Mueller Industries - 10-Q quarterly report FY2013 Q3

 

 

 

 

Certain information and footnote disclosures normally included in annual financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted.  Results of operations for the interim periods presented are not necessarily indicative of results which may be expected for any other interim period or for the year as a whole.  This Quarterly Report on Form 10-Q should be read in conjunction with the Company’s Annual Report on Form 10-K, including the annual financial statements incorporated therein.

The accompanying unaudited interim financial statements include all normal recurring adjustments which are, in the opinion of management, necessary to a fair statement of the results for the interim periods presented.

Basic per share amounts have been computed based on the average number of common shares outstanding.  Diluted per share amounts reflect the increase in average common shares outstanding that would result from the assumed exercise of outstanding stock options and vesting of restricted stock awards, computed using the treasury stock method.  Approximately 136 thousand stock based awards were excluded from the computation of diluted earnings per share for the quarter ended September 28, 2013 because they were antidilutive.

The Company is involved in certain litigation as a result of claims that arose in the ordinary course of business, which management believes will not have a material adverse effect on the Company’s financial position, results of operations, or cash flows.  The Company may also realize the benefit of certain legal claims and litigation in the future; these gain contingencies are not recognized in the Condensed Consolidated Financial Statements.

Mueller Industries, Inc., WTC Holding Company, Inc., DENO Holding Company, Inc., Mueller Europe, Limited, and DENO Acquisition EURL (the Mueller entities) have received letters from counsel for IMI plc and IMI Kynoch Limited (IMI) and from counsel for Boliden AB (Boliden) concerning contribution proceedings by IMI and Boliden against the Mueller entities regarding copper tube.  In the Competition Appeal Tribunal (the CAT) in the United Kingdom, IMI and Boliden have been served with claims by 21 claimants, all companies within the Travis Perkins Group (TP and the TP Claimants).  The TP Claimants are seeking follow-on damages arising out of conduct described in the European Commission’s September 3, 2004, decision regarding copper tube.  The claims purport to arise from the findings of the European Commission as set forth in that decision.

Mueller Industries, Inc., Mueller Europe, Limited, and WTC Holding Company, Inc. also have received a letter from counsel for IMI concerning contribution proceedings by IMI against those three Mueller entities regarding copper fittings.  In the High Court, IMI has been served with claims by 21 TP Claimants.  The TP Claimants are seeking follow-on damages arising out of conduct described in the European Commission’s September 20, 2006, decision regarding copper fittings.  The claims similarly purport to arise from the findings of the European Commission as set forth in that decision.

The letters confirm that IMI and Boliden have commenced legal proceedings against the Mueller entities, and in those proceedings are claiming a contribution for any follow-on damages.  IMI and Boliden have formally served their claims on the Mueller entities.

 

While the TP Claimants have provided their preliminary calculations of aggregate claimed damages for the copper tube claim and the copper fittings claim, Mueller does not believe these matters will have a material affect on the Condensed Consolidated Financial Statements for the contribution claims.

As to the claims arising from the Copper Tube Decision brought in the CAT, following the CAT’s grant of approval, the case has now been transferred to the High Court. Mueller’s defenses in response to the contribution claims brought by IMI and Boliden were served on March 15, 2013.  A case management conference is to be held on or about November 28, 2013.

As to the claims arising from the Copper Fittings Decision, these proceedings have been stayed until the next case management conference which is to take place on December 16, 2013.

At this time, the Company does not believe that this matter will have a material impact on its financial position, results of operations, or cash flows.

U.S.S. Lead Refinery, Inc. (Lead Refinery), a non-operating wholly owned subsidiary of Mining Remedial Recovery Company, has conducted corrective action and interim remedial activities and studies (collectively, Site Activities) at Lead Refinery’s East Chicago, Indiana site pursuant to the Resource Conservation and Recovery Act.  Site Activities, which began in December 1996, have been substantially concluded.  Lead Refinery is required to perform monitoring and maintenance activities with respect to Site Activities pursuant to a post-closure permit issued by the Indiana Department of Environmental Management effective as of March 2, 2013.  Lead Refinery spent approximately $0.1 million annually in 2012, 2011 and 2010 with respect to this site.  Approximate costs to comply with the post-closure permit, including associated general and administrative costs, are between $2.4 million and $3.6 million over the next 20 years.

