Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

Mueller Water Products, Inc. (NYSE:MWA)

F2Q09 (Qtr End 03/31/09) Earnings Call Transcript

May 6, 2009 9:00 am ET

Executives

Martie Zackas – SVP, Strategic Planning and IR

Greg Hyland – Chairman, President, and CEO

Evan Hart – SVP and CFO

Analysts

Mike Schneider – Robert W. Baird

Kevin Maczka – BB&T Capital Markets

Christopher Glynn – Oppenheimer & Co.

Michael Gaugler – Brean Murray Carret

Brent Thielman – D.A. Davidson

Seth Weber – Banc of America, Merrill Lynch

Michael Roomberg – Boenning & Scattergood

Matt Materioso [ph] – Barclays Capital

Brett Levy – Jefferies & Co.

Operator

Welcome and thank you for standing by. (Operator instructions) At this time, I would like to introduce Martie Zackas. Thank you. You may begin.

Martie Zackas

Good morning everyone, and thank you for joining us today as we discuss Mueller Water Products results for the 2009 second quarter. We issued our press release reporting results of operations for the three months ended March 31st, 2009 yesterday afternoon and a copy of it is available on our website. Mueller Water Products had 115.6 million shares outstanding at March 31st, 2009.

With us on the call this morning are Greg Hyland, our Chairman, President, and CEO, and Evan Hart, our CFO.

In our press release and on this call we referenced certain non-GAAP financial measures, which are derived from GAAP financial measures. These non-GAAP measures are provided because they are used by the financial community. We believe these measures will assist in assessing the company’s underlying performance for the period being reported. There are limitations to these non-GAAP measures, and reconciliations between non-GAAP and GAAP financial measures are included in the supplemental information within our press release.

This morning we will refer to adjusted income, loss from operations, adjusted net income loss, adjusted EPS, and adjusted EBITDA and EBITDA loss, all of which exclude the impairment and restructuring charges in fiscal 2009 and 2008. These numbers are provided in the press release.

On today's call, we will make forward-looking statements in accordance with the Safe Harbor Provision of the Securities Litigation Reform Act of 1995. Remarks containing words such as expect, believe, anticipate, and project, constitute forward-looking statements. They are not guarantees, and such statements involve risks and uncertainties that could cause actual results to differ materially from these statements. Please see our Form 10-K for the fiscal year ended September 30, 2008 for a discussion of these risks.

This morning’s call is being recorded and web cast live on the internet. The archived web cast along with the corresponding slides we are presenting this morning will be available in the Investor Relations section of our web site www.muellerwaterproducts.com for at least 90 days after the presentation.

The slides related to this morning’s call are available to help illustrate the quarter’s results. In addition, we will be filing a copy of this morning’s call’s prepared remarks on form 8-K. After the prepared remarks, we will open the call to questions from our dial-in participants.

I will now turn the call over to Greg.

Greg Hyland

Thank you, Marty, and good morning everyone. We appreciate you joining us this morning as we discuss our results for the second quarter of fiscal 2009. I’ll begin today with a brief overview of the quarter. Evan Hart will then follow up with a detailed financial report, after which I will update you on key drivers influencing our business and our outlook. We will then open up the call for your questions.

Net sales for the 2009 second quarter were $322.2 million, down 23.6% year-over-year. Adjusted loss from operations in the second quarter was $5.1 million and adjusted net loss per share was $0.13. Adjusted operating margin in the second quarter was a negative 1.6% and adjusted EBITDA margin was 5.8% for the quarter. Excluded from these results are non-cash impairment charges of $570.9 million and restructuring charges of $42.2 million, which Evan will discuss in detail.

Demand for our products continued to deteriorate in the second quarter from the first, which we had expected and which we discussed on our last quarter's call. Net sales for the second quarter were down 12.4% from the first quarter. Traditionally, the second quarter is the lowest quarter for end-market demand for our water infrastructure products due to seasonality. This year the situation was magnified by a continued deterioration in residential construction and little movement in the municipal markets.

Additionally, we believe most of distributors completed their destocking programs in the second quarter and maintained those lower inventory levels throughout the quarter. We also saw an acceleration of declining demand from the non-residential construction end-market, which primarily affects our Anvil business.

As a result, our consolidated shipment volumes were down $36.5 million and 9.9% from the first quarter fiscal year 2009 and $124.4 million or 29.5% year-over-year. During the quarter, we significantly cut back production in order to lower inventories. We continue to reduce costs as we implemented further headcount reductions, restructured certain manufacturing operations at U.S. Pipe North Birmingham manufacturing facility, and implemented other actions that we will discuss later in this call.

Despite a substantial decline in volumes, we were able to generate positive cash flow in the second quarter. Additionally, we have further reduced our overall cost structure, which will continue to enhance our earnings power, when demand in our markets improve.

I will now turn the call over to Evan Hart, who will discuss our financial results, including our debt and liquidity position. I will then come back and provide an outlook for the second half of fiscal 2009.

Evan Hart

Thanks Greg. Good morning everyone. I will first review the consolidated results and then discuss segment performance. The results I will be discussing, exclude the impact of the second quarter 2009 non-cash impairment charge and restructuring charge, which I will discuss after presenting segment performance.

Consolidated net sales of $322.2 million in the 2009 second quarter decreased $99.4 million year-over-year. Net sales decreased due to lower shipment volumes of $124.4 million across all business segments and $8 million in unfavorable Canadian currency exchange rates, which were partially offset by $33 million of price increases primarily implemented in fiscal 2008.

