Edgar Filing: Mueller Water Products, Inc.

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

For the quarterly period ended March 31, 2007.

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

Commission File Number 333-131536

MUELLER WATER PRODUCTS, INC.

(Exact name of registrant as specified in its charter)

Delaware		20-3547095
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer identification No.)

1200 Abernathy Road
Atlanta, GA 30328

(Address of principal executive offices)

(770) 206-4200

(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 o

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.

Large Accelerated Filer o

Accelerated Filer o

Non-accelerated Filer x

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

There were 114,766,327 shares of common stock of the Registrant outstanding as of May 1, 2007, composed of 28,921,407 shares of Series A common stock and 85,844,920 shares of Series B common stock.

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

MUELLER WATER PRODUCTS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)

	March 31, 2007				September 30, 2006
	(dollars in millions)
Assets
Cash and cash equivalents		$	69.2			$	81.4
Receivables, net of allowance for doubtful accounts of $4.9 million and $4.8 million at March 31, 2007 and September 30, 2006, respectively		274.3				322.9
Inventories		510.8				454.6
Deferred income taxes		42.3				42.6
Prepaid expenses		35.7				33.7
Total current assets		932.3				935.2
Property, plant and equipment, net		343.7				337.0
Deferred financing fees and other long-term assets		13.7				16.8
Identifiable intangible assets, net		834.0				835.4
Goodwill		865.6				865.5
Total assets		$	2,989.3			$	2,989.9
Liabilities
Current portion of long-term debt		$	8.9			$	9.0
Accounts payable		115.4				129.9
Accrued expenses and other current liabilities		89.0				116.3
Total current liabilities		213.3				255.2
Long-term debt		1,119.5				1,118.3
Accrued pension liability, net		45.7				43.7
Accumulated postretirement benefits obligation		44.7				46.3
Deferred income taxes		284.1				278.5
Other long-term liabilities		20.9				20.9
Total liabilities		1,728.2				1,762.9
Shareholders’ Equity
Common stock, $0.01 par value per share:
Class A—400,000,000 shares authorized. 28,916,736 and 28,750,000 shares issued at March 31, 2007 and September 30, 2006, respectively		0.3				0.3
Class B—200,000,000 shares authorized and 85,844,920 shares issued at March 31, 2007 and September 30, 2006		0.8				0.8
Capital in excess of par value		1,418.7				1,417.5
Accumulated deficit		(138.1		)		(173.0		)
Accumulated other comprehensive loss		(20.6		)		(18.6		)
Total shareholders’ equity		1,261.1				1,227.0
Total liabilities and shareholders’ equity		$	2,989.3			$	2,989.9

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

MUELLER WATER PRODUCTS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)

	Three months ended March 31,
	2007		2006
	(dollars in millions)
Net sales	$	459.7	$	434.9
Cost of sales	341.9		340.3
Gross profit	117.8		94.6
Operating expenses:
Selling, general and administrative	64.9		60.8
Related party corporate charges	—		2.0
Facility rationalization, restructuring and related costs	—		4.3
Total operating expenses	64.9		67.1
Income from operations	52.9		27.5
Interest expense, net of interest income	21.1		30.1
Income (loss) before income taxes	31.8		(2.6		)
Income tax expense (benefit)	13.9		(0.8		)
Net income (loss)	$	17.9	$	(1.8	)
Basic and diluted income (loss) per share	$	0.16	$	(0.02	)

	Six months ended March 31,
	2007		2006
	(dollars in millions)
Net sales	$	871.6	$	915.3
Cost of sales	646.1		777.2
Gross profit	225.5		138.1
Operating expenses:
Selling, general and administrative	122.0		117.9
Related party corporate charges	1.6		3.8
Facility rationalization, restructuring and related costs	—		28.4
Total operating expenses	123.6		150.1
Income (loss) from operations	101.9		(12.0		)
Interest expense, net of interest income	41.5		62.3
Income (loss) before income taxes	60.4		(74.3		)
Income tax expense (benefit)	25.5		(23.7		)
Net income (loss)	$	34.9	$	(50.6	)
Basic and diluted income (loss) per share	$	0.30	$	(0.59	)

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

MUELLER WATER PRODUCTS, INC.
CONDENSED CONSOLIDATED STATEMENT OF SHAREHOLDER’S EQUITY
AND COMPREHENSIVE INCOME
FOR THE SIX MONTHS ENDED MARCH 31, 2007
(UNAUDITED)

	Common Stock			Capital in Excess of Par Value				Accumulated Deficit				Comprehensive Income			Accumulated Other Comprehensive Loss			Total
	(dollars in millions)
Balance at September 30, 2006		$	1.1		$	1,417.5			$	(173.0	)		$	—		$	(18.6)	$	1,227.0
Dividend paid, $0.0175 per share					(4.0		)											(4.0		)
Share-based compensation					5.2													5.2
Comprehensive income
Net income									34.9				34.9			—		34.9
Unrealized loss on derivative instruments													(0.8)			(0.8)		(0.8		)
Foreign currency translation adjustments													(1.2)			(1.2)		(1.2		)
Comprehensive income													$	32.9
Balance at March 31, 2007		$	1.1		$	1,418.7			$	(138.1	)					$	(20.6)	$	1,261.1

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

MUELLER WATER PRODUCTS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)

