NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE MONTHS ENDED
DECEMBER 31, 2017
Mueller Water Products, Inc., a Delaware corporation, together with its consolidated subsidiaries, operates in
two
business segments: Infrastructure and Technologies. Infrastructure manufactures valves for water and gas systems, including butterfly, iron gate, tapping, check, knife, plug and ball valves, as well as dry-barrel and wet-barrel fire hydrants. Technologies offers metering systems, leak detection, pipe condition assessment and other related products and services. The “Company,” “we,” “us” or “our” refer to Mueller Water Products, Inc. and its subsidiaries. With regard to the Company’s segments, “we,” “us” or “our” may also refer to the segment being discussed.
On January 6, 2017, we sold our former Anvil segment. Amounts applicable to Anvil have been classified as discontinued operations.
Infrastructure owns a
49%
ownership interest in an industrial valve joint venture. Due to substantive control features in the operating agreement, all of the joint venture's assets, liabilities and results of operations are included in our consolidated financial statements. The net loss attributable to noncontrolling interest is included in selling, general and administrative expenses. Noncontrolling interest is recorded at its carrying value, which approximates fair value.
Unless the context indicates otherwise, whenever we refer to a particular year, we mean our fiscal year ended or ending September 30 in that particular calendar year.
Our consolidated financial statements are prepared in conformity with accounting principles generally accepted in the United States of America (“GAAP”), which require us to make certain estimates and assumptions that affect the reported amounts of assets, liabilities, sales and expenses and the disclosure of contingent assets and liabilities for the reporting periods. Actual results could differ from those estimates. All significant intercompany balances and transactions have been eliminated. These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements included in our Annual Report on Form 10-K for the year ended
September 30, 2017
. In our opinion, all normal and recurring adjustments that we consider necessary for a fair financial statement presentation have been made. Certain reclassifications have been made to previously reported amounts to conform to the current presentation. The condensed consolidated balance sheet data at
September 30, 2017
was derived from audited financial statements, but does not include all disclosures required by GAAP.
On October 1, 2017, we adopted Financial Accountings Standards Board
Accounting Standards Update No. 2017-07,
which requires us to exclude from operating income the components of net periodic benefit cost other than service cost. Accordingly, in the Condensed Consolidated Statement of Operations for the three months ended December 31, 2016, we have reclassified
$0.2 million
from selling, general and administrative expenses and
$0.1 million
from cost of sales to pension costs other than service.
On February 15, 2017, we acquired Singer Valve. Singer had net sales of
$3.7 million
in the quarter ended December 31, 2017 and is included in Infrastructure.
HR-1, formerly referred to as the Tax Cuts and Jobs Act, was enacted on December 22, 2017 and made significant revisions to federal income tax laws, including lowering the corporate income tax rate to
21%
from
35%
, effective January 1, 2018. The effects of these revisions are discussed in Note 3.
In May 2014, the Financial Accounting Standards Board (“FASB”) issued new guidance for the recognition of revenue and requiring additional financial statement disclosures. We plan to adopt this guidance using the modified retrospective transition method beginning in the first quarter of fiscal 2019. We have completed our initial scoping and are implementing a project plan to evaluate revenue recognition practices for each revenue stream against the new requirements, to consider changes to the terms of our sales contracts, and to design and implement processes to quantify the effects of necessary changes. This work is ongoing, but at this time, we do not expect the new guidance to materially impact our stockholders' equity, net sales or operating income.
On September 7, 2017, we announced a strategic reorganization plan designed to accelerate our product innovation and revenue growth. We have adopted a matrix management structure, where business teams have line and cross-functional responsibility for managing distinct product portfolios, and engineering, operations, sales and marketing and other functions are centralized to better align with business needs and generate greater efficiencies. Costs and expenses in the quarter ended
December 31, 2017
for this plan, included in strategic reorganization and other charges, were primarily personnel-related.
