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EX-31.1 - SECTION 302 CERTIFICATION OF THE CEO - MUELLER INDUSTRIES INCex311.htm
EX-32.2 - SECTION 906 CERTIFICATION OF THE CFO - MUELLER INDUSTRIES INCex322.htm
EX-32.1 - SECTION 906 CERTIFICATION OF THE CEO - MUELLER INDUSTRIES INCex321.htm
EX-31.2 - SECTION 302 CERTIFICATION OF THE CFO - MUELLER INDUSTRIES INCex312.htm


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.

FORM 10-Q

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

For the quarterly period ended October 1, 2016
Commission file number 1–6770


MUELLER INDUSTRIES, INC.
(Exact name of registrant as specified in its charter)

Delaware
25-0790410
(State or other jurisdiction
(I.R.S. Employer
of incorporation or organization)
Identification No.)

8285 Tournament Drive, Suite 150
 
Memphis, Tennessee
38125
(Address of principal executive offices)
(Zip Code)

(901) 753-3200
(Registrant's telephone number, including area code)

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).   Yes     x No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of "large accelerated filer", "accelerated filer", and "smaller reporting company" in Rule 12b-2 of the Exchange Act.

Large accelerated filer   
Accelerated filer   
Non-accelerated filer   
Smaller reporting company   

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

The number of shares of the Registrant's common stock outstanding as of October 24, 2016 was 57,378,695.

MUELLER INDUSTRIES, INC.

FORM 10-Q

For the Quarterly Period Ended October 1, 2016

__________________________

As used in this report, the terms "Company," "Mueller," and "Registrant" mean Mueller Industries, Inc. and its consolidated subsidiaries taken as a whole, unless the context indicates otherwise.

__________________________

INDEX


 
 
Page Number
 
 
 
 
 
 
 
 
 
 
 
 
 
 
     
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
     
 
     
 
 
 
 

 

2

 
PART I. FINANCIAL INFORMATION
Item 1.  Financial Statements

MUELLER INDUSTRIES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)

 
 
For the Quarter Ended
   
For the Nine Months Ended
 
(In thousands, except per share data)
 
October 1, 2016
   
September 26, 2015
   
October 1, 2016
   
September 26, 2015
 
 
                       
Net sales
 
$
506,584
   
$
535,184
   
$
1,583,464
   
$
1,628,019
 
 
                               
Cost of goods sold
   
424,668
     
467,167
     
1,327,370
     
1,398,366
 
Depreciation and amortization
   
9,016
     
8,749
     
26,997
     
24,790
 
Selling, general, and administrative expense
   
32,413
     
32,241
     
102,707
     
97,922
 
Asset impairments
   
3,000
     
     
3,000
     
570
 
Gain on sale of assets
   
     
     
     
(15,376
)
Severance
   
     
     
     
3,442
 
 
                               
Operating income
   
37,487
     
27,027
     
123,390
     
118,305
 
 
                               
Interest expense
   
(1,830
)
   
(1,682
)
   
(5,370
)
   
(5,977
)
Other income, net
   
120
     
164
     
880
     
534
 
 
                               
Income before income taxes
   
35,777
     
25,509
     
118,900
     
112,862
 
 
                               
Income tax expense
   
(10,837
)
   
(5,223
)
   
(38,963
)
   
(36,374
)
Income (loss) from unconsolidated affiliates, net of tax
   
1,122
     
(2,191
)
   
3,049
     
(2,191
)
 
                               
Consolidated net income
   
26,062
     
18,095
     
82,986
     
74,297
 
 
                               
Net income attributable to noncontrolling interests
   
(84
)
   
(295
)
   
(581
)
   
(868
)
 
                               
Net income attributable to Mueller Industries, Inc.
 
$
25,978
   
$
17,800
   
$
82,405
   
$
73,429
 
 
                               
Weighted average shares for basic earnings per share
   
56,631
     
56,375
     
56,536
     
56,272
 
Effect of dilutive stock-based awards
   
586
     
598
     
589
     
690
 
 
                               
Adjusted weighted average shares for diluted earnings per share
   
57,217
     
56,973
     
57,125
     
56,962
 
 
                               
Basic earnings per share
 
$
0.46
   
$
0.32
   
$
1.46
   
$
1.30
 
 
                               
Diluted earnings per share
 
$
0.45
   
$
0.31
   
$
1.44
   
$
1.29
 
 
                               
Dividends per share
 
$
0.100
   
$
0.075
   
$
0.275
   
$
0.225
 
 
                               
See accompanying notes to condensed consolidated financial statements.
 

3

 
MUELLER INDUSTRIES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited)

 
 
For the Quarter Ended
       
For the Nine Months Ended
     
(In thousands)
 
October 1,
2016
       
September 26,
 2015
       
October 1,
2016
     
September 26,
2015
     
 
         
Consolidated net income
 
$
26,062
       
$
18,095
       
$
82,986
     
$
74,297
     
 
                                             
Other comprehensive income (loss), net of tax:
                                             
Foreign currency translation
   
(4,304
)
       
(12,153
)
       
(15,601
)
     
(13,501
)
   
Net change with respect to derivative instruments and hedging activities
   
(139
)
(1
)
   
(915
)
 
(2
)
 
1,155
 
(3
)
 
(2,016
)
(4
)
Net decrease in minimum pension and postretirement obligation adjustments
   
743
 
(5
)
   
1,231
   
(6
)
 
3,445
 
(7
)
 
2,000
 
(8
)
Attributable to unconsolidated affiliates
   
5,112
 
(9
)
   
         
6,550
 
(10
)
 
     
Other, net
   
54
         
(53
)
       
77
       
(46
)
   
 
                                             
Total other comprehensive income (loss)
   
1,466
         
(11,890
)
       
(4,374
)
     
(13,563
)
   
 
                                             
Consolidated comprehensive income
   
27,528
         
6,205
         
78,612
       
60,734
     
Comprehensive (income) loss attributable to noncontrolling interests
   
(480
)
       
709
         
382
       
534
     
 
                                             
Comprehensive income attributable to Mueller Industries, Inc.
 
$
27,048
       
$
6,914
       
$
78,994
     
$
61,268
     
 
                                             
See accompanying notes to condensed consolidated financial statements.
 
 
                                             
 
                                             

_______________________________________ 
 
(1) Net of tax of $(119)
(2) Net of tax of $575
(3) Net of tax of $(606)
(4) Net of tax of $1,014
(5) Net of tax of $(255)
(6) Net of tax of $(429)
(7) Net of tax of $(1,175)
(8) Net of tax of $(715)
(9) Net of tax of $(2,888)
(10) Net of tax of $(3,700)
4

MUELLER INDUSTRIES, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)

(In thousands, except share data)
 
October 1, 2016
   
December 26, 2015
 
Assets
           
Current assets:
           
Cash and cash equivalents
 
$
297,793
   
$
274,844
 
Accounts receivable, less allowance for doubtful accounts of $554 in 2016 and $623 in 2015
   
295,672
     
251,571
 
Inventories
   
251,130
     
239,378
 
Other current assets
   
28,999
     
34,608
 
 
               
Total current assets
   
873,594
     
800,401
 
 
               
Property, plant, and equipment, net
   
289,074
     
280,224
 
Goodwill, net
   
128,004
     
120,252
 
Intangible assets, net
   
37,386
     
40,636
 
Investment in unconsolidated affiliates
   
79,199
     
65,900
 
Other assets
   
18,864
     
31,388
 
 
               
Total assets
 
$
1,426,121
   
$
1,338,801
 
 
               
Liabilities
               
Current liabilities:
               
Current portion of debt
 
$
16,907
   
$
11,760
 
Accounts payable
   
92,451
     
88,051
 
Accrued wages and other employee costs
   
34,447
     
35,636
 
Other current liabilities
   
58,395
     
73,982
 
 
               
