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 June 30, 2006.

o                                 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

 

(I.R.S. Employer

incorporation or organization)

 

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)

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

There were 114,594,920 shares of common stock of the registrant outstanding at July 31, 2006.

 




PART I.                   FINANCIAL INFORMATION

ITEM 1.                FINANCIAL STATEMENTS

MUELLER WATER PRODUCTS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)

 

 

June 30,
2006

 

September 30,
2005

 

 

 

(dollars in millions)

 

Assets

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

239.7

 

 

$

 

 

Receivables, net of allowance for doubtful accounts of $5.5 million and $0.9 million at June 30, 2006 and September 30, 2005, respectively

 

309.2

 

 

118.5

 

 

Inventories

 

466.2

 

 

147.2

 

 

Deferred income taxes

 

58.1

 

 

11.1

 

 

Prepaid expenses

 

30.8

 

 

1.5

 

 

Total current assets

 

1,104.0

 

 

278.3

 

 

Property, plant and equipment, net

 

338.2

 

 

149.2

 

 

Deferred financing fees

 

25.4

 

 

 

 

Deferred income taxes

 

 

 

9.5

 

 

Due from parent, Walter Industries

 

10.8

 

 

 

 

Identifiable intangibles, net

 

842.6

 

 

 

 

Goodwill

 

860.7

 

 

58.4

 

 

Other long-term assets

 

9.5

 

 

 

 

Total assets

 

$

3,191.2

 

 

$

495.4

 

 

Liabilities and Shareholders’ Equity (Deficit)

 

 

 

 

 

 

 

Current portion of long-term debt

 

$

171.7

 

 

$

 

 

Accounts payable

 

117.1

 

 

52.5

 

 

Accrued expenses and other liabilities

 

106.0

 

 

34.7

 

 

Payable to affiliate, Sloss Industries

 

2.0

 

 

2.5

 

 

Total current liabilities

 

396.8

 

 

89.7

 

 

Long-term debt

 

1,132.3

 

 

 

 

Payable to parent, Walter Industries

 

 

 

443.6

 

 

Accrued pension liability, net

 

104.3

 

 

53.6

 

 

Accumulated postretirement benefits obligation

 

47.0

 

 

51.1

 

 

Deferred income taxes

 

295.2

 

 

 

 

Other long-term liabilities

 

25.4

 

 

12.6

 

 

Total liabilities

 

2,001.0

 

 

650.6

 

 

Commitments and contingencies (Note 16)

 

 

 

 

 

 

 

Shareholders’ equity (deficit):

 

 

 

 

 

 

 

Common stock, $.01 par value per share:

 

 

 

 

 

 

 

Class A—400,000,000 shares authorized and 28,750,000 shares issued

 

0.3

 

 

 

 

Class B—200,000,000 shares authorized and 85,844,920 shares issued

 

0.8

 

 

 

 

Capital in excess of par value

 

1,417.0

 

 

68.3

 

 

Accumulated deficit

 

(189.9

)

 

(178.1

)

 

Accumulated other comprehensive loss

 

(38.0

)

 

(45.4

)

 

Total shareholders’ equity (deficit)

 

1,190.2

 

 

(155.2

)

 

Total liabilities and shareholders’ equity (deficit)

 

$

3,191.2

 

 

$

495.4

 

 

 

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

1




MUELLER WATER PRODUCTS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)

 

 

Three months ended June 30,

 

 

 

          2006          

 

          2005          

 

 

 

(dollars in millions, except per
share amounts)

 

Net sales

 

 

$

500.0

 

 

 

$

162.0

 

 

Cost of sales

 

 

365.5

 

 

 

139.2

 

 

Gross profit

 

 

134.5

 

 

 

22.8

 

 

Operating expenses:

 

 

 

 

 

 

 

 

 

Selling, general and administrative

 

 

62.6

 

 

 

10.7

 

 

Related party corporate charges

 

 

2.3

 

 

 

1.8

 

 

Facility rationalization, restructuring and related costs

 

 

0.2

 

 

 

 

 

Total operating expenses

 

 

65.1

 

 

 

12.5

 

 

Income from operations

 

 

69.4

 

 

 

10.3

 

 

Interest expense arising from related party payable to Walter Industries

 

 

 

 

 

(4.9

)

 

Interest expense, net of interest income

 

 

(31.9

)

 

 

 

 

Income before income taxes

 

 

37.5

 

 

 

5.4

 

 

Income tax expense (benefit)

 

 

(1.3

)

 

 

1.8

 

 

Net income

 

 

$

38.8

 

 

 

$

3.6

 

 

Basic and diluted income per share

 

 

$

0.41

 

 

 

$

0.04

 

 

 

 

 

Nine months ended June 30,

 

 

 

          2006          

 

          2005          

 

 

 

(dollars in millions, except per
share amounts)

 

Net sales

 

 

$

1,415.3

 

 

 

$

427.8

 

 

Cost of sales

 

 

1,142.7

 

 

 

381.7

 

 

Gross profit

 

 

272.6

 

 

 

46.1

 

 

Operating expenses:

 

 

 

 

 

 

 

 

 

Selling, general and administrative

 

 

180.5

 

 

 

29.0

 

 

Related party corporate charges

 

 

6.1

 

 

 

5.5

 

 

Facility rationalization, restructuring and related costs

 

 

28.6

 

 

 

 

 

Total operating expenses

 

 

215.2

 

 

 

34.5

 

 

Income from operations

 

 

57.4

 

 

 

11.6

 

 

Interest expense arising from related party payable to Walter Industries

 

 

 

 

 

(15.9

)

 

Interest expense, net of interest income

 

 

(94.2

)

 

 

(0.3

)

 

Loss before income taxes

 

 

(36.8

)

 

 

(4.6

)

 

Income tax expense (benefit)

 

 

(25.0

)

 

 

2.5

 

 

Net loss

 

 

$

(11.8

)

 

 

$

(7.1

)

 

Basic and diluted loss per share

 

 

$

(0.13

)

 

 

$

(0.08

)

 

 

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

2




MUELLER WATER PRODUCTS, INC.

