Mueller Water Products' (MWA) CEO Scott Hall on Q2 2017 Results - Earnings Call Transcript

Apr. 28, 2017 4:15 PM ETMueller Water Products, Inc. (MWA)
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Mueller Water Products, Inc. (NYSE:MWA) Q2 2017 Earnings Conference Call April 28, 2017 9:00 AM ET

Executives

Martie Zakas - SVP, Strategy, Corporate Development & Communications

Scott Hall - President & CEO

Evan Hart - Chief Financial Officer

Analysts

Seth Weber - RBC Capital Markets

Brian Lee - Goldman Sachs

Michael Gaugler - Janney Montgomery Scott

Ryan Connors - Boenning & Scattergood

Jim Giannakouros - Oppenheimer

Operator

Welcome and thank you for standing by. At this time all participants will be on the listen-only mode until the question-and-answer session of today’s conference. [Operator Instructions]. This call is being recorded. If you have any objections you may disconnect at this time.

I’ll be turning the call over to your speaker, Ms. Martie Zakas. You may begin.

Martie Zakas

Good morning, everyone. Welcome to Mueller Water Products' 2017 Second Quarter Conference Call. We issued our press release reporting results of operations for the quarter ended March 31, 2017, yesterday afternoon. A copy of it is available on our website, muellerwaterproducts.com.

Discussing the second quarter's results this morning are Scott Hall, our President and CEO, and Evan Hart, our CFO. This morning's call is being recorded and webcast live on the Internet. We have also posted slides on our website to help illustrate the quarter's results, as well as to address non-GAAP disclosure requirements and forward-looking statements.

At this time, please refer to slide two. This slide identifies certain non-GAAP financial measures referenced in our press release, on our slides, and on this call and discloses the reasons why we believe that these measures provide useful information to investors. Reconciliations between GAAP and non-GAAP financial measures are included in the supplemental information within our press release and on our website.

Slide three addresses forward-looking statements made on this call. This slide includes cautionary information, identifying important factors that could cause actual results to differ materially from those included in forward-looking statements as well as specific examples of forward-looking statements. Please review slides two and three in their entirety.

As a reminder, we sold our Anvil in January 2017. As a result, Anvil's operating results for all prior periods and the gain from its sales have been reclassified as discontinued operation. We filed a Form 8-K on February 21st which included the reclassified 2016 results by quarter.

During this call, all references to a specific year or quarter, unless specified otherwise refer to our fiscal year which ends on September 30. A replay of this morning's call will be available for 30 days at 1-800-867-1928. The archived webcast and corresponding slides will be available for at least 90 days in the Investor Relations section of our website. In addition, we will furnish a copy of our prepared remarks on Form 8-K later this morning.

I'll now turn the call over to Scott.

Scott Hall

Thanks Martie and good morning. Thanks for joining us today as we discussed our results for the 2017 second quarter. On the last call I'd only been at Mueller for about a week. It has been a busy period since then. I have enjoyed meeting many of you at conferences in meetings and by phone. It is also been an important time to meet the many talented people across Mueller.

I’ll begin our discussion this morning of the quarter with a brief overview followed by Evan’s more detailed financial report. I’ll then provide additional color on the quarter results and developments in our end markets, as well as our outlook for the 2017 third quarter and full year.

Overall, consolidated second quarter net sales increased slightly due to strong growth at Mueller Technologies. We were pleased to see that the Mueller Technologies’ team grew net sales 20.7% in the quarter.

However, net sales performance at Mueller Company was disappointing as net sales declined 600,000 this quarter year-over-year. This net sales decline was largely the result of lower international sales, as sales outside of North America were down about $3 million.

Taking a closer look at our domestic water sales at Mueller Company we also note that the adverse weather conditions in the Western United States impacted sales in the quarter as well.

Western region water sales were down about 13%, however all other domestic water sales were up about 4%. Despite slightly lower net sales at Mueller Company, adjusted operating margins improved 40 basis points to 19.8%, the 19th consecutive quarter of margin expansion.

The improvements in both adjusted operating margin and adjusted operating income from continuing operations were due to productivity improvement. The team at Mueller Technologies again delivered improved adjusted operating performance this quarter. This improvement was $1.1 million versus prior year, largely the result of the net sales growth.

We recently became aware that in certain environments some of our radios produced between 2011 and 2014 were feeling prematurely. During the quarter we took a discrete $9.8 million charge to meet current and future warranty obligations associated with these products.

Evan will speak more detail about the accounting and handling of the charge. I will speak a little bit about the steps we took to ensure this isn’t repeated in the future. In particular we have approved the manufacturing process, so this particular failure mode won't repeat itself and we instituted accelerated lifecycle testing on all of our radios.

I believe we have correctly scoped and address this problem and implemented the corrective steps to ensure that our products meet industry and Mueller standards for reliability.

