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Mueller Water Products (NYSE:MWA)

Q3 2012 Earnings Call

August 01, 2012 9:00 am ET

Executives

Marietta Edmunds Zakas - Senior Vice President of Strategy, Corporate Development and Communications

Gregory E. Hyland - Executive Chairman, Chief Executive Officer, President, Chairman of Executive Committee and Member of Proxy Committee

Evan L. Hart - Chief Financial Officer, Senior Vice President and Member of Proxy Committee

Analysts

L. Todd Vencil - Sterne Agee & Leach Inc., Research Division

Jerry Revich - Goldman Sachs Group Inc., Research Division

Timothy Feron - Janney Montgomery Scott LLC, Research Division

Michael E. Gaugler - Brean Murray, Carret & Co., LLC, Research Division

Seth Weber - RBC Capital Markets, LLC, Research Division

Brent Thielman - D.A. Davidson & Co., Research Division

Operator

Welcome, and thank you all for patiently holding. [Operator Instructions] I will now turn the call over to Ms. Martie Zakas. Ma'am, you may begin.

Marietta Edmunds Zakas

Very good. Thank you, and good morning, everyone. Welcome to Mueller Water Products Fiscal 2012 Third Quarter Conference Call. We issued our press release reporting results of operations for the quarter ended June 30, 2012, yesterday afternoon. A copy of it is available on our website, muellerwaterproducts.com. Mueller Water Products had approximately 156.8 million shares outstanding at June 30, 2012.

Discussing the third quarter's results this morning are Greg Hyland, our Chairman, President and CEO; and Evan Hart, our CFO. This morning's call is being recorded and webcast live on the Internet. We have also posted slides on our website, which are available to help illustrate the quarter's results, as well as to address our Safe Harbor disclosure statement and our non-GAAP disclosure requirements.

At this time, please refer to Slide 2. This slide identifies certain non-GAAP financial measures that we 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 3 is our Safe Harbor disclosure statement addressing forward-looking statements. This slide includes cautionary statements identifying important factors that could cause actual results to differ materially from those included in the forward-looking statements, as well as specific examples of forward-looking statements. Please take note of Slides 2 and 3 in their entirety.

During this call, all references to a specific year or quarter refer to our fiscal year, which ends on September 30, unless specified otherwise. As previously announced, we sold U.S. Pipe effective April 1, 2012. U.S. Pipe's operating results have been reclassified as discontinued operations, and its assets and liabilities have been reclassified as held-for-sale for all periods presented. The archived webcast and the corresponding slides will be available for at least 90 days in the Investor Relations section of our website. In addition, we will furnish a copy of our prepared remarks on Form 8-K later this morning. After the prepared remarks, we will open the call to questions.

I'll now turn the call over to Greg.

Gregory E. Hyland

Thanks, Martie. We appreciate you joining us today as we discuss our results for the 2012 third quarter. I'll begin 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 fourth quarter.

Third quarter results yielded increases in net sales, adjusted operating income and adjusted EBITDA on a year-over-year basis. The data on the residential construction market is trending positive, and we believe we saw some pockets of growth from this market segment during the third quarter.

At Mueller Co. base business in the third quarter, net sales increased 6.9%, and adjusted operating income grew 14%, driven by increased domestic shipments of valves, hydrants and brass products.

We also had a number of wins at both Mueller Systems and Echologics. Mueller Systems announced a supply agreement with American Water, the largest publicly traded U.S. water and wastewater utility company for water meters and automated meter reading systems, and also a $6.6 million agreement for our meters and AMI systems with Bentonville, Arkansas.

Echologics also recently extended its contract with the City of New Orleans, which is expected to generate approximately $5 million in revenue over the next 2 years. It is encouraging to see the traction both businesses are gaining in the marketplace.

Anvil, again, delivered solid results in the third quarter. We saw some softness in certain markets. While net sales were essentially flat, adjusted operating income increased year-over-year. We continue to believe that we are well-positioned for future profitable growth, as end market demand improves, and we are able to increase capacity utilization.

