Mueller Industries - 10-Q quarterly report FY2014 Q1

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(Unaudited)

 

 

 

MUELLER INDUSTRIES, INC.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Unaudited)

 

 

MUELLER INDUSTRIES, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited)

 

MUELLER INDUSTRIES, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

 

MUELLER INDUSTRIES, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

General

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.  

Note 1 – Earnings per Common Share

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.

On February 21, 2014, the Company’s Board of Directors announced a two-for-one stock split of its common stock effected in the form of a stock dividend of one share for each outstanding share.  The record date for the stock split was March 14, 2014, and the additional shares were distributed on March 28, 2014.  Accordingly, all references to share and per share amounts presented in the Condensed Consolidated Financial Statements and this Quarterly Report on Form 10-Q have been adjusted retroactively to reflect the stock split.

Note 2 – Commitments and Contingencies

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.

  United States Department of Commerce Antidumping Review

 

On December 24, 2008, the United States Department of Commerce (DOC) initiated an antidumping administrative review of the antidumping duty order covering circular welded non-alloy steel pipe and tube from Mexico to determine the final antidumping duties owed on U.S. imports during the period November 1, 2007 through October 31, 2008, by certain subsidiaries of the Company.  On April 19, 2010, the DOC published the final results of this review and assigned Mueller Comercial de Mexico, S. de R.L. de C.V. (Mueller Comercial) an antidumping duty rate of 48.3 percent.  The Company appealed the final determination to the U.S. Court of International Trade (CIT).  The Company and the United States have reached an agreement to settle the appeal.  As a result, the DOC published on March 22, 2013 the amended final results of the review and assigned Mueller Comercial an antidumping duty rate of 40.5 percent.  U.S. Customs and Border Protection has assessed antidumping duties on subject imports during the period of review.  As of March 29, 2014, Mueller Comercial has complied with all requests for payment of duties related to this review period.

On December 23, 2009, the DOC initiated an antidumping administrative review of the antidumping duty order covering circular welded non-alloy steel pipe and tube from Mexico for the November 1, 2008  through October 31, 2009 period of review.  The DOC selected Mueller Comercial as a respondent in the review.  On June 21, 2011, the DOC published the final results of the review and assigned Mueller Comercial an antidumping duty rate of 19.8 percent.  On August 22, 2011, the Company appealed the final results to the CIT.  On December 21, 2012, the CIT issued a decision upholding the Department’s final results in part.  The CIT issued its final judgment on May 2, 2013.  On May 6, 2013, the Company appealed the CIT decision to the U.S. Court of Appeals for the Federal Circuit (Federal Circuit). On January 10, 2014, the Federal Circuit held oral arguments in the appeal.  The Company anticipates that certain of its subsidiaries will incur antidumping duties on subject imports made during the period of review and, as such, established a reserve of approximately $1.1 million for this matter.

 

Subsequent to October 31, 2009, Mueller Comercial did not ship subject merchandise to the United States.  Therefore, there is zero antidumping duty liability for periods of review after October 31, 2009.

 

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 March 29, 2014 were $7.5 million.

Note 3 – Inventories

Note 4 – Industry Segments

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 primarily in Europe.  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 also includes 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.  For the quarter ended March 29, 2014, cost of goods sold included a decrease in accruals related to import duties of $3.1 million.

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:

 

Note 6 – 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 (income) cost are as follows:

Note 7 – Income Taxes

The Company’s effective tax rate for the first quarter of 2014 was 33 percent compared with 34 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 quarter of 2014 were reductions related to the U.S. production activities deduction of $1.2 million and decreases in valuation allowances of $0.9 million. These items were partially offset by the provision for state income taxes, net of the federal benefit, of $1.3 million.

For the first quarter of 2013, the difference between the effective tax rate and what would be computed using the U.S. federal statutory tax rate was attributable to reductions for: (i) the U.S. production activities deduction of $1.2 million; (ii) decreases in valuation allowances of $0.5 million; and (iii) the effect of foreign tax rates lower than statutory tax rates and other foreign adjustments of $0.3 million. These items were partially offset by the provision for state income taxes, net of the federal benefit, of $1.1 million.

Total unrecognized tax benefits, including derecognized deferred tax assets, at the end of the first quarter of 2014 were $2.8 million.  It is reasonably possible that this amount may decrease by the full amount over the next twelve months, none of which will impact the effective tax rate.

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 and is open for certain state and foreign returns for earlier tax years due to ongoing audits and differing statute periods.  The Internal Revenue Service has audited the 2010 federal income tax return, the results of which were immaterial to the consolidated financial statements, and is currently auditing the 2012 federal income tax return.  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.

 

Note 8 – Derivative Instruments and Hedging Activities

Cash Flow Hedges

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.   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 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, Derivatives and Hedging (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 twelve months, the Company will reclassify into earnings realized gains or losses of cash flow hedges; at March 29, 2014, this amount was approximately a $664 thousand loss.

At March 29, 2014, the Company held open futures contracts to purchase approximately $34.9 million of copper over the next 16 months related to fixed price sales orders.  The fair value of those futures contracts was a $664 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 commodity contract derivative instruments classified as cash flow hedges:

Inventory Fair Value Hedges

The Company may enter into futures contracts to protect the value of inventory against market fluctuations.   These futures contracts have been designated as fair value hedges.  For fair value hedges, the changes in value of the hedging derivative, as well as the changes in value of the related hedged item due to the risk being hedged, are reflected in current earnings.  Hedge ineffectiveness is reflected in current earnings in the period in which it occurs.