Total current liabilities
   
202,200
     
209,429
 
 
               
Long-term debt, less current portion
   
213,847
     
204,250
 
Pension liabilities
   
14,517
     
17,449
 
Postretirement benefits other than pensions
   
17,021
     
17,427
 
Environmental reserves
   
20,708
     
20,943
 
Deferred income taxes
   
19,106
     
7,161
 
Other noncurrent liabilities
   
2,118
     
2,440
 
 
               
Total liabilities
   
489,517
     
479,099
 
 
               
Equity
               
Mueller Industries, Inc. stockholders' equity:
               
Preferred stock - $1.00 par value; shares authorized 5,000,000; none outstanding
   
     
 
Common stock - $.01 par value; shares authorized 100,000,000; issued 80,183,004; outstanding 57,378,695 in 2016 and 57,158,608 in 2015
   
802
     
802
 
Additional paid-in capital
   
271,476
     
271,158
 
Retained earnings
   
1,130,249
     
1,063,543
 
Accumulated other comprehensive loss
   
(58,401
)
   
(54,990
)
Treasury common stock, at cost
   
(450,354
)
   
(453,228
)
 
               
Total Mueller Industries, Inc. stockholders' equity
   
893,772
     
827,285
 
Noncontrolling interests
   
42,832
     
32,417
 
 
               
Total equity
   
936,604
     
859,702
 
 
               
Commitments and contingencies
   
     
 
 
               
Total liabilities and equity
 
$
1,426,121
   
$
1,338,801
 
 
               
See accompanying notes to condensed consolidated financial statements.
 

5

MUELLER INDUSTRIES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)

 
 
For the Nine Months Ended
 
(In thousands)
 
October 1, 2016
   
September 26, 2015
 
 
     
Cash flows from operating activities
           
Consolidated net income
 
$
82,986
   
$
74,297
 
Reconciliation of consolidated net income to net cash provided by operating activities:
               
Depreciation and amortization
   
27,267
     
25,132
 
Stock-based compensation expense
   
4,553
     
4,611
 
Equity in (earnings) losses of unconsolidated affiliates
   
(3,049
)
   
2,191
 
Gain on disposal of assets
   
(747
)
   
(14,875
)
Impairment charges
   
3,000
     
570
 
Deferred income taxes
   
6,491
     
(8,262
)
Income tax benefit from exercise of stock options
   
     
(953
)
Changes in assets and liabilities, net of businesses acquired:
               
Receivables
   
(45,780
)
   
5,249
 
Inventories
   
(914
)
   
29,901
 
Other assets
   
14,428
     
4,302
 
Current liabilities
   
(15,998
)
   
(27,580
)
Other liabilities
   
(2,101
)
   
740
 
Other, net
   
450
     
145
 
 
               
Net cash provided by operating activities
   
70,586
     
95,468
 
 
               
Cash flows from investing activities
               
Capital expenditures
   
(15,632
)
   
(22,502
)
Acquisition of businesses, net of cash acquired
   
(20,533
)
   
(107,405
)
Net withdrawals from restricted cash balances
   
1,177
     
1,822
 
Investment in unconsolidated affiliates
   
     
(65,900
)
Proceeds from sales of assets
   
5,301
     
5,521
 
 
               
Net cash used in investing activities
   
(29,687
)
   
(188,464
)
 
               
Cash flows from financing activities
               
Dividends paid to stockholders of Mueller Industries, Inc.
   
(15,555
)
   
(12,669
)
Dividends paid to noncontrolling interests
   
(3,765
)
   
 
Issuance of long-term debt
   
2,000
     
 
Issuance (repayment) of debt by joint ventures, net
   
5,006
     
(21,597
)
Net cash used to settle stock-based awards
   
(1,356
)
   
(718
)
Repayments of long-term debt
   
(769
)
   
(750
)
Income tax benefit from exercise of stock options
   
     
953
 
 
               
Net cash used in financing activities
   
(14,439
)
   
(34,781
)
 
               
Effect of exchange rate changes on cash
   
(3,511
)
   
(3,612
)
 
               
Increase (decrease) in cash and cash equivalents
   
22,949
     
(131,389
)
Cash and cash equivalents at the beginning of the period
   
274,844
     
352,134
 
 
               
Cash and cash equivalents at the end of the period
 
$
297,793
   
$
220,745
 
 
               
See accompanying notes to condensed consolidated financial statements.
 


6


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 for a fair presentation of the results for the interim periods presented herein.  The fiscal nine months and quarter ended October 1, 2016 contained 40 weeks and 13 weeks, respectively, while the fiscal nine months and quarter ended September 26, 2015 contained 39 weeks and 13 weeks, respectively.

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.  Approximately 218 thousand and 383 thousand stock-based awards were excluded from the computation of diluted earnings per share for the quarters ended October 1, 2016 and September 26, 2015, respectively, because they were antidilutive.

Note 2 – Acquisitions and Dispositions

Acquisitions

On April 26, 2016, the Company entered into an agreement providing for the purchase of a 60.0 percent equity interest in Jungwoo Metal Ind. Co., LTD (Jungwoo-Mueller) for approximately $20.5 million in cash.  Jungwoo-Mueller, which manufactures copper-based pipe joining products, is headquartered in Seoul, South Korea and serves markets worldwide.  It complements the Company's existing copper fittings businesses in the Piping Systems segment and is reported in the Company's Condensed Consolidated Financial Statements one month in arrears.

This acquisition was accounted for using the acquisition method of accounting whereby the total purchase price was allocated to tangible and intangible assets acquired and liabilities assumed based on respective fair values.

The fair value of the assets acquired totaled $48.8 million, consisting primarily of property, plant, and equipment of $25.9 million, inventories of $15.8 million, accounts receivable of $5.6 million, and other current assets of $1.5 million.  The fair value of the liabilities assumed totaled $17.3 million, consisting primarily of long-term debt of $8.7 million, accounts payable of $7.3 million, pension liabilities of $0.8 million, and other current liabilities of $0.5 million.  Of the remaining purchase price, $3.6 million was allocated to non-deductible goodwill.  The noncontrolling interest in Jungwoo-Mueller is $14.6 million.  The purchase price allocation is provisional as of October 1, 2016 and subject to change upon completion of the final valuation of the long-lived assets and noncontrolling interest during the measurement period.

The valuations of certain businesses acquired in 2015 were finalized during 2016.  During the second quarter of 2016, a deferred tax liability of $4.1 million was recorded that resulted from a basis difference in the long-lived assets acquired from Great Lakes Copper Ltd.  This resulted in an increase in goodwill. There were no changes to the purchase price allocations for Turbotec Products, Inc. or Sherwood Valve LLC from the amounts presented in the Company's 2015 Annual Report on Form 10-K.

7

 
Dispositions

On June 1, 2015, the Company sold certain assets.  Simultaneously, the Company entered into a lease agreement with the purchaser of the assets for their continued use for a period of approximately 22 months (Lease Period).

The total sales price was $20.2 million, of which $5.0 million was received on June 1, 2015; the Company will receive $5.0 million on December 30, 2016 and the remaining $10.2 million will be received at the end of the Lease Period, March 31, 2017.  This transaction resulted in a pre-tax gain of $15.4 million in the second quarter of 2015, or 17 cents per diluted share after tax.  This gain was recognized in the Piping Systems segment.

