UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

x

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended December 31, 2005.

¨

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission File Number 333-131536


MUELLER WATER PRODUCTS, INC.

(Exact name of registrant as specified in its charter)

Delaware

20-3547095

(State or other jurisdiction of
incorporation or organization)

(I.R.S. Employer
identification No.)

4211 W. Boy Scout Blvd.

Tampa, FL 33607

(Address of principal executive offices)

 

(813) 871-4811

(Registrant’s telephone number, including area code)

Mueller Water Products, LLC
500 West Eldorado Street
Decatur, IL  62522-1808

(Former name or former address, if changed since last report)

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x  No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer” and “large accelerated filer” in Rule 12b-2 of the Exchange Act.

Large Accelerated Filer o  Accelerated Filer o  Non-accelerated Filer x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). o Yes  x No

None of the Registrant’s voting stock was held by non-affiliates as of February 21, 2006. As of February 21, 2006, Mueller Water Products, Inc. had one unit outstanding.

 




PART I.                   FINANCIAL INFORMATION

ITEM 1.                FINANCIAL STATEMENTS

MUELLER WATER PRODUCTS, INC.
UNAUDITED CONSOLIDATED BALANCE SHEETS

 

 

December 31,
2005

 

September 30,
2005

 

 

 

  (unaudited)  

 

 

 

 

 

(dollars in millions)

 

Assets

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

 

$

72.4

 

 

 

$

 

 

Receivables, net of allowance for doubtful accounts of $6.4 million and $0.9 million at December 31, 2005 and September 30, 2005, respectively

 

 

267.0

 

 

 

118.5

 

 

Inventories

 

 

429.1

 

 

 

147.2

 

 

Deferred income taxes

 

 

58.8

 

 

 

11.1

 

 

Prepaid expenses

 

 

32.1

 

 

 

1.5

 

 

Total current assets

 

 

859.4

 

 

 

278.3

 

 

Property, plant and equipment, net

 

 

344.8

 

 

 

149.2

 

 

Deferred financing fees, net

 

 

32.0

 

 

 

 

 

Deferred income taxes

 

 

 

 

 

9.5

 

 

Due from Walter affiliate

 

 

20.0

 

 

 

 

 

Intangible assets, net

 

 

849.3

 

 

 

 

 

Goodwill

 

 

856.7

 

 

 

58.4

 

 

Total assets

 

 

$

2,962.2

 

 

 

$

495.4

 

 

Liabilities

 

 

 

 

 

 

 

 

 

Current portion of long-term debt

 

 

$

11.5

 

 

 

$

 

 

Accounts payable

 

 

105.9

 

 

 

52.5

 

 

Accrued expenses and other liabilities

 

 

119.0

 

 

 

34.7

 

 

Payable to affiliate, Sloss Industries

 

 

 

 

 

2.5

 

 

Total current liabilities

 

 

236.4

 

 

 

89.7

 

 

Long-term debt

 

 

1,537.1

 

 

 

 

 

Payable to parent, Walter Industries

 

 

2.6

 

 

 

443.6

 

 

Accrued pension liability, net

 

 

97.2

 

 

 

53.6

 

 

Accumulated postretirement benefits obligation

 

 

52.8

 

 

 

51.1

 

 

Deferred income taxes

 

 

290.6

 

 

 

 

 

Other long-term liabilities

 

 

20.2

 

 

 

12.6

 

 

Total liabilities

 

 

2,236.9

 

 

 

650.6

 

 

Shareholder’s equity (deficit):

 

 

 

 

 

 

 

 

 

Membership unit:

 

 

 

 

 

 

 

 

 

(1 unit outstanding at December 31, 2005 and September 30, 2005)

 

 

 

 

 

 

 

Capital in excess of par value

 

 

998.8

 

 

 

68.3

 

 

Accumulated deficit

 

 

(226.9

)

 

 

(178.1

)

 

Accumulated other comprehensive loss

 

 

(46.6

)

 

 

(45.4

)

 

Total shareholder’s equity (deficit)

 

 

725.3

 

 

 

(155.2

)

 

Total liabilities and shareholder’s equity (deficit)

 

 

$

2,962.2

 

 

 

$

495.4

 

 

 

The accompanying notes are an integral part of the consolidated financial statements.

1




MUELLER WATER PRODUCTS, INC.
UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS

 

 

Three months ended

 

 

 

December 31, 2005

 

December 31, 2004

 

 

 

(dollars in millions)

 

Net sales

 

 

$

480.4

 

 

 

$

130.3

 

 

Cost of sales

 

 

436.9

 

 

 

117.6

 

 

Gross profit

 

 

43.5

 

 

 

12.7

 

 

Operating expenses:

 

 

 

 

 

 

 

 

 

Selling, general and administrative

 

 

57.1

 

 

 

13.2

 

 

Related party corporate charges

 

 

1.8

 

 

 

1.9

 

 

Facility rationalization, restructuring and related costs

 

 

24.1

 

 

 

 

 

Total operating expenses

 

 

83.0

 

 

 

15.1

 

 

Loss from operations

 

 

(39.5

)

 

 

(2.4

)

 

Interest expense arising from related party payable to Walter Industries 

 

 

 

 

 

(5.9

)

 

Interest expense, net of interest income

 

 

(32.2

)

 

 

(0.1

)

 

Loss before income taxes

 

 

(71.7

)

 

 

(8.4

)

 

Income tax expense (benefit)

 

 

(22.9

)

 

 

1.1

 

 

Net loss

 

 

$

(48.8

)

 

 

$

(9.5

)

 

 

The accompanying notes are an integral part of the consolidated financial statements.

2




MUELLER WATER PRODUCTS, INC.
UNAUDITED CONSOLIDATED STATEMENT OF SHAREHOLDER’S EQUITY (DEFICIT)
FOR THE THREE MONTHS ENDED DECEMBER 31, 2005

 

 

 

 

 

 

 

 

Accumulated

 

 

 

 

 

Capital in
Excess of 
Par Value

 

Accumulated
Deficit

 

Comprehensive
Income
(Loss)

 

Other
Comprehensive
Loss

 

Total

 

Balance at September 30, 2005

 

 

$

68.3

 

 

 

$

(178.1

)

 

 

 

 

 

 

$

(45.4

)

 

$

(155.2

)

Walter’s investment in subsidiary

 

 

943.4

 

 

 

 

 

 

 

 

 

 

 

 

943.4

 

Dividend to Walter

 

 

(444.5

)

 

 

 

 

 

 

 

 

 

 

 

(444.5

)

Dividend to Walter for acquisition costs

 

 

(12.0

)

 

 

 

 

 

 

 

 

 

 

 

(12.0

)

Forgiveness of U.S. Pipe payable to Walter

 

 

443.6

 

 

 

 

 

 

 

 

 

 

 

 

443.6

 

Comprehensive loss

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net loss

 

 

 

 

 

(48.8

)

 

 

(48.8

)

 

 

 

 

(48.8

)

Unrealized loss on interest rate swaps, net of tax

 

 

 

 

 

 

 

 

(1.1

)

 

 

(1.1

)

 

(1.1

)

Foreign currency translation adjustments 

 

 

 

 

 

 

 

 

(0.1

)

 

 

(0.1

)

 

(0.1

)

Comprehensive loss

 

 

 

 

 

 

 

 

 

 

$

(50.0

)

 

 

 

 

 

 

 

Balance at December 31, 2005

 

 

$

998.8

 

 

 

$

(226.9

)

 

 

 

 

 

 

$

(46.6

)

 

$

725.3

 

 

The accompanying notes are an integral part of the consolidated financial statements.

3




MUELLER WATER PRODUCTS, INC.
UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS

 

 

Three months ended

 

 

 

December 31,
2005

 

December 31,
2004

 

 

 

(dollars in millions)

 

Cash flows from operating activities

 

 

 

 

 

 

 

 

 

Net loss

 

 

$

(48.8

)

 

 

$

(9.5

)

 

Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:

 

 

 

 

 

 

 

 

 

Depreciation

 

 

17.1

 

 

 

6.5

 

 

Amortization of intangibles

 

 

6.6

 

 

 

 

 

Amortization of deferred financing fees

 

 

1.2

 

 

 

 

 

Amortization of tooling

 

 

0.1

 

 

 

 

 

Accretion resulting from valuing acquired debt at fair value

 

 

(1.9

)

 

 

 

 

Accretion on senior discount notes

 

 

5.2

 

 

 

 

 

Gain on disposal of property, plant and equipment

 

 

(0.4

)

 

 

0.7

 

 

Impairments of property, plant and equipment

 

 

19.2

 

 

 

 

 

Provision for deferred income taxes

 

 

(25.8

)

 

 

 

 

Gain on interest rate swaps

 

 

(0.4

)

 

 

 

 

Changes in assets and liabilities, net of the effects of acquisitions:

 

 

 

 

 

 

 

 

 

Receivables

 

 

28.9

 

 

 

16.5

 

 

Inventories

 

 

91.2

 

 

 

(4.2

)

 

Income taxes payable

 

 

 

 

 

10.7

 

 

Prepaid expenses and other current assets

 

 

1.0

 

 

 

0.4

 

 

Pension and other long-term liabilities

 

 

(4.4

)

 

 

2.5

 

 

Accounts payable, accrued expenses and other current liabilities

 

 

(13.9

)

 

 

(2.3

)

 

Other, net

 

 

 

 

 

0.2

 

 

Net cash provided by operating activities

 

 

74.9

 

 

 

21.5

 

 

Cash flows from investing activities

 

 

 

 

 

 

 

 

 

Purchase of property, plant and equipment

 

 

(16.0

)

 

 

(7.9

)

 

Increase in amounts due from Walter

 

 

(20.0

)

 

 

(12.5

)

 

Net cash used in investing activities

 

 

(36.0

)

 

 

(20.4

)

 

Cash flows from financing activities

 

 

 

 

 

 

 

 

 

Book cash overdrafts

 

 

0.6

 

 

 

(1.2

)

 

Proceeds from short-term borrowings

 

 

55.9

 

 

 

 

 

Retirement of short-term debt

 

 

(55.9

)

 

 

 

 

Proceeds from long-term debt

 

 

1,050.0

 

 

 

 

 

Retirement of long-term debt, including capital lease obligations

 

 

(615.3

)

 

 

 

 

Payment of deferred financing fees

 

 

(21.6

)

 

 

 

 

Dividend to Walter

 

 

(444.5

)

 

 

 

 

Dividend to Walter for acquisition costs

 

 

(12.0

)

 

 

 

 

Walter contribution of Predecessor Mueller’s cash

 

 

76.3

 

 

 

 

 

Net cash used in financing activities

 

 

33.5

 

 

 

(1.2

)

 

Increase (decrease) in cash and cash equivalents

 

 

72.4

 

 

 

(0.1

)

 

Cash and cash equivalents

 

 

 

 

 

 

 

 

 

Beginning of period

 

 

 

 

 

0.1

 

 

End of period

 

 

$

72.4

 

 

 

$

 

 

 

4




Schedule of non-cash investing and financing activities:

On October 3, 2005, the Company’s parent Walter Industries, purchased all the outstanding common stock of Predecessor Mueller.