I'll now turn the call over to Evan, who will provide more details on our third quarter financial results.

Evan L. Hart

Thanks, Greg, and good morning, everyone. I'll first review the consolidated results, and then discuss segment performance. Consolidated net sales for the 2012 third quarter of $275.9 million increased $16.3 million or 6.3% from the 2011 third quarter net sales of $259.6 million. Net sales increased due to higher shipment volumes and higher prices.

Consolidated gross profit of $79.6 million for the 2012 third quarter improved from $73.1 million for the 2011 third quarter. Gross profit margin for the 2012 third quarter improved 70 basis points to 28.9%, and was positively impacted, primarily, by higher sales prices at both Mueller Co. and Anvil, as well as higher shipment volumes at Mueller Co.

Consolidated selling, general and administrative expenses of $53.2 million for the 2012 third quarter, compared to $48.1 million for the 2011 third quarter.

Selling, general and administrative expenses were higher, driven primarily, by planned investments associated with Mueller Systems and Echologics, higher sales commissions and other costs. Adjusted operating income for the 2012 third quarter of $26.4 million improved from $25 million for the 2011 third quarter, primarily driven by higher shipment volumes and higher sales prices.

Adjusted EBITDA for the 2012 third quarter of $41.4 million, improved from $40.7 million for the 2011 third quarter. Interest expense, excluding terminated swap contracts, decreased $1.1 million in the third quarter year-over-year, due primarily to lower levels of total debt outstanding. Interest expense net for the 2012 third quarter was $14.9 million, which included $1.3 million of non-cash costs for terminated interest rate swap contracts, compared to $16.8 million for the 2011 third quarter, which included $2.1 million for such contracts. Although these contracts were terminated prior to 2011, the related costs are being amortized over the original term of the swap contracts.

During the 2012 third quarter, income tax expense was $3.4 million, on income before taxes of $9.3 million, or an effective income tax rate of 36.6%. Effective income tax rate for the 2011 third quarter was 12.7%, reflecting an adjustment to estimated tax rates for state and non-U.S. income taxes on pre-tax earnings of $7.9 million.

Net operating loss carryforwards remained available to offset future taxable earnings. Adjusted net income per diluted share for both the 2012 and 2011 third quarters was $0.05. The 2012 third quarter adjusted results, exclude the after-tax gain from discontinued operations of $3.9 million, after-tax loss on early extinguishment of debt of $900,000, after-tax interest rate swap costs of $800,000, and after-tax restructuring expenses of $400,000.

The 2011 third quarter adjusted results, exclude the after-tax loss from discontinued operations of $9.6 million, after-tax interest rate swap costs of $1.3 million and after-tax restructuring expenses of $200,000.

Discontinued operations for the 2012 third quarter was primarily related to a refinement of the income tax valuation allowance recorded in the 2012 second quarter. There was a weighted average of 158 million diluted shares of our common stock outstanding for the 2012 third quarter, compared to a weighted average of 156.4 million diluted shares outstanding for the 2011 third quarter.

I'll now move on to segment performance and begin with Mueller Co. Mueller Co.'s net sales for the 2012 third quarter of $182.6 million increased 10.1% from the 2011 third quarter net sales of $165.8 million. Net sales grew due to higher shipment volumes across all 3 businesses and higher prices, primarily in our base business, partially offset by unfavorable Canadian currency exchange rates. Shipment volumes increased for domestic valves, hydrants and brass products, all part of Mueller Co.'s base business, which excludes Mueller Systems and Echologics.

Domestic unit shipments of valves increased 11.5%, hydrants increased 3.5%, and brass products increased 12.7%, in the third quarter on a year-over-year basis.

Adjusted operating income for the 2012 third quarter increased 7.9% to $24.6 million from $22.8 million for the 2011 third quarter. Base business adjusted operating income margin improved to 17.2% this quarter from 16.1% last year. Mueller Co. total adjusted operating income margin declined slightly to 13.5% for the 2012 third quarter, from 13.8% in the 2011 third quarter, which includes the impact of investments at Mueller Systems and Echologics.