Activity in accrued restructuring, reported as part of other current liabilities, is presented below.
|
|
|
|
|
|
Three months ended
|
|
December 31, 2017
|
|
(in millions)
|
Beginning balance
|
$
|
3.3
|
|
Expense
|
2.3
|
|
Payments
|
(1.4
|
)
|
Ending balance
|
$
|
4.2
|
|
|
|
Note 2.
|
Discontinued Operations and Divestitures
|
On December 4, 2017, we sold an idle property in Burlington, New Jersey that had previously been a plant in our former U.S. Pipe segment and recorded a gain of
$9.0 million
on our Corporate segment. We received
$7.4 million
in cash, recorded net current assets of
$0.8 million
and conveyed plant, property and equipment with a net carrying value of
$0.4 million
, and the buyer assumed related environmental liabilities with a carrying value of
$1.2 million
.
On
January 6, 2017
, we sold our former Anvil segment to affiliates of One Equity Partners. The table below presents a summary of the operating results for the Anvil discontinued operations during the quarter ended
December 31, 2016
. These operating results do not reflect what they would have been had Anvil not been sold.
|
|
|
|
|
|
Three months ended
|
|
December 31, 2016
|
|
(in millions)
|
Net sales
|
$
|
83.1
|
|
Cost of sales
|
62.8
|
|
Gross profit
|
20.3
|
|
Operating expenses:
|
|
Selling, general and administrative
|
18.3
|
|
Other charges
|
0.2
|
|
Total operating expenses
|
18.5
|
|
Operating income
|
1.8
|
|
Income tax expense
|
0.5
|
|
Income from discontinued operations
|
$
|
1.3
|
|
On December 22, 2017, HR-1, formerly referred to as the Tax Cuts and Jobs Act (“Act”), was enacted, which made significant revisions to federal income tax laws, including lowering the corporate income tax rate to
21%
from
35%
effective January 1, 2018, overhauling the taxation of income earned outside the United States and eliminating or limiting certain deductions.
Our deferred tax assets and liabilities are provided at the enacted tax rates in effect when we expect to recognize the related tax expenses or benefits. The average of these rates varies slightly from year to year but historically has been approximately
39%
. With the legislation changing enacted rates taking place in the current quarter, we have remeasured our deferred tax items at an average rate of approximately
25%
. This resulted in a provisional income tax benefit of
$42.6 million
, which is subject to change, if necessary, as we continue to analyze certain aspects of the Act and refine our calculations. We do not expect changes to this amount to be material.
The Act also imposes a one-time transition tax on the undistributed, non-previously taxed, post-1986 foreign “earnings and profits” (as defined by the IRS) of certain U.S.-owned corporations. Determination of our transition tax liability requires us to calculate foreign earnings and profits going back to 1992, which in many cases requires information that is not readily available, and then to assess our historical overall foreign loss position and the applicability of certain foreign tax credits. We are gathering this information and completing these calculations, but we are unable at this time to reasonably estimate our transition tax liability, and therefore we have not recorded any amount for this tax at
December 31, 2017
.
In addition to the deferred tax remeasurement item discussed above, our income tax benefit includes federal income tax expense on our current period earnings at a full-year blended rate of
24.5%
, since the rate reduction in the Act is effective on January 1, 2018. The reconciliation between the U.S. federal statutory income tax rate and the effective tax rate is presented below.
|
|
|
|
|
|
|
|
Three months ended
|
|
December 31,
|
|
2017
|
|
2016
|
U.S. federal statutory income tax rate
|
24.5
|
%
|
|
35.0
|
%
|
Adjustments to reconcile to the effective tax rate:
|
|
|
|
State income taxes, net of federal benefit
|
4.3
|
|
|
3.9
|
|
Valuation allowance adjustment related to stock compensation
|
(5.7
|
)
|
|
—
|
|
Excess tax benefits related to stock compensation
|
(2.8
|
)
|
|
(7.6
|
)
|
Domestic production activities deduction
|
(1.6
|
)
|
|
(3.3
|
)
|
Tax credits
|
(0.9
|
)
|
|
(0.8
|
)
|
Other
|
0.5
|
|
|
0.8
|
|
|
18.3
|
%
|
|
28.0
|
%
|
Remeasurement of deferred taxes for change in rates
|
(278.4
|
)
|
|
—
|
|
Effective income tax rate
|
(260.1
|
)%
|
|
28.0
|
%
|
At
December 31, 2017
and
September 30, 2017
, the gross liabilities for unrecognized income tax benefits were
$3.1 million
and
$3.0 million
, respectively.
