UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended July 1, 2006 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 is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of "accelerated filer and large accelerated filer" in Rule 12b-2 of the Exchange Act. (Check one): Large accelerated filer [X] Accelerated filer [ ] Non-accelerated filer [ ] Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X] The number of shares of the Registrant's common stock outstanding as of July 25, 2006, was 36,946,768. -1- MUELLER INDUSTRIES, INC. FORM 10-Q For the Period Ended July 1, 2006 INDEX Part I. Financial Information Page Item 1. Financial Statements (Unaudited) a.) Condensed Consolidated Statements of Income for the quarters and six months ended July 1, 2006 and July 2, 2005 3 b.) Condensed Consolidated Balance Sheets as of July 1, 2006 and December 31, 2005 7 c.) Condensed Consolidated Statements of Cash Flows for the six months July 1, 2006 and July 2, 2005 9 d.) Notes to Condensed Consolidated Financial Statements 11 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 25 Item 3. Quantitative and Qualitative Disclosures About Market Risk 30 Item 4. Controls and Procedures 32 Part II. Other Information Item 1. Legal Proceedings 34 Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 36 Item 4. Submission of Matters to a Vote of Security Holders 37 Item 6. Exhibits 38 Signatures 39 -2- PART I. FINANCIAL INFORMATION Item 1. Financial Statements MUELLER INDUSTRIES, INC. CONDENSED CONSOLIDATED STATEMENTS OF INCOME (Unaudited)
For the Quarter Ended July 1, July 2, 2006 2005 (In thousands, except per share data) Net sales $ 779,663 $ 410,506 Cost of goods sold 637,038 345,663 ---------- ---------- Gross profit 142,625 64,843 Depreciation and amortization 10,376 10,411 Selling, general, and administrative expense 39,689 29,136 ---------- ---------- Operating income 92,560 25,296 Interest expense (5,214) (4,752) Other (expense) income, net (67) 3,973 ---------- ---------- Income before income taxes 87,279 24,517 Current income tax expense (29,584) (7,545) Deferred income tax benefit 1,055 211 ---------- ---------- Total income tax expense (28,529) (7,334) ---------- ---------- Net income $ 58,750 $ 17,183 ========== ========== See accompanying notes to condensed consolidated financial statements.
-3- MUELLER INDUSTRIES, INC. CONDENSED CONSOLIDATED STATEMENTS OF INCOME (continued) (Unaudited)
For the Quarter Ended July 1, July 2, 2006 2005 (In thousands, except per share data) Weighted average shares for basic earnings per share 36,891 36,599 Effect of dilutive stock options 421 466 ---------- ---------- Adjusted weighted average shares for diluted earnings per share 37,312 37,065 ---------- ---------- Basic earnings per share $ 1.59 $ 0.47 ========== ========== Diluted earnings per share $ 1.57 $ 0.46 ========== ========== Dividends per share $ 0.10 $ 0.10 ========== ========== See accompanying notes to condensed consolidated financial statements.
-4- MUELLER INDUSTRIES, INC. CONDENSED CONSOLIDATED STATEMENTS OF INCOME (continued) (Unaudited)
For the Six Months Ended July 1, July 2, 2006 2005 (In thousands, except per share data) Net sales $ 1,330,702 $ 812,169 Cost of goods sold 1,094,107 679,687 ---------- ---------- Gross profit 236,595 132,482 Depreciation and amortization 20,571 20,489 Selling, general, and administrative expense 74,648 59,491 ---------- ---------- Operating income 141,376 52,502 Interest expense (10,076) (9,936) Other (expense) income, net 1,946 4,767 ---------- ---------- Income before income taxes 133,246 47,333 Current income tax expense (46,077) (15,981) Deferred income tax benefit 4,946 1,039 ---------- ---------- Total income tax expense (41,131) (14,942) ---------- ---------- Net income $ 92,115 $ 32,391 ========== ========== See accompanying notes to condensed consolidated financial statements.
-5- MUELLER INDUSTRIES, INC. CONDENSED CONSOLIDATED STATEMENTS OF INCOME (continued) (Unaudited)
For the Six Months Ended July 1, July 2, 2006 2005 (In thousands, except per share data) Weighted average shares for basic earnings per share 36,791 36,552 Effect of dilutive stock options 405 556 ---------- ---------- Adjusted weighted average shares for diluted earnings per share 37,196 37,108 ---------- ---------- Basic earnings per share $ 2.50 $ 0.89 ========== ========== Diluted earnings per share $ 2.48 $ 0.87 ========== ========== Dividends per share $ 0.20 $ 0.20 ========== ========== See accompanying notes to condensed consolidated financial statements.
-6- MUELLER INDUSTRIES, INC. CONDENSED CONSOLIDATED BALANCE SHEETS (Unaudited)
July 1, 2006 December 31, 2005 (In thousands) Assets Current assets: Cash and cash equivalents $ 138,887 $ 129,685 Accounts receivable, less allowance for doubtful accounts of $7,595 in 2006 and $5,778 in 2005 408,666 248,395 Inventories: Raw material and supplies 58,307 42,268 Work-in-process 37,711 24,610 Finished goods 152,650 130,109 ---------- ---------- Total inventories 248,668 196,987 Other current assets 40,308 36,919 ---------- ---------- Total current assets 836,529 611,986 Property, plant, and equipment, net 313,248 307,046 Goodwill 152,175 152,171 Other assets 17,549 33,435 ---------- ---------- $ 1,319,501 $ 1,104,638 ========== ========== See accompanying notes to condensed consolidated financial statements.
-7- MUELLER INDUSTRIES, INC. CONDENSED CONSOLIDATED BALANCE SHEETS (continued) (Unaudited)
July 1, 2006 December 31, 2005 (In thousands, except share data) Liabilities and Stockholders' Equity Current liabilities: Current portion of long-term debt $ 26,961 $ 4,120 Accounts payable 206,171 124,216 Accrued wages and other employee costs 36,980 38,095 Other current liabilities 95,088 84,961 ---------- ---------- Total current liabilities 365,200 251,392 Long-term debt 308,483 312,070 Pension liabilities 22,702 21,721 Postretirement liabilities other than pensions 13,132 13,515 Environmental reserves 8,997 9,073 Deferred income taxes 51,341 63,944 Other noncurrent liabilities 2,884 3,078 ---------- ---------- Total liabilities 772,739 674,793 ---------- ---------- Minority interest in subsidiaries 21,017 6,937 Stockholders' equity: Preferred stock - shares authorized 4,985,000; none outstanding - - Series A junior participating preferred stock - $1.00 par value; shares authorized 15,000; none outstanding - - Common stock - $.01 par value; shares authorized 100,000,000; issued 40,091,502; outstanding 36,946,768 in 2006 and 36,643,590 in 2005 401 401 Additional paid-in capital, common 254,177 252,889 Retained earnings 338,174 253,433 Accumulated other comprehensive income (loss) 1,471 (8,848) Treasury common stock, at cost (68,478) (74,967) ---------- ---------- Total stockholders' equity 525,745 422,908 ---------- ---------- Commitments and contingencies (Note 2) - - ---------- ---------- $ 1,319,501 $ 1,104,638 ========== ========== See accompanying notes to condensed consolidated financial statements.
-8- MUELLER INDUSTRIES, INC. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
For the Six Months Ended July 1, July 2, 2006 2005 (In thousands) Cash flows from operating activities Net income $ 92,115 $ 32,391 Reconciliation of net income to net cash (used in) provided by operating activities: Depreciation and amortization 20,719 20,568 Deferred income taxes (4,946) (1,039) Minority interest in subsidiaries 1,805 7 Share-based compensation expense 1,308 - Equity in earnings of unconsolidated subsidiary (964) (3,471) Gain on early retirement of debt (97) - Loss on disposal of properties 1,905 457 Gain on sale of equity investment (1,876) - Income tax benefit from exercise of stock options (1,042) 529 Changes in assets and liabilities: Receivables (162,602) (30,347) Inventories (51,127) (3,823) Other assets (4,642) (1,305) Current liabilities 93,754 20,058 Other liabilities 4,439 161 Other, net (3,657) 304 ---------- ---------- Net cash (used in) provided by operating activities (14,908) 34,490 ---------- ---------- Cash flows from investing activities Capital expenditures (20,918) (8,876) Business acquired, net of cash received 3,632 - Proceeds from sales of properties and equity investment 23,218 559 ---------- ---------- Net cash provided by (used in) investing activities 5,932 (8,317) ---------- ---------- See accompanying notes to condensed consolidated financial statements.
