UNITED STATES

 

SECURITIES AND EXCHANGE COMMISSION

 

Washington, D.C. 20549

 

FORM 10-Q

 

ý		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 26, 2004.
o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

Commission File Number 333-116590

 

MUELLER HOLDINGS (N.A.), INC.

(Exact name of registrant as specified in its charter)

 

Delaware		52-2175259
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer identification No.)
500 West Eldorado St. Decatur, IL  62522-1808
(Address of principal executive offices)

 

(217) 423-4471

(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 o   No.ý.

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the

Exchange Act.)  Yes o No ý

 

 

 

MUELLER HOLDINGS (N.A.), INC.

REPORT ON FORM 10-Q FOR THE QUARTERLY PERIOD ENDED JUNE 26, 2004

TABLE OF CONTENTS

 

	PART I – FINANCIAL INFORMATION
	Item 1.  Unaudited Financial Statements
		Condensed Consolidated Balance Sheets
		Condensed Consolidated Statements of Operations
		Condensed Consolidated Statements of Cash Flows
		Notes to Condensed Consolidated Financial Statements
	Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations
	Item 3.  Quantitative and Qualitative Disclosures About Market Risk
	Item 4.  Controls and Procedures
	PART II – OTHER INFORMATION
	Item 6.  Exhibits
	Signatures

 

2

 

PART I.  FINANCIAL INFORMATION

ITEM 1.  FINANCIAL STATEMENTS

 

MUELLER HOLDINGS (N.A.), INC.

UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS

 

		September 30, 2003			June 26, 2004
		(unaudited)
		(dollars in millions)
Assets
Cash and cash equivalents		$	71.4		$	23.3
Receivables, less allowance for doubtful accounts of $4.9 in September 2003 and $4.4 in June 2004		137.3			155.5
Inventories		240.5			260.6
Deferred income taxes		5.6			7.3
Prepaid expenses and other current assets		29.8			25.9
Total current assets		484.6			472.6
Property, plant and equipment, net		208.4			192.8
Goodwill, net		163.2			163.2
Identifiable intangibles, net		63.0			57.7
Pension intangible		0.9			0.9
Deferred financing fees, net		12.0			37.3
Deferred income taxes		18.3			26.2
Other noncurrent assets		0.2			0.3
Total assets		$	950.6		$	951.0
Liabilities
Accounts payable		$	46.7		$	55.6
Current portion of long-term debt		6.2			2.4
Accrued expenses and other current liabilities		69.2			69.2
Total current liabilities		122.1			127.2
Long-term debt, net of current portion		569.5			1,039.1
Accrued pension liability		32.2			36.6
Other long-term liabilities		17.2			6.8
Total liabilities		741.0			1,209.7
Commitments and contingencies (Note 10)		—			—
Redeemable preferred stock		96.6			—
Redeemable common stock		2.6			0.1
Shareholders’ equity
Common stock:
Class A, $0.01 par value (400,000,000 shares authorized and 131,208,998 issued)		1.1			1.3
Class B, $0.01 par value, convertible, non-voting (150,000,000 shares authorized and 89,343,699 shares issued)		0.9			0.9
Additional paid-in capital		142.3			—
Retained deficit		(10.6		)	(240.3		)
Accumulated other comprehensive loss		(20.5		)	(20.7		)
Shareholder loans, including interest receivable		(2.8		)	—
Total shareholders’ equity		110.4			(258.8		)
Total liabilities and shareholders’ equity		$	950.6		$	951.0

 

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

 

3

 

MUELLER HOLDINGS (N.A.), INC.

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

 

		Three months ended
		June 28, 2003			June 26, 2004
		(unaudited)
		(dollars in millions)
Net sales		$	232.4		$	288.7
Cost of sales		170.5			205.7
Gross profit		61.9			83.0
Selling, general and administrative expense		39.2			47.6
Stock compensation expense		0.2			15.5
Facility rationalization and related costs		0.2			—
Operating income		22.3			19.9
Interest expense and early repayment costs		(9.1		)	(20.8		)
Interest income		0.2			0.1
Income (loss) before income taxes		13.4			(0.8		)
Income tax expense (benefit)		5.6			(3.8		)
Net income		$	7.8		$	3.0

 

		Nine months ended
		June 28, 2003			June 26, 2004
		(unaudited)
		(dollars in millions)
Net sales		$	671.4		$	743.6
Cost of sales		495.4			533.7
Gross profit		176.0			209.9
Selling, general and administrative expense		113.9			126.6
Stock compensation expense		0.5			15.8
Facility rationalization and related costs		1.7			0.9
Operating income		59.9			66.6
Interest expense and early repayment costs		(28.3		)	(42.0		)
Interest income		0.7			0.5
Income before income taxes		32.3			25.1
Income tax expense		13.2			6.6
Net income		$	19.1		$	18.5

 

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

 

4

 

MUELLER HOLDINGS (N.A.), INC.