|
|
Note 4.
|
Borrowing Arrangements
|
The components of our long-term debt are presented below.
|
|
|
|
|
|
|
|
|
|
December 31,
|
|
September 30,
|
|
2017
|
|
2017
|
|
(in millions)
|
ABL Agreement
|
$
|
—
|
|
|
$
|
—
|
|
Term Loan
|
483.7
|
|
|
484.8
|
|
Other
|
1.7
|
|
|
1.7
|
|
|
485.4
|
|
|
486.5
|
|
Less deferred financing costs
|
5.5
|
|
|
5.9
|
|
Less current portion
|
5.6
|
|
|
5.6
|
|
Long-term debt
|
$
|
474.3
|
|
|
$
|
475.0
|
|
ABL Agreement
. At
December 31, 2017
, our asset based lending agreement (“ABL Agreement”) consisted of a revolving credit facility for up to
$225 million
of revolving credit borrowings, swing line loans and letters of credit. The ABL Agreement permits us to increase the size of the credit facility by an additional
$150 million
in certain circumstances subject to adequate borrowing base availability. We may borrow up to
$25 million
through swing line loans and may have up to
$60 million
of letters of credit outstanding.
Borrowings under the ABL Agreement bear interest at a floating rate equal to LIBOR, plus a margin ranging from
125
to
150
basis points, or a base rate, as defined in the ABL Agreement, plus a margin ranging from
25
to
50
basis points. At
December 31, 2017
, the applicable rate was LIBOR plus
125
basis points.
The ABL Agreement terminates on
July 13, 2021
. We pay a commitment fee for any unused borrowing capacity under the ABL Agreement of
25
basis points per annum. Our obligations under the ABL Agreement are secured by a first-priority perfected lien on all of our U.S. receivables and inventories, certain cash and other supporting obligations. Borrowings are not subject to any financial maintenance covenants unless excess availability is less than the greater of
$17.5 million
and
10%
of the Loan Cap as defined in the ABL Agreement. Excess availability based on
December 31, 2017
data, as reduced by outstanding letters of credit, swap contract liabilities and accrued fees and expenses of
$19.8 million
, was
$96.3 million
.
Term Loan
. On
November 25, 2014
, we entered into a
$500.0 million
senior secured term loan (“Term Loan”). The proceeds from the Term Loan, along with other cash, were used to prepay our 7.375% Senior Subordinated Notes and 8.75% Senior Unsecured Notes and to satisfy and discharge our obligations under the respective indentures.
The Term Loan accrues interest at a floating rate equal to LIBOR, subject to a floor of
0.75%
, plus
250
basis points. At
December 31, 2017
, the weighted-average effective interest rate was
4.60%
.
We may voluntarily repay amounts borrowed under the Term Loan at any time. The principal amount of the Term Loan is required to be repaid in quarterly installments of
$1.225 million
, with any remaining principal due on
November 25, 2021
. The Term Loan is guaranteed by substantially all of our U.S. subsidiaries and is secured by essentially all of our assets, although the ABL Agreement has a senior claim on certain collateral securing borrowings thereunder. The Term Loan is reported net of unamortized discount, which was
$1.4 million
at
December 31, 2017
. Based on quoted market prices, the outstanding Term Loan had a fair value of
$490 million
at
December 31, 2017
.
The Term Loan contains affirmative and negative operating covenants applicable to us and our restricted subsidiaries. We believe we were compliant with these covenants at
December 31, 2017
and expect to remain in compliance through
December 31,
2018
.
|
|
Note 5.
|
Derivative Financial Instruments
|
We are exposed to interest rate risk that we manage to some extent using derivative instruments. Under our April 2015 interest rate swap contracts, we receive interest calculated using 3-month LIBOR, subject to a floor of
0.75%
, and pay fixed interest at
2.341%
, on an aggregate notional amount of
$150.0 million
. These swap contracts effectively fix the cash interest rate on
$150.0 million
of our borrowings under the Term Loan at
4.841%
from
September 30, 2016
through
September 30, 2021
.
