Welcome, everyone, and thank you for standing by. At this time, all participants will be on a listen-only mode until the question and answer session of today's conference. At that time, to ask a question, please press star followed by the number 1 on your phone and record your name at the prompt. This call is being recorded. If you have any objections, you may disconnect at this moment. I would now like to turn it over to your host, Mrs. Marietta Zakas. Ma'am, you may begin.
Good morning, everyone. Welcome to Mueller Water Products' 2017 third quarter conference call. We issued our press release reporting results of operations for the quarter ended June 30, 2017 yesterday afternoon. A copy of it is available on our website, muellerwaterproducts.com. Discussing the third 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 Anvil in January 2017. As a result, Anvil's operating results for all prior periods and the gain from its sale have been classified as discontinued operations. 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 1-866-446-5476. 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.
Thanks, Martie, and good morning. Thanks for joining us today as we discuss our results for the 2017 third quarter. I'll begin our discussion this morning with a brief overview of the quarter, followed by Evan's more detailed financial report. I'll then provide additional color on the quarter's results and developments in our end markets, as well as our outlook for the full year. Overall, we are pleased with third quarter net sales growth of 3.3%, highlighted by 4.5% growth at Mueller Co. Although there were some minor puts and takes, net sales growth was about as we expected. Operationally, we continued to execute on our productivity plans and realize the resulting cost savings. However, higher material costs represented stronger than expected headwinds in the quarter.
During the quarter, we completed our $50 million accelerated share repurchase program and also repurchased an additional $5 million worth of shares under our existing share repurchase authorization. All in all, we were pleased with the quarter. Progress in the market, progress in integrating Singer Valve, and progress in operational improvements all met our expectations. With that, I'll turn the call over to Evan.
Thanks, Scott, and good morning, everyone. I will first review our third quarter consolidated financial results and then discuss segment performance. I will only be discussing our results from continuing operations. Net sales increased 3.3% in the 2017 third quarter to $232.2 million as compared with $224.7 million for the 2016 third quarter. Net sales increased due to volume growth at Mueller Co. and the February acquisition of Singer Valve. Gross profit, excluding a purchase accounting adjustment related to Singer Valve inventory, was $83.3 million for the 2017 third quarter compared with $83.2 million last year. Productivity improvements were largely offset by higher material costs at Mueller Co. Selling, general, and administrative expenses were at $38.7 million in the 2017 third quarter compared with $39.4 million last year, primarily due to lower personnel-related expenses.
SG&A expenses as a percent of net sales was 16.7%, or 80 basis points lower than the 17.5% in the prior year. Adjusted operating income increased 1.8% to $44.6 million as compared with $43.8 million for the 2016 third quarter. Lower SG&A expenses were partially offset by higher material costs. As you may recall, 2016 third quarter adjusted results excluded $21.2 million of other operating expenses, comprised of a $16.6 million non-cash pension settlement charge and charges primarily associated with the demolition of a surplus facility. Adjusted EBITDA for the 2017 third quarter increased to $54.8 million compared with $53.6 million for the 2016 third quarter. For the trailing 12 months, adjusted EBITDA was $163.1 million or 20% of net sales, an improvement of 70 basis points compared with the prior year period.
Net interest expense decreased $900,000 to $5.1 million in the 2017 third quarter as compared to $6 million in the 2016 third quarter. Income tax expense was $13.4 million or 35.7% of pre-tax income for the 2017 third quarter, and $5.6 million or 33.7% of pre-tax income for the 2016 third quarter. We grew third quarter adjusted earnings from continuing operations per share to $0.16 from $0.15 last year. I will now move on to segment performance, beginning with Mueller Co. Mueller Co. net sales for the 2017 third quarter increased 4.5% to $207.6 million as compared with $198.7 million last year. The increase was largely due to volume growth in both the U.S. and Canada and the addition of Singer Valve. Adjusted operating income was $54.1 million in both the 2017 third quarter and 2016 third quarter.
Adjusted operating income benefited from volume growth and productivity improvements, offset by higher material costs. Adjusted operating margin decreased 110 basis points to 26.1% for the 2017 third quarter, compared with 27.2% for the 2016 third quarter. Adjusted EBITDA for the 2017 third quarter increased to $63 million, compared with $62.6 million for the 2016 third quarter. Adjusted EBITDA margin for the quarter decreased 120 basis points to 30.3% from 31.5% last year. However, trailing 12-month adjusted EBITDA margin through the end of the third quarter was 60 basis points higher compared with the prior year. Now Mueller Technologies. Overall, Mueller Technologies' third quarter net sales decreased $1.4 million to $24.6 million compared with $26 million last year.