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

 

		Nine months ended
		June 28, 2003			June 26, 2004
		(dollars in millions)
Cash flows from operating activities
Net income		$	19.1		$	18.5
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
Depreciation		35.5			34.3
Amortization of intangibles		12.5			13.5
Amortization of deferred financing fees		2.1			2.1
Amortization of tooling		1.7			1.7
Write off of deferred financing fees		—			7.0
Deferred income taxes		4.1			(9.5		)
Stock compensation (non-cash amounts)		0.5			3.2
Asset impairment		1.4			0.1
Unrealized gain on interest rate swaps		(9.8		)	(10.4		)
Changes in assets and liabilities, net of the effects of acquisitions:
Receivables		3.7			(14.7		)
Inventories		(21.2		)	(9.9		)
Prepaid expenses and other current assets		(1.0		)	2.2
Pension, net		4.4			4.0
Accounts payable, accrued expenses and other current liabilities		(5.2		)	5.5
Accrued royalty expense		(13.5		)	—
Other, net		(1.2		)	2.5
Net cash provided by operating activities		33.1			50.2
Cash flows from investing activities
Purchase of property, plant and equipment		(12.6		)	(17.4		)
Loss on disposal of property, plant and equipment		0.5			0.6
Acquisition of businesses, net of cash acquired		(11.2		)	(19.8		)
Decrease in restricted cash		11.6			—
Net cash provided by (used in) investing activities		(11.7		)	(36.6		)
Cash flows from financing activities
Proceeds from short-term borrowings		—			9.2
Payment of short-term debt		—			(9.2		)
Proceeds from long-term debt		—			1,070.1
Payment of long-term debt		(2.6		)	(603.4		)
Redemption of preferred stock		—			(106.5		)
Financing of assets through capital leases		(0.8		)	(1.0		)
Payment of deferred financing fees		—			(34.5		)
Dividends paid (excluding amounts paid to optionholders)		—			(386.6		)
Contributed capital		0.7			—
Net cash used in financing activities		(2.7		)	(61.9		)
Effect of exchange rate changes on cash		10.7			0.2
Increase (decrease) in cash and cash equivalents		29.4			(48.1		)
Cash and cash equivalents
Beginning of period		20.9			71.4
End of period		$	50.3		$	23.3

 

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

 

5

 

MUELLER HOLDINGS (N.A.), INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

THREE MONTHS ENDED JUNE 28, 2003 AND JUNE 26, 2004

(UNAUDITED)

 

1.  Basis of Presentation

 

Mueller Holdings (N.A.), Inc. (“Holdings” or the “Company”) is the parent company of Mueller Group, Inc. (“Group”).  The accompanying unaudited condensed consolidated financial statements of Mueller Holdings (N.A.), Inc. have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information. Accordingly, the unaudited condensed consolidated financial statements and notes do not contain certain information included in the Company’s annual financial statements. In the opinion of management, all normal and recurring adjustments that are considered necessary for a fair presentation have been made. Operating results for the three months ended June 26, 2004 and the nine months ended June 26, 2004 are not necessarily indicative of the results that may be expected for the fiscal year ended September 30, 2004. The consolidated financial statements should be read in conjunction with the audited consolidated financial statements for the year ended September 30, 2003 as seen in our registration statement filed on Form S-4.

 

2. Segment Information

 

Our operations consist of two operating segments under SFAS No. 131, “Disclosures About Segments of an Enterprise and Related Information”:  Mueller Co. and Anvil.  The operating segments are organized around differences in products and are consistent with how the operating entities are being managed, how resources are being allocated, and information used by the chief operating decision maker.  Mueller Co. products consist primarily of hydrants, water and gas valves and related products used in water, power and gas distribution.  Anvil products consist primarily of pipe fittings and couplings, pipe nipples and hangers and purchased products related to piping systems used in a variety of applications.

 

The accounting policies of both of the segments are the same as those described in Note 3.  Intersegment sales and transfers are made at established intersegment selling prices generally intended to cover costs.  Our determination of segment earnings does not reflect allocations of certain corporate expenses not attributable to segment operations and intersegment eliminations, which we designate as Corporate in the segment presentation, and is before interest expense, interest income and income taxes.  Corporate expenses include costs related to financial and administrative matters, treasury, risk management, human resources, legal counsel, and tax functions.  Corporate assets include items booked at the date of the Company’s inception such as step-up on fixed assets and non-compete agreements with the predecessor parent company, as well as intellectual property.  These assets and any related depreciation or amortization expense have not been pushed down to Mueller Co. and Anvil.  Therefore, segment earnings are not reflective of results on a stand-alone basis.

 

The Company evaluates segment performance based on EBITDA.  EBITDA is defined as income (loss) before cumulative effect of accounting change plus income tax expense, interest expense (not net of interest income), depreciation and amortization expense.

 

6

 

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

 

		Three months ended June 26, 2004			Three months ended June 28, 2003			Nine months ended June 26, 2004			Nine months ended June 28, 2003
		(dollars in millions)
Net Sales:
Mueller Co.		$	172.4		$	136.0		$	432.7		$	384.2
Anvil		116.3			96.4			310.9			287.2
Consolidated		288.7			232.4			743.6			671.4
Intersegment sales:
Mueller Co.		4.1			3.2			10.1			9.6
Anvil		0.2			0.1			0.5			0.4
Consolidated		4.3			3.3			10.6			10.0
EBITDA:
Mueller Co.		45.2			32.9			111.4			94.0
Anvil		10.8			9.0			28.8			23.5
Corporate		(19.7		)	(2.6		)	(23.6		)	(7.2		)
Consolidated		36.3			39.3			116.6			110.3
Depreciation and amortization:
Mueller Co.		5.7			6.3			17.9			18.2
Anvil		4.3			4.2			12.7			12.5
Corporate		6.3			6.3			18.9			19.0
Consolidated		16.3			16.8			49.5			49.7
Impairment charges:
Mueller Co.		—			0.1			—			1.0
Anvil		—			0.1			0.1			0.4
Corporate		—			—			—			—
Consolidated		—			0.2			0.1			1.4
Capital expenditures:
Mueller Co.		3.1			2.9			9.3			7.8
Anvil		3.3			1.5			8.1			4.8
Corporate		—			—			—			—
Consolidated		6.4			4.4			17.4			12.6

 

7

 