	Six months ended March 31,
	2007				2006
	(dollars in millions)
Operating Activities
Net income (loss)		$	34.9			$	(50.6	)
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Depreciation		35.0				34.4
Amortization of intangibles		14.5				13.6
Amortization of deferred financing fees		1.3				2.5
Accretion on debt		5.4				6.6
Share-based compensation expense		5.2				0.3
Impairments of property, plant and equipment		—				21.3
Provision (credit) for deferred income taxes		6.6				(26.1		)
Other, net		2.6				(0.8		)
Changes in assets and liabilities, net of the effects of acquisitions:
Receivables		53.1				23.4
Inventories		(50.8		)		62.1
Prepaid expenses and other current assets		(1.5		)		1.8
Pension and other long-term liabilities		0.1				3.5
Accrued expenses and other current liabilities		(49.7		)		(28.9		)
Net cash provided by operating activities		56.7				63.1
Investing Activities
Additions to property, plant and equipment		(42.5		)		(30.9		)
Acquisitions of businesses, net of cash acquired		(22.5		)		(15.5		)
Decrease in amounts due to Walter		—				(15.6		)
Net cash used in investing activities		(65.0		)		(62.0		)
Financing Activities
Increase in dollar value of bank checks outstanding		3.9				9.7
Proceeds from short-term borrowings		—				55.9
Retirement of short-term debt		—				(55.9		)
Proceeds from long-term debt		—				1,050.0
Retirement of long-term debt		(4.3		)		(617.9		)
Payment of deferred financing fees		—				(21.6		)
Dividend to shareholders		(4.0		)		(444.5		)
Dividend to Walter for acquisition costs		—				(12.0		)
Walter contribution of Predecessor Mueller’s cash		—				76.3
Net cash (used in) provided by financing activities		(4.4		)		40.0
Effect of exchange rate changes on cash		0.5				—
Net (decrease) increase in cash and cash equivalents		(12.2		)		41.1
Cash and cash equivalents at beginning of period		81.4				—
Cash and cash equivalents at end of period		$	69.2			$	41.1

MUELLER WATER PRODUCTS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
(UNAUDITED)

Schedule of non-cash investing and financing activities:

On October 3, 2005, the Company’s former parent, Walter Industries, Inc., purchased all the outstanding common stock of Predecessor Mueller in the Acquisition (as defined in Note 1. to the Condensed Consolidated Financial Statements).

	(dollars in millions)
Contribution of Predecessor Mueller by Walter		$	932.9
Less: Cash of Predecessor Mueller received		(76.3		)
Total net assets received excluding cash		$	856.6

Subsequent to the Acquisition, the Company’s former parent, Walter Industries, Inc., forgave an intercompany receivable with U.S. Pipe of $443.6 million.

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

MUELLER WATER PRODUCTS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
AS OF AND FOR THE THREE AND SIX MONTHS ENDED
MARCH 31, 2007 AND MARCH 31, 2006
(UNAUDITED)

Note 1. Organization

The registrant is Mueller Water Products, Inc., a Delaware corporation (“Mueller Water” or the “Company”). The Company is the surviving corporation of the merger on February 2, 2006 of Mueller Water Products, LLC (Commission File Number: 333-116590) and Mueller Water Products Co-Issuer, Inc. with and into Mueller Holding Company, Inc., a Delaware corporation. On June 1, 2006, Mueller Water completed its initial public offering of its Series A common stock (NYSE: MWA). On December 14, 2006, Walter Industries, Inc. (“Walter”), a diversified New York Stock Exchange traded company (NYSE:WLT), distributed all of the Company’s outstanding Series B common stock (NYSE: MWA.B) to its shareholders.

On October 3, 2005, through a series of transactions (the “Acquisition”), Walter, through a wholly-owned subsidiary, acquired all outstanding shares of capital stock of Mueller Water Products, Inc. (“Predecessor Mueller”), which immediately was converted into Mueller Water Products, LLC, a Delaware limited liability company, and contributed United States Pipe and Foundry Company, LLC (“U.S. Pipe”) to the acquired company. The results of operations of Predecessor Mueller are included in the Condensed Consolidated Statements of Operations beginning October 3, 2005.

The Company was originally organized as United States Pipe and Foundry Company, Inc. (“Inc.”) and was a wholly-owned subsidiary of Walter. On September 23, 2005, Inc. was dissolved, United States Pipe and Foundry Company, LLC was organized in the state of Alabama, and the operations of Inc. were conducted under the form of a limited liability company. The Company has three operating segments, which are named after its leading brands in each segment: Mueller Co., U.S. Pipe and Anvil.

The condensed consolidated financial statements are prepared in conformity with accounting principles generally accepted in the United States of America, which require management to make certain estimates and assumptions that affect the reported amounts of assets, liabilities, sales and expenses for the reporting periods. Actual results could differ from those estimates. All significant intercompany balances and transactions have been eliminated. In the opinion of management, all normal and recurring adjustments that are considered necessary for a fair financial statement presentation have been made. The condensed balance sheet data as of September 30, 2006 was derived from audited financial statements, but does not include all disclosures required by accounting principles generally accepted in the United States of America.

Note 2. Related Party Transactions

Related Party Transactions—The Company purchases foundry coke from Sloss Industries, Inc., which was an affiliate until December 14, 2006, for an amount that approximates the market value of comparable transactions. Costs included in cost of sales related to purchases from Sloss Industries, Inc. were $4.5 million and $5.4 million for the three months ended March 31, 2007 and 2006, respectively, and $9.0 million and $10.8 million for the six months ended March 31, 2007 and 2006, respectively.

Other services that Sloss Industries, Inc. provides to the Company include the delivery of electrical power to one of the Company’s facilities, rail car switching and the leasing of a distribution facility. Charges for such services were immaterial for the three months ended March 31, 2007, $0.4 million for the

three months ended March 31, 2006, and $0.3 million and $0.8 million for the six months ended March 31, 2007 and 2006, respectively.