I'll now turn to Anvil. Net sales for the 2012 third quarter were $93.3 million compared to $93.8 million for the 2011 third quarter. Net sales decreased slightly due to lower shipment volumes, primarily in Anvil's industrial market, which were mostly offset by higher prices. Anvil sales to the oil & gas market were up only slightly year-over-year, as we saw strong market expansion last year, making the year-over-year comparisons tougher.

Adjusted operating income increased slightly to $9.9 million in the 2012 third quarter from $9.6 million in the 2011 third quarter. Adjusted operating margin for the 2012 third quarter was 10.6%, compared to the 2011 third quarter adjusted operating margin of 10.2%.

For the 2012 third quarter, Anvil improved both its adjusted EBITDA and adjusted EBITDA margin, year-over-year. Adjusted EBITDA increased to $13.5 million, or an adjusted EBITDA margin of 14.5% for the 2012 third quarter, compared to adjusted EBITDA of $13.3 million, or an adjusted EBITDA margin of 14.2% for the 2011 third quarter.

Discontinued operations for the 2012 third quarter included a pre-tax loss of $1.4 million from the sale of U.S. Pipe. During the 2012 third quarter, discontinued operations included an income tax benefit of $4.3 million, primarily related to a refinement of the income tax valuation allowance recorded in the 2012 second quarter.

Turning now to a discussion of our liquidity. Free cash flow, which is cash flows from continuing operations from operating activities less capital expenditures, was $5 million for the first 9 months of the 2012 versus a negative $16.1 million for the comparable period in 2011. The year-over-year increase in pre-cash flow was primarily related to the timing of cash collections and disbursement, and the income tax refund we've received in the 2012 second quarter.

At June 30, 2012, total debt was $622.8 million, and included $420 million of 7 3/8% senior subordinated notes due 2017, $199.8 million of 8.75% senior unsecured notes due 2020, and $3 million of other.

Based on June 30, 2012 data, we had $141.3 million of excess availability under our asset-based credit agreement.

During the 2012 third quarter, the company reduced its total debt outstanding by $69.7 million to $622.8 million. During the quarter, interest expense declined $1.1 million on a year-over-year basis, primarily due to our debt repayment.

I'll now turn the call back to Greg.

Gregory E. Hyland

Thanks, Evan. I'll now elaborate a little more on our 2012 third quarter performance and end markets, and then provide an outlook for our fourth quarter. I'll begin with Mueller Co.

We are pleased with the net sales growth in Mueller Co.'s base business, where shipments of domestic valves, hydrants and brass products in both dollars and units were up year-over-year. We believe demand for our products benefited from spending by municipal water systems, and we also believe we saw pockets of growth in demand from residential construction. Our quotation activity in the third quarter for Mueller Co.'s base business was up more than 15% in a number of quotations, and up more than 20% in dollars quoted year-over-year. We also believe the distributor inventories at the end of the third quarter were down, from both the previous quarter and year-over-year. We believe this is positive because we expect that distributors will have to place additional orders to satisfy end market demand, rather than solely shipping from their existing inventories.

Last quarter, we said that we were uncertain as to the extent to which our increased volume of valves and hydrants were simply due to an earlier weather-related start to the construction season. However, based on what we saw in the third quarter, we are more comfortable that the volume increases in the second quarter were not solely a pull-forward of construction activity due to weather, but also resulted from growth in our end markets.

We continue to make good progress at Mueller Systems with net sales in the quarter up almost 60% year-over-year. As we mentioned, we were successful in winning several of our anticipated agreements, although the timing was later than our original expectations. We also continue to make nice progress in introducing our Echologic leak detection and pipe condition assessment technologies to the marketplace. For example, as mentioned earlier, we recently extended our agreement with the City of New Orleans based on the benefits we were able to achieve for their city. The interest on leak detection and pipe condition assessment services is growing, as municipalities increasingly look for ways to help them prioritize their capital spending, and more efficiently, manage the challenges of addressing their aging water infrastructure.