		At June 26, 2004			At September 30, 2003
Total assets:
Mueller Co.		$	505.7		$	498.9
Anvil		301.7			273.2
Corporate		143.6			178.5
Consolidated		951.0			950.6
Goodwill:
Mueller Co.		149.1			149.2
Anvil		14.1			14.0
Consolidated		163.2			163.2
Identifiable intangibles:
Mueller Co.		6.6			5.7
Anvil		7.5			1.6
Corporate		43.6			55.7
Consolidated		57.7			63.0

 

We present EBITDA because we consider it an important supplemental measure of our performance.  A reconciliation of consolidated EBITDA to consolidated income before income taxes follows:

 

		Three months ended June 26, 2004			Three months ended June 28, 2003			Nine Months ended June 26, 2004			Nine Months ended June 28, 2003
		(dollars in millions)
Total consolidated EBITDA		$	36.3		$	39.3		$	116.6		$	110.3
Interest expense and early repayment costs		(20.8		)	(9.1		)	(42.0		)	(28.3		)
Depreciation and amortization		(16.3		)	(16.8		)	(49.5		)	(49.7		)
Income (loss) before income taxes		$	(0.8	)	$	13.4		$	25.1		$	32.3

 

Geographical area information with respect to net sales, as determined by the location of the customer invoiced, and property, plant and equipment – net, as determined by the physical location of the assets, were as follows for the nine months ended June 26, 2004 and June 28, 2003:

 

		Nine months ended June 26, 2004			Nine months ended June 28, 2003
		(dollars in millions)
Net sales:
United States		$	618.6		$	562.7
Canada		116.7			98.7
Other Countries		8.3			10.0
		$	743.6		$	671.4

 

8

 

		At June 26, 2004			At September 30, 2003
Property, plant and equipment, net:
United States		$	180.1		$	195.1
Canada		11.4			12.4
Other Countries		1.3			0.9
		$	192.8		$	208.4

 

3.  Summary of Significant Accounting Policies

 

Fiscal Year - -The Company’s fiscal year ends on September 30. The Company’s third quarter ends on the Saturday preceding June 30.

 

Inventory - -Inventories are recorded at the lower of cost (first-in, first-out) or market value. Additionally, the Company evaluates its inventory reserves in terms of excess and obsolete exposures. This evaluation includes such factors as anticipated usage, inventory turnover, inventory levels and ultimate product sales value. As such, these factors may change over time causing the reserve level to adjust accordingly.

 

Goodwill, Intangible Assets and Other Assets -In accordance with SFAS No. 142, “Goodwill and Other Intangible Assets” the Company no longer amortizes goodwill, but instead tests it for impairment at least annually. In addition, the Company no longer amortizes indefinite lived intangibles, such as tradenames, but instead tests these assets for impairment in accordance with the standard until their lives are determined to no longer be indefinite. Recognized intangible assets that have definite lives are amortized over their respective estimated useful lives.

 

Identifiable intangible assets consist of the following:

 

		September 30, 2003						June 26, 2004
		Gross Carrying Amount			Accumulated Amortization			Gross Carrying Amount			Accumulated Amortization
		(dollars in millions)
Amortized intangible assets
Non-compete agreements		$	82.9		$	67.2		$	84.7		$	80.0
Patents		0.5			0.1			0.5			0.1
Design and engineering drawing rights		2.9			0.6			7.3			0.9
Customer relationships		2.0			0.1			4.0			0.5
		88.3			68.0			96.5			81.5
Indefinite-lived intangible assets
Tradenames		42.7			—			42.7			—
		$	131.0		$	68.0		$	139.2		$	81.5

 

9

 

Aggregated amortization expense for the nine months ended June 28, 2003 and June 26, 2004 was $12.5 million and $13.5 million, respectively. Estimated amortization for the years ending September 30, 2004, 2005, 2006, 2007 and 2008 is $15.0 million, $1.2 million, $1.0 million, $0.4 million and $0.4 million, respectively.  The $13.8 million decrease from 2004 to 2005 is due to a non-compete agreement becoming fully amortized in August 2004.

 

The changes in various amortizable intangible assets’ gross carrying amount for the nine months ended June 26, 2004 relate primarily to acquisitions (see Note 4).

 

Deferred Financing Fees — Deferred costs of debt financing included in other non-current assets are amortized over the life of the related debt agreements, which range from one to eight 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”.  During the quarter ended June 26, 2004, the Company entered into a new senior credit facility and issued new notes, as described in Note 6.  These transactions resulted in recording $34.5 million of new deferred financing fees, and because the new credit facility represented a partial extinguishment of the former credit facility, a write-off of $6.6 million of existing deferred financing fees.

 

Warranty Costs - -The Company accrues for the estimated cost of product warranties at the time of sale based on historical experience. Adjustments to obligations for warranties are made as changes in the obligations become reasonably estimable. The following table summarizes information concerning the Company’s product warranty:

 

		Three months Ended June 26, 2004			Nine months Ended June 26, 2004
		(dollars in millions)
Beginning balance		$	0.9		$	0.9
Accruals for warranties		2.0			4.5
Settlement of warranty claims		(0.9		)	(3.4		)
Accrual at June 26, 2004		$	2.0		$	2.0

 

Income Taxes - -The Company’s current estimated effective tax rate for fiscal 2004 is 40 percent, excluding discrete items. Discrete third quarter events which include the conclusion of the federal tax examination, the conclusion of certain state tax examinations and expiration of certain state statutes of limitation allowed the Company to adjust tax accruals by approximately $6.4 million.  Additional third quarter financing is expected to inhibit the Company’s ability to realize deferred tax assets related to Foreign Tax Credits. Therefore, the Company has recorded a full valuation allowance against such assets equal to $0.5 million.  Additionally, a deduction of Foreign Tax Credits of approximately $2.3 million was claimed in the third quarter, reducing the previously expected benefit by $1.4 million.