 

 

(dollars in millions)

 

Contribution of Predecessor Mueller by Walter

 

 

$

943.4

 

 

Less: Cash of Predecessor Mueller received

 

 

(76.3

)

 

Total net assets received excluding cash

 

 

$867.1

 

 

 

Subsequent to the Acquisition, the Company’s parent, Walter Industries, forgave an intercompany receivable with U.S. Pipe of $443.6 million.

The accompanying notes are an integral part of the consolidated financial statements.

5




MUELLER WATER PRODUCTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
AS OF AND FOR THE THREE MONTHS ENDED DECEMBER 31, 2005 AND DECEMBER 31, 2004
(UNAUDITED)

Note 1.   Organization

The registrant is Mueller Water Products, Inc., a Delaware corporation (“Mueller Water” or the “Company”). The Company is the surviving corporation of the merger on February 2, 2006 of Mueller Water Products, LLC (Commission File Number: 333-116590) and Mueller Water Products Co-Issuer, Inc. with and into Mueller Holding Company, Inc., a Delaware corporation. See Note 15 for a detailed description of the merger.

On October 3, 2005, through a series of transactions (the “Acquisition”), Walter Industries, Inc. (“Walter”), through a wholly-owned subsidiary, acquired all outstanding shares of capital stock of Mueller Water Products, Inc. (“Predecessor Mueller”), which immediately was converted into Mueller Water Products, LLC, a Delaware limited liability company and contributed United States Pipe and Foundry Company, LLC, (“U.S. Pipe”), owned by Walter since 1969, to the acquired company. In accordance with generally accepted accounting principles, for accounting purposes U.S. Pipe is treated as the acquirer of Predecessor Mueller. Accordingly, effective October 3, 2005, U.S. Pipe’s basis of accounting is used for the Company and all financial data for periods prior to October 3, 2005 of the Company included in this report on Form 10-Q, is that of U.S. Pipe. The results of operations of Predecessor Mueller are included in the Consolidated Statements of Operations beginning October 3, 2005.

The Company was originally organized as United States Pipe and Foundry Company, Inc. (“Inc.”) and was a wholly-owned subsidiary of Walter Industries, Inc., a diversified New York Stock Exchange traded company (NYSE: WLT). On September 23, 2005, Inc. was dissolved and United States Pipe and Foundry Company, LLC was organized in the state of Alabama, and the operations of Inc. were conducted under the form of a limited liability company.

In December 2005, U.S. Pipe changed its fiscal year-end to September 30, which coincides with the fiscal year end of Predecessor Mueller. Beginning with the quarter ended December 31, 2005, the Company has three operating segments which are named after its leading brands in each segment: Mueller, U.S. Pipe, and Anvil.

The consolidated financial statements are prepared in conformity with accounting principles generally accepted in the United States of America, which requires management to make certain estimates and assumptions that affect the reported amounts of assets, liabilities, sales and expenses for the reporting periods. Actual results for future periods could differ from those estimates used by management. In the opinion of management, all normal and recurring adjustments that are considered necessary for a fair financial statement presentation have been made.

Certain amounts in the prior period’s consolidated financial statements have been reclassified to conform to the current-period presentation. On the Consolidated Balance Sheet as of September 30, 2005, prepaid pension cost of $19.3 million has been netted against accrued pension liability of $72.9 million and is presented as accrued pension liability, net of $53.6 million.

Note 2.   Summary of Significant Accounting Policies

Revenue Recognition—The Company recognizes revenue based on the recognition criteria set forth in the Securities and Exchange Commission’s Staff Accounting Bulletin 104 “Revenue Recognition in Financial Statements”, which is when delivery of product has occurred or services have been rendered and

6




there is persuasive evidence of a sales arrangement, selling prices are fixed or determinable, and collectibility from the customer is reasonably assured. Revenue from the sale of products via rail or truck is recognized when title passes upon delivery to the customer. Revenue earned for shipments via ocean vessel is recognized under international shipping standards as defined by Incoterms 2000 when title and risk of loss transfer to the customer. Sales are recorded net of estimated cash discounts and rebates.

Shipping and Handling—Costs to ship products to customers are included in cost of sales in the Consolidated Statements of Operations. Amounts billed to customers, if any, to cover shipping and handling costs are included in net sales.

Customer Rebates—Customer rebates are applied against net sales at the time the sales are recorded based on estimates with respect to the deductions to be taken.

Cash and Cash Equivalents—The Company considers all highly liquid investments with original maturities of ninety days or less when purchased to be cash equivalents. Outstanding checks are netted against cash when there is a sufficient balance of cash available in the Company’s accounts at the bank to cover the outstanding amount and the right of offset exists. Where there is no right of offset against cash balances, outstanding checks are classified along with accounts payable. At December 31, 2005 and September 30, 2005 checks issued but not yet presented to the banks for payment (i.e. book cash overdrafts) were $0.6 million and zero, respectively, and were recorded in accounts payable.

Receivables—Receivables relate primarily to amounts due from customers located in North America. To reduce credit risk, credit investigations are performed prior to accepting an order and, when necessary, letters of credit are required to ensure payment.

The estimated allowance for doubtful accounts receivable is based, in large part, upon judgments and estimates of expected losses and specific identification of problem trade accounts. Significantly weaker than anticipated industry or economic conditions could impact customers’ ability to pay such that actual losses may be greater than the amounts provided for in these allowances. The periodic evaluation of the adequacy of the allowance for doubtful accounts is based on an analysis of prior collection experience, specific customer creditworthiness and current economic trends within the industries served. In circumstances where a specific customer’s inability to meet its financial obligation is known to the Company (e.g., bankruptcy filings or substantial downgrading of credit ratings), the Company records a specific allowance to reduce the receivable to the amount the Company reasonably believes will be collected.

InventoriesInventories are recorded at the lower of cost (first-in, first-out) or market value. Additionally, the Company evaluates its inventory in terms of excess and obsolete exposures. This evaluation includes such factors as anticipated usage, inventory turnover, inventory levels and ultimate product sales value. Inventory cost includes an overhead component that can be affected by levels of production and actual costs incurred. Management periodically evaluates the effects of production levels and actual costs incurred on the costs capitalized as part of inventory.

Property, plant and equipment—Property, plant and equipment is recorded at cost, less accumulated depreciation and amortization. Depreciation is recorded on the straight-line method over the estimated useful lives of the assets. Leasehold improvements are amortized on the straight-line method over the lesser of the useful life of the improvement or the remaining lease term. Estimated useful lives used in computing depreciation expense are 2 to 20 years for machinery and equipment and 3 to 50 years for land improvements and buildings. Gains and losses upon disposition are reflected in the Consolidated Statements of Operations in the period of disposition.

Direct internal and external costs to implement computer systems and software are capitalized as incurred. Capitalized costs are amortized over the estimated useful life of the system or software,

7




beginning when site installations or module development is complete and ready for its intended use, which generally is 3 to 5 years.

The Company accounts for its asset retirement obligations related to plant and landfill closures in accordance with Statement of Financial Accounting Standards No. 143 (“SFAS 143”). Under SFAS 143, liabilities are recognized at fair value for an asset retirement obligation in the period in which it is incurred and the carrying amount of the related long-lived asset is correspondingly increased. Over time, the liability is accreted to its future value. The corresponding asset capitalized at inception is depreciated over the useful life of the asset.

Tooling—Prepaid expenses include maintenance and tooling inventory costs. Perishable tools and maintenance items are expensed when put into service. More durable items are amortized over their estimated useful lives, ranging from 4 to 10 years.

Environmental Expenditures—The Company capitalizes environmental expenditures that increase the life or efficiency of property or that reduce or prevent environmental contamination. The Company accrues for environmental expenses resulting from existing conditions that relate to past operations when the costs are probable and reasonably estimable. The Company is indemnified by Tyco for all environmental liabilities associated with Predecessor Mueller as it existed as of August 16, 1999, whether known or not.

Accounting for the Impairment of Long-Lived Assets—Long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the book value of the asset may not be recoverable. Goodwill and intangible assets that have an indefinite life are not amortized, but instead are tested for impairment annually (or more frequently if events or circumstances indicate possible impairments) using both a discounted cash flow method and a market comparable method.

Workers’ Compensation—The Company is self-insured for workers’ compensation benefits for work related injuries. Liabilities, including those related to claims incurred but not reported, are recorded principally using annual valuations based on discounted future expected payments and using historical data of the Company or insurance industry data when historical data is limited. The Company is indemnified by Tyco for all liabilities associated with Predecessor Mueller that occurred prior to August 16, 1999. Workers’ compensation liabilities were as follows (in millions):

 

 

December 31,
2005

 

September 30,
2005

 

Undiscounted aggregated estimated claims to be paid

 

 

$

27.0

 

 

 

$

14.4

 

 

Workers’ compensation liability recorded on a discounted basis

 

 

$

22.8

 

 

 

$

11.9

 

 

 

The Company applies a discount rate at a risk-free interest rate, generally a U.S. Treasury bill rate, for each policy year. The rate used is one with a duration that corresponds to the weighted average expected payout period for each policy year. Once a discount rate is applied to a policy year, it remains the discount rate for that policy year until all claims are paid. The use of this method decreases the volatility of the liability related solely to changes in the discount rate. The weighted average rate used for discounting the liability at December 31, 2005 and September 30, 2005 was 4.6%. At December 31, 2005, a one-percentage-point increase in the discount rate on the discounted claims liability would decrease the liability by $0.1 million, while a one-percentage-point decrease in the discount rate would increase the liability by $0.1 million.

Warranty Costs—The Company accrues for U.S. Pipe segment warranty expenses that include customer costs of repair and/or replacement, including labor, materials, equipment, freight and reasonable overhead costs, determined on a case-by-case basis, whenever the Company’s products and/or services fail to comply with published industry standards or mutually agreed upon customer requirements.

8




The Company accrues for the estimated cost of product warranties of the Mueller and Anvil segments at the time of sale based on historical experience. Adjustments to obligations for warranties are made as changes in the obligations become reasonably estimable.

Activity in accrued warranty, included in the caption accrued expenses in the accompanying Consolidated Balance Sheets, was as follows (in millions):

 

 

Three months ended
December 31,

 

 

 

   2005   

 

   2004   

 

Accrued balance at beginning of period

 

 

$

4.7

 

 

 

$

1.8

 

 

Accrued warranty of Predecessor Mueller

 

 

1.6

 

 

 

 

 

Warranty expense

 

 

0.4

 

 

 

0.8

 

 

Settlement of warranty claims

 

 

(1.7

)

 

 

(0.9

)

 

Balance at end of period

 

 

$

5.0

 

 

 

$

1.7

 

 

 

Deferred Financing Fees—Costs of debt financing included in other non-current assets are amortized over the life of the related loan agreements, which range from five to ten years. Such costs are reassessed when amendments occur, in accordance with Emerging Issues Task Force (EITF) 96-19, “Debtors Accounting for a Modification or Exchange of Debt Instruments.”

Income Taxes—Deferred tax liabilities and assets are recognized for the expected future tax consequences of events that have been included in the financial statements or tax returns. Deferred tax liabilities and assets are determined based on the differences between the financial statements and the tax basis of assets and liabilities, using tax rates in effect for the years in which the differences are expected to reverse. A valuation allowance is provided to offset any net deferred tax assets if, based upon the available evidence, it is more likely than not that some or all of the deferred tax assets will not be realized.