We have designated our interest rate swap contracts as cash flow hedges of our future interest payments and elected to apply the “shortcut” method of assessing hedge effectiveness. As a result, the gains and losses on the swap contracts are reported as a component of other comprehensive loss and are reclassified into interest expense as the related interest payments are made. During the quarters ended
December 31, 2017
and
December 31, 2016
, we included
$0.4 million
and
$0.6 million
of such interest expense in income from continuing operations, respectively.
The fair values of the swap contracts are presented below.
|
|
|
|
|
|
|
|
|
|
December 31,
|
|
September 30,
|
|
2017
|
|
2017
|
|
(in millions)
|
Interest rate swap contracts, designated as cash flow hedges:
|
|
|
|
Other current liabilities
|
$
|
0.7
|
|
|
$
|
1.2
|
|
Other noncurrent liabilities
|
0.2
|
|
|
1.3
|
|
|
$
|
0.9
|
|
|
$
|
2.5
|
|
|
|
|
|
Currency swap contracts, not designated as hedges:
|
|
|
|
Other noncurrent liabilities
|
$
|
1.3
|
|
|
$
|
1.3
|
|
The fair values and the classification of the fair values between current and noncurrent portions are based on calculated cash flows using publicly available interest rate forward rate yield curve information, but amounts due at the actual settlement dates are dependent on actual rates in effect at the settlement dates and may differ significantly from amounts shown above.
The components of net periodic benefit cost for our pension plans are presented below.
|
|
|
|
|
|
|
|
|
|
Three months ended
|
|
December 31,
|
|
2017
|
|
2016
|
|
(in millions)
|
Service cost
|
$
|
0.5
|
|
|
$
|
0.5
|
|
Pension costs other than service:
|
|
|
|
Interest cost
|
3.6
|
|
|
3.6
|
|
Expected return on plan assets
|
(4.2
|
)
|
|
(4.3
|
)
|
Amortization of actuarial net loss
|
0.8
|
|
|
1.0
|
|
|
0.2
|
|
|
0.3
|
|
Net periodic benefit cost
|
$
|
0.7
|
|
|
$
|
0.8
|
|
The amortization of actuarial losses, net of tax, is recorded as a component of other comprehensive loss.
|
|
Note 7.
|
Stock-based Compensation Plans
|
We have granted various forms of stock-based compensation, including stock options, restricted stock units and both cash-settled and stock-settled performance-based restricted stock units (“PRSUs”) under our Amended and Restated 2006 Mueller Water Products, Inc. Stock Incentive Plan (the “2006 Stock Plan”).
A PRSU award represents a target number of units that may be paid out at the end of a multi-year award cycle consisting of a series of annual performance periods coinciding with our fiscal years. After we determine the financial performance targets related to PRSUs for a given performance period, typically during the first quarter of that fiscal year, we consider that portion of a PRSU award to be granted. Thus, each award consists of a grant in the year of award and grants in the designated following years. Settlement will range from
zero
to
two
times the number of PRSUs granted, depending on our financial performance against the targets. As determined at the date of award, PRSUs may settle in cash-value equivalent of, or directly in, shares of our common stock.
We awarded
171,288
stock-settled PRSUs in the quarter ended
December 31, 2017
scheduled to settle in
three
years.
We issued
146,061
shares and
263,410
shares of common stock during the quarters ended December 31, 2017 and 2016, respectively, to settle PRSUs.
In addition to the PRSU activity,
213,532
restricted stock units vested during the quarter ended
December 31, 2017
.
We have granted cash-settled Phantom Plan instruments under the Mueller Water Products, Inc. Phantom Plan (“Phantom Plan”). At
December 31, 2017
, the outstanding Phantom Plan instruments had a fair value of
$12.53
per instrument and our liability for Phantom Plan instruments was
$1.2 million
.