CONDENSED CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY (DEFICIT) AND
COMPREHENSIVE LOSS

FOR THE NINE MONTHS ENDED JUNE 30, 2006
(UNAUDITED)
(dollars in millions)

 

 

Common
Stock

 

Capital in
Excess of 
Par Value

 

Accumulated
Deficit

 

Comprehensive
Income
(Loss)

 

Accumulated
Other
Comprehensive
Loss

 

Total

 

Balance at September 30, 2005

 

 

 

 

$

68.3

 

 

$

(178.1

)

 

 

 

 

 

 

$

(45.4

)

 

$

(155.2

)

Walter’s investment in subsidiary

 

 

 

 

932.9

 

 

 

 

 

 

 

 

 

 

 

932.9

 

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

 

Sale of common stock in initial public offering

 

 

$

1.1

 

 

428.2

 

 

 

 

 

 

 

 

 

 

 

429.3

 

Share-based compensation

 

 

 

 

0.5

 

 

 

 

 

 

 

 

 

 

 

0.5

 

Comprehensive income (loss)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net loss

 

 

 

 

 

 

(11.8

)

 

 

(11.8

)

 

 

 

 

(11.8

)

Other comprehensive income (loss), net of tax

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Unrealized gain on interest rate swaps

 

 

 

 

 

 

 

 

 

5.3

 

 

 

5.3

 

 

5.3

 

Foreign currency translation adjustments

 

 

 

 

 

 

 

 

 

2.1

 

 

 

2.1

 

 

2.1

 

Comprehensive loss

 

 

 

 

 

 

 

 

 

 

 

 

$

(4.4

)

 

 

 

 

 

 

 

Balance at June 30, 2006

 

 

$

1.1

 

 

$

1,417.0

 

 

$

(189.9

)

 

 

 

 

 

 

$

(38.0

)

 

$

1,190.2

 

 

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

3




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

 

 

Nine months ended June 30,

 

 

 

       2006       

 

       2005       

 

 

 

(dollars in millions)

 

OPERATING ACTIVITIES

 

 

 

 

 

 

 

 

 

Net loss

 

 

$

(11.8

)

 

 

$

(7.1

)

 

Adjustments to reconcile net loss to net cash provided by operating activities:

 

 

 

 

 

 

 

 

 

Depreciation

 

 

51.6

 

 

 

19.7

 

 

Amortization of intangibles

 

 

21.0

 

 

 

 

 

Amortization of deferred financing fees

 

 

7.8

 

 

 

 

 

Accretion on debt

 

 

10.3

 

 

 

 

 

Loss on disposal of property, plant and equipment

 

 

1.3

 

 

 

 

 

Stock-based compensation expense

 

 

1.0

 

 

 

 

 

Impairments of property, plant and equipment

 

 

21.6

 

 

 

 

 

Provision (credit) for deferred income taxes

 

 

(25.8

)

 

 

8.5

 

 

Gain on interest rate swaps

 

 

(0.5

)

 

 

 

 

Other, net

 

 

(2.0

)

 

 

 

 

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

 

 

 

 

 

 

 

 

 

Receivables

 

 

(11.6

)

 

 

3.3

 

 

Inventories

 

 

58.8

 

 

 

(49.8

)

 

Income taxes payable

 

 

 

 

 

3.8

 

 

Prepaid expenses and other current assets

 

 

1.8

 

 

 

 

 

Other non-current assets

 

 

(0.4

)

 

 

 

 

Pension and other long-term liabilities

 

 

2.5

 

 

 

3.1

 

 

Accounts payable, accrued expenses and other current liabilities

 

 

(32.6

)

 

 

3.4

 

 

Net cash provided by (used in) operating activities

 

 

93.0

 

 

 

(15.1

)

 

INVESTING ACTIVITIES

 

 

 

 

 

 

 

 

 

Additions to property, plant and equipment

 

 

(48.0

)

 

 

(15.7

)

 

Acquisitions of businesses, net of cash acquired

 

 

(15.5

)

 

 

 

 

Increase in amounts due (from) to Walter

 

 

(12.5

)

 

 

33.1

 

 

Net cash (used in) provided by investing activities

 

 

(76.0

)

 

 

17.4

 

 

FINANCING ACTIVITIES

 

 

 

 

 

 

 

 

 

Increase (decrease) in dollar value of bank checks outstanding

 

 

12.0

 

 

 

(2.4

)

 

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

 

 

(866.9

)

 

 

 

 

Proceeds from issuance of common stock

 

 

429.3

 

 

 

 

 

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 provided by (used in) financing activities

 

 

222.6

 

 

 

(2.4

)

 

Effect of exchange rate changes on cash

 

 

0.1

 

 

 

 

 

Net increase (decrease) in cash and cash equivalents

 

 

239.7

 

 

 

(0.1

)

 

Cash and cash equivalents at beginning of period

 

 

 

 

 

0.1

 

 

Cash and cash equivalents at end of period

 

 

$

239.7

 

 

 

$

 

 

 

4




Schedule of non-cash investing and financing activities:

On October 3, 2005, the Company’s parent, Walter Industries, Inc. (“Walter”), purchased all of the outstanding common stock of Mueller Water Products, Inc. (“Predecessor Mueller”).

 

 

(dollars in millions)

 

Contribution of Predecessor Mueller by Walter

 

 

$

932.9

 

 

Less: Cash of Predecessor Mueller received

 

 

(76.3

)

 

Total net assets received excluding cash

 

 

$

856.6

 

 

 

Subsequent to the Acquisition, Walter forgave an intercompany receivable from U.S. Pipe of $443.6 million.