Research and Development—Research and development expenditures are expensed when incurred.

Advertising—Advertising costs are expensed when incurred.

Translation of Foreign Currency—Assets and liabilities of the Company’s businesses operating outside of the United States of America which maintains accounts in a functional currency other than U.S. dollars are translated into U.S. dollars using year-end exchange rates. Revenues and expenses are translated at the average exchange rates effective during the year. Foreign currency translation gains and losses are included as a separate component of stockholders’ equity. Gains and losses resulting from foreign currency transactions, the amounts of which are not material, are included in cost of sales.

Derivative Instruments and Hedging Activities—The Company currently uses interest rate swaps as required in the 2005 Mueller Credit Agreement to reduce the risk of interest rate volatility. The amount to be paid or received from interest rate swaps is charged or credited to interest expense over the lives of the interest rate swap agreements. Changes in the fair value of derivatives are recorded each period in earnings or Accumulated Other Comprehensive Income (Loss), depending on whether or not a derivative is designated and effective as part of a hedge transaction and meets the applicable requirements associated with Statement of Financial Accounting Standards No. 133 (“SFAS 133”) (see Note 6).

Additionally, the Company utilizes forward contracts to mitigate its exposure to changes in foreign currency exchange rates from third party and intercompany forecasted transactions. The primary currency to which the Company is exposed and to which it hedges the exposure is the Canadian Dollar. The effective portion of unrealized gains and losses associated with forward contracts are deferred as a component of Accumulated Other Comprehensive Income (Loss) until the underlying hedged transactions are reported in the Company’s Consolidated Statements of Operations.

9




Related Party TransactionsThe Company purchases foundry coke from an affiliate, Sloss Industries, Inc. for an amount that approximates the market value of comparable transactions. Costs included in cost of sales related to purchases from Sloss Industries, Inc. were $5.7 million and $3.6 million for the three months ended December 31, 2005 and 2004, respectively.

Other services that Sloss Industries, Inc. provides to the Company include the delivery of electrical power to one of the Company’s facilities, rail car switching and the leasing of a distribution facility. The total of these other services included in the Company’s operating expenses were $0.4 million and $0.4 million for the three months ended December 31, 2005 and 2004, respectively.

Related Party AllocationsCertain costs incurred by Walter such as insurance, executive salaries, professional service fees, human resources, transportation, healthcare and other centralized business functions are allocated to its subsidiaries. Certain costs that were considered directly related to the U.S. Pipe segment were charged to the Company and included in selling, general and administrative expenses. These costs were approximately $0.5 million and $0.3 million for the three months ended December 31, 2005 and 2004, respectively. Costs incurred by Walter that cannot be directly attributed to its subsidiaries are allocated to them based on estimated annual revenues. Such costs were allocated to the Company and are recorded in the caption, related party corporate charges, in the accompanying Consolidated Statements of Operations and were approximately $1.8 million and $1.9 million for the three months ended December 31, 2005 and 2004, respectively.

While the Company considers the allocation of such costs to be reasonable, in the event the Company was not affiliated with Walter, these costs may increase or decrease.

Note 3.   Acquisition of Predecessor Mueller by Walter Industries

On October 3, 2005, pursuant to the agreement dated June 17, 2005, Walter acquired all of the outstanding common stock of Predecessor Mueller for $943.4 million and assumed $1.05 billion of indebtedness. Predecessor Mueller was converted into a limited liability company on October 3, 2005 and was merged with and into the Company on February 2, 2006. Transaction costs included in the acquisition price were $14.8 million. In conjunction with the acquisition, U.S. Pipe was contributed in a series of transactions to Mueller Group, LLC (“Mueller Group” or “Group”), a wholly-owned subsidiary of the Company, on October 3, 2005.

Walter’s acquisition of Predecessor Mueller has been accounted for as a business combination with U.S. Pipe considered the acquirer for accounting purposes. Assets acquired and liabilities assumed were recorded at their fair values as of October 3, 2005. The total purchase price of $943.4 million is comprised of (dollars in millions):

Acquisition of the outstanding common stock of Predecessor Mueller

 

$

928.6

 

Acquisition-related transaction costs

 

14.8

 

Total purchase price

 

$

943.4

 

 

Acquisition-related transaction costs include investment banking, legal and accounting fees and other external costs directly related to the Acquisition.

10




Under business combination accounting, the purchase price was allocated to Predecessor Mueller’s net tangible and identifiable intangible assets based on their fair values as of October 3, 2005. The excess of the purchase price over the net tangible and identifiable intangible assets is recorded as goodwill. Based on current fair values, the purchase price was allocated as follows (dollars in millions):

Receivables, net

 

$

177.4

 

Inventory

 

373.2

 

Property, plant and equipment

 

215.5

 

Identifiable intangible assets

 

855.9

 

Goodwill

 

798.3

 

Net other assets

 

376.5

 

Net deferred tax liabilities

 

(280.7

)

Debt

 

(1,572.7

)

Total purchase price allocation

 

$

943.4

 

 

The purchase price allocation is preliminary and is subject to future adjustments to goodwill for the execution of certain restructuring plans identified by Walter prior to the acquisition date primarily related to Predecessor Mueller facility rationalization actions. These facility rationalization actions are expected to be completed by fiscal 2008.

Receivables are short-term trade receivables and their net book value approximates current fair value.

Finished goods inventory is valued at estimated selling price less cost of disposal and reasonable profit allowance for the selling effort. Work in process inventory is valued at estimated selling price of finished goods less costs to complete, cost of disposal and a reasonable profit allowance for the completing and selling effort. Raw materials are valued at book value, which approximates current replacement cost. The carrying value of inventories include $70.2 million in excess of Predecessor Mueller’s carrying value, of which $58.4 million was charged to cost of sales during the three months ended December 31, 2005.

Property, plant and equipment are valued at the current replacement cost as follows (in millions):

 

 

 

 

Depreciation
Period

 

Land

 

$

14.1

 

Indefinite

 

Buildings

 

51.8

 

5 to 14 years

 

Machinery and equipment

 

136.4

 

3 to 5 years

 

Other

 

13.2

 

3 years

 

Total property, plant and equipment

 

$

215.5

 

 

 

 

Identifiable intangible assets acquired consist of trade name, trademark, technology and customer relationships and were valued at their current fair value. Trade name and trademark relate to Mueller®, Anvil®, Hersey ™, Henry Pratt™ and James Jones™. Technology represents processes related to the design and development of products. Customer relationships represent the recurring nature of sales to current distributors, municipalities, contractors and other end customers regardless of their contractual nature.

Identifiable intangible assets were as follows (dollars in millions):

 

 

 

 

Amortization
Period

 

Trade name and trademark

 

$

403.0

 

 

Indefinite

 

 

Technology

 

56.3

 

 

10 years

 

 

Customer relationships

 

396.6

 

 

19 years

 

 

Total identifiable intangible assets

 

$

855.9

 

 

 

 

 

 

11




Goodwill represents the excess of the purchase price over the fair value of tangible and identifiable intangible assets acquired. Goodwill is not amortized, but rather is tested for impairment at least annually. In the event that we determine the book value of goodwill has become impaired, we will incur an accounting charge for the amount of impairment during the fiscal quarter in which such determination is made. The Company’s goodwill is not tax deductible.

Net other assets include cash, prepaid expenses, deferred financing fees, accounts payable, accrued expenses and accrued pension liability and were valued at their approximate current fair value. After the purchase price allocation Predecessor Mueller paid a $444.5 million dividend to Walter.

Net deferred tax liabilities include the tax effects of fair value adjustments related to identifiable intangible assets and net tangible assets.

Debt is valued at fair market value as of October 3, 2005.

The following table of unaudited pro forma results of operations of Predecessor Mueller and U.S. Pipe for the three months ended December 31, 2004 is presented as if the Acquisition and borrowings under the 2005 Mueller Credit Agreement had taken place on October 1, 2004 and were carried forward through December 31, 2004.

The unaudited pro forma amounts are not intended to represent or be indicative of the consolidated results of operations that would have been reported had the Acquisition and borrowings under the 2005 Mueller Credit Agreement been completed as of the dates presented, and should not be taken as representative of the future consolidated results of operations of the Company.

 

 

Three months
ended December 31,
2004

 

 

 

(dollars in millions)

 

 

 

(unaudited)

 

Net sales

 

 

$

386.4

 

 

Net income

 

 

$

(10.9

)

 

 

The pro forma amounts are based on the historical results of operations and are adjusted for amortization of definite-lived intangibles of $6.6 million, depreciation of property, plant and equipment of ($0.2) million, interest expense of $7.4 million and amortization of financing fees related to the 2005 Mueller Credit Agreement of $2.4 million.

12




Note 4.   Facility Rationalization, Restructuring and Related Costs

On October 26, 2005, Walter announced plans to close U.S. Pipe’s Chattanooga, Tennessee plant and transfer the valve and hydrant production of that plant to Mueller’s Chattanooga, Tennessee and Albertville, Alabama plants. The eventual closure of the U.S. Pipe Chattanooga plant is expected to occur in calendar 2006, resulting in the termination of approximately 340 employees. Total estimated restructuring and impairment charges related to this closure are $29.3 million, of which $24.1 million was expensed during the three months ended December 31, 2005. Restructuring costs recognized in the Consolidated Statement of Operations associated with this plant closure were as follows:

 

 

 

 

Restructuring & impairment
charges expensed

 

 

 

Total estimated
restructuring costs

 

For the three months ended
December 31, 2005

 

 

 

(dollars in millions)

 

Termination benefits

 

 

$

3.6

 

 

 

$

3.0

 

 

Other employee-related costs

 

 

3.3

 

 

 

 

 

Other associated costs

 

 

3.4

 

 

 

2.1

 

 

Impairment of property, plant and equipment

 

 

19.0

 

 

 

19.0

 

 

Total

 

 

$

29.3

 

 

 

$

24.1

 

 

 

Termination benefits relating to the U.S. Pipe Chattanooga plant closure of $3.0 million consist primarily of severance related to staff reductions of hourly and salaried personnel. The Company expects to recognize an additional $0.6 million for severance expense during the remainder of fiscal 2006. In addition, the Company expects to recognize other employee-related costs of approximately $3.3 million related to pension and other postretirement benefit obligations during the first quarter of Walter’s pension benefit measurement period, which begins on January 1, 2006.

Other associated costs of $2.1 million principally include an increase to the estimated asset retirement obligation. The Company expects to recognize an additional $1.3 million of environmental-related costs, as those costs are incurred during fiscal 2006.

Fixed asset impairment charges of $19.0 million were recorded during the three months ended December 31, 2005. These assets have a net book value of $3.9 million at December 31, 2005.

Activity in accrued restructuring was as follows (dollars in millions):

 

 

For the three
months ended
December 31,
2005

 

Beginning balance

 

 

$

 

 

Restructuring expenses accrued

 

 

5.1

 

 

Restructuring payments and charges

 

 

(1.3

)

 

Ending balance

 

 

$

3.8

 

 

 

In addition to transferring production to Mueller facilities, the responsibility for U.S. Pipe valve and hydrant products was transferred to the Mueller segment. Through this transfer, it was determined that certain U.S. Pipe inventory would not ultimately be sold. As a result, inventory obsolescence charges relating to U.S. Pipe valve and hydrant inventory of $10.7 million were recorded to cost of sales during the three months ended December 31, 2005.