As a reminder, we completed a number of strategic initiatives in the second quarter. We acquired Singer Valve in February which added automatic control valves to our product portfolio. We initiated the repurchase of $50 million of shares under the accelerated share repurchase program.

We increased our quarterly dividend 33% to $0.04 per share. We amended our term loan which lowers our interest rates spread and we completed the divestiture of Anvil in early January.

We believe these initiatives demonstrate our ongoing commitment to create long-term value for shareholders. We will discuss our outlook in more detail later, but we continue to expect year-over-year growth in 2017 from demand for our products in our address to water markets. We believe that Mueller Water Products remains well-positioned to deliver long-term value for shareholders.

And with that, I’ll turn the call over to Evan.

Evan Hart

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

Mueller Technologies drove the 1.3% increase in consolidated net sales in the 2017 second quarter. Consolidated net sales increased $2.5 million to $199.7 million as compared with $197.2 million for the 2016 second quarter. Adjusted gross profit improved both Mueller Company and Mueller Technologies and was $62.2 million for the 2017 second quarter compared with $59.3 million last year.

Adjusted gross margin increased 100 basis points to 31.1% in 2017 second quarter from 30.1% in the 2016 second quarter. Selling, general and administrative expenses were $39 million in the 2017 second quarter compared with $37.4 million last year.

The $1.6 million increase was due primary to personnel related expenses including our planned increase investment in product development. G&A expenses as a percent of net sales were 19.5%, slightly higher compared with 19% of net sales in the prior year.

Both Mueller Company and Mueller Technologies contributed to the $1.3 million increase in adjusted operating income from continuing operations for the 2017 second quarter, which was $23.2 million as compared with $21.9 million for the 2016 second quarter.

Adjusted EBITDA for the 2017 second quarter increased to $33.8 million compared with $31.8 million for the 2016 second quarter. For the trailing 12 months adjusted EBITDA was $161.9 million or 20.1% of net sales.

We amended our term loan credit agreement on February 21, 2017. Through this amendment we reduce the applicable interest rate spread by 75 basis points. Interest expense net for the 2017 second quarter decreased to $5.5 million as compared with $5.9 million for the 2016 second quarter.

For the 2017 second quarter, income tax expense of $700,000 was 13% of income before income taxes. We recognize net discrete tax benefits of $1.2 million in the quarter primarily excess tax benefits related to stock-based compensation. We grew adjusted earnings per diluted share year-over-year to $0.09 from $0.07.

I’ll now move on to segment performance beginning with Mueller Company. Net sales for the 2017 second quarter decreased 600,000 to $181.6 million as compared with $182.2 million for the 2016 second quarter.

Mueller Company increased adjusted operating income and adjusted operating margin in the second quarter due to productivity improvements. Adjusted operating income for the 2017 second quarter grew 1.7% to $35.9 million as compared with just $35.3 million for the 2016 second quarter and adjusted operating margin grew 40 basis points despite slightly lower net sales.

Adjusted EBITDA for the 2017 second quarter increased to $45 million compared with $43.9 million for the 2016 second quarter and adjusted EBITDA margin for the quarter increased 70 basis points to 24.8% from 24.1% last year.

And now, Mueller Technologies, net sales in the 2017 second quarter increased 20.7% to $18.1 million as compared with $15 million for the 2016 second quarter. As Scott mentioned we recently became aware that in certain environments some radio products produced between 2011 and 2014 were failing at a higher than expected rate.

Consequently, we refined our estimates and increase the warranty reserve. We've taken a discrete warranty charge of $9.8 million in the quarter to meet current and future obligations of which $8.4 million is now reserved for future obligations.

Turning to discussion of Mueller Water Products liquidity, free cash flow which is cash flows from operating activities of continuing operations less capital expenditures with negative $6.3 million for the 2017 second quarter compared with negative $4 million for the 2016 second quarter.

At March 31, 2017 total debt was comprised of a $480.5 million senior secured term loan due November 2021 and $1.3 million of other. The term loan accrues interest at a floating rate equal to LIBOR plus a spread of 250 basis points. At March, 31 net debt leverage was .9 times in our excess availability under the ABL credit agreement was about $125 million.

I’ll now turn the call back to Scott.

Scott Hall

Thanks Evan. As we analyzed Mueller Technologies’ second quarter, the overall 21% net sales growth was primarily driven by a 40% increase in AMI shipments at Mueller systems. This was the sixth consecutive quarter of year-over-year double-digit growth in our AMI product line.

At the end of the second quarter Mueller systems AMI backlog was up about 12% from the prior year and Echologics added $2.5 million of projects under contract. Mueller Technologies adjusted operating loss of $3.8 million for the second quarter was an improvement of $1.1 million from the prior year due to higher shipment volumes.