-9- MUELLER INDUSTRIES, INC. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (continued) (Unaudited)
For the Six Months Ended July 1, July 2, 2006 2005 (In thousands) Cash flows from financing activities Issuance of debt by joint venture $ 22,425 $ - Dividends paid (7,373) (7,320) Proceeds from the sale of treasury stock 5,823 3,911 Repayments of long-term debt (3,413) (396) Income tax benefit from exercise of stock options 1,042 - Acquisition of treasury stock (396) (168) ---------- ---------- Net cash provided by (used in) financing activities 18,108 (3,973) ---------- ---------- Effect of exchange rate changes on cash 70 (509) ---------- ---------- Increase in cash and cash equivalents 9,202 21,691 Cash and cash equivalents at the beginning of the period 129,685 47,449 ---------- ---------- Cash and cash equivalents at the end of the period $ 138,887 $ 69,140 ========== ========== See accompanying notes to condensed consolidated financial statements.
-10- MUELLER INDUSTRIES, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) General Certain information and footnote disclosures normally included in annual financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted. Results of operations for the interim periods presented are not necessarily indicative of results which may be expected for any other interim period or for the year as a whole. This Quarterly Report on Form 10-Q should be read in conjunction with the Company's Annual Report on Form 10-K, including the annual financial statements incorporated therein. The accompanying unaudited interim financial statements include all normal recurring adjustments which are, in the opinion of management, necessary to a fair statement of the results for the interim periods presented. The six-month period ended July 1, 2006 contained 26 weeks while the six-month period ended July 2, 2005 contained 27 weeks. Note 1 - Earnings per Common Share and Stock-Based Compensation 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, computed using the treasury stock method. Effective January 1, 2006, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 123 (R), "Share-Based Payment", and began recognizing compensation expense in its Condensed Consolidated Statements of Income as a selling, general, and administrative expense, for its stock option grants based on the fair value of the awards. Prior to January 1, 2006, the Company accounted for stock option grants under the recognition and measurement provisions of APB Opinion 25, "Accounting for Stock Issued to Employees", and related Interpretations, as permitted by SFAS No. 123, "Accounting for Stock-Based Compensation". No stock-based compensation expense was reflected in net income prior to adopting SFAS 123 (R) as all options were granted at an exercise price equal to the market value of the underlying common stock on the date of grant. SFAS 123 (R) was adopted using the modified prospective transition method. Under this transition method, compensation cost recognized in the periods after adoption includes: (i) compensation cost for all share-based payments granted prior to, but not yet vested as of January 1, 2006, based on the grant-date fair value estimated in accordance with the original provisions of SFAS 123, and (ii) compensation cost for all share-based payments granted subsequent to January 1, 2006, based on the grant-date fair value estimated in accordance with the provisions of SFAS 123 (R). Results from prior periods have not been restated. As a result of adopting SFAS 123 (R), the Company's income before income taxes and net income was decreased by $0.7 million and $0.5 million, respectively, for the second quarter of 2006 and $1.3 million and $1.0 million, respectively, for the first six months of 2006. -11- Prior to the adoption of SFAS 123 (R), the Company presented all tax benefits of deductions resulting from the exercise of stock options as operating cash flows in the Condensed Consolidated Statements of Cash Flows. SFAS 123 (R) requires the cash flows resulting from the tax benefits resulting from tax deductions in excess of the compensation cost recognized for those options to be classified as financing cash flows. The $1.0 million tax benefit classified as a financing cash inflow in the first six months of 2006 would have been classified as an operating cash flow under previous guidance. The following table illustrates the pro forma effect on the prior year's net income and earnings per share as if the Company had applied the fair value recognition provisions of SFAS 123 to options granted under the Company's stock option plans. For purposes of this pro forma disclosure, the value to the options is estimated using a Black-Scholes- Merton option pricing model and amortized to expense over the options' vesting period.
For the For the Six Quarter Ended Months Ended July 2, July 2, 2005 2005 (In thousands, except per share data) Net income as reported $ 17,183 $ 32,391 Deduct: Total stock-based compensation expense determined under a fair value based method, net of related tax effects (691) (1,225) ---------- ---------- SFAS No. 123 pro forma net income $ 16,492 $ 31,166 ========== ========== Pro forma earnings per share: Basic $ 0.45 $ 0.85 Diluted $ 0.44 $ 0.84 Earnings per share, as reported: Basic $ 0.47 $ 0.89 Diluted $ 0.46 $ 0.87
Under existing plans, the Company may grant options to purchase shares of common stock at prices not less than the fair market value of the stock on the date of grant. Generally, the options vest annually in equal increments over a five-year period beginning one year from the date of grant. Any unexercised options expire after not more than ten years. The fair value of each grant is estimated as a single award and amortized into compensation expense on a straight-line basis over its vesting period. -12- The Company estimates the fair value of all stock option awards as of the grant date by applying the Black-Scholes-Merton option pricing model. The use of this valuation model involves assumptions that are judgmental and highly sensitive in the determination of compensation expense and include the expected life of the option, stock price volatility, risk-free interest rate, dividend yield, and exercise price. Additionally under SFAS 123 (R), forfeitures are estimated at the time of valuation and reduce expense ratably over the vesting period. The forfeiture rate, which is estimated at a weighted average of 3.5 percent of unvested options outstanding as of July 1, 2006, is adjusted periodically based on the extent to which actual forfeitures differ, or are expected to differ, from the previous estimate. Under SFAS 123 and APB 25, the Company elected to account for forfeitures when awards were actually forfeited and reflected the forfeitures as a cumulative adjustment to the pro forma expense. In accordance with SFAS 123 (R), the fair values of options granted prior to adoption and determined for purposes of disclosure under SFAS 123 have not been changed. The fair value of options granted prior to adoption of SFAS 123 (R), of which a portion is unvested, was estimated assuming the following weighted averages: expected life of six years, dividend yield of 1.3 percent for grants in 2005 and 2004 (no dividend payments prior to 2004), risk-free interest rate of 3.8 percent, and expected volatility of 30.6 percent. The Company generally issues treasury shares when options are exercised. A summary of stock option activity since our most recent fiscal year end is as follows:
Weighted Average Options Exercise Price (Shares in thousands) Outstanding at December 31, 2005 1,912 $ 21.49 Granted 10 34.46 Exercised (317) 18.43 Cancelled (6) 26.27 -------- Outstanding at July 1, 2006 1,599 20.20 ========
At July 1, 2006, the aggregate intrinsic value of all outstanding options was $21.6 million with a weighted average remaining contractual term of 6.8 years, of which 758,714 of the outstanding options are currently exercisable with an aggregate intrinsic value of $11.8 million, a weighted average exercise price of $20.20 and a weighted average remaining contractual term of 5.7 years. The total intrinsic value of options exercised during the quarter and six months ended July 1, 2006 was $1.3 million and $4.0 million, respectively. Shares available for future employee grants were approximately 1.0 million at July 1, 2006. The total compensation cost at July 1, 2006 related to non-vested awards not yet recognized was $5.4 million with an average expense recognition period of 3.0 years. -13- Under the Company's 1994 Non-Employee Director Stock Option Plan, each member of the Company's Board of Directors who is neither an employee nor an officer of the Company is automatically granted each year on the date of the Company's Annual Meeting of Stockholders', without further action by the Board, an option to purchase 2,000 shares of Common Stock at the fair market value of the Common Stock on the date the option is granted. As of July 1, 2006, options to purchase 54,232 shares of Common Stock were outstanding under this Plan and 21,588 options are available under the Plan for future issuance. On February 16, 2006, the Board approved an amendment and restatement of the 2002 Stock Option Plan which, among other things, would increase the number of shares available for issuance by 1.0 million shares. The amendment and restatement was approved by the Company's stockholders at the Annual Meeting held on May 4, 2006. Note 2 - Commitments and Contingencies The Company is involved in certain litigation as a result of claims that arose in the ordinary course