Mueller Water Products, Inc. (MWA) Q4 2015 Earnings Report, Transcript and Summary

Welcome and thank you all for standing by. At this time all participants will be in listen-only mode. [Operator Instructions] This call is being recorded. If you have any objection, please disconnect at this time. Now, we'll turn over to your host, Ms. Martie Zakas. Ma'am, you may begin.

Thank you, Gabby and good morning everyone. Welcome to Mueller Water Products’ 2015 Fourth Quarter Conference Call. We issued our press release reporting results of operations for the quarter ended September 30, 2015 yesterday afternoon, a copy of it is available on our website muellerwaterproducts.com. Discussing the fourth 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 to help illustrate the quarter's results as well as to address forward-looking statements and our non-GAAP disclosure requirement. 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 3 addresses our 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 2 and 3 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 30th. A replay of this morning's call will be available for 30 days after the call at 1-800-396-1242. 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 want you to note that we have redefined our reporting segments to provide greater transparency to stockholders and to the financial community, as well as to better reflect how we manage our businesses. We are now reporting financial results for three segments: Mueller Co., Anvil and Mueller Technologies. Mueller Technologies is currently comprised of the results of the Mueller Systems and Echologics businesses which were previously reported within the Mueller Co. segment. We will file an 8-K today which will provide the quarterly results for these three segments for 2014 and 2015. After the prepared remarks we will open the call to questions. I'll now turn the call over to Greg.

Thanks, Martie. Thanks for joining us today as we discuss our results for the 2015 fourth quarter and full year. I'll begin with a brief overview followed by Evan's more detailed financial report. I will then provide additional comments on the quarter's results and developments in our end markets as well as our outlook for the 2016 full year and first quarter. We continue to improve our operating performance. For consolidated Mueller Water Products, adjusted EBITDA margin for the 2015 fourth quarter improved 130 basis points to 19.2% as compared with 17.9% last year. We had particularly strong margin improvement at Mueller Company which now excludes the Mueller Systems and Echologics businesses. Adjusted EBITDA margin at Mueller Company was 28.8%, an improvement of 230 basis points from 26.5% last year. This adjusted EBITDA margin was the highest at Mueller Company for the fourth quarter since 2008. For the full year, Mueller Company's adjusted EBITDA margin was 26.2% compared to 24.6% in 2014. This full year EBITDA margin was the highest since 2007. However, overall for the fourth quarter, our consolidated results came in slightly less than expected due to lower growth in net sales at Mueller Company. We believe distributors were able to meet end market demand largely through higher inventory levels they held at the beginning of the fourth quarter primarily in states impacted by extreme rainfall in the third quarter. By September, however, we believe their inventory levels were back in equilibrium as we saw a significant pickup in orders over the course of the month. Although our orders met our expectations for the quarter, our shipments were lower given the timing of the orders. We'll discuss this in more detail later in the call. For the fourth quarter, our adjusted net income per diluted share increased 17% to $0.14. With that, I'll turn the call over to Evan for a more detailed discussion of our financial results for the quarter.