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

5




MUELLER WATER PRODUCTS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
AS OF AND FOR THE THREE AND NINE MONTHS ENDED JUNE 30, 2006 AND JUNE 30, 2005
(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. On June 1, 2006, Mueller Water completed its initial public offering (“IPO”) of its Series A common stock (NYSE: MWA). Walter Industries, Inc. (“Walter”) is the holder of all of the Company’s outstanding Series B common stock. The Company was a wholly-owned subsidiary of Walter.

On October 3, 2005, through a series of transactions (the “Acquisition”), 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, 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 accompanying unaudited condensed consolidated financial statements of the Company have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three-month and nine-month periods ended June 30, 2006 are not necessarily indicative of the results that may be expected for the year ending September 30, 2006.

The balance sheet at September 30, 2005, has been derived from the audited financial statements at that date but does not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements.

6




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 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.

Share-Based Compensation—On May 25, 2006, the Company adopted the Mueller Water Products, Inc. 2006 Stock Incentive Plan (the “2006 Plan”), which is more fully described in Note 6. The Company records compensation costs for stock options and restricted stock units granted to employees based on the fair value at the grant dates as prescribed by Statement of Financial Accounting Standards (“SFAS”) No. 123(R), “Share-Based Payment”. The Company records share-based compensation costs as selling, general and administrative in the condensed consolidated statements of operations.

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 June 30, 2006 and September 30, 2005 checks issued but not yet presented to the banks for payment (i.e. the dollar value of bank checks outstanding) were $12.0 million and zero, respectively, and were recorded in accounts payable.

The cash balance as of June 30, 2006 included $183.3 million that was used on July 3, 2006 for the partial redemption of the Company’s outstanding debt, accrued interest and prepayment premiums and other debt repayment costs which is more fully described in Note 18 “Subsequent Events”.

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

7




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.

Inventories—Inventories 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 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, 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 estimated 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 depreciated 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.

8




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 or combined insurance industry data when historical data is limited. Pursuant to the terms of the Tyco Purchase Agreement, Predecessor Mueller is indemnified by Tyco for all liabilities that occurred prior to August 16, 1999. Workers’ compensation liabilities were as follows:

 

 

June 30,
2006

 

September 30,
2005

 

 

 

(dollars in millions)

 

Workers’ compensation liability recorded on a discounted basis

 

 

$

24.8

 

 

 

$

11.9

 

 

 

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.

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

 

Nine months ended

 

 

 

June 30, 2006

 

June 30, 2005

 

June 30, 2006

 

June 30, 2005

 

Accrued balance at beginning of period

 

 

$

4.4

 

 

 

$

1.8

 

 

 

$

4.7

 

 

 

$

1.8

 

 

Accrued warranty of Predecessor Mueller

 

 

 

 

 

 

 

 

1.6

 

 

 

 

 

Warranty expense

 

 

1.4

 

 

 

2.8

 

 

 

3.2

 

 

 

4.5

 

 

Settlement of warranty claims

 

 

(1.7

)

 

 

(0.8

)

 

 

(5.4

)

 

 

(2.5

)

 

Balance at end of period

 

 

$

4.1

 

 

 

$

3.8

 

 

 

$

4.1

 

 

 

$

3.8

 

 

 

Deferred Financing Fees—Costs of debt financing 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.

9




Translation of Foreign Currency—Assets and liabilities of the Company’s businesses operating outside of the United States of America that maintain 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 are included in either cost of sales or selling, general and administrative expense, as appropriate.

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 (see Note 8).

Additionally, the Company utilizes forward contracts to mitigate its exposure to changes in foreign currency exchange rates from third party and intercompany 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.

Related Party Transactions—The 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 $4.8 million and $6.5 million for the three months ended June 30, 2006 and 2005, respectively, and $15.6 million and $16.7 million for the nine months ended June 30, 2006 and 2005, 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 $0.5 million and $0.4 million for the three months ended June 30, 2006 and 2005, respectively, and $1.3 million and $1.2 million for the nine months ended June 30, 2006 and 2005, respectively.

Related Party Allocations—Certain 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 $0.6 million and $0.4 million for the three months ended June 30, 2006 and 2005, respectively, and approximately $1.5 million and $1.2 million for the nine months ended June 30, 2006 and 2005, 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 $2.3 million and $1.8 million for the three months ended June 30, 2006 and 2005, respectively, and approximately $6.1 million and $5.5 million for the nine months ended June 30, 2006 and 2005, 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.

Certain of the Company’s employees have been granted Walter restricted stock units and stock options under Walter’s stock-based compensation plans. The Company has expensed $0.2 million and

10




$0.5 million related to the stock-based compensation costs allocated from Walter for the three and nine months ended June 30, 2006, respectively.

During the three months ended June 30, 2006, the Company recorded $1.4 million of interest income receivable related to the $20.0 million note receivable from Walter. This amount is included in Interest Expense, net of Interest Income on the consolidated statement of operations.

Note 3.   Acquisitions

Hunt Industries, Inc.

On January 4, 2006, the Company acquired Hunt Industries, Inc. (“Hunt”) for $6.8 million in cash. Hunt, based in Murfreesboro, Tennessee, is a manufacturer of meter pits and meter yokes which are sold by the Company’s Mueller segment.

The estimated fair values of the assets and liabilities acquired are as follows (dollars in millions):

Current assets

 

$

0.2

 

Goodwill

 

6.8

 

Current liabilities

 

(0.2

)

Net assets acquired

 

$

6.8

 

 

CCNE, L.L.C.

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 estimated fair values of the assets and liabilities acquired are as follows (dollars in millions):

Inventory

 

$

2.1

 

Intangible assets

 

6.7

 

Net assets acquired

 

$

8.8

 

 

The intangible assets acquired represent purchased technology and are being amortized over an estimated useful life of 55 months.

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. On February 23, 2006, Walter received $10.5 million based on the final closing cash and working capital, adjusting the purchase price to $932.9 million.