of business, which management believes will not have a material adverse effect on the Company's financial position or results of operations. Additionally, the Company may realize the benefit of legal claims and litigation in the future; these gain contingencies are not recognized in the Condensed Consolidated Financial Statements. Beginning in September 2004, the Company has been named as a defendant in several purported class action complaints brought by direct and indirect purchasers alleging anticompetitive activities with respect to the sale of copper tubes in the United States (the Copper Tube Actions). Two such purported class actions were filed in the United States District Court for the Western District of Tennessee (the Federal Actions). The remaining Copper Tube Actions were filed in state courts in Tennessee, California and Massachusetts. Certain of the Copper Tube Actions purport to address the sale of copper plumbing tube in particular. Plaintiffs' motions to consolidate the Federal Actions and the actions pending in California state court, respectively, have been granted. All of the Copper Tube Actions, which are similar, seek monetary and other relief. Wholly owned Company subsidiaries, WTC Holding Company, Inc., Deno Holding Company, Inc., and Mueller Europe Ltd. (Mueller Europe), are named in all of the Copper Tube Actions, and Deno Acquisition Eurl is named in two of the Copper Tube Actions. The claims against WTC Holding Company, Inc. and Deno Holding Company Inc. have been dismissed without prejudice in the Copper Tube Actions pending in California and Massachusetts state court. -14- Motions to dismiss the Federal Actions for failure to state a claim have been denied as to WTC Holding Company, Inc., Deno Holding Company, Inc. and the Company. Mueller Europe's motion to dismiss the Federal Actions for lack of personal jurisdiction and on other grounds is pending. The Company's demurrer to the complaint and the Company's motion to dismiss for failure to state a claim are pending in the state court actions filed in California and Tennessee, respectively. The Company has not yet been required to respond to the complaint in the action pending in Massachusetts state court. Mueller Europe has not yet been required to respond to the complaints in any of the state court actions pending in Tennessee, California or Massachusetts. The Company believes that the claims for relief in the Copper Tube Actions are without merit and intends to defend the Copper Tube Actions vigorously. In March 2006, the Company and Mueller Europe were named in a complaint brought by Carrier Corporation, Carrier S.A., and Carrier Italia S.p.A. alleging anticompetitive activities with respect to the sale of copper tubes used in the manufacturing of air-conditioning and refrigeration units (ACR copper tubes) in the United States and elsewhere (the Carrier Action). The Carrier Action was filed in United States District Court for the Western District of Tennessee. Neither the Company nor Mueller Europe has yet been required to respond to the complaint in the Carrier Action. In addition, beginning in April 2006, the Company has been named as a defendant in several purported class actions lawsuits brought by direct and indirect purchasers also alleging anticompetitive activities with respect to the sale of ACR copper tubes in the United States and elsewhere (the ACR Class Actions, and with the Carrier Action, the ACR Actions). Mueller Europe is named in all of the ACR Class Actions. One of the ACR Class Actions was filed in United States District Court for the Northern District of California, while the remaining ACR Class Actions were filed in the United States District Court for the Western District of Tennessee. Plaintiffs' motion to consolidate the ACR Class Actions brought by direct purchasers in the Western District of Tennessee has been granted. All of the ACR Actions seek monetary and other relief. Neither the Company nor Mueller Europe has yet been required to respond to the complaints in any of the ACR Class Actions. The Company believes that the claims for relief in the ACR Actions are without merit and intends to defend the ACR Actions vigorously. Two of the Company's subsidiaries, Mueller Copper Tube Products Inc. and Mueller Copper Tube Company Inc., brought a lawsuit (the Price Manipulation Action) against J.P. Morgan Chase & Co. and Morgan Guaranty Trust Company of New York (collectively Morgan) to recover damages the Company believes it suffered on first purchases of copper cathode resulting from an alleged conspiracy to manipulate the price of copper cathode by Morgan (and certain of its predecessors and affiliates) and others in violation of the federal antitrust laws. The lawsuit was filed on June 12, 2003, in the U.S. District Court for the Western District of Wisconsin. The Company's lawsuit was consolidated with those of certain -15- other first purchasers of copper cathode and rod under the name In re Copper Antitrust Litigation. Although the Price Manipulation Action was dismissed by the district court on March 2, 2004, as barred by the statute of limitations, the U.S. Court of Appeals for the Seventh Circuit, on February 6, 2006, reversed the district court's decision in part and remanded the Price Manipulation Action for further proceedings in the district court. Although the Company is unable to predict the likely outcome of the Price Manipulation Action at this time, the Company is prosecuting the case vigorously, and intends to continue to do so in the future. In June 2006, the Canada Border Services Agency (CBSA) initiated an investigation into the alleged dumping of copper pipe fittings from the United States and from South Korea and the dumping and subsidizing of these same goods from China. The Company and certain affiliated companies were identified by the CBSA as possible U.S. exporters and importers of these goods and requested to provide information to Canadian authorities. The Company is responding to the CBSA's requests for information regarding the investigation. The Company is aware of investigations of competition in markets in which it participates, or has participated in the past, in Europe and Canada. On September 22, 2005, the European Commission adopted a statement alleging infringements in Europe of competition rules by manufacturers of copper fittings and related companies, including the Company, WTC Holding Company, Inc., and Mueller Europe, for activities undertaken in Europe. The Company took the lead in bringing these issues to the attention of the European Commission and has fully cooperated in the resulting investigation from its inception. The Company does not anticipate any material adverse effect on its business or financial condition as a result of the matters discussed in this paragraph. The Company has assessed its risk and provided estimated accruals for various potential tax matters in a number of jurisdictions. Although the ultimate amount of the liabilities, if any, may vary, the Company believes it has adequate reserves for its assessed risk. Guarantees, in the form of letters of credit, are issued by the Company generally to guarantee the payment of insurance deductibles, retiree health benefits, and certain operating costs of a foreign subsidiary. The terms of the Company's guarantees are generally one year but are renewable annually as required. The maximum potential amount of future payments the Company could have been required to make under its guarantees at July 1, 2006 was $18.9 million. -16- Note 3 - Acquisitions and Investments In December 2005, two subsidiaries of the Company received a business license from a Chinese industry and commerce authority, establishing a joint venture with Jiangsu Xingrong Hi-Tech Co., Ltd. and Jiangsu Baiyang Industries Ltd. The joint venture, in which the Company holds a 50.5 percent interest, produces inner groove and smooth tube in level-wound coils, pancake coils, and straight lengths, primarily to serve the Chinese domestic OEM air-conditioning market as well as to complement the Company's U.S. product line. The joint venture is located primarily in Jintan City, Jiangsu Province, China. The joint venture entity is named Jiangsu Mueller-Xingrong Copper Industries Limited (Mueller-Xingrong). In December 2005, the Company contributed $7.0 million cash investment to the venture. During the first quarter of 2006 the Company contributed an additional $12.4 million, which completed its initial planned cash investment. Non-cash contributions from the other joint venture parties included long-lived assets of approximately $5.3 million in December 2005 and $8.5 million during the first quarter of 2006. The results of operations of this joint venture are reported in the OEM segment and are included in the Company's Condensed Consolidated Financial Statements from January 1, 2006. During the first quarter of 2006, Mueller-Xingrong had a temporary Bridge Loan Facility with two banks providing for secured borrowings of up to RMB 110 million, or $13.7 million USD, to fund working capital. On April 4, 2006, Mueller-Xingrong entered into a Credit Agreement with a syndicate of four banks establishing a secured RMB 320 million, or $39.9 million USD, revolving working capital credit facility (the JV Credit Facility) which matures in April 2007. Proceeds from the JV Credit Facility were used to pay-off amounts outstanding under the Bridge Loan Facility. Borrowings under the JV Credit Facility are secured by the real property and equipment of Mueller-Xingrong and bear interest at 98 percent of the latest