Thanks, Greg and good morning everyone. I'll first review our fourth quarter consolidated financial results and then discuss segment performance. Net sales for the 2015 fourth quarter of $311.4 million decreased $9.3 million or 2.9% from the 2014 fourth quarter net sales of $320.7 million, largely due to lower oil and gas shipment volumes at Anvil as well as unfavorable exchanges in Canadian currency exchange rate. Sales grew at both Mueller Company and Mueller Technologies. Gross profit was $97.7 million for the 2015 fourth quarter compared with $101.3 million for the 2014 fourth quarter. Gross margin of 31.4% in the 2015 fourth quarter decreased 20 basis points from 31.6% in the 2014 fourth quarter primarily due to a less favorable product mix at Anvil. Gross margin at Mueller Company improved 80 basis points year-over-year, and also improved at Mueller Technologies. Selling, general and administrative expenses were lower year over year due primarily to personnel-related expenses. Selling, general and administrative expenses were $53.2 million in the 2015 fourth quarter compared with $58.2 million in the 2014 fourth quarter. Selling, general and administrative expenses as a percent of net sales improved 100 basis points to 17.1% from 18.1% in 2014. Adjusted operating income for the 2015 fourth quarter increased 4.4% to $45 million as compared with $43.1 million for the 2014 fourth quarter which included a $2.5 million gain on the sale of Anvil's Bloomington, Minnesota fabrication facility. Excluding the gain from the sale, adjusted operating income improved 10.8% for the 2015 fourth quarter. Adjusted operating income benefited from improved operating efficiencies, lower raw material costs, and lower corporate expenses. These benefits were offset by lower shipment volumes at Anvil and unfavorable changes in Canadian currency exchange rate. Adjusted EBITDA for the 2015 fourth quarter increased to $59.9 million compared with $57.3 million for the 2014 fourth quarter. Adjusted EBITDA for 2015 was $189 million or 16.2% of net sales, an improvement of 70 basis points. Interest expense net for the 2015 fourth quarter declined $6.2 million to $5.8 million as compared with $12 million for the 2014 fourth quarter. We benefited from lower interest expense this quarter due to lower interest rates and lower amounts of debt outstanding following the refinancing we completed in the 2015 first quarter. For the 2015 fourth quarter, income tax expense was $16.3 million on income before income taxes of $38.6 million or an effective income tax rate of 42.2%. Income tax expense included deferred tax asset valuation allowance adjustment of $300,000 compared with an $8 million benefit included in the 2014 fourth quarter. Excluding these adjustments, the effective income tax rate were 41% and 39% in the fourth quarter of 2015 and 2014 respectively. Also, the 41% rate in the fourth quarter of 2015 was higher than a full year effective income tax rate of 38.5%. Net income per diluted share for the 2015 fourth quarter was $0.14 compared with $0.16 in the prior year. However, adjusted net income per diluted share for the 2015 fourth quarter improved to $0.14 from $0.12 in the 2014 fourth quarter. As a reminder, the primary adjustment in the 2014 fourth quarter net income per diluted share was a deferred tax valuation allowance which reduced tax expense by $8 million. I'll now move on to segment performance addressing each of our now three reporting statements beginning with Mueller Company. Net sales for the 2015 fourth quarter increased $3.2 million to $192 million compared with $188 million for the 2014 fourth quarter. Higher shipment volumes were partially offset by $3.4 million from the divestiture of our Canadian municipal castings business earlier this year and $3 million from unfavorable changes in Canadian currency exchange rate. Excluding the impact of the divestiture and unfavorable changes in Canadian currency exchange rate, shipment volumes would have increased 5.2%. Adjusted operating income for the 2015 fourth quarter improved to $45.6 million compared with $40.4 million for the 2014 fourth quarter. The $5.2 million adjusted operating income improvement was largely due to operating efficiencies, lower raw material costs and lower selling, general and administrative expenses. Adjusted operating margin of 23.8% for the 2015 fourth quarter improved 240 basis points from 21.4% for the 2014 fourth quarter. Adjusted EBITDA for the 2015 fourth quarter increased to $55.3 million compared with $50.1 million for the 2014 fourth quarter. And adjusted EBITDA margin for the quarter increased 230 basis points to 28.8% from 26.5% last year. I'll now turn to Anvil. Net sales for the 2015 fourth quarter decreased $14 million to $93.7 million compared with $107.7 million for the 2014 fourth quarter. As expected, net sales decreased due to lower sales of oil and gas related products which were down approximately 60% or $12.9 million. Additionally, Anvil was impacted by approximately $1.1 million in unfavorable changes in Canadian currency exchange rates. Adjusted operating income for the 2015 fourth quarter was $8.9 million compared with $16.8 million for the 2014 fourth quarter. Adjusted operating margin decreased to 9.5% compared with 15.6% for the 2014 fourth quarter. As previously mentioned, 2014 fourth quarter adjusted operating income included a $2.5 million gain on the sale of its Bloomington, Minnesota fabrication facility. The decline in operating income was also impacted by fewer shipments of higher margin products to the oil and gas market. Adjusted EBITDA for the 2015 fourth quarter was $12.8 million compared with $20.4 million for the 2014 fourth quarter. Adjusted EBITDA margin for the 2015 fourth quarter was 13.7% compared with 18.9% for the 2014 fourth quarter. I'll now turn to Mueller Technologies. Net sales for the 2015 fourth quarter increased $1.5 million to $25.7 million compared with $24.2 million for the 2014 fourth quarter. Adjusted operating loss for the 2015 fourth quarter was $1.8 million compared with $2.1 million for the 2014 fourth quarter. Adjusted EBITDA for the 2015 fourth quarter was a loss of $600,000 compared with a loss of $1.3 million for the 2014 fourth quarter. Corporate expenses for the 2015 fourth quarter were $7.7 million compared with $12 million for the 2014 fourth quarter. The decrease was due primarily to lower personnel related expenses. Turning now to a discussion of our liquidity. Free cash flow, which is cash flows from operating activities less capital expenditures, was $57.4 million for the 2015 fourth quarter, compared with $75.2 million for the 2014 fourth quarter. For the full year, 2015 free cash flow was $50.3 million compared with $110.7 million in 2014. Free cash flow was lower in 2015 primarily due to the timing of purchase and disbursement activity mostly related to inventory. Purchasing was relatively high late in 2014 and the related disbursements occurred in 2015. In 2015, purchasing activity was weighted for the earlier part of the year. At September 30, 2015, total debt was comprised of $486.6 million senior secured term loan due November 2021, and $2.4 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. Our total debt outstanding at the end of 2015 was down $52 million from the end of 2014. I'm also pleased to report that during the quarter, Moody's upgraded our corporate family rating to Ba3, and our term loan rating to Ba3. Net debt leverage was two times at September 30, 2015. And our excess availability under the ABL agreement was approximately $170 million. I'll now turn the call back to Greg.