11




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 $932.9 million is comprised of (dollars in millions):

Acquisition of the outstanding common stock of Predecessor Mueller

 

$

918.1

 

Acquisition-related transaction costs

 

14.8

 

Total purchase price

 

$

932.9

 

 

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

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 was recorded as goodwill. Based on estimated fair values, the purchase price was allocated as follows (dollars in millions):

Receivables, net

 

$

177.4

 

Inventory

 

373.2

 

Property, plant and equipment

 

215.7

 

Identifiable intangible assets

 

856.9

 

Goodwill

 

789.4

 

Net other assets

 

376.1

 

Net deferred tax liabilities

 

(283.1

)

Debt

 

(1,572.7

)

Total purchase price allocation

 

$

932.9

 

 

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. Costs related to these facility rationalization actions will be recorded to goodwill through October 3, 2006.

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 nothing was charged to cost of sales during the three months ended June 30, 2006 and $70.2 million was charged to cost of sales during the nine months ended June 30, 2006.

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

 

136.6

 

3 to 5 years

 

Other

 

13.2

 

3 years

 

Total property, plant and equipment

 

$

215.7

 

 

 

 

12




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

 

397.6

 

16 and 19 years

 

Total identifiable intangible assets

 

$

856.9

 

 

 

 

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 the Company determines the book value of goodwill has become impaired, the Company 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, which resulted in a $36.0 million and an $18.9 million fair value increase to the senior discount notes and the senior subordinated notes, respectively.

The following table of unaudited pro forma results of operations of Predecessor Mueller and U.S. Pipe for the three and nine months ended June 30, 2005 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 June 30, 2005.

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

 

Nine months
ended

 

 

 

June 30, 2005

 

June 30, 2005

 

 

 

(dollars in millions, except per share amounts)

 

 

 

(unaudited)

 

Net sales

 

 

$

458.9

 

 

 

$

1,266.1

 

 

Net income

 

 

$

13.4

 

 

 

$

3.0

 

 

Basic income per share

 

 

$

0.16

 

 

 

$

0.03

 

 

Diluted income per share

 

 

$

0.16

 

 

 

$

0.03

 

 

 

The pro forma amounts are based on the historical results of operations and are adjusted for amortization of definite-lived intangibles of $5.9 million and $17.7 million for the three and nine months ended June 30, 2005, respectively; depreciation of property, plant and equipment of ($0.2) million and

13




($0.6) million for the three and nine months ended June 30, 2005, respectively; interest expense of $4.7 million and $15.3 million for the three and nine months ended June 30, 2005, respectively; and amortization of financing fees related to the 2005 Mueller Credit Agreement of ($0.1) million and $2.3 million for the three and nine months ended June 30, 2005, respectively.

Note 4.   Facility Rationalization, Restructuring and Related Costs

On April 20, 2006, the Company announced the closure of the Mueller Canada valve and hydrant manufacturing facility in Milton, Ontario, Canada, which is included in the Company’s Mueller segment. The eventual closure of the facility is expected to occur by the end of fiscal year 2006, resulting in the termination of approximately 130 employees. The transfer of production to other Mueller facilities began in the third quarter of fiscal 2006. Total estimated costs related to this closure are $3.9 million, of which $2.5 million, consisting of termination benefits, and $0.2 million, consisting of fixed asset impairments, were recorded as adjustments to goodwill in the three months ended June 30, 2006. Other estimated costs of $1.2 million, associated with relocating the Milton warehouse and equipment, will be expensed as incurred. The restructuring costs are recorded to goodwill as the overall plan to close the facility was identified prior to the Acquisition.

On January 26, 2006, the Company announced the closure of the Henry Pratt valve manufacturing facility in Dixon, Illinois, which is included in the Company’s Mueller segment. The eventual closure of the facility is expected to occur by the end of the fiscal year 2006, resulting in the termination of approximately 100 employees. Total estimated costs related to this closure are $3.4 million, of which $1.0 million, consisting of termination benefits, and $1.4 million, consisting of fixed asset impairment charges, were recorded as adjustments to goodwill. The remaining other estimated costs of $1.0 million include costs to transfer and install equipment and temporary outsourcing of manufacturing and will be expensed when incurred. During the three and nine months ended June 30, 2006, $0.7 million and $1.0 million, respectively, of termination benefits and $1.4 million and $1.4 million, respectively, of fixed asset impairment charges were recorded as adjustments to goodwill. The restructuring costs are recorded to goodwill as the overall plan to close the facility was identified prior to the Acquisition.

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 exit costs are expected to approximate $49.9 million of which approximately $28.6 million qualify as restructuring and impairment charges. The remaining exit costs of $21.3 million were comprised of an inventory write-down totaling $11.4 million, a $9.0 million write-off of unabsorbed overhead costs, and $0.9 million of other related costs, of which $3.1 million and $21.3 million were recognized in cost of sales during the three months and nine months ended June 30, 2006, respectively.

Total estimated restructuring and impairment charges and the amounts recorded to restructuring expenses are as follows (in millions):

 

 

 

 

Restructuring & impairment
charges expensed

 

 

 

Total estimated
restructuring costs

 

For the three months 
ended June 30, 2006

 

For the nine months
ended June 30, 2006

 

 

 

(dollars in millions)

 

 

 

Termination benefits

 

 

$

3.8

 

 

 

$

0.4

 

 

 

$

3.8

 

 

Other employee-related costs

 

 

3.3

 

 

 

(0.6

)

 

 

3.3

 

 

Other associated costs

 

 

2.1

 

 

 

 

 

 

2.1

 

 

Impairment of property, plant and equipment

 

 

19.4

 

 

 

0.4

 

 

 

19.4

 

 

Total

 

 

$

28.6

 

 

 

$

0.2

 

 

 

$

28.6

 

 

 

14




Termination benefits relating to the U.S. Pipe Chattanooga plant closure of $3.8 million consist primarily of severance related to staff reductions of hourly and salaried personnel. In addition, the Company recognized other employee-related costs (benefits) of approximately $(0.6) million and $3.3 million related to pension and other postretirement benefit obligations during the three and nine months ended June 30, 2006, respectively.