Mueller Technologies net sales of AMI and leak detection and condition assessment products were higher year-over-year, but were more than offset by lower AMR and visual read meter shipments. Adjusted operating loss was $1.6 million in the 2017 third quarter and was $1.5 million last year. Turning now to a discussion of Mueller Water Products liquidity. Free cash flow, which is cash flows from operating activities of continuing operations less capital expenditures, was $34.2 million for the 2017 third quarter compared with $54.4 million for the 2016 third quarter. Timing of disbursements as well as higher income tax payments resulted in lower year-over-year free cash flow in the quarter. At June 30th, 2017, total debt was comprised of a $479.7 million senior secured term loan due November 2021 and $1.5 million of other.
The term loan accrues interest at a floating rate equal to LIBOR plus a spread of 250 basis points. At June 30th, net debt leverage was again below one and our excess availability under the ABL credit agreement was $109.5 million. I'll now turn the call back to Scott.
Thanks, Evan. As I mentioned before, we are pleased to see the increased growth in our end markets this quarter with our overall net sales growth coming in about as expected. I continue to be encouraged by the operating performance of the company as we delivered meaningful productivity improvements in the quarter. These improvements, however, were not enough to offset the unfavorable material cost environment we are in. It appears that last year at the end of the third quarter, materials had bottomed out. This year, prices of brass ingot and scrap metal are on the rise, and in the 2017 third quarter, were up 13% and 20% respectively from the second quarter, and 25% and 30% respectively year-over-year, which unfavorably impacted our margins.
We expect material costs to continue to rise, but the impact to be less as we expect to further offset these costs with additional productivity improvements and higher market pricing. With this rising material cost environment, price has been lagging to changes in these input costs. However, we were encouraged to see higher pricing in the third quarter versus the second quarter. Moving on to a more detailed discussion on Mueller Co.'s results. Mueller Co. experienced solid net sales growth in the quarter despite a difficult comparison with a year ago. Last year, third quarter sales growth was the strongest in the last several years. This year, net sales were up in the mid-single digits and included growth from both our domestic and international markets. Additionally, we experienced growth from the Singer Valve acquisition, which I am pleased to report has experienced a smooth integration into Mueller Water Products.
Adjusted EBITDA margins remain at roughly 30%, but decreased 120 basis points year-over-year in the quarter due to higher material costs. On a trailing 12-month basis, however, adjusted EBITDA margins continue to improve, up 60 basis points over the last 12-month period. The unfavorable material cost environment led to our decision to announce brass price increases in both the U.S. and Canada during the third quarter. As I mentioned before, we are realizing improved brass pricing and expect this to partially offset significantly higher material costs in the fourth quarter. The brass price increase announcement also led to strong order volumes in the third quarter. We believe our strong order volume in advance of the price increase is a positive signal that our end markets outlook remains solid. Taking a closer look at sales in the third quarter at Mueller Technologies, results were somewhat mixed.
You will recall last quarter, we expected growth to moderate as we enter into tougher comparison periods. We are encouraged to have realized sales growth in our higher margin product offerings, fixed leak detection, pipe condition assessment, and AMI systems. However, lower AMR and visual read meter shipments more than offset this growth. As a result, 2017 third quarter net sales decreased $1.4 million year-over-year. To close out the third quarter discussion, I am happy to report our fixed leak detection business continues to gain interest in the market. As you will recall, during the quarter, we announced the San Jose project, which could be up to 10,000 nodes. On the strength of that project and due to the success of West Coast trials, we received additional orders from adjacent water authorities in the Bay Area. Now, looking ahead to the full year.
For our 2017 full year, on a consolidated basis, we expect low to mid-single-digit net sales growth year-over-year. We expect adjusted operating income improvement to slightly exceed net sales growth. We expect higher shipment volumes, productivity improvements, and better sales pricing to drive this margin expansion. We also expect to face significantly higher material costs. Evan will wrap up now with some other items.
Based on our current expectations for the full year, corporate expenses will be $33 million-$35 million. Depreciation and amortization will be $42 million-$43 million, and interest expense will be $22 million-$23 million. We expect our adjusted effective income tax rate to be 31%-33%, and capital expenditures to be between $36 million and $38 million. Finally, we expect 2017 free cash flow to be less than the $83 million generated in 2016, primarily due to larger income tax payments in 2017. We expect 2017 free cash flow to approximate adjusted income from continuing operations. Operator, would you please open the call for questions?
Thank you. We will now begin the question and answer session of today's conference. To ask a question, please press star followed by the number 1, unmute your phone and record your name at the prompt. Your name will be used to introduce your question. To cancel your question, press star 2. Speakers, our first question is coming from Mike Wood. Mike, your line is now open.
Hi, good morning, guys.
Good morning.
Good morning.
Thank you for the full year guidance. Just curious, if you could provide some more color on fiscal fourth quarter profit margin guidance, I guess particularly at Mueller Co.