We granted stock-based compensation awards under the 2006 Stock Plan, the Mueller Water Products, Inc. 2006 Employee Stock Purchase Plan and the Phantom Plan during the
three months ended
December 31, 2017
as follows.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Number granted
|
|
Weighted average grant date fair value per instrument
|
|
Total grant date fair value
(in millions)
|
Restricted stock units
|
|
171,288
|
|
|
$
|
12.41
|
|
|
$
|
2.1
|
|
Employee stock purchase plan instruments
|
|
35,099
|
|
|
2.28
|
|
|
0.1
|
|
Phantom Plan awards
|
|
160,672
|
|
|
12.41
|
|
|
2.0
|
|
PRSUs: 2018 award
|
|
57,092
|
|
|
12.41
|
|
|
0.7
|
|
2017 award
|
|
71,070
|
|
|
12.41
|
|
|
0.9
|
|
2016 award
|
|
71,072
|
|
|
12.41
|
|
|
0.9
|
|
|
|
|
|
|
|
$
|
6.7
|
|
Income from continuing operations included stock-based compensation expense of
$2.4 million
and
$2.7 million
during the three months ended
December 31, 2017
and
2016
, respectively. At
December 31, 2017
, there was approximately
$8.9 million
of unrecognized compensation expense related to stock-based compensation arrangements, and
185,270
PRSUs that have been awarded for the 2019 and 2020 performance periods, for which performance goals have not been set.
We excluded
70,996
and
323,010
of stock-based compensation instruments from the calculations of diluted earnings per share for the quarters ended
December 31, 2017
and
2016
, respectively, since their inclusion would have been antidilutive.
|
|
Note 8.
|
Supplemental Balance Sheet Information
|
Selected supplemental balance sheet information is presented below.
|
|
|
|
|
|
|
|
|
|
December 31,
|
|
September 30,
|
|
2017
|
|
2017
|
|
(in millions)
|
Inventories:
|
|
|
|
Purchased components and raw material
|
$
|
74.3
|
|
|
$
|
67.7
|
|
Work in process
|
37.8
|
|
|
35.6
|
|
Finished goods
|
43.1
|
|
|
35.6
|
|
|
$
|
155.2
|
|
|
$
|
138.9
|
|
|
|
|
|
Other current assets:
|
|
|
|
Maintenance and repair tooling
|
$
|
3.2
|
|
|
$
|
3.3
|
|
Income taxes
|
11.9
|
|
|
10.9
|
|
Other
|
11.4
|
|
|
10.2
|
|
|
$
|
26.5
|
|
|
$
|
24.4
|
|
|
|
|
|
Property, plant and equipment:
|
|
|
|
Land
|
$
|
5.5
|
|
|
$
|
5.6
|
|
Buildings
|
51.4
|
|
|
53.4
|
|
Machinery and equipment
|
270.0
|
|
|
266.7
|
|
Construction in progress
|
25.2
|
|
|
24.7
|
|
|
352.1
|
|
|
350.4
|
|
Accumulated depreciation
|
(229.8
|
)
|
|
(228.1
|
)
|
|
$
|
122.3
|
|
|
$
|
122.3
|
|
Other current liabilities:
|
|
|
|
Compensation and benefits
|
$
|
18.2
|
|
|
$
|
26.9
|
|
Customer rebates
|
8.1
|
|
|
6.5
|
|
Taxes other than income taxes
|
2.4
|
|
|
3.2
|
|
Warranty
|
3.7
|
|
|
3.5
|
|
Income taxes
|
0.8
|
|
|
0.9
|
|
Environmental
|
1.2
|
|
|
1.3
|
|
Interest
|
0.7
|
|
|
0.6
|
|
Restructuring
|
4.2
|
|
|
3.3
|
|
Other
|
6.8
|
|
|
7.3
|
|
|
$
|
46.1
|
|
|
$
|
53.5
|
|
|
|
Note 9.
|
Segment Information
|
Summarized financial information for our segments is presented below.