Note 3 –Segment Information

During the first quarter of 2016, the Company made changes to its management reporting structure as a result of a change in the way the Chief Executive Officer, who serves as the Chief Operating Decision Maker, manages and evaluates the business, makes key operating decisions, and allocates resources.  Previously, the Company had two reportable segments: Plumbing & Refrigeration and OEM.  During the first quarter, the Company realigned its operating segments into three reportable segments: Piping Systems, Industrial Metals, and Climate.  Management has recast certain prior period amounts to conform to the current period presentation. Each of the reportable segments is composed of certain operating segments that are aggregated primarily by the nature of products offered as follows:

Piping Systems

Piping Systems is composed of the following operating segments: Domestic Piping Systems Group, Canadian Operations, European Operations, Trading Group, Mueller-Xingrong (the Company's Chinese joint venture), and Jungwoo-Mueller (the Company's South Korean joint venture).  The Domestic Piping Systems Group manufactures copper tube and fittings, plastic fittings, and line sets.  These products are manufactured in the U.S. and sold in North America.   Outside the U.S., the Canadian Operations manufacture copper tube and line sets and sell the products primarily in the U.S. and Canada, and the European Operations manufacture copper tube in the U.K. which is sold primarily in Europe.  The Trading Group manufactures pipe nipples and imports and resells brass and plastic plumbing valves, malleable iron fittings, faucets, and plumbing specialty products in the U.S. and Mexico.  Mueller-Xingrong manufactures engineered copper tube primarily for air-conditioning applications in China.  Jungwoo-Mueller manufactures copper-based joining products that are sold worldwide.  The Piping Systems segment's products are sold primarily to plumbing, refrigeration, and air-conditioning wholesalers, hardware wholesalers and co-ops, building product retailers, and air-conditioning original equipment manufacturers (OEMs).
 
During the third quarter of 2016, the segment recognized impairment charges of $3.0 million on fixed assets used for  product development.   During the second quarter of 2015, the segment recognized approximately $3.4 million of severance costs related to the reorganization of Yorkshire Copper Tube, acquired in 2014.

Industrial Metals

Industrial Metals is composed of the following operating segments: Brass Rod & Copper Bar Products, Impacts & Micro Gauge, and Brass Value-Added Products.  These businesses manufacture brass rod, impact extrusions, and forgings, as well as a wide variety of end products including plumbing brass, automotive components, valves, fittings, and gas assemblies.  These products are manufactured in the U.S. and sold primarily to OEMs in the U.S., many of which are in the industrial, construction, heating, ventilation, and air-conditioning, plumbing, and refrigeration markets.

Climate

Climate is composed of the following operating segments: Refrigeration Products, Fabricated Tube Products, Westermeyer, and Turbotec.  These domestic businesses manufacture and fabricate valves and assemblies primarily for the heating, ventilation, air-conditioning, and refrigeration markets in the U.S.



8


 
Summarized segment information is as follows:

 
 
For the Quarter Ended October 1, 2016
 
(In thousands)
 
Piping Systems
   
Industrial Metals
   
Climate
   
Corporate and Eliminations
   
Total
 
 
                             
Net sales
 
$
351,557
   
$
131,350
   
$
30,003
   
$
(6,326
)
 
$
506,584
 
 
                                       
Cost of goods sold
   
301,867
     
107,512
     
22,210
     
(6,921
)
   
424,668
 
Depreciation and amortization
   
5,905
     
1,964
     
612
     
535
     
9,016
 
Selling, general, and administrative expense
   
16,647
     
3,125
     
2,357
     
10,284
     
32,413
 
Asset impairments
   
3,000
     
     
     
     
3,000
 
 
                                       
Operating income
   
24,138
     
18,749
     
4,824
     
(10,224
)
   
37,487
 
                                         
Interest expense
                                   
(1,830
)
Other income, net
                                   
120
 
                                         
Income before income taxes
                                 
$
35,777
 
 
 

 
 
 
For the Quarter Ended September 26, 2015
 
(In thousands)
 
Piping Systems
   
Industrial Metals
   
Climate
   
Corporate and Eliminations
   
Total
 
 
                             
Net sales
 
$
367,892
   
$
139,472
   
$
28,494
   
$
(674
)
 
$
535,184
 
 
                                       
Cost of goods sold
   
320,571
     
125,146
     
22,160
     
(710
)
   
467,167
 
Depreciation and amortization
   
5,430
     
2,154
     
608
     
557
     
8,749
 
Selling, general, and administrative expense
   
16,469
     
3,044
     
2,283
     
10,445
     
32,241
 
 
                                       
Operating income
   
25,422
     
9,128
     
3,443
     
(10,966
)
   
27,027
 
                                         
Interest expense
                                   
(1,682
)
Other income, net
                                   
164
 
                                         
Income before income taxes
                                 
$
25,509
 



9


Segment information (continued):

 
 
For the Nine Months Ended October 1, 2016
 
(In thousands)
 
Piping Systems
   
Industrial Metals
   
Climate
   
Corporate and Eliminations
   
Total
 
 
                             
Net sales
 
$
1,109,109
   
$
393,608
   
$
92,068
   
$
(11,321
)
 
$
1,583,464
 
 
                                       
Cost of goods sold
   
949,015
     
321,615
     
68,363
     
(11,623
)
   
1,327,370
 
Depreciation and amortization
   
17,341
     
6,219
     
1,829
     
1,608
     
26,997
 
Selling, general, and administrative expense
   
51,497
     
9,989
     
7,336
     
33,885
     
102,707
 
Asset impairments
   
3,000
     
     
     
     
3,000
 
 
                                       
Operating income
   
88,256
     
55,785
     
14,540
     
(35,191
)
   
123,390
 
                                         
Interest expense
                                   
(5,370
)
Other income, net
                                   
880
 
                                         
Income before income taxes
                                 
$
118,900
 
 

 
 
 
For the Nine Months Ended September 26, 2015
 
(In thousands)
 
Piping Systems
   
Industrial Metals
   
Climate
   
Corporate and Eliminations
   
Total
 
 
                             
Net sales
 
$
1,109,124
   
$
435,736
   
$
85,803
   
$
(2,644
)
 
$
1,628,019
 
 
                                       
Cost of goods sold
   
959,599
     
373,678
     
67,561
     
(2,472
)
   
1,398,366
 
Depreciation and amortization
   
15,952
     
5,452
     
1,647
     
1,739
     
24,790
 
Selling, general, and administrative expense
   
50,021
     
8,044
     
6,637
     
33,220
     
97,922
 
Asset impairments
   
570
     
     
     
     
570
 
Gain on sale of assets
   
(15,376
)
   
     
     
     
(15,376
)
Severance
   
3,442
     
     
     
     
3,442
 
 
                                       
Operating income
   
94,916
     
48,562
     
9,958
     
(35,131
)
   
118,305
 
                                         
Interest expense
                                   
(5,977
)
Other income, net
                                   
534
 
                                         
Income before income taxes
                                 
$
112,862
 
 

 
(In thousands)
 
October 1, 2016
   
December 26, 2015
 
 
           
Segment assets:
           
Piping Systems
 
$
855,036
   
$
811,343
 
Industrial Metals
   
160,413
     
153,102
 
Climate
   
61,713
     
61,672
 
General Corporate
   
348,959
     
312,684
 
 
               
   
$
1,426,121
   
$
1,338,801
 
 
               


10


 
Note 4 – Inventories

(In thousands)
 
October 1, 2016
   
December 26, 2015
 
       
             
Raw materials and supplies
 
$
63,915
   
$
58,987
 
Work-in-process
   
37,131
     
25,161
 
Finished goods
   
157,128
     
161,410
 
Valuation reserves
   
(7,044
)
   
(6,180
)
                 
Inventories
 
$
251,130
   
$
239,378
 

 
Note 5 – Derivative Instruments and Hedging Activities

The Company's earnings and cash flows are subject to fluctuations due to changes in commodity prices, foreign currency exchange rates, and interest rates.  The Company uses derivative instruments such as commodity futures contracts, foreign currency forward contracts, and interest rate swaps to manage these exposures.