Related Party Allocations—Certain costs incurred by Walter such as insurance, executive salaries, professional service fees, human resources, transportation, healthcare and other centralized business functions were allocated to its subsidiaries. Certain costs that were considered directly related to the U.S. Pipe segment were charged to the Company and included in selling, general and administrative expenses. As of December 15, 2006, Walter is no longer considered a related party. These costs were approximately $0.5 million, $0.6 million and $1.0 million for the six months ended March 31, 2007 and the three months and six months ended March 31, 2006, respectively. Costs incurred by Walter that could not be directly attributed to its subsidiaries were allocated based on estimated annual revenues. Such costs were allocated to the Company and are recorded as related party corporate charges in the accompanying Condensed Consolidated Statements of Operations. There were no charges during the three months ended March 31, 2007 and $2.0 million of such charges for the three months ended March 31, 2006. Allocated expenses were $1.6 million and $3.8 million for the six months ended March 31, 2007 and 2006, respectively. While the Company considers the allocation of such costs to be reasonable, the cost of performing such services on its own behalf may vary from historically allocated amounts.

Certain of the Company’s employees had been granted Walter restricted stock units and stock options under Walter’s share-based compensation plans. In connection with Walter’s distribution of all the Company’s Series B common stock to its shareholders on December 14, 2006, Walter cancelled these instruments. The Company had no expenses related to this share-based compensation allocated from Walter for the three months ended March 31, 2007 and expensed $0.2 million for the three months ended March 31, 2006, and $0.5 million and $0.2 million for the six months ended March 31, 2007 and 2006, respectively.

Note 3. Acquisitions

Fast Fabricators, Inc.

On January 4, 2007, the Company acquired the assets of Fast Fabricators, Inc., a ductile iron pipe fabricator headquartered in Bloomfield, Connecticut, for $22.5 million in cash, net of cash acquired. In March 2007, the Company accrued an additional amount due of $0.5 million based on the final net asset value, adjusting the purchase price to $23.0 million. This accrued amount was paid in April 2007. The purchase price may increase by up to $1.5 million for an earnout holdback. The earnout holdback will be settled by March 15, 2008, based on the 2007 calendar year EBITDA as defined in the purchase agreement with the seller. The Company has deposited $1.5 million into escrow, which is included in cash and cash equivalents in the accompanying Condensed Consolidated Balance Sheet, for the Earnout Holdback. The Company cannot access these funds until the earnout, if any, has been paid.

The estimated fair values of the assets acquired and liabilities assumed are as follows (dollars in millions):

Current assets	$	10.5
Identified intangibles	13.1
Goodwill	0.5
Plant, property, and equipment and other noncurrent assets	1.8
Accounts payable and accrued liabilities	(2.9		)
Net assets acquired	$	23.0

Acquisition of Predecessor Mueller by Walter Industries

On October 3, 2005, pursuant to the agreement dated June 17, 2005, Walter acquired all of the outstanding common stock of Predecessor Mueller for $944.0 million and assumed $1.05 billion of indebtedness. Predecessor Mueller was converted into a limited liability company on October 3, 2005 and was merged with and into the Company on February 2, 2006. In conjunction with the acquisition, U.S. Pipe was contributed in a series of transactions to Mueller Group, LLC (“Mueller Group” or “Group”), a wholly-owned subsidiary of the Company, on October 3, 2005. On February 23, 2006, Walter received $10.5 million based on the final closing cash and working capital, adjusting the purchase price to $933.5 million.

Walter’s acquisition of Predecessor Mueller has been accounted for as a business combination with U.S. Pipe considered the acquirer for accounting purposes. The total purchase price is comprised of (dollars in millions):

Acquisition of the outstanding common stock of Predecessor Mueller	$	918.1
Acquisition-related transaction costs	15.4
Total purchase price	$	933.5

Acquisition-related transaction costs include investment banking, legal and accounting fees and other external costs directly related to the Acquisition.

The excess of the purchase price over the net tangible and identifiable intangible assets is recorded as goodwill. Based on current fair values, the purchase price was allocated as follows (dollars in millions):

Receivables, net	$	177.4
Inventory	373.2
Property, plant and equipment	214.2
Identifiable intangible assets	856.9
Goodwill	801.7
Net other assets	350.7
Net deferred tax liabilities	(267.9		)
Debt	(1,572.7		)
Total purchase price allocation	$	933.5

Note 4. Facility Rationalization, Restructuring and Related Costs

On October 26, 2005 Walter announced plans to close U.S. Pipe’s Chattanooga, Tennessee plant and transfer the valve and hydrant production of that plant to Mueller Co.’s Chattanooga, Tennessee and Albertville, Alabama plants. The plant closed in 2006, resulting in the termination of approximately 340 employees. Exit costs totaled $49.9 million of which approximately $28.6 million was related to severance and fixed asset write-offs and qualified as restructuring and impairment charges. The remaining exit costs of $21.3 million were comprised of an inventory write-down totaling $11.4 million, a $9.0 million write-off of unabsorbed overhead costs and $0.9 million of other related costs, which were recognized in cost of sales during the year ended September 30, 2006. The Company paid $0.1 million and $0.4 million of the above-mentioned severance in the three and six months ended March 31, 2007, respectively.

On January 26, 2006, the Company announced the closure of the Henry Pratt valve manufacturing facility in Dixon, Illinois, which is included in the Company’s Mueller Co. segment. The eventual closure of the facility is expected to occur in fiscal year 2007, resulting in the termination of approximately 100 employees. Total estimated costs related to this closure are $3.7 million, including termination benefits of $1.0 million and property impairment charges of $1.7 million, which were recorded as adjustments to

goodwill in the year ended September 30, 2006. These restructuring costs were recorded to goodwill as the overall plan to close the facility was identified prior to the Acquisition. The remaining estimated costs of $1.0 million are for the transfer and installation of equipment and temporary outsourcing of manufacturing and will be expensed when incurred. The Company paid $0.1 million and $0.5 million of the above-mentioned severance in the three and six months ended March 31, 2007, respectively.