 

A reconciliation of tax expense at the current estimated effective tax rate of 40% to the total recorded income tax expense for the quarter and nine months ended June 26, 2004 is as follows:

 

10

 

		Three months Ended June 26, 2004			Nine months Ended June 26, 2004
		(dollars in millions)
Tax expense at current estimated effective rate		$	0.3		$	10.7
Adjustment of tax accruals for conclusion of examinations and expiration of certain state statutes		(6.4		)	(6.4		)
Deduction of Foreign Tax Credits		1.4			1.4
Creation of valuation allowance related to Foreign Tax Credits		0.5			0.5
Other, including the effect on prior period deferred tax balances of change in effective rate		0.4			0.4
Tax expense (benefit) for period ended June 26, 2004		$	(3.8	)	$	6.6

 

Comprehensive Income -The Company’s comprehensive income for the three and the nine months ended June 26, 2004 consisted of foreign currency adjustments of $(1.1) million and $0.2 million, respectively, and minimum pension liability adjustments of $(0.4) million for both periods.

 

Related Party Transactions -In April 2004, the Company paid Credit Suisse First Boston, LLC (“CSFB”), an affiliate of the DLJ Merchant Banking funds (a principal stockholder of Mueller Holdings (N.A.), Inc.), fees and expenses of $24.5 million in connection with the arrangement and syndication of our senior credit facility, the arrangement as sole lead bookrunning manager for our Second Priority Senior Secured Floating Rate notes due 2011, our 10% Senior Subordinated Notes due 2012 and our Senior Discount Notes due 2014.  The Company also paid CSFB a management fee of $0.1 million for each of the three month periods ended June 28, 2003 and June 26, 2004.

 

Stock-Based Compensation -The Company accounts for its stock-based compensation plan under Accounting Principles Board Opinion No. 25 (“APB No. 25”), “Accounting for Stock Issued to Employees,” which requires recognizing compensation costs based upon the intrinsic value of the equity instrument at the grant date. The FASB issued SFAS No. 123, “Accounting for Stock-Based Compensation,” which encourages companies to recognize compensation costs based upon the fair value of the equity instrument at the grant date. However, SFAS No. 123 allows companies to continue to apply the provisions of APB No. 25 and make pro forma disclosures assuming a hypothetical fair value application. The Company has adopted the pro forma disclosure provisions of SFAS No. 123.

 

The Company recognizes compensation cost for stock-based compensation arrangements equal to the difference, if any, between the quoted market price of the stock option and the exercise price at the date of the grant in accordance with the provisions of APB No. 25. All options granted under the Management Incentive Plan were issued at quoted market prices at the date of grant.

 

The following table illustrates the effect on net income if the Company had applied the fair value recognition provisions of SFAS No. 123, “Accounting for Stock-Based Compensation,” as amended by SFAS No. 148 “Accounting for Stock-Based Compensation -Transition and Disclosure,” to stock-based employee compensation.

 

11

 

		Three months ended June 28, 2003			Three months ended June 26, 2004			Nine months ended June 28,2003			Nine months ended June 26, 2004
		(dollars in millions)
Net income, as reported		$	7.8		$	3.0		$	19.1		$	18.5
Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects		(0.1		)	——			(0.3		)	(0.2		)
Pro forma net income		$	7.7		$	3.0		$	18.8		$	18.3

 

Use of Estimates -The preparation of financial statements in accordance with accounting principles generally accepted in the United States of America requires management to make extensive use of certain estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reported periods. Significant estimates in these financial statements include allowances for doubtful accounts receivable, estimates of future cash flows associated with assets, asset impairments, useful lives for depreciation and amortization, loss contingencies, net realizable value of inventories, income taxes and tax valuation reserves and the determination of discount and other rate assumptions for pension and post-retirement employee benefit expenses. Actual results could differ from those estimates.

 

4. Acquisitions

 

Effective January 15, 2004, the Company acquired certain assets of STAR Pipe, Inc. (“STAR”).  The acquisition is being accounted for in accordance with SFAS No. 141 and the operating results have been included in the consolidated results since the date of acquisition.  STAR is a leading distributor of foreign-sourced cast and grooved fittings and couplings.  The STAR acquisition provides an entry into the foreign-sourced product marketplace.  The acquisition’s purchase price is $17 million, and was paid in cash.

 

The following summary presents the preliminary estimated fair values of the assets and liabilities assumed as of January 15, 2004:

 

(dollars in millions)

 

Current assets		$	13.5
Property, plant & equipment		0.4
Intangible assets		6.7
Total assets		$	20.6
Current liabilities		3.6
Net assets acquired		$	17.0

 

As part of the acquisition, the Company has agreed to a future payment to be made to the seller to the extent that the gross profit of the acquired business exceeds a targeted gross profit.  The maximum potential deferred payment amount is $23 million.  Management currently estimates the

 

12

 

deferred payment could total approximately $11 to $13 million for the deferred payment period which begins February 1, 2004 and ends January 31, 2007.  The deferred payment amount indicated above is based on management’s best estimate, but the actual adjustment could be materially different.  The liability for such deferred payment will be recorded at the end of each deferred payment period, in accordance with the purchase agreement.

 

The final purchase price allocation is subject to completion of certain asset valuations, which the Company is in the process of finalizing.  The preliminary allocation of purchase price could change based upon completion of these valuations.  Additionally, to the extent the fair value of assets acquired exceeds purchase price, a deferred credit will be recorded as the purchase agreement contains a provision for future contingent consideration (deferred payment).