All derivatives are recognized in the Condensed Consolidated Balance Sheets at their fair value.  On the date the derivative contract is entered into, it is either a) designated as (i) a hedge of a forecasted transaction or the variability of cash flow to be paid (cash flow hedge) or (ii) a hedge of the fair value of a recognized asset or liability (fair value hedge), or b) not designated in a hedge accounting relationship, even though the derivative contract was executed to mitigate an economic exposure, as the Company does not enter into derivative contracts for trading purposes (economic hedge).  Changes in the fair value of a derivative instrument that is qualified, designated and highly effective as a cash flow hedge are recorded in accumulated other comprehensive income (AOCI), to the extent effective, until they are reclassified to earnings in the same period or periods during which the hedged transaction affects earnings.  Changes in the fair value of a derivative that is qualified, designated and highly effective as a fair value hedge, along with the gain or loss on the hedged recognized asset or liability that is attributable to the hedged risk, are recorded in current earnings.  Changes in the fair value of undesignated derivative instruments and the ineffective portion of designated derivative instruments are reported in current earnings.

The Company documents all relationships between derivative instruments and hedged items, as well as the risk-management objective and strategy for undertaking various hedge transactions.  This process includes linking all derivative instruments that are designated as fair value hedges to specific assets and liabilities in the Condensed Consolidated Balance Sheets and linking cash flow hedges to specific forecasted transactions or variability of cash flow.

The Company also assesses, both at the hedge's inception and on an ongoing basis, whether the designated derivative instruments that are used in hedging transactions are highly effective in offsetting changes in cash flow or fair values of hedged items.  When a derivative instrument is determined not to be highly effective as a hedge or the underlying hedged transaction is no longer probable of occurring, hedge accounting is discontinued prospectively in accordance with the derecognition criteria for hedge accounting.

Commodity Futures Contracts

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.  

11

 
At October 1, 2016, the Company held open futures contracts to purchase approximately $33.1 million of copper over the next 10 months related to fixed price sales orders.  The fair value of those futures contracts was a $1.6 million net gain position, which was determined by obtaining quoted market prices (level 1 within the fair value hierarchy).  In the next 12 months, the Company will reclassify into earnings realized gains or losses relating to cash flow hedges.  At October 1, 2016, this amount was approximately $350 thousand of deferred net gains, net of tax.

The Company may also enter into futures contracts to protect the value of inventory against market fluctuations.  At October 1, 2016, the Company held open futures contracts to sell approximately $6.1 million of copper over the next six months related to copper inventory.  The fair value of those futures contracts was a $129 thousand net loss position, which was determined by obtaining quoted market prices (level 1 within the fair value hierarchy).

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 within the fair value hierarchy).  Interest payable and receivable under the swap agreement is accrued and recorded as an adjustment to interest expense.  The fair value of the interest rate swap was a $1.6 million net loss position at October 1, 2016, and there was $1.0 million of deferred losses, net of tax, included in AOCI that are expected to be reclassified into interest expense over the term of the hedged item.

The Company presents its derivative assets and liabilities in the Condensed Consolidated Balance Sheets on a net basis by counterparty.  The following table summarizes the location and fair value of the derivative instruments and disaggregates the net derivative assets and liabilities into gross components on a contract-by-contract basis:

 
Asset Derivatives
 
Liability Derivatives
 
 
  
 
Fair Value
 
 
 
Fair Value
 
(In thousands)
Balance Sheet Location
 
October 1,
2016
 
December 26,
 2015
 
Balance Sheet Location
 
October 1,
2016
 
December 26,
 2015
 
Hedging instrument:
 
         
 
         
  Commodity contracts - gains
Other current assets
   
$
1,634
   
$
60
 
Other current liabilities
   
$
   
$
238
 
  Commodity contracts - losses
Other current assets
     
(23
)
   
 
Other current liabilities
     
(129
)
   
(1,864
)
  Interest rate swap
Other assets
     
     
 
Other liabilities
     
(1,601
)
   
(1,692
)
Total derivatives (1)
 
   
$
1,611
   
$
60
 
 
   
$
(1,730
)
 
$
(3,318
)
 
 
                 
 
                 
(1) Does not include the impact of cash collateral received from or provided to counterparties.
 
 
 
                 
 
                 





12



The following tables summarize the effects of derivative instruments on the Company's Condensed Consolidated Statements of Income:

 
  
 
Quarter  Ended
 
Nine Months Ended
 
(In thousands)
Location
 
October 1,
2016
 
September 26,
 2015
 
October 1,
 2016
 
September 26,
 2015
 
Fair value hedges:
 
                 
  (Loss) gain on commodity contracts (qualifying)
Cost of goods sold
   
$
(37
)
 
$
1,831
   
$
(420
)
 
$
3,300
 
  Gain (loss) on hedged item - Inventory
Cost of goods sold
     
31
     
(1,943
)
   
382
     
(3,593
)

 
  
 
Quarter  Ended
 
Nine Months Ended
 
(In thousands)
Location
 
October 1,
 2016
 
September 26,
 2015
 
October 1,
2016
 
September 26,
 2015
 
Undesignated derivatives:
 
                         
  Gain on commodity contracts (nonqualifying)
Cost of goods sold
   
$
855
   
$
1,143
   
$
2,676
   
$
2,422
 

 
 
The following tables summarize amounts recognized in and reclassified from AOCI during the period:

 
Quarter Ended October 1, 2016
 
(In thousands)
(Loss) Gain Recognized in AOCI (Effective Portion), Net of Tax
 
Classification Gains (Losses)
 
(Gain) Loss Reclassified from AOCI (Effective Portion), Net of Tax
 
Cash flow hedges:
   
 
     
Commodity contracts
 
$
(1,434
)
Cost of goods sold
   
$
814
 
Interest rate swap
   
457
 
Interest expense
     
58
 
Other
   
(32
)
Other
     
(2
Total
 
$
(1,009
)
Total
   
$
870
 
 
 

 
 
Quarter Ended September 26, 2015
 
(In thousands)
(Loss) Gain Recognized in AOCI (Effective Portion), Net of Tax
 
Classification Gains (Losses)
 
(Gain) Loss Reclassified from AOCI (Effective Portion), Net of Tax
 
Cash flow hedges:
   
 
     
Commodity contracts
 
$
(2,046
)
Cost of goods sold
   
$
1,708
 
Interest rate swap
   
(632
)
Interest expense
     
58
 
Other
   
(7
)
Other
     
4
 
Total
 
$
(2,685
)
Total
   
$
1,770
 
 
 

 
 
Nine Months Ended October 1, 2016
 
(In thousands)
Gain (Loss) Recognized in AOCI (Effective Portion), Net of Tax
 
Classification Gains (Losses)
 
(Gain) Loss Reclassified from AOCI (Effective Portion), Net of Tax
 
Cash flow hedges:
   
 
     
Commodity contracts
 
$
1,903
 
Cost of goods sold
   
$
(477
)
Interest rate swap
   
(128
)
Interest expense
     
186
 
Other
   
(329
)
Other
     
 
Total
 
$
1,446
 
Total
   
$
(291
)




13

 
Derivative information (continued):

 
Nine Months Ended September 26, 2015
 
(In thousands)
(Loss) Gain Recognized in AOCI (Effective Portion), Net of Tax
 
Classification Gains (Losses)
 
(Gain) Loss Reclassified from AOCI (Effective Portion), Net of Tax
 
Cash flow hedges:
   
 
     
Commodity contracts
 
$
(2,931
)
Cost of goods sold
   
$
2,198
 
Interest rate swap
   
(1,397
)
Interest expense
     
189
 
Other
   
(75
)
Other
     
 
Total
 
$
(4,403
)
Total
   
$
2,387
 

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 hedge contracts through October 1, 2016 was not material to the Condensed Consolidated Statements of Income.