On November 18, 2006, the Company announced the relocation of pipe nipple and merchant coupling production in the Canvil manufacturing facility in Ontario, Canada to the Beck facility in Pennsylvania, both of which are included in the Company’s Anvil segment. The consolidation of these product lines in the Beck Facility was completed during the quarter ended March 31, 2007, resulting in the termination of approximately 60 employees. Termination benefits of $1.8 million were recorded as adjustments to goodwill in the year ended September 30, 2006. These restructuring costs were recorded to goodwill as the overall plan to close the facility was identified prior to the Acquisition. In the current fiscal year, the Company revised its severance estimate, and decreased the goodwill balance and accrued severance by $0.4 million. The Company paid $0.5 million of the above-mentioned severance in the three and six months ended March 31, 2007.

Activity in accrued restructuring and other severance for the three and six months ended March 31, 2007 was as follows (dollars in millions):

	For the three months ended March 31, 2007				For the six months ended March 31, 2007
Beginning balance		$	4.2			$	5.3
Adjustments to accruals allocated to goodwill for plant closures identified prior to the Acquisition		—				(0.4		)
Restructuring and other severance payments		(1.2		)		(1.9		)
Ending balance		$	3.0			$	3.0

Note 5. Share-Based Compensation Plans

Certain of the Company’s employees had been granted Walter restricted stock units and stock options under Walter’s share-based compensation plans. The Company has expensed $0.5 million related to the share-based compensation costs allocated from Walter for the six months ended March 31, 2007. In connection with Walter’s distribution of all the Company’s Series B common stock to its shareholders on December 14, 2006, Walter cancelled these outstanding instruments and the Company replaced them with restricted stock units and options to acquire shares of the Company’s Series A common stock. These equity awards were designed to provide intrinsic value and terms equal to the Walter cancelled instruments as follows:

	Number of instruments		Range of exercise prices		Weighted average exercise price			Total compensation
	(millions)							(dollars in millions)
Restricted stock units		0.4				$	14.95		$	5.7
Traditional stock options		0.5	$	2.05 – 20.56		13.45			0.6
		0.9							$	6.3

The Company also granted stock options and restricted stock units separately during the six months ended March 31, 2007 as follows:

	Number of instruments		Range of exercise prices		Weighted average fair value per instrument			Total compensation
	(millions)							(dollars in millions)
Restricted stock units		0.4				$	15.09		$	6.7
Traditional stock options		0.4	$	14.19-15.09		5.76			2.3
Employee stock purchase plan options		0.1				3.65			0.3
		0.9							$	9.3

As of March 31, 2007, there was approximately $28.1 million of unrecognized compensation cost related to non-vested share-based compensation arrangements granted under the 2006 Stock Incentive Plan, including the Walter replacement instruments described above. The Company expensed $2.7 million and $5.2 million related to share-based compensation for the three and six months ended March 31, 2007, respectively.

Note 6. Borrowing Arrangements

Long-Term Debt—Long-term debt consists of the following obligations:

	March 31, 2007				September 30, 2006
	(dollars in millions)
2005 Mueller Credit Agreement		$	789.7			$	793.8
Senior subordinated notes		214.2				215.1
Senior discount notes		122.6				116.3
Capital lease obligations		1.9				2.1
		1,128.4				1,127.3
Less current portion		(8.9		)		(9.0		)
		$	1,119.5			$	1,118.3

2005 Mueller Credit Agreement: On October 3, 2005, Group entered into a credit agreement (the “2005 Mueller Credit Agreement”) consisting of a $145 million senior secured revolving credit facility maturing in October 2010 (the “2005 Mueller Revolving Credit Facility”) and a $1,050 million senior secured term loan maturing in October 2012 (the “2005 Mueller Term Loan”). The commitment fee on the unused portion of the 2005 Mueller Revolving Credit Facility is 0.375% and the interest rate is a floating interest rate of 1.75% over LIBOR. The 2005 Mueller Term Loan carries a floating interest rate of 2.0% over LIBOR.

Senior Subordinated Notes: In April 2004, Group issued $315.0 million principal face amount of senior subordinated notes due 2012. The notes were recorded at fair value in connection with the Acquisition, resulting in an effective interest rate of 9.2%.

Senior Discount Notes: In April 2004, Predecessor Mueller issued $223.0 million principal face amount of senior discount notes due 2014. The notes were recorded at fair value in connection with the Acquisition, resulting in an effective interest rate of 12.1%.

Tender Offer—On May 1, 2007, the Company announced a cash tender offer to repurchase all of the outstanding Senior Subordinated Notes and Senior Discount Notes and consent solicitation to amend the related indentures in connection with the proposed refinancing of the 2005 Mueller Credit Agreement and issuance of $350 million of new Senior Subordinated Notes.

Note 7. Derivative Financial Instruments

Interest Rate Swaps—The Company uses interest rate swap contracts with a cumulative total notional amount of $425.0 million to hedge against cash-flow variability arising from changes in LIBOR rates in conjunction with its LIBOR-indexed variable rate borrowings. The Company recorded an unrealized loss from its swap contracts, net of tax, of $0.1 million at March 31, 2007 in accumulated other comprehensive income. These swaps have a fair value of $0.2 million at March 31, 2007, which is included in other long-term liabilities in the accompanying Condensed Consolidated Balance Sheet, and are accounted for as effective hedges.

Forward Foreign Currency Exchange Contracts—The Company uses Canadian dollar forward exchange contracts with a cumulative notional amount of $26.7 million to hedge against cash-flow variability arising from changes in the Canadian dollar-U.S. dollar exchange rate in connection with anticipated transactions, primarily inventory purchases denominated in Canadian dollars. These contracts are accounted for as effective hedges. The Company recorded an unrealized gain of $0.2 million, net of tax, from its forward exchange contracts at March 31, 2007. These forwards have a fair value of $0.3 million at March 31, 2007, which is included in deferred financing fees and other long-term assets in the accompanying Condensed Consolidated Balance Sheet.