 

The preliminary intangible assets acquired include trademarks, customer relationships and a non-compete agreement with the former owners.  These intangibles are being amortized over their estimated useful lives of ten years, three years and five years, respectively.

 

Also effective January 15, 2004, the Company acquired certain assets of Modern Molded Products (“Modern Molded”).  The acquisition is being accounted for in accordance with SFAS No. 141 and the operating results have been included in the consolidated results since the date of acquisition.  The purchase of the assets and technology of Modern Molded will allow the company to internally produce parts that we previously purchased.  The acquisition will allow the Company to reduce spending as well as to increase product supply line predictability. The acquisition’s purchase price is $2.8 million and was paid in cash.

 

The following summary presents the preliminary estimated fair values of the assets and liabilities assumed as of January 15, 2004:

 

(dollars in millions)

 

Current assets		$	0.2
Property, plant & equipment		0.7
Intangible assets		1.9
Net assets acquired		$	2.8

 

The intangible assets acquired include a non-compete agreement with the former owners and purchased technology.  These intangibles are being amortized over their estimated useful lives of five years.

 

The following unaudited pro forma summary presents the consolidated results of operations for the quarter and nine months ended June 28, 2003 and June 26, 2004 as if the acquisitions of STAR and Modern Molded had occurred as of October 1, 2002:

 

		Three months ended						Nine months ended
		June 28, 2003			June 26, 2004			June 28, 2003			June 26, 2004
		(dollars in millions)
Net Sales		$	238.5		$	288.7		$	688.4		$	751.2
Net income		8.2			3.0			20.0			18.8

 

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The unaudited consolidated pro forma information is not necessarily indicative of the combined results that would have occurred had the acquisitions occurred on that date, nor is it indicative of the results that may occur in the future.

 

5.  New Accounting Pronouncements

 

In April 2003, the Financial Accounting Standards Board (FASB) issued SFAS No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities.” SFAS No. 149 amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts (collectively referred to as derivatives) and for hedging activities under SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities.” SFAS No. 149 is effective for contracts entered into or modified after June 30, 2003, except for certain hedging relationships designated after June 30, 2003. The adoption of this statement did not have any impact on the Company’s financial condition or results of operations.

 

On December 24, 2003, the FASB issued a revision to Staff Interpretation (FIN) No. 46 (revised 2003), which clarified some of the provisions of the original Interpretation No. 46 “Consolidation of Variable Interest Entities,” and exempted certain entities from its requirements. The application of revised FIN 46 is required in financial statements of public entities that have interests in variable interest entities commonly referred to as special-purpose entities for periods ending after December 15, 2003. Application by public entities, other than small business entities, for all other types of entities is required in financial statements for periods ending March 15, 2004. The Company does not believe the revised FIN No. 46 will have a material effect on its financial condition or results of operations and the Company will provide the disclosures, where appropriate, as provided for in revised FIN No. 46.  At June 26, 2004 the Company did not have any entities that would be considered variable interest entities.

 

On December 23, 2003, the FASB issued SFAS No. 132 (revised 2003), “Employers’ Disclosures about Pensions and Other Postretirement Benefits.” SFAS No. 132 retains the disclosures required by the original Statement No. 132, which standardized the disclosure requirements for pensions and other postretirement benefits to the extent practicable and required additional information on changes in the benefit obligations and fair values of plan assets. Additional disclosures have been added in response to concerns expressed by users of financial statements. Those disclosures include information describing the types of plan assets, investment strategy, measurement date(s), plan obligations, cash flows, and components of net periodic benefit cost recognized during interim periods. The provisions of Statement 132 remain in effect until the provisions of the revised Statement 132 are adopted. This revised Statement is effective for financial statements with fiscal years ending after December 15, 2003. The interim-period disclosures required by this revised Statement are effective for interim periods beginning after December 15, 2003. The Company has provided the additional required disclosure information.

 

On December 17, 2003, the Securities and Exchange Commission (SEC) issued Staff Accounting Bulletin No. 104 (SAB 104), Revenue Recognition, which supercedes SAB 101, Revenue Recognition in Financial Statements. SAB 104’s primary purpose is to rescind accounting guidance contained in SAB 101 related to multiple element revenue arrangements, superceded as a result of the issuance of Emerging Issues Task Force (EITF) 00-21, “Accounting for Revenue Arrangements with Multiple Deliverables.” Additionally, SAB 104 rescinds the SEC’s Revenue

 

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Recognition in Financial Statements Frequently Asked Questions and Answers issued with SAB 101 that had been codified in SEC Topic 13, Revenue Recognition. The adoption of this bulletin did not have an impact on the Company’s financial condition or results of operations.

 

In May 2003, the FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments With Characteristics of Both Liabilities and Equity.” SFAS 150 establishes standards for how a company classifies and measures certain financial instruments with characteristics of both liabilities and equity. It requires that a company classify a financial instrument that is within its scope as a liability (or an asset in some circumstances). As discussed in Note 7, Holdings issued 16% Senior Exchangeable Preferred Stock in connection with the formation of the Company which would be subject to SFAS 150 for the fiscal year beginning October 1, 2004.  The preferred stock was redeemed by Holdings on April 23, 2004 (see Note 6).  Therefore, the adoption of this statement will not have any impact on the Company’s financial condition or result of operations.