The Company primarily enters into International Swaps and Derivatives Association master netting agreements with major financial institutions that permit the net settlement of amounts owed under their respective derivative contracts.  Under these master netting agreements, net settlement generally permits the Company or the counterparty to determine the net amount payable for contracts due on the same date and in the same currency for similar types of derivative transactions.  The master netting agreements generally also provide for net settlement of all outstanding contracts with a counterparty in the case of an event of default or a termination event.  The Company does not offset fair value amounts for derivative instruments and fair value amounts recognized for the right to reclaim cash collateral.  At October 1, 2016 and December 26, 2015, the Company had recorded restricted cash in other current assets of $1.4 million and $2.6 million, respectively, as collateral related to open derivative contracts under the master netting arrangements.

Note 6 – Investment in Unconsolidated Affiliates

The Company owns a 50 percent interest in Tecumseh Products Holdings LLC (Joint Venture), an unconsolidated affiliate that acquired Tecumseh Products Company (Tecumseh) during the third quarter of 2015.  The Company also owns a 50 percent interest in a second unconsolidated affiliate that provided financing to Tecumseh in conjunction with the acquisition.  These investments are recorded using the equity method of accounting, as the Company can exercise significant influence but does not own a majority equity interest or otherwise control the respective entities.  Under the equity method of accounting, these investments are stated at initial cost and are adjusted for subsequent additional investments and the Company's proportionate share of earnings or losses and distributions.

The Company records its proportionate share of the investees' net income or loss one quarter in arrears as income (loss) from unconsolidated affiliates, net of tax, in the Condensed Consolidated Statements of Income.   

The following tables present summarized financial information derived from the Company's equity method investees'  combined consolidated financial statements, which are prepared in accordance with U.S. GAAP.

(In thousands)
 
June 30,  2016
   
September 30, 2015
 
         
Current assets
 
$
254,910
   
$
251,389
 
Noncurrent assets
   
133,200
     
112,156
 
Current liabilities
   
155,406
     
178,784
 
Noncurrent liabilities
   
74,291
     
63,643
 
                 
 
 
14

 
 
 
             
             
 
June 30, 2016
 
(In thousands)
For the Quarter Ended
 
For the Nine Months Ended
 
 
   
Net sales
 
$
146,700
   
$
437,200
 
Gross profit 
   
22,200
     
59,700
 
Net income
   
2,244
     
6,097
 

Included in the equity method investees' net income for the nine months ended June 30, 2016 is a gain of $17.1 million that resulted from the allocation of the purchase price, which was finalized during the quarter ended December 31, 2015.  That gain was offset by restructuring and impairment charges of $5.3 million and net losses of $5.7 million.

Note 7 –Benefit Plans

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 (income) are as follows:

 
 
For the Quarter Ended
   
For the Nine Months Ended
 
(In thousands) 
 
October 1,
 2016
   
September 26, 2015
   
October 1,
 2016
   
September 26, 2015
 
       
Pension benefits:
                       
Service cost
 
$
180
   
$
250
   
$
540
   
$
750
 
Interest cost
   
1,973
     
2,041
     
5,917
     
6,122
 
Expected return on plan assets
   
(2,466
)
   
(2,654
)
   
(7,398
)
   
(7,963
)
Amortization of net loss
   
760
     
685
     
2,280
     
2,055
 
                                 
Net periodic benefit cost
 
$
447
   
$
322
   
$
1,339
   
$
964
 
                                 
Other benefits:
                               
Service cost
 
$
61
   
$
90
   
$
183
   
$
270
 
Interest cost
   
153
     
193
     
458
     
579
 
Amortization of prior service (credit) cost
   
(224
)
   
2
     
(672
)
   
5
 
Amortization of net gain
   
(9
)
   
(7
)
   
(27
)
   
(20
)
                                 
Net periodic benefit (income) cost
 
$
(19
)
 
$
278
   
$
(58
)
 
$
834
 
                                 

Note 8 – 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.

Guarantees

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 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 October 1, 2016 were $7.0 million.


15


Note 9 – Income Taxes

The Company's effective tax rate for the third quarter of 2016 was 30 percent compared with 20 percent for the same period last year.  The items impacting the effective tax rate for the third quarter of 2016 were primarily attributable to reductions for the U.S. production activities deduction of $0.6 million and the effect of foreign tax rates lower than statutory tax rates of $1.0 million.  These items were partially offset by the provision for state income taxes, net of the federal benefit, of $0.6 million.

For the third quarter of 2015, the difference between the effective tax rate and the amount computed using the U.S. federal statutory tax rate was primarily attributable to a permanent reduction to the Company's deferred tax liabilities of $4.2 million resulting from the acquisition of a foreign subsidiary and the U.S. production activities deduction of $0.8 million.

The Company's effective tax rate for the first nine months of 2016 was 33 percent compared with 32 percent for the same period last year.  The items impacting the effective tax rate for the first nine months of 2016 were primarily attributable to reductions for the U.S. production activities deduction of $2.5 million and the effect of foreign tax rates lower than statutory tax rates of $3.5 million.  These items were partially offset by the provision for state income taxes, net of the federal benefit, of $2.3 million.

For the first nine months of 2015, the difference between the effective tax rate and the amount computed using the U.S. federal statutory tax rate was primarily attributable to reductions to the Company's deferred tax liabilities of $4.2 million and the U.S. production activities deduction of $3.0 million.  These items were partially offset by the provision for state income taxes, net of federal benefit, of $2.1 million.

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 2013 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.  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 10 – Accumulated Other Comprehensive Income

AOCI includes certain foreign currency translation adjustments from those subsidiaries not using the U.S. dollar as their functional currency, net deferred gains and losses on certain derivative instruments accounted for as cash flow hedges, adjustments to pension and OPEB liabilities, unrealized gains and losses on marketable securities classified as available-for-sale, and other comprehensive income attributable to unconsolidated affiliates.


16


 
The following table provides changes in AOCI by component, net of taxes and noncontrolling interests (amounts in parentheses indicate debits to AOCI):

 
 
For the Nine Months Ended October 1, 2016
 
(In thousands)
 
Cumulative Translation Adjustment
   
Unrealized (Losses) Gains on Derivatives
   
Minimum Pension/OPEB Liability Adjustment
   
Other
   
Total
 
 
                             
Balance at December 26, 2015
 
$
(24,773
)
 
$
(2,009
)
 
$
(28,429
)
 
$
221
   
$
(54,990
)
 
                                       
Other comprehensive income (loss) before reclassifications
   
(14,638
)
   
1,446
     
2,258
     
6,627
     
(4,307
)
Amounts reclassified from AOCI
   
     
(291
)
   
1,187
     
     
896
 
 
                                       
Net current-period other comprehensive income (loss)
   
(14,638
)
   
1,155
     
3,445
     
6,627
     
(3,411
)
 
                                       
Balance at October 1, 2016
 
$
(39,411
)
 
$
(854
)
 
$
(24,984
)
 
$
6,848
   
$
(58,401
)
 
 
 

 
 
 
For the Nine Months Ended September 26, 2015
 
(In thousands)
 
Cumulative Translation Adjustment
   
Unrealized (Losses) Gains on Derivatives
   
Minimum Pension/OPEB Liability Adjustment
   
Other
   
Total
 
 
                             
Balance at December 27, 2014
 
$
(7,076
)
 
$
(953
)
 
$
(35,164
)
 
$
270
   
$
(42,923
)
 
                                       
Other comprehensive income (loss) before reclassifications
   
(12,099
)
   
(4,403
)
   
510
     
(46
)
   
(16,038
)
Amounts reclassified from AOCI
   
     
2,387
     
1,490
     
     
3,877
 
 
                                       
Net current-period other comprehensive income (loss)
   
(12,099
)
   