The Company has also entered into Canadian dollar forward exchange contracts reducing the Company’s exposure to currency fluctuations from its Canadian-denominated intercompany loans. The instruments have a cumulative notional amount of $32.8 million. With these instruments, the Company sells Canadian dollars for U.S. dollars at a weighted average rate of $0.864. Gains and losses on these instruments are included in selling, general and administrative expenses in the accompanying Condensed Consolidated Statement of Operations. The Company recorded a net loss of $0.2 million and a net gain of $0.8 million for the three months and six months ended March 31, 2007, respectively. The Company entered into three Canadian dollar forward exchange contracts with a cumulative notional amount of $2.4 million to hedge against cash flow variability in connection with certain intercompany transactions that are not accounted for as effective hedges during the quarter ended March 31, 2007. These instruments have a weighted average translation rate of $0.819, expire in April and May 2007, and resulted in a loss of $0.1 million in the three and six month periods ended March 31, 2007 that is included in selling, general and administrative expenses in the accompanying Condensed Consolidated Statement of Operations.

Natural Gas Swaps—The Company uses natural gas swap contracts with a cumulative total notional amount of approximately 499,000 mmbtu to hedge against cash-flow variability arising from changes in natural gas prices on the NYMEX exchange in conjunction with its anticipated purchases of natural gas. These contracts fix the Company’s purchase price for natural gas at prices ranging from $6.67 to $7.56 per mmbtu for a total purchased volume of 499,000 mmbtu through September 30, 2007. The Company recorded an unrealized gain from its swap contracts, net of tax, of $0.2 million at March 31, 2007 in accumulated other comprehensive income. These swaps have a fair value of $0.3 million at March 31, 2007, which is included in deferred financing fees and other long-term assets in the accompanying Condensed Consolidated Balance Sheet, and are accounted for as effective hedges.

Note 8. Pension and Other Post-employment Benefits

The components of net periodic benefit cost for pension and post-employment benefits for the three months and six months ended March 31, 2007 and 2006 are as follows:

	Pension Benefits								Other Benefits
	For the three months ended March 31,								For the three months ended March 31,
	2007				2006				2007				2006
	(dollars in millions)
Components of net periodic benefit cost
Service cost		$	1.6			$	1.9			$	0.1			$	0.2
Interest cost		5.1				4.7				0.3				0.3
Expected return on plan assets		(5.9		)		(4.9		)		—				—
Amortization of prior service cost (credit)		0.1				0.2				(0.6		)		(0.6		)
Amortization of net loss (gain)		0.5				1.8				(0.4		)		(0.2		)
Curtailment settlement loss (gain)		—				4.9				—				(1.1		)
Net periodic benefit cost (credit)		$	1.4			$	8.6			$	(0.6	)		$	(1.4	)

	Pension Benefits								Other Benefits
	For the six months ended March 31,								For the six months ended March 31,
	2007				2006				2007				2006
	(dollars in millions)
Components of net periodic benefit cost
Service cost		$	3.2			$	3.9			$	0.2			$	0.4
Interest cost		10.2				9.4				0.6				0.6
Expected return on plan assets		(11.8		)		(9.8		)		—				—
Amortization of prior service cost (credit)		0.2				0.3				(1.2		)		(1.2		)
Amortization of net loss (gain)		1.0				3.7				(0.8		)		(0.4		)
Curtailment settlement loss (gain)		—				4.9				—				(1.1		)
Net periodic benefit cost (credit)		$	2.8			$	12.4			$	(1.2	)		$	(1.7	)

For the three months and six months ended March 31, 2007, the Company had no contributions to its pension plans. The Company presently anticipates contributing approximately $7.7 million to fund its pension plans and $2.0 million to its other post-employment benefit plan in fiscal 2007, and may make further discretionary payments.

Note 9. Supplementary Balance Sheet Information

Selected supplementary balance sheet information is presented below:

	March 31, 2007			September 30, 2006
	(dollars in millions)
Inventories
Purchased materials and manufactured parts		$	81.2		$	66.7
Work in process		128.2			127.7
Finished goods		301.4			260.2
		$	510.8		$	454.6

	March 31, 2007				September 30, 2006
	(dollars in millions)
Property, plant and equipment
Land		$	28.3			$	28.4
Buildings		85.3				83.4
Machinery and equipment		512.9				489.9
Other		59.0				46.4
		685.5				648.1
Accumulated depreciation		(341.8		)		(311.1		)
		$	343.7			$	337.0

	March 31, 2007			September 30, 2006
	(dollars in millions)
Accrued expenses and other current liabilities
Vacations and holidays		$	14.1		$	13.6
Workers compensation		5.8			6.0
Accrued payroll and bonus		13.5			23.5
Accrued sales commissions		4.4			5.0
Accrued other taxes		5.9			7.7
Accrued warranty claims		2.8			2.7
Accrued environmental claims		—			2.5
Accrued cash discounts and allowances		13.7			22.1
Accrued interest		13.9			13.6
Accrued restructuring and other severance		3.0			5.3
Accrued medical		4.2			3.7
Other		7.7			10.6
		$	89.0		$	116.3

Note 10. Supplementary Income Statement Information

The components of interest expense, net of interest income are presented below:

	Three months ended March 31,								Six months ended March 31,
	2007				2006				2007				2006
	(dollars in millions)
Interest expense, net of interest income
Contractual interest expense		$	21.9			$	29.4			$	43.7			$	58.6
Deferred financing fee amortization		0.6				1.3				1.3				2.5
Write-off of bridge loan commitment fees		—				—				—				2.5
Interest rate swap gains		(0.8		)		(0.1		)		(1.7		)		(0.5		)
Interest expense		21.7				30.6				43.3				63.1
Interest income		(0.6		)		(0.5		)		(1.8		)		(0.8		)
		$	21.1			$	30.1			$	41.5			$	62.3

Note 11. Income Taxes

The Company calculated its 2007 effective tax rate using Accounting Principles Board Opinion No. 28, which requires that an estimated annual effective tax rate be determined and applied to the pre-tax income. For the six months ended March 31, 2007, the Company determined its effective tax rate to be

42.2%. The tax rate for the six months ended March 31, 2006 was 31.9%. The difference between the federal, state, and foreign statutory tax rates and the effective tax rate is due primarily to non-deductible interest expense.