Gross profit was $54.9 million in the 2009 second quarter, a decrease of $43.9 million compared to $98.8 million in the 2008 second quarter. Gross margin was 17% compared to 23.4% in the prior year period. Gross profit decreased primarily due to lower volume of $39.3 million, higher raw material costs of $10.5 million, and $34.4 million due to under-absorbed overheads from lower production. Gross profit was partially offset by higher sales pricing of $33 million and manufacturing cost savings of $8.8 million.

Adjusted loss from operations for the quarter of $5.1 million decreased $34.6 million from the prior year period adjusted income from operations of $29.5 million. 2009 second quarter adjusted income from operations was negatively impacted by lower shipment volumes of $39.3 million, under-absorbed overhead of $34.4 million and higher raw material costs of $10.5 million. This was partially offset by higher sales pricing of $33 million, manufacturing cost savings of $8.8 million, and reduced selling, general, and administrative expenses of $9.3 million.

Second quarter 2009 adjusted operating loss and adjusted EBITDA margins of negative 1.6% and positive 5.8% respectively compared with the 2008 second quarter adjusted income margin of 7% and adjusted EBITDA margin of 12.4% respectively. Selling, general, and administrative expenses were $60 million in the 2009 second quarter compared with $69.3 million in the 2008 second quarter. This decline was the result of cost saving actions and lower shipment volumes.

Interest expense, net of interest income, declined $1.5 million to $16.6 million in the 2009 second quarter compared to $18.1 million in the 2008 second quarter. Gross interest expense totaled $16.9 million in the 2009 quarter compared with $19.1 million in the prior year quarter. Gross and net interest expenses were down year-over-year due to lower interest rates and lower average net debt outstanding.

In the 2009 second quarter, primarily due to the very limited income tax benefit associated with the goodwill impairment, the effective tax rate was 10.7%. Excluding goodwill impairment, the effective tax rate for the second quarter would have been approximately 38% compared to the Federal statutory rate of 35%. The effective tax rate for the second quarter of fiscal 2008 was approximately 42%.

Adjusted net loss per share was $0.13 in the 2009 second quarter compared to adjusted net income per share of $0.06 in the 2008 second quarter. The 2009 adjusted second-quarter results exclude $4.77 per share related to impairments and restructuring. The 2008 adjusted second-quarter results exclude $0.01 per share of restructuring charges associated with the previously announced closure of U.S. Pipe manufacturing facility in Burlington, New Jersey.

I will now move on to segment performance. Net sales for the Mueller Co. segment were $114.8 million in the 2009 second quarter compared to $168.9 million in the prior year quarter. Lower shipment volumes of $62.2 million and $1.5 million of unfavorable Canadian foreign currency exchange rates were partially offset by higher pricing of $9.6 million. Unit shipment volumes of Iron Gate valves, fire hydrants, and brass service products declined about 45% in the quarter.

Adjusted income from operations of $2.6 million and adjusted EBITDA of $15.8 million in the 2009 second quarter compared to income from operations of $27.4 million and EBITDA of $39.7 million in the 2008 second quarter. Adjusted income from operations was reduced primarily by $23.2 million of lower shipment volumes, $15.4 million of under-absorbed overhead due to lower production, and $4.1 million of higher raw material cost. This was partially offset by higher sales pricing of $9.6 million, manufacturing cost savings of $5.6 million and $2.8 million of reduced selling, general and administrative expenses.

Net sales for the U.S. Pipe segment were $93.2 million in the 2009 second quarter compared to $114.2 million in the prior year quarter. The net sales decrease was primarily attributable to $31.9 million of lower shipment volumes, partially offset by $10.9 million of higher pricing.

In the 2009 second quarter, adjusted loss from operations was $10.9 million and adjusted EBITDA loss was $4.7 million. These results compared to adjusted loss from operations of $1.3 million and adjusted EBITDA of $4.1 million in the 2008 second quarter.

The 2009 second quarter results were negatively impacted by $7.9 million due to lower shipment volumes, and $12.8 million of under-absorbed overhead due to lower production. Higher sales pricing of $10.9 million more than offset higher raw material costs of $3 million.

Additional benefits in the quarter included manufacturing cost savings of $2.1 million reduced selling, general and administrative expenses of $2.5 million.

Net sales for the Anvil segment were $114.2 million in the 2009 second quarter compared to $138.5 million in the prior year quarter. The net sales decline was driven primarily by $30.3 million of lower shipment volumes and $6.5 million of unfavorable Canadian currency exchange rates. This decline was partially offset by higher sales pricing of $12.5 million.

Adjusted income from operations of $12.1 million and adjusted EBITDA of $16.5 million in the 2009 second quarter compared to income from operations of $12.9 million and EBITDA of $17.9 million in the 2008 second quarter. Income from operations decreased principally due to $8.2 million of lower shipment volumes, $6.2 million of under-absorbed overhead due to lower production, and $3.4 million of higher raw material costs, which were partially offset by higher sales pricing of $12.5 million, lower selling, general and administrative expenses of 3.4 million and manufacturing cost savings of $1.1 million.

Free cash flow, which is cash provided by operating activities less capital expenditures, was $8.1 million in the 2009 second quarter. This compares to negative free cash flow of $15.7 million for the second quarter 2008. The increase in cash flow was primarily attributable to our working capital management, principally due to lower inventories.