As Evan discussed, Anvil had another solid quarter. Most of its addressed markets are relatively stable, with the oil & gas market, which accounted for approximately 20% of Anvil sales, remaining strong, although it was up only slightly year-over-year, due to tougher comparisons. Meanwhile, we saw a softening in Anvil's addressed industrial markets.

Before I turn to our outlook for the fourth quarter, I'll discuss what we are seeing with some of the macro drivers in our end markets. While most of the recent macroeconomic data has turned negative compared to earlier this year, we believe our water infrastructure markets have essentially hit bottom and have stabilized. The general municipal spending environment continues to remain stable, although budget pressures and economic uncertainty persists.

State tax receipts grew at 6.6% year-over-year, and local tax receipts were up only slightly for the latest 12 months, as of March 31.

On the municipal bond front, rates are still very attractive from a historical perspective, and year-to-date, issuance is up 65%, although the bulk of the issuance is for refinancing.

Finally, the housing market appears to have stabilized with some signs that a recovery is underway. Housing starts in June represented the sixth consecutive month of greater than 700,000 units on a seasonally adjusted annualized basis. June was the first time above 750,000 starts since October 2008. Furthermore, June single-family starts were above 500,000 units for the third consecutive month, and the 539,000 unit-reading, was the strongest since April 2010. As a potential future indicator, we saw housing permits above 700,000 for the fifth consecutive month, both total and single-family permits grow close to 20% on a year-over-year basis. Again, it is important to note that an improving housing market ultimately helps bolster the municipal market, as local governments benefit from increased property taxes, as well as connection fees and other ancillary fees associated with residential construction.

Overall, we think the signs we are seeing in our water markets are mostly positive, giving us more confidence that our markets have stabilized, and we could see some continued growth.

Turning now to our outlook for the fourth quarter. On a year-over-year basis for the fourth quarter, we expect Mueller Co.'s net sales to increase, due to both volume growth and higher prices in our base business. For Mueller Systems and Echologics, we expect to see significantly higher net sales on a year-over-year basis. For example, the backlog at Mueller Systems is up over 60% at the end of July, as compared to the same date a year ago. Generally, we expect raw material costs to be slightly lower year-over-year.

Mueller Co.'s base business is expected to benefit from greater capacity utilization in the second half of this year, compared to the prior year and, therefore, achieve a higher operating leverage. At Mueller Systems and Echologics, we expect operating performance will improve, both year-over-year and sequentially, primarily driven by shipments associated with our recent win. In total, we expect adjusted operating income for Mueller Co. to be significantly higher year-over-year, with improved performance at both our base business, as well as Mueller Systems and Echologics. However, we expect that volume in our base business, and consequently adjusted operating income, will be less than what we experienced in the third quarter of this year.

Now I'll turn to Anvil. We expect to see essentially flat shipment volumes in the 2012 fourth quarter year-over-year, as energy and fire protection markets remain stable, while we expect its industrial markets to remain soft. In total, we expect to see a slight decline in Anvil's adjusted operating income, since we will be negatively impacted by slightly higher per unit costs, due to lower production in the third quarter of this year versus a year ago.

I'll now discuss some other key variables for 2012. Our corporate expenses are estimated to be approximately $30 million. Depreciation and amortization is estimated to be about $61 million and interest expense is estimated to be approximately $60 million, which includes $5 million of non-cash interest expense associated with the terminated swap contracts. Capital expenditures are estimated to be between $28 million and $30 million.

Our effective income tax rate for the fourth quarter of 2012 is expected to be between 43% and 45%. We expect 2012 free cash flow from continuing operations to be slightly greater than $30 million. We continue to improve our working capital efficiency. For example, inventory turns for the 12-month ended June 30, 2012, improved about half a turn from the comparable period -- prior year period. Furthermore, for the latest 12 months, average receivables, inventories and accounts payable, as a percentage of net sales, decreased about 180 basis points from a year ago.