Thanks, Evan. I'll now elaborate on our 2015 fourth quarter results and end markets and provide an overview of our expectations for 2016 and an outlook for the first quarter. As you recall on our last earnings call, we highlighted certain areas of the country that were impacted by heavy rainfall in May and June. In those areas, particularly Texas, Colorado, and parts of the Midwest, our distributors ended the third quarter with about 90 days of inventory, more than double their target. We believe distributors in these areas were largely able to meet recovering end market demand from their existing inventory. As a result, our shipments to distributors in these areas during the quarter were down on a year-over-year basis. While we expected to continue to see weather impact on our fourth quarter results, it took longer for distributor inventories to reach their desired level. September orders were up notably year over year reinforcing our belief that distributors are positive about continued growth as we look to 2016. Total domestic orders of valves, hydrants and brass products increased 7% year-over-year. However, as I just mentioned, quarters were heavily weighted in September, which affected our shipment timing. In addition, we experienced particularly strong year-over-year shipment growth for Henry Pratt plant and water treatment valve, with net sales up about 30%. As we have discussed in the past, a lot of Pratt's business is project oriented and we can experience a significant swing in net sales on a quarter-over-quarter basis. As Evan mentioned, we again delivered excellent operating performance at Mueller Company. Greater manufacturing efficiencies through our lean initiatives and lower raw material costs helped drive a 230-basis point improvement in adjusted EBITDA margin. At Anvil, as expected, we continued to fall off of sales into the oil and gas markets which were down approximately 60% in the fourth quarter year over year. Our sales into this market have generally correlated with rig counts which were down 58% year over year at the end of the fourth quarter. We saw low single digit percentage growth in sales to the non-residential construction market during the quarter. At Mueller Technologies, our new reporting segment, net sales were up 6.2% year over year. Adjusted operating results improved slightly as the mix of our metering products continued to shift towards AMI metering systems from AMR and visual read meters. Mueller Systems was essentially breakeven for the quarter. This improvement was largely offset by investments in scalable technology and business development activity related to leak detection and pipe condition assessments. Over the last four months, we have seen a significant year-over-year increase in AMI projects awarded to Mueller Systems as the overall market for AMI systems has shown improvement and we have introduced new longer range capabilities. In fact, Mueller Systems began 2016 with AMI backlog and award of $36 million compared with $13 million at the beginning of 2015. During the fourth quarter we continued to make small investments at Echologics to support the long term growth of our leak detection and condition assessment business. The market is still in the early adoption phase of these technologies but interest from municipalities, from water utilities continue to increase. Echologics began 2016 with $6.2 million under contract, the highest such amount at the beginning of a year in its history. As we look at 2016, I'll discuss each segment and let you know what we expect to see with our end markets and our performance. 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 2016. We expect the residential construction market to be the fastest growing market segment. We expect solid growth in municipal spending and we expect spending in the non-residential construction market to grow but not as much as our other two end markets. At Mueller Company, we estimate that in 2015 about 70% of net sales were associated with the repair and replacement of municipal water distribution and treatment systems, 25% with residential construction, and 5% with natural gas utilities. Overall at Mueller Company, we expect net sales growth in the mid single digits for 2016, which includes the expected unfavorable impact from changes in Canadian currency exchange rate and a divestiture of the municipal castings business in December last year. Given our current outlook for product mix, we expect to see conversion margin of about 40%. At Anvil, about 85% of 2015 net sales were associated with non-residential construction, 10% with oil and gas down from 20% in 2014, and 5% with the power generation market. For fiscal 2016, we expect Anvil's overall net sales percentage growth to be in the low single digits. As we look to 2016, there is a general expectation among industry forecasters that spending for non-residential construction will increase in the mid single digits, which should drive demand for Anvil's products. However, we believe Anvil's overall growth will continue to be impacted by an expected decline in net sales to its addressed oil and gas markets due to tough comparisons in the first half of the year especially in the first quarter. As a reminder, Anvil's net sales into this market grew 14% year over year in the first quarter of 2015. Based on the current market conditions, we would expect Anvil's net sales into this market during the second half of the year to be flat on a year-over-year basis. Given our current outlook with respect to product mix, we expect to see a conversion margin of Anvil of about 15% to 20%. Although the municipal market is the key end market for Mueller Technologies, the drivers of demand are different than those from Mueller Company. Mueller Technologies is a more project oriented segment and depends on customer adoption of its new technology products and services. As we have previously discussed, our strategy is for Mueller Systems to be a leading provider of AMI systems. For 2016, we entered the year with significantly higher AMI backlog and projects awarded for Mueller Systems and higher projects under contract at Echologics. We are encouraged by the increased interest we are seeing in the marketplace. Overall, we expect Mueller Technologies to show year-over-year net sales growth of about 10% to 15% and for its operating results to improve about $7 million to $10 million. Other 2016 key variables include corporate expenses which are expected to be $36 million to $38 million, depreciation and amortization, which is expected to be $56 million to $58 million, and interest expense, which is expected to be $23 million to $25 million. We expect our adjusted effective income tax rate to be 37% to 39%, and capital expenditures to be $38 million to $40 million. For 2016, 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 plan. Our target is for free cash flow to exceed adjusted net income. Turning now to our outlook for the 2016 first quarter. I'll begin with Mueller Company. We expect 2016 first quarter net sales percentage growth in the low single digits. In our core domestic valve, hydrants and brass products, now that we believe distributor inventories are back at their targeted levels, we expect to see high single digit growth driven by strong residential construction and solid municipal spending. We expect this growth will be partially offset by the divestiture of our Canadian municipal castings business in December 2014 and unfavorable changes in Canadian currency exchange rate. Additionally, shipments of Henry Pratt's water treatment valve are expected to be down in the first quarter due to the timing of projects in our backlog. As we said earlier, this business can be choppy as we saw in our 2015 fourth quarter shipments were up 30% other year. We expect first quarter adjusted operating income to be up between 10% and 15%. We expect Anvil's 2016 first quarter net sales to decline in the high single digits largely due to the tough comparison with its oil and gas business. Based on current market conditions, we expect net sales for the oil and gas segment to be down 60%, which is approximately $12 million. We will offset some of the operating income decline from the lower revenue with cost reduction actions we have been implementing in our oil and gas business. We expect to see the benefit of lower raw material costs and increased adjusted operating income from growth in shipment for the non-residential construction market. In total, however, we expect adjusted operating income will be down approximately 40% this quarter. As you recall, we began seeing a significant drop off in our oil and gas business in our second quarter last year. Therefore, we don't expect adjusted operating income to be significantly impacted due to the downturn in the oil and gas market beyond this quarter as compared to the prior year. We expect 2016 first quarter net sales at Mueller Technologies to be down slightly with a slightly higher year-over-year adjusted operating loss. While we are entering 2016 with a higher AMI backlog, we do not expect to benefit from this higher backlog until the second half of the year. For Mueller Water Products as a whole we expect 2016 first quarter net sales to decline slightly year over year as growth at Mueller Co. should be more than offset by a decline at Anvil. We expect adjusted net income per diluted share to be essentially flat as the benefits of lower interest expense will likely be partially offset by lower adjusted operating income. Reflecting on 2015, we are certainly pleased with the increase in both our overall adjusted operating margin and adjusted EBITDA margin as well as with the 30% increase in our adjusted net income per diluted share to $0.39 from $0.30. We also successfully reduced our debt and lowered our total debt outstanding both of which gives us more flexibility in managing our business and in pursuing growth opportunities. We were negatively impacted by the decline of sales into the oil and gas market at Anvil and unfavorable changes in Canadian currency exchange rates. Our consolidated net sales growth was negatively impacted by 260 basis points due to the lower sales into the oil and gas markets, and by 90 basis points due to unfavorable changes in Canadian currency exchange rate. Net sales of our product into the oil and gas market represented about 7% of our consolidated net sales in 2014 but only about 4% in 2015. In 2015, we continued to focus on enhancing value for our customers and expanding our Intelligent Water Technology offerings. We continued to invest in new products and services that are designed to help water utilities improve their operations and better manage their water assets. At Echologics, we expanded our worldwide sales force and continued to invest in our fixed leak detection solution. During the year, we also introduced new technology in our AMI offering that significantly increased our radio range and reduced the infrastructure required for our system. We believe this development contributed to us winning AMI awards in recent months. We also entered into the LoRa Alliance, which is focused on bringing the Internet of Things to a number of municipal applications, including water infrastructure. We expect to see improved performance at our Mueller Technologies segment as we increase net sales of higher margin products. Our technology businesses have seen an increase in backlog and contract, which leads us to believe our investment in these areas will pay dividends as more municipalities and water utilities focus on improving their ability to accurately measure water usage, enhance customer service, and detect leaks as a means of conserving water and extending the life of their water infrastructure. As we just discussed, we believe the outlook for our key end market, new water infrastructure driven by residential construction, repair and replacement of existing water infrastructure for municipalities and non-residential construction remain positive. However, as we mentioned, spending decline in oil and gas markets will result in tough comparisons for part of our business especially in the first quarter. As our capacity utilization increases we believe we will continue to demonstrate improved operating leverage which should lead to expanding margin and improved returns for our stockholders. With that, Operator, I will open this call up for questions. Operator, I wonder if you would open up the call for questions, please?