(2,016
)
   
2,000
     
(46
)
   
(12,161
)
 
                                       
Balance at September 26, 2015
 
$
(19,175
)
 
$
(2,969
)
 
$
(33,164
)
 
$
224
   
$
(55,084
)





17



Reclassification adjustments out of AOCI were as follows:

 
 
Amount reclassified from AOCI
   
For the Quarter Ended
   
(In thousands)
 
October 1,
  2016
   
September 26, 2015
 
Affected line item
 
         
Unrealized losses (gains) on derivatives: 
           
   
  Commodity contracts
 
$
848
   
$
2,339
 
Cost of goods sold
  Interest rate swap
   
91
     
91
 
Interest expense
 
   
(67
)
   
(664
)
Income tax expense
 
   
872
     
1,766
 
Net of tax
 
   
     
 
Noncontrolling interests
 
               
      
 
 
$
872
   
$
1,766
 
Net of tax and noncontrolling
  interests
 
               
      
Amortization of net loss and prior service cost on employee benefit plans
 
$
527
   
$
680
 
Selling, general, and administrative
  expense
 
   
(132
)
   
(188
)
Income tax expense
 
   
395
     
492
 
Net of tax
 
   
     
 
Noncontrolling interests
 
               
      
 
 
$
395
   
$
492
 
Net of tax and noncontrolling
  interests
 
 

 
 
 
Amount reclassified from AOCI
   
For the Nine Months Ended
   
(In thousands)
 
October 1,
 2016
   
September 26, 2015
 
Affected line item
 
         
Unrealized losses (gains) on derivatives: 
           
   
  Commodity contracts
 
$
(1,023
)
 
$
2,990
 
Cost of goods sold
  Interest rate swap
   
291
     
295
 
Interest expense
 
   
441
     
(898
)
Income tax expense
 
   
(291
)
   
2,387
 
Net of tax
 
   
     
 
Noncontrolling interests
 
               
      
 
 
$
(291
)
 
$
2,387
 
Net of tax and noncontrolling
  interests
 
               
      
Amortization of net loss and prior service cost on employee benefit plans
 
$
1,581
   
$
2,040
 
Selling, general, and administrative
   expense
 
   
(394
)
   
(550
)
Income tax expense
 
   
1,187
     
1,490
 
Net of tax
 
   
     
 
Noncontrolling interests
 
               
      
 
 
$
1,187
   
$
1,490
 
Net of tax and noncontrolling
  interests
 
 

 
18


 
Note 11 – Noncontrolling Interests

(In thousands)
 
Noncontrolling Interests
 
 
     
Balance at December 26, 2015
 
$
32,417
 
Purchase of Jungwoo-Mueller
   
14,562
 
Dividends paid to noncontrolling interests
   
(3,765
)
Net income attributable to noncontrolling interests
   
581
 
Other comprehensive loss attributable to noncontrolling interests, net of tax:
       
     Foreign currency translation
   
(963
)
 
       
Balance at October 1, 2016
 
$
42,832
 
 
       
 
 
Note 12 – Recently Issued Accounting Standards

In March 2016, the Financial Accounting Standards Board (FASB) issued ASU (Accounting Standards Update) No. 2016-09, Compensation – Stock Compensation (Topic 718): Improvement to Employee Share-Based Payment Accounting (ASU 2016-09).  The ASU requires all income tax effects of awards to be recognized in the income statement when the awards vest or are settled.  It also allows a company to make a policy election to account for forfeitures as they occur.  The guidance is effective for public business entities in interim and fiscal periods beginning after December 15, 2016.  Early adoption is permitted, but all of the guidance must be adopted in the same period.  The Company early adopted this standard effective December 27, 2015.  The impact of the adoption of this standard was as follows:
 
·
Approximately $0.8 million of excess tax benefits was recorded through income tax expense as a discrete item for the three and nine months ended October 1, 2016, adopted on a prospective basis from December 27, 2015.
·
Excess tax benefits were combined with other income tax cash flows within operating cash flows adopted on a prospective basis rather than as a financing activity.
·
The Company has elected to change its current policy of estimating forfeitures to a policy of recognizing forfeitures when they occur on a prospective basis from December 27, 2015.

In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842) (ASU 2016-02).  ASU 2016-02 requires an entity to recognize a right-of-use asset and lease liability for all leases with terms of more than 12 months.  Recognition, measurement and presentation of expenses will depend on classification as a financing or operating lease.  The amendments also require certain quantitative and qualitative disclosures about leasing arrangements.  The ASU will be effective for interim and fiscal periods beginning after December 15, 2018.  Early adoption is permitted.  The updated guidance requires a modified retrospective adoption.  The Company is still evaluating the effects that the provision of ASU 2016-02 will have on its Condensed Consolidated Financial Statements.

In April 2015, the FASB issued ASU No. 2015-03, Interest – Imputation of Interest (Topic 835-30): Simplifying the Presentation of Debt Issue Costs (ASU 2015-03).  The ASU simplifies the presentation of debt issuance costs by requiring debt issuance costs related to a recognized debt liability to be presented on the balance sheet as a direct deduction from the debt liability rather than as a separate asset.  In circumstances in which there is not an associated debt liability amount recorded in the financial statements when the debt issuance costs are incurred, they will be reported on the balance sheet as an asset until the debt liability is recorded.  The guidance is effective for public business entities in interim and fiscal periods beginning after December 15, 2015.  Retrospective application is required.  The Company adopted ASU 2015-03 effective December 27, 2015.  The adoption of the ASU did not have a material impact on the Company's Condensed Consolidated Financial Statements.

In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606) (ASU 2014-09).  The ASU will supersede virtually all existing revenue recognition guidance under U.S. GAAP and will be effective for annual reporting periods beginning after December 15, 2017.  The fundamental principles of the new guidance are that companies should recognize revenue in a manner that reflects the timing of the transfer of services to customers and the amount of revenue recognized reflects the consideration that a company expects to receive for the goods and services provided.  The new guidance establishes a five-step approach for the recognition of revenue.  The Company is in the process of evaluating the impact of ASU 2014-09 on its Condensed Consolidated Financial Statements.


19


Item 2.  Management's Discussion and Analysis of Financial Condition and Results of Operations

General Overview

We are a leading manufacturer of copper, brass, aluminum, and plastic products.  The range of these products is broad:  copper tube and fittings; line sets; brass and copper alloy rod, bar, and shapes; aluminum and brass forgings; aluminum impact extrusions; plastic fittings and valves; refrigeration valves and fittings; fabricated tubular products; and steel nipples.  We also resell imported brass and plastic plumbing valves, malleable iron fittings, faucets and plumbing specialty products.  Mueller's operations are located throughout the United States and in Canada, Mexico, Great Britain, South Korea, and China.

During the first quarter of 2016, we made changes to our management reporting structure as a result of a change in the way the Chief Executive Officer, who serves as the Chief Operating Decision Maker, manages and evaluates the business, makes key operating decisions, and allocates resources.  Previously, we had two reportable segments: Plumbing & Refrigeration and OEM.  During the first quarter, we realigned our operating segments into three reportable segments: Piping Systems, Industrial Metals, and Climate.  The changes to the reporting structure resulted from management's decision to operationally separate certain businesses in order to enhance the level of focus on those businesses.  This included the appointment of separate management teams.  In addition, as a result of several acquisitions, we separated certain businesses with similar characteristics to create the Climate and Industrial Metals segments.  These businesses were previously aggregated within the OEM segment.  Management has recast certain prior period amounts to conform to the current period presentation. Each of the reportable segments is composed of certain operating segments that are aggregated primarily by the nature of products offered as follows:

·
Piping Systems:  The Piping Systems segment is composed of Domestic Piping Systems Group, Canadian Operations, European Operations, Trading Group, Mueller-Xingrong (our Chinese joint venture), and Jungwoo-Mueller (our South Korean joint venture).  The Domestic Piping Systems Group manufactures and sells copper tube, copper and plastic fittings, line sets, and valves in North America.  The Canadian Operations manufacture copper tube and line sets in Canada and sell the products primarily in the U.S. and Canada. European Operations manufacture copper tube in the United Kingdom, which is sold throughout Europe.  The Trading Group manufactures pipe nipples and sources products for import distribution in North America.  Mueller-Xingrong manufactures engineered copper tube primarily for air-conditioning applications; these products are sold primarily to OEMs located in China.  Jungwoo-Mueller manufactures copper-based joining products that are sold worldwide.  The Piping Systems segment sells products to wholesalers in the plumbing and refrigeration markets, distributors to the manufactured housing and recreational vehicle industries, building material retailers, and air-conditioning OEMs.