 

6.  Borrowing Arrangements and Recapitalization

 

Long-Term Debt:

 

		September 30, 2003			June 26 2004
		(dollars in millions)
Credit facility
Term loans		$	523.4		$	515.0
Senior subordinated notes		50.0			—
Second Priority Senior Secured Notes		—			100.0
10% Senior Subordinated Notes		—			315.0
14 ¾% Senior discount notes (1)		—			109.0
Capital lease obligations		2.3			2.5
		575.7			1,041.5
Less current portion		(6.2		)	(2.4		)
		$	569.5		$	1,039.1

(1) The accreted value of the notes is reduced by $3.7 million to reflect the fair market value assigned to the warrants sold as units with the notes.  The fair market value assigned to the warrants is reflected in stockholders’ equity.

 

A schedule of debt maturities as of June 26, 2004 is as follows:

 

		Less than 1 year			1 -3 years			4 - 5 years			After 5 years			Total
		(dollars in millions)
Term loans		$	1.4		$	10.9		$	10.9		$	491.8		$	515.0
Second Priority Senior Secured Notes		—			—			—			100.0			100.0
10% Senior Subordinated Notes		—			—			—			315.0			315.0
14 ¾% Senior Discount Notes		—			—			—			109.0			109.0
Capital lease obligations		1.0			1.5			—			—			2.5
Total debt maturities		$	2.4		$	12.4		$	10.9		$	906.8		$	1,041.5

 

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Recapitalization and refinancing

 

At April 23, 2004 Group completed a refinancing of existing term loans, issuance of $415 million of new notes and payment of a dividend to Holdings.  Existing ownership of the Company was unchanged as a result of these transactions.  The transactions are described further as follows:

 

Second Priority Senior Secured Floating Rate Notes:  Group issued $100 million of such notes.  Interest on the secured notes is payable at a rate equal to the three-month reserve-adjusted London-interbank offered rate, or LIBOR, which is reset quarterly, plus 4.75% on February 1, May 1, August 1 and November 1 of each year, beginning on August 1, 2004.  The interest rate for the first interest period ending August 1, 2004 was 5.89% per annum.  The secured notes mature in 2011 and are guaranteed by each of the existing domestic restricted subsidiaries and secured by second-priority liens on the assets securing the senior credit facility (other than certain subsidiary stock and assets of Holdings). The secured notes contain customary covenants and events of default, including covenants that limit Group’s ability to incur debt, pay dividends and make investments and also include a maintenance covenant limiting Group’s senior total leverage as a multiple of EBITDA, as defined in the indenture.

 

10% Senior Subordinated Notes:  Group issued $315 million of such notes.  Interest on the subordinated notes is payable at an annual rate of 10% on May 1 and November 1 of each year, beginning on November 1, 2004.  The subordinated notes mature in 2012 and 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.

 

Senior Credit Facility:  Group entered into a new senior credit facility, which includes a $545 million amortizing term loan maturing seven years after closing and an $80.0 million revolving credit facility that will terminate five years after closing. The revolving credit facility and/or the term loan facility are expected to be subject to a potential, although uncommitted, increase of up to an aggregate of $50.0 million at Group’s request at any time prior to maturity. In addition, although uncommitted, a foreign currency sub-facility may be made available to one or more of Group’s restricted foreign subsidiaries in an aggregate principal amount of up to the U.S. dollar equivalent of $30.0 million. This increase and the additional foreign currency sub-facility will only be available if one or more financial institutions agree to provide them.

 

Borrowings under the senior credit facility are generally expected to bear interest based on a margin over, at Group’s option, the base rate or LIBOR. The applicable margin is 3.25% over LIBOR and 2.00% over the base rate for borrowings under the revolving senior credit facility and 3.25% over LIBOR and 2.00% over the base rate for term loans. Beginning at a time set forth in the senior credit facility, the applicable margin for revolving credit loans varies based upon the ratio of consolidated debt to EBITDA, as defined in the senior credit facility. Group’s obligations under the senior credit facility are guaranteed by Holdings and all of Group’s existing or future domestic restricted subsidiaries and is secured by substantially all of the assets of Group and its subsidiary guarantors, including a pledge of the capital stock of all Group’s existing and future domestic subsidiaries, a pledge of no more than 65.0% of the voting stock of any of Group’s foreign subsidiaries, a pledge of all intercompany indebtedness in favor of Group and its domestic restricted subsidiaries, and a

 

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pledge of Group’s capital stock by Holdings. The senior credit facility contains customary covenants, including covenants that limit Group’s ability to incur debt and liens, pay dividends and make investments and capital expenditures, and events of default.

 

Senior Discount Notes:  At April 29, 2004, Holdings issued 223,000 units, each consisting of $1,000 principal amount at maturity of 14¾% Senior Discount Notes due 2014 and one warrant to purchase 109.80889 shares of Class A common stock, par value $0.01 per share, of the Company. After the separation date, the notes and the warrants are separately transferable.  The notes are the Company’s senior unsecured obligations and rank equally with all of its existing and future senior indebtedness. The notes are effectively subordinated to all of its existing and future secured debt and to all indebtedness and other liabilities of its subsidiaries, including Group.  The Company used the proceeds to pay an additional dividend to its equityholders.

 

At June 26, 2004, Group and Holdings were in compliance with all restrictive covenants.

 

Use of proceeds from recapitalization and refinancing

 

The Company used the net proceeds from these offerings and the credit facility borrowings to repay all existing loans under Group’s existing credit facility together with accrued interest and a 1.0% prepayment premium thereon and to pay a dividend to our equityholders, which was used to (i) redeem the preferred stock at a price equal to liquidation preference ($105.5 million at April 23, 2004) plus a 1.0% premium thereon, (ii) pay a dividend to its common stockholders of $1.91 per share, or approximately $386.6 million in the aggregate and (iii) make a payment to its employee optionholders of the excess of the per share dividend to our common stockholders over the exercise price of their options, or $12.6 million in the aggregate. Group retained approximately $10.0 million of proceeds from its offerings to be used for general corporate purposes.