On April 9, 2009, pursuant to the Comprehensive Environmental Response, Compensation, and Liability Act (CERCLA), the Environmental Protection Agency (EPA) added the Lead Refinery site, and properties surrounding the Lead Refinery site, to the National Priorities List (NPL).  The NPL is a list of priority sites where the EPA has determined that there has been a release or threatened release of hazardous substances that warrant investigation and, if appropriate, remedial action.  The NPL does not assign liability to any party including the owner or operator of a property placed on the NPL.  The placement of a site on the NPL does not necessarily mean that remedial action must be taken.  On July 17, 2009, Lead Refinery received a written notice from the EPA that the agency is of the view that Lead Refinery may be a potentially responsible party (PRP) under CERCLA in connection with the release or threat of release of hazardous substances including lead into properties surrounding the Lead Refinery site.  The EPA has identified two other PRPs in connection with the release or threat of release of hazardous substances into properties surrounding the Lead Refinery site. PRPs under CERCLA include current and former owners and operators of a site, persons who arranged for disposal or treatment of hazardous substances at a site, or persons who accepted hazardous substances for transport to a site.  In November 2012, the EPA adopted a remedy in connection with properties surrounding the Lead Refinery site.  The EPA has estimated that the cost to implement the November 2012 remedy will be $29.9 million.

 

Other

Guarantees, in the form of letters of credit, are issued by the Company generally to assure the payment of insurance deductibles and certain retiree health benefits.  The terms of the Company’s guarantees are generally one year but are renewable annually as required.  These letters are primarily backed by the Company’s revolving credit facility.  The maximum payments that the Company could be required to make under its guarantees at September 28, 2013, were $10.0 million.

Wynne, Arkansas Manufacturing Operation

In September 2011, a portion of the Company’s Wynne, Arkansas manufacturing operation was damaged by fire.  Certain inventories, production equipment, and building structures were extensively damaged.  During the second quarter of 2013, the Company settled the claim with its insurer for total proceeds of $127.3 million, net of the deductible of $0.5 million.  As a result of the settlement with its insurer, all proceeds received and all costs previously deferred (which were recorded as other current liabilities in prior periods) were recognized, resulting in a pre-tax gain of $106.3 million in the second quarter of 2013, or $2.33 per diluted share after tax.

Fulton, Mississippi Copper Tube Facility

In July 2009, there was an explosion at the Company’s copper tube facility in Fulton, Mississippi resulting in damage to certain production equipment.  In the first quarter of 2012, the Company settled the business interruption portion of this claim and recognized a $1.5 million gain.

 

During 2011, inventory quantities valued using the last-in, first-out (LIFO) method declined which resulted in liquidation of LIFO inventory layers.  This liquidation resulted from intercompany sales; therefore, the gain from the LIFO liquidation of approximately $8.0 million was deferred.  During the first quarter of 2012, the Company sold this inventory to third parties and recognized the gain.  This recognition resulted in a reduction of approximately $8.0 million to cost of sales, or $0.13 per diluted share after tax.

 

The Company’s reportable segments are Plumbing & Refrigeration and Original Equipment Manufacturers (OEM).  For disclosure purposes, as permitted under Accounting Standards Codification (ASC) 280, Segment Reporting, certain operating segments are aggregated into reportable segments.  The Plumbing & Refrigeration segment is composed of Standard Products (SPD), European Operations, and Mexican Operations.  The OEM segment is composed of Industrial Products (IPD), Engineered Products (EPD), and Jiangsu Mueller–Xingrong Copper Industries Limited (Mueller-Xingrong).  These segments are classified primarily by the markets for their products.  Performance of segments is generally evaluated by their operating income.  Intersegment transactions are generally conducted on an arms-length basis.

SPD manufactures copper tube and fittings, plastic fittings, plastic pipe, and line sets.  These products are manufactured in the U.S.  Outside the U.S., the Company’s European Operations manufacture copper tube, which is sold in Europe and the Middle East.  SPD also imports and resells brass and plastic plumbing valves, malleable iron fittings, faucets, and plumbing specialty products.  Mexican Operations consist of pipe nipple manufacturing and import distribution businesses including product lines of malleable iron fittings and other plumbing specialties.  The European Operations consist of copper tube manufacturing and the import distribution of fittings, valves, and plumbing specialties primarily in the U.K. and Ireland.  The Plumbing & Refrigeration segment’s products are sold primarily to plumbing, refrigeration, and air-conditioning wholesalers, hardware wholesalers and co-ops, and building product retailers.

IPD manufactures brass rod, impact extrusions, and forgings which are used in a wide variety of end products including plumbing brass, automotive components, valves, and fittings.  EPD manufactures and fabricates valves and assemblies primarily for the refrigeration, air-conditioning, and gas appliance markets and specialty copper, copper-alloy, and aluminum tubing.  Mueller-Xingrong manufactures engineered copper tube primarily for air-conditioning applications.  These products are sold primarily to original equipment manufacturers.