This is the fourth consecutive quarter where Mueller Technologies has improved its adjusted operating performance year-over-year. Turning to Mueller Company we again delivered solid adjusted operating performance in the quarter with the 19th consecutive quarter of adjusted operating margin expansion.

Productivity improvements exceeded the 40 basis point increase in adjusted operating margin compared to last year offset by higher raw material costs and price. Looking at our latest 12 months Mueller Company's adjusted EBITDA margin was 28% or a 140 basis point improvement from the prior trailing 12 month period.

Looking ahead to the third quarter and staying with Mueller Company, this year bookings in advance of the effective date of the price increase were lower year-over-year and shipments were comparable between the quarters.

We believe that overall distributor inventory levels at the end of the second quarter were about flat year-over-year. Therefore we have entered the third visibility than we typically have at this time of year.

While we remain cautiously optimistic about end market demand growth from residential construction and municipal markets, uncertainty from less for demand visibility remains for this business.

Mueller Technologies had a strong first half of the year with nearly 17% sales growth. We expect that growth rate to moderate in the second half of the year largely due to year-over-year comparisons.

You’ll remember that last year our third and fourth quarters were our strongest quarters for Mueller Technologies. Second-half growth is expected to come from increased shipment volumes of AMI system and growth of fixed leak detection projects.

For example, we announced yesterday that San Jose water Company has selected Echologics leak detection technology. This project will be the largest deployment of Echologics fixed leak detection technology to-date with more than 10,000 notes deployed throughout San Jose's service area. And we expect that bookings in the third quarter for distribution fixed leak detection products will exceed all bookings for these products to-date.

Looking at the third quarter on a consolidated basis, with the tougher comp in AMI products and the lower pre-buying advance of the effective date of the price increase of Mueller Company we believe third quarter consolidated net sales percentage growth will be in the low to mid single-digit.

From an operating perspective the combination of continued productivity improvements offset by the rising raw material costs environment and the dilution from the Singer acquisition, our expected results in adjusted operating margins for the third quarter comparable with previous year Q3 margins.

We believe that the demand environment for our municipal and residential end markets remained strong over the long-term. But for the full year 2017 we expect consolidated net sales percentage growth to be in the low to mid single-digits much of that is expected to be in the third quarter.

Evan will wrap up now with some other items. Evan?

Evan Hart

Based on our current expectations for the full year corporate expenses will be $33 million to $36 million, depreciation and amortization will be $42 million to $44 million and interest expense will be $22 million to $23 million.

We expect our adjusted effective income tax rate to be 32% to 34% clearly higher in the second half of the year and capital expenditures to be between $33 million and $37 million.

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

Operator, would you please open the call for questions.

Question-and-Answer Session

Operator

Thank you. We will now start question and answer session of today’s conference. [Operator Instructions] Our first question comes from the line of Mike. Your line is open. Mike Wood, your line is open.

Scott Hall

I’m not hearing anything operator if Mike is asking the question.

Operator

Okay. Let’s move on to the second question. It’s coming from the line of Seth Weber. Your line is open.

Seth Weber

Hey, good morning everybody.

Scott Hall

Good morning.

Seth Weber

I guess first just a clarification Scott, are you looking for organic revenue growth for Mueller Co, here in the third quarter of every-over-year, excluding the Singer acquisition.

Scott Hall

Yes, [very slight] I think it’s where I would put itself. I mean, there is going to be some organic growth. I think there were some pent-up demand as we referenced from the west where we have that slowdown and bookings will grow there. So, to answer the question directly, yes, we expect the small amount of organic growth from Mueller Co. in Q3.

Seth Weber

Okay and I guess kind of taking that to the next level; bigger picture, I mean this is going to be your fourth quarter on a row with kind of plus or minus zero growth in the Mueller Co. business. I mean, what do you really think is going on there and what you think is the real kind of sustainable top line growth level for that business. I am trying to reconcile. You have been pushing through price increases pretty consistently, but it’s not showing up on the revenue line. So, I am trying to understand what they kind of inherent volume growth for that business where it is?

Scott Hall

I think the inherent volume growth should be around something like 100 basis points or better greater than GDP. I mean, that’s kind of how I think about the business, many years of neglect in the water infrastructure, so as for a long-term growth that exceeds normal growth for lack of better words. I referenced it my comments one of the things I want to make sure we do as we talk about these things as speak plainly. So, that there is no questions price we have gotten in the past. We have not got it in Q2. In fact, price was about $1 million, unfavorable in the quarter.

So, we had good price for a long time. Certainly, while the raw material was dropping, we were able to get a little bit of price and the spread would open. That certainly reversed itself in Q2. I suspect that’s a lag. They don’t see. I expect we’ll start get support for price now as we start to see. The increase in raw material cost, but we will have to wait and see, but I think the answer to question directly that we should see better than GDP growth in water spending for some time. I think inherently there has to be.