At March 31st, 2009 net debt totaled $934.6 million, which is total debt of $1.0877 billion less cash on hand of $153.1 million. Total debt at March 31st, 2009 was comprised of our 420 million senior subordinated notes at a fixed rate of 7.375 %; $141.6 million of term A debt at LIBOR plus 175 basis points; $524.1 million of term B debt at LIBOR plus 175 basis points; and $2 million of capital leases and others [ph].

Our scheduled principal repayments are minimal over the next three fiscal years, with $6.2 million due in the remainder of fiscal 2009 and $19.5 million due in each of fiscal 2010 and 2011. Our first significant debt repayments are not scheduled until 2012, when our term A debt matures.

At the end of the second quarter, our leverage ratio, in accordance with our 2007 credit agreement, which is net debt to EBITDA, was 4.27 times below the maximum leverage ratio of five times. Our only other maintenance covenant is interest coverage, which was 3.25 times at March 31st, 2009 above the minimum interest coverage of 2.5 times.

We were in compliance with these financial covenants at March 31, 2009. Based on our current expectations, we believe that we will not remain in compliance with these financial covenants. We have initiated discussions with the administrative agent under our 2007 credit agreement to seek relief in connection with these financial covenants by June 30, 2009. We currently believe that we will be able to successfully amend our 2007 credit agreement in advance of that date. However, there can be no assurance that we will be able to do so.

We anticipate that our existing cash, cash equivalents and borrowing capacity combined with our expected operating cash flows will be sufficient to meet our anticipated operating expenses, capital expenditures, pension contributions, and scheduled debt service obligations as they become due.

The company reported a non-cash goodwill impairment charge of $400 million in the 2009 first quarter subject to additional fair value analysis. At that time, any additional impairment charge was not expected to exceed $200 million.

During the 2009 second quarter, however, the company's common stock began trading at prices significantly lower than prior quarters, especially in the second half of the quarter. This lower market capitalization, for the company as a whole, prompted additional impairment testing. The company’s additional 2009 second quarter goodwill impairment testing led to the conclusion that all of its remaining goodwill was fully impaired and other indefinite lived intangible assets at Mueller Co. were partially impaired.

Consequently, during the 2009 second quarter the company reported additional goodwill impairment charges of $376.8 million from Mueller Co. and $97.2 for Anvil. The impairment charges for the other indefinite lived intangible assets at Mueller Co. was $101.4 million and the remaining carrying value for these assets at March 31, 2009 was $263 million.

The company's other intangible assets of $418.9 million were not impaired as there were sufficient undiscounted future cash flows to support these carrying values. These impairment charges are non-cash items, and therefore will not result in any cash expenditures, and will not affect the company's cash position, tax payments, cash flows from operating activities, free cash flow, liquidity position, or availability under its credit facilities.

Furthermore, these charges are excluded from all of the company’s financial results and evaluating compliance with financial covenants under its credit agreement.

Also during the 2009 second quarter, the company restructured manufacturing operations at its U.S. Pipe North Birmingham facility. These actions resulted in a non-cash charge of $38.5 million primarily for property, plant and equipment. Additionally, the company incurred $3.5 million of severance charges related to headcount reductions throughout the organization.

I will now turn the call back over to Greg.

Greg Hyland

Thanks Evan. As we look at the second quarter, the biggest factor impacting our results was the continued falloff in market demand, which not only impacted our net sales but also caused us to lower our production levels even further. We also continued to take aggressive actions to reduce our manufacturing capacity and the overall costs in our businesses.

With respect to market demand, looking at our water infrastructure business, shipments for our Mueller branded fire hydrants, valve and brass products dropped almost 50% year-over-year, and ductile iron pipe shipments dropped almost 40%. These drops in shipments where the result of the continued decline in residential construction and frozen municipal spending, however, we don't believe the year-over-year drop is entirely attributable to the drop-off in end-market demand due to two factors. First, last year distributors placed orders in advance of our February 1 price increase on valves and hydrants. We did not have a price increase this year.

Second, we believe most of our distributors completed their destocking programs this quarter and they maintained those lower inventory levels.

For our Anvil business, shipment volume dropped 22% as we saw the drop-off in spending on non-residential construction accelerate in the quarter. We did benefit in the quarter from higher pricing year-over-year in all business units. In the second quarter of fiscal 2009, the average sales price per ton of ductile iron pipe was 27% higher year-over-year. The prices for valves and hydrants continued to be about 10% to 12% higher year-over-year, and prices for Anvil products were on average about 9% higher year-over-year.

For the quarter, all business units covered raw material cost increases with higher pricing on a year-over-year basis. During the quarter, we significantly adjusted our production schedules to help ensure that we would reduce inventories and generate positive cash flow.

Our Mueller Co. valves, hydrants, and brass manufacturing facilities operated only 66% of the available days in the quarter and average unit production dropped about 55% in the quarter year-over-year. U.S. Pipe manufacturing facilities operated only 70% of the available days in the second quarter, and tons produced dropped 43% in the quarter year-over-year.

While inventories dropped $25.7 million in the second quarter from our first quarter levels, the associated drop in production to achieve these lower inventory levels increased under-absorbed overheads. The cost of this under-absorbed overhead negatively impacted our second-quarter earnings and will negatively impact third-quarter earnings as well. Sequentially, under-absorbed overhead costs were $26.1 million higher this quarter as compared to first quarter, and on a year-over-year basis, we incurred $34.4 million higher in under-absorbed overhead costs in this quarter.