Other associated costs of $2.1 million principally include environmental liabilities.

Property impairment charges of $0.4 million and $19.4 million were recorded during the three and nine months ended June 30, 2006, respectively.

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

 

 

For the three 
months ended
June 30, 2006

 

For the nine
months ended
June 30, 2006

 

Beginning balance

 

 

$

3.6

 

 

 

$

 

 

Restructuring expenses accrued

 

 

0.7

 

 

 

6.2

 

 

Restructuring accruals allocated to goodwill for plant closures identified prior to the Acquisition

 

 

3.8

 

 

 

3.8

 

 

Restructuring payments and charges

 

 

(2.0

)

 

 

(3.9

)

 

Ending balance

 

 

$

6.1

 

 

 

$

6.1

 

 

 

Note 5.   Capital Stock

On June 1, 2006, the Company completed its IPO of 28.8 million shares of its Series A common stock at an offering price of $16.00 per share. The gross proceeds of $460.0 million were offset by $27.6 million in underwriter fees and $3.1 million of other costs associated with the IPO. The remainder of the proceeds will be used to pay down the Company’s existing debt—see Note 7 and Note 18.

Immediately prior to the issuance of the Series A stock, the Company issued 85.8 million shares of the Company’s Series B common stock to Walter in exchange for one unit.

Holders of Series A common stock are entitled to one vote per share, and holders of Series B common stock are entitled to eight votes per share. Walter, which owns all of the Company’s outstanding Series B common stock, holds 96.3% of the combined voting power of all of the Company’s outstanding common stock as of June 30, 2006.

Note 6.   Share-Based Compensation Plans

The stockholders of the Company approved the 2006 Stock Incentive Plan (the “2006 Plan”),  under which an aggregate of 8.0 million shares of the Company’s common stock have been reserved for grant and issuance of awards of incentive stock options, nonstatutory stock options, restricted stock bonuses, restricted stock purchase rights, stock appreciation rights, phantom stock units, restricted stock units, performance share bonuses and performance share units. Generally, all of the employees (including executive officers), members of the Board of Directors, and employees of its designated subsidiaries and its affiliates are eligible to participate in the 2006 Plan.

Under the 2006 Plan, an award becomes exercisable at such times and in such installments as set by the Compensation Committee of the Board of Directors (generally, vesting occurs over three years in equal annual increments), but no award will be exercisable after the tenth anniversary of the date on which it is granted.

The Company records compensation costs for stock options and restricted stock units granted to employees based on the fair value at the grant dates as prescribed by SFAS No. 123(R), “Share-Based

15




Payment”, which requires that compensation costs related to share-based payment transactions be recognized in the financial statements over the period that an employee provides service in exchange for the award. Compensation cost for new and modified awards is recorded over the related vesting period of such awards.

The effect of share-based compensation on the financial performance of the Company for the three and nine months ended June 30, 2006 was as follows (in millions, except per share data):

 

 

For the
three months ended
June 30, 2006

 

For the
nine months ended
June 30, 2006

 

Decrease in income from operations before income taxes

 

 

$

0.5

 

 

 

$

0.5

 

 

Decrease in net income

 

 

$

0.2

 

 

 

$

0.2

 

 

Cash outflow from operating activities

 

 

$

 

 

 

$

 

 

Cash inflow from financing activities

 

 

$

 

 

 

$

 

 

Decrease in basic and diluted earnings per share

 

 

$

 

 

 

$

 

 

 

During the three months and nine months ended June 30, 2006, the Company recorded share-based compensation expense associated with the 2006 Plan of approximately $0.5 million. These amounts are reflected in selling, general and administrative expenses and have been allocated to the reportable segments.

In addition to the share-based compensation expense associated with the 2006 Plan, certain of the Company’s employees have been granted Walter restricted stock units and stock options under Walter’s share-based compensation plans. The Company has expensed $0.2 million and $0.5 million related to the share-based compensation costs allocated from Walter for the three and nine months ended June 30, 2006, respectively.

A summary of activity related to stock options under the 2006 Plan as of June 30, 2006 and changes during the three months then ended is presented below:

 

 

Shares

 

Weighted
Average
Exercise Price

 

Weighted
Average
Remaining
Contractual
Term

 

Aggregate
Intrinsic Value

 

 

 

 

 

 

 

(in years)

 

($ millions)

 

Outstanding at March 31, 2006

 

 

 

$

 

 

 

 

 

 

 

 

 

 

Granted

 

85,600

 

 

16.00

 

 

 

 

 

 

 

 

 

 

Exercised

 

 

 

 

 

 

 

 

 

 

 

 

 

Cancelled

 

 

 

 

 

 

 

 

 

 

 

 

 

Outstanding at June 30, 2006

 

85,600

 

 

16.00

 

 

 

9.9

 

 

 

$

0.1

 

 

Exercisable at June 30, 2006

 

 

 

$

 

 

 

 

 

 

$

 

 

 

Weighted average assumptions used to determine the grant-date fair value of options granted during the three months ended June 30, 2006 under the Black-Scholes method were:

Risk-free interest rate

 

5.05

%

Dividend yield

 

0.44

%

Expected life (years)

 

6.00

 

Volatility

 

31.80

%

Forfeiture rate

 

5.00

%

 

16




The risk-free interest rate is based on the U.S. Treasury yield in effect at the time of grant and has a term equal to the expected life. The expected dividend yield is based on the Company’s estimated annual dividend payout at grant date. The expected term of the options represents the period of time the options are expected to be outstanding. Expected volatility is based on management’s best estimate using the most recently disclosed data from a group of comparable companies. The Company incorporated the volatility data from comparable companies because of its limited historical share price information since the Company’s IPO on June 1, 2006. Since the Company’s 2006 Plan is at its inception, the Company does not have a sufficient history to estimate the expected pre-vesting forfeiture rate. Since the structure and terms of the plan are very similar to Walter’s plan, the Company has decided it would be reasonable to use a pre-vesting forfeiture rate similar to Walter’s current historical rate of approximately 5% as an initial estimate for the Company’s plan. This initial estimate will be re-evaluated as the Company accumulates actual experience with the passage of time.