Seth Weber

Okay, that’s helpful. And I guess my follow up question, how are you thinking – obviously you’ve already been there for short time, but if you change your thoughts around capital allocation, you do have the accelerated share program that you announced previously but are you thinking anymore? Are you closer to any M&A or you are thinking about boosting share buyback at all or maybe just you kind of updated thoughts on capital allocation?

Scott Hall

So, let me reiterated that we are on path with when I laid out in our last quarter call where we were examining our strategic options as far as we are to take the business outside of just pure play water infrastructure as we look at this swim lane, but I think I described in detail in the past we have all of that still that work ongoing. We have our board meeting in July still speed up to have that work presented and then something to communicate to you in the after that kind of in the first quarter of next year kind of timeframe when we lay out what our strategic direction is going to be.

We are filling our M&A pipeline. We continue to look at many options, but I think that we are not going to have a knee-jerk reaction here. The bulldogs certainly will continue with what if there is going to be a new leg of the stool so to speak. It’s not going to come, because somebody put an offering memorandum out or something like that.

Seth Weber

Very helpful, thanks a lot guys.

Scott Hall

Thank you Seth.

Operator

Our next question comes from the line of Mr. Brian Lee. Your line is open.

Brian Lee

Hi, guys. Thanks for taking the questions. Just to follow up on the guidance point on the low to mid-single-digit guide for the year, it’s some change from the mid-single-digit number from your prior outlook. Is that all from Mueller Co. or can you maybe provide some context on the mid-single-digit in 15% growth targets you had laid out from Mueller Co. and Technologies on the last call?

Scott Hall

Yes. Thanks for the question to clarify. I think overall, we are moderating our view to how much growth we will get in the Mueller Co. business in 2017. I have been here a quarter now and I have seen the bookings and the trends that I think that there is really mixed kind of messages from the market as far as where the growth is going to come and how sustainable that is in the new term.

I do believe the team has had a difficult environment. I can’t point to a single municipality that said, “Oh! I am not going to do what I said I was going to do, but I do think that the pent-up demand has been muted by people waiting for this infrastructure spending, and so I think that uncertainty doesn’t look like it’s going to be fixed anytime soon. So, I think it’s proven to kind of – so I think that number is going to be in the three or lower kind of range for Mueller Co., but the AMI trends remain strong. So I think that our success rate with AMI and where our growth is coming from. I still expect that business to deliver 15% and I expect that business to give us better conversion on the [growth life]. Frankly, I expect it to give us better conversion on the growth than they gave us in Q2. We’ve got some work to do there and we are working on it.

Brian Lee

Okay. Thanks that’s super helpful. Maybe Scott just staying on Mueller Co. for a second, year, you mentioned the weakness in the international [segway]. Can you remind us how much international exposure you have there? I am assuming it’s mostly north of the border here and then how much of that is playing into your sort of slightly downgraded view of Mueller Co. outlook? Was that the biggest surprise outside of maybe the California whether on the quarter?

Scott Hall

Yes. So to be clear, I said outside North America, Canada remains okay. Not great, but okay. Really it’s [maybe] Latin American problem in the quarter and part of it is complex. It’s about 5% of the business, but I think the outlook for it could be difficult in Q3 at the end as well.

So, I think Middle East mostly though I think is where we are experiencing the softness and I don’t know the outlook right now, we’ve got a couple of things in hopper that could get them back to kind of breakeven, but right now our forecast is breakeven for that non North American piece of the market, but through [summer script].

Brian Lee

Okay, great. Last one from me. I will pass it on – just on the – you had eluded to the rising raw material cost and the guidance here for fiscal Q3 as for operating margins to be relatively flat year-on-year. How should we think about the trend in and margins here in that context of may be a tougher year-on-year environment from the raw materials cost perspective. Just curious to hear your take on what we should be thinking there. Thanks.

Scott Hall

Okay, no problem. Thanks for the question, because I kind of want to spend a little time on this. So, in my prepared comments I said, we had about 40 basis points improvement in Mueller Company and if you really dig into where the productivity came from, there was some material usage productivity. There were some machine utilization productivity and then there were some – mostly some in-sourcing absorption productivity that were really strong in the quarter that I want to make sure everybody realizes, and if you think about the difficulty they had from the volume point of view then you go ahead and layer in the ballpark $1 million of inflationary pressures they felt in their raw material buying and $1 million or so of price pressure we felt year-over-year price declines.

Manufacturing team basically delivered the 40 basis points, plus 2 million and incumbent such their spending, so that there is a little of lower volume, also didn’t hurt margin. So, I am very pleased with the situation and awareness and the execution at Mueller Company around that. With that said, I have no reason to expect they can’t deliver similar performance in Q3 from an execution point of view, but I have cautioned you to when you think upon the margin in Q3, the reason I am calling it flat is because I haven’t said we are going to get that price back and I haven’t said we are not going to be able to feel those same inflationary pressures.