In summary, the data on the residential construction market is trending positive, and we believe we saw some pockets of growth from this market segment during the third quarter. We continue to believe that we are well-positioned for future profitable growth, as end market demand improves and we are able to increase capacity utilization. We are also encouraged by the sales growth we are seeing in both Mueller Systems and Echologics.

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

Question-and-Answer Session

Operator

[Operator Instructions] Our first question today comes from Todd Vencil.

L. Todd Vencil - Sterne Agee & Leach Inc., Research Division

Sterne Agee. You mentioned the pockets of strength in residential demand, and we've talked about that, sort of developing in the past. I'm wondering if you can just update us on where those pockets are, and what you're seeing there, a little more color, please?

Gregory E. Hyland

Yes, Todd. It's hard for us to put an exact dollar number on that. But as we looked in the third quarter and the information we get back from our distributors in our field sales force -- actually, it was in different parts of the country. Arizona and California, surprisingly, we saw some increased activity there. Then Northern Virginia, which is not quite surprising because the Washington D.C. area never has any fall off. But then also, Texas and Florida. So, as I said, it was, as we look -- those 5 states, where I think we saw, a nice uptick in activity.

L. Todd Vencil - Sterne Agee & Leach Inc., Research Division

That's great. And then, in terms of the industrial markets, can you give a little more color on that as well? I mean, how much of the industrial market -- perhaps I should say, how much of Anvil is represented by these industrial markets that you've seen softening? And is there any geographic, or sort of industry concentration in what you're seeing?

Gregory E. Hyland

Good question. And it varies, and what percent of Anvil sales that may be at any given time. I think when you look at it, one of our strengths of the Anvil business, I think, is the diversification of its addressed markets in the non-residential or commercial construction markets. One year ago, we were seeing a very nice increase in spending on upgrading and expansions in the industrial market segment. This would include manufacturing facilities, warehouses associated with the industrial markets. We believe actually, what we were seeing was some pent-up demand, since I think a lot of work has been delayed. As we said, spending in this segment has slowed down. I think that they certainly caught up, and while we are seeing some improvement in other segments of the non-industrial -- the non-residential markets, they haven't yet rebounded to the level to offset the growth we saw a year ago in the industrial segment. So I think when we look at it, we just think it's a -- it could be a couple of quarters of year-over-year timing. Because at any given -- as I said, at any given time, we can see one of our market segments in the non-residential construction, being a little better. And if you look at, I think, those segments other than industrial, they're improving, but still haven't got to the point where demand was at the level that we were seeing in industrial markets a year ago.

L. Todd Vencil - Sterne Agee & Leach Inc., Research Division

Got it. And withou trying to pin you down, I mean, is this industrial, as much as half of Anvil? Or is it?

Gregory E. Hyland

No, no. But when you look at a year ago, we -- the commercial construction -- non-res construction is 75% of our, I've said, of our total, but in every given quarter or a couple of quarters, one of those segments can account for a larger percentage. And that's what we were seeing a year ago. We were seeing the industrial markets rebounding very, very nicely, while the rest is the -- I think the rest of the non-res construction market was flat. Now we're seeing, as I said, some upturn in those other segments, but they're still not back to the point, I'd say, year-over-year growth, than we were seeing in the industrial markets.

Operator

Our next question comes from Jerry Revich.

Jerry Revich - Goldman Sachs Group Inc., Research Division

It's Goldman Sachs. Can you please talk about what was the impact of pricing in material cost in each of the businesses in the quarter? And sounds like it's going to be a pretty meaningful tailwind for Mueller Co. in the fourth quarter. I'm wondering if you could just flesh that out for us?