|
|
|
|
|
|
|
|
|
|
Three months ended
|
|
December 31,
|
|
2017
|
|
2016
|
|
(in millions)
|
Net sales, excluding intercompany:
|
|
|
|
Infrastructure
|
$
|
160.1
|
|
|
$
|
146.3
|
|
Technologies
|
18.2
|
|
|
20.9
|
|
|
$
|
178.3
|
|
|
$
|
167.2
|
|
Intercompany sales:
|
|
|
|
Infrastructure
|
$
|
—
|
|
|
$
|
1.1
|
|
Technologies
|
—
|
|
|
—
|
|
|
$
|
—
|
|
|
$
|
1.1
|
|
Operating income (loss):
|
|
|
|
Infrastructure
|
$
|
28.1
|
|
|
$
|
26.2
|
|
Technologies
|
(4.7
|
)
|
|
(2.2
|
)
|
Corporate
|
(2.7
|
)
|
|
(9.8
|
)
|
|
$
|
20.7
|
|
|
$
|
14.2
|
|
Depreciation and amortization:
|
|
|
|
Infrastructure
|
$
|
9.1
|
|
|
$
|
9.0
|
|
Technologies
|
1.4
|
|
|
1.2
|
|
Corporate
|
0.1
|
|
|
0.1
|
|
|
$
|
10.6
|
|
|
$
|
10.3
|
|
Strategic reorganization and other charges:
|
|
|
|
Infrastructure
|
$
|
—
|
|
|
$
|
0.1
|
|
Technologies
|
0.1
|
|
|
—
|
|
Corporate
|
3.8
|
|
|
1.2
|
|
|
$
|
3.9
|
|
|
$
|
1.3
|
|
Capital expenditures:
|
|
|
|
Infrastructure
|
$
|
4.8
|
|
|
$
|
3.0
|
|
Technologies
|
1.5
|
|
|
1.1
|
|
Corporate
|
0.1
|
|
|
0.1
|
|
|
$
|
6.4
|
|
|
$
|
4.2
|
|
|
|
Note 10.
|
Accumulated Other Comprehensive Loss
|
Accumulated other comprehensive loss is presented below.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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Pension, net of tax
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|
Foreign currency translation
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|
Derivative instruments, net of tax
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|
Total
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|
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Balance at September 30, 2017
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$
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(47.0
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)
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$
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(3.3
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)
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$
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(1.5
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)
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$
|
(51.8
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)
|
Current period other comprehensive income (loss)
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0.5
|
|
|
0.1
|
|
|
1.0
|
|
|
1.6
|
|
Balance at December 31, 2017
|
$
|
(46.5
|
)
|
|
$
|
(3.2
|
)
|
|
$
|
(0.5
|
)
|
|
$
|
(50.2
|
)
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|
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Note 11.
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Commitments and Contingencies
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We are involved in various legal proceedings that have arisen in the normal course of operations, including the proceedings summarized below. The effect of the outcome of these matters on our financial statements cannot be predicted with certainty as any such effect depends on the amount and timing of the resolution of such matters. Other than the litigation described below, we do not believe that any of our outstanding litigation would have a material adverse effect on our business or prospects.
Environmental.
We are subject to a wide variety of laws and regulations concerning the protection of the environment, both with respect to the operations at many of our properties and with respect to remediating environmental conditions that may exist at our own or other properties. We accrue for environmental expenses resulting from existing conditions that relate to past operations when the costs are probable and reasonably estimable.
In the acquisition agreement pursuant to which a predecessor to Tyco sold our businesses to a previous owner in August 1999, Tyco agreed to indemnify us and our affiliates, among other things, for all “Excluded Liabilities.” Excluded Liabilities include, among other things, substantially all liabilities relating to the time prior to August 1999, including environmental liabilities. The indemnity survives indefinitely. Tyco’s indemnity does not cover liabilities to the extent caused by us or the operation of our businesses after August 1999, nor does it cover liabilities arising with respect to businesses or sites acquired after August 1999. Since 2007, Tyco has engaged in multiple corporate restructurings, split-offs and divestitures. While none of these transactions directly affects the indemnification obligations of the Tyco indemnitors under the 1999 acquisition agreement, the result of such transactions is that the assets of, and control over, such Tyco indemnitors has changed. Should any of these Tyco indemnitors become financially unable or fail to comply with the terms of the indemnity, we may be responsible for such obligations or liabilities.
On July 13, 2010, Rohcan Investments Limited, the former owner of property leased by Mueller Canada Ltd. and located in Milton, Ontario, filed suit against Mueller Canada Ltd. and its directors seeking
C$10.0 million
in damages arising from the defendants’ alleged environmental contamination of the property and breach of lease. Mueller Canada Ltd. leased the property from 1988 through 2008. We are pursuing indemnification from a former owner for certain potential liabilities that are alleged in this lawsuit, and we have accrued for other liabilities not covered by indemnification. On December 7, 2011, the Court denied the plaintiff’s motion for summary judgment.
