Nov 3, 2016
Executives
Marietta Edmunds Zakas - Mueller Water Products, Inc. Gregory E.
Hyland - Mueller Water Products, Inc. Evan L.
Hart - Mueller Water Products, Inc.
Analysts
Brendan Shea - RBC Capital Markets LLC Jose Ricardo Garza - G.research LLC
Operator
Welcome and thank you for standing by. At this time all participants are in a listen-only mode.
This call is being recorded. If you have any objections you may disconnect at this point.
Your host today is Ms. Martie Zakas.
Ma'am, you may begin.
Marietta Edmunds Zakas - Mueller Water Products, Inc.
Good morning, everyone. Welcome to Mueller Water Products' 2016 Fourth Quarter Conference Call.
We issued our press release reporting results of operations for the quarter and full year ended September 30, 2016 yesterday afternoon. A copy of it is available on our website, muellerwaterproducts.com.
Discussing the fourth quarter and full year results this morning are Greg 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 to help illustrate the quarter's and full year's results, as well as to address forward-looking statements and our non-GAAP performance and liquidity measures. At this time, please refer to slide two.
This slide identifies certain non-GAAP financial measures referenced in our press release, on our slides and on this call, and discloses the reasons why we believe that these measures provide useful information to investors. Reconciliations between GAAP and non-GAAP performance and liquidity measures are included in the supplemental information within our press release and on our website.
Slide three addresses forward-looking statements made on this call. This slide includes cautionary information, identifying important factors that could cause actual results to differ materially from those included in forward-looking statements, as well as specific examples of forward-looking statements.
Please review slides two and three in their entirety. During this call, all references to a specific year or quarter, unless specified otherwise, refer to our fiscal year.
Our fiscal year ends on September 30. A replay of this morning's call will be available for 30 days after the call at 1-866-513-1238.
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.
After the prepared remarks, we will open the call to questions. I'll now turn the call over to Greg.
Gregory E. Hyland - Mueller Water Products, Inc.
Thanks, Martie. Thank you for joining us today, as we discuss our results for the 2016 fourth quarter and full year.
I'll begin with a brief overview, followed by Evan's more detailed financial report. We are pleased that we continued to see margin expansion in all three of our businesses, which contributed to a 7.6% increase in adjusted operating income in the fourth quarter and which more than offset the impact of a slight decrease in revenue.
For Mueller Water Products, adjusted EBITDA margin for the 2016 fourth quarter improved 120 basis points to 20.4%, and our adjusted EBITDA for the year increased to $198.1 million. Free cash flow was $105.7 million for the year or 132% of adjusted net income.
Mueller Company's domestic sales of valves, hydrants and brass products increased 4.4% in the fourth quarter year-over-year. This growth was not enough to offset the expected sales decline of our Henry Pratt water treatment valves.
Mueller Company again had strong margin improvement with adjusted EBITDA margin improving 150 basis points to 30.3%. Anvil's net sales for the 2016 fourth quarter decreased 7.3% due to lower shipment volumes into the mechanical and oil and gas markets.
Despite lower net sales, Anvil's adjusted EBITDA margin increased 90 basis points this quarter. Mueller Technologies showed meaningful operating improvement in the fourth quarter on essentially flat year-over-year net sales.
Favorable product mix contributed to this improvement. For Mueller Water Products, we again improved our adjusted operating performance in 2016 representing the seventh consecutive year of operating margin expansion.
Our 2016 adjusted net income improved nearly 25% compared to the prior year and 2016 adjusted EBITDA margins was the highest in our history. We ended the year with net debt leverage down to 1.5 times.
Adjusted net income per share for the quarter was up 21.4% to $0.17 versus $0.14 a year ago. For the full year adjusted net income per share increased 25% to $0.49 compared to $0.39 last year.
As we look to 2017, we expect continued growth in our key end markets. As capacity utilization increases; we believe operating leverage will continue to be strong in all three businesses.