 

Senior Subordinated Debt -The senior subordinated debt at September 30, 2003 consisted of promissory notes with a principal amount of $50.0 million. A majority of these notes were owned or held by an owner of the Company. These notes accrued interest at a rate of 14.0% per annum, payable semi-annually.

 

On November 14, 2003, Group redeemed the notes in full, along with accrued and unpaid interest of $0.3 million and early redemption penalty of $7.0 million. Additionally, $0.4 million of deferred financing fees were written off.

 

Interest Rate Swap - Group has entered into interest rate swap agreements in order to reduce interest rate risks and manage interest expense. As of June 26, 2004, a notional principal amount of $150 million in swap agreements is still outstanding and scheduled to mature between July 2004 and July 2005. The swap agreements effectively convert floating-rate debt into fixed-rate debt and carry an average fixed interest rate of 7.55% at June 26, 2004. Interest differentials to be paid or received because of swap agreements are reflected as an adjustment to interest expense over the related debt period. While Group is exposed to credit loss on its interest rate swaps in the event of non-performance by the counterparties to such swaps, management believes such nonperformance is unlikely to occur given the financial resources of the counterparties.

 

Distributions to Holdings – Holdings 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 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

 

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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 currently Holdings’ only direct subsidiary.  However, the terms of Group’s borrowing arrangements significantly restrict its ability to pay dividends to Holdings.

 

7. Shareholders’ Equity

 

A summary of the changes in the components of Shareholders’ Equity since September 30, 2003 is as follows:

		Class A Common Stock		Class B Common Stock		Add’l Paid-In Capital		Retained Deficit		Accum. Other Compre- hensive Loss		Shareholder Loans		Total		Redeem- able Preferred Stock		Redeem- able Common Stock
		(dollars in millions)
Balance at September 30, 2003		1.1		0.9		142.3		(10.6	)	(20.5	)	(2.8	)	110.4		96.6		2.6
Issuance of stock		0.2				(0.2	)							—
Employee stock compensation						15.8								15.8
Fair market value of warrants						3.7								3.7
Accretion of redeemable preferred stock						(9.9	)							(9.9	)	9.9
Retirement of preferred stock														—		(106.5	)
Interest on shareholder loans												(0.2	)	(0.2	)			(0.2	)
Repayment of shareholder loans, including interest								(6.2	)			3.0		(3.2	)			3.2
Dividends paid						(151.7	)	(242.0	)					(393.7	)			(5.5	)
Net income								18.5						18.5
Change in foreign currency translation adjustment										0.2				0.2
Additional minimum pension liability, net of tax										(0.4	)			(0.4	)
Balance at June 26, 2004		1.3		0.9		—		(240.3	)	(20.7	)	—		(258.8	)	—		0.1

 

As of June 26, 2004, there were 131,208,998 shares of Class A common stock and 89,343,699 shares of Class B common stock outstanding.

 

8. Redeemable Preferred Stock

 

Redeemable Preferred Stock -In connection with the Company’s formation in 1999, Holdings issued two million shares of 16% Senior Exchangeable Preferred Stock, due August 15, 2010, par value $0.01 per share (“preferred stock”). The preferred stock bears dividends at a rate of 16% per annum, which dividends will accrue or be payable in cash, at Holdings’ option until August 2006 and must be paid in cash thereafter when and if declared by Holdings’ board out of funds legally available therefor. The liquidation value on any future date is the sum of $25 per share plus the dividend accretion since issuance.

 

Upon a change of control or upon the payment by the Company of certain types of restricted payments, including payment of dividends on the common stock of the Company, the preferred stock is subject to redemption at the holder’s option at 101% of its liquidation preference. Additionally, the stock is subject to mandatory redemption for cash in August 2010 out of funds legally available therefor. Group’s credit facility imposes restrictions upon its ability to make distributions to the Company. A failure by the Company to pay dividends or redeem such stock

 

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when required or a breach of certain covenants would entitle the holders to two directors on the Company’s board.

 

The Company may at its option redeem the preferred stock at the following liquidation values:

 

Year beginning August 15,		Percentage liquidation value
2004		108.000	%
2005		105.333	%
2006		102.667	%
2007 and thereafter		100.000	%

 

The preferred stock, in certain circumstances, is exchangeable at the option of the Company for 16% Senior Subordinated Exchange Debentures due 2010.

 

The accretion of dividends of $1.9 million and $9.9 million for the three months and the nine months ended June 26, 2004, respectively, was accounted for as a non-cash transaction.  The accretion reduces the net income available to common shareholders.  As described in Note 6, the preferred stock was redeemed by the Company on April 23, 2004.

 

Redeemable Common Stock – Group has entered into an employment agreement with Dale Smith, Group’s president and Chief Executive Officer.  This agreement, in certain circumstances, gives Mr. Smith the right to sell to the Company, at a price equal to the fair market value of his equity interests as of the date of such sale or purchase, his shares of common stock.  The Company has classified an amount representing the initial fair value of the redeemable shares of common stock owned by Mr. Smith outside of permanent equity. At September 30, 2003 and June 26, 2004 there were 5.5 million Class A common shares outstanding.  Shareholder loans and interest receivable associated with these shares at September 30, 2003 were approximately $3.2 million.  The loans and all related interest receivable were paid in full by Mr. Smith, in connection with the recapitalization of the Company during the third quarter of 2004.  Therefore, there were no loans and interest outstanding at June 26, 2004.  These shares of common stock have not been marked-to-market as the circumstances that would give rise to Mr. Smith’s right to sell, and the Company’s obligation to purchase Mr. Smith’s shares of common stock , are considered remote currently.