If we are able to move the price in the market as we are certainly trying to recover those increase raw material costs then I think we could have some margin expansion, but I was [very clan] in the discussion that, that’s not in what’s right now, because I haven’t got a long history of being successful and say, oh, I am going to raise price and put it on [the talk] there’s always some dynamics there that we forget or it’s difficult in the industrial market. So, I have got it flat, but yes price in sustentation of the inflationary pressures would be upside in the quarter.

Brian Lee

Okay, thanks guys.

Operator

Thank you. Our next question comes from Mr. Michael Gaugler. Your line is open.

Michael Gaugler

Good morning everyone.

Scott Hall

Good morning.

Michael Gaugler

Scott on the last call you mentioned you were anxious to get out on the road and visit the plants. Perhaps you could provide us with some color on what you found, particularly in the area of opportunities to improve margins.

Scott Hall

I think – well, thanks Michael. I think the tour has been first of all fantastic and I think the team that I have been happy to hear is they’re very talented than and I think our employees are really motivated.

With that said I think that as you think about self-directed workforce you think about [solid] manufacturing, you think about single piece flow. There was opportunity at all the plants I have been to, to improve. Somehow quite large opportunity set and others are near world-class. I would really like to applause the team in Alabama. It’s the best probably I have ever been in and great visual system. Exactly where they are, your production schedule every day, every way where they are and your assembly schedule, the flow on the plant is all things that you can see what operation is going to happen next in impressive facility.

On the other end, things are some that I think other investment in certain places. So, I think between summer machine jobs and some other foundries there was opportunity as it relates in the brass business and in the gauge valve for margin expansion, both through combination of investments and relaying out some of the plants and thinking more about flow.

Now, the thing I normally would do here is try and quantify it for you and give you 100 basis points here or 200 basis points there. I think there is enough of an opportunity set that we conceptually at a high level should be thinking about margin expansion of somewhere around 50 to 75 basis points a year and then I think we’re under invested in our engineering resources as it relates to new product development and some piece of that being reinvested back into the engineering and product development piece of the business.

Michael Gaugler

Okay. That’s good color. Then as a follow-up regarding the San Jose water announcement, should we expect to see other announcements like that from large well-known water utilities in the near future.

Scott Hall

We have a couple of things in the [hopper] that we know that we’re optimistic of. So, yes, and as I said in my comments, we expect the distribution, leak detection product, that DS product actually in Q3 take more orders in for each of the next foreseeable quarters then all previous years’ sales. So, it’s finally catching on I think the success we’ve seen in the trials we’ve run. The leak locates have the efficacy of this product is starting to catch on. We really think we may have. We are hoping with top lighting and above here, but it’s too soon to call it, but early indications are really exciting.

Michael Gaugler

All right. That’s all I had. Thank you.

Scott Hall

Thank you.

Operator

Thank you. Our next question comes from the line of [Jose]. Your line is open.

Unidentified Analyst

Good morning guys.

Evan Hart

Good morning.

Scott Hall

Good morning Jose.

Unidentified Analyst

Hey Scott! You gave some good color on Mueller Tech. business. I’m just wondering if your expectations are still for kind of the profitability improvement in that business over the course of the year that maybe you guys had at the beginning of the year.

Scott Hall

So, I realized when I am talking on this, there are employees listening too. My expectation is just we can made it to $10 million of operating improvement when we developed our plant and if we are going to have a culture of execution we do what we say we are going to do.

With that said I think I will look at the conversion we’ve got in the quarter. We increased sales 3 million and we’re only doing $1.1 million of operating improvement that I would have expected there to be in the 1.5 to 1.7 range kind of number. So, I realize we have some risk and there’s probably on that $10 million of year-over-year improvements there is risk, but if you are going to have a culture of execution then you find ways to develop your countermeasures. You take other actions that meet your commitment levels and so we have to review those plans for technologies and it can’t just be always sell your way out of trouble. Sometimes you have to look at the cost structures, you have to look at your inputs and so to answer the question directly, I still expected, but I recognized have seen Q2 performance that there is a little bit of risk.

Unidentified Analyst

Okay, that’s very helpful. And maybe Evan you can help on this one. What’s kind of the expectation for the warranty expense kind of going forward and it kind of [cadence] to that you got?

Evan Hart

Well, Jose with this particular issue as we mentioned we did record about $9.8 million in the quarter and we were left with about $8.4 million warranty reserve for this particular item and I will note that back in Q1 we saw about $800,000 of expense for this particular problem and that really was the catalyst for us to take a more detailed look, do a in-depth study and we’d find our estimates to come up with the particular charge in the second quarter.