Note 12. Segment Information

	Three months ended March 31,								Six months ended March 31,
	2007				2006				2007				2006
	(dollars in millions)
Net sales
Mueller Co.		$	200.3			$	193.3			$	367.4			$	373.5
U.S. Pipe		133.3				119.7				250.7				290.8
Anvil		134.3				127.4				267.9				260.2
Consolidating eliminations		(8.2		)		(5.5		)		(14.4		)		(9.2		)
Consolidated		$	459.7			$	434.9			$	871.6			$	915.3
Income (loss) from operations
Mueller Co.		$	42.8			$	39.2			$	78.5			$	35.4
U.S. Pipe		6.8				(7.2		)		14.0				(35.0		)
Anvil		13.6				5.0				26.6				3.5
Corporate expense(1)		(10.3		)		(8.9		)		(17.2		)		(15.3		)
Consolidating eliminations		—				(0.6		)		—				(0.6		)
Consolidated		$	52.9			$	27.5			$	101.9			$	(12.0	)
Depreciation and amortization expense
Mueller Co.		$	13.0			$	12.9			$	25.7			$	24.9
U.S. Pipe		6.2				5.3				11.7				11.6
Anvil		5.7				5.9				11.6				11.3
Corporate		0.2				0.1				0.5				0.2
Consolidated		$	25.1			$	24.2			$	49.5			$	48.0
Capital expenditures
Mueller Co.		$	5.7			$	8.4			$	12.4			$	14.4
U.S. Pipe		12.1				3.1				19.9				10.5
Anvil		3.7				3.4				8.8				5.9
Corporate		1.0				—				1.4				0.1
Consolidated		$	22.5			$	14.9			$	42.5			$	30.9

(1) Includes certain expenses not allocated to segments.

Note 13. Commitments and Contingencies

Income Tax Litigation

A dispute exists with regard to federal income taxes for fiscal years 1980 through 1994 allegedly owed by the Walter consolidated group, which included the U.S. Pipe segment during these periods. It is estimated that the amount of tax presently claimed by the Internal Revenue Service is approximately $34.0 million for issues currently in dispute in bankruptcy court for matters unrelated to the Company. This amount is subject to interest and penalties. In addition, the IRS has issued a Notice of Proposed Deficiency assessing additional tax of $80.4 million for the fiscal years ended May 31, 2000, December 31, 2000 and December 31, 2001. As a matter of law, the Company is jointly and severally liable for any final tax determination. However, Walter management has indicated to the Company that they believe that

Walter’s tax filing positions have substantial merit and that they intend to defend vigorously any claims asserted. Walter management has further indicated to the Company that Walter has an accrual that they believe to be sufficient to cover the estimated probable loss, including interest and penalties. The Company has concluded the risk of loss to the Company is not probable and accordingly, no liability has been recorded in the Company’s condensed consolidated financial statements.

Environmental Matters

The Company is subject to a wide variety of laws and regulations concerning the protection of the environment, both with respect to the construction and operation of many of its plants and with respect to remediating environmental conditions that may exist at its own and other properties. The Company believes that it is in substantial compliance with federal, state and local environmental laws and regulations. The Company accrues for environmental expenses resulting from existing conditions that relate to past operations when the costs are probable and reasonably estimable.

Solutia Inc. and Pharmacia Corporation filed suit against U.S. Pipe and Walter on January 5, 2003 for contribution and cost recovery by Solutia with respect to costs incurred and to be incurred by Solutia in performing remediation of polychlorinated biphenyls (PCBs) and heavy metals mandated by the Environmental Protection Agency in Anniston, Alabama under an administrative consent order negotiated with the EPA (an “ACO”). The ACO provides protection against contribution claims by third parties, such as Solutia. The Magistrate has entered an Order staying discovery in this matter but has allowed Solutia to proceed with “on-site” sampling discovery. Management believes that the likelihood of liability in the contribution litigation is remote.

The Company and its U.S. Pipe subsidiary have been named in a purported civil class action case originally filed on April 8, 2005 in the Circuit Court of Calhoun County, Alabama, and removed to the U.S. District Court for the Northern District of Alabama under the Class Action Fairness Act. The putative plaintiffs in the case filed an amended complaint with the U.S. District Court on December 15, 2006. The case was filed against U.S. Pipe and other foundries in the Anniston, Alabama area alleging state law tort claims (negligence, failure to warn, wantonness, nuisance, trespass and outrage) arising from creation and disposal of “foundry sand” alleged to contain harmful levels of PCBs and other toxins, including arsenic, cadmium, chromium, lead and zinc. The plaintiffs are seeking damages for real and personal property damage and for other unspecified personal injury. Management believes this matter is still in early stages of litigation and no substantial discovery has taken place. In addition, management believes that both procedural and substantive defenses would likely be available should this class action be allowed to proceed. At present, management has no reasonable basis to form a view with respect to the probability of liability in this matter.