Gregory E. Hyland

Yes, Jerry. In each of our businesses, our price increases more than offset the higher raw material cost. And I think that, that is going to continue in the -- we'll see some of that in the fourth quarter, too. Though, I think the -- on the Anvil business, we may not see it as much as we did in the third quarter. But I think that's a result, a little bit, of product mix that could impact pricing. And -- but when we look at certainly, at the Mueller Co., we still expect to see a very positive relationship between price and raw material cost.

Jerry Revich - Goldman Sachs Group Inc., Research Division

And in terms of the Mueller Systems and Echologics business, can you just talk about what was the impact on Mueller Co.'s segment, in terms of sales and operating margin as you've framed for us in the past?

Gregory E. Hyland

Yes. When you look at our base business, and I think we said this in the release and our prepared remarks, margins at our Mueller Co. base business were a little over 17% for the quarter. But you can see, as a result of the Mueller -- the Echologics and Mueller Systems, that reduced the overall margin to a little over 13%. So certainly, it had a negative impact on the margin side. If you look at our sales growth in our base business, certainly the growth in Mueller Systems and Echologics contribute to a higher year-over-year sales growth. But if you look at our Mueller base business, sales on a year-over-year business -- a year-over-year basis grew slightly under 7%. So it certainly, it did help boost the overall year-over-year growth on revenue and did have a negative impact on margins. We saw a nice growth in Mueller base business margins from a little over 16% a year ago, to a little over 17% this quarter.

Jerry Revich - Goldman Sachs Group Inc., Research Division

That's great color. And lastly, can you talk about how bookings activity came in for the quarter? And if you could just touch on how demand ebbed and flowed over the course of a quarter? We heard from a couple of construction material and rental companies that demand really slowed into June and into July, and I'm wondering if you saw any of that as the quarter shook out?

Gregory E. Hyland

Yes. Actually, we did. And in fact, if you look at our Mueller business -- now, when I think about -- let me -- I'll discuss that in terms of Mueller, and I'll discuss that at an Anvil. Anvil did see, I think, exactly the situation that you described. And I think that we entered the third quarter with their bookings in April remaining at a nice pace. We did see them slowdown in May and June. So yes, we did see that trend there. Actually, on the Mueller System, it was pretty stable and pretty solid throughout the quarter. And in fact, when you look at our backlog at Mueller at the end of July, and it's important for me to point out the -- I think, backlog certainly, is an indicator, I think, of activity, but on the other hand, most of our products at the Mueller business, we have 2-3 week deliveries. So backlogs will tend to be small because it turns -- they turn quickly. But at the end of July though, they do vary by product line. If look at our core valve, hydrant and brass products, that group, the backlog is up about 18%. If I look at total Mueller Co., it's up about 14%. So all in all, I would say that no. We saw a continued steady flow of bookings throughout the third quarter, and in July, for Mueller, but we did see the slowdown at Anvil, similar to the scenario you described.

Operator

Next question comes from Ryan Connors.

Timothy Feron - Janney Montgomery Scott LLC, Research Division

This is actually Tim Feron, from Janney Montgomery Scott, filling in for Ryan. My first question just deals with the municipal market. You've done a little bit of work there in the past few months, just by taking a look at some of the budgets for the larger municipalities that operate on June fiscal years. It seems like there could be some upside there going into next year? I was just curious to get your take, if you think some municipalities are increasing their water budgets, and what the effect could be on demand over the next 12 months?

Gregory E. Hyland

Yes. Tim, good question. I can certainly answer that perspective of what we're seeing now, and then how we think that may -- how that may evolve. We do believe we are seeing a little growth in municipal spending, and we think we've seen it in the last couple of quarters. I think a good example is the growth in spending that we are seeing this year, for instance, for large transmission lines. Some of that spending is driven by regulation. And some of it, because we just think that they can no longer delay. For instance, we're seeing large transmission for our larger gate valves going into transmission lines that are being installed, driven by the EPA consent decrees, which combine water and sewage storm run-offs. But we're also seeing spending on larger transmission lines, driven by increased failure rate. And I think this is another example of what -- I think we've seen municipalities a year ago, cutting back spending and they got to a point where they just could not continue to hold off any spending. So we're actually seeing some spending on transmission lines that are driven by the need to go to new water sources, that are a result of droughts of several years ago. So I think, Tim, all in all, we think that we are seeing slight growth, and I think that we're comfortable in concluding, that at least the market is very stable, certainly from where this was this time a year ago, and we think it's reasonable, just out of pure need, that we could continue to see a little bit of growth in municipal spending going forward.