Summarized segment information is as follows:

 

 

Segment information (continued):

 

 

 

 

Segment information (continued):

 

On September 24, 2013, Mueller-Xingrong entered into a credit agreement (the JV Credit Agreement) with a syndicate of four banks establishing a secured RMB 450 million, or approximately $74.0 million, revolving credit facility with a maturity date of September 24, 2014.  The JV Credit Agreement replaced the previous secured RMB 350 million financing agreement that matured during the quarter.  Borrowings outstanding under the JV Credit Agreement, which were $32.0 million at September 28, 2013, are secured by the real property and equipment of Mueller-Xingrong and bear interest at the latest base-lending rate published by the People’s Bank of China, which was 5.88 percent at September 28, 2013.  The JV Credit Agreement requires lender consent for the payment of dividends.

 

 

Note 7 – Employee Benefits

The Company sponsors several qualified and nonqualified pension plans and other postretirement benefit plans for certain of its employees.  The components of net periodic benefit cost are as follows:

The Company’s effective tax rate for the third quarter of 2013 was 40 percent compared with 36 percent for the same period last year.  Factors that explain the difference between the effective tax rate and what would be computed using the U.S. federal statutory tax rate for the third quarter of 2013 were increases related to: (i) the impairment of goodwill of $1.8 million; (ii) increases in the valuation allowance of $1.0 million; (iii) the provision for state income taxes, net of federal benefit of $1.2 million; and (iv) the effect of foreign adjustments of $0.4 million.  These items were partially offset by the U.S. production activities deduction of $1.0 million.

The Company’s effective tax rate for the first nine months of 2013 was 37 percent compared with 31 percent for the same period last year.  Factors that explain the difference between the effective tax rate and what would be computed using the U.S. federal statutory tax rate for the first nine months were increases related to: (i) goodwill impairment of $1.8 million and (ii) the provision for state income taxes, net of the federal benefit, of $7.4 million.  These items were partially offset by reductions related to: (i) the effect of foreign tax rates lower than statutory tax rates and other foreign items of $1.1 million; (ii) decreases in valuation allowances of $0.4 million; and (iii) the U.S. production activities deduction of $3.9 million.

The Company’s effective tax rate for the third quarter of 2012 was 36 percent and for the first nine months of 2012 was 31 percent.  Factors that explain the difference between the effective tax rate and what would be computed using the U.S. federal statutory tax rate for the first nine months of 2012 were reductions related to: (i) the effect of foreign tax rates lower than statutory tax rates and other foreign items of $3.7 million; (ii) decreases in unrecognized tax benefits of $1.3 million; (iii) decreases in valuation allowances of $0.5 million; and (iv) the U.S. production activities deduction of $2.2 million.  These items were partially offset by the provision for state income taxes, net of the federal benefit, of $2.7 million.

 

 

Total unrecognized tax benefits, including derecognized deferred tax assets, at the end of the third quarter were $2.8 million, none of which would impact the effective tax rate, if recognized.

The Company files a consolidated U.S. federal income tax return and numerous consolidated and separate-company income tax returns in many state, local, and foreign jurisdictions.  The statute of limitations is open for the Company’s federal tax return and most state income tax returns for 2010 and all subsequent years.  The Internal Revenue Service has audited the Company’s 2009 and 2010 consolidated U.S. federal income tax returns, the results of which were immaterial to the consolidated financial statements.  The statutes of limitations for certain state and foreign returns are open for earlier tax years due to ongoing audits and differing statute periods.  While the Company believes that it is adequately reserved for possible future audit adjustments, the final resolution of these examinations cannot be determined with certainty and could result in final settlements that differ from current estimates.

Copper and brass represent the largest component of the Company’s variable costs of production.  The cost of these materials is subject to global market fluctuations caused by factors beyond the Company’s control.  The Company occasionally enters into forward fixed-price arrangements with certain customers; the risk of these arrangements is generally managed with commodity futures contracts.  The Company accounts for these futures contracts in accordance with ASC 815, Derivatives and Hedging (ASC 815).  These futures contracts have been designated as cash flow hedges.  The fair value of open futures contracts is recognized as a component of accumulated other comprehensive income (OCI) until the position is closed, which corresponds to the period when the related hedged transaction is recognized in earnings.  Should these contracts no longer meet hedge criteria in accordance with ASC 815, either through lack of effectiveness or because the hedged transaction is no longer probable of occurring, all deferred gains and losses related to the hedge would be immediately reclassified from accumulated other comprehensive income into earnings.  In the next 12 months, the Company will reclassify into earnings realized gains or losses on cash flow hedges; at September 28, 2013, the net fair value of these contracts was a $172 thousand loss position.