 

9.  Derivative Instruments

 

Changes in the fair value of derivatives are recorded each period in earnings or Accumulated Other Comprehensive Income (Loss), depending on whether a derivative is designated and effective as part of a hedge transaction and, if it is, the type of hedge transaction. Any gains and losses on derivative instruments that are reported in Accumulated Other Comprehensive Income (Loss) are included in earnings in the periods in which earnings are affected by the hedged item. All gains or losses on interest rate swaps since the adoption of SFAS No. 133 have been included in earnings and have not been included in Accumulated Other Comprehensive Income (Loss) as the Company has not treated these instruments as hedges under SFAS 133.

 

For a derivative to qualify as a hedge at inception and throughout the hedge period, the Company must formally document the nature and relationships between the hedging instruments and hedged items, as well as its risk-management objectives, strategies for undertaking the various hedge transactions and method of assessing hedge effectiveness. Any financial instruments

 

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qualifying for hedge accounting must maintain a specified level of effectiveness between the hedging instrument and the item being hedged, both at inception and throughout the hedged period.

 

Interest Rate Swaps -At June 26, 2004 and September 30, 2003 the fair value of interest rate swaps was a liability of $6.8 million and $17.2 million, respectively, and has been recorded in Other Long-Term Liabilities on the Consolidated Balance Sheets.

 

10.  Commitments and Contingencies

 

The Company is subject to retention on certain contracts, with the retention portion of the amount receivable paid upon project completion.

 

In the normal course of business, the Company incurs claims with respect to product liability. Such claims are insured up to certain limits, with such policies containing certain self-insured retention limits. Prior to August 1999, product liability and environmental claims that occurred are subject to indemnification by Tyco, based on the provisions of the acquisition agreement.

 

Workers compensation claims are self-insured by the Company to the extent of stop loss coverage per claim. The claim liability is recorded based on an actuarially determined estimate of the present value of the obligation outstanding at year-end. The recorded reserve at September 30, 2003 and June 26, 2004 was approximately $7.2 million and $8.0 million, respectively.

 

The Company is subject to warranty claims related to sales of water meters that can be read remotely by hand-held or drive-by electronic readers. Radio transmitters purchased from one of its third party vendors have demonstrated a high failure rate and actions to correct the issue have been only partially effective. To date, the third party vendor has taken financial responsibility with respect to this matter and the Company has incurred insignificant costs. However, should the third party vendor be unable to correct the issue or be unable to meet its warranty obligations with respect to this matter, the Company may find it necessary to replace the third party vendors’ radio transmitters, which is not expected to exceed $3 million. The Company has estimated that it will incur costs of approximately $1 million related to the warranty claims.  The Company has accrued $1 million as of June 26, 2004.

 

Certain of our products contain lead. Environmental advocacy groups, relying on standards established by California’s Proposition 65, are seeking to eliminate or reduce the content of lead in some of our products offered for sale in California. In certain cases, we have entered into settlement agreements with these environmental advocacy groups to modify our products or offer substitutes. The Company may incur additional costs to implement the provisions under these settlement agreements. Further, similar issues may be raised by other advocacy groups in other jurisdictions under Proposition 65.

 

The Company expects to incur costs at its steel and iron foundries to comply with the United States Environmental Protection Agency’s National Emissions Standards for Hazardous Air Pollutants which were issued April 22, 2004.  The Company is in the process of performing an analysis to assess the impact of these standards on the financial results of the Company.

 

James Jones Company and its former parent company are defendants in a false claims lawsuit in which a former James Jones Company employee is suing on behalf of cities, water districts and municipalities. The employee alleges that the defendants sold allegedly non-conforming public water system parts to various government entities. The lawsuit seeks

 

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consequential damages, penalties and punitive damages. Mueller Co., which had also been named as a defendant, brought a summary judgment motion and was dismissed from this litigation in January 2004. Any liability associated with the lawsuit is covered by an indemnification from our previous owner.

 

On March 31, 2004, Anvil International entered into a consent order with the Georgia Department of Natural Resources regarding various alleged hazardous waste violations at Anvil’s formerly operated Statesboro, Georgia site. Pursuant to the consent order, Anvil has agreed to pay a settlement amount of $100,000, comprised of a $50,000 monetary fine and $50,000 towards a supplemental environmental project. Anvil has also agreed to perform various investigatory and remedial actions at the site and its landfill. While the ultimate investigatory and remedial costs are currently unknown, the total costs are estimated to be between $0.3 million and $0.5 million.  The Company has accrued $0.3 million as of June 26, 2004.

 

In the opinion of management, accruals associated with contingencies incurred in the normal course of business are sufficient. Resolution of existing known contingencies is not expected to significantly affect the Company’s financial position and result of operations.

 

11. Net Periodic Benefit Cost – Defined Benefit Plans

 

For a detailed disclosure on the Company’s pension and employee benefits plans, please refer to Note 11 of the Company’s Audited Consolidated Financial Statements for the year ended September 30, 2003, as found in our registration statement filed on Form S-4 (File No. 333-116590).

 

The following sets forth the components of net periodic benefit cost of the domestic non-contributory defined benefit plans for the three months and the nine months ended June 26, 2004:

 

		Three months ended June 26, 2004			Nine months ended June 26, 2004
		(dollars in millions)
Service cost		$	0.5		$	1.5
Interest cost		1.4			4.2
Expected return (loss) on plan assets		(1.1		)	(3.4		)
Amortization of loss		0.6			2.0
Net periodic cost		$	1.4		$	4.3

 

Employer Contributions

 

As of June 26, 2004, no contributions have been made and there are no anticipated statutory funding requirements for the remainder of 2004.

 

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