13




In addition, current period actual production output at U.S. Pipe Chattanooga was significantly lower than normal capacity, resulting in additional facility expenses of $5.2 million charged to cost of sales during the three months ended December 31, 2005.

Note 5.   Borrowing Arrangements

Long-Term Debt—Long-term debt consists of the following obligations:

 

 

December 31,
2005

 

September 30,
2005

 

 

 

(dollars in millions)

 

2005 Mueller Credit Agreement

 

 

$

1,047.4

 

 

 

$

 

 

10% senior subordinated notes(1)

 

 

333.2

 

 

 

 

 

143¤4% senior discount notes(2)

 

 

165.7

 

 

 

 

 

Capital lease obligations

 

 

2.3

 

 

 

 

 

 

 

 

1,548.6

 

 

 

 

 

Less current portion

 

 

(11.5

)

 

 

 

 

 

 

 

$

1,537.1

 

 

 

$

 

 


1)               The value of the 10% senior subordinated notes were recorded at fair value at October 3, 2005 which was an increase of $18.9 million over Predecessor Mueller’s carrying amount. This amount is amortized over the life of the notes as a reduction to interest expense. As of December 31, 2005, the unamortized fair value adjustment was $18.2 million.

2)               The value of the 143¤4 % senior discount notes were recorded at fair value at October 3, 2005 which was an increase of $36.0 million over Predecessor Mueller’s carrying amount. This amount is amortized over the remaining life of the notes as a reduction to interest expense. As of December 31, 2005 the unamortized fair value adjustment was $34.8 million.

2005 Mueller Credit Agreement:   On October 3, 2005, Group entered into a credit agreement (the “2005 Mueller Credit Agreement”) consisting of a $145 million senior secured revolving credit facility maturing in October 2010 (the “2005 Mueller Revolving Credit Facility”) and a $1,050 million senior secured term loan maturing in October 2012 (the “2005 Mueller Term Loan”). The 2005 Mueller Credit Agreement is a secured obligation of Group and substantially all of its wholly-owned domestic subsidiaries, including U.S. Pipe. The 2005 Mueller Term Loan requires quarterly principal payments of $2.6 million through October 3, 2012, at which point in time the remaining principal outstanding is due. The commitment fee on the unused portion of the 2005 Mueller Revolving Credit Facility is 0.50% and the interest rate is a floating interest rate of 2.5% over LIBOR. The 2005 Mueller Term Loan carries a floating interest rate of 2.25% over LIBOR.

Proceeds from the 2005 Mueller Credit Agreement were $1,053.4 million, net of $21.6 million of underwriting fees and expenses which will be amortized over the life of the loans. The proceeds were used to finance the acquisition of Predecessor Mueller by Walter and to refinance existing indebtedness.

The 2005 Mueller Credit Agreement contains customary events of default and covenants, including covenants that restrict the ability of Group and certain of its subsidiaries to incur certain additional indebtedness, pay dividends, create or permit liens on assets, engage in mergers or consolidations, and certain restrictive financial covenants.

On January 24, 2006, Group entered into an Amendment No. 1 (the “First Amendment”) to the 2005 Credit Agreement. The First Amendment removes the requirement that Group and its subsidiaries change their fiscal year end to December 31 and, in the event of an initial public offering of the Company, provides the ability for Group to pay up to $8.5 million in cash dividends to the Company for further distribution to the Company’s shareholders. The Company is a wholly-owned subsidiary of Walter.

14




The debt instruments described below were liabilities of Predecessor Mueller and Group prior to the Acquisition on October 3, 2005 and continue as liabilities of the Company and Group subsequent to the Acquisition.

10% Senior Subordinated Notes:   On April 23, 2004, Mueller Group, Inc. (now, Mueller Group, LLC) issued $315 million principal face amount of 10% senior subordinated notes due 2012. The senior subordinated notes are guaranteed by each of Group’s existing domestic restricted subsidiaries. The subordinated notes contain customary covenants and events of default, including covenants that limit Group’s ability to incur debt, pay dividends and make investments.

On October 4, 2005, Group notified the holders of the subordinated notes that the Acquisition was a change in control and that, as a result, the holders had a right to cause Group to repurchase their senior subordinated notes on or before 5:00 p.m. eastern standard time, on November 4, 2005 at a price of 101% of the principal face amount of such notes. The change of control offer expired at 5:00 p.m. eastern standard time, on November 6, 2005, with no subordinated notes being validly tendered and not withdrawn and, accordingly, no subordinated notes were purchased pursuant to the change of control offer.

143¤4% Senior Discount Notes:   On April 29, 2004, Predecessor Mueller issued 223,000 units, consisting of $223 million principal face amount of 143¤4% senior discount notes due 2014 and warrants to purchase 24,487,383 shares of Predecessor Mueller’s common stock. In connection with the Acquisition, these warrants were cancelled and converted into the right to receive cash equal to the number of shares of common stock into which the warrants would have been exercisable multiplied by the per-share merger consideration (less the exercise price per warrant). The senior discount notes remain senior unsecured obligations of the Company and are effectively subordinated to all of its existing and future secured debt and to all indebtedness and other liabilities of the Company’s subsidiaries, including Group. The senior discount notes do not require cash interest payments until April 2009.

On October 4, 2005, the Company notified the holders of the senior discount notes that the Acquisition was a change in control and that, as a result, the holders had a right to cause the Company to repurchase their senior discount notes on or before 5:00 p.m., New York City time, on November 4, 2005 at a price of 101% of the accreted value of the notes at the time of change of control. The change of control offer expired at 5:00 p.m., New York City time, on November 6, 2005, with no senior discount notes being validly tendered and not withdrawn and, accordingly, no senior discount notes were purchased pursuant to the change of control offer.

Capital Leases—The Company leases automobiles under capital lease arrangements that expire over the next four years.

Interest Rate Swaps—These hedges are described in Note 6 and comply with covenants contained in the 2005 Mueller Credit Agreement.

Distributions from Group—The Company has no material assets other than its ownership of Group’s capital stock and accordingly depends upon distributions from Group to satisfy its cash needs. The Company’s principal cash needs will be debt service on its senior discount notes due 2014. These senior discount notes do not require cash interest payments until 2009 and contain restrictive covenants that will, among other things, limit the ability of the Company and its subsidiaries (including Group) to incur debt, pay dividends and make investments. Neither Group nor any of its subsidiaries guarantee these notes. The Company, however, is a holding company and its ability to pay interest on the notes will be dependent upon the receipt of dividends from its subsidiaries. Group is the Company’s only direct subsidiary. However, the terms of Group’s borrowing arrangements significantly restrict its ability to pay dividends to the Company.

15




Note 6.   Derivative Financial Instruments

Interest Rate Swaps—On October 27, 2005, Group entered into six interest rate hedge transactions with a cumulative notional amount of $350 million. The swap terms are between one and seven years with five separate counter-parties. The objective of the hedges is to protect the Company against rising LIBOR interest rates that would have a negative effect on the Company’s cash flows due to changes in interest payments on its 2005 Mueller Term Loan. The structure of the hedges are a one-year 4.617% LIBOR swap of $25 million, a three-year 4.740% LIBOR swap of $50 million, a four-year 4.800% LIBOR swap of $50 million, a five-year 4.814% LIBOR swap of $100 million, a six-year 4.915% LIBOR swap of $50 million, and a seven year 4.960% LIBOR swap of $75 million. These swap agreements call for the Company to make fixed rate payments over the term at each swap’s stated fixed rate and to receive payments based on three month LIBOR from the counter-parties. These swaps will be settled quarterly over their lives and will be accounted for as cash flow hedges. As such, changes in the fair value of these swaps that take place through the date of maturity will be recorded in Accumulated Other Comprehensive Income (Loss). These hedges comply with covenants contained in the 2005 Mueller Credit Agreement.

Group also has two interest rate hedge agreements that existed as of October 3, 2005: a two-year 3.928% LIBOR swap that matures in May 2007 and a two-year 4.249% LIBOR swap that matures in April 2007. The changes in fair value of these two swaps were recorded as interest expense in the Statements of Operations until achieving hedge effectiveness in October 2005 and November 2005, respectively, at which times such changes in fair value were recorded in Accumulated Other Comprehensive Income (Loss).

The Company recorded an unrealized loss from its swap contracts, net of tax, of $1.1 million at December 31, 2005 in Accumulated Other Comprehensive Income (Loss).

Forward Foreign Currency Exchange Contracts

The Company entered into forward exchange contracts primarily to hedge currency fluctuations from transactions (primarily anticipated inventory purchases) denominated in foreign currencies, thereby limiting the risk that would otherwise result from changes in foreign currency exchange rates. The majority of the Company’s exposure to currency movements is in Canada. All of the foreign currency exchange contracts have maturity dates in 2006. Gains and losses on the forward foreign currency exchange contracts are expected to be offset by losses / gains in recognized net underlying foreign currency exchange transactions. As of December 31, 2005, the Company had entered into one forward contract at a notional amount of less than $0.1 million, selling U.S. dollars and purchasing euros at an exchange rate of $1.3635.

Subsequent to December 31, 2005, the Company entered into forward foreign currency exchange contracts at a notional amount of $9.1 million primarily to protect anticipated inventory purchases by its Canadian operations. With these hedges, the Company purchases U.S. dollars and sells Canadian dollars at an average exchange rate of $0.867.

Natural Gas Swap

On January 12, 2006, Group entered into a swap contract to hedge anticipated purchases of natural gas from February 2006 through March 2006 totaling 0.4 million mmbtu, or approximately 80% of expected natural gas consumption, at a price of $9.41 per mmbtu. This swap contract effectively converts a portion of forecasted purchases at market prices to a fixed price basis. Any change in the fair value of this swap contract will be recorded in Accumulated Other Comprehensive Income (Loss).

16




Note 7.   Interest Expense Arising from Related Party Payable to Walter Industries

Interest expense associated with the outstanding debt payable to Walter was allocated to the Company up to the date of the Acquisition based upon the outstanding balance of the intercompany note. An intercompany note to Walter of $443.6 million was forgiven and contributed to capital. Intercompany interest expense was zero and $5.9 million for the three months ended December 31, 2005 and 2004, respectively.

Note 8.   Pension and Other Postretirement Benefits

The components of net periodic benefit cost for pension and postretirement benefits for the three months ended December 31, 2005 and December 31, 2004 are as follows:

 

 

Pension Benefits

 

Other Benefits

 

 

 

For the three months
ended December 31,

 

For the three months
ended December 31,

 

 

 

    2005    

 

    2004    

 

    2005    

 

    2004    

 

 

 

(dollars in millions)

 

Components of net periodic benefit cost:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Service cost

 

 

$

2.0

 

 

 

$

1.1

 

 

 

$

0.2

 

 

 

$

0.1

 

 

Interest cost

 

 

4.7

 

 

 

3.2

 

 

 

0.3

 

 

 

0.4

 

 

Expected return on plan assets

 

 

(4.9

)

 

 

(3.1

)

 

 

 

 

 

 

 

Amortization of prior service cost

 

 

0.1

 

 

 

0.1

 

 

 

(0.6

)

 

 

(0.7

)

 

Amortization of net loss (gain)

 

 

1.9

 

 

 

0.8

 

 

 

(0.2

)

 

 

(0.2

)

 

Curtailment settlement loss

 

 

 

 

 

 

 

 

 

 

 

0.3

 

 

Net periodic benefit cost

 

 

$

3.8

 

 

 

$

2.1

 

 

 

$

(0.3

)

 

 

$

(0.1

)

 

 

For the three months ended December 31, 2005, the Company had no contributions to its pension plans. The Company presently anticipates contributing approximately $0.5 million to fund its pension plans in fiscal 2006 and may make further discretionary payments.