At September 28, 2013, the Company held open futures contracts to purchase approximately $18.5 million of copper over the next 18 months related to fixed price sales orders.  The fair value of those futures contracts was a $140 thousand loss position, which was determined by obtaining quoted market prices (Level 1 hierarchy as defined by ASC 820, Fair Value Measurements and Disclosures (ASC 820)).

Derivative instruments designated as cash flow hedges under ASC 815 are reflected in the Condensed Consolidated Financial Statements as follows:

 

 

The following tables summarize activities related to the Company’s derivative instruments classified as cash flow hedges in accordance with ASC 815:

The Company enters into futures contracts in order to protect the value of inventory against market fluctuations.  These futures contracts have been designated as fair value hedges in accordance with ASC 815.  For fair value hedges, the changes in value of the hedging instrument, as well as the changes in value of the related hedged item, are reflected in current earnings.  Hedge ineffectiveness is reflected in current earnings in the period in which it occurs.

At September 28, 2013, the Company held open futures contracts to sell approximately $61.0 million of copper over the next six months related to inventory.  The fair value of those futures contracts was a $1.2 million loss position and was recorded in other current liabilities.  The fair value was determined by obtaining quoted market prices (Level 1 hierarchy as defined by ASC 820).

Derivative instruments designated as fair value hedges under ASC 815 are reflected in the Condensed Consolidated Financial Statements as follows:

 

 

The following tables summarize the gains (losses) on the Company’s fair value hedges:

 

 

 

 

During 2012 and 2013, the Company entered into contracts to purchase heavy machinery and equipment. These contracts are denominated in euros.  In anticipation of entering into these contracts, the Company has entered into forward contracts to purchase euros to protect itself against adverse exchange rate fluctuations.  At September 28, 2013, the Company held open forward contracts to purchase approximately 13.7 million euros over the next 18 months.  The fair value of these contracts, which was determined by obtaining quoted market prices (Level 1 hierarchy as defined by ASC 820), was not material to the Company’s financial position, results of operations, or cash flows at September 28, 2013.

On February 20, 2013, the Company entered into a two-year forward-starting interest rate swap agreement with an effective date of January 12, 2015, and an underlying notional amount of $200.0 million, pursuant to which the Company receives variable interest payments based on one-month LIBOR and pays fixed interest at a rate of 1.4 percent.  Based on the Company’s current variable premium pricing on its Term Loan Facility, the all-in fixed rate on the effective date is 2.7 percent.  The interest rate swap will mature on December 11, 2017, and is structured to fix the interest rate risk associated with the Company’s floating-rate, LIBOR-based Term Loan Facility Agreement.  The swap was designated and accounted for as a cash flow hedge from inception.

The fair value of the interest rate swap is estimated based on the present value of the difference between expected cash flows calculated at the contracted interest rate and the expected cash flows at the current market interest rate using observable benchmarks for LIBOR forward rates at the end of the period (Level 2 hierarchy as defined by ASC 820).  The effective portion of the mark-to-market gain or loss is reported as a component of accumulated OCI and subsequently reclassified into earnings when the hedged transactions occur and affect earnings.  Interest payable and receivable under the swap agreement will be accrued and recorded as an adjustment to interest expense.  The fair value of the interest rate swap was a $1.0 million gain position and was recorded in other assets at September 28, 2013.

The following tables summarize the activity related to the interest rate swap:

 

The Company enters into futures and forward contracts that closely match the terms of the underlying transactions.  As a result, the ineffective portion of the open cash flow and fair value hedge contracts through September 28, 2013 was not material to the Condensed Consolidated Statements of Income.

The Company does not offset the fair value of amounts for derivative instruments and the fair value amounts recognized for the right to reclaim cash collateral.  At September 28, 2013, the Company had recorded restricted cash of $2.9 million related to open futures contracts.

 

 

On August 16, 2012, the Company acquired 100 percent of the outstanding stock of Westermeyer Industries, Inc. (Westermeyer) for approximately $11.5 million in cash.  Westermeyer, located in Bluffs, Illinois, designs, manufactures, and distributes high-pressure components and accessories for the air-conditioning and refrigeration markets.  The acquisition of Westermeyer complements the Company’s existing refrigeration business, a component of the OEM segment.  This acquisition was accounted for using the purchase method of accounting, and, as such, the results of operations for Westermeyer have been included in the accompanying Condensed Consolidated Financial Statements from the acquisition date.  The fair values of the assets acquired totaled $7.5 million, consisting of receivables of $2.0 million, inventories of $1.9 million, and property, plant, and equipment of $3.6 million.  These assets were partially offset by current liabilities of approximately $1.0 million.  Of the remaining purchase price, $2.4 million was allocated to goodwill and $2.7 million to other intangible assets.