I will provide additional comments on the quarter's results and developments in our end markets as well as our outlook for the 2017 full year and first quarter later in the call. With that, I'll turn the call over to Evan.
Evan L. Hart - Mueller Water Products, Inc.
Thanks, Greg, and good morning, everyone. I'll first review our fourth quarter consolidated financial results and then discuss segment performance.
2016 fourth quarter net sales decreased $8.9 million or 2.9% to $302.5 million compared with $311.4 million last year, primarily due to lower shipment volumes at Anvil. Gross profit improved $103.6 million for the 2016 fourth quarter from $97.7 million last year.
Gross margin increased 280 basis points to 34.2% from 31.4% in 2015. Selling, general and administrative expenses were $55.2 million in the quarter, compared with $52.7 million last year.
The increase was due primarily to personnel-related expenses. Adjusted operating income for the 2016 fourth quarter increased 7.6% or $3.4 million to $48.4 million as compared with $45 million last year.
Operating performance improved at Mueller Company, Anvil and Mueller Technologies. Adjusted EBITDA for the 2016 fourth quarter increased to $61.8 million compared with $59.9 million last year.
In 2016, adjusted EBITDA was $198.1 million. Interest expense net for the 2016 fourth quarter was $5.6 million, down from $5.8 million last year.
For 2016, interest expense net was $23.6 million, the lowest in our history. For the 2016 fourth quarter, income tax expense of $14.6 million was 35.5% of income before income taxes.
Adjusted net income per share improved to $0.17 for the 2016 fourth quarter compared with $0.14 last year. I'll now move on to segment performance beginning with Mueller Company.
Net sales for the 2016 fourth quarter of $190.1 million, decreased $1.9 million as compared with $192 million last year. Domestic shipments of valves, hydrants and brass products increased 4.4%, but were more than offset by lower shipments of water treatment valves at Henry Pratt.
We experienced strong improvement in adjusted operating income in the 2016 fourth quarter, largely due to favorable product mix, lower raw material cost and other cost savings. Adjusted operating income improved 7.2% to $48.9 million as compared with $45.6 million last year.
Adjusted operating margin improved 190 basis points to 25.7%, as compared with 23.8% last year. Adjusted EBITDA for the 2016 fourth quarter increased to $57.6 million compared with $55.3 million last year.
And adjusted EBITDA margin increased 150 basis points to 30.3% from 28.8% last year. The 2016 fourth quarter was the 17th consecutive quarter where Mueller Company increased year-over-year adjusted operating income and adjusted operating margin.
Continuing with Anvil, net sales decreased 7.3% to $86.9 million for the 2016 fourth quarter compared with $93.7 million last year. Lower shipment volumes primarily of mechanical and oil and gas products were partially offset by increased sales of fire protection products.
Operating efficiencies and other cost savings more than offset the impact of lower net sales and adjusted operating income improved to $9.5 million, as compared with $8.9 million. And now concluding with Mueller Technologies.
Net sales for the 2016 fourth quarter were essentially flat year-over-year. Shipments of our higher margin AMI products increased $3.1 million or 42% year-over-year, but were more than offset by lower AMR shipments.
AMI shipments represented almost 50% of Mueller Systems' total net sales in the quarter. For the 2016 fourth quarter, Mueller Technologies' adjusted operating loss improved $1.3 million, despite essentially flat sales and adjusted operating margin improved 500 basis points due to favorable mix and lower overhead costs.
Now turning to a discussion of our liquidity. Free cash flow, which is cash flows from operating activities less capital expenditures was $54.7 million for the 2016 fourth quarter.
Free cash flow for the full year was $105.7 million, $55.4 million higher year-over-year. At September 30, 2016, total debt was comprised of a $483.1 million senior secured term loan due November 2021; and $2 million of other.
The term loan accrues interest at a floating rate equal to LIBOR, subject to a floor of 75 basis points, plus a margin of 325 basis points. In April 2014, we entered into interest rate swap contracts that effectively fixed the interest rate on $150 million of term loan borrowings at 5.6% from September 30, 2016 through September 30, 2021.