[Operator Instructions] The first question comes from the line of Kevin Maczka [BB&T Capital Markets].

Greg, can we first start on AMI and the better awards? I think you said in the last four months, you've seen an uptick there, you've got a better backlog now entering the new year. Can you just talk about what's driving that? Is there anything that you – I know this is project oriented and lumpy, but is there anything driving that? I know budgets have been an issue and extended pilots timeframes have been an issue. What's really turned that business?

I think two things, Kevin. I look externally, and I think we were pretty consistent through 2015, as I was [ph] mentioning that we are starting to see more and more inquiries. So I do think that utilities are being able to justify the higher capital expenditure on AMI because the AMI system just keeps getting better. And I think that they can build a better business case. And they're seeing the benefits. I think for us specifically, and I mentioned this in our prepared remarks that I would say for the last 18 months, we entered the AMI market about four years ago. It's been a learning curve for us both in terms of what we needed to do to not only enhance the solutions we were offering the end user but we needed to do find and reduce our costs and get a better cost system, I mean cost for our system. And I think we had a nice breakthrough in 2015. We were able to significantly increase the range of our radios which reduces the number of repeaters and collectors, which in turn reduces the costs of the infrastructure for our system. So I think that has put us in a much better competitive position. So I think that, that certainly has contributed to the uptick that we've seen in the last several months of the awards that we've been winning. But I think it's a combination of -- it's certainly been much slower than our original expectation in terms of adoption of AMI by the water utilities in the US. I think we are starting to see more and more of that because we're seeing the benefits. And then, again, I think we have a system that is not only much more competitive but overall it's a better system than what we were offering a year ago.

Okay. And just to be clear you said the backlog entering the year was $36 million and it was $13 million the prior year?

Yes. And that's a combination of backlog and awards. Sometimes we may have a two or three-month lag between the time we're given the award and the contract actually sold. But fortunately we've never had an award not turn into a contract. So we feel pretty comfortable adding those two together to come up with $36 million. And that's the way that the $13 million was calculated too.

And then on the oil and gas side, so that was under pressure all year post Q1. I think it's down to, did you say about 4% of total sales now. You mentioned some new cost actions there. I know that's a smaller piece of business now. But can you talk about that? And are there any other larger cost actions going on elsewhere beyond oil and gas that we should know about? And I understand you have growth in most of the other business but is there anything else going on?