Approximately 1.1 million restricted stock units were granted during the three months ended June 30, 2006 and were outstanding at June 30, 2006. At June 30, 2006, the weighted-average remaining contractual term on the Company’s restricted stock units was 2.9 years.

The weighted-average grant-date fair value of stock options and of restricted stock units granted during the three months and nine months ended June 30, 2006 was $6.52 for stock options and  $16.00 for restricted stock untis. There were no stock options exercised during the three months ended June 30, 2006. As of June 30, 2006, there was approximately $17.8 million of unrecognized compensation cost related to non-vested share-based compensation arrangements granted under the 2006 Plan; that cost is to be recognized over the three year period during which they vest.

Note 7.   Borrowing Arrangements

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

 

 

June 30,
2006

 

September 30,
2005

 

 

 

(dollars in millions)

 

2005 Mueller Credit Agreement

 

$

795.7

 

 

$

 

 

10% senior subordinated notes(1)

 

331.7

 

 

 

 

143¤4% senior discount notes(2)

 

174.2

 

 

 

 

Capital lease obligations

 

2.4

 

 

 

 

 

 

1,304.0

 

 

 

 

Less current portion

 

(171.7

)

 

 

 

 

 

$

1,132.3

 

 

$

 

 


       (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 June 30, 2006, the unamortized fair value adjustment was $16.7 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 June 30, 2006 the unamortized fair value adjustment was $32.5 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

17




Agreement is a secured obligation of Group and substantially all of its wholly-owned domestic subsidiaries. The 2005 Mueller Term Loan requires quarterly principal payments of $2.0 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. As of June 30, 2006, the weighted average interest rate including interest rate swaps was 7.2% and the weighted average interest rate excluding interest rate swaps was 7.5%.

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.

An amendment to the 2005 Mueller Credit Agreement made in January 2006 provides that in the event of an initial public offering, Group may pay annual dividends of up to $8.5 million to the Company to pay its common shareholders.

On June 1, 2006, the Company used $246.0 million of the $429.3 million in proceeds from the Company’s IPO for a partial redemption of the outstanding 2005 Mueller Term Loan. A $4.1 million portion of the deferred financing fees related to the 2005 Mueller Term Loan was written off to interest expense as a result of this transaction during the three months ended June 30, 2006. In addition to this transaction, the Company paid $1.0 million of the outstanding 2005 Mueller Term Loan during the three months ended June 30, 2006.

10% Senior Subordinated Notes:   In 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. The effective interest rate was 8.0% as of the June 30, 2006 market value of the the notes.

On July 3, 2006, the Company used $123.1 million of the $429.3 million in proceeds from the Company’s IPO for a partial redemption of $116.1 million of the senior subordinated notes, plus accrued interest of $1.8 million. The Company will record a $2.5 million charge to interest expense for the write-off of deferred financing fees.

143¤4% Senior Discount Notes:   In 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. The effective interest rate was 10.6% as of the June 30, 2006 market value of the notes.

On July 3, 2006, the Company used $60.2 million of the proceeds from its IPO for a partial redemption of $61.0 million of the senior discount notes. The Company will record a $1.0 million charge to interest expense for the write-off of deferred financing fees.

18




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 8 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.

Note 8.   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 gain from its interest rate swap contracts, net of tax, of $5.3 million at June 30, 2006 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 an intercompany loan and 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 fluctuations is in Canada. Gains and losses on the forward foreign currency exchange contracts are expected to be offset by losses / gains on identified underlying foreign currency exchange transactions. As of June 30, 2006, the Company had entered into forward foreign currency exchange contracts at a notional amount of $8.7 million to protect anticipated inventory purchases over the next three months by its Canadian operations. With these hedges, the Company purchases U.S. dollars and sells Canadian dollars at an average exchange rate of $0.885.

19




The Company has also entered into hedges protecting the Company from currency fluctuations from its Canadian-denominated intercompany loan. The hedges have a notional value of $37.3 million and mature over the next three years. With these hedges, the Company sells Canadian dollars for U.S. dollars at an exchange rate of $0.8681. Gains or losses on these hedges will be recorded in earnings. The loss on the hedges for the three months and nine months ended June 30, 2006 was $1.6 million and $1.6 million, respectively.

Note 9.   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. On October 3, 2005, the intercompany note to Walter of $443.6 million was forgiven and contributed to capital. Intercompany interest expense was zero and $4.9 million for the three months ended June 30, 2006 and 2005, respectively, and was zero and $15.9 million for the nine months ended June 30, 2006 and 2005, respectively.