Well, I think that we continue in the fourth quarter to expect to get margin expansion as we have in every other quarter except the third quarter. Mainly due to the fact that we're experiencing a somewhat better price environment, and we believe that the rapid rise in materials that we saw in the third quarter will kind of slow down a little bit, like we're not expecting 30 points of brass increase or 25% in steel metal. Ballpark, think kind of 20-40 basis points kind of margin expansion overall at Mueller Co. Kind of still wait and see where we are with tech.
Okay, great. Thank you. Then, when will you know if the price increase that you implemented on brass, when that would be successful, and what's your early read to date on that price increase?
We believe it's been successful. The order book that we're taking in through the month of July, it was sticking and we're realizing our book, if you look at our backlog right now, we're realizing price to offset cost increases. To not overly complicate this, we are expecting almost 100% coverage from price in the fourth quarter, not quite. There's a little bit less there. We measure our bookings coming in to see what they're yielding, and those yields all are encouraging, especially in hydrants, brass, and valves.
Thank you. Just finally, can you give that regional performance again like you did last quarter in terms of sales, and was there any lingering impact from things like West Coast potential price mix impact? Thank you.
No, I think we did see a little catch up in the West, basically, we were at our kind of forecasted performance by territory.
Great. Thank you.
Brian Lee, your line is now open.
Hey, guys. Thanks for taking the questions. Maybe first off, just to clarify, Scott, the 20 to 40 basis point improvement that you just commented on for Mueller Co., that's sequential? I just wanted to clarify, is that a sequential improvement you're speaking to?
No, let me be clear. I was speaking to kind of a consolidated performance. I know he asked Mueller Co. In my mind, I'm looking at consolidated, that's more in that line. We're thinking that kind of that 20 to 40 basis points in the fourth quarter will be overall and basically coming from the recovery of price and the continued productivity performance.
Okay. Just to be clear, the baseline for the improvement is off of the fiscal 3Q?
Yeah, off of fourth quarter. It's a year-over-year.
Year-over-year. Okay. Just wanted to be clear on that. Okay.
Yeah.
Thank you. Then, again, on the pricing commentary, super helpful, and also encouraging to hear that a lot of the brass pass-through seems to be sticking here in the fiscal fourth quarter. Can you speak to the price increases that you implemented earlier this year? Sort of what you've seen in terms of those price increases sticking, and then what sort of visibility you have for the rest of the year, if you're still looking for feedback on customers from those earlier price increases?
Okay. Sure. One of the things I think I did in the last quarter is probably scare too many people or something, and certainly that was not my intent. Sequentially, so Q3 versus Q2, we experienced exactly what I expected to experience, which was price improvement as rising material cost inputs forced all producers to look at their market pricing, and we see this lag. As we had the squeeze in Q2, where we had a poor price environment coupled with rising costs, we've seen that reverse in Q3, where we've started to see a pickup in the price environment. After a prolonged decline, and then bottom in Q3 of last year in the raw material world, we started to see this uptick. We've seen all through Q3, sequentially month by month, a better price environment.
We have seen through the first month of Q4, sequentially over June, in July, a better price environment. We have seen it everywhere. Valves, hydrants, brass, every single category has seen price. The question that remains, and I guess I've made too much of a big deal about, is that I'm watching very closely to ensure that we get as much price in Q4 as we have inflation. Will we catch it all up at once? Currently, we think there'll still be a little bit of breakage. It's up to operations then to countermeasure that with their productivity plans so that we can then have the margin expansion and continue the growth and cost reduction programs that we had. I want to reiterate, bookings in the quarter exceeded shipments by like $13 million-$14 million.
We had a strong order book, and everything we took in was at a higher price with each sequential month. We've seen price in all of the major categories, and we've seen a good demand environment, which is why I am encouraged. I'm encouraged and I thought we had a good quarter because we've seen the improvements in the order book. We finally got some growth, and we finally have started to see the materials and price get back in lockstep with each other, that as materials go up, so do prices.
Okay. That's great context. Couple last ones from me, and I'll pass it on. Specifically on Mueller Technologies, I'm assuming at this point the 15% targeted growth for the year, you're going to be changing that. Is there a new number to report there? What's the mix between AMI and legacy at this point? Should we expect legacy deployments rolling off to remain a drag here on organics? Or when do you get to a point that you start lapping those?
It's a great question. Obviously, the demand fell off on the visual read and the AMR a little faster than we expected. We're still evaluating that. I think long story short, if you were to look at just the meter business, I would say that that's probably going to be a little bit north of $2 million kind of growth instead of 15% at this point, based on what I've seen in the order book, based on the size of the backlog. We were expecting, frankly, two projects to have closed in the quarter that we think we're in good shape to win.