Our excess availability under the ABL Agreement was $169 million. Net debt leverage improved to 1.5 times at September 30, 2016.
I'll now turn the call back to Greg.
Gregory E. Hyland - Mueller Water Products, Inc.
Thanks, Evan. I'll now comment further on our 2016 fourth quarter results and end markets and provide an overview of our expectations and outlook for the 2017 full year and first quarter, beginning with Mueller Company.
While Mueller Company's domestic sales of valves, hydrants and brass products grew 4.4% year-over-year, this was below our expectations. We saw a nice growth in orders in the third quarter and that continued in July.
However, we did see orders slow down in August through mid September. Orders rebounded somewhat at the end of September.
Even though we had an easier comparison during this time period from a year ago because of the weather issues in May and June of 2015. In retrospect, we believe our distributors were building inventory in the third quarter and early in the fourth quarter and as a result, slowed down their ordering in August and most of September.
In addition, I would again point out, as we discussed on our last call, we had a very difficult comparison for Pratt product line revenue this quarter. As we have mentioned a number of times, Pratt plant work is project driven and is subject to significant swings.
The fourth quarter last year was our best quarter in several years. Pratt sales were down 16% this quarter.
However, our backlog grew and is up entering 2017. Despite slightly lower net sales, Mueller Company's adjusted operating income improved in the fourth quarter, benefiting from favorable product mix, ongoing cost-saving initiatives and lower raw material costs.
The 2016 fourth quarter is the 17th consecutive quarter where Mueller Company increased year-over-year adjusted operating income and adjusted operating margin. For the full year 2016, Mueller Company's adjusted operating income increased 11.7%.
This increase reflects not only a favorable mix, but also an improvement in operating performance. With our Lean manufacturing initiatives, we continue to achieve efficiency improvements.
Additionally, we have been making capital investments to introduce more automation into the manufacturing process. With the results we realized in 2016 and what we expect to achieve moving forward, we believe we are gaining benefits from both operating performance and operating leverage as capacity utilization increases, leading to margin expansion.
Turning to Anvil, end market demand for Anvil's products was mixed. As we expected, sales of our products that go directly into the oil and gas market were down year-over-year.
Demand from our addressed industrial markets, especially those segments related to oil and gas, was also down. Sales of our fire protection products, however, were up approximately 5% year-over-year and accounted for about 25% of total sales.
As we have discussed in the past, Anvil's sales into the oil and gas market have closely correlated with the U.S. rig count, current rig count has declined 28% from last year and is down 71% from two years ago.
The active rig count has increased 16 weeks out of the last 18 weeks, which is a positive indicator. Also during the quarter, we announced that we will be closing Anvil's facility in Longview, Texas, which is dedicated to the manufacturing of products sold into the oil and gas market.
We will be consolidating those operations with Anvil's manufacturing facility in Houston. This move will not only reduce our fixed cost in the short-term but we expect to realize higher conversion margins when volume increases.
We expect this consolidation to be completed by March 2017. Despite lower net sales, Anvil's adjusted operating income improved 6.7% and adjusted operating margin improved 140 basis points, driven by increased operating efficiencies and other cost reductions.
Anvil's revenues declined $32.8 million in 2016, largely attributable to sales of products into the oil and gas market, which are typically at a higher margin. It is worth noting that even with this level of revenue decline, Anvil's adjusted operating income only declined $1.6 million.
And its adjusted operating margin improved for the full year. Anvil's continued focus on operating efficiencies in its manufacturing plants, coupled with lower raw material cost and other cost savings, contributed to its ability to manage through a challenging end market environment.
Mueller Technologies, although Mueller Technologies fourth quarter net sales were essentially flat, we were pleased to see substantially higher sales of our fixed and mobile leak detection solutions, and our AMI products. These increases were offset by a year-over-year decline in AMR sales, primarily to one customer, as we have discussed in the past.