Yes. The cost actions and we referenced these I think in the last quarter too. When we look at our manufacturing operations and we do have at Anvil two plants that are dedicated to the manufacturing products directly going to oil and gas, our headcount's down about 50%. So we're doing, obviously, the normal things that need to be done when you see the volumes come down. We have not really addressed, or taken any action on our field sales force. When we look at our oil and gas business there, we only have four or five salespeople dedicated directly to the oil and gas markets and we don't want to lose those relationships. We are not forecasting when this market, don't know when it will turn around, but if history prevails, it will turn around again and be a very good market. Relative to any other big cost reduction actions, I think that our cost reduction actions aren't going to be driven by I think any big event. It's just going to be I think what we have been seeing and that's a continual improvement of our efficiencies as our lean initiatives become more and more of the culture. I think when we look at, when we look at the improvement that we've seen year over year, certainly at Mueller Co., by far our largest operation, where we had a 240 basis point improvement on just a slight increase in sales, certainly we benefited from lower raw material costs. We benefited because the divestiture of our Canadian business was in a loss position, the municipal castings business. But also because we're seeing I think ongoing and pretty quarter to quarter efficiency improvements. So, nothing that I would say would be a large event. There are big events for cost reduction. But we're continued focusing on quarter over quarter, year over year efficiency improvements that are giving us lower costs and contributing to margin expansion.

Thank you. The next question comes from the line of Seth Weber [RBC Capital Markets].

So on the technologies business, I think what I heard you say was for 2016, operating improvement of $7 million to $10 million. The business lost, it looks like $13 million in 2015. So does that mean that you're still going to be at an operating loss for 2015 or ‘16, rather?

Yes. Overall, Seth, we think we will still be. We think that when we look at it, we expect our Mueller Systems to be profitable. And we're still, I think, in the early stages of growing the Echologics business where we have our sales infrastructure to support a larger business because we're moving in that direction. And secondly, we still have some investments to make on fixed leak detection. That has been – we have had our end users respond very favorably to the pilots that we have completed on fixed leak detection. Again, just to remind everyone, this is where we put connect sensors to the system, they're there full time, and then we're taking readings and communicating that either over a cellular network, on transmission lines and our objective is to be able to move distribution, reading distribution lines both over a cellular network and an RF network. So we're able then to inform a utility or the utility to make their own assessment as to what's happening, or any leaks developing. And we still have more investments, Seth, on that fixed leak detection side especially in developing the cellular technology because we think that is key to drive growth. So, yes, we do expect that this business will slightly lose money next year and the negative – the loss will be more in our Echologics business because given the backlog we just talked about of our AMI system, we expect our systems business to be profitable.

So two follow-up questions. I mean is that consistent with what you had said last quarter? Because I was under the impression that the whole category would be profitable this year. And then I guess the follow-up is, do you expect the technologies business to be profitable at any quarter during the year or is it losing money for all four quarters?

I think it’s consistent with what we said. Of course I think we were talking more about -- last quarter I think we were talking about Mueller Systems being profitable and specifically because of the higher backlog and awards we were receiving on the AMI. And I think that we were always of the belief that we had more R&D spending in the Echologics business. Right now, it's tough for me to give a quarterly outlook for 2016.

And then just really quickly, on the 7% increase in orders for the base business, hydrants, brass, and valves, was there any change in pricing timing that contributed to that, or is it kind of an apples to apples? Was there a pricing with the calendar that might have caused any sort of decrease in orders?

Seth, no. Apples to apples, and we did receive one nice award from New York that we will ship later in the year. And last year we also received an order for New York for $2.5 million, this year it was $5 million. That's almost some of their annual requirements. So I wouldn't say that was out of the ordinary. But that was nice that order was expanded this year versus last year. As I said, that will ship later in the year. Other than that, I think it was just normal business.

Thank you. The next question comes from the line of Kevin Bennett [Sterne Agee Capital].

Greg, I wanted to start with a question about Texas. I know certainly the weather in the third quarter was a disaster, and I get there's a lot going on in the channel. But I'm wondering if you have any comments on kind of underlying demand in Texas, if you've seen it slowing given the oil and gas downturn or if that continues to perform well?

You know, Kevin, from what we can see, it continues to perform well. And that's certainly a reasonable question if somebody was watching. Because I think there was pent up demand. I think when you go back, especially when we took it under housing development, there were developments that builders just couldn't start because they couldn't get labor earlier in the year. So I think that they may still be working through that backlog of opportunities. But I would say it's something we need to keep an eye on. And because certainly the energy markets, the oil and gas market's a big driver of the economy in Texas. I can say we haven't seen it yet. But it is something that could impact us and something that we're watching as close as we can.

And then a question on Echologics. I know part of this long term strategy is to move that internationally. I was wondering if you've had any success on that yet or if it's still a little too early?

No. We have had some success. We've had it more in Asia, and specifically in Malaysia. And actually what we've learned in that particular project is giving us some opportunity to actually what we learned in Malaysia to bring it back to our product offering in the United States and our inquiry level is up in Asia, Malaysia. There's different other utilities in Malaysia looking to do more work. And we're in the process of quoting that right now and I would say that Singapore is another area that we've been in a lot of discussions. Hasn't turned into what I would say any substantial orders but we think the groundwork is being laid. As well as Australia has been moving, I think, in a positive direction for us. But we're seeing more activity in Asia than we are in Europe right now. But we are gaining some traction. And Kevin, just let me give you a little more insight into Texas. We talked about how our orders were up big time in September, actually. Our orders were up 60% in Texas just for the month but up 9% for the quarter. So when you realize that was the area that had most of the inventory, we were pretty pleased at the overall orders that grew 9% coming out of that state.

That's helpful. And then one last quick question for Evan. I was wondering can you remind us what the sales impact was of the castings business that you sold I guess in the year ago first quarter?

Yes, Kevin that was about $11.5 million on an annual basis.

Can you give us for the first quarter just so we know what the comp is?

If you look at the first quarter, that was roughly around $2 million.

Thank you. The next question comes from the line of David Rose [Wedbush Securities].

I just wanted a couple questions, one was a follow-up on a earlier question regarding progress on AMI. I know you had some significant challenges with Port Angeles on the service side and I was just getting a better sense of what you've done so that we get comfortable from a service or execution standpoint going forward that these products you have are more smoothly implemented?