Although the Company now produces a small amount of no-lead brass products, most of the Company’s brass valve products contain approximately 5.0% lead. Environmental advocacy groups, relying on standards established by California’s Proposition 65, are seeking to eliminate or reduce the content of lead in water infrastructure products offered for sale in California. Some of the Company’s subsidiaries have entered into settlement agreements with these environmental advocacy groups to modify products or offer substitutes for sale in California. Legislation to substantially restrict lead content in water infrastructure products has been introduced in the United States Congress. Congress or state jurisdictions other than California may enact legislation similar to Proposition 65 to restrict the content of lead in water products, which could require the Company to incur additional capital expenditures to modify production. The Company incurred approximately $8.0 million in capital spending during the year ended September 30, 2006 to implement a no-lead brass production line. Also, the Company began consolidating its two existing brass foundries into one facility, incurring $5.8 million and $2.0 million in capital spending during the year ended September 30, 2006 and the six months ended March 31, 2007, respectively. The

Company expects to complete the foundry consolidation project during 2007 with total capital spending of approximately $11.0 million.

Commitments and Contingencies—Other

As part of the acquisition on January 15, 2004 of the business of Star Pipe, Inc. (“Star”), Anvil has agreed to a future payment to be made to the sellers of Star to the extent that the gross profit of the acquired business exceeds a targeted gross profit. The maximum potential payment amount is $23.0 million. The Company is in the process of determining the final settlement, and currently estimates the payment to be approximately $3.0 million for the payment period that began February 1, 2004 and ended January 31, 2007. The Company will record the liability for such payment upon the resolution of the contingency with a corresponding increase to goodwill.

Note 14. Subsequent Events

On April 30, 2007, the Company declared a quarterly dividend of $0.0175 per share of the Company’s Series A and Series B common stock, payable on May 21, 2007 to shareholders of record at the close of business on May 10, 2007.

On May 1, 2007, the Company announced a cash tender offer to repurchase all of the outstanding Senior Subordinated Notes and Senior Discount Notes consent solicitation to amend the related indentures in connection with the proposed refinancing of the 2005 Mueller Credit Agreement and issuance of $350 million of new Senior Subordinated Notes.

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion should be read in conjunction with the audited consolidated financial statements and notes thereto that appear in the Company’s Annual Report filed on Form 10-K and with the condensed consolidated financial statements that appear elsewhere in this quarterly report. This report contains certain statements that may be deemed “forward-looking statements” within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended. All statements, other than statements of historical fact, that address activities, events or developments that we or our management intends, expects, projects, believes or anticipates will or may occur in the future are forward-looking statements. Such statements are based upon certain assumptions and assessments made by our management in light of their experience and their perception of historical trends, current conditions and expected future developments. Actual results and the timing of events may differ significantly from those projected in such forward-looking statements due to a number of factors, including those set forth in the section entitled “Risk Factors” in Item 1A of Part II of this Report.

The registrant is Mueller Water Products, Inc., a Delaware corporation (“Mueller Water” or the “Company”). The Company is the surviving corporation of the merger on February 2, 2006 of Mueller Water Products, LLC (Commission File Number: 333-116590) and Mueller Water Products Co-Issuer, Inc. with and into Mueller Holding Company, Inc., a Delaware corporation. On June 1, 2006, Mueller Water completed its initial public offering of its Series A common stock (NYSE: MWA). On December 14, 2006, Walter Industries, Inc. (“Walter”), a diversified New York Stock Exchange traded company (NYSE: WLT), distributed all of the Company’s outstanding Series B common stock (NYSE: MWA.B) to Walter’s shareholders.

On October 3, 2005, through a series of transactions (the “Acquisition”), Walter, through a wholly-owned subsidiary, acquired all outstanding shares of capital stock of Mueller Water Products, Inc. (“Predecessor Mueller”), which immediately was converted into Mueller Water Products, LLC, a Delaware limited liability company and contributed United States Pipe and Foundry Company, LLC (“U.S. Pipe”) to the acquired company.

In this report, each of the terms “Mueller Water,” the “Company,” “we,” “us” or “our” refers to Mueller Water Products, Inc. and its subsidiaries, except where the context makes clear that the reference is only to Mueller Water Products, Inc. itself, and is not inclusive of its subsidiaries.

Except as otherwise noted, we present all financial and operating data on a fiscal year and fiscal quarter basis. Our fiscal year ends on September 30, and our second fiscal quarter ends on March 31.

Overview

The Company’s net income for the three months ended March 31, 2007 was $17.9 million, or $0.16 per diluted share, which compares to a net loss in the prior year period of $1.8 million, or a loss of $0.02 per diluted share. The prior year period includes U.S. Pipe Chattanooga plant closure costs of $6.7 million, pre-tax; expenses related to valuing the acquired inventory of Mueller Co. and Anvil segments at fair value at $12.0 million, pre-tax; and reduced interest expense from using the net cash proceeds received from the initial public offering in June 2006. In addition, increased net income for the quarter was also driven by higher selling prices across all segments, as well as achievements resulting from the synergy plan, improved product mix, and cost reduction initiatives at U.S. Pipe, but these items were partially offset by lower volumes. During the past twelve months, the Company has implemented selling price increases in response to higher raw material costs, most notably associated with both brass ingot, which is comprised primarily of copper, and scrap iron. The synergy plan, which includes certain plant closures and increased benefits from combining purchasing and commercial selling efforts of the segments, was started in January 2006. Synergy plan results for the current quarter include approximately $6.0 million of additional realized operating income benefits compared to the prior year period. The lower volumes principally relate to higher margin

water infrastructure products, such as hydrants and iron gate valves, as a result of softness in the residential construction market.