Note 10.   Pension and Other Postretirement Benefits

The components of net periodic benefit cost for pension and postretirement benefits for the three months and nine months ended June 30, 2006 and 2005 are as follows:

 

 

Pension Benefits

 

Other Benefits

 

 

 

For the three months
ended June 30,

 

For the three months
ended June 30,

 

 

 

    2006    

 

   2005   

 

    2006    

 

   2005   

 

 

 

(dollars in millions)

 

Components of net periodic benefit cost:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Service cost

 

 

$

2.0

 

 

 

$

1.3

 

 

 

$

0.1

 

 

 

$

0.1

 

 

Interest cost

 

 

4.7

 

 

 

3.1

 

 

 

0.4

 

 

 

0.3

 

 

Expected return on plan assets

 

 

(4.9

)

 

 

(3.5

)

 

 

 

 

 

 

 

Amortization of prior service cost

 

 

 

 

 

0.1

 

 

 

(0.7

)

 

 

(0.6

)

 

Amortization of net loss (gain)

 

 

1.2

 

 

 

0.8

 

 

 

(0.3

)

 

 

(0.2

)

 

Curtailment and termination benefits loss (gain)

 

 

0.1

 

 

 

 

 

 

(0.6

)

 

 

 

 

Net periodic benefit cost

 

 

$

3.1

 

 

 

$

1.8

 

 

 

$

(1.1

)

 

 

$

(0.4

)

 

 

 

 

Pension Benefits

 

Other Benefits

 

 

 

For the nine months
ended June 30,

 

For the nine months
ended June 30,

 

 

 

    2006    

 

   2005   

 

    2006    

 

   2005    

 

 

 

(dollars in millions)

 

Components of net periodic benefit cost:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Service cost

 

 

$

5.9

 

 

 

$

3.7

 

 

 

$

0.5

 

 

 

$

0.3

 

 

Interest cost

 

 

14.1

 

 

 

9.4

 

 

 

1.0

 

 

 

1.0

 

 

Expected return on plan assets

 

 

(14.7

)

 

 

(10.1

)

 

 

 

 

 

 

 

Amortization of prior service cost

 

 

0.2

 

 

 

0.3

 

 

 

(1.9

)

 

 

(1.9

)

 

Amortization of net loss (gain)

 

 

3.5

 

 

 

2.4

 

 

 

(0.7

)

 

 

(0.6

)

 

Curtailment and termination benefits loss (gain)

 

 

5.0

 

 

 

 

 

 

(1.7

)

 

 

0.3

 

 

Net periodic benefit cost

 

 

$

14.0

 

 

 

$

5.7

 

 

 

$

(2.8

)

 

 

$

(0.9

)

 

 

The curtailment and termination benefits loss (gain) shown in the schedule above are related to the closure of the U.S. Pipe Chattanooga, Tennessee plant as described in Note 4. These components of net periodic benefit cost for pension and postretirement plans were charged to restructuring expense in the statement of operations.

20




For the three months and nine months ended June 30, 2006, the Company had contributions to its pension plans of $2.9 million. The Company anticipates contributing approximately $5.3 million to fund its pension plans in fiscal 2006 and may make further discretionary payments.

Note 11.   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:

 

 

June 30, 2006

 

 

 

Cost

 

Accumulated
Amortization

 

 

 

(dollars in millions)

 

Definite-lived intangible assets

 

 

 

 

 

 

 

Technology

 

$

63.0

 

 

$

4.9

 

 

Customer relationships

 

397.6

 

 

16.1

 

 

 

 

460.6

 

 

21.0

 

 

Indefinite-lived intangible assets

 

 

 

 

 

 

 

Trade name and trademarks

 

403.0

 

 

 

 

 

 

$

863.6

 

 

$

21.0

 

 

 

Identifiable intangible assets, net, were $842.6 million at June 30, 2006, compared to zero at September 30, 2005. The increase primarily represents the allocation of purchase price of the Acquisition of $855.9 million as of October 3, 2005. During the three months ended March 31, 2006, there was an addition of $6.7 million of technology intangibles related to the acquisition of CCNE, L.L.C. in January 2006. During the three months ended June 30, 2006 there was an adjustment to the purchase price allocation of the Acquisition to increase customer relationships by $1.0 million and decrease goodwill by the same amount. Amortization expense was $7.4 million and $21.0 million for the three and nine months ended June 30, 2006, respectively.

Goodwill was $860.7 million at June 30, 2006, compared to $58.4 million at September 30, 2005. The following adjustments have been recorded during the nine months ended June 30, 2006:

(dollars in millions)

 

 

 

 

 

Balance at September 30, 2005

 

 

$

58.4

 

 

Allocation of the purchase price of Predecessor Mueller, as adjusted

 

 

799.8

 

 

Final working capital and cash adjustments to the purchase price of Predecessor Mueller

 

 

(10.5

)

 

Acquisition of Hunt Industries

 

 

6.8

 

 

Restructuring items allocated to goodwill for plant closures identified prior to the Acquisition

 

 

6.2

 

 

Balance at June 30, 2006

 

 

$

860.7

 

 

 

Goodwill is expected to increase as the Company implements facility rationalizations that were formally identified prior to the Acquisition up to, and no later than, October 3, 2006. Certain facility

21




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 are not reflected as a component of goodwill.

Note 12.   Supplementary Balance Sheet Information

Selected supplementary balance sheet information is presented below:

 

 

June 30,
2006

 

September 30,
2005

 

 

 

(dollars in millions)

 

Inventories

 

 

 

 

 

 

 

 

 

Purchased materials and manufactured parts

 

 

$

75.8

 

 

 

$

30.6

 

 

Work in process

 

 

119.0

 

 

 

15.5

 

 

Finished goods

 

 

271.4

 

 

 

101.1

 

 

 

 

 

$

466.2

 

 

 

$

147.2

 

 

 

 

 

June 30,
2006

 

September 30,
2005

 

 

 

(dollars in millions)

 

Property, plant and equipment

 

 

 

 

 

 

 

Land

 

$

25.6

 

 

$

11.3

 

 

Buildings

 

89.0

 

 

33.8

 

 

Machinery and equipment

 

534.1

 

 

401.7

 

 

Other

 

39.7

 

 

16.2

 

 

Accumulated depreciation

 

(350.2

)

 

(313.8

)

 

 

 

$

338.2

 

 

$

149.2

 

 

 

 

 

June 30,
2006

 

September 30,
2005

 

 

 

(dollars in millions)

 

Accrued expenses and other current liabilities

 

 

 

 

 

 

 

 

 

Vacations and holidays

 

 

$

14.7

 

 

 

$

4.5

 

 