The purchaser of U.S. Pipe has been identified as a “potentially responsible party” (“PRP”) under the Comprehensive Environmental Response, Compensation and Liability Act (“CERCLA”) in connection with a former manufacturing facility operated by U.S. Pipe that was in the vicinity of a proposed Superfund site located in North Birmingham, Alabama. Under the terms of the acquisition agreement relating to our sale of U.S. Pipe, we agreed to indemnify the purchaser for certain environmental liabilities, including those arising out of the former manufacturing site in North Birmingham. Accordingly, the purchaser tendered the matter to us for indemnification, which we accepted. Ultimate liability for the site will depend on many factors that have not yet been determined, including the determination of EPA’s remediation costs, the number and financial viability of the other PRPs (there are four other PRPs currently) and the determination of the final allocation of the costs among the PRPs. Accordingly, because the amount of such costs cannot be reasonably estimated at this time, no amounts had been accrued for this matter at
December 31, 2017
.
Walter Energy
. Each member of the Walter Energy consolidated group, which included us through December 14, 2006, is jointly and severally liable for the federal income tax liability of each other member of the consolidated group for any year in which it is a member of the group at any time during such year. Accordingly, we could be liable in the event any such federal income tax liability is incurred, and not discharged, by any other member of the Walter Energy consolidated group for any period during which we were included in the Walter Energy consolidated group.
Walter Energy effectively controlled all of our tax decisions for periods during which we were a member of the Walter Energy consolidated group for federal income tax purposes and certain combined, consolidated or unitary state and local income tax groups. Under the terms of an income tax allocation agreement between us and Walter Energy, dated May 26, 2006, we generally compute our tax liability on a stand-alone basis, but Walter Energy has sole authority to respond to and conduct all tax proceedings (including tax audits) relating to our federal income and combined state tax returns, to file all such tax returns on our behalf and to determine the amount of our liability to (or entitlement to payment from) Walter Energy for such previous periods.
As described further below, the IRS is currently alleging that Walter Energy owes substantial amounts for prior taxable periods (specifically, 1983-1994, 2000-2002 and 2005). As a matter of law, we are jointly and severally liable for any final tax determination, which means we would be liable in the event Walter Energy is unable to pay any amounts owed.
In July 2015, Walter Energy filed a petition for reorganization under Chapter 11 of the U.S. Bankruptcy Code before the Bankruptcy Court for the Northern District of Alabama (“Chapter 11 Case”). During the pendency of the Chapter 11 Case, we monitored the proceeding to determine whether we could be liable for all or a portion of this federal income tax liability if it is incurred, and not discharged, for any period during which we were included in the Walter Energy consolidated group. On January 11, 2016, the IRS filed a proof of claim in the Chapter 11 Case, alleging that Walter Energy owes taxes, interest and penalties for the years 1983-1994, 2000-2002 and 2005 in an aggregate amount of
$554.3 million
(
$229.1 million
of which the IRS claims is entitled to priority status in the Chapter 11 Case). The IRS asserts that its claim is based on an alleged settlement of Walter Energy’s tax liability for the 1983-1995 taxable periods in connection with Walter Energy’s prior bankruptcy proceeding in the United States Bankruptcy Court for the Middle District of Florida. In the proof of claim, the IRS included an alternative calculation in the event the alleged settlement of the prior bankruptcy court is found to be non-binding, which provides for a claim by the IRS in an aggregate amount of
$860.4 million
(
$535.3 million
of which the IRS claims is entitled to priority status in the Chapter 11 Case).
According to a quarterly report on Form 10-Q filed by Walter Energy with the SEC on November 5, 2015 (“Walter November 2015 Filing”), at September 30, 2015, Walter Energy had
$33.0 million
of accruals for unrecognized tax benefits in connection with the matters subject to the IRS claims. In the Walter November 2015 Filing, Walter Energy stated it believed it had sufficient accruals to address any claims, including interest and penalties, and did not believe that any potential difference between any final settlements and amounts accrued would have a material effect on Walter Energy’s financial position, but such potential difference could be material to its results of operations in a future reporting period.