Yes. I think that Port Angeles was our very first AMI project. I think our learnings from that project certainly on the project management, we've gotten a lot better on the project management side. Secondly, I think we're a lot smarter on how we need to educate the customer in AMI systems and what they expect to receive out of the AMI systems. And so I think that those are our two greatest learnings. One, don't over estimate the customer's understanding of what they're going to get right up front. Spend more time, I think, during that process. And then secondly, I think that we have become a lot better on the project management side.

So we should expect better profitability going forward out of the AMI business?

Well, yes. We would think that we would see better profitability out of the AMI business going forward. I think just coming up – as I said coming up the learning curve we're a lot better today than we were several years ago.

And then maybe from a high level view in terms of any product gaps you're missing on the technology side. Obviously, Echologics was a great decision. What else do you need to do from an M&A standpoint to add to your capabilities?

As we look at it, we're pretty comfortable with the products that we've developed in our current suite of products. I think there are always opportunities I think on the meter side. We don't have a solid state meter. That's a small portion of the market. So we think that could grow at a faster rate. We have decided to go down the route of a solid state register so we do see benefits of a solid state meter, of having a solid state meter. When we look at from an acquisition standpoint, I think just getting access to some of the markets outside the United States, I think certainly the market in Europe we've talked in the past and how that market may be developing faster than any region around the world. I think they have a better sense. I think we've mentioned in the past for the UK alone spends a $100 million a year in leak detection, that's as much as we are able to identify that's being spent in the United States. There, I think we have most of the technology. I think we could add to our technology. But perhaps getting access to the market would be opportune for us. So I think from where we are today, that we're pretty pleased and satisfied with the technology we have. I think if we think more on the acquisition front, it would be getting a better access to a market.

Thank you, that's very helpful. Last one just on the inventory levels, can you provide just some quick thoughts on where you should be on inventory and how are you going to drive the working capital performance, the improvements going forward in ‘16?

Yes. Evan and I will team up on this. Our inventories grew this year. And I think one of the biggest drivers for that in the third quarter, we were building to a forecast and we were very surprised by what happened in the third quarter. We think related to the excess rainfall. So we build inventories at our Mueller Co. business that we're still working through and we brought them down in the fourth quarter on a year-over-year basis but we still have inventory to take off there. And on the oil and gas side, we also, at Anvil, I would say in the mid year didn't expect much of the drop off that we've seen there. So we have inventory to take out – still to bleed off related to oil and gas. I think when we gave our outlook for free cash flow for next year, we said that would be driven by both improvements in operation, operating improvements, as well as working capital, coming from working capital. Evan, anything to add?

That's right. As Greg outlined inventory did decrease in the fourth quarter and I think came down about $6 million. So overall net for the year inventory up about $20 million. And kind of adding onto free cash flow, certainly it was related to the timing of purchasing a disbursement activity related to the inventory. I will note when you look at our fourth quarter free cash flow, which was down about $18 million on a year-over-year basis, there was roughly about an $8 million to $10 million impact relative to cash taxes. We became a federal tax payer in 2015 and the taxes that we did pay were heavily weighted toward the fourth quarter compared to minimal last year. And then there was also some timing on interest payments that impacted our fourth quarter about $5 million to $7 million as well. So, the purchasing activity was a big driver of cash flow and inventory but in the fourth quarter we had those two other items in the tax and interest area.

Thank you. The next question comes from the line of Brent Thielman [D.A. Davidson].

First a clarifying question. I'm sorry if you have this reported somewhere. I didn't see it. But on Mueller Co., the op income growth and sales growth numbers you provided for Q1, do you have last year’s revised sales and EBIT numbers just given the segments have changed?

Brent, we will be providing an 8-K later this morning and in that 8-K, we will be having the quarterly information for the three segments for the years 2014 and 2015. So you will have that broken out, everyone will have that broken out shortly.

And then in terms of Anvil, how did the oil and gas piece do on a sequential basis? Did you see further pressure there?

On a sequential basis, I think that Brent, for the most part, it leveled off. Now, I would say that we may have seen a little more pricing pressure. But from a volume, we saw about a 60% drop off in the third quarter, saw that similar drop off in the fourth quarter.

And then shifting to Mueller Co. again, has any of their order timing shift you've seen recently I guess changed your plans for timing of price increases over the next 6 to 12 months for that business?

We evaluate every year what pricing actions we should be taking. And we're in that evaluation right now. I would say that nothing probably has surfaced that would alter our thinking from previous years especially now since we think that distributor inventories are back at their targeted levels. So right now as we're looking at it, we're obviously looking at saying, what are the market dynamics, what are the opportunities for price increases? Going through that process, but nothing that I would say that has surfaced in the last four or five or six months that would really impact our thinking about timing, at least currently.

And then your business up in Canada, aside from currency, I know it's small but I think it's been a bit of a headwind for you. Do you see activity stabilizing up there?

Actually, we saw growth and when you look at Canadian dollars, that business grew for us in 2015. So the real headwind has been currency. So when we look at the first quarters, we said we will be impacted by the divestiture. The divestiture that Evan just referenced. And we think that we may be flat or maybe see some slight growth in the first quarter. But for the full year 2015, Canada, again, in Canadian dollars grew nicely for us.

And then, Greg, in terms of that CapEx for 2016, can you remind me how much is kind of sustaining recurring spending versus I guess investment for building out the technologies business?