base-lending rate published by the Peoples Bank of China (currently 5.2 percent). On August 15, 2005, the Company acquired 100 percent of the outstanding stock of KX Group LTD (Brassware). Brassware, located in Witton, Birmingham, England, is an import distributor of plumbing and residential heating products with historical annual sales of approximately $48.0 million to plumbers' merchants and builders' merchants in the U.K. and Ireland. The cost of the acquired business, including cash of $10.6 million plus $1.8 million of notes issued, totaled $12.4 million. The total estimated fair value of assets acquired was approximately $17.6 million, consisting primarily of receivables of $8.4 million, inventory of $6.4 million and property and equipment of $1.5 million. The total estimated fair value of liabilities assumed was approximately $16.4 million, consisting primarily of notes payable of $8.3 million and trade payables and other current liabilities of $8.1 million. The excess of the purchase price over the estimated fair value of assets acquired and liabilities assumed of $11.2 million was allocated to goodwill of the Plumbing & Refrigeration segment. This acquisition will broaden the Company's product line in the U.K. The acquisition was accounted for using the purchase method of accounting. Therefore, the results of operations of -17- the acquired business were included in the Company's Condensed Consolidated Financial Statements from its acquisition date. The purchase price, which was financed by available cash balances, has been allocated to the assets of the acquired business based on their respective fair market values. In April 2006, the Company sold its approximately 38 percent interest in Conbraco Industries, Inc. which had a net book value of approximately $21.1 million. Aggregate cash proceeds from the sale were approximately $23.0 million. This transaction resulted in a pre-tax gain of approximately $1.9 million. Note 4 - Industry Segments The Company's businesses are aggregated into two reportable segments: the Plumbing & Refrigeration segment and the OEM segment. Prior to the fourth quarter of 2005, the Company disclosed its reportable segments as Standard Products and Industrial Products. Additional operating segments have been recognized following an internal reorganization in 2005. For disclosure purposes, as permitted under SFAS No. 131 "Disclosures about Segments of an Enterprise and Related Information", certain operating segments are aggregated into reportable segments. The Plumbing & Refrigeration segment is composed of the Standard Products Division (SPD), the Trading Group, and European Operations. The OEM segment is composed of the Industrial Products Division (IPD) and the Engineered Products Division (EPD). These reportable segments are described in more detail below. SPD manufactures and sells copper tube, copper and plastic fittings, and valves in North America. European Operations manufactures copper tube in Europe, which is sold in Europe and the Middle East; activities also include import distribution. The Trading Group sources products for import distribution in North America. The Plumbing & Refrigeration segment sells products to wholesalers in the HVAC (heating, ventilation, and air-conditioning), plumbing, and refrigeration markets, to distributors to the manufactured housing and recreational vehicle industries, and to building material retailers. The OEM segment, through IPD, manufactures and sells brass and copper alloy rod, bar, and shapes; aluminum and brass forgings; and aluminum and copper impact extrusions; and through EPD, manufactures and sells refrigeration valves and fittings; fabricated tubular products; gas valves and assemblies; and commercial copper tube. The OEM segment sells its products primarily to original equipment manufacturers (OEMs), many of which are in the HVAC, plumbing, and refrigeration markets in the U.S., Mexico, and China. -18- Summarized segment information is as follows:
For the Quarter Ended July 1, July 2, 2006 2005 (In thousands) Net sales: Plumbing & Refrigeration $ 551,158 $ 302,435 OEM 242,128 110,958 Elimination of intersegment sales (13,623) (2,887) ---------- ---------- $ 779,663 $ 410,506 ========== ========== Operating income: Plumbing & Refrigeration $ 78,328 $ 23,150 OEM 21,511 7,306 Unallocated expenses (7,279) (5,160) ---------- ---------- $ 92,560 $ 25,296 ========== ========== Income before income taxes: Plumbing & Refrigeration $ 77,419 $ 23,260 OEM 19,029 7,339 Unallocated expenses (9,169) (6,082) ---------- ---------- $ 87,279 $ 24,517 ========== ==========
-19-
For the Six Months Ended July 1, July 2, 2006 2005 (In thousands) Net sales: Plumbing & Refrigeration $ 938,099 $ 596,332 OEM 410,100 222,283 Elimination of intersegment sales (17,497) (6,446) ---------- ---------- $ 1,330,702 $ 812,169 ========== ========== Operating income: Plumbing & Refrigeration $ 122,521 $ 47,777 OEM 32,464 13,840 Unallocated expenses (13,609) (9,115) ---------- ---------- $ 141,376 $ 52,502 ========== ========== Income before income taxes: Plumbing & Refrigeration $ 121,946 $ 48,142 OEM 29,584 13,888 Unallocated expenses (18,284) (14,697) ---------- ---------- $ 133,246 $ 47,333 ========== ==========
July 1, 2006 December 31, 2005 (In thousands) Segment assets: Plumbing & Refrigeration $ 816,915 $ 718,484 OEM 293,961 197,697 General corporate 208,625 188,457 ---------- ---------- $ 1,319,501 $ 1,104,638 ========== ==========
Operating income and income before income taxes for the OEM segment was reduced by a $3.9 million impairment charge during the six months ended July 2, 2005. The quarter and six month period ended July 1, 2006, includes the acquired operations of Brassware in the Plumbing & Refrigeration segment and Mueller-Xingrong in the OEM segment. -20- Note 5 - Comprehensive Income Comprehensive income is as follows:
For the Quarter Ended July 1, July 2, 2006 2005 (In thousands) Comprehensive income: Net income $ 58,750 $ 17,183 Other comprehensive income (loss): Foreign currency translation 5,645 (3,427) Minimum pension liability 4,315 - Change in the fair value of derivatives (53) (36) ---------- ---------- $ 68,657 $ 13,720 ========== ==========
For the Six Months Ended July 1, July 2, 2006 2005 (In thousands) Comprehensive income: Net income $ 92,115 $ 32,391 Other comprehensive income (loss): Foreign currency translation 5,901 (5,734) Minimum pension liability 4,315 - Change in the fair value of derivatives 103 92 ---------- ---------- $ 102,434 $ 26,749 ========== ==========
The change in cumulative foreign currency translation adjustment primarily relates to the Company's investment in its U.K. and Mexican subsidiaries and fluctuations in exchange rates between their local currencies and the U.S. dollar. During the first six months of 2006, the value of the British pound sterling increased 7.3 percent compared to the U.S. dollar and the value of the Mexican peso decreased 5.5 percent compared to the U.S. dollar. -21- Note 6 - Employee Benefits The Company sponsors several qualified and nonqualified pension plans and other postretirement benefit plans for certain of its employees. The net periodic benefit (income) cost is based on estimated values provided by independent actuaries. The components of net periodic benefit (income) cost are as follows:
For the Quarter Ended July 1, July 2, 2006 2005 (In thousands) Pension benefits: Service cost $ 422 $ 555 Interest cost 1,861 2,061 Expected return on plan assets (2,241) (2,613) Amortization of prior service cost 93 98 Amortization of net (gain) loss 106 (159) ---------- ---------- Net periodic benefit (income) cost $ 241 $ (58) ========== ========== Other benefits: Service cost $ 2 $ 1 Interest cost 160 162 Amortization of prior service cost 2 (2) Amortization of net loss 32 36 ---------- ---------- Net periodic benefit cost $ 196 $ 197 ========== ==========
-22-
For the Six Months Ended July 1, July 2, 2006 2005 (In thousands) Pension benefits: Service cost $ 949 $ 1,109 Interest cost 3,884 4,124 Expected return on plan assets (4,849) (4,937) Amortization of prior service cost 186 187 Amortization of net (gain) loss 418 (279) ---------- ---------- Net periodic benefit (income) cost $ 588 $ 204 ========== ========== Other benefits: Service cost $ 4 $ 2 Interest cost 318 324 Amortization of prior service cost 4 (4) Amortization of net loss 65 72 ---------- ---------- Net periodic benefit cost $ 391 $ 394 ========== ==========