Workers’ compensation and comprehensive liability

 

 

6.4

 

 

 

2.9

 

 

Accrued payroll and bonus

 

 

17.3

 

 

 

3.9

 

 

Accrued sales commissions

 

 

4.3

 

 

 

1.0

 

 

Accrued other taxes

 

 

6.2

 

 

 

2.1

 

 

Accrued warranty claims

 

 

4.1

 

 

 

4.7

 

 

Accrued environmental claims

 

 

3.4

 

 

 

4.0

 

 

Accrued income taxes payable (receivable)

 

 

(7.0

)

 

 

5.5

 

 

Accrued cash discounts and rebates

 

 

18.5

 

 

 

4.8

 

 

Accrued interest

 

 

11.1

 

 

 

 

 

Other

 

 

27.0

 

 

 

1.3

 

 

 

 

 

$

106.0

 

 

 

$

34.7

 

 

 

 

22




Note 13.   Supplementary Income Statement Information

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

 

 

Three months ended

 

Nine months ended

 

 

 

June 30,
2006

 

June 30,
2005

 

June 30,
2006

 

June 30,
2005

 

 

 

(dollars in millions)

 

Interest expense, net of interest income:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest expense

 

 

$

28.9

 

 

 

$

 

 

 

$

87.5

 

 

 

$

0.3

 

 

Deferred financing fee amortization

 

 

1.2

 

 

 

 

 

 

3.7

 

 

 

 

 

Write off of bridge loan commitment fees

 

 

 

 

 

 

 

 

2.5

 

 

 

 

 

Write off of deferred financing fees

 

 

4.1

 

 

 

 

 

 

4.1

 

 

 

 

 

Interest rate swap gains

 

 

 

 

 

 

 

 

(0.5

)

 

 

 

 

Total interest expense

 

 

34.2

 

 

 

 

 

 

97.3

 

 

 

0.3

 

 

Interest income

 

 

(2.3

)

 

 

 

 

 

(3.1

)

 

 

 

 

Total interest expense, net of interest income

 

 

$

31.9

 

 

 

$

 

 

 

$

94.2

 

 

 

$

0.3

 

 

 

The bridge loan commitment fees represent fees paid to lenders to make available to the Company a bridge loan commitment to repurchase the 143¤4% 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. 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.

On June 1, 2006, Group used $246.0 million of the proceeds from the Company’s initial public offering to prepay a portion of the outstanding 2005 Mueller Term Loan. A $4.1 million portion of the deferred financing fees related to the 2005 Mueller Term Loan was written off as a result of this transaction during the three months ended June 30, 2006.

Note 14.   Net Income (Loss) Per Share

A reconciliation of the basic and diluted net income (loss) per share computations for the three and nine months ended June 30, 2006 and 2005 are as follows (in millions, except per share data):

 

 

For the three months ended June 30,

 

 

 

2006

 

2005

 

 

 

Basic

 

Diluted

 

Basic

 

Diluted

 

Numerator:

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

38.8

 

 

$

38.8

 

 

$

3.6

 

 

$

3.6

 

 

Denominator:

 

 

 

 

 

 

 

 

 

 

 

 

 

Average number of common shares outstanding

 

95.3

 

 

95.3

 

 

85.8

 

 

85.8

 

 

Effect of dilutive securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

Stock options and restricted stock units(a)

 

 

 

 

 

 

 

 

 

 

 

95.3

 

 

95.3

 

 

85.8

 

 

85.8

 

 

Net income per share

 

$

0.41

 

 

$

0.41

 

 

$

0.04

 

 

$

0.04

 

 

 

23




 

 

 

For the nine months ended June 30,

 

 

 

2006

 

2005

 

 

 

Basic

 

Diluted

 

Basic

 

Diluted

 

Numerator:

 

 

 

 

 

 

 

 

 

Net loss

 

$

(11.8

)

$

(11.8

)

$

(7.1

)

$

(7.1

)

Denominator:

 

 

 

 

 

 

 

 

 

Average number of common shares outstanding

 

89.0

 

89.0

 

85.8

 

85.8

 

Effect of dilutive securities:

 

 

 

 

 

 

 

 

 

Stock options and restricted stock units(a)

 

 

 

 

 

 

 

89.0

 

89.0

 

85.8

 

85.8

 

Net loss per share

 

$

(0.13

)

$

(0.13

)

$

(0.08

)

$

(0.08

)


        (a) Represents the number of shares of common stock issuable on the exercise of dilutive employee stock options and restricted stock units less the number of shares of common stock, which could have been purchased with the proceeds from the exercise of such awards. These purchases were assumed to have been made at the higher of either the market price of the common stock at the end of the period or the average market price for the period.

Note 15.   Segment Information

Prior to the Acquisition on October 3, 2005, the Company had one segment—U.S. Pipe. As of June 30, 2006, 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. The determination of segment earnings does not reflect allocations of certain corporate expenses not directly attributable to segment operations and intersegment eliminations, which is designated 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. Costs allocated by Walter to the Company are recorded in the determination of U.S. Pipe’s operating income. 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 the Company’s 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 recorded by U.S. Pipe and Corporate and are reflected in the Company’s consolidated SG&A expenses.

24




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

 

 

Three months ended
June 30,

 

Nine months ended
June 30,

 

 

 

   2006   

 

    2005    

 

2006

 

2005

 

 

 

(dollars in millions)

 

Net sales:

 

 

 

 

 

 

 

 

 

 

 

 

 

Mueller

 

 

$

225.5

 

 

 

$

 

 

$

599.0

 

$

 

U.S. Pipe

 

 

143.8

 

 

 

162.0

 

 

434.6

 

427.8

 

Anvil

 

 

136.5

 

 

 

 

 

396.7

 

 

Consolidating eliminations

 

 

(5.8

)

 

 

 

 

(15.0

)

 

Consolidated

 

 

$

500.0

 

 

 

$

162.0