Yeah. Brent, in fact, about $27 million, $28 million we think is, for sustainable CapEx, and a lot of our CapEx above that has been going into our core businesses for efficiency improvements. We're, for instance, in the middle of completely automating, or almost completely automating the assembly of hydrants. So we have been investing the kind of money where it's a pretty quick pay back and improves our efficiencies and lowers our costs. We've also, for instance, still in the midst – and still have a little more spending putting in a new ERP system at Anvil. So we gave guidance to probably see a capital spending about $10 million above our sustaining and those are going to efficiency improvement, cost reductions, and some of that is going to the new technology businesses. But I would say more of what's above sustaining is still going into our core businesses for efficiency improvements.

And, Brent, for the Technologies for fiscal 2015 for those businesses we spent around $6 million on capital spending.

And last one, if I could, it sounds like newer systems will hit the profitability threshold this year. It sounds like you have a nice momentum in Echologics. What level of business, or how do we think about timing of that business getting to kind of a breakeven point?

I think that I'll put it more in terms of we're moving away -- in the process of moving away from that business having more revenues coming from doing fieldwork to what we're calling leveragable business. And that is where we don't want to be involved in having a lot of people tied up in doing field work. We want to sell the technology, such as fixed leak detection that we talked about. And we think that is much more leveragable. So, it depends really on the adoptions of that kind of technology. But given the pilots that we conducted in 2015, I think given some of the inquiries and additional discussions we are having with new potential customers, that I am right now looking at it, I think that if that technology's adopted, on the time that we think it will be, I think we're pretty right now optimistic about 2017.

Thank you. The next question comes from the line of Joe Giordano [Cowen & Company].

I just wanted to clarify something on the cash conversion. I know your goal for ‘16 over a 100%. You typically have been way, way above that. And it looks like on a trailing 12 month basis fourth quarter conversion on adjusted earnings slipped below a hundred for the first time since 2012 something like that. With going to a cash payer on taxes what's a better normalized view to think about going forward.

Certainly, our fourth quarter was not as strong as the previous quarter and did fall a little bit below. And as I mentioned, we had roughly about a $10 million impact relative to cash taxes that were paid in the fourth quarter this year compared to the fourth quarter last year. And there was about a $6 million or $7 million cash interest payment made this quarter that we didn't see in the last quarter. Before we moved into the term loan, we paid interest about twice per year, that we're paying it on a monthly basis so it's just timing, albeit overall interest was down on a year over year basis. But specifically, if you look at all of 2014 free cash flow about $110 million, very strong and around $50 million for this year, you kind of almost need to kind of look at the average of the two years because we did pay quite a bit of the payments related to purchasing activities last year in our first quarter and then with the operating activity and the timing of purchases this year it just had a fairly significant impact on us for the year. So I still believe as we go forward, our free cash flow should be greater than adjusted net income. It was just a bit of a timing between ‘14 and ‘15 that led to a lower amount this year.

Fair enough. I want to shift over to on the metering side. See if you had any updates on the American water contract I think it's up in January. I just want to understand the margin profile of what you've been booking recently versus that and how critically you look at that, how big is that as a percentage of that business and how critical is it to maintain that despite maybe a less favorable margin profile there?

Our AMI business have higher margin than the American water business. American water business is primarily AMR and, of course, what we've been is AMI and AMI by its very nature has higher margins. I will say that the request for proposal has been issued. We're in the midst of responding to that request for proposal. So it would be difficult for us to actually give any more detail relative about the specific proposal. But I will say that our objective has always been to become a leader in AMI. So as we move to a greater percent of our business being AMI, let me put it this way, that's definitely our focus, to grow that business. And given its margin profile, we're a lot better off having a greater percentage of our business being AMI.

And then maybe lastly on capital allocation priorities, I was a little surprised to not see any activity on the buyback given the shares dipped below $7 there for a bit. I guess the revenue under performance of some systems over the last couple of years, how are you viewing the best way to deploy capital here over the next couple of years versus buybacks versus businesses that are kind of operating at the breakeven operating level?

Yes. Well, you bring up a good point. If these businesses continue to operate at a breakeven level, I think that we will certainly change our thoughts on capital allocation. I think right now as I said, that we made assumptions four or five years ago about the AMI business market, and it's been slow to develop. However, I think if we look at the last 12 months we've been pretty encouraged by both the movement in the marketplace and certainly with our technology. I think still based on our current outlook, that we can believe that Mueller Systems can achieve an ROIC in the range of 35% to 40%. We're very bullish about the leak detection because we're moving that to be a very asset light, an asset light business. But I would say that if we find that our assumptions about either the adoption of the technology in the marketplace or the competitive dynamics change, we'll adjust our strategy. But I would say as we look at it today that we think in the midterm to long term that we can generate better returns by investing in that business. But certainly, as I said, that if we see that it's not playing out that way, then we'll make the adjustments in our strategy.

Thank you. The next question comes from the line of Mike Wood [Macquarie Capital].

I was hoping you could give us some color in terms of the Anvil non-res trends? Sort of what growth you had this quarter excluding currency and what you're seeing in your orders and backlog that underpins your 2016 view?

Mike, I would say that we have been somewhat disappointed relative to our expectations on the non-res construction side. In this quarter I think we were somewhere between the 1% to 2% range in our growth, outside oil and gas. And I think if we continue to look at some of the forecasts for non-res construction spending throughout the year they continue to come down. When we look at 2016, the general forecasts are for mid to single digit growth. When we look at the ABI index, certainly for most of the year, it was positive. I would say that our outlook when we gave the outlook for 2016, it was based on the assumption that we'll see non-residential construction growing in mid single digits. But I will say that we're probably a little less confident in what's happening in that market as we are in what's happening in residential construction and municipal spending.