During the quarter, we continued to take actions to reduce our overall cost structure. We lowered headcount by nearly 600 positions. Year-to-date in fiscal 2009, we have reduced our workforce by about 15%. Also during the quarter, we restructured our North Birmingham ductile iron pipe manufacturing facility, essential to the reducing capacity of that plant by 50%.

As Evan mentioned, we incurred a $38.5 million non-cash restructuring charge. We believe that this action will reduce costs by $17 million on an annualized basis. We expect to achieve about $8 million of that savings in the second half of fiscal 2009. As a result of the restructuring actions to date this fiscal year at U.S. Pipe we have reduced capacity by more than 20% and have lowered our breakeven production levels.

We implemented a number of other cost-saving actions in the quarter in response to the downturn in the economy and its impact on our markets. Beyond the temporary plant shutdowns and headcount reductions we have already discussed, we implemented temporary pay reductions of 20% for members of the company's Board of Directors and most of our executive officers, as well as lesser reductions in base pay and/or reduced work weeks for other salaried employees.

We also suspended the company's match on our 401-K plans through the end of the calendar year. Manufacturing costs and SG&A expenses for all of Mueller Water Products were $18.1 million lower this quarter as compared to second-quarter 2008.

Now let's look at the second half of our fiscal year. We believe the second-quarter represents a low point in demand in our addressed water infrastructure markets. First of all, we expect to see a seasonal up-tick in the second half of the fiscal year. Secondly, while housing starts may deteriorate a little further, we believe demand for our products has hit bottom. We believe our shipments to this segment in the last two quarters were minimal. As we stated earlier, we believe our Mueller Co. and U.S. Pipe distributors have completed their destocking programs.

We expect that they will attempt to maintain their inventories well below last year's levels. The big question for us remains what will happen in municipal spending. We estimate that prior to September 2008 demand from this segment was growing at about 10% annually. However, we believe that over the last several months, municipal spending has been paralyzed.

Initially, it stalled due to the liquidity crisis including a closed municipal bond market. Then, we believe most activity was suspended when the possibility of a stimulus package was first announced, and remain so even after the bill was signed into law in February, primarily due to confusion over certain provisions especially the Buy American clause.

We are seeing early signs that municipal spending maybe starting to fall. This is the first quarter in the last five quarters that our ductile iron pipe public bid quotation has not declined on a year-over-year basis. The EPA has just recently provided some clarity concerning implementation of the Buy American clause that has been causing confusion.

Therefore, we expect that American Recovery and Reinvestment Act spending for drinking water may soon begin to make its way into the market. The direct dollars coming from this act are very small when compared to the overall need.

In the past, federal funding has accounted for less than 3% of total funding for drinking water projects. We expect that our products will be used in some of the specific projects that received federal funding. But more importantly, we believe that once those dollars start flowing, it can open up additional projects that have been delayed due to the uncertainty.

From a timing perspective, we anticipate that it will be at least the fourth quarter of the fiscal year before we begin shipping any products to stimulus funded projects. I want to make sure that our comments about the water infrastructure markets are kept in context. Our shipments into the residential construction market have been minimal in the past two quarters. So we do not expect to fall below minimal. However, keep in mind that in fiscal 2008 we estimate that 30% of total Mueller Water Products sales were to this segment. It accounted for approximately 40% of our total water infrastructure sales.

So we believe that it will be a long recovery and that we will be at the bottom for some time since we expect to lag the rebound in housing starts. Concerning municipal spending, we do expect to see positive movement in this segment relative to the last seven months. However, demand has been very depressed. So it is positive movement from a very low base.

We expect that it will take a while before we see demand equals to that which we saw in fiscal 2008. So while we believe the water infrastructure spending for our products are at a low point this quarter, we expect that it will be a slow recovery. As I said earlier, we saw an accelerating drop in demand from non-residential construction in the second quarter, and Anvil experienced a 22% drop in volume.

As we look at the second half of the fiscal year, we believe that on a year-over-year basis, non-residential construction spending will be down comparably. Economic forecasts from Ivy Zelman [ph] and McGraw-Hill-Dodge project a 20% decline in non-residential construction spending for the calendar year. As I mentioned earlier, we did see higher pricing on a year-over-year basis in all three business segments. However, we're beginning to see some price deterioration especially at U.S. Pipe.

While the average price per ton was 27% higher this quarter than in the second quarter of fiscal 2008, in the first quarter of this fiscal year the average price per ton was 37.5% higher than a year ago. The average price per ton for ductile iron pipe dropped 7% in the second quarter from the first quarter, and the average price from December through March dropped 12%.

We expect that prices could continue to deteriorate in the third quarter. Pricing for our valve and hydrants has been more stable, but we have seen some recent downward pressure. In this environment, we believe that we could see that downward pressure continue. We will do what is necessary to maintain our market share.

In fiscal year 2008, we were very aggressive in implementing price increases in our Anvil business in response to escalating raw material costs. We expect as raw material costs have been declining that prices may also decline. However, we do expect that prices will remain higher on a year-over-year basis.

The cost of raw materials flowing through our cost of goods is declining. On a year-over-year basis, these costs were $10.5 million higher in the second-quarter, whereas in the first quarter they were $40 million higher. Specifically, the purchase price of scrap iron at U.S. Pipe in April was $159 per ton, a 68% decline from a year ago. Through Mueller Co., purchases of scrap iron declined sharply during the quarter with prices paid in March falling 60% below the peak price paid in July 2008.