Those decisions continue to get delayed, I'm not going to sit here and say the order book is going to be as strong at the end of this year as it was at the end of last year when we had Lee County and others. I think it's realistic that we won't be in that 15% range. We'll have some growth, but nowhere near as much as we had hoped. With that said, I think there's a little upside in tech as a result of how quickly we get these nodes, the DX nodes deployed at Echologics. We're going to be pushing to get as much of that out as we can in the fiscal year, but at the same time, want to ensure that we have as much value add there as we possibly can.
We're going to be kind of trying to balance that. All in all, I expect the technologies business to kind of be up in that 5%-7% range, certainly well below our expectations at the beginning of the year.
Okay, that's great. Last one. Can you maybe just speak to this recent Landis+Gyr announcement, the relationship there? Just curious if you can walk through some of the dynamics of what hardware or software do you guys provide versus them, and then also how does it integrate or how does it work with the Mi.Net, given their protocol and their platform that they have there, which I believe is mesh. Thanks.
First, let me back up a little bit before we talk about that, and talk in general about technologies and this notion of an open architecture radio. We will communicate with anybody who allows us to communicate with them. We believe our radio ranges, our power utilization, whether we are using something like a LoRa technology or we're using our own fixed network technologies, that we are open to having our meters and our radios interface with any fixed network. This Landis+Gyr RF mesh program is just more of that. It's us making sure that our systems can communicate where fixed networks exist. A portion of the municipalities that L&G have serve electricity and water, and they have strength in the channel, especially from their electricity position.
We thought it'd be a great way to get some volume for our meters using their fixed network and using their channel power. I expect that we'll have 50,000-80,000 units as a result of this agreement, and we certainly look forward to working with them closer. Long story short, a channel play, a technology play, and right in line strategically with our view to an open architecture world.
Okay, thank you.
Thank you.
Our next question is coming from Seth Weber. Mr. Weber, your line is now open.
Hey, thanks. Good morning.
Morning, Seth.
A couple quick clarifications first. Can you give us what the organic Mueller Co. revenue was without Singer or Currency?
Yeah, it was about 2.5%.
Okay, thank you. Just going back to the last question, were systems and Echologics sales in the third quarter about as you expected, or I'm just trying to kind of separate-
No, I think, no. I mean, Eco was right where I thought it would be, if you think back to what I said in the second quarter, we're not going to duck. I was expecting more flat sales, certainly at the time did not want it to be down. We booked enough that we could have been flat year-over-year. We had a couple of bumps along the way, a couple of push-outs, no, I'm not going to sit here and say, Seth, that we were expecting it to be down $1.4 million. I was expecting it to be flat to slightly up, and as the quarter developed, it was small.
What I think I'm most pleased about, though, I guess, my roots and the way I think about it is once it became apparent that we were going to have a few operational issues there, the challenge went out to make sure we covered that and that we countermeasured and that we did the things we had to do as a well-operated business to make sure we met our commitments. I was pleased to see the Mueller Co. performance cover what needed to be covered and get us to where we had said we would be.
I think, when you think about an environment where you are implementing Lean Manufacturing, where you are focusing on margin expansions through your productivity initiatives, where you are trying to manage the market and get in front of price and things like that you hit those levers to make sure you make your commitments. I would say the systems business kind of fell below expectations. Mueller Co. and Eco were there to pick up the slack and all in all, I think a solid quarter. The thing I will tip my hat to the systems guys on is that we did book about $3 million or so more than we shipped, and we could have pulled it out if we hadn't had some late quarter problems.
Okay. Scott, just kind of doing some math here. It looks like your guides, I mean, it's not real guidance, but for tech, it looks like revenue should be up a little bit sequentially from 3Q to 4Q. My question is, that's call it a $100 million kind of run rate into next year, based on 3Q, 4Q. Is that a high enough revenue number for that business to be profitable? If that, let's say revenue is $100 million next year, can tech be profitable at that level?
That's a great question, and one that I'm not trying to duck on, Seth, but I know I'm very sensitive to the fact that at the beginning of the year, we had guided you to $10 million improvements on about that level of sales. I think that that, with a quarter to go, is something that we're going to have to reckon with, because I don't think it's within reach now. In theory, yes, of course, it should be possible. A $100 million business should be profitable. With that said, there's things that have to happen- the business in order for that to be achieved. I'm not really prepared at this time to say next year's profitability outlook for tech is X or Y. We'll go through our AOP process. We're going to press for a significant margin expansion.
Even at the price, I think there's opportunity. Even if we don't get a single penny of price in the systems business, I believe there's opportunity for margin expansion. Yeah. I don't want to duck it, but at the same time, I don't want to sit here and say we can be profitable at $100 million. I would certainly say we should be profitable at $100 million.