We think that the charge is adequate and sufficient to cover these issues with the [radius] produce between 2011 and 2014. I think going forward we will just have a normal warranty charge provision that we’ve always had and so there is nothing expected from a large magnitude like this in the future.

Unidentified Analyst

Okay.

Scott Hall

And I would like to go and say that we did the advance lifecycle testing Jose on the things made after 14. We have been running those environmental tests and the failure rate has been better than industry averages by a lot, like 0.04%.

Unidentified Analyst

Okay. That’s helpful.

Scott Hall

So, I feel like the team – I wasn’t here, but whatever the change is when they realize they were having some of these issues and basically for everybody’s benefit it’s when they are underwater in a pit environment in warm climate that’s when they really start to have a problem.

Unidentified Analyst

Okay. And just any changes in terms of the raw material that you saw throughout the quarter that you kind of extrapolating into the rest of the year or is it roughly the same across both businesses?

Evan Hart

I would say this. When you take a look at our two largest inputs, scrap sale, where I think in the second quarter, they were up about 5% and as a reminder that accounts for about 15% of cost of goods sold related Mueller Company and that was roughly around $1 million impact in the quarter for us. I think as we go forward I think the data to forecast that are calling for mid to say 9% increase in those raw material input. So, I wouldn’t say anything a significant at this point on the rising, but I think it will be faced with a little higher input cost in the third quarter as well.

Unidentified Analyst

Okay. Very helpful. Thanks guys.

Scott Hall

Thank you.

Operator

Thank you. Our next question comes from the line of Ryan. Your line is open.

Ryan Connors

Thank you. Yes, Ryan Connors with Boenning & Scattergood. I wanted to just kind of drill down on this pricing issue a little bit Scott and I am little surprised about the pricing. I want to understand some of the dynamics behind that you mentioned in your comment earlier that there always these dynamics that crop up the impact price, but my understanding of Mueller Co. has always been that even though it might not have the sex appeal of Mueller Tech. it’s oligopoly market, that even maybe duopoly with some of the products and issues and pricing has always been very rationale. So, in this kind of environment where we’ve got raw material price cost up and the demand environment is at least okay if not phenomenal or at least certainly serviceable. I mean, what are those dynamics that are preventing you from getting price. Is it some kind of bad actor in the market that’s suddenly acting a irrationally or is it some channel issues. I mean, anything you can give us in terms of why that’s happening?

Scott Hall

Yes. I can give you my theory. And I’m happy to do that, but it is just that. I mean, here’s what’s happened. I think that last year we announced the price increase just as did this year. And in anticipation that price increase, distribution took a whole lot of orders in a pre-buy. Certainly, $15million, $20 million more than you would anticipate, a normal February being. They bought that, they pre-bought in Q3 and then raw materials ran away, they ran down. And so, competitive forces being what they were in the first quarter basically our first fiscal quarter basically the pre-buy that did in our Q2 for their shipments in Q3 didn’t actually result in higher gross margins for them.

Why does the distributor pre-buy? They pre-buy for their gross margins they belong. They get the benefit of the lower cost, but they get to sell into the higher price market. Raw materials ran down and pricing was basically flat. Price to price was flat. So this year you come along and everybody announces a price increase. Distribution doesn’t pre-buy. And so now, inventories are getting heavy in the distributor lanes, and so they now come out with their buys and people being hungry and not having the visibility. All of a sudden now might be willing to discount the level. Is there are a bad actor in the market? Yes. There’s a bad actor in the market might be in somebody’s not got the discipline to keep where there need to be.

And I’ll say it’s not so much around hydrants as it is around valves and brass. So, when you look at where the price came out, that’s part of it. The other thing I want to make sure everybody understands is when you think about our products think about the deeper they go in the ground the more valuable they are. So a fire hydrants with a 10-foot stuff for Canada sales for more money than our fire hydrants been has a white barrel and basically it just got the L going under the surface of the ground.

And if you think about what we lost at west as an average, weighted average price on a fire hydrants, but you think about what we loss at west as a result to the rain, that also play kind of almost like a regional mix impact on our price. So I think those were the two big drivers of why we’ve had the difficult price environment in Q2 than we traditionally have Ryan.

Ryan Connors

Got it. Well, that’s maybe only theory, but that’s very helpful one. Now, my second question is actually related in that bigger picture, but as you look at capital deployment there been a number of companies, some of them in the metering side, some of them for were in the pump side and elsewhere that has started to kind forward integrate into their channel and distribution, started to go into more of a corporate channel as opposed to the traditional third-party channel.

So, obviously you’re going to tip your hand in terms of whether that something that’s being tactically contemplated. But what's your view of that as a concept? Is that something that at any point you think would make sense or do you feel that the traditional channel is the way to go?