The current purchase price of brass ingot is down 39% from a year ago and 45% from its peak. There is a timing difference between when we purchase raw materials and when we sell the related finished goods to our customers, because we use the first in, first out method of determining cost of sales. It will be several quarters before we realize the full benefit of this decline in raw material costs due to the significant drop in volumes and reduced production.

Specifically for the third quarter, the biggest impact on our financial results will be volume declines, and the impact of under-absorbed overhead associated with both the decline in volume and our aggressive cutback in production in the last two quarters. We anticipate the increased year-over-year costs of under-absorbed overhead to be comparable to the second-quarter increase of about $35 million. We expect consolidated operating income to be close to breakeven, and we expect U.S. Pipe to be in an operating loss position in the third quarter.

In addition, we are tightly managing capital expenditures, which we now project to be in the range of $40 million to $45 million. We expect to generate positive free cash flow for the full year. Other key variables for fiscal 2009 are corporate spending, estimated to be between $40 million and $42 million. Our effective income tax rate, excluding goodwill impairment, is estimated to be between 38% and 40%.

We estimate 2009 net interest expense to be within the range of $68 million to $71 million under the terms of our existing credit facility. As Evan mentioned, we have initiated discussions with our lead banks under our 2007 credit agreements to seek relief in connection with the financial covenants.

We currently believe that we will be able to successfully amend our 2007 credit agreement, but as you know, we can provide no assurance that we will be able to do so.

In summary, we believe demand in our water infrastructure markets hit their low point this quarter. Although we will continue to have a tough year-over-year comparison and expect a slow recovery, demand from residential construction will likely require a long recovery period, but we do expect to see positive movement in the municipal market. Non-residential construction, the primary market for our Anvil product is forecasted to decline further. We continue to reduce capacity and other costs in this business segment.

We are currently at that stage of the cycle where we are severely impacted by decremental margins. We are taking actions such as the restructuring of U.S. Pipe manufacturing operations in North Birmingham to reduce capacity and lower our breakeven point. We will realize the benefits of positive operating leverage when our production volumes and shipments increase.

Our primary focus remains on generating positive free cash flow and managing our controllable expenses, while maintaining our quality and market leading positions, the reputation of our brands and service to our customers. Again as a reminder, the prepared remarks from this morning's call are being filed as an 8-K. With that I will open it up for questions.

Question-and-Answer Session

Operator

Thank you. (Operator instructions) Our first question today is from Mike Schneider. You may ask your question and please state your company name.

Mike Schneider – Robert W. Baird

Good morning all, it is Mike Schneider from Robert W. Baird.

Greg Hyland

Good morning Mike.

Evan Hart

Hi, Mike.

Mike Schneider – Robert W. Baird

I guess starting off with the obvious question about the debt covenants. Do you anticipate just getting a waiver for the third quarter or is the case where you want to amend the entire covenants structure in the agreement?

Greg Hyland

Yes. We are in discussions with our lead banks at this time and you know, it is our expectation that we will seek relief in the format of amendment. So that will be a process that we are going through and plan to have achieved, you know, by the end of June of this year.

Mike Schneider – Robert W. Baird

Okay, and can you give us the sense of just the timing of this. Why would you wait until the fiscal third quarter to commence the process to do something that occurred during the second quarter that was materially worse than you expected because, Greg as you said we talked about these market conditions last quarter on the call. I am just curious what if anything changed or if this has been going on even since last quarter.

Greg Hyland

Yes Mike. I think that we look at four primary variables that we think have changed the last three months relative to the outlook that we had – the prior outlook. First of all, I think that we've seen non-residential construction market has worsened and the potential recovery has moved out. So certainly as everyone knows that this is the big driver for Anvil demand. So we think that the market for Anvil has deteriorated from where we thought it was three months ago.

Secondly that three months ago, I think we were more optimistic about the timing of the up-tick in municipal spending primarily driven by the stimulus package and now we think with the confusion that there still remains a lot jammed, we know that there has been significant discussions within the EPA of trying to get better clarity on the Buy American clause, but I think that that money has not started flowing yet. So as we referenced a little earlier, now we think the earliest we will see any benefit from the stimulus package will be in our fourth quarter of our fiscal year, and then we think it runs the risk of getting into the season where construction becomes very difficult.

So we think this – the last three or four months delay in getting stimulus money flowing not only is going to impact the timing in fiscal 2009 for us, but we think it runs the risk of being even delayed, pushed to the later half of 2010 just because we're going to get into that construction season, where very little can be done. Third thing that hit us is that we when we saw how this was playing out, we became very, very aggressive in cutting back our production as again and I think we've always been consistent that we think in an environment like this our primary focus is just to make sure that we are generating positive free cash flow, and so we became even more aggressive than what we thought we are going to have to in cutting back production.

So that under-absorbed overheads, we had a bigger hit for under-absorbed overhead this quarter. That is going to flow into Q3 for sure, and it'll be a wait-and-see on how much more production we may have to take out, and I think the fourth impact has been a deterioration in our – in the pipe business and primarily due to pricing. As we pointed out, our price per ton for ductile iron pipe was up 27% year-over-year.

So I mean, I think that we tried to do everything to hold on that but as I also – hold that pricing, but as I also referenced we saw that deteriorating throughout the quarter. Quite frankly, we think that perhaps that some of our competitors were not as disciplined as we were in controlling inventories. We think that our intelligence tells us that they may have – they may be sitting on some pretty significant inventories, and we expect that that they will find a need to try to convert that into cash. So we have a – I think a little more pessimistic look on what will happen in the pricing in our pipe business. So when we put these four variables together, the way they played out in the last three months has put us in the position that Evan referenced and requires that we enter this process with our banks.