Note 9.   Goodwill and Identifiable Intangibles

Goodwill and intangible assets that have an indefinite life are not amortized, but instead are tested for impairment annually (or more frequently if events or circumstances indicate possible impairments) using both a discounted cash flow method and a market comparable method. Definite-lived intangible assets are amortized over their respective estimated useful lives and reviewed for impairment if events or circumstances indicate possible impairment. The Company uses an estimate of future undiscounted net cash flows of the related asset or asset grouping over the remaining life in measuring whether the assets are recoverable.

Identifiable intangible assets consist of the following:

 

 

December 31, 2005

 

 

 

Cost

 

Accumulated
Amortization

 

 

 

(dollars in millions)

 

Definite-lived intangible assets

 

 

 

 

 

 

 

Technology

 

$

56.3

 

 

$

1.4

 

 

Customer relationships

 

396.6

 

 

5.2

 

 

 

 

452.9

 

 

6.6

 

 

Indefinite lived intangible assets

 

 

 

 

 

 

 

Trade name and trademarks

 

403.0

 

 

 

 

 

 

$

855.9

 

 

$

6.6

 

 

 

17




 

Goodwill was $856.7 million at December 31, 2005, compared to $58.4 million at September 30, 2005. The increase of $798.3 million represents goodwill identified during the allocation of the purchase price of the Acquisition. Goodwill is expected to increase over the next twelve months as the Company implements facility rationalizations that were formally identified prior to the Acquisition. Certain facility rationalization costs, primarily related to severance, will be recorded as a liability at the time identified as permitted under accounting principles generally accepted in the United States of America, with a corresponding increase in goodwill. All closure costs related to the shut-down of the U.S. Pipe Chattanooga facility (as described in Note 4) have been charged to operating expenses and not reflected as a component of goodwill.

Note 10.   Supplementary Balance Sheet Information

Selected supplementary balance sheet information is presented below:

 

 

December 31,
2005

 

September 30,
2005

 

 

 

(dollars in millions)

 

Inventories

 

 

 

 

 

 

 

 

 

Purchased materials and manufactured parts

 

 

$

74.9

 

 

 

$

30.6

 

 

Work in process

 

 

111.3

 

 

 

15.5

 

 

Finished goods

 

 

242.9

 

 

 

101.1

 

 

 

 

 

$

429.1

 

 

 

$

147.2

 

 

 

 

 

December 31,
2005

 

September 30,
2005

 

 

 

(dollars in millions)

 

Property, plant and equipment

 

 

 

 

 

 

 

 

 

Land

 

 

$

25.5

 

 

 

$

11.3

 

 

Buildings

 

 

86.0

 

 

 

33.8

 

 

Machinery and equipment

 

 

540.0

 

 

 

401.7

 

 

Other

 

 

20.5

 

 

 

16.2

 

 

Accumulated depreciation

 

 

(327.2

)

 

 

(313.8

)

 

 

 

 

$

344.8

 

 

 

$

149.2

 

 

 

18




 

 

 

December 31,
2005

 

September 30,
2005

 

 

 

(dollars in millions)

 

Accrued expenses and other liabilities

 

 

 

 

 

 

 

 

 

Vacations and holidays

 

 

$

14.3

 

 

 

$

4.5

 

 

Workers’ compensation and comprehensive liability

 

 

6.3

 

 

 

2.9

 

 

Accrued payroll and bonus

 

 

10.9

 

 

 

3.9

 

 

Accrued sales commissions

 

 

3.3

 

 

 

1.0

 

 

Accrued other taxes

 

 

6.1

 

 

 

2.1

 

 

Accrued warranty claims

 

 

5.0

 

 

 

4.7

 

 

Accrued environmental claims

 

 

4.0

 

 

 

4.0

 

 

Accrued income taxes

 

 

3.9

 

 

 

5.5

 

 

Accrued cash discounts and rebates

 

 

24.2

 

 

 

4.8

 

 

Accrued interest

 

 

12.2

 

 

 

 

 

Unclaimed payments to Predecessor Mueller warrant holders(1)

 

 

8.9

 

 

 

 

 

Other

 

 

19.9

 

 

 

1.3

 

 

 

 

 

$

119.0

 

 

 

$

34.7

 

 


(1)          Together with the issuance of the 143¤4% senior discount notes, Predecessor Mueller issued 223,000 warrants to purchase 24,487,383 shares of Class A common stock at $0.01 per share. On October 3, 2005, in connection with the Acquisition of the Company by Walter, the outstanding warrants were converted into the right to receive cash upon exercise of the warrants. As of December 31, 2005, approximately 12,000 warrants had not been presented for payment. All funds required for settlement of warrants are funded by amounts held in escrow in connection with the Acquisition.

Note 11.   Supplementary Income Statement Information

The components of interest expense, net of interest income are presented below:

 

 

Three months ended

 

 

 

December 31,
2005

 

December 31,
2004

 

 

 

(dollars in millions)

 

Interest expense, net of interest income:

 

 

 

 

 

 

 

 

 

Contractual interest expense

 

 

$

29.2

 

 

 

$

0.1

 

 

Deferred financing fee amortization

 

 

1.2

 

 

 

 

 

Write off of bridge loan commitment fees

 

 

2.5

 

 

 

 

 

Interest rate swap gains

 

 

(0.4

)

 

 

 

 

Interest expense

 

 

32.5

 

 

 

0.1

 

 

Interest income

 

 

(0.3

)

 

 

 

 

Total interest expense, net of interest income

 

 

$

32.2

 

 

 

$

0.1

 

 

 

The bridge loan commitment fees represent fees paid to lenders to make available to the Company a bridge loan facility to repurchase the 14 ¾% senior discount notes and 10% senior subordinated notes from the holders of such notes under the terms of the change of control provisions of the indentures, as described in Note 5. No notes were tendered under the offer and the bridge loan was not used. The related commitment fees were charged to interest expense during the three months ended December 31, 2005.

19




Note 12.   Income Taxes

The Company files a consolidated federal income tax return with Walter Industries Inc. The tax provision has been determined under FAS 109 “Accounting for Income Taxes” taking into account the intercompany tax sharing agreement.

The components of pretax earnings (losses) are as follows (in millions):

 

 

For the quarter
ended
December 31,

 

 

 

2005

 

2004

 

United States

 

$

(74.5

)

$

(8.5

)

Foreign

 

$

2.8

 

$

 

 

Income tax expense (benefit) applicable to continuing operations consists of the following components (in millions):

 

 

12/31/05

 

12/31/04

 

 

 

Current

 

Deferred

 

Total

 

Current

 

Deferred

 

Total

 

Federal

 

 

$

0.4

 

 

 

$

(20.1

)

 

$

(19.7

)

 

$

(3.6

)

 

 

$

(0.1

)

 

$

(3.7

)

State and local

 

 

1.5

 

 

 

(5.7

)

 

(4.2

)

 

(0.6

)

 

 

5.4

 

 

4.8

 

Foreign

 

 

1.1

 

 

 

(0.1

)

 

1.0

 

 

 

 

 

 

 

 

Total

 

 

$

3.0

 

 

 

$

(25.9

)

 

$

(22.9

)

 

$

(4.2

)

 

 

$

5.3

 

 

$

1.1

 

 

The Company estimates its annual effective tax rate in accordance with APB Opinion 28 “Interim Financial Reporting”. The estimated effective tax rate difference from the statutory rate is primarily due to nondeductible interest and state income taxes.

The reduction in valuation allowance from $9.0 million to zero during the three months ended December 31, 2005 consists of $7.5 million of state income tax benefits at U.S. Pipe for which the Company believes is more likely than not to be realized and $1.5 million of assets that expired during the current period due to the passage of time or as a result of the Acquisition. These valuation allowance reductions were not recorded as a component of income tax expense.

The Company has gross deferred tax assets of $135.1 million and gross deferred tax liabilities of $366.9 million as of December 31, 2005.

The Company has Federal and State net operating loss carryforwards of approximately $8.1 million and $77 million respectively that expire in 2024. If certain changes in ownership occur, utilization of the net carryforwards may be limited.

Undistributed earnings of the Company’s foreign subsidiaries amounted to approximately $80.2 million at December 31, 2005. Deferred taxes have not been provided on the foreign earnings because the Company intends to reinvest those earnings indefinitely.

A controversy exists with regard to federal income taxes allegedly owed by the Walter consolidated group, which includes the Company, for fiscal years 1980 through 1994. It is estimated that the amount of tax presently claimed by the IRS in approximately $34.0 million for issues currently in dispute in bankruptcy court for matters unrelated to the Company. This amount is subject to interest and penalties. Under tax law, the Company is jointly and severally liable for any final tax and intends to defend vigorously any claims asserted. Walter believes that it has sufficient accruals to address any claims, including interest and penalties and furthermore these matters do not relate to the operations of the Company. There are no changes or accruals in the Company’s accounts related to these issues since these matters do not relate to the operations of the Company.

20




Note 13.   Segment Information

Prior to the Acquisition on October 3, 2005, the Company had one segment—U.S. Pipe. As of December 31, 2005, the Company’s operations consisted of three operating segments: Mueller, U.S. Pipe and Anvil. These segments are organized based on products and are consistent with how the operating segments are managed, how resources are allocated, and how information is used by the chief operating decision maker. The Mueller segment is a manufacturer of valves, fire hydrants and other related products utilized in the distribution of water and gas and in water and wastewater treatment facilities. The U.S. Pipe segment is a manufacturer of ductile iron pressure pipe, fittings and other cast iron products used primarily for major water and wastewater transmission and collection systems. The Anvil segment is a manufacturer of cast iron and malleable iron pipe fittings, ductile iron couplings and fittings, pipe hangers and other related products for the fire protection, plumbing, heating, mechanical, construction, retail hardware and other related industries. The accounting policies of the segments are the same as those described in the summary of significant accounting policies.

Intersegment sales and transfers are made at established intersegment selling prices generally intended to cover costs. Our determination of segment earnings does not reflect allocations of certain corporate expenses not directly attributable to segment operations and intersegment eliminations, which we designate as Corporate in the segment presentation, and is before interest expense, net of interest income, and income taxes. Corporate expenses include those costs incurred by Mueller’s corporate function and do not include any allocated costs from Walter. Corporate costs include those costs related to financial and administrative matters, treasury, risk management, human resources, legal counsel, and tax functions. Corporate assets include cash, deferred tax assets and deferred financing fees. These assets have not been pushed down to our segments and are maintained as Corporate items. Therefore, segment earnings are not reflective of results on a stand-alone basis. See also Note 2 regarding Related Party Allocations from Walter which are reflected in the Company’s SG&A expenses.