Management has identified the following significant developments, trends and factors that may impact our future results:

· The Company recently announced an increase in ductile iron pipe selling prices effective January 2007 of about 4%. The Company also announced an increase in valve and hydrant selling prices effective in February 2007 of approximately 5%. The Company has historically implemented price increases to alleviate rising raw material costs, but in certain market conditions the full amount of these increases may not be sustained.

· For the month of March 2007, new privately-owned housing unit starts declined 23% over March 2006. Approximately 40% of fiscal 2006 consolidated net sales were into residential construction end markets.

· Management believes the Company will benefit from projected spending increases in the water infrastructure repair and replacement market. The American Water Works Association forecasts that project repair and replacement spending will grow 11% in 2007. The Company’s U.S. Pipe segment public works quotation activity increased 18%, in tons, in fiscal 2007 compared to the prior year period.

· Subsequent to the spinoff of the Company from Walter, the Company is no longer subject to corporate expense allocations from Walter. Such charges totaled $1.6 million and $8.0 million for the six months ended March 31, 2007 and the year ended September 30, 2006, respectively, and were recorded as a component of U.S. Pipe segment operating results. However, the Company’s corporate segment expenses are expected to increase as the Company provides certain services previously provided by Walter. The corporate segment is expected to incur increased expenses in the future, primarily employee-related costs as staffing levels increase to replace the functionality previously provided by Walter, as well as increased audit costs related to Sarbanes-Oxley compliance, and other costs related to operating as a stand-alone public company.

· The Company’s synergy plan has achieved an annual operating income run-rate benefits of $45 million as of March 31, 2007 and is expected to be at the high end of a $40 million to $50 million annual range by early fiscal 2008. Further significant volume or price declines may impede the Company’s ability to maintain or exceed its current synergy run rates. The synergy plan also contemplates plant closures that have been announced for certain facilities. Costs related to these plant closures, which will eliminate fixed plant costs, are expected to reduce future operating income.

· During fiscal 2006, brass ingot costs rose from $1.60 per pound to approximately $3.00 per pound. Brass ingot costs have decreased slightly from prior year levels during the current fiscal year. Also, during the current quarter, scrap iron prices increased from approximately $237 per net ton to a high of $313 per net ton. These prices are expected to fluctuate based on marketplace demand.

· On May 1, 2007, the Company announced a cash tender offer to repurchase all of the outstanding Senior Subordinated Notes and Senior Discount Notes and a consent solicitation to amend the related indentures in connection with a proposed refinancing of the 2005 Mueller Credit Agreement and issuance of $350 million of new Senior Subordinated Notes. Annual interest expense is expected to decline after these actions are completed. Management expects these actions will be completed in the third quarter of fiscal 2007.

· During the remainder of the fiscal year the Company plans to reduce the buildup of inventory. In order to achieve this, the Company may need to reduce man-hours worked in its foundries, which could cause compression of gross margins if the manufactured cost of those products rise.

Results of Operations

Three Months Ended March 31, 2007 Compared to the Three Months Ended March 31, 2006

	Three months ended March 31,
	2007						2006						FY07 Q2 vs. FY06 Q2
				Percentage of net sales(1)						Percentage of net sales(1)			Increase/ (decrease)				Percentage increase/ (decrease)
	(dollars in millions)
Net sales
Mueller Co.	$	195.9			42.6	%	$	189.4			43.5	%		$	6.5			3.4	%
U.S. Pipe	129.7				28.2		118.2				27.2			11.5				9.7
Anvil	134.1				29.2		127.3				29.3			6.8				5.3
Consolidated	$	459.7			100.0		$	434.9			100.0			$	24.8			5.7
Gross profit
Mueller Co.	$	63.0			32.2		$	58.0			30.6			$	5.0			8.6
U.S. Pipe	17.6				13.6		9.4				8.0			8.2				87.2
Anvil	37.2				27.7		27.8				21.8			9.4				33.8
Consolidating eliminations	—				—		(0.6		)		(0.1	)		0.6				100.0
Consolidated	$	117.8			25.6		$	94.6			21.8			$	23.2			24.5
Selling, general and administrative
Mueller Co.	$	20.2			10.3		$	18.8			9.9			$	1.4			7.4
U.S. Pipe	10.8				8.3		10.3				8.7			0.5				4.9
Anvil	23.6				17.6		22.8				17.9			0.8				3.5
Corporate	10.3				2.2		8.9				2.0			1.4				15.7
Consolidated	$	64.9			14.1		$	60.8			14.0			$	4.1			6.7
Related party corporate charges
U.S. Pipe	$	—			—		$	2.0			1.7			$	(2.0	)		(100.0	)
Consolidated	$	—			—		$	2.0			0.5			$	(2.0	)		(100.0	)
Facility rationalization, restructuring and related costs
U.S. Pipe	$	—			—		$	4.3			3.6			$	(4.3	)		(100.0	)
Consolidated	$	—			—		$	4.3			1.0			$	(4.3	)		(100.0	)
Income (loss) from operations
Mueller Co.	$	42.8			21.8		$	39.2			20.7			$	3.6			9.2
U.S. Pipe	6.8				5.2		(7.2		)		(6.1	)		14.0				194.4
Anvil	13.6				10.1		5.0				3.9			8.6				172.0
Corporate	(10.3		)		(2.2	)	(8.9		)		(2.0	)		(1.4		)		(15.7	)
Consolidating eliminations	—				—		(0.6		)		(0.1	)		0.6				100.0
Consolidated	$	52.9			11.5		$	27.5			6.3			$	25.4			92.4
Interest expense, net of interest income	21.1				4.6		30.1				6.9			51.2				170.1
Income (loss) before income taxes	31.8				6.9		(2.6		)		(0.6	)		34.4				1,323.1
Income tax expense (benefit)	13.9				3.0		(0.8		)		(0.2	)		14.7				1,837.5
Net income (loss)	$	17.9