Okay. Thanks, Scott. If I could just ask a follow-up. Your leverage here is below one turn.
I think you've talked about wanting to look at the M&A landscape a little bit in your first year, how are you thinking about share buyback here, given the leverage ratio and you haven't announced any M&A?
Right. I think the answer we gave before is the one, it will be balanced. It will be continuing to look at our dividend, continuing to look at share buyback, continuing to look at the opportunities in the M&A pipeline. I think the whole capital allocation discussion is a fair one to have. I would say, given where we are, we went through with our board the strategic review, if you will, a strategic business review, to look at where we thought the attractive spaces were, both in potable and non-potable water, where we thought the attractive spaces were from a geographic basis. Looking at that M&A pipeline. I would say we'll probably be more active in the near future than we have been.
I think we said we did $5 million over and above the $50 million ASR, I would say we'll be more active than $5 million, as I think the cash flow and cash generation looks good for the business, and there's still plenty of powder drive for acquisitions. Balanced approach, probably a little more stock buyback and go from there is how I'd like to frame it for you.
Okay. I appreciate all the thoughts. Thanks, guys.
Thank you.
Our next question is coming from Mr. Brent Thielman. Brent, your line is now open.
Thanks. Good morning.
Morning.
Hey, Scott, maybe on that last question on Mueller Technologies, because I know you come in with a strong background here, but as you spend more time with the business, are you finding things you can do to markedly improve the cost structure of the business?
Yeah, I think so. I think this two quarters now, we're right at the end. I don't want to get into too much detail, but Spike did say with four days left in the quarter, we had a couple of machines down that were not anticipated. All hands on deck, ended up throwing some overtime at it, ended up throwing some more cost at it. I think it sounds like a repeat of what I told you last quarter. I'm a little bit sensitive to always having some kind of a late quarter excuse for not making a number. Certainly, there is plenty of things there to answer your question directly, both from a sourcing point of view. What do we outsource? What can we cast ourselves?
Look at assembly processes, look at automation, look at a lot of things there that I think we can structurally take cost out of the cost of producing a radio or the cost of producing a meter. I do see it, and I also want to say that operationally, the team has already taken out quarter-over-quarter a significant amount of OT. Their first pass yields and quality costs have come down like 70% quarter-over-quarter. There is operational improvement there, but there's still things we can do.
Okay. Those investments, maybe a new automation, are those things you're still evaluating, or you plan to put those to action over the course of the next 12 months?
Well, our planning cycle is that this quarter we're in right now is what we call our annual operating plan cycle. We'll make our allocation decisions as regards to capital at that point. We're not going to sign up for CapEx that doesn't pay for itself. As long as the resulting cost improvements are forthcoming as people think about capital and we think about capital plans, it'll get through our screen. If it doesn't, it won't get through our screen.
Okay.
That's kind of the process we're in right now.
Got it. Okay. It, Scott, seems like we keep hearing about more activity in residential project and land development across the country, which should be good for Mueller Co. I know it's difficult to pinpoint exactly where the products are going, but I guess I'm a little surprised, just given what you hear out there from developers, construction companies, volumes don't have a little more momentum behind them. I guess the question, are you still seeing some pullback in municipal repair replacement? Is there maybe an inventory overhang out there with distributors? Is it activity is just not coming around as much and where the Mueller brands are really strong? Any color there based on context of what you're hearing out there?
Yeah, I think everybody's basically gone before us, you're looking at municipal spending that's either flat in-- I think the census data would even say the pipe and hydrant part of municipal is actually down year-over-year.
Yeah.
I think that what we're seeing is, if it wasn't for the lift we're getting in the resi construction space, repair and replace would be slightly down year-over-year. It has muted the growth that we would have expected otherwise. If you look at everybody else who's reported in the quarter, I think that flat to down is kind of where we are muni-wise, and if it wasn't for the growth in residential construction, we too would be. There's not a lot of share shift going to go on here in these markets.
Right. Okay. One last one, I guess. If I recall, Canada had been a headwind for some time, certainly for other industrial manufacturers out there. Does this kind of volume improvement look sustainable? Is there some year-on-year comps to think about? What are you seeing there?
Certainly the price environment in Canada improved. It was a net positive for us, and we started to see some volume improvement year-over-year. I think we're keeping our eye on it. There's some reports that maybe their residential cycle is a little overheated right now, and it could draw back in 2018. We're keeping our eye on it's certainly been, for Q3, a good news story after kind of dragging and the exchange problems, et cetera, dragging on the business through the first couple of quarters. Good news Q3, hopefully it sustains through the rest of the Q4.
Okay. Thank you.
Thank you.
Our next question is coming from Mr. Jose Garza. Jose, your line's now open.