21




Segment assets consist primarily of accounts receivable, inventories, property, plant and equipment, goodwill, and identifiable intangibles. Summarized financial information for our segments follows:

 

 

For the three months ended:

 

 

 

December 31,
2005

 

December 31,
2004

 

 

 

(dollars in millions)

 

Net sales:

 

 

 

 

 

 

 

 

 

Mueller

 

 

$

176.7

 

 

 

$

 

 

U.S. Pipe

 

 

171.1

 

 

 

130.3

 

 

Anvil

 

 

132.6

 

 

 

 

 

Consolidated

 

 

$

480.4

 

 

 

$

130.3

 

 

Loss from operations:

 

 

 

 

 

 

 

 

 

Mueller

 

 

$

(3.8

)

 

 

$

 

 

U.S. Pipe

 

 

(27.8

)

 

 

(2.4

)

 

Anvil

 

 

(1.5

)

 

 

 

 

Corporate expense(1)

 

 

(6.4

)

 

 

 

 

Consolidated

 

 

$

(39.5

)

 

 

$

(2.4

)

 

Depreciation and amortization expense:

 

 

 

 

 

 

 

 

 

Mueller

 

 

$

12.0

 

 

 

$

 

 

U.S. Pipe

 

 

6.3

 

 

 

6.5

 

 

Anvil

 

 

5.4

 

 

 

 

 

Corporate

 

 

0.1

 

 

 

 

 

Consolidated

 

 

$

23.8

 

 

 

$

6.5

 

 

Capital expenditures:

 

 

 

 

 

 

 

 

 

Mueller

 

 

$

6.0

 

 

 

$

 

 

U.S. Pipe

 

 

7.4

 

 

 

7.9

 

 

Anvil

 

 

2.5

 

 

 

 

 

Corporate

 

 

0.1

 

 

 

 

 

Consolidated

 

 

$

16.0

 

 

 

$

7.9

 

 


(1)          Includes certain expenses not allocated to segments.

 

 

December 31,
2005

 

September 30,
2005

 

 

 

(dollars in millions)

 

Total assets:

 

 

 

 

 

 

 

 

 

Mueller

 

 

$

1,864.3

 

 

 

$

 

 

U.S. Pipe

 

 

431.8

 

 

 

495.4

 

 

Anvil

 

 

488.0

 

 

 

 

 

Corporate

 

 

178.1

 

 

 

 

 

Consolidated

 

 

$2,962.2

 

 

 

$

495.4

 

 

Goodwill:

 

 

 

 

 

 

 

 

 

Mueller

 

 

$

710.5

 

 

 

$

 

 

U.S. Pipe

 

 

58.4

 

 

 

58.4

 

 

Anvil

 

 

87.8

 

 

 

 

 

Consolidated

 

 

$

856.7

 

 

 

$

58.4

 

 

Identifiable intangibles:

 

 

 

 

 

 

 

 

 

Mueller

 

 

$

759.6

 

 

 

$

 

 

U.S. Pipe

 

 

 

 

 

 

 

Anvil

 

 

89.7

 

 

 

 

 

Consolidated

 

 

$

849.3

 

 

 

$

 

 

 

22




Geographical area information with respect to net sales, as determined by the location of the customer invoiced, and property, plant and equipment—net, as determined by the physical location of the assets, were as follows:

 

 

For the three months ended:

 

 

 

December 31,
2005

 

December 31,
2004

 

 

 

(dollars in millions)

 

Net sales:

 

 

 

 

 

 

 

 

 

United States

 

 

$

430.1

 

 

 

$

126.8

 

 

Canada

 

 

48.1

 

 

 

 

 

Other Countries

 

 

2.2

 

 

 

3.5

 

 

 

 

 

$

480.4

 

 

 

$

130.3

 

 

 

 

 

December 31,
2005

 

September 30,
2005

 

 

 

(dollars in millions)

 

Property, plant and equipment, net:

 

 

 

 

 

 

 

 

 

United States

 

 

$

325.7

 

 

 

$

149.2

 

 

Canada

 

 

17.6

 

 

 

 

 

Other Countries

 

 

1.5

 

 

 

 

 

 

 

 

$

344.8

 

 

 

$

149.2

 

 

 

Note 14.   Commitments and Contingencies

Income Tax Litigation

A controversy exists with regard to federal income taxes allegedly owed by the Walter consolidated group, which includes the U.S. Pipe segment, for fiscal years 1980 through 1994. It is estimated that the amount of tax presently claimed by the IRS is approximately $34.0 million for issues currently in dispute in bankruptcy court for matters unrelated to the Company. This amount is subject to interest and penalties. In addition, the Internal Revenue Service has issued a Notice of Proposed Deficiency assessing additional tax of $80.4 million for the fiscal years ended May 31, 2000, December 31, 2000, and December 31, 2001.  The proposed adjustments relate primarily to Walter’s method of recognizing revenue on the sale of homes and related interest income on the instalment notes receivable. Under tax law, the Company is jointly and severally liable for any final tax determination. However, Walter and its affiliates believe that their tax filing positions have substantial merit and intend to defend vigorously any claims asserted. Walter believes that it has an accrual sufficient to cover the estimated probable loss, including interest and penalties. There are no charges or accruals in the Company’s accounts related to these issues since these matters do not relate to the operations of the Company.

Environmental Matters

The Company is subject to a wide variety of laws and regulations concerning the protection of the environment, both with respect to the construction and operation of many of its plants and with respect to remediating environmental conditions that may exist at its own and other properties. The Company believes that it is in substantial compliance with federal, state and local environmental laws and regulations. The Company accrues for environmental expenses resulting from existing conditions that relate to past operations when the costs are probable and reasonably estimable. Expenses charged to the statement of operations for compliance of ongoing operations and for remediation of environmental conditions arising from past operations in the three months ended December 31, 2005 and 2004 were approximately $0.4 million and $0.2 million , respectively. Because environmental laws and regulations continue to evolve and because conditions giving rise to obligations and liabilities under environmental

23




laws are in some circumstances not readily identifiable, it is difficult to forecast the amount of such future environmental expenditures or the effects of changing standards on future business operations or results. Consequently, the Company can give no assurance that such expenditures will not be material in the future. The Company capitalizes environmental expenditures that increase the life or efficiency of property or that reduces or prevents environmental contamination. Capital expenditures for environmental requirements are anticipated to average approximately $2.0 million per year in the next five years. Capital expenditures for the three months ended December 31, 2005 and 2004 for environmental requirements were approximately $0.6 million and $1.2 million, respectively.

The Company has implemented an Administrative Consent Order (“ACO”) for its Burlington, New Jersey plant that was required under the New Jersey Environmental Cleanup Responsibility Act (now known as the Industrial Site Recovery Act). The ACO required soil and ground water cleanup, and the Company has completed, and has received final approval on, the soil cleanup required by the ACO. U. S. Pipe is continuing to address ground water issues at this site. Further remediation could be required. These remediation costs are expected to be minimal. Long-term ground water monitoring will be required to verify natural attenuation. It is not known how long ground water monitoring will be required. Management does not believe monitoring or further cleanup costs, if any, will have a material adverse effect on the financial condition or results of operations of the Company.

The Federal Comprehensive Environmental Response, Compensation and Liability Act (“CERCLA”) generally imposes liability, which may be joint and several and is without regard to fault or the legality of waste generation or disposal, on certain classes of persons, including owners and operators of sites at which hazardous substances are released into the environment (or pose a threat of such release), persons that disposed or arranged for the disposal of hazardous substances at such sites, and persons who owned or operated such sites at the time of such disposal. CERCLA authorizes the EPA, the States and, in some circumstances, private entities to take actions in response to public health or environmental threats and to seek to recover the costs they incur from the same classes of persons. Certain governmental authorities can also seek recovery for damages to natural resources. Currently, U.S. Pipe has been identified as a potentially responsible party (“PRP”) by the EPA under CERCLA with respect to cleanup of hazardous substances. U.S. Pipe is among many PRP’s at the site and a significant number of the PRP’s are substantial companies. With respect to the site located in Anniston, Alabama, the PRP’s have negotiated an administrative consent order with the EPA. Based on these negotiations, management estimates the Company’s share of liability for cleanup, after allocation among several PRP’s, will be approximately $4.0 million, which was accrued in 2004. Civil litigation in respect of the site is also ongoing, including a putative class action lawsuit alleging property damage and personal injury. Management does not believe that U.S. Pipe’s share of any additional liability will have a material adverse effect on the financial condition of the Company, but could be material to results of operations in future reporting periods.

The Company’s segment entered into a Consent Order with Georgia Department of Natural Resources regarding alleged hazardous waste violations at Anvil’s former foundry facility in Statesboro, Georgia. Pursuant to the Consent Order, Anvil agreed to pay a settlement of $50,000 and perform a supplemental environmental project. Anvil has also agreed to perform various investigatory and remedial actions at the foundry and its landfill. The total costs are estimated to be between $1.2 million and $1.4 million. The Company maintains an adequate reserve to cover these estimated costs.

Over the next two years, the Company could potentially incur between $8.5 million and $12.5 million of capital costs at its iron foundries to comply with the United States Environmental Protection Agency’s National Emissions Standards for Hazardous Air Pollutants which were issued April 22, 2004. The Company is in the process of analyzing the impact of this standard and the costs associated with compliance.

24




Although no assurances can be given that the Company will not be required in the future to make material expenditures relating to these or other sites, management does not believe at this time that the cleanup costs, if any, associated with these or other sites will have a material adverse effect on the financial condition or results of operations of the Company, but such cleanup costs could be material to results of operations in a reporting period.

In 2004, the Company entered into a settlement and release agreement with a former insurer whereby the former insurer paid $1.9 million, net of legal fees, to the Company for historical insurance claims, previously expensed as incurred by the Company. Such claims had not previously been submitted to the insurance company for reimbursement. The Company released the insurer of both past and future claims, and recorded a $1.9 million reduction to selling, general and administrative expenses in 2004.

In 2005, the Company entered into a settlement and release agreement with a former insurer whereby the former insurer agreed to pay $5.1 million, net of legal fees, to the Company for historical insurance claims previously expensed as incurred by the Company. Such claims had not previously been submitted to the insurance company for reimbursement. The Company released the insurer of both past and future claims. During 2005, the Company received $2.8 million in cash and the remainder is expected to be received in the second quarter of fiscal 2006. The Company recorded a $5.1 million reduction to selling, general and administrative expenses in 2005.

Under the terms of the agreement whereby Tyco International sold the Company in August 1999 to our prior owners (the “August 1999 Tyco Transaction”), Tyco agreed to indemnify Predecessor Mueller Water and its affiliates for all "Excluded Liabilities". Excluded Liabilities include, among other things, substantially all environmental liabilities relating to the time prior to the August 1999 Tyco Transaction. The indemnity survives indefinitely, is not subject to any deductibles or caps, and continues with respect to our current operations, other than those operations acquired since the August 1999 Tyco Transaction, including the operations of our U.S. Pipe segment. If Tyco ever becomes financially unable to, or otherwise fails to comply with the terms of the indemnity, we may be responsible for the Tyco-indemnified obligations. In addition, Tyco’s indemnity does not cover environmental liabilities to the extent caused by us or Predecessor Mueller or the operation of the Predecessor Mueller business after the August 1999 Tyco Transaction, nor does it cover environmental liabilities arising with respect to businesses or sites acquired after the August 1999 Tyco Transaction, which would include the U.S. Pipe business and facilities.