The Company anticipates contributions to its pension plans for 2006 to be approximately $2.4 million. During the first six months of 2006, approximately $1.2 million of contributions have been made to certain pension plans. Note 7 - Environmental Reserves The Company is subject to normal environmental standards imposed by federal, state, local, and foreign environmental laws and regulations. At July 1, 2006, the Company had $9.0 million reserved for environmental remediation, post-closure monitoring, and related obligations. The Company periodically reassesses these amounts and estimates its obligations over the foreseeable future based upon results of ongoing remediation and monitoring programs, communications with regulatory agencies, and changes in environmental law. While additional costs are possible, the Company believes that its reserve is adequate and amounts beyond that are not reasonably estimable. Costs of estimated future expenditures for environmental remediation obligations are not discounted to their present value. Accrued environmental liabilities are not reduced by potential insurance reimbursements. Based upon information currently available, management believes that the outcome of pending environmental matters will not materially affect the overall financial position and results of operations of the Company. -23- Note 8 - Income Taxes The Company's effective tax rate for the second quarter of 2006 was 32.7 percent compared with 29.9 percent for the same period of last year. The current period rate was less than the expected federal rate due primarily to reductions to valuation allowances related to the U.K. net operating loss carryforwards of approximately $1.0 million, or $0.03 per diluted share, recognition of a benefit from U.S. manufacturer's deduction of $0.4 million, and recognition of a benefit of a foreign tax holiday of approximately $1.0 million. The Company's effective tax rate for the first six months of 2006 was 30.9 percent compared with 31.6 percent for the same period of last year. The current period rate was less than the expected federal rate due primarily to reductions to valuation allowances related to the U.K. net operating loss carryforwards of approximately $3.0 million, or $0.08 per diluted share, recognition of a benefit from U.S. manufacturer's deduction of $0.7 million, recognition of a benefit of a foreign tax holiday of approximately $1.0 million, and recognition of approximately $0.8 million benefit from the favorable resolution of an Internal Revenue Service audit of tax returns filed for 2002 and 2003. Note 9 - Other (expense) income, net
For the Quarter Ended July 1, July 2, 2006 2005 (In thousands) Interest income $ 1,003 $ 319 Gain on sale of equity investment 1,876 - Equity in earnings of unconsolidated subsidiary - 3,205 Gain on early retirement of debt 97 - Environmental expense (140) (145) Minority interest in income of subsidiaries (1,412) (7) Loss on disposal of properties, net (2,026) (364) Rent, royalties, and other 535 965 ---------- ---------- $ (67) $ 3,973 ========== ==========
-24-
For the Six Months Ended July 1, July 2, 2006 2005 (In thousands) Interest income $ 1,963 $ 705 Gain on sale of equity investment 1,876 - Equity in earnings of unconsolidated subsidiary 964 3,471 Gain on early retirement of debt 97 - Environmental expense (265) (290) Minority interest in income of subsidiaries (1,805) (7) Loss on disposal of properties, net (1,905) (457) Rent, royalties, and other 1,021 1,345 ---------- ---------- $ 1,946 $ 4,767 ========== ==========
Note 10 - Recently Issued Accounting Standards In June 2006, the Financial Accounting Standards Board issued Interpretation No. 48, "Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109" (FIN 48). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise's financial statements. It prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of tax positions taken or expected to be taken in a tax return. FIN 48 is effective for fiscal years beginning after December 15, 2006. The Company has not yet completed the process of evaluating what effect, if any, the adoption of FIN 48 will have on its consolidated statements of income or financial position. Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations General Overview The Company is a leading manufacturer of copper, brass, plastic, and aluminum products. The range of these products is broad: copper tube and fittings; brass and copper alloy rod, bar, and shapes; aluminum and brass forgings; aluminum and copper impact extrusions; plastic fittings and valves; refrigeration valves and fittings; and fabricated tubular products. The Company also resells imported brass and plastic plumbing valves, malleable iron fittings, steel nipples, faucets and plumbing specialty products. The Company's operations are located throughout the United States, and in Canada, Mexico, Great Britain, and China. -25- The Company's businesses are aggregated into two reportable segments: the Plumbing & Refrigeration segment and the OEM segment. Prior to the first quarter of 2005, the Company disclosed its reportable segments as Standard Products and Industrial Products. Additional operating segments have been recognized following an internal reorganization in 2005. For disclosure purposes, as permitted under SFAS No. 131 Disclosures about Segments of an Enterprise and Related Information, certain operating segments are aggregated into reportable segments. The Plumbing & Refrigeration segment is composed of the Standard Products Division (SPD), the Trading Group, and European Operations. The OEM segment is composed of the Industrial Products Division (IPD) and the Engineered Products Division (EPD). These reportable segments are described in more detail below. SPD manufactures and sells copper tube, copper and plastic fittings, and valves in North America. European Operations manufactures copper tube in Europe, which is sold in Europe and the Middle East; activities also include import distribution. The Trading Group sources products for import distribution in North America. The Plumbing & Refrigeration segment sells products to wholesalers in the HVAC (heating, ventilation, and air-conditioning), plumbing, and refrigeration markets, to distributors to the manufactured housing and recreational vehicle industries, and to building material retailers. The OEM segment, through IPD, manufactures and sells brass and copper alloy rod, bar, and shapes; aluminum and brass forgings; and aluminum and copper impact extrusions; and through EPD, manufactures and sells refrigeration valves and fittings; fabricated tubular products; gas valves and assemblies; and commercial copper tube. The OEM segment sells its products primarily to original equipment manufacturers (OEMs), many of which are in the HVAC, plumbing, and refrigeration markets in the U.S., Mexico, and China. New housing starts and commercial construction are important determinants of the Company's sales to the HVAC, refrigeration, and plumbing markets because the principal end use of a significant portion of the Company's 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. Profitability of certain of the Company's product lines depends upon the "spreads" between the cost of raw material and the selling prices of its completed products. The open market prices for copper cathode and scrap, for example, influence the selling price of copper tubing, a principal product manufactured by the Company. The Company attempts to minimize the effects on profitability from fluctuations in material costs by passing through these costs to its customers. The Company's earnings and cash flow are dependent upon these spreads that fluctuate based upon market conditions. -26- Earnings and profitability are also subject to market trends such as substitute products and imports. Plastic plumbing systems are the primary substitute product; these products represent an increasing share of consumption. Imports of copper tubing from Mexico have increased in recent years, although U.S. consumption is still predominantly supplied by U.S. manufacturers. The six-month period ended July 1, 2006 contained 26 weeks while the six-month period ended July 2, 2005 contained 27 weeks. Results of Operations During the second quarter of 2006, the Company's net sales were $779.7 million, which compares with net sales of $410.5 million over the same period of 2005. Net sales were $1.33 billion in the first half of 2006 compared with $812.2 million in the same period of 2005. The increase in net sales is attributable to higher selling prices, increased volumes and acquired businesses. The average price of copper was approximately 88 percent higher in the first half of 2006 compared with the same period of 2005. Businesses acquired in late 2005 contributed $92.3 million of sales in the first half of 2006. Cost of goods sold increased from $345.7 million in the second quarter of 2005 to $637.0 million in the same period of 2006. Cost of goods sold for the six months ended July 1, 2006 was $1.09 billion compared with $679.7 million for the first six months of 2005. The current year increase was attributable to higher material costs and increased volume. Gross profit increased to $142.6 million from $64.8 million in the second quarter and increased to $236.6 million from $132.5 for the six-month period due primarily to higher margins on copper tube, European operations, and Brass rod. The impact of rising raw material costs also significantly contributed to the gross profit improvement. Inventories valued using the LIFO method totaled $26.9 million at July 1, 2006 and $33.5 million at December 31, 2005. At July 1, 2006 and December 31, 2005, the approximate FIFO cost of such inventories was $124.2 million and $87.7 million, respectively. During the first six months of 2006, inventory quantities valued using the LIFO method declined. The Company expects to replenish these LIFO inventories during 2006 and as such, has not recognized the effect of liquidating LIFO layers. Selling, general, and administrative expense was $39.7 million for the second quarter of 2006 compared with $29.1 million for the same period of 2005. Year-to-date selling, general, and administrative expense was $74.6 million for 2006 compared with $59.5 million for the same period of 2005. The increase for the quarter and six months was primarily due to businesses acquired in second half of 2005 and increased incentive compensation including stock-based compensation. -27- For the second quarter of 2006, operating income at the Plumbing & Refrigeration segment was $78.3 million, which compares with $23.2 million in the same period of 2005. Year-to-date, 2006 operating income at the