Operator

Thank you. Our next question is from Kevin Maczka. You may ask your question and please state your company name.

Kevin Maczka – BB&T Capital Markets

Good morning Kevin Maczka, BB&T Capital Markets.

Greg Hyland

Good morning Kevin.

Kevin Maczka – BB&T Capital Markets

Good morning. Greg, I just want to make sure I understood your comment about the seasonal up-tick. Are you – so you're expecting a seasonal up-tick in Mueller and U.S. Pipe offset by further weakness in Anvil as commercial continues to slow. Is that right for a net positive? Am I thinking about that right?

Greg Hyland

Yes. Certainly, Kevin we at the time we will – we do expect to see a seasonal up-tick on Mueller and U.S. Pipe. If – even sequentially I think that we would probably still expect to see Anvil’s revenues up slightly, but I think that the – to obviously a much lesser extent than we would see at Mueller and U.S. Pipe. So from a revenue standpoint that we would expect revenue in all three business units to be up in Q3, but probably down Q3 versus Q2, but probably down somewhere around the same amount in total in the third – year-over-year in the third quarter as we were year-over-year in the second quarter.

Kevin Maczka – BB&T Capital Markets

Okay, got it. And then Greg on your comments on price pressure increasing, your head of the commodity cost increases with price in all three segments this quarter. Now it sounds like pricing and, of course, the commodity costs are both coming down. So you know, with them both trending up before, both trending down now, do you expect to stay ahead of that in the back half of the year or will price sort of more than offset the decline in commodity cost.

Greg Hyland

Yes, certainly Kevin, our visibility in Q4 because given when we are at this point in the market, we don't have quite the same visibility as we might in Q3, but we still expect in Q3 on a year-over-year basis that our higher pricing will be more than the negative impact of raw material cost.

Kevin Maczka – BB&T Capital Markets

Okay Greg, and then just finally Greg on the stimulus, Q4 it sounds like – is when you are expecting to see benefit and I know there is uncertainty, still lot of things are still unclear but is there anything you can quantify there at all in terms of what the bid activity looks like, the pipeline. What sort of, you know, the top line impact might be, maybe even just qualitatively.

Greg Hyland

Yes. Qualitatively, we did mention a little earlier the difference the first time in the last five quarters that we haven't had a decline in our public bid quotation. So we think that some of that is being driven by the stimulus package relative to, and we have started to see inquiries, questions about our US content in our product. So I think that that is the precursor to actually start seeing inquiries. So we're getting, I'd say the last two, three, four weeks we've been getting a number of inquiries to certify the US content in each of our products. So that I would say again I'm repeating myself is the precursor we think to the different water municipalities or water companies getting ready to issue the inquiries, but I could say right now we haven't seen too many of the actual inquiries, but we’ve seen activity that would lead us to believe they are getting ready to issue those. So again, I think that we'll see it in Q4, at the earliest in Q4, and I’ll put it qualitatively. We think it probably will be small rather than, you know, a big impact. I think we'll see a much bigger impact a little later.

Kevin Maczka – BB&T Capital Markets

Okay. Thanks for the color.

Greg Hyland

Thank you.

Operator

Thank you. Our next question is from Christopher Glynn. You may ask your question and please state your company name.

Christopher Glynn – Oppenheimer & Co.

Thanks. Christopher Glynn, Oppenheimer & Co. Good morning.

Greg Hyland

Good morning.

Christopher Glynn – Oppenheimer & Co.

Just stretching a little bit on the first time in five quarters not declining public inquiries. I guess that's not actual quotations.

Greg Hyland

Yes. Yes, no sorry those are actual bids and that's from our US pipe business unit that we'll quote many more of those direct, and so we have a better handle. So to really put it in perspective, we did see a slight increase in the second quarter of this year over the first quarter of this year in the amount of tons we bid and probably equal to about the number of tons that we bid on the second quarter in 2008, but again in the last four quarters, we have been sequentially bidding on fewer, you know, fewer tons. So, Chris, I would say that the best way to think of it is directional with seeing the increase directionally, but I think that when one looks at it still in absolute tons what we were bidding in 2008 are quotations – we were bidding on higher more tons in 2008 than what we have been bidding on so far in 2009.

Christopher Glynn – Oppenheimer & Co.

Okay, that’s helpful, and what kind of amendments might you address, maybe this is sensitive but could you, you know, maybe get a pass on some of the under-absorbed or something like that?

Greg Hyland

Well, it is sensitive right now, because we are in discussions and limited is with what we can say, but I’ll see what color Evan can provide.

Evan Hart

So I would agree. We’ve, you know, entered into our discussions and really can’t comment as we are in this process, you know, starting our negotiations but you know, we'll be taking a look at, you know, every aspect as we look at our ratios under our 2007 credit agreement, and you know, determine what the terms will be going forward. So we'll be looking at you know, all aspects.

Christopher Glynn – Oppenheimer & Co.

Okay, and I guess would higher interest rates be a likely outcome there?

Evan Hart

You know, we can’t you know, can’t comment as we are in the process. So you can look to, you know, other amendments that have been out in the marketplace, but you know, at this time because we are you know, in the midst of those discussions. We cannot comment.

Christopher Glynn – Oppenheimer & Co.