Miscellaneous Litigation

In 2003, the Company increased its accruals for outstanding litigation by approximately $6.5 million, principally related to the settlement of a class action employment matter. The settlement was finalized in May 2004 for an amount approximating the accrual.

In the purchase agreement relating to the August 1999 sale by Tyco of the Predecessor Mueller business to our prior owners, Tyco agreed to indemnify Predecessor Mueller and its affiliates for all “Excluded Liabilities.” Excluded Liabilities include, among other things, substantially all liabilities relating to the time prior to the August 1999 Tyco sale. The indemnity survives indefinitely and is not subject to any deductibles or caps. However, we may be responsible for these liabilities in the event that Tyco (or any successor entity) ever becomes financially unable or fails to comply with, the terms of the indemnity. In addition, Tyco’s indemnity does not cover environmental liabilities to the extent caused by us or Predecessor Mueller or the operation of the Predecessor Mueller business after the August 1999 Tyco sale, nor does it cover environmental liabilities arising with respect to businesses or sites acquired after the August 1999 Tyco sale, which would include the U.S. Pipe business and facilities.

Our subsidiary, James Jones Company, and its former parent company are defendants in a false claims lawsuit in which a former James Jones Company employee is suing on behalf of cities, water districts and

25




municipalities. The employee alleges that the defendants sold allegedly non-conforming public water system parts to various government entities. The lawsuit seeks consequential damages, penalties and punitive damages. Our subsidiary, Mueller Co., which had also been named as a defendant, brought a summary judgment motion and was dismissed from this litigation in January 2004. On September 15, 2004, the trial court ruled against the intervention of approximately 30 municipalities that had failed to intervene within the time deadlines previously specified by the Court. The trial court also ruled that the majority of municipalities that had purchased James Jones products from contractors or distributors, were not in privity with the James Jones Company and were not entitled to punitive damages. Following the Court’s ruling, the water districts and municipalities filed a new action against the James Jones Company, Mueller Co. and Watts (former parent company of James Jones Company), alleging fraud and intentional misrepresentation. This lawsuit is based on the same underlying facts as the false claims lawsuit. Any liability associated with these lawsuits is covered by the Tyco indemnity, and the defense is being paid for and conducted by Tyco.

Some of our subsidiaries have been named as defendants in a small number of asbestos-related lawsuits. We do not believe these lawsuits, either individually or in the aggregate, are material to our financial position or results of operations.

The Company is a party to a number of other lawsuits arising in the ordinary course of business. The Company provides for costs relating to these matters when a loss is probable and the amount is reasonably estimable. The effect of the outcome of these matters on the Company’s future results of operations cannot be predicted with certainty as any such effect depends on future results of operations and the amount and timing of the resolution of such matters. While the results of litigation cannot be predicted with certainty, the Company believes that the final outcome of such other litigation will not have a materially adverse effect on the Company’s financial statements.

Note 15.   Subsequent Events

In January 2006, the Company’s Mueller segment completed two acquisitions. On January 4, 2006, the Company acquired Hunt Industries, Inc. (“Hunt”) for $6.8 million in cash. Hunt is a manufacturer of meter pits and meter yokes, based in Murfreesboro, Tennessee, which are sold by our Mueller segment. On January 27, 2006, the Company acquired the operating assets of CCNE, L.L.C., a Connecticut-based manufacturer of check valves for sale to the water and wastewater treatment markets, for $8.8 million in cash. The CCNE assets will be operated by our Milliken Valve Company and Henry Pratt Company subsidiaries.

On January 26, 2006, the Company announced plans to close its Henry Pratt valve manufacturing facility in Dixon, Illinois by the end of 2006. The process of transferring the Dixon plant’s operations to other Henry Pratt facilities has begun.

On January 31, 2006, Mueller Holding Company, Inc., a Delaware corporation (“Holdco”), Mueller Water Products, LLC, a Delaware limited liability company (“Mueller LLC”), and Mueller Water Products Co-Issuer, Inc., a Delaware corporation (“Co-Issuer”), entered into an Agreement and Plan of Merger (the “Merger Agreement”). On February 2, 2006, pursuant to the terms of the Merger Agreement, Mueller LLC and Co-Issuer merged (the “Merger”) with and into Holdco, which was the surviving corporation and which changed its name, upon merger, to Mueller Water Products, Inc. In the Merger, each limited liability company interest of Mueller LLC and each share of common stock of Co-Issuer outstanding immediately prior to the Merger was cancelled and retired and ceased to exist, and each share of common stock of Holdco remained unchanged and continued to remain outstanding after the Merger.

On February 3, 2006, the Company filed with the Securities and Exchange Commission a registration statement on Form S-1 (Registration No. 333-131536) relating to a proposed initial public offering of the Company’s Series A common stock.

26




Note 16.   New Accounting Pronouncements

In November 2004, the Financial Accounting Standards Board issued SFAS No. 151, “Inventory Costs,” which clarifies the accounting for abnormal amounts of idle facility expense, freight, handling costs, and wasted material. This Statement requires that those items be recognized as current-period charges regardless of whether they meet the criterion of “so abnormal.” In addition, this Statement requires that allocation of fixed production overheads to the costs of conversion be based on the normal capacity of the production facilities. The Company adopted SFAS No. 151 on October 1, 2005, the beginning of its 2006 fiscal year. The impact of the adoption of SFAS No. 151 on the Company’s financial statements may have a material impact on our operating income in the event actual production output is significantly higher or lower than normal capacity. In the event actual production capacity is significantly different than normal capacity, the Company may be required to recognize certain amounts of facility expense, freight, handling costs or wasted materials as a current period expense.

In March 2005, the FASB issued FASB Interpretation No. 47, “Accounting for Conditional Asset Retirement Obligations” (“FIN 47”), which is an interpretation of FASB No. 143, “Accounting for Asset Retirement Obligations” (“SFAS 143”). This interpretation clarifies terminology within SFAS 143 and requires companies to recognize a liability for the fair value of a conditional asset retirement obligation when incurred if the liability’s fair value can be reasonably estimated. FIN 47 is effective for fiscal years beginning after December 15, 2005. This standard is not expected to have a material impact on the Company’s financial condition or results of operations.

In June 2005, the FASB issued FASB No. 154, “Accounting Changes and Error Corrections”, which changes the requirements for accounting for and reporting of a change in accounting principle. SFAS 154 requires retrospective application to prior periods’ financial statements of a voluntary change in accounting principle unless it is impracticable. SFAS 154 also requires that a change in method of depreciation, amortization or depletion for long-lived, nonfinancial assets be accounted for as a change in accounting estimate that is affected by a change in accounting principle. SFAS 154 is effective for accounting changes made in fiscal years beginning after December 15, 2005. The adoption of SFAS 154 is not expected to have a material impact on the Company’s financial condition or results of operations.

27




ITEM 2.                MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

In this report, each of the terms “Mueller Water,” the “Company,” “we,” “us” or “our” refers to Mueller Water Products, Inc. and its subsidiaries, except where the context makes clear that the reference is only to Mueller Water Products, Inc. itself, and is not inclusive of its subsidiaries.

Except as otherwise noted, we present all financial and operating data on a fiscal year and fiscal quarter basis. Our fiscal year ends on September 30, and our first fiscal quarter ends on December 31.

Overview

Organization

The registrant is Mueller Water Products, Inc., a Delaware corporation (“Mueller Water” or the “Company”). The Company is the surviving corporation of the merger on February 2, 2006 of Mueller Water Products, LLC (Commission File Number: 333-116590) and Mueller Water Products Co-Issuer, Inc. with and into Mueller Holding Company, Inc., a Delaware corporation.

On October 3, 2005, through a series of transactions (the “Acquisition”), Walter Industries, Inc. (“Walter”), through a wholly-owned subsidiary, acquired all outstanding shares of capital stock of Mueller Water Products, Inc. (“Predecessor Mueller”), which immediately was converted into Mueller Water Products, LLC, a Delaware limited liability company and contributed United States Pipe and Foundry Company, LLC, (“U.S. Pipe”), owned by Walter since 1969, to the acquired company. In accordance with generally accepted accounting principles, for accounting purposes U.S. Pipe is treated as the acquirer of Predecessor Mueller. Accordingly, effective October 3, 2005, U.S. Pipe’s basis of accounting is used for the Company and all historical financial data of the Company included in this report on Form 10-Q, is that of U.S. Pipe. The results of operations of Predecessor Mueller are included in the Consolidated Statements of Operations beginning October 3, 2005.

The Company was originally organized as United States Pipe and Foundry Company, Inc. (“Inc.”) and was a wholly-owned subsidiary of Walter Industries, Inc., a diversified New York Stock Exchange traded company (NYSE: WLT). On September 23, 2005, Inc. was dissolved and United States Pipe and Foundry Company, LLC was organized in the state of Alabama, and the operations of Inc. were conducted under the form of a limited liability company.

In December 2005, U.S. Pipe changed its fiscal year-end to September 30, which coincides with the fiscal year end of Predecessor Mueller. Beginning with the quarter ended December 31, 2005, the Company has three operating segments which are named after our leading brands in each segment: Mueller, U.S. Pipe, and Anvil.

Consistent with generally accepted accounting principles, the discussion of the Company’s results of operations for the three months ended December 31, 2005 includes the financial results of Predecessor Mueller for all but the first two days of the period. The inclusion of these results, plus the continuing integration process, may render direct comparison with the results for prior periods less meaningful. Accordingly, the discussion below addresses, where appropriate, trends that we believe are significant, separate and apart from the impact of the Acquisition. Supplemental information with comparisons of the three months ended December 31, 2005 Statement of Operations data to the pro forma three months ended December 31, 2004 Statement of Operations data is provided below under the subheading “Supplemental Information—Results of Operations for the Three Months Ended December 31, 2005 Compared to Pro Forma Results of Operations for the Three Months Ended December 31, 2004.”

28




Business

We are a leading North American manufacturer of a broad range of water infrastructure and flow control products for use in water distribution networks, water and wastewater treatment facilities, gas distribution and piping systems. We manage our business and report operations through three operating segments, based largely on the products they sell and the markets they serve. Our segments are named after lead brands in each segment:

·       Mueller.   The Mueller segment produces and sells hydrants, valves and related products primarily to the water and wastewater infrastructure markets. Sales of our Mueller segment products are driven principally by spending on water and wastewater infrastructure upgrade, repair and replacement and new water and wastewater infrastructure. Subsequent to the Acquisition, U.S. Pipe transferred its valve and hydrant business to our Mueller segment. Mueller segment sales are estimated to be approximately 50% for new infrastructure, with the remainder for upgrade, repair and replacement. A significant portion of Mueller’s sales are made through its broad distributor network. For most of our Mueller segment products, which are sold through independent distributors, end-users choose the brand or establish product specifications. We believe our reputation for quality, extensive distributor relationships, installed base and coordinated marketing approach have helped our Mueller segment products to be “specified” as an approved product for use in most major metropolitan areas throughout the United States.