Scott Hall

I think the whole channel question is a fascinating discussion and I think this intermediation and more direct sales as you see more municipalities try to entering the [MWBE] space and disable that trend and I think there a just a ton of dynamics going on in the channel right now. You see potentially the HB supply could be after waterworks for sale, could go P/E, go strategic buyer. So there’s a lot of moving pieces there.

That said, I am not sure on our core competency is ever going to be round putting together the portfolio if you need to be a successful distributor. I had distribution business previously in my career and I can tell you to make them successful and add value to people that use them generally a lot of what you have to be good at manufacturing are not necessarily things you're going to be good at to be distributor. And therefore, while it remains the possibility it’s something that I would give a very very low probabilities, it’s a [top class].

And the other thing I would say is, when you’re number one in well established channel, very, very difficult to go into competition with your customers. And so, it’s always a play of the distinct player to try to take that role to disrupt the distribution channels because they're really not getting their fair share of the distribution channel, so probably not something that we see Mueller do.

Ryan Connors

Got it. Well, it’s [very excited] and thanks for your time.

Scott Hall

Thank you.

Operator

Thank you. Our next question comes from Jim. You line is open Jim.

Jim Giannakouros

Hi, Jim Giannakouros from Oppenheimer. Thanks for taking my questions. I understand you’re pleased with acquisition and plans, appreciate that you’re doing good things in there’s, is there investment and plan that we should be cognizant of when thinking about incremental margin progression as capacity utilization clears 70% and heads up from here?

Scott Hall

Well, I don’t think there’s anything massive, so I think that we’re not contemplating Jim, a big new foundry. At this point I think that there's enough available capacity. I think there’s enough fine-tuning. I think there’s enough square footage and other things that we – if we needed a well furnish at some point we could buy both.

So, I don’t think there’s any massive depression load coming in the next two or three years. With that said, I think that there is a modernization that needs to happen. Indicator, there is modernization it needs to happen in [Indiscernible] so that there’s some modernization that needs to happen, Cleveland, North Carolina. So I think that there will perhaps, as I said in the last call $4 million, $5 million, $6 million kind of incremental CapEx for some period of time as we fixed the machine tool, utilization part of the business and improve our assembly capabilities those kinds of things but not anything major.

Jim Giannakouros

Got it. Okay. And apologize, I did hop on a little late here. Quite a few comments on the muni side, of course a head of clarity on stimulus et cetera that you're seeing. Any comments on how residential, I guess either housing starts or more specifically new community development is tracking versus your expectation? Curious to the outlook view through your lens, our checks and read certainly suggest strength but your results certainly don't stack up? Thanks.

Scott Hall

Yes. I think that’s one of the things we’re trying to connect the dots on. We feel good about what we’ve seen in housing starts and land development. I think single-family units were strong in January and February, and I think we were tracking pretty at January and February. We’ve single-family dwelling. And then, March was a bit of cliff that fell off. I think part of that was weather-related as I think when you look at the housing starts date, I think March actually on an annualized basis seasonally adjustments was down from the January, February, try to muting what is good fundamentals going forward for strengthen in land development. If you think about brass, it’s predominantly residential and that's an area that we've got to start getting some growth from here in Q3 that we’re going to be our and your expectations.

Jim Giannakouros

Okay. Thanks. And a clarification point, I think it was one that asked on pricing. I surprised as well, you did say that there is “bad actor” but where's the pressure coming from? Are you feeling the pressure is from distributors that may have inflated inventories or can you just provide a little more color there because I kind of miss point on where exactly the pressure is coming from?

Scott Hall

Okay. So let me try and give you some clarity. If you look at the average price that I sold a distributor in Q2 versus the average price I sold a distributor the exact same product Q2 year ago. That is down ever so slightly, like less than $100,000. If you look at how much [Indiscernible] valve is going forward that’s getting buried in Las Vegas versus one that’s getting very in North Florida. You will see that same valve has a different price and I’m making those up, and now we should take away and say, the actually regional pricing difference is such that losing a lot of the west volume as a weighted average cost us about $0.5 million and then about 400,000 kind of comes from the mix of different deals between customers.

So, you might get a rebate or you might take the answer, you might get that and somebody else doesn’t, free terms and things like that are also part of our price. So, it’s a complex subject and I want to give too much away on in terms of the competitive dynamic, but at the same time it's something that I can tell you we have [our rung] around and we’re watching very very carefully. There should have been better support regardless of fall sides of the price increase in valves and hydrants. There’s been another increase for brass that’s recently been announced and we haven’t baked any of it in to our forecast because we got to wait and see how everybody behaves and hope we’ll be watching it carefully.

So to summarize part of it is the regional difference in pricing, part of it is the mix of large distributors versus small distributors and then part of it is just some small amount of year-over-year price degradation.