·
Industrial Metals:  The Industrial Metals segment is composed of Brass Rod & Copper Bar Products, Impacts & Micro Gauge, and Brass Value-Added Products.  The segment manufactures and sells brass and copper alloy rod, bar, and shapes; aluminum and brass forgings; aluminum impact extrusions; and gas valves and assemblies.   The segment manufactures and sells its products primarily to domestic OEMs in the industrial, construction, heating, ventilation, and air-conditioning, plumbing, and refrigeration markets.

·
Climate: The Climate segment is composed of Refrigeration Products, Fabricated Tube Products, Westermeyer, and Turbotec.  The segment manufactures and sells refrigeration valves and fittings and fabricated tubular products.  The segment sells its products primarily to the heating, ventilation, air-conditioning, and refrigeration markets in the U.S.

New housing starts and commercial construction are important determinants of the Company's sales to the heating, ventilation, and air-conditioning, refrigeration, and plumbing markets because the principal end use of a significant portion of our products is in the construction of single and multi-family housing and commercial buildings.  Repairs and remodeling projects are also important drivers of underlying demand for these products.  
 

 
20

 
 
Residential construction activity has shown improvement in recent years, but remains at levels below long-term historical averages.  Continued improvement is expected, but may be tempered by continuing low labor participation rates, the pace of household formations, and tighter lending standards.  Per the U.S. Census Bureau, the September 2016 seasonally adjusted annual rate of new housing starts was 1.0 million compared with the September 2015 rate of 1.2 million.  Mortgage rates remain at historically low levels, as the average 30-year fixed mortgage rate was 3.59 percent for the first nine months of 2016 and 3.85 percent for the twelve months ended December 2015. 

The private non-residential construction sector, which includes offices, industrial, health care, and retail projects, has shown improvement in recent years.  The seasonally adjusted annual value of private nonresidential construction put in place was $422.4 billion in August 2016 compared to August 2015 rate of $405.5 billion.  We expect that most of these conditions will continue to improve.

Profitability of certain of our product lines depends upon the "spreads" between the costs of raw materials and the selling prices of our products.  The open market prices for copper cathode and scrap, for example, influence the selling price of copper tube, a principal product manufactured by the Company.  We attempt to minimize the effects on profitability from fluctuations in material costs by passing through these costs to our customers.  Our earnings and cash flow are dependent upon these spreads that fluctuate based upon market conditions.

Earnings and profitability are also impacted by unit volumes that are subject to market trends, such as substitute products, imports, technologies, and market share.  In core product lines, we intensively manage our pricing structure while attempting to maximize our profitability.  From time-to-time, this practice results in lost sales opportunities and lower volume.  For plumbing systems, plastics are the primary substitute product; these products represent an increasing share of consumption.  U.S. consumption of copper tube is still predominantly supplied by U.S. manufacturers.  For certain air-conditioning and refrigeration applications, aluminum-based systems are the primary substitution threat.  We cannot predict the acceptance or the rate of switching that may occur.  In recent years, brass rod consumption in the U.S. has declined due to the outsourcing of many manufactured products from offshore regions.

Results of Operations

Consolidated Results

The following table compares summary operating results for 2016 and 2015:

 
Quarter Ended
 
Percent Change
   
Nine Months Ended
 
Percent Change
   
(In thousands)
Oct. 1, 2016
 
Sept. 26, 2015
 
2016 vs. 2015
   
Oct. 1, 2016
 
Sept. 26, 2015
 
2016 vs. 2015
   
 
                           
Net sales
 
$
506,584
   
$
535,184
     
(5.3
)
  
%
 
$
1,583,464
   
$
1,628,019
     
(2.7
)
 %
Operating income
   
37,487
     
27,027
     
38.7
       
123,390
     
118,305
     
4.3
   
Net income
   
25,978
     
17,800
     
45.9
       
82,405
     
73,429
     
12.2
   
 
                                                   
 
 
The following are components of changes in net sales compared to the prior year:

 
 
Quarter-to-Date
 
 
 
Year-to-Date
 
 
 
 
 
2016 vs. 2015
 
 
 
2016 vs. 2015
 
 
 
Net selling price in core product lines
 
(8.1
)
%
 
(11.4
)
%
 
Unit sales volume in core product lines
 
1.9
 
 
 
(1.8
)
 
 
Acquisitions
 
1.5
     
10.8
     
Other
 
(0.6
)
 
 
(0.3
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(5.3
)
%
 
(2.7
)
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
21

 
 
The decrease in net sales during the third quarter of 2016 was primarily due to lower net selling prices of $43.4 million in our core product lines, primarily copper tube and brass rod. This decrease was offset by (i) higher unit sales volume of $10.4 million, primarily in our North American copper tube businesses, and (ii) $7.8 million of sales recorded by Jungwoo Metal Ind. Co., LTD (Jungwoo-Mueller), acquired in April 2016.

The decrease in net sales during the first nine months of 2016 was primarily due to (i) lower net selling prices of $185.6 million in our core product lines and (ii) lower unit sales volume of $30.0 million in our core product lines, primarily in the Industrial Metals segment and at Mueller-Xingrong.  These decreases were offset by (i) $139.9 million of incremental sales recorded by Great Lakes Copper Ltd. (Great Lakes), acquired in July 2015, (ii) $21.9 million of incremental sales recorded by Sherwood Valve LLC (Sherwood), acquired in June 2015, (iii) $11.0 million of sales recorded by Jungwoo-Mueller, and (iv) $3.7 million of incremental sales recorded by Turbotec Products, Inc. (Turbotec), acquired in March 2015.

Net selling prices generally fluctuate with changes in raw material costs.  Changes in raw material costs are generally passed through to customers by adjustments to selling prices.  The following graph shows the Comex average copper price per pound by quarter for the current and prior fiscal years:

            

 
 
The following tables compare cost of goods sold and operating expenses as dollar amounts and as a percent of net sales for 2016 and 2015:

 
 
Quarter  Ended
   
Nine Months Ended
 
(In thousands)
 
Oct. 1, 2016
   
Sept. 26, 2015
   
Oct. 1, 2016
   
Sept. 26, 2015
 
 
                       
Cost of goods sold
 
$
424,668
   
$
467,167
   
$
1,327,370
   
$
1,398,366
 
Depreciation and
  amortization
   
9,016
     
8,749
     
26,997
     
24,790
 
Selling, general and administrative expense
   
32,413
     
32,241
     
102,707
     
97,922
 
Asset impairments
   
3,000
     
     
3,000
     
570
 
Gain on sale of assets
   
     
     
     
(15,376
)
Severance
   
     
     
     
3,442
 
 
                               
Operating expenses
 
$
469,097
   
$
508,157
   
$
1,460,074
   
$
1,509,714
 





22



 
 
 
Quarter  Ended
   
Nine Months Ended
 
   
Oct. 1, 2016
   
Sept. 26, 2015
   
Oct. 1, 2016
   
Sept. 26, 2015
 
 
                       