And then can you quantify for us the incremental leak detection and just general Mueller Systems investments you're making next year? Maybe also comment on why the incremental in the quarter of Mueller Systems was 20% whereas I imagine you're seeing a richer mix come through from AMI.

The AMI is lumpy and project oriented. We did see some AMI this quarter. But the bulk of what we have received will come through the second half of the year. I think that relative to investments, we haven't put a dollar amount on that. But when we look at where we think the real investment in these two businesses next year beyond just day to day will probably still be – as I answered the question little earlier -- in the development on our fixed leak detection so that will be on the R&D side. And more specifically to be able to communicate data over a cellular network. And we still have to -- I think, some improvements in our RF network. But I would say most of the investments that we saw in 2015 are behind us. We've built our worldwide sales force. There may always be some adjustments. We started the development on the fixed network. I think in 2016 what we will see is continued investment in developing the network for fixed leak detection. And I think relative to Mueller Systems from an investment standpoint, that for probably mid 2014 through mid 2015, we were spending development money on increasing the range of our radio. We've introduced that to the market in June so I think a lot of those investments are behind us. So when we compare ‘16 to ‘15, much more investment in ‘15 than what we expect to make in ‘16.

Thank you. Your next question comes from the line of Jose Garza [Gabelli & Company].

I just have a question about kind of the longer term. I know you guys have broken up the economics on Mueller Technologies. Just the longer term to kind of get you to some of the numbers that you've talked about especially as you kind of like you mentioned make the business a little bit more leveragable to get you to 20% EBITDA margins down the road?

Yes. On the Mueller System side, it's increased penetration, the AMI market and that market picking up is growth trajectory. Jose, as I said, we think we saw that both of those happening in 2015. We've seen more and more inquiries for AMI coming in from municipalities, and we've increased our win rate. We need to continue on that path. Relative to Echologics, and I answered this in a previous question, we think that 2017, we see that business being profitable based on the adoption of -- a greater adoption of fixed leak detection. So I think where we're positioned right now, it will be driven by the top line. I think that on Mueller Systems we have our cost of our system where it needs to be. I think on Echologics, we now need to lever the sales force that we've put this place as well as the technology that we're developing. And to me I think if that happens we start seeing that 2017 and 2018.

Okay. But I guess the assumption is a large increase in your gross margin in that segment [ph]?

Yes. The gross margins, though, will come from the volume growth. And when I look at Echologics, when you look at our gross margins on that business, I mean it goes between on a project by project basis 50% to 70%. We need the volume there to absorb the fixed cost we would put in that business, so it would grow. On Mueller Systems, we think margin improvement comes via shift to a greater mix of AMI.

Very helpful. And then I know you talked about the first quarter for Henry Pratt, but what's kind of the overall outlook for 2016 in that part of the business?

Yeah. When we look at 2016, right now and a lot of that comes out of our current backlog. We think it will be up in the low single digits. We do think that we will see nice growth in our distribution, our products to go to water distribution. We will have a little bit of a tough comparison because as you know, we discussed this in the past. From time to time, we have orders that go direct for fit to a nuclear plant. We shipped some of those this year, we don't see that coming back, replacing that in 2016. That's a long lead time item. So we know pretty much now if it's not in our backlog today that we won't probably see it over the next 12 months. And then the other is we made some nice shipments to water treatment facilities in the fourth quarter of this year. Our quotation activity is up on water treatment facilities but based on that timing, that could be down a bit. So sorry, I'm trying to give you all the different components. We think Pratt's going to be up probably in the low single digits this year.

Thank you. The next question comes from the line of Walter Liptak [Seaport Global Securities].

Sorry for, call's running a little bit late so I'll just ask one. The Mueller Co. operating leverage was very good this quarter. And the 40% that you had in your 2016 guidance, I wondered even what assumptions go in that if you can give us any color on pricing or mix into that 40% or is that just sort of the normal run rate for the business?

The 40%, Walt, would be that -- and this ties in a little bit on Jose's question. That we expect in 2016 probably see a mix shift more to our valves and hydrants, less from Pratt's. Because we think valves and hydrants are going to grow at a greater rate. So that certainly contributes to a better conversion margin. So, it's based on right now our expectations for the overall mix and timing of shipment. I will say that, of course, if you look at the last two quarters, we've had conversion margins significantly above that. But that's because of – and Evan referenced this little earlier -- the divestiture of our municipal castings business that was around $11 million to $12 million of revenue for us in 2015. It was only $14 million this year and it lost money in 2014. So, you'll see that the divestiture negatively impacts our overall revenue growth rate but has a nice positive impact on our margin. So I would say that the 40% right now is based on how we think our mix will play out and it's one that unless there's a change to that mix, we're reasonably confident in.

Thank you and the next question comes from the line of Seth Weber.

Just a quick clarification. The $36 million backlog and awards, is that a next 12-month number or does that get extended over a longer period of time?

That's entering backlog for 2016, the majority of those today are scheduled to ship in 2016. A little of that could move into 2017, but by far the vast majority is currently scheduled for 2016. And we certainly hope to add to that because we still have quotations outstanding that if those turn into awards the next couple months we would still have opportunity to ship those in ‘16. End of Q&A

Thank you. No questions at this time. [Operator Instructions]

Operator, I think as Walt mentioned, we have gone a long time today. So we want to thank everybody for their – thank everyone for their continued interest in Mueller Water Products, and thank you for joining us.

Thank you. That concludes today's conference call. Thank you all for joining. You may now disconnect.