Understood, and then just if you said it, I missed it, but relative to the financial statement, EBITDA, would the adjustment to that used for calculating the compliance?

Evan Hart

(inaudible).

Christopher Glynn – Oppenheimer & Co.

The $5 million.

Greg Hyland

Yes, the difference traditionally on a – you know, we look at you know, covenant compliance on a trailing 12-month EBITDA basis and bank EBITDA is higher than our adjusted EBITDA that we publish by about $15 million on a trailing 12-month basis, and that is primarily related to stock compensation and a few other add backs that we have in the calculation.

Christopher Glynn – Oppenheimer & Co.

Okay, great. And just lastly, some interesting variability in the pricing comments. I mean I think if the Mueller Co. segment is a little bit of a strong franchise competitively maybe than the Anvil, but you talked about defending share there and it sounded a little bit more (inaudible) about the pricing situation with Anvil. So I thought that was kind of curious.

Greg Hyland

Yes, it was – I think on the Anvil side – I think on the Mueller side, clearly that as a specified product you are right. We have a stronger position and end users at times will just demand a continued use, the products that they have in place, but I think that Chris what we were I think trying to convey is that in this environment that I think that it is reasonable for us to expect that we could see some more pricing you know, pricing pressure, more pricing pressure than we would typically expect to see, and while we are up year-over-year, and we would expect to have higher pricing throughout the year on a year-over-year basis for the Mueller business that we are seeing, I think a little more pressure. And we're also seeing some pressure on, you know, some pressure on Anvil too, but I think that the key there is that we would still expect on a year-over-year basis to have higher pricing in those businesses than we did last year.

Christopher Glynn – Oppenheimer & Co.

Okay. And I'm sorry to have one more just on the free cash flow outlook, some of the pieces moving around there, deferred taxes were a big number in the quarter. Is that something that can come back favorable and kind of goose the free cash flow in the second half?

Greg Hyland

I will ask Evan to address that.

Evan Hart

Right, the deferred taxes was related to our write-off of other intangible assets, and so you know that’s specifically related to that, you know that one item.

Christopher Glynn – Oppenheimer & Co.

Okay, so there is nothing that kind of comes back there?

Greg Hyland

Correct. Nothing comes back.

Christopher Glynn – Oppenheimer & Co.

Right. Okay, thanks very much.

Operator

Thank you. Our next question is from Michael Gaugler. You may ask your question and please state your company name.

Michael Gaugler – Brean Murray Carret

Brean Murray Carret. Good morning everyone.

Greg Hyland

Good morning Michael.

Michael Gaugler – Brean Murray Carret

I’d like to follow up a little bit on Mike's earlier line of questioning regarding the debt levels. You know, when Mueller came public, debt levels were in line with a certain level of sales and profits. Given the current sales and profitability and the difficulty that you're seeing in your end-markets, and that's obviously going to continue for at least a few more quarters, have you considered reducing debt via an equity offering to more closely align your current sales profit debt as it exists today.

Greg Hyland

You know, Mike, good question. I can say that the management team with the board that we look at all options. We talked to our advisers. I think that it is always safe to assume that we would not rule out all possibilities, but I think as we are looking at it today that we think the most, the right approach is to amend the 2007 credit agreement, but again I want to emphasize that it is a dynamic process, and we are always looking at all the different possibilities.

Michael Gaugler – Brean Murray Carret

Okay, and just – so you know. I mean I asked a question because again you know, you became public with a lot of debt obviously, and your sales and your profits were much higher than they are today, and with the share price having run up recently to these levels, it is pretty much neutral. I just thought that perhaps that might set you up better in terms of bottom-line growth if you can get a little bit of that debt off the balance sheet.

Greg Hyland

Mike, I think again I think very good insight, good comment, and I think that we look at all options, and certainly that would always be a possibility.

Michael Gaugler – Brean Murray Carret

All right. Thanks guys.

Greg Hyland

Thanks Mike.

Operator

Thank you. Our next question is from Brent Thielman. You may ask your question and please state your company name.

Brent Thielman – D.A. Davidson

Hi. Excuse me. Brent Thielman with D.A. Davidson.

Greg Hyland

Hi Brent.

Brent Thielman – D.A. Davidson

You know, really just one question left for me and I think really more particularly on the Anvil side, but you know have you guys seen any change in terms of import activity on some of the products that you guys produced there, just as given so that, you know, I guess decline in market demand. Just any sense there in the imports?

Greg Hyland

Yes, I think that – I think that in the last couple months we have seen the pricing of imported products dropping pretty, you know, in the 10% to 20% range. So both products that we compete with in the market as well as products that we source. So it is a – I think it is reasonable to expect that that we might see in this environment imported products gaining a little share, but again there are a number of projects especially in cities where the various construction unions have a very strong foothold that only domestic products will be installed. But yes, I think that the last – say the last three or four months we have seen imported products pricing decline where a year ago they were actually increasing.

Brent Thielman – D.A. Davidson

Okay, thanks a lot guys.

Greg Hyland

Thanks.

Operator

Thank you. Our next question is from Seth Weber. You may ask your question and please state your company name.

Seth Weber – Banc of America, Merrill Lynch

Hi. Good morning. It’s Banc of America, Merrill Lynch. Hi everybody.

Greg Hyland

Good morning Seth.

Seth Weber – Banc of America, Merrill Lynch

Sorry if I missed this, there are lot of numbers flying around, but in general would you expect your cost saving initiatives and your pricing or recovery in raw materials to offset the under-absorption in the second half of the year. I don’t know if I’ve asked that clearly.