Cost of goods sold
   
83.8
%
   
87.3
%
   
83.8
%
   
85.9
%
Depreciation and
  amortization
   
1.8
     
1.6
     
1.7
     
1.5
 
Selling, general and administrative expense
   
6.4
     
6.0
     
6.5
     
6.0
 
Asset impairments
   
0.6
     
     
0.2
     
 
Gain on sale of assets
   
     
     
     
(0.9
)
Severance
   
     
     
     
0.2
 
 
                               
Operating expenses
   
92.6
%
   
94.9
%
   
92.2
%
   
92.7
%

Q3 2016 compared to Q3 2015

The decrease in cost of goods sold was primarily due to the decrease in the average cost of copper, our principal raw material, partially offset by the increase in sales volume in certain businesses.  Depreciation and amortization increased in the third quarter of 2016 primarily as a result of depreciation and amortization of long-lived assets of businesses acquired in 2015 and 2016.Selling, general, and administrative expense for the third quarter of 2016 was consistent with the third quarter of 2015.    In addition, there were fixed asset impairment charges for certain manufacturing equipment of $3.0 million recognized during the third quarter of 2016. 

Interest expense and other income, net, for the third quarter of 2016 were consistent with the third quarter of 2015.

Our effective tax rate for the third quarter of 2016 was 30 percent compared with 20 percent for the same period last year.  The items impacting the effective tax rate for the third quarter of 2016 were primarily attributable to reductions for the U.S. production activities deduction of $0.6 million and the effect of foreign tax rates lower than statutory tax rates of $1.0 million.  These items were partially offset by the provision for state income taxes, net of the federal benefit, of $0.6 million.

For the third quarter of 2015, the difference between the effective tax rate and the amount computed using the U.S. federal statutory tax rate was primarily related to reductions to our deferred tax liabilities of $4.2 million resulting from the acquisition of a foreign subsidiary and the U.S. production activities deduction of $0.8 million.

We own a 50 percent interest in Tecumseh Products Holdings LLC, an unconsolidated affiliate that acquired Tecumseh Products Company (Tecumseh) during the third quarter of 2015.  We also own a 50 percent interest in a second unconsolidated affiliate that provided financing to Tecumseh in conjunction with the acquisition.  We account for these investments using the equity method of accounting.  For the third quarter of 2016, we recognized income of $1.1 million on these investments.  For the third quarter of 2015, we recognized $2.2 million of losses on these investments related to transaction costs.

2016 YTD compared to 2015 YTD

The decrease in cost of goods sold was primarily due to the decrease in the average cost of copper, partially offset by the increase in sales volume related to businesses acquired during 2015 and 2016.  Depreciation and amortization increased slightly in the first nine months of 2016 primarily as a result of depreciation and amortization of long-lived assets of businesses acquired.Selling, general, and administrative expense increased for the first nine months of 2016 primarily as a result of incremental expenses of $7.3 million associated with businesses acquired.  This was partially offset by a reduction in (i) foreign currency exchange losses of $0.8 million and (ii) employee compensation expenses, including incentive compensation, of $0.6 million.  In addition, there were equipment relocation costs of $0.9 million related to the rationalization of Yorkshire Copper Tube (Yorkshire) recognized in the first nine months of 2015. 
 

 
23

 
During the first nine months of 2016, there were fixed asset impairment charges for certain manufacturing equipment of $3.0 million recognized.  During the first nine months of 2015, our operating results were positively impacted by a net gain of $15.4 million recorded on the sale of certain assets. This was offset by $3.4 million of severance charges and $0.6 million of fixed asset impairment charges related to the rationalization of Yorkshire.

Interest expense decreased in the first nine months of 2016 primarily as a result of decreased borrowing costs at Mueller-Xingrong.  Other income, net, for the first nine months of 2016 was consistent with the first nine months of 2015.

Our effective tax rate for the first nine months of 2016 was 33 percent compared with 32 percent for the same period last year.  The items impacting the effective tax rate for the first nine months of 2016 were primarily attributable to reductions for the U.S. production activities deduction of $2.5 million and the effect of foreign tax rates lower than statutory tax rates of $3.5 million.  These items were partially offset by the provision for state income taxes, net of the federal benefit, of $2.3 million.

For the first nine months of 2015, the difference between the effective tax rate and the amount computed using the U.S. federal statutory tax rate was attributable to a reduction to our deferred tax liabilities of $4.2 million resulting from the acquisition of a foreign subsidiary and the U.S. production activities deduction of $3.0 million.  These items were partially offset by state income taxes of $2.1 million.

During the first nine months of 2016, we recognized $3.0 million of income on our investment in unconsolidated affiliates.  This included the gain that resulted from the allocation of the purchase price recorded by our equity method investees, which was offset by restructuring and impairment charges and net losses.  For the first nine months of 2015, we recognized $2.2 million of losses on our investments related to transaction costs.

Piping Systems Segment

The following table compares summary operating results for 2016 and 2015 for the businesses comprising our Piping Systems segment:

 
Quarter Ended
   
Percent Change
 
 
Nine Months Ended
   
Percent Change
   
(In thousands)
Oct. 1, 2016
 
Sept. 26, 2015
   
2016 vs. 2015
 
 
Oct. 1, 2016
 
Sept. 26, 2015
   
2016 vs. 2015
   
 
             
 
               
Net sales
 
$
351,557
   
$
367,892
     
(4.4
)
 
%
 
$
1,109,109
   
$
1,109,124
     
%
 
Operating income
   
24,138
     
25,422
     
(5.1
)
     
88,256
     
94,916
     
(7.0
)
 
 
                       
 
                         
 
 
The following are components of changes in net sales compared to the prior year:

 
 
Quarter-to-Date
     
Year-to-Date
   
 
 
2016 vs.
2015
     
2016 vs. 2015
   
Net selling price in core product lines
   
(9.8
)
   
%
   
(12.2
)%
   
 
Unit sales volume in core product lines
   
3.3
       
(0.9
)
 
Acquisitions
   
2.1
       
13.6
   
Other
   
       
(0.5
)
 
 
                       
 
   
(4.4
)
   
%
   
%
 
 
                       
 
 
 
24

 
The decrease in net sales during the third quarter of 2016 was primarily attributable to lower net selling prices in the segment's core product lines, primarily copper tube, of $35.8 million. These decreases were offset by (i) higher unit sales volume of $12.2 million in the segment's core product lines, primarily in our North American copper tube businesses, and (ii) $7.8 million of sales recorded by Jungwoo-Mueller.

Sales during the first nine months of 2016 were consistent with sales for the first nine months of 2015.  This was primarily due to (i) $139.9 million of incremental sales recorded by Great Lakes and (ii) $11.0 million of sales recorded by Jungwoo-Mueller.  These increases were offset by (i) lower net selling prices of $135.2 million in the segment's core product lines, (ii) a reduction in unit sales volume of $10.4 million in the segment's core product lines, and (iii) a decrease in net sales of $6.5 million in the segment's non-core product lines.

The following tables compare cost of goods sold and operating expenses as dollar amounts and as a percent of net sales for 2016 and 2015:

 
 
Quarter Ended
   
Nine Months Ended
 
(In thousands)
 
Oct. 1, 2016
   
Sept. 26, 2015
   
Oct. 1, 2016
   
Sept. 26, 2015
 
 
                       
Cost of goods sold
 
$
301,867
   
$
320,571
   
$
949,015
   
$
959,599
 
Depreciation and
  amortization
   
5,905
     
5,430
     
17,341
     
15,952
 
Selling, general and administrative expense
   
16,647
     
16,469
     
51,497
     
50,021
 
Asset impairments
   
3,000
     
     
3,000
     
570
 
Gain on sale of assets