nonresidential construction point to a low to mid single digit increase.

For 2017, forecasts we have seen range from 3% to 6% growth in non residential construction spending. At Mueller Company, we estimate that in 2016, about 60% of net sales were associated with the repair and replacement of municipal water distribution and treatment systems, 30% new water infrastructure related to residential construction and 10% with natural gas utilities. Overall, at Mueller Company, we expect net sales growth around mid single digits for 2017. Given our current outlook for product mix, we expect to see a conversion margin close to 40%. For fiscal twenty seventeen, we expect Anvil's overall net sales percentage growth to be in the mid single digits.

Given our current outlook with respect to product mix, we expect to see a conversion margin of about 20%. For 2017, we expect Mueller Technologies year over year net sales percentage growth to be about 15%. We believe operating results will continue to benefit from both increased sales of higher margin products and cost savings. We expect adjusted operating performance to improve about 10,000,000 in 2017. Other 2017 key variables include corporate expenses, which are expected to be 33,000,000 to $36,000,000 depreciation and amortization, which is expected to be 55,000,000 to $57,000,000 and interest expense, which is expected to be 25,000,000 to $27,000,000 We expect our adjusted effective income tax rate to be 34% to 36% and capital expenditures to be $40,000,000 to $44,000,000 For 2017, we expect free cash flow to be driven by improved operating results and improvement in working capital.

We also expect to make only minimal cash contributions to our pension plans. We expect free cash flow to exceed adjusted net income. Turning now to our outlook for the twenty seventeen first quarter, beginning with Mueller Company. Our outlook for our principal end markets remains solid. We expect net sales percentage growth in the mid single digits in the first quarter with growth across most of our products.

We also expect Mueller Company to continue its trend in improving year over year adjusted operating income and margins. First quarter adjusted operating income is expected to improve in the high single digits. Turning now to Anvil. Net sales for the first quarter is expected to be higher year over year, driven by low single digit growth in non residential construction. We expect both adjusted operating income and margins to continue to improve at Anvil.

And now on to Mueller Technologies. We expect Mueller Technologies net sales to grow about 15% in the first quarter with continued higher shipments of AMI and fixed and mobile leak detection products. We expect to show meaningful operating performance improvement in the first quarter at Mueller Technologies, similar to that achieved in the fourth quarter. Overall, we were pleased with the continued margin expansion that we saw in all three of our businesses in the quarter and the seventh consecutive year of operating margin expansion for the company as a whole. We were also pleased with our adjusted EBITDA margin for '16, the highest in the company's history and the free cash flow we generated.

Looking ahead, we believe our three primary end markets will grow in 2017. We believe our strategy with Mueller Technologies is working, and we expect to build on the significant progress we made this past year. With that, operator, I will open up this call for questions.

Speaker 0

Thank you. We will now begin the question and answer session. Session. Our first question comes from Mr. Seth Weber.

Sir, your line is now open.

Speaker 4

Hi, thanks. This is Brendan Shea on for Seth. Looking at your Technologies business, the loss versus the gain that you had expected in the third quarter, I just want to make sure, is that due to Lea County receiving the contract kind of late? Or was there something else that played into that?

Speaker 2

Yes. No, thanks for the question. That was the primary driver. As we said in our prepared remarks, we were advised in June that we would be awarded this contract. At that time, and all indications were that we would be able to begin shipping this in September.

So we included that in our outlook. As we look, there were a number of reasons that we ended up getting the actual contract just late last week. So we'll start begin shipping a little bit of that in this quarter. We'll begin shipping that in more of that in the second quarter. And then as we said in our prepared remarks, that will carry out for several years.

So when we look back at Mueller Technologies in the fourth quarter, our miss from expectations, though we had very nice year over year improvement of about one point we our operating performance improved close to 1.5 being short, the $500,000 to 600,000 we were short of being profitable was related to the Lea County project, which again we expected to start shipping in September.

Speaker 4

Okay, thanks. And then can you just go over any change to capital allocation priorities given your low net debt leverage and healthy free cash flow generation?

Speaker 2

Yes. As Evan mentioned in his prepared remarks, the net debt our net debt leverage is currently at 1.5 times. Again, as you mentioned, we are confident about our outlook and about future free cash flow that we'll generate. We have a stronger balance sheet and have more flexibility. So we have been having more detailed capital allocation discussions with our Board.