Greg Hyland

Yes, I think you did. That’s good question. We don’t believe that will be the case in the third quarter. The under-absorbed overhead as I referenced little earlier, we cut back production quite significantly in the second quarter. That will flow through in the third quarter. So again on a year-over-year basis that we expect to see positive pricing, we will still be a little negative on raw materials, but we expect overhead absorption to be on a year-over-year basis to be about the same in Q3 that we saw in Q2, which is around $35 million. And so pricing will not offset that absorption hit.

Seth Weber – Banc of America, Merrill Lynch

Pricing plus your cost, do you have these cost-saving initiatives?

Greg Hyland

Other cost savings, we will see other cost savings combined that on a year-over-year basis that our pricing and other cost savings will come very close to offsetting overhead absorption, but I still think that we will have slightly higher overhead absorption.

Seth Weber – Banc of America, Merrill Lynch

Okay, that is helpful, thank you. And then just the – should we expect additional charges in the third quarter, I think that Greg intimated there might be additional actions coming if – I don’t know, maybe it is just as necessary, but is there something that is planned currently?

Greg Hyland

Seth the only – potentially, nothing that we have planned, but we could have potentially additional severance expenses relative to as Evan pointed out, nothing else in the terms of impairment.

Seth Weber – Banc of America, Merrill Lynch

Right, okay. Thank you very much.

Greg Hyland

Okay Seth.

Operator

Thank you. Our next question is from Ryan Connors. You may ask your question and please state your company name.

Michael Roomberg – Boenning & Scattergood

Hi, good morning. This is actually Michael Roomberg. I'm actually sitting in for Ryan today from Boenning & Scattergood. I had one more question on the Anvil side, you guys have mentioned in your prepared remarks that the decline in municipal and residential spending seems to be leveling off. Is that also the case, and perhaps you may have touched on it previously with respect to non-residential spending, construction spending.

Greg Hyland

No, in fact we referenced that we probably we expect we saw about a 22% drop in Anvil shipments in the second quarter, the forecast that we are looking at is calling for a 20% drop on a calendar year basis for non-res. So we think that we will see probably drop off on a year-over-year basis in demand pretty comparable to that 20%, and again I think the other, the other forecast we are looking at are still calling for non-residential construction to drop, the spending in non-residential construction to drop in 2010. I think today that varies from anywhere from another 5% to 15% drop in 2010 based on the forecast we had looked at.

Michael Roomberg – Boenning & Scattergood

Okay. All my other questions were answered. Thanks a lot.

Greg Hyland

Thank you.

Operator

Thank you. Our next question is from Matt Materioso [ph]. You may ask your question and please state your company name.

Matt Materioso – Barclays Capital

Good morning. Barclays Capital. You have given some pretty good color on the earnings potentials, could you just maybe comment directionally on that 5.8% adjusted EBITDA margin in Q2, where would we see that going in Q3. It's that kind of flat versus –

Greg Hyland

Matt, we don't give guidance, but we did say in our prepared remarks that we expected operating income in the Q3 to be near break even. So that certainly would say that EBITDA margins will go up slightly in Q3.

Matt Materioso – Barclays Capital

Okay great, and just given what we have seen with other companies that have come to or gone to their banks to get amendments, you know obviously, typically a higher interest rate would be included in that, and just curious if you have factored that into your free cash flow positive guidance. Is there anything that would significantly move the needle there or do you expect to generate plenty of cash flow to cover that?

Greg Hyland

Obviously, we can’t comment on our discussions there, but I think given our focus, our focus on reducing – still continue to reduce inventories and the other actions that we are taking, we are confident that we would in either case, in any case have positive free cash flow for the year.

Matt Materioso – Barclays Capital

Great that is helpful. Thanks.

Operator

Thank you and our next question is from Brett Levy. You may ask your question and please state your company name.

Brett Levy – Jefferies & Co.

Jefferies & Co., most of my questions have been answered as well. Can you guys talk a little bit about CapEx for the year and kind of what portion of it is going to be growth or is there any of that, what is maintenance and is there any kind of continuation projects in the CapEx number?

Greg Hyland

Yes, currently we gave the guidance where we say CapEx will be somewhere between $40 million and $45 million, and I would say for the most part that is that our maintenance level with perhaps a little bit of that spending is still for growth. But I would generally say that we always said on our previous calls, and it is our expectation that the $40 million to $45 million level is pretty much maintenance.

Brett Levy – Jefferies & Co.

And then, you know, should things start to turn, do you guys have the ability now to buy back bonds in the open market, and would you contemplate it as part of your discussions, giving yourself the ability to do that going forward?

Greg Hyland

Again, we have the ability, I will turn to Evan here, we have the ability to buy back bonds but it is capped.

Currently, we do have the ability to buy up to $75 million, and we always selectively look at that as we go forward as one potential strategy, but right now we are in the middle of a negotiation process. So we will have to factor that in as we go forward.

Brett Levy – Jefferies & Co.

Sounds good. Thank you very much guys.

Greg Hyland

Thank you. Well, we see that we have no further questions. Again, we like to thank everyone for joining us today and again and remind you that we will be filing the script as an 8-K. Thanks very much.

Operator

Thank you. This concludes today's conference. Thank you for participating. You may disconnect at this time.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Mueller Water Products, Inc. F2Q09 (Qtr End 03/31/09) Earnings Call Transcript
This Transcript
All Transcripts