Hey, good morning, guys.
Good morning, Jose.
Scott, you kind of touched on it a little earlier. I guess you guys had a board meeting in July and just wanted to see any updates on capital allocation with the Anvil cash and how you're going to communicate that to the investment community.
Well, as I said, we're going to stick with what we said, which is we continue to look at the capital allocation. We want to take a balanced approach. That balanced approach will look at dividend policy, it'll look at share buyback, and it'll look at M&A. I think that the refocusing of the M&A pipeline, I think it had been primarily focused on potable water. We're going to be looking at some other adjacencies that we think are also attractive, but I really don't want to get into what they would be. We're looking for alignment with channel, or we're looking for alignment with our manufacturing capabilities, or we're looking for geographic alignment. That's kind of where the M&A pipeline is.
I think in the near term, you can expect in the next-- and by near term, I mean the next three to four quarters kind of thing, a little more participation with stock buyback than you had seen from us in the third quarter, where I think after the ASR was done, we did $5 million or something. I think you'll see some of that cash be used there. Plus, I was pretty happy with the cash generation for the quarter as well. I think it gives us some flexibility that we have that we wouldn't have had before.
Yeah. I guess tied to that, just the puts and takes on reducing, I guess, the gross debt on that term loan. Maybe this is a better question for Evan. How do we think about that here in the short term, since the cash, I guess it's just the interest is, I guess, a negative carry there?
Certainly we're talking about it, I'll let Evan give you the full answer. If you look at what we're earning on the cash versus what the spread is on the debt, certainly it's something that we're talking about. Does it give us anything to pay that down, and what's the economics of it? Go ahead, Evan.
Yeah, no, that's right. I would say we're in an evaluation stage really across the board when we look at the capital allocation and specifically with respect to the Term Loan B. We have about $480 million outstanding with a little over $350 million in cash. We're in a solid position, but I think that's all tied into this share repurchase debt retirement overall discussion, and I think we'll be balanced as we move forward.
Okay. I guess just in terms of how you guys would approach a share repurchase, I guess what's your preference in terms of an ASR versus just out in the open market?
I don't really want to say one way or the other. If we do an ASR, obviously we'll announce it, but I think it just causes some front running and I have a bias for open market activities, but I think that there's greater financial minds than my own that will say this is a better way to do it or not. Certainly it will be something we take in concert with the board as we go forward. I'm not sure that the ASR and having that does any good for you. I have a bias for open market, but we'll see as we go forward.
Okay. Just one more. Just your sense on kind of hydrants and pipes kind of, I guess year to date, I guess in your market, you did talk a little bit about the quarter. Just any kind of bigger picture there?
I'm not sure what you mean, Jose. Do you mean in, I'm sorry, in terms of the overall market growth or?
Yeah. For Mueller Co.
Yeah. Valves and hydrants are going to be up and we originally came into the year talking in terms of mid-single digits. You'll recall last quarter, I had said, no, that's probably low to mid-single digits. I think that's all being driven by what has been a little less strong muni environment than we anticipated. Been a little bit stronger resi market, but not enough to offset. I still think we're going to end up in that 3% range with a fairly strong fourth quarter for valves, hydrants and brass, what we talk about in terms of core. The fundamentals about still needing to retrofit the existing infrastructure along with an improving resi environment. We're still not back to what I would consider equilibrium.
If you think about us being around 1.2 million housing starts, and you say we kind of need to be between 1.4 and 1.6 million housing starts, kind of be in our long-term equilibrium. There's 10% or 15% growth opportunity there. Plus, you take the need for the retrofitting, if you will, of the existing infrastructure. You come up with a growth number that says our long-term growth on valves, hydrants, and brass, what we consider our core, should be a little bit stronger than GDP kind of growth. There is no reason, and I've seen nothing that would make me change my mind in that direction. I think that the long-term growth for those businesses should be like that. I think in the near term, we'll get a little lift because there was a lull.
I also think that the Washington situation is one that continues to perplex. Not a political comment one way or the other, but I do think that we have to say what we're going to do about infrastructure so that people all start moving in a direction. Right now it feels kind of confused and a little choppy out there.
Yeah. Okay. Thanks very much, guys.
Thank you.
Our next question's coming from Mr. Jim Giannakaris. Jim, your line is now open.
Hi, good morning.
Morning, Jim.
Price increases in brass similar in magnitude to what's been introduced in hydrants and valves, or how should we be thinking about magnitude there?
I think the hydrants and valves back in February went after 7. It was delayed. I can't remember off the top of my head what the yield looks like right now. I think in brass, we went after 5, and the yield will be something less than that. I should say the yield should be around 5, and I think we went after 10 and expect to get 5 or 6. These yields with exchange and everything else are a little bit, I don't know, choppy. I've used that word for demand. It's uneven. We've seen an ever-improving bookings condition on brass, but brass costs have continued to go up. I'm going off the top of my head here, but if you look at Q3, I think our average brass was $2.78. I think in Q4, we expect that number to be around $2.87.