 

At March 29, 2014, the Company held open futures contracts to sell approximately $5.2 million of copper over the next six months related to copper inventory. The fair value of those futures contracts was a $294 thousand gain position, which was determined by obtaining quoted market prices (Level 1 hierarchy as defined by ASC 820).  During the fourth quarter of 2013, the Company dedesignated previous hedges on its inventory because the hedging relationship was no longer deemed to be highly effective.  These contracts no longer qualified as hedging instruments as of December 28, 2013.

 

Derivative commodity instruments are reflected in the Condensed Consolidated Financial Statements as follows:

 

Gains and losses related to the change in the value of the commodity contracts, the change in the value of the inventory being hedged, and hedge ineffectiveness are recorded in cost of goods sold. During the first quarter of 2014 and 2013, gains of $0.5 million and $0.4 million, respectively, were recorded. Also, as a result of the Company’s dedesignation of previous hedges on its inventory during the fourth quarter of 2013, a net gain of $1.5 million was recorded in current earnings to record these contracts at fair value during the first quarter of 2014.

 

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

 

Foreign Currency 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.  The fair value of open contracts are recognized as a component of OCI until the position is closed which corresponds to the period when the related hedged transaction is recognized in the Company’s Condensed Consolidated Financial Statements.  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 OCI into earnings.  

At March 29, 2014, the Company held open forward contracts to purchase approximately 6.8 million euros over the next 12 months.  The fair value of these contracts, which was determined by obtaining quoted market prices (Level 1 hierarchy as defined by ASC 820), was a $571 thousand gain position recorded in other current assets at March 29, 2014, and an $836 thousand gain position recorded in other current assets at December 28, 2013.

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

 

 

Interest Rate Swap

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 offset 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 $0.9 million gain position and was recorded in other assets at March 29, 2014.

The following table summarizes activities related to the interest rate swap agreement derivative instruments classified as a cash flow hedge:

The Company enters into futures 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 March 29, 2014 was not material to the Condensed Consolidated Statements of Income.

The Company does not offset fair value of amounts for derivative instruments and fair value amounts recognized for the right to reclaim cash collateral.  At March 29, 2014, the Company had recorded restricted cash of $0.8 million related to open futures contracts.

 

Note 9 – Accumulated Other Comprehensive 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:

 

Note 10 – Acquisitions

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.  Yorkshire produces European standard copper distribution tubes.  This transaction received regulatory approval in the United Kingdom on February 11, 2014 and closed on February 28, 2014.  The purchase price was approximately $30.1 million, paid in cash.  The acquisition of Yorkshire complements the Company’s existing copper tube businesses in the Plumbing and Refrigeration segment.  In 2012, Yorkshire had annual revenue of approximately $196.1 million.  The estimated fair value of the assets acquired totaled $21.1 million, consisting primarily of inventories of $17.6 million, property, plant, and equipment of $2.5 million, and other current assets of $1.0 million.  The estimated fair value of the liabilities assumed totaled $15.6 million, consisting primarily of accounts payable and accrued expenses of $15.2 million and other current liabilities of $0.4 million.  Of the remaining purchase price, $24.6 million was allocated to tax-deductible goodwill.  The allocation of the purchase price to long-lived assets is provisional as of March 29, 2014 and subject to change upon completion of the final valuation of these assets.  The results of operations for Yorkshire have been included in the accompanying Condensed Consolidated Financial Statements from the acquisition date.

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 for approximately $55.3 million in cash, net of working capital adjustments.  Howell manufactures copper tube and line sets for U.S. distribution.  The acquisition of Howell complements the Company’s copper tube and line sets businesses, both components of the Plumbing and Refrigeration segment.   For the twelve months ended August 31, 2013, Howell’s net sales for copper tube and line sets totaled $156.3 million.  During the first quarter of 2014, the purchase price allocation, including all fair value measurements, was finalized.  The fair value of the assets acquired totaled $63.0 million, consisting primarily of receivables of $14.6 million, inventories of $27.6 million, property, plant, and equipment of $20.3 million, and other current assets of $0.5 million.  The fair value of the liabilities assumed totaled $11.4 million, consisting primarily of accounts payable and accrued expenses of $9.9 million and other current liabilities of $1.5 million.  Of the remaining purchase price, $2.3 million was allocated to other intangible assets and $1.4 million to tax-deductible goodwill.  The results of operations for Howell have been included in the accompanying Condensed Consolidated Financial Statements from the acquisition date of October 17, 2013.

Note 11 – Recently Issued Accounting Standards

In December 2011, the FASB issued ASU No. 2011-11, Balance Sheet (Topic 210) (ASU 2011-11). The amendments in this ASU require improved disclosure information about financial instruments and derivative instruments that are either offset or subject to an enforceable master netting arrangement or similar agreement.  Subsequently in January 2013, the FASB issued ASU 2013-01, Clarifying the Scope of Disclosures about Offsetting Assets and Liabilities (ASU 2013-01), which clarifies the types of instruments and transactions that are subject to the offsetting disclosure requirements established by ASU 2011-11. These ASUs should be applied retrospectively for all comparative periods presented for annual periods beginning on or after January 1, 2013 and interim periods within those annual periods. The requirements of these ASUs were adopted during the first quarter of 2014 and did not have a significant impact on our disclosures.