Timothy Feron - Janney Montgomery Scott LLC, Research Division

Great. And just to follow up on that. I think, you guys, a couple of quarters ago, talked about some larger projects, both for you and just in general, in the industry, kind of being pushed out further. Do you see some of those projects now that the larger items, kind of come into the point where they can't be pushed off anymore? And...

Gregory E. Hyland

Yes, I think that, that's our conclusion. In fact, in our second quarter call, we referenced that we were getting some orders and seeing a new quotation activity on projects that had been around for several years. So in fact, I think, we specifically commented last quarter that we were starting to see some of those come to fruition. And I think it exactly falls in that category, that they can only be pushed off for so long, and then we're going to have to see -- and then, I think municipalities are just going to have to spend. And, yes, I think we are seeing some of that.

Operator

Next, we have Michael Gaugler.

Michael E. Gaugler - Brean Murray, Carret & Co., LLC, Research Division

Brean Murray, Carret. I'd like to focus a little bit on the metering business, briefly. As you mentioned earlier, you've had a nice wins there recently. And I'm wondering where you go with that longer term. Do you push out into the, maybe the gas and electric markets, where you have some exposure? Some of your other business lines? And do you push out internationally?

Gregory E. Hyland

Mike, great question. And our focus, our focus is really, I think -- we think there's a lot of upside in the water segment, as more and more water systems migrate from AMR to 2-way AMI. And we think we like our technology. Certainly, if you look at the investments that we've made, those costs are flowing through and hitting the income statement, which includes software development, engineering, R&D, sales. These expenses are fixed and semi-fixed in nature. But we've made the investments to be able to support a much bigger business. And I think that we believe that we can leverage our position with our traditional products to move from, what I will say is, smart metering that we define as 2-way AMI, and the smart water infrastructure. So we believe that it's still in the very early stages, and just a very, very small percentage of water municipalities, water systems, have made the switch to 2-way AMI. And we think there's a lot of growth there, and we think that the technology that we've invested in, and continue to invest in, coupled to what we're doing with leak detection, that we think it all comes together in a nice package to just improve the overall intelligence of water systems. So that's where our focus will be. I don't know if that answers your question or not.

Michael E. Gaugler - Brean Murray, Carret & Co., LLC, Research Division

It does a little bit, but again, just wondering -- I mean, it seems like if I'm hearing you correctly, you're going to stay on the water side of the business for quite a bit.

Gregory E. Hyland

Yes. Water as compared to electric, we really had nothing going into the electric. Let me put it this way. Right now, we participate in the electric meter market when a system is operating both water and electric systems, and we have an arrangement with Landis+Gyr, that we source our electric meters from Landis+Gyr, when we have the opportunity to provide our system and the water meter. So I think that will continue to be a focus for us. So sorry, but I don't suspect that -- I mean, I believe that our R&D investment will still be on certainly, the water side, and anything that we can do to enhance our system in the water application. So I do expect that we will continue to go after those water systems and those municipalities, that operate both electric and water systems. And when they want to put in one system to handle both.

Operator

Next question comes from Seth Weber.

Seth Weber - RBC Capital Markets, LLC, Research Division

It's RBC. Greg, a couple of times you mentioned capacity utilization on the call, and how things are getting better. Can you give us an idea where you're at in capacity utilization? And what you think incremental margins or pull-through should be, as we go into next year?