Another $0.09. If you think about a yield in the 5 range and you think about a cost probably going up another $0.09, $0.10 a pound, you'd be kind of right there with where I think the quarter's going to come out. The announced price increase and the yield price increase are always something that moves around for us. I think, in the past, we've guided that when we announce a price increase, we generally expect to yield around 50%. I think that's where we're modeling brass right now, and that's what we think we're going to yield.
Okay. Thank you. That's helpful. Since we're on that, puts and takes on Mueller Co margin progression, obviously, liking that prices there offsetting inflation. Can you frame for us or size base incremental margins on volume growth? How much in productivity benefits should we be thinking annually? What are you guys targeting there? Thanks.
Oh, there's a lot to that question. I think Mueller Co full year, I'm expecting somewhere to be a little south of $20 million total productivity. If you were to do that math of what they've delivered so far versus what's left to be delivered, I think there's probably another couple of million dollars in the quarter in Q4. As some of the bigger projects like Project Bear come off the year-over-year comparison because they were implemented in Q3 of last year. Probably a couple of million more to come from Mueller Co in cost out. Probably, think about it in the context of maybe a couple of million in price in the quarter.
All in all, that 30 basis points I was talking about improvement on a consolidated basis I think that Mueller Co could be anywhere from up similar numbers to down 40 basis points, depending on what you assume for steel, scrap, and brass. If you hold us flat at that 278 number, we'd be up. If it runs all the way to 287 in the quarter or 290, we could have a few more headwinds, and we're not contemplating that all of the price yield will come in in one great swoop here in August. That's the best way I can dimension it for you, Jim, is that it's going to be a range of outcomes. Where we think we are right now is that there's $couple of million left to get in price, $couple of million left to get in productivity.
There'll be a little bit of volume absorption, and depending on what happens with scrap steel and brass, will be the determinant.
Okay. That $20 million is an FY 2017 number. Is there a productivity or cost takeout figure that you're contemplating on an annual basis? Is it 5, $10 million that you typically targeted? Sounds like you had some heavier lifting coming into this fiscal year. Is there something, just when we're modeling out years, how we should be thinking about your productivity-
Yeah
initiatives? Yeah.
Yeah. Sorry. Yeah, I think we should be looking. I generally say 100 basis points forever. You have to reinvest in the business, and you have to have a steady drumbeat of new products coming in. If you think about total productivity at, let's call it $20 million, net inflation at a takeaway, you would expect to see about 100 basis points of productivity from the combined plant operations every year. That contemplates, though, for your out year modeling, that we grow our new product or our Vitality Index to something approaching 15%-20%. That you have 15%-20% of the products you're making, year one, year two, year three, that you're going to have the steepest productivity curve on.
The notion that when you start a new product, its highest cost is its first year of production, and its lowest cost is its last year of production. That's kind of as you manage the product life cycle, where the bulk of your productivity comes from. We haven't yet achieved a Vitality Index anywhere near the 20s, but it's something we have to. At the same time, as we're getting those new products across our machines and through our foundries, we should be able to give 100 basis points of productivity. Next year, I think it'll be a little heavier than that. Next year, I believe that we should have this year kind of productivity, kind of $20 million-ish, a little bit of inflation. The net flow-through to be a little higher, because I do believe we've under-invested in engineering.
As I said in the Q2, I think it's something we have to invest in in order to prime the pump on new products.
Got it. That's very helpful. One last one, if I may. A quick one on Middle East. I know it's small, but there have been hiccups there. Has that stabilized or still declining quarter-over-quarter?
I would call it up, but it is kind of bumpy. It was up Q3 versus Q3 last year. There's a couple of big projects going on over there in Oman. There's some big investments, and they continue in Saudi and some other places where there's desalination projects that could be of interest to us. I would say it's bumpy, but it was a good quarter internationally overall.
Got it. Thank you.
Thank you.
Our next question is coming from Sir Joe Giordano. Joe, your line is now open.
Hey, guys. Good morning. This is Tristan in for Joe today. Thanks for taking the questions. If I look at your distributors, how do they forecast the level of inventory that they need to carry, and what kind of visibility do they have there?
Gosh, how do I answer that? They don't. They give you some point-of-sale information. They have their financial targets. Our two largest, Ferguson and HD Supply. Well, HD Supply has just been purchased by Clayton, Dubilier & Rice. Wolseley, Ferguson, they have their cash metrics that they're trying to manage. They have their terms that they're trying to manage. It's a negotiated discussion region by region based on what sell-through looks like. Our visibility quarter to quarter is relatively short.