Plumbing & Refrigeration segment was $122.5 million, which compares with $47.8 million in the same period of 2005. The second quarter and six month increase are primarily attributable to better margins from copper tube, plastic fittings, and European operations including contributions from acquired businesses. Operating income at the OEM segment was $21.5 million in the second quarter of 2006 compared with $7.3 million in the second quarter of 2005. Year-to-date, 2006 operating income at the OEM segment was $32.5 million, which compares with $13.8 million in the same period of 2005. Improved profitability in the second quarter and first half of 2006 was due to (i) higher volumes in the brass rod business, (ii) contributions from Mueller-Xingrong, which reported total operating income of $3.3 million for the quarter and $4.1 million for the first half of 2006, and (iii) improvements in other product lines. Operating income for the first half of 2005 was reduced by a $3.9 million impairment charge. Interest expense for the second quarter of 2006 totaled $5.2 million, compared with $4.8 million for the same period of 2005. For the first half of 2006, interest expense was $10.1 million compared with $9.9 million for the same period of 2005. The increase in the second quarter and first half of 2006 is primarily attributable to increased borrowings at Mueller-Xingrong. Other (expense) income, net was $1.9 million for the first half of 2006 compared with $4.8 million for the same period of 2005. The current year decrease is primarily due to a decrease in earnings from unconsolidated subsidiary and elimination of minority interest in Mueller-Xingrong. In April 2006, the Company sold its approximately 38 percent interest in Conbraco Industries, Inc. which had a net book value of approximately $21.1 million. This transaction resulted in a pre-tax gain of approximately $1.9 million. Aggregate cash proceeds from the sale were approximately $23.0 million. The Company's effective tax rate for the first six months of 2006 was 30.9 percent compared with 31.6 percent for the same period of last year. The current period rate was less than the expected federal rate due primarily to reductions to valuation allowances related to the U.K. net operating loss carryforwards of approximately $3.0 million, or $0.08 per diluted share, recognition of a benefit from a U.S. manufacturer's deduction of $0.7 million, recognition of a benefit of a foreign tax holiday of approximately $1.0 million, and recognition of approximately $0.8 million benefit from the favorable resolution of an Internal Revenue Service audit of tax returns filed for 2002 and 2003. The Company's effective tax rate for the second quarter of 2006 was 32.7 percent compared with 29.9 percent for the same period of last year. The current period rate was less than the expected federal rate due primarily to reductions to valuation allowances primarily related to the U.K. net operating loss carryforwards of approximately $1.0 million, or $0.03 per diluted share, recognition of a benefit from U.S. manufacturer's deduction of $0.4 million, and recognition of a benefit of a foreign tax holiday of approximately $1.0 million. -28- Liquidity and Capital Resources Cash used in operating activities during the first half of 2006 totaled $14.9 million, which is primarily attributable to increased receivables of $162.6 million and increased inventories of $51.1 million, offset primarily by net income of $92.1 million, depreciation and amortization of $20.7 million, and increased current liabilities of $93.8 million. Fluctuations in the cost of copper and other raw materials affect the Company's liquidity. Changes in material costs directly impact components of working capital, primarily inventories and accounts receivable. During the first half of 2006, the average COMEX copper price was approximately $2.81 per pound, which represents an 88 percent increase over the average price during the first half of 2005. This rise in the price of cathode has also resulted in sharp increases in the open market price for copper scrap and, to a lesser extent, the price of brass scrap. During the first half of 2006, cash provided by investing activities was $5.9 million, consisting primarily of $23.2 million proceeds from the sale of properties including the equity interest in Conbraco Industries, Inc. partially offset by capital expenditures totaling $20.9 million. Cash provided by financing activities totaled $18.1 million for the first half of 2006 consisting primarily of issuance of debt to fund working capital of Mueller-Xingrong of $22.4 million and proceeds from the sale of treasury stock of $5.8 million, partially offset by payment of dividends of $7.4 million. Repayments of long-term debt totaled $3.4 million for the first half of 2006 which included $1.8 million of the Company's 6% Subordinated Debentures. The Company has a $150 million unsecured line-of-credit (Credit Facility) which expires in November 2007. At July 1, 2006, there were no outstanding borrowings under the Credit Facility. Approximately $18.8 million in letters of credit were backed by the Credit Facility at the end of the quarter. At July 1, 2006, the Company's total debt was $335.4 million or 39 percent of its total capitalization. Covenants contained in the Company's financing obligations require, among other things, the maintenance of minimum levels of working capital, tangible net worth, and debt service coverage ratios. At July 1, 2006, the Company was in compliance with all of its debt covenants. The Company declared and paid a regular quarterly cash dividend of ten cents per common share in the first and second quarters of 2006 and 2005. Payment of dividends in the future is dependent upon the Company's financial condition, cash flows, capital requirements, earnings, and other factors. On May 1, 2006, the Company made its semi- annual interest payment of approximately $9.0 million on its 6% Subordinated Debentures. Management believes that cash provided by operations and currently available cash of $138.9 million will be adequate to meet the Company's normal future capital expenditures and operational needs. The Company's current ratio was 2.3 to 1 at July 1, 2006. -29- The Company's Board of Directors has authorized the repurchase until October 2006 of up to ten million shares of the Company's common stock through open market transactions or through privately negotiated transactions. The Company has no obligation to purchase any shares and may cancel, suspend, or extend the time period for the purchase of shares at any time. The Company may hold any shares purchased in treasury or use a portion of the repurchased shares for employee benefit plans, as well as for other corporate purposes. Through July 1, 2006, the Company has repurchased approximately 2.4 million shares under this authorization. Additionally, the Company may repurchase its outstanding 6% Subordinated Debentures through open market transactions. Purchases of those securities, if any, will be funded primarily through existing cash and cash from operations. There have been no significant changes in the Company's contractual cash obligations reported at December 31, 2005, except the following. At December 31, 2005 the Company reported contractual supply commitments for raw materials consumed in the ordinary course of business totaling $327.3 million or $2.05 per pound. At July 1, 2006 the price per pound for the same raw materials was approximately $3.40. The increased price will affect cash outflows during the second half of 2006. Item 3. Quantitative and Qualitative Disclosures About Market Risk The Company is exposed to market risk from changes in raw material costs, energy costs, interest rates, and foreign currency exchange. To reduce such risks, the Company may periodically use financial instruments. All hedging transactions are authorized and executed pursuant to policies and procedures. Further, the Company does not buy or sell financial instruments for trading purposes. Cost and Availability of Raw Materials and Energy Adequate supplies of raw material have historically been available to the Company from primary producers, metal brokers, and scrap dealers. Sufficient energy in the form of natural gas, fuel oils, and electricity is available to operate the Company's production facilities. While temporary shortages of raw material and fuels may occur occasionally, to date they have not materially hampered the Company's operations. 