This is the last quarter where we will have this negative comparison. Mueller Technologies' operating performance improved $1.3 million compared to last year, and its operating loss was $500,000.
Mueller Systems was again profitable for the quarter. In June of this year we were awarded a project for an AMI system and meters for Lee County, Florida.
Though we initially expected to begin making shipments for this project in the fourth quarter, we did not receive the contract until late October and will begin shipping for this project in the first half of fiscal 2017. This 80,000 endpoint project is one of the larger AMI orders Mueller Systems has received and will be deployed over the next three years.
We enter 2017 with a strong backlog at Mueller Systems, especially for AMI products. The market remains in various stages of early adoption for some of our offerings, but the growth we continue to see in these businesses reinforces our strategic focus on higher margin technology products.
Moving on to our outlook for fiscal 2017, I'll first discuss our key end markets, then review our growth and performance expectations for each of our segments. We expect our three primary end markets, repair and replacement of water infrastructure, new water infrastructure driven by residential construction and non-residential construction to grow in 2017.
We expect the residential construction market to be the fastest growing of these market segments with a year-over-year increase in the high single digits. We also expect low to mid single digit growth for both municipal spending and non-residential construction.
With regard to residential construction, Blue Chip Economic Indicators, which is a consensus of more than 50 economists, forecasts an 8% growth in housing starts in calendar 2017. Also, Zelman & Associates' October Land Development Survey indicated an improving sentiment for future land development among homebuilders and developers.
The responses also indicated finished lots are down year-over-year, which we believe is a positive indicator for increased land development to meet expected housing demand. As you know, development of raw land for residential construction is a key driver of demand for our products.
On the municipal front, based on discussions with our customers and distributors, we expect to continue to see demand grow for repair, replacement of water infrastructure. State and local seasonally adjusted tax receipts continue to increase year-over-year as do water rates.
CPI for water and sewage maintenance increased around 4% for the last 12 months ended September 2016. These are just some of the positive indicators we are seeing that should indicate increased municipal spending for water infrastructure projects.
Current economic forecasts for non-residential construction point to a low to mid single digit increase. For 2017, forecasts we have seen range from 3% to 6% growth in non-residential construction spending.
At Mueller Company, we estimate that in 2016 about 60% of net sales were associated with the repair and replacement of municipal water distribution and treatment systems, 30% new water infrastructure related to residential construction and 10% with natural gas utilities. Overall, at Mueller Company.
We expect net sales growth around mid single digits for 2017. Given our current outlook for product mix, we expect to see a conversion margin close to 40%.
For fiscal 2017, we expect Anvil's overall net sales percentage growth to be in the mid single digits, given our current outlook with respect to product mix. We expect to see a conversion margin of about 20%.
For 2017, we expect Mueller Technologies year-over-year net sales percentage growth to be about 15%. We believe operating results will continue to benefit from both increased sales of higher margin products and cost savings.
We expect adjusted operating performance to improve about $10 million in 2017. Other 2017 key variables include corporate expenses which are expected to be $33 million to $36 million, depreciation and amortization, which is expected to be $55 million to $57 million and interest expense, which is expected to be $25 million to $27 million.
We expect our adjusted effective income tax rate to be 34% to 36% and capital expenditures to be $40 million to $44 million. For 2017, we expect free cash flow to be driven by improved operating results and improvement in working capital.
We also expect to make only minimal cash contributions to our pension plans. We expect free cash flow to exceed adjusted net income.
Turning now to our outlook for the 2017 first quarter, beginning with Mueller Company. Our outlook for our principal end markets remain solid, we expect net sales percentage growth in the mid single digits in the first quarter, with growth across most of our products.
We also expect Mueller Company to continue its trend in improving year-over-year adjusted operating income and margins. First quarter adjusted operating income is expected to improve in the high single digits.
Turning now to Anvil. Net sales for the first quarter is expected to be higher year-over-year, driven by low single digit growth in non-residential construction.