All right. Thanks. If I look at your AMI meters, I don't know if you can tell, who are you gaining share from? I don't know if you have any colors on what region you're gaining share the most. Thank you.
Well, Tristan, I would say that the market is in an adoption phase, you're not taking share from anybody. This is an emerging market. The AMI space, whether it be kind of that AMR operable or fixed network AMI, that as people adopt, you battle it out with all of the traditional players. There's only a few people in fixed network. We are growing faster there, we believe, than the market is actually growing. We should have, at the end of it, a higher participation in the AMI market than we have in the traditional markets. That's been the strategy. I wouldn't characterize it as taking share from anybody. I would characterize it as AMI being adopted, replacing visual read or drive-by AMR, and us participating in that emerging market.
With that said, I think that one of the things we're not doing as an industry, perhaps others are doing it better than us, is if you think about the fixed networks, I think the fixed network in a 50,000-person city and below, you can see maybe some economics for people like us and people, the traditional competitors, to put in a fixed network.
I think if you get to a New York City or even Philadelphia, which is out there now, or one of these top 25 MSAs, to think they're going to deploy a fixed network for the water infrastructure, deploy a fixed network for the electrical infrastructure, deploy a fixed network for policing, deploy a fixed network for street lighting, deploy a fixed network for all of the things that will ultimately need to be automated in a metropolis, I think it's unrealistic to think that water is going to be at the locus or some kind of reserved bandwidth is going to be at the locus of those deployments. That's why we commit ourselves to being in this open architecture environment. That's why we are in LoRa. That's why we will look at IEEE 802.11 and every communications method, whether it be a WAN system or whatever.
We know that in the large-scale deployments in the future, the person that's positioned to integrate into fixed networks that are, let's call them open architecture, will be well-positioned. We believe that that's the path we're on with our product development, and we'll continue to believe that that's the right path to take share in the emerging markets.
Yeah, I appreciate the comments, Scott. Thank you so much. When I was talking about share take, I guess I was just referencing you integrating or implementing AMI technology where maybe some of your competitors have a visual read, that sort of thing. With that being said, are you seeing any pockets of strength at different locations in the U.S.?
I can't answer that. It's not that I won't, it's that I can't answer it, I'd be happy to get back to you when we look at the regional data. I think it's pretty broad-based. I know the West Coast, Southern Cal, probably had the greatest adoptions so far, kind of the early adopters. I can't answer because I don't have the data in front of me, certainly it's not something we'd be unwilling to share. I'll be happy to get back to you or Joe.
Fair enough. Thanks.
Our next question is coming from Mr. Seth Weber. Mr. Weber, your line is now open.
Hi, thanks for taking the follow-up. Just real quickly, we've been hearing more recently about China trying to make some progress with water leakage in their systems. I'm wondering if you have any initiatives to try and push into that market. Do you have feet on the ground there? Have you had any conversations with any potential customers there? Thanks.
To answer the question, I know this came up on another call. China is not a focus for Echo right now. It is something that we're interested in and something we'll be following up. We do have feet on the ground in China. We actually have assets capable of having the discussion in Shanghai, in Beijing, in Guangzhou. Right now, as we think about where Echo is in its deployment, and especially as it relates to pipe condition assessment and fixed leak detection, China has not been one of the Southeastern Asian cities that have been focused for us. I think that the biggest thing has been kind of that Malaysia, Singapore, the island nations that have relatively limited access to fresh water and extremely high marginal cost of water. That's kind of how we focus the Echologics businesses around that.
Marginal cost of a gallon of water is more than kind of digging another well, then it's well-positioned for people to be willing to spend for a fixed leak detection network. To answer the question directly, Seth, it's not a focus area for us at this time, but it could become in the future.
Great. Thanks again. Appreciate it.
Thanks. I see nothing else in the queue. What I'd like to kind of summarize saying is, look, I was pleased with the quarter. Between the growth that we were able to show from shipments, along with the increase in backlog, which as I said to you in the Q&A, was around $15 million, along with the improvement we saw in performance from the plants offsetting what was some pretty stiff headwinds in the material environment, along with an improving sequentially price environment, I was happy. Some will tell you that's difficult. I thought we had a solid quarter, and I thought the team responded well to the challenges that you have in the quarter. I thought operationally we were on point, and I was happy with the sales team's ability to put through the price increase and deliver volume.
All in all, I'm positive, and I thought it was a good quarter, and I'll be happy to talk to any of you after the fact as we have some calls lined up. In summary, pleased with Q3. On that note, with nothing left, I think, Marty, we're good. Operator, I think we can-
That concludes today's conference. Thank you all for your participation. You may disconnect at this moment.