As you know, during the last eighteen months, we have increased dividends twice. We have repurchased shares. And we've also, I think, had a evaluated pretty in-depth acquisition strategy with Board. So I can assure you that we are very thoughtfully looking at capital allocation options that we believe will best drive stockholder value. And I think where we are today, we certainly have a lot of flexibility.

Speaker 4

That's it for me. Thank you.

Speaker 2

Thank you.

Speaker 0

Thank you. Our next question comes from Mr. Jose Garza. Sir, your line is now open.

Speaker 5

Good morning,

Speaker 2

Good morning.

Speaker 3

Good morning.

Speaker 5

Guess I just wanted to get your thoughts on just kind of where your inventory level is on the MuellerCo side, Greg?

Speaker 2

Jose, are you talking about in the distribution channel or

Speaker 5

our manufacturing facility? In the distribution channel.

Speaker 2

Yes, yes, sorry. Yes, I think that when as we said in our prepared remarks, we had very strong orders in the third quarter and in July. As we mentioned on our last call, domestic orders for valves and hydrants and brass products grew 13% in the third quarter. They were up another 10% in July. So we as we referenced, we started to see a slowdown in August.

In fact, beginning in August for about a seven week period, orders grew about one percent. We think that slowdown that began in August was due to elevated inventories at our distributors. We think the inventories were elevated because, one, distributors did order aggressively in the April time period. And this was on top of a strong pre buy to the February price increase in valves and hydrants. Two, in some areas, we think that there was a slowing in the growth in construction.

It probably slowed. If we look at some recent data, it appears that growth in construction was a little less than it was earlier in the year. For instance, when looking at housing starts, single housing starts grew almost 15% in the first half of our fiscal year, continue to grow in the second half, but about 4%. So when we look at it, we think that in most of our distributors have our their inventories where they want them. I think we may have a few.

The inventory still may be high. But all in all, we remain very bullish about end market demand in the for twenty seventeen. Housing starts, expect to grow 8%, municipal spending in mid single digits. So we think that even where distributors in some areas may have a little more than what they typically expect to have, that we think that will get in line pretty quickly. So we think more of the issue is what happened is that we saw very, very aggressive orders in the third quarter on top of a strong pre buy, went in early in July.

So we just think we went through a seven, eight week, maybe a ten week period of some adjustment there. We don't think we have any big issues with distributor inventories out of line. And we think in most cases, for most of our distributors, they have them where they want them.

Speaker 5

Okay. That's very helpful, Greg. I just kind of want to get your thoughts on where you see kind of the municipal kind of cycle in terms of where we are. And then looking forward, obviously, you think next year is pretty decent, but just talking further out?

Speaker 2

Yes. I'm not sure we're in I think we're still in the middle of the cycle. I think that as we say that for the most part, I think municipalities are healthier than they certainly were several years ago. The need to repair and replace the existing infrastructure hasn't gone away. I think if anything, there has been more discussion about the need to upgrade the infrastructure.

I think that certainly became a greater focus and greater focus after the Flint issues. I think we're even seeing more discussion at the federal level about making money available for water infrastructure. I know both presidential candidates have talked about that. And that in both houses in the Congress have talked about more and more money to be available for water infrastructure. So I think we're in the right in the middle of the of that cycle.

As we said in our prepared remarks, we still expect to see mid single digit growth in that market segment for our products.

Speaker 5

Okay. And then one last one on Mueller Technologies, $10,000,000 improvement, is that kind of across both platforms or more geared towards Mueller systems?

Speaker 2

Both platforms will improve, a little more towards Mueller systems. We look at Mueller systems was profitable for the last two quarters of our fiscal year twenty sixteen fiscal year. As we said with the Lea County order that is now firmly in our backlog, our when we look at our AMI shipments in our backlog this year that are scheduled in our backlog this year versus what was scheduled in our backlog in 2,000 entering this year, it's up almost 80%. So we look for about two thirds of that improvement probably coming from Mueller system, but we do expect to see the improvement in Ecologics also. And as I said, about a third of that improvement coming from Ecologics.

Speaker 5

Okay. That's very helpful. Thanks, guys.

Speaker 2

Thank you. Thank

Speaker 5

you.

Speaker 2

Great. Well, seeing that there are no additional questions, thanks very much for your interest. And I'm sure we'll be seeing everyone soon.

Speaker 0

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