·       U.S. Pipe.   The U.S. Pipe segment produces and sells ductile iron pressure pipe, restraint joints and fittings and related products to the water infrastructure market. U.S. Pipe products are sold primarily to water works distributors, contractors, municipalities, private utilities and other governmental agencies. A substantial percentage of ductile iron pressure pipe orders result from contracts that are bid by contractors or directly issued by municipalities or private utilities. To support our customers’ inventory and delivery requirements, U.S. Pipe utilizes numerous storage depots throughout the country.

·       Anvil.   The Anvil segment produces, sources and sells pipe fittings, pipe hangers and pipe nipples and a variety of related products primarily to the commercial fire protection piping systems and HVAC applications market. Sales of our Anvil segment products are driven principally by spending on non-residential construction projects.

Developments and Trends

The Acquisition of Predecessor Mueller on October 3, 2005, as well as other developments, trends and factors may impact our future results including the following:

·       We have implemented price increases for Mueller segment products effective February 1, 2006, as planned.

·       As presented herein, the operating results from the Acquisition of Predecessor Mueller will be consolidated with those of U.S. Pipe’s results from October 3, 2005, the date of Acquisition.

·       In the quarter ended December 31, 2005, our wholly-owned subsidiary, Mueller Group, entered into the 2005 Mueller Credit Agreement. Proceeds of the 2005 Mueller Credit Agreement were approximately $1,053.4 million, net of approximately $21.6 million of underwriting fees and expenses which will be amortized over the life of the loans. The proceeds were used to refinance Predecessor Mueller’s 2004 Credit Facility (“2004 Mueller Credit Facility”), redeem Predecessor Mueller’s second priority senior secured floating rate notes, and finance the acquisition of Predecessor Mueller by Walter Industries. During the period subsequent to September 30, 2005, and prior to Walter Industries acquiring Predecessor Mueller on October 3, 2005, Predecessor Mueller expensed $18.4 million of deferred financing fees related to the 2004 Mueller Credit

29




Facility. Mueller Group wrote off $2.4 million of deferred financing fees related to the second priority senior secured floating rate notes.

·       In the period subsequent to September 30, 2005 and prior to Walter Industries acquiring Predecessor Mueller on October 3, 2005, Predecessor Mueller expensed transaction fees of approximately $20.1 million and transaction bonuses of $10.0 million. These fees were contingent upon completion of the sale of Predecessor Mueller to Walter Industries. Non-contingent fees and expenses of approximately $3.1 million were expensed by Predecessor Mueller during the fiscal year ended September 30, 2005.

·       We have initiated a synergy plan designed to streamline our manufacturing operations, add incremental volume through combining sales efforts for complementary products and create savings through a coordinated purchasing plan to reduce raw material and overall production costs. We expect that the full implementation of our synergy plan by early fiscal 2008 will produce approximately $25-$35 million of ongoing incremental annual operating income. These benefits could be substantially higher if additional production, purchasing and sales improvements are realized.

·       As part of the synergy plan, in October 2005 we announced and have initiated the closure of the U.S. Pipe Chattanooga, Tennessee plant and the transfer of the valve and hydrant production of that plant to our Mueller segment’s Chattanooga, Tennessee and Albertville, Alabama plants. The transfer of valve and hydrant production was completed in December 2005. The eventual closure of the U.S. Pipe Chattanooga, Tennessee plant will occur sometime in fiscal 2006. Total costs related to this plant closure are expected to be approximately $45.2 million, which will be expensed and included as a component of operating income in accordance with generally accepted accounting principles. Total costs recorded as components of operating income for the three months ended December 31, 2005 were $15.9 million charged to cost of sales related to inventory obsolescence and additional facility expenses and $24.1 million of restructuring costs primarily related to fixed asset impairments, severance and environmental costs. Additional costs of $5.2 million are expected to be expensed during the remainder of fiscal 2006 as a result of closing this facility.

·       As part of the synergy plan, on January 26, 2006, the Company announced the closure of the Henry Pratt (“Pratt”) valve manufacturing facility in Dixon, Illinois by the end of fiscal 2006. The process of transferring the Dixon plant’s operations to other Pratt facilities has begun. Severance costs associated with this plant closure of approximately $1.5 million will be allocated to goodwill. Costs associated with relocating equipment will be expensed as incurred. The Company has other plans that were formally identified prior to the Acquisition to rationalize facilities and substantial cash expenditures in the form of severance and new equipment may be required to implement these plans. Although certain expenditures related to future plant rationalizations are expected to qualify for purchase accounting treatment and are not expected to be charged to operations, all costs of future facility rationalizations may not qualify for purchase accounting treatment.

·       On February 3, 2006, the Company filed a Registration Statement on Form S-1 with respect to the initial public offering of the Company’s Common Stock. The filing was pursuant to the October 21, 2005 announcement by Walter Industries to initiate an initial public offering of equity securities and subsequent spin-off of the Company.

·       In January 2005, the Company’s Mueller segment completed two acquisitions. On January 4, 2006, the Company acquired Hunt Industries, Inc. (“Hunt”) for $6.8 million in cash. Hunt is a manufacturer of meter pits and meter yokes, based in Murfreesboro, Tennessee, which are sold by our Mueller segment. On January 27, 2006, the Company acquired the operating assets of CCNE, L.L.C., a Connecticut-based manufacturer and seller of check valves to the water and wastewater

30




treatment markets, for $8.8 million in cash. The CCNE assets will be operated by our Milliken Valve Company and Henry Pratt Company subsidiaries.

·       The Company has announced its intention to enter into a tax allocation agreement (“Tax Allocation Agreement”) with Walter Industries in connection with the initial public offering of the Company’s Common Stock. Pursuant to the Tax Allocation Agreement, we and Walter Industries will make payments to each other such that, with respect to any period during which we are or were a member of the consolidated federal income tax group or any combined state or local income tax group with Walter Industries or any Walter Industries subsidiaries, the amount of taxes to be paid by us, or the amount of tax benefit to be refunded to us by Walter Industries, subject to certain adjustments, will be determined as though we were to file separate federal, state and local income tax returns as the common parent of an affiliated group of corporations filing combined, consolidated or unitary (as applicable) federal, state and local returns rather than a consolidated subsidiary of Walter Industries with respect to federal, state and local income taxes. With respect to our tax assets, our right to reimbursement from Walter Industries will be determined based on the usage of such tax assets by the Walter Industries consolidated federal income tax group or the combined, consolidated or unitary state or local income tax group. Walter Industries will continue to have all the rights of a parent of a consolidated group (and similar rights provided for by applicable state and local law with respect to a parent of a combined, consolidated or unitary group), will be the sole and exclusive agent for us in any and all matters relating to the combined, consolidated or unitary federal, state and local income tax liabilities of us, will have sole and exclusive responsibility for the preparation and filing of consolidated federal income and consolidated or combined state and local tax returns (or amended returns), and will have the power, in its sole discretion, to contest or compromise any asserted tax adjustment or deficiency and to file, litigate or compromise any claim for refund on behalf of us related to any such combined, consolidated or unitary (as applicable) federal, state or local tax return.

·       The Company has announced its intention to adopt a new 2006 stock incentive plan designed to promote our long-term growth and financial success by providing incentives to our employees, directors and consultants through grants of stock-based awards. The impact to net income for future grants has not yet been determined.

·       As of December 31, 2005, scrap metal costs for our U.S. Pipe segment declined 16% from their peak in 2004. Recently scrap costs have increased and are expected to remain elevated at least through March 2006. In addition, the price of brass ingot has increased by up to approximately 60% over the cost budgeted for brass ingot for fiscal year 2006.  If brass ingot pricing remains at current levels, production costs for our Mueller segment could increase, and there can be no assurance that any of this increase can be passed along to our customers.

Forward-Looking Statements

This report contains certain statements that may be deemed “forward-looking statements” within the meaning of Section 21E of the Securities Exchange Act of 1934. All statements other than statements of historical fact are statements that could be deemed forward looking statements. In this context, forward-looking statements often address our future business and financial performance, and may be characterized by terminology such as “believe”, “anticipate”, “should”, “intend”, “plan”, “will”, “expects”, “estimates”, “projects”, “positioned”, “strategy”, and similar expressions. These statements are based on assumptions and assessments made by the Company’s management in light of its experience and its perception of historical trends, current conditions, expected future developments and other factors it believes to be appropriate. These forward looking statements are subject to a number of risks and uncertainties, including but not limited to: the Company’s ability to continue long-standing relationships with major customers; increased competition; demand for and market acceptance of new and existing products in the

31




markets we serve; adverse changes in currency exchange rates or raw material prices, specifically steel scrap, steel pipe and brass ingot; unanticipated developments that could occur with respect to contingencies such as litigation, product liability exposures and environmental matters; the Company’s ability to integrate acquired businesses into its operations; and other risks and uncertainties that affect the manufacturing sector generally including, but not limited to, economic, political, governmental and technological factors affecting the Company’s operations, markets, products, services and prices. Any such forward looking statements are not guarantees of future performances and actual results, developments and business decisions may differ from those envisaged by such forward looking statements. These forward looking statements speak only as of the date of this Quarterly Report. The Company disclaims any duty to update any forward looking statement, all of which are expressly qualified by the foregoing Forward-Looking Statements.

32




Results of Operations

Three Months Ended December 31, 2005 As Compared to the Three Months Ended December 31, 2004

 

 

Three months ended

 

 

 

 

 

 

 

December 31, 2005

 

December 31, 2004

 

FY06 Q1 vs. FY05 Q1

 

 

 

 

 

Percentage
of net
sales(1)

 

 

 

Percentage
of net
sales(1)

 


Increase/
(decrease)

 

Percentage
increase/
(decrease)

 

 

 

(dollars in millions)

 

Net sales

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Mueller

 

$

176.7

 

 

36.8

%

 

$

 

 

%

 

 

$

176.7

 

 

 

 

 

 

U.S. Pipe

 

171.1

 

 

35.6

 

 

130.3

 

 

100.0

 

 

 

40.8

 

 

 

31.3

%

 

Anvil

 

132.6

 

 

27.6

 

 

 

 

 

 

 

132.6

 

 

 

 

 

 

Consolidated

 

$

480.4

 

 

100.0

 

 

$

130.3

 

 

100.0

 

 

 

$

350.1

 

 

 

 

 

 

Gross profit

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Mueller

 

$

15.5

 

 

8.8

 

 

$

 

 

 

 

 

$

15.5

 

 

 

 

 

 

U.S. Pipe

 

9.1

 

 

5.3

 

 

12.7

 

 

9.7

 

 

 

(3.6

)

 

 

(28.3

)

 

Anvil

 

18.9

 

 

14.3

 

 

 

 

 

 

 

18.9

 

 

 

 

 

 

Consolidated

 

$

43.5

 

 

9.1

 

 

$

12.7

 

 

9.7

 

 

 

$

30.8

 

 

 

 

 

 

Selling, general and administrative

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Mueller

 

$

19.3

 

 

10.9

 

 

$

 

 

 

 

 

$

19.3

 

 

 

 

 

 

U.S. Pipe

 

11.0

 

 

6.4

 

 

13.2

 

 

10.1

 

 

 

(2.2

)

 

 

(16.7

)

 

Anvil

 

20.4

 

 

15.4

 

 

 

 

 

 

 

20.4

 

 

 

 

 

 

Corporate

 

6.4

 

 

1.3

 

 

 

 

 

 

 

6.4