Jim Giannakouros

Thank you. That’s helpful.

Operator

Thank you. Our next question comes from the line Joe. Joe, you’re line is open.

Unidentified Analyst

Hey, guys. This is actually [Indiscernible] from Joseph Giordano at a Cowen today. Thanks for taking the question. I believe that Singer Valve has a much more global – is much more global than other businesses that you have. Have you already identified some opportunities where you might be able to like go back to these global customers and introduce your full range of products?

Scott Hall

Yes. That part of integration is, what we think about the synergies. We are looking where they can take us and their channels are established and we are looking where we can actually grow their presence in our existing channel. And so, whether we do some Mueller branded private control valves or Singer’s channel can actually [take key] valves and butterfly valves and the [white] into their market, certainly those are the things that we’re working on and that we’ve identified.

What I think to be fair to the development team out there, I think the channel development work is more than in immediate quarter kind of time line, so when we think about where that growth is going to come from, we think about those developing infrastructures around the world, we think that the sale cycle on those is measured in quarters not in days.

Unidentified Analyst

Okay. Thanks. And then I think one of your competitor has mentioned that they have remote disconnect capabilities which I think you were probably one of the few companies to open now. Could you remind us some the spec that separates you from your competition? Thank you.

Scott Hall

Yes. I think that’s a biggest difference is A, for everybody benefit we are partnering with our radio technology. And B, our actuation technology is such that we’re not going to denigrate anybody’s but we’re confident that we have more than 50% advantage in battery life usage when you actually have to use the RDM, ours is the most efficient from a not having to back out and replace the battery and get – I don’t want to be incorrect there, so somebody clean me up if I’m wrong, but I think twice as many actuations where you can actually turn off and turn back on the meter without actually having to service the battery. So very few are tough roles if you use our solution than anybody else’s. And basically it’s because we partnered the valve and the actuation methodology that is the most power efficient.

Operator

Our next question comes from the line of [Indiscernible] your line is open.

Unidentified Analyst

Good morning.

Scott Hall

So, last quarter AMI backlog was up 70% from the last year this quarter around 12% so what’s the average time expect to turn that backlog into revenue?

Scott Hall

Great question that I’m not trying to doc here, but I am trying to get some clarity on for ourselves. I think the behavior here is that you get your award and contract from your municipality or from your PUC, and you get a target date when they're going to start their install. And then you get another target data, when they're going to start their install. And then as you get closer you get refinements, so all stuff that’s been awarded and contracted is on book.

What is really, really difficult to estimate the time and until we get within the 90 day window when they’re actually going to use the resources to put across in the field to start the changes. And the part that’s really I think we’ve got a fair deal of clarity around is the part where its new construction, new homes are going up and they are being sold, that’s got some clarity around it, it’s the swap programs that the estimates are very wildly on in. So, I know it's a very satisfying answer, but the answer is we miss on the contracted pieces by 90 or 180 days quite often.

Unidentified Analyst

That helps. And then looking at I guess acquisition scenarios for the Mueller Technologies segment, is there an area that you would consider to complement what you have and also for Mueller Co can you find adjacent business operating at the market profile you do in that business?

Scott Hall

I think the margin is difficult. I understand the margin dilution discussion, but very much we have to create opportunities if we can make investments that exceed our weighted average cost of capital and then we’re creating value. And sometimes the margins – EBITDA margins would be dilutive and sometimes hopefully there’ll be accretive, but this is a very, very good business, we have with Mueller Company from an EBITDA margin point of view.

But I also think that there are adjacencies out there that we can absolutely get into lever and be successful. As per Mueller Technologies, I'm less inclined right now to do acquisitions. I think there's a lot of operational heavy lifting to do in front of that business. I think, I said it earlier also I think that conversion had been strong on the 3 million of volume and you’d say okay, they are executing and every things running exactly the way you want it to run. And then you would consider that they have the capacity for integration, but I don't think where they are right now, and so I would expect to see a little more execution if you will in systems business.

I think in the Echologics business, it’s a different challenge. I think that their order book has swollen I think the challenge of the San Jose water thing, we have to be mindful if there could be pieces there that we would need to bolt-on to increase their capabilities, increase their assembly capacity, and that I would certainly do, because I think the future is bright there and I think we have enough operational excellence in Mueller Co and in other parts of the business that we can make sure that business grows with full potential by levering what’s internal.

So, more volume to do adjacencies willing to bolt-on [Indiscernible] and Echologics want to see some execution on technologies first – I’m sorry, systems first.

Operator

Thank you. I show no question at the moment.

Scott Hall

Well, let me thanks everybody and that will wrap this up for today. And Martie if you have anything, you want to say to wrap up, we’ll go from there.

Martie Zakas

Nothing. Thank you all very much.

Operator

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

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