Gregory E. Hyland

Yes, sure, Seth. When you look at -- if you look at our Mueller business, especially our production levels, are up about 15% in the third and fourth quarter. So we've bumped up our capacity utilization, I think in -- across that business segment up into -- in some cases, in the third quarter, we were around 69% at our valve plant, a little less than in some of the other plants. So I would say that if you look at -- they were up from, say, maybe 55%, 50% a year ago to 65%, and maybe up a little more in some other plants. Anvil production was down a little bit, but their overall capacity utilization is up. Our conversion margins are going to vary by product line, but I think we feel very -- that as capacity utilization increases -- and we've said in the past, we look at our valve and hydrant business that we -- that should be over 50% and some of the other products will be at a lower rate. But I think on average, for a Mueller business of 40%, I think that we would feel comfortable based on the mix, and it would be a little less than that at the Anvil business.

Seth Weber - RBC Capital Markets, LLC, Research Division

That's perfect. And then on the new -- the service Echologics business, can you -- I'm sorry if I missed this. But can you frame for us what revenue number you were thinking about what, would get you to breakeven there? Or when we could expect that to be, kind of a breakeven-ish number or profitable next year?

Gregory E. Hyland

Yes, it will certainly depend on mix. But we feel when we look at these businesses and Mueller Systems in particular, that we do expect to be profitable in 2013. And when I say mix -- let me give you a great -- a good example here in mix and timing. We sell both meters and software now and software maintenance services. At this point in our development, we've incurred much greater costs, relative to the development of software, without really accompanying revenue. 60%, 70% of our deployments, our customer will elect to pay us a licensing fee and then on -- an annual license fee, and in some cases, a hosting fee. And we'll collect those annually over a number of years. So while we're in the state of getting those deployments and we're getting those installed, we've incurred the costs to develop a software, but really not collecting the revenue. So I think that, that answer is, as our overall volume increases, that we will start -- these businesses will start being profitable. And as we -- as I said, that we expect that they'll be profitable in 2013. Obviously, the exact timing will depend on our ongoing wins and shipments to existing customers, and there will be seasonality in these businesses. When we get to December, January, February, there's going to be fewer meters installed, and maybe less field work done in -- on leak detection. But all in all, we think that when we look at fiscal year 2013, we expect that it will be profitable.

Operator

Our final question today comes from Brent Thielman.

Brent Thielman - D.A. Davidson & Co., Research Division

D.A. Davidson. Yes, Greg, I was just hoping to get a little more commentary on -- obviously, the market seems to be a little better for you, particularly in Mueller Co. What are the opportunities around price increases there?

Gregory E. Hyland

Brent, we -- relative to price increases, we really focused on -- when you think -- 19 out of the last 20 years, we've had a price increase in the January, February time frame. We did again this year, and I would expect that any short-term or immediate-term price increases would be driven more on what we see happening in raw material costs, and I would say, right now, I think that those look stable. So we -- when we put our quotations in, we look on it on a quotation-by-quotation basis. And obviously, look to what we can achieve on pricing. But I would say right now, we're in a pretty stable cost environment when we look at it from a raw material cost. So I would say, relative to -- and that probably had -- would have the biggest influence on what we do with list pricing, anything we do with our list price, in the short term.

Brent Thielman - D.A. Davidson & Co., Research Division

And then, not to pick on this, but I guess, with regard to the tech divisions, and you mentioned looking for profitability in 2013. I mean, do you think this is achievable in the first half? Or are you thinking more second half?

Gregory E. Hyland

Right now, I think that it's going to depend on timing of shipments, and when some of our backlog is released by our customers. Certainly, as I mentioned, our backlogs are up 60% year-over-year, so we're going into 2013, our next fiscal year, in a much stronger position than we did last year. But there is seasonality, and so relative to the first half of the year, I think it will depend on how much is released in the October, November timeframe. If I do expect it, the market will slow down in the December, January, February time frame. So I would, right now, I would say that there are probably a little too many variables for us to be able to pinpoint exactly what quarter next year.

Gregory E. Hyland

That concludes today's call. So again, thank you for joining us this morning.

Operator

Thank you all for joining. That does conclude our presentation. You may now disconnect.

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