On August 9, 2013, the Company sold certain of its plastic fittings manufacturing assets located in Portage, Michigan and Ft. Pierce, Florida.  Simultaneously, the Company entered into a lease agreement with the purchaser of the assets to continue to manufacture and distribute Schedule 40 plastic fittings utilizing the Ft. Pierce assets for a period of approximately eight to 14 months (Transition Period).  The total sales price was $66.2 million, of which $61.2 million was received on August 9, 2013; the remaining $5.0 million will be received at the end of the Transition Period.  This transaction resulted in a pre-tax gain of $39.8 million in the third quarter of 2013, or 81 cents per diluted share after tax.

The net book value of assets disposed was $15.9 million.  For goodwill testing purposes, these assets were part of the SPD reporting unit which is a component of the Company’s Plumbing & Refrigeration operating segment.  Because these assets met the definition of a business in accordance with ASC 805 Business Combinations, $10.5 million of the SPD reporting unit’s goodwill balance was allocated to the disposal group.  The amount of goodwill allocated was based on the relative fair values of the asset group which was disposed and the portion of the SPD reporting unit which was retained.

The Company will continue to manufacture and supply plastic drain, waste, and vent (“DWV”) fittings.  The Company extended its third party supply agreement to complement its product offering with purchased products the Company does not competitively manufacture with its remaining assets.  This supply agreement was originally entered into after the majority of the Company’s plastic manufacturing assets were destroyed in the 2011 fire at its Wynne, Arkansas facility.  The extended supply agreement has an initial five-year term.

With the decision to cease the Company’s manufacturing operations in Portage, there was an evaluation of the remaining long-lived assets for impairment, and it was determined that the carrying value of the land and building were no longer recoverable.  An impairment charge of $3.2 million was recognized during the third quarter of 2013 to adjust the carrying value of the land and building to their estimated fair value.  The fair value estimate was determined by obtaining and evaluating recent sales data for similar assets (Level 2 hierarchy as defined by ASC 820).

 

 

During the first quarter of 2013, the Company adopted Accounting Standards Update (ASU) No. 2013-02, Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income (ASU 2013-02). Under ASU 2013-02, an entity is required to provide information about the amounts reclassified out of accumulated OCI by component. In addition, an entity is required to present significant amounts reclassified out of accumulated OCI by the respective line items of net income.

 

Changes in accumulated OCI by component, net of taxes and noncontrolling interest, were as follows:

 

 

Reclassification adjustments out of accumulated OCI were as follows:

On October 17, 2013, the Company entered into a Stock Purchase Agreement with Commercial Metals Company and Howell Metal Company (“Howell”) providing for the purchase of all of the outstanding capital stock of Howell.  Howell manufactures copper tube and line sets for U.S. distribution.  The purchase price of $58.5 million was funded by cash on-hand.  This is subject to a customary working capital adjustment.  For the twelve months ended August 31, 2013, Howell’s net sales for copper tube and line sets were $156.3 million.

On October 18, 2013, the Company entered into a definitive agreement with KME Yorkshire Limited (“Yorkshire”) to acquire certain assets and assume certain liabilities of Yorkshire for purposes of acquiring its copper tube business.  The consummation of the transaction is subject to the receipt of regulatory approval in the United Kingdom and other customary closing conditions.  Yorkshire produces European standard copper distribution tubes.  The purchase price will be £18.0 million.  In 2012, Yorkshire had annual revenue of £119.0 million.

 

 

In December 2011, the Financial Accounting Standards Board (FASB) issued amendments to ASU 2011-11, Balance Sheet (Topic 210), Disclosures about Offsetting Assets and Liabilities.  The amendments in this update are designed to enhance disclosures by requiring improved information about financial instruments and derivative instruments that are either (a) offset in accordance with certain right to set-off conditions prescribed by current accounting guidance or (b) subject to an enforceable master netting arrangement or similar agreement, irrespective of whether they are offset in accordance with current accounting guidance. The amendments to ASU 2011-11 were effective for the first interim or annual period beginning on or after January 1, 2013. The Company does not expect the adoption of ASU 2011-11 to have a material impact on its consolidated financial position, results of operations, or cash flows.