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. Significant increases in the cost of metal, to the extent not reflected in prices for the Company's finished products, or the lack of availability could materially and adversely affect the Company's business, results of operations and financial condition. -30- The Company occasionally enters into forward fixed-price arrangements with certain customers. The Company may utilize forward contracts to hedge risks associated with forward fixed-price arrangements. The Company may also utilize forward contracts to manage price risk associated with inventory. Gains or losses with respect to these positions are deferred in stockholders' equity as a component of comprehensive income and reflected in earnings upon the sale of inventory. Periodic value fluctuations of the contracts generally offset the value fluctuations of the underlying fixed-price transactions or inventory. As of July 1, 2006, the Company held open forward contracts to purchase approximately $18.6 million of copper through December 2006. Futures contracts may also be used to manage price risk associated with natural gas purchases. Gains and losses with respect to these positions are deferred in stockholders' equity as a component of comprehensive income and reflected in earnings upon consumption of natural gas. Periodic value fluctuations of the contracts generally offset the value fluctuations of the underlying natural gas prices. At July 1, 2006, the Company had open forward contracts to purchase $1.0 million of natural gas through March 2007. The lack of availability of energy sources and the impact of rising energy prices could materially affect the Company's business, results of operations and financial condition. Interest Rates At July 1, 2006, the Company had variable rate debt outstanding of $25.3 million, the majority of which relates to the debt issued during the second quarter by Mueller-Xingrong which is discussed above. At these borrowing levels, a hypothetical 10 percent increase in interest rates would have had an insignificant unfavorable impact on the Company's pre-tax earnings and cash flows. The primary interest rate exposure on floating-rate debt is based on LIBOR and on the base-lending rate published by the People's Bank of China. Foreign Currency Exchange Rates Foreign currency exposures arising from transactions include firm commitments and anticipated transactions denominated in a currency other than an entity's functional currency. The Company and its subsidiaries generally enter into transactions denominated in their respective functional currencies. Foreign currency exposures arising from transactions denominated in currencies other than the functional currency are not material; however, the Company may utilize certain forward fixed-rate contracts to hedge such transactional exposures. Gains and losses with respect to these positions are deferred in stockholders' equity as a component of comprehensive income and reflected in earnings upon collection of receivables. At July 1, 2006, one of the Company's foreign subsidiaries had $4.9 million in open forward contracts to purchase U.S. dollars. -31- The Company's primary foreign currency exposure arises from foreign-denominated revenues and profits and their translation into U.S. dollars. The primary currencies to which the Company is exposed include the Canadian dollar, the British pound sterling, the Euro, and the Mexican peso. Additionally, with the investment in Mueller-Xingrong, the Company is exposed to the Chinese currency (RMB). The Company generally views as long-term its investments in foreign subsidiaries with a functional currency other than the U.S. dollar. As a result, the Company generally does not hedge these net investments. Item 4. Controls and Procedures Evaluation of Disclosure Controls and Procedures The Company maintains disclosure controls and procedures designed to ensure information required to be disclosed in Company reports filed under the Securities Exchange Act of 1934, as amended (the Exchange Act), is recorded, processed, summarized, and reported within the time periods specified in the Securities and Exchange Commission's rules and forms. Disclosure controls and procedures are designed to provide reasonable assurance that information required to be disclosed in Company reports filed under the Exchange Act is accumulated and communicated to management, including the Company's Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. The Company's management, with the participation of the Company's Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the Company's disclosure controls and procedures pursuant to Rule 13a-15(b) of the Exchange Act as of the end of the period covered by this report. Based on that evaluation, the Company's Chief Executive Officer and Chief Financial Officer have concluded that, because of the material weakness in internal controls related to the accounting for income taxes as described below, the Company's disclosure controls and procedures were not effective as of July 1, 2006. The Company's management, with the participation of the Company's Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the Company's internal control over financial reporting as of December 31, 2005 based on the control criteria established in a report entitled Internal Control-Integrated Framework, issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on such evaluation management determined that a material weakness related to the accounting for income taxes existed as of December 31, 2005. At July 1, 2006, management determined that the material weakness had not yet been remediated. -32- As defined by the Public Company Accounting Oversight Board's Auditing Standard No. 2, a material weakness in internal control is a significant deficiency, or combination of significant deficiencies, that results in more than a remote likelihood that a material misstatement of the financial statements would not be prevented or detected on a timely basis by the Company. The principal factors contributing to the material weakness in accounting for income taxes were (1) inadequate staffing and technical expertise within the Company's tax department, (2) ineffective review and approval practices, (3) inadequate processes to effectively reconcile income tax accounts, and (4) inadequate application of the provisions of SFAS No. 109 to tax planning strategies. These deficiencies resulted in adjustments to correct the Company's accounting for income taxes which were recorded prior to the issuance of the Consolidated Financial Statements as of and for the year ended December 31, 2005. These deficiencies, in the aggregate, were determined to be a material weakness. As a result of the aforementioned material weakness, management has concluded that the Company's internal control over financial reporting was not effective as of December 31, 2005. Management has also determined that the existence of the material weakness did not result in a material misstatement of the financial results reported for prior annual or interim periods. Changes in Internal Control over Financial Reporting Management is in the process of implementing additional procedures to enhance the controls surrounding accounting for income taxes. Specifically, management has begun to undertake the following actions intended to address the identified control weakness: * Evaluate current staffing resources; * Require additional education and training in prevailing accounting standards that govern income tax reporting for personnel involved in the preparation and review of income tax reporting matters; * Engage third-party experts to conduct an independent review and evaluation of the Company's process of accounting for and reporting of income taxes; and * Implement a standardized reporting system related to income tax reporting matters that will facilitate timely information gathering and analysis for all business units. As of July 1, 2006, selected members of the corporate accounting and tax departments have completed training courses in prevailing accounting standards that govern income tax reporting, a third-party expert has completed its initial review of the Company's process of accounting for and reporting of income taxes, although recommendations have not yet been implemented, and the corporate accounting department has increased its staffing. There were no changes in the Company's internal control over financial reporting during the Company's fiscal quarter ending July 1, 2006, that have materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting. However, as described above, the Company has begun to undertake changes in internal control over financial reporting to correct the material weakness related to the accounting for income taxes. -33- PART II. OTHER INFORMATION Item 1. Legal Proceedings General 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 or results of operations. Additionally, the Company may realize the benefit of legal claims and litigation in the future; these gain contingencies are not recognized in the Condensed Consolidated Financial Statements. Copper Tube Antitrust Litigation Beginning in September 2004, the Company has been named as a defendant in several purported class action complaints brought by direct and indirect purchasers alleging anticompetitive activities with respect to the sale of copper tubes in the United States (the Copper Tube Actions). Two such purported class actions were filed in the United States District Court for the Western District of Tennessee (the Federal Actions). The remaining Copper Tube Actions were filed in state courts in Tennessee, California and Massachusetts. Certain of the Copper Tube Actions purport to address the sale of copper plumbing tube in particular. Plaintiffs' motions to consolidate the Federal Actions and the actions pending in California state court, respectively, have been granted. All of the Copper Tube Actions, which are similar, seek monetary and other relief. Wholly owned Company subsidiaries, WTC Holding Company, Inc., Deno Holding Company, Inc., and Mueller Europe Ltd. (Mueller Europe), are named in all of the Copper Tube Actions, and Deno Acquisition Eurl is named in two of the Copper Tube Actions. The claims against WTC Holding Company, Inc. and Deno Holding Company Inc. have been dismissed without prejudice in the Copper Tube Actions pending in California and Massachusetts state court. Motions to dismiss the Federal Actions for failure to state a claim have been denied as to WTC Holding Company, Inc., Deno Holding Company, Inc. and the Company. Mueller Europe's motion to dismiss the Federal Actions for lack