We expect both adjusted operating income and margins to continue to improve at Anvil. And now onto Mueller Technologies.
We expect Mueller Technologies net sales to grow about 15% in the first quarter with continued higher shipments of AMI and fixed and mobile leak detection products. We expect to show meaningful operating performance improvement in the first quarter at Mueller Technologies, similar to that achieved in the fourth quarter.
Overall, we were pleased with the continued margin expansion that we saw in all three of our businesses in the quarter and the seventh consecutive year of operating margin expansion for the company as a whole. We were also pleased with our adjusted EBITDA margin for 2016, the highest in the company's history, and the free cash flow we generated.
Looking ahead, we believe our three primary end markets will grow in 2017. We believe our strategy with Mueller Technologies is working, and we expect to build on the significant progress we made this past year.
With that operator, I will open up this call for questions.
Operator
Thank you. We will now begin the question-and-answer session.
Our first question comes from Mr. Seth Weber [RBC Capital Markets].
Sir, your line is now open.
Brendan Shea - RBC Capital Markets LLC
Hi, thanks. This is Brendan Shea on for Seth.
Looking at your Technologies business, the loss versus the gain that you had expected in the third quarter, I just want to make sure, is that due to the Lee County receiving the contract kind of late, or was there something else that played into that?
Gregory E. Hyland - Mueller Water Products, Inc.
Yeah, so thanks for the question. That was the primary driver.
As we said in our prepared remarks, we were advised in June that we would be awarded this contract. At that time and all indications were that we would be able to begin shipping this in September.
So we included that in our outlook. As we look, there were a number of reasons that we ended up getting the actual contract this late last week.
So we'll start begin shipping a little bit of that in this quarter. We'll begin shipping more of that in the second quarter.
And then, as we said in our prepared remarks, that will carry out for several years. So when we look back at Mueller Technologies in the fourth quarter, our mix from expectations, though we had very nice year-over-year improvement of about – our operating performance improved closed to $1.5 million, being short the $500,000 – we were short of being profitable was related to the Lee County project, which again we expected to start shipping in September.
Brendan Shea - RBC Capital Markets LLC
Okay. Thanks.
And then, can you just go over any change to capital allocation priorities given your low debt leverage and healthy free cash flow generation?
Gregory E. Hyland - Mueller Water Products, Inc.
Yeah, as Evan mentioned in his prepared remarks, our net debt leverage is currently at 1.5 times. Again, as you mentioned, we are confident about our outlook and about the future of free cash flow that we'll generate.
We have a stronger balance sheet and have more flexibility. So we have been having more detailed capital allocation discussions with our board.
As you know, during the last 18 months, we have increased dividends twice. We have repurchased shares, and we've also I think have evaluated pretty in-depth acquisition strategy with our board.
So I can assure you that we are very thoughtfully looking at capital allocation options that we believe will best drive stockholder value. And I think where we are today; we certainly have a lot of flexibility.
Brendan Shea - RBC Capital Markets LLC
Okay. That's it for me.
Thank you.
Gregory E. Hyland - Mueller Water Products, Inc.
Thank you.
Operator
Thank you. Our next question comes from Mr.
Jose Garza [G.research LLC]. Sir, your line is now open.
Jose Ricardo Garza - G.research LLC
Good morning, guys.
Evan L. Hart - Mueller Water Products, Inc.
Good morning.
Gregory E. Hyland - Mueller Water Products, Inc.
Good morning.
Evan L. Hart - Mueller Water Products, Inc.
Jose.
Jose Ricardo Garza - G.research LLC
I guess I just wanted to get your thoughts on just kind of what your inventory level is on the Mueller Co. side, Greg?
Gregory E. Hyland - Mueller Water Products, Inc.
Jose, you're talking about in the distribution channel or our manufacturing facility?
Jose Ricardo Garza - G.research LLC
In the distribution channel.
Gregory E. Hyland - Mueller Water Products, Inc.
Yeah. Sorry.