According to a Form 8-K filed by Walter Energy with the SEC on April 1, 2016 (“Walter April 2016 Filing”), on March 31, 2016, Walter Energy closed on the sale of substantially all of Walter Energy’s Alabama assets pursuant to the provisions of Sections 105, 363 and 365 of the Bankruptcy Code. The Walter April 2016 Filing further stated that Walter Energy would have no further material business operations after April 1, 2016 and Walter Energy was evaluating its options with respect to the wind down of its remaining assets. The asset sale did not impact the IRS’ proof of claim filed in the bankruptcy cases and the proof of claim, as well as the alleged tax liability thereunder, remain unresolved.
On February 2, 2017, at the request of Walter Energy, the Bankruptcy Court for the Northern District of Alabama signed an order converting the Chapter 11 Case to a liquidation proceeding under Chapter 7 of the U.S. Bankruptcy Code, pursuant to which Walter Energy will be wound-down and liquidated (“Chapter 7 Case”). In its objection contesting such conversion, the IRS indicated its intent to pursue collection of amounts included in the Proof of Claim from former members of the Walter Energy consolidated group.
We cannot predict whether or to what extent we may become liable for the tax-related amounts of the Walter Energy consolidated group asserted in the IRS’ proof of claim filed in the bankruptcy cases, in part, because: (i) the amounts owed by the Walter Energy consolidated group for certain of the taxable periods from 1980 through 2006 remain unresolved; (ii) it is unclear what priority, if any, the IRS will receive in the Chapter 7 Case with respect to its claims against Walter Energy, and whether and to what extent funds will be available in the Chapter 7 Case to pay priority tax claims. We also intend to vigorously assert any and all available defenses against any liability we may have as a member of the Walter Energy consolidated group. However, we cannot currently estimate our liability, if any, relating to the tax-related liabilities of Walter Energy’s consolidated tax group for tax years prior to 2007, and such liability could have a material adverse effect on our business, financial condition, liquidity or results of operations.
Indemnifications
. We are a party to contracts in which it is common for us to agree to indemnify third parties for certain liabilities that arise out of or relate to the subject matter of the contract. In some cases, this indemnity extends to related liabilities arising from the negligence of the indemnified parties, but usually excludes any liabilities caused by gross negligence or willful misconduct. We cannot estimate the potential amount of future payments under these indemnities until events arise that would trigger a liability under the indemnities.
Additionally, in connection with the sale of assets and the divestiture of businesses, such as the divestitures of U.S. Pipe and Anvil, we may agree to indemnify buyers and related parties for certain losses or liabilities incurred by these parties with respect to: (i) the representations and warranties made by us to these parties in connection with the sale and (ii) liabilities related to the pre-closing operations of the assets or business sold. Indemnities related to pre-closing operations generally include certain environmental and tax liabilities and other liabilities not assumed by these parties in the transaction.
Indemnities related to the pre-closing operations of sold assets or businesses normally do not represent additional liabilities to us, but simply serve to protect these parties from potential liability associated with our obligations existing at the time of the sale. As with any liability, we have accrued for those pre-closing obligations that are considered probable and reasonably estimable. Should circumstances change, increasing the likelihood of payments related to a specific indemnity, we will accrue a liability when future payment is probable and the amount is reasonably estimable.
Other Matters.
We are party to a number of lawsuits arising in the ordinary course of business, including product liability cases for products manufactured by us or third parties. We provide for costs relating to these matters when a loss is probable and the amount is reasonably estimable. Administrative costs related to these matters are expensed as incurred. The effect of the outcome of these matters on our future financial statements cannot be predicted with certainty as any such effect depends on the amount and timing of the resolution of such matters. While the results of litigation cannot be predicted with certainty, we believe that the final outcome of such other litigation is not likely to have a materially adverse effect on our business or prospects.
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Note 12.
|
Subsequent Events
|
On
January 24, 2018
, our board of directors declared a dividend of
$0.05
per share on our common stock, payable on or about
February 20, 2018
to stockholders of record at the close of business on
February 9, 2018
.