of personal jurisdiction and on other grounds is pending. The Company's demurrer to the complaint and the Company's motion to dismiss for failure to state a claim are pending in the state court actions filed in California and Tennessee, respectively. The Company has not yet been required to respond to the complaint in the action pending in Massachusetts state court. Mueller Europe has not yet been required to respond to the complaints in any of the state court actions pending in Tennessee, California or Massachusetts. The Company believes that the claims for relief in the Copper Tube Actions are without merit and intends to defend the Copper Tube Actions vigorously. -34- In March 2006, the Company and Mueller Europe were named in a complaint brought by Carrier Corporation, Carrier S.A., and Carrier Italia S.p.A. alleging anticompetitive activities with respect to the sale of copper tubes used in the manufacturing of air-conditioning and refrigeration units (ACR copper tubes) in the United States and elsewhere (the Carrier Action). The Carrier Action was filed in United States District Court for the Western District of Tennessee. Neither the Company nor Mueller Europe has yet been required to respond to the complaint in the Carrier Action. In addition, beginning in April 2006, the Company has been named as a defendant in several purported class actions lawsuits brought by direct and indirect purchasers also alleging anticompetitive activities with respect to the sale of ACR copper tubes in the United States and elsewhere (the ACR Class Actions, and with the Carrier Action, the ACR Actions). Mueller Europe is named in all of the ACR Class Actions. One of the ACR Class Actions was filed in United States District Court for the Northern District of California, while the remaining ACR Class Actions were filed in the United States District Court for the Western District of Tennessee. Plaintiffs' motion to consolidate the ACR Class Actions brought by direct purchasers in the Western District of Tennessee has been granted. All of the ACR Actions seek monetary and other relief. Neither the Company nor Mueller Europe has yet been required to respond to the complaints in any of the ACR Class Actions. The Company believes that the claims for relief in the ACR Actions are without merit and intends to defend the ACR Actions vigorously. Copper Price Manipulation Litigation Two of the Company's subsidiaries, Mueller Copper Tube Products Inc. and Mueller Copper Tube Company Inc., brought a lawsuit (the Price Manipulation Action) against J.P. Morgan Chase & Co. and Morgan Guaranty Trust Company of New York (collectively Morgan) to recover damages the Company believes it suffered on first purchases of copper cathode resulting from an alleged conspiracy to manipulate the price of copper cathode by Morgan (and certain of its predecessors and affiliates) and others in violation of the federal antitrust laws. The lawsuit was filed on June 12, 2003, in the U.S. District Court for the Western District of Wisconsin. The Company's lawsuit was consolidated with those of certain other first purchasers of copper cathode and rod under the name In re Copper Antitrust Litigation. Although the Price Manipulation Action was dismissed by the district court on March 2, 2004, as barred by the statute of limitations, the U.S. Court of Appeals for the Seventh Circuit, on February 6, 2006, reversed the district court's decision in part and remanded the Price Manipulation Action for further proceedings in the district court. Although the Company is unable to predict the likely outcome of the Price Manipulation Action at this time, the Company is prosecuting the case vigorously, and intends to continue to do so in the future. -35- Canadian Dumping and Countervail Investigation In June 2006, the Canada Border Services Agency (CBSA) initiated an investigation into the alleged dumping of copper pipe fittings from the United States and from South Korea and the dumping and subsidizing of these same goods from China. The Company and certain affiliated companies were identified by the CBSA as possible U.S. exporters and importers of these goods and requested to provide information to Canadian authorities. The Company is responding to the CBSA's requests for information regarding the investigation. Other Matters The Company is aware of investigations of competition in markets in which it participates, or has participated in the past, in Europe and Canada. On September 22, 2005, the European Commission adopted a statement alleging infringements in Europe of competition rules by manufacturers of copper fittings and related companies, including the Company, WTC Holding Company, Inc., and Mueller Europe, for activities undertaken in Europe. The Company took the lead in bringing these issues to the attention of the European Commission and has fully cooperated in the resulting investigation from its inception. The Company does not anticipate any material adverse effect on its business or financial condition as a result of the matters discussed in this paragraph. Item 2. Unregistered Sales of Equity Securities and Use of Proceeds Issuer Purchases of Equity Securities The Company's Board of Directors has authorized the repurchase, until October 2006, of up to ten million shares of the Company's Common Stock through open market transactions or through privately negotiated transactions. The Company has no obligation to purchase any shares and may cancel, suspend, or extend the time period for the purchase of shares at any time. Any purchases will be funded primarily through existing cash and cash from operations. The Company may hold any shares purchased in treasury or use a portion of the repurchased shares for employee benefit plans, as well as for other corporate purposes. Through July 1, 2006, the Company had repurchased approximately 2.4 million shares under this authorization. Below is a summary of the Company's stock repurchases for the quarterly period ended July 1, 2006. -36-
(a) (b) (c) (d) Total Number of Maximum Shares Number of Purchased Shares that as Part of May Yet Be Total Publicly Purchased Number of Average Announced Under the Shares Price Paid Plans or Plans or Purchased per Share Programs Programs 7,647,030(1) April 2 - April 29, 2006 - $ - April 30 - May 27, 2006 - - May 28 - July 1, 2006 249(2) 31.60 (1) Shares available to be purchased under the Company's 10 million share repurchase authorization until October 2006. This repurchase plan was announced on October 27, 2005. (2) Shares tendered to the Company by employee stock option holders in payment of the option purchase price and/or withholding taxes upon exercise.
Item 4. Submission of Matters to a Vote of Security Holders On May 4, 2006, the Company held its Annual Meeting of Stockholders at which three proposals were voted upon: (i) the election of directors, (ii) the approval of the amendment and restatement of the Company's 2002 Stock Option Plan and (iii) the approval of the appointment of independent auditors. The following persons were duly elected to serve, subject to the Company's Bylaws, as Directors of the Company until the next Annual Meeting, or until election and qualification of their successors: Votes in Favor Votes Withheld Alexander P. Federbush 32,977,534 1,066,755 Gennaro J. Fulvio 32,977,634 1,066,655 Gary S. Gladstein 32,276,209 1,768,080 Terry Hermanson 32,990,145 1,054,144 Robert B. Hodes 28,729,845 5,314,444 Harvey L. Karp 32,655,632 1,388,657 William D. O'Hagan 32,658,528 1,385,761 The proposal to approve the amendment and restatement of the Company's 2002 Stock Option Plan was ratified by 29,277,127 votes in favor, 1,151,894 votes against, 87,680 votes abstaining, and 3,527,588 broker non-votes. -37- The proposal to approve the appointment of Ernst & Young LLP as the Company's independent registered public accounting firm was ratified by 33,601,587 votes in favor, 428,416 votes against, and 10,886 votes abstaining. Item 6. Exhibits 10.1 Mueller Industries, Inc. 2002 Stock Option Plan (Amended and Restated as of February 16, 2006) (Incorporated herein by reference to Exhibit 10.1 of the Registrant's Current Report on Form 8-K dated May 10, 2006). 19.1 Mueller Industries, Inc.'s Quarterly Report to Stockholders for the quarter ended July 1, 2006. Such report is being furnished for the information of the Securities and Exchange Commission only and is not to be deemed filed as part of this Quarterly Report on Form 10-Q. 31.1 Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 31.2 Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 32.1 Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 32.2 Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. Items 1A, 3, and 5 are not applicable and have been omitted. -38- SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. MUELLER INDUSTRIES, INC. July 28, 2006 /S/ KENT A. MCKEE Date Kent A. McKee Executive Vice President and Chief Financial Officer July 28, 2006 /S/ RICHARD W. CORMAN Date Richard W. Corman Vice President - Controller -39- EXHIBIT INDEX Exhibits Description 19.1 Mueller Industries, Inc.'s Quarterly Report to Stockholders for the quarter ended July 1, 2006. Such report is being furnished for the information of the Securities and Exchange Commission only and is not to be deemed filed as part of this Quarterly Report on Form 10-Q. 31.1 Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 31.2 Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 32.1 Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 32.2 Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. -40-