I think that the – as we said in our prepared remarks, we had very strong orders in the third quarter and in July. As we mentioned on our last call, domestic orders for valves and hydrants and brass products grew 13% in the third quarter.
They were up another 10% in July. So, we – as we referenced, we started to see a slowdown in August.
In fact, beginning in August for about a seven-week period, orders grew about 1%. We think that slowdown that began in August was due to elevated inventories at our distributors.
We think the inventories were elevated because, one, the distributors did order aggressively in the April-June time period. And this was on top of a strong pre-buy, the February price increase in valves and hydrants.
Two, in some areas, we think there was a slowing in the growth in construction. It probably slowed.
If we look at some recent data, it appears that the growth of construction was a little less than it was earlier in the year. For instance, when looking at housing starts, single housing starts grew almost 15% in the first half of our fiscal year; continue to grow in the second half, but about 4%.
So when we look at it, we think that in most – most of our distributors have already their inventories where they want them. I think we may have a few, the inventories still may be high, but all-in-all, we remain very bullish about end market demand in the – for 2017 housing starts, we expect to grow 8% municipal spending in mid single digits.
So we think that even where distributors in some areas may have a little more than what they typically expect to have, that we think that'll get in line pretty quickly. So, but we think more of the issue is – what happened is that we saw very, very aggressive orders in the third quarter on top of a strong pre-buy, went in early in July.
So we just said we went through a seven-week to eight-week, maybe a ten-week period of some adjustment there. We don't think we have any big issues with distributor inventories out of line and we think in most cases, for most of our distributors, they have them where they what them.
Jose Ricardo Garza - G.research LLC
Okay. That's very helpful, Greg.
Just kind of want to get your thoughts on where you see kind of the municipal kind of cycle in terms of where we are and then looking forward obviously you think next year's pretty decent but just talking further out?
Gregory E. Hyland - Mueller Water Products, Inc.
Yeah, yeah. I'm not sure we're in – I think we're still in the middle of the cycle.
I think that, as we stated, for the most part I think municipalities are healthier than they certainly were several years ago. The need to repair and replace the existing infrastructure hasn't gone away.
I think of anything, there has been more discussion about the need to upgrade the infrastructure, I think that certainly became a greater focus – in greater focus after the Flint – you know the Flint issues. I think we're even seeing more and more discussion at the federal level about making money available for water infrastructure.
I know that both presidential candidates have talk about that and that in both the houses in the Congress have talked about more and more money to be available for water infrastructure. So I think we're in the – right in the middle of the – of that cycle and as we said in our prepared remarks, we still expect – we still expect to see mid single digit growth in that market segment for our products.
Jose Ricardo Garza - G.research LLC
Okay. And then, one last one on the Mueller Technologies that $10 million improvement, is that kind of across both platforms or more geared toward Mueller Systems?
Gregory E. Hyland - Mueller Water Products, Inc.
You know it's both – both platforms will improve, a little more towards Mueller Systems. When we look at Mueller Systems, it was profitable for the last two quarters of our fiscal year 2016 fiscal year, as we said with the Lee County order that is now firmly in our backlog.
Our – when we look at our AMI shipments in our backlog this year that are scheduled in our backlog this year versus what was scheduled in our backlog in – entering this year, it's up almost 80%. So we look for about two-thirds of that improvement probably coming from Mueller Systems, but we do expect to see the improvement at Echologics also.
And as I said about a third of that improvement coming from Echologics/
Jose Ricardo Garza - G.research LLC
Okay. That's very helpful.
Thanks guys.
Gregory E. Hyland - Mueller Water Products, Inc.
Thank you.
Evan L. Hart - Mueller Water Products, Inc.
Thanks.
Operator
Thank you.
Gregory E. Hyland - Mueller Water Products, Inc.
Great. Well, seeing that there are no additional questions.
Thanks very much for your interest and I'm sure we'll be seeing everyone soon.
Operator
Thank you. And that concludes today's conference.
Thank you all for participating. You may now disconnect.