United Components 10Q 2006 Q1 Quarterly report

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

FORM 10-Q


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

For the quarterly period ended March 31, 2006


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

For the transition period from to

Commission File Number: 333-107219

UNITED COMPONENTS, INC.

(Exact Name of Registrant as Specified in Its Charter)


Delaware		04-3759857
(State or Other Jurisdiction of Incorporation or Organization)		(I.R.S. Employer Identification No.)

14601 Highway 41 North		47725
Evansville, Indiana		(Zip Code)
(Address of Principal Executive Offices)

(812) 867-4156
(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.

Yeso Noþ

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 filero Accelerated filero Non-accelerated filerþ

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yeso Noþ

The registrant had 1,000 shares of its $0.01 par value common stock outstanding as of May 4, 2006.

United Components, Inc.


Index

Part I		FINANCIAL INFORMATION

Item 1.		Financial Statements (unaudited)
		Condensed consolidated balance sheets — March 31, 2006 and December 31, 2005
		Condensed consolidated income statements — Three months ended March 31, 2006 and 2005
		Condensed consolidated statements of cash flows — Three months ended March 31, 2006 and 2005
		Condensed consolidated statements of changes in shareholder’s equity — Three months ended March 31, 2006 and 2005
		Notes to condensed consolidated financial statements

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

Item 3.		Quantitative and Qualitative Disclosures About Market Risk

Item 4.		Controls and Procedures

Part II		OTHER INFORMATION

Item 1.		Legal Proceedings

Item 1A.		Risk Factors

Item 2.		Unregistered Sales of Equity Securities and Use of Proceeds

Item 3.		Default Upon Senior Securities

Item 4.		Submission of Matters to Vote of Security Holders

Item 5.		Other Information

Item 6.		Exhibits

Signatures

Exhibits

PART I
FINANCIAL INFORMATION

Item 1. Financial Statements

United Components, Inc.

Condensed Consolidated Balance Sheets(unaudited)
(in thousands)


	March 31,			December 31,
	2006			2005
Assets

Current assets
Cash and cash equivalents	$	45,074		$	26,182
Accounts receivable, net		265,533			259,619
Inventories, net		184,476			183,186
Deferred tax assets		27,383			26,295
Other current assets		18,212			22,123

Total current assets		540,678			517,405

Property, plant and equipment, net		192,024			194,600
Goodwill		166,559			166,559
Other intangible assets, net		86,234			87,197
Deferred financing costs, net		5,854			6,177
Pension and other assets		13,002			12,904


Total assets	$	1,004,351		$	984,842


Liabilities and shareholder’s equity

Current liabilities
Accounts payable	$	118,724		$	109,912
Short-term borrowings		319			261
Current maturities of long-term debt		1			12
Accrued expenses and other current liabilities		101,721			96,064

Total current liabilities		220,765			206,249

Long-term debt, less current maturities		442,432			442,274
Pension and other postretirement liabilities		51,081			49,623
Deferred tax liabilities		2,382			4,380
Other long-term liabilities		1,306			1,970
Contingencies — Note H		—			—

Total liabilities		717,966			704,496


Shareholder’s equity
Common stock		—			—
Additional paid in capital		264,393			263,636
Retained earnings		22,299			17,546
Accumulated other comprehensive income (loss)		(307	)		(836	)

Total shareholder’s equity		286,385			280,346


Total liabilities and shareholder’s equity	$	1,004,351		$	984,842

The accompanying notes are an integral part of these statements.

United Components, Inc.

Condensed Consolidated Income Statements(unaudited)
(in thousands)


	Three Months ended March 31,
	2006			2005
Net sales	$	263,665		$	245,506
Cost of sales		209,515			199,420

Gross profit		54,150			46,086

Operating expenses
Selling and warehousing		18,923			18,263
General and administrative		14,537			12,419
Amortization of acquired intangible assets		1,383			1,532
Costs of closing facilities and consolidating operations — Note B		1,393			—


Operating income		17,914			13,872

Other income (expense)
Interest expense, net		(9,375	)		(8,772	)
Management fee expense		(500	)		(500	)
Miscellaneous, net		(77	)		(52	)


Income before income taxes		7,962			4,548
Income tax expense		3,209			1,819

Net income	$	4,753		$	2,729

The accompanying notes are an integral part of these statements.

United Components, Inc.

Condensed Consolidated Statements of Cash Flows(unaudited)
(in thousands)


	Three Months ended March 31,
	2006			2005
Cash flows from operating activities:
Net income	$	4,753		$	2,729
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization of other intangible assets		9,545			9,840
Amortization of deferred financing costs and debt issuance costs		481			493
Deferred income taxes		(3,435	)		595
Other non-cash, net		1,584			1,774
Changes in operating assets and liabilities
Accounts receivable		(5,752	)		(5,648	)
Inventories		(1,290	)		(5,002	)
Other current assets		(2,492	)		(1,918	)
Accounts payable		8,729			19,669
Accrued expenses and other current liabilities		12,060			2,589
Other assets		(99	)		(1,329	)
Other long-term liabilities		700			1,319


Net cash provided by operating activities		24,784			25,111

Cash flows from investing activities:
Capital expenditures		(6,479	)		(9,687	)
Proceeds from sale of property, plant and equipment		175			112


Net cash used in investing activities		(6,304	)		(9,575	)


Cash flows from financing activities:
Issuances of debt		58			39
Debt repayments		(11	)		(583	)
Shareholder’s equity contribution		340			600


Net cash provided by financing activities		387			56


Effect of exchange rate changes on cash		25			(127	)


Net increase in cash and cash equivalents		18,892			15,465

Cash and cash equivalents at beginning of year		26,182			11,291


Cash and cash equivalents at end of period	$	45,074		$	26,756

The accompanying notes are an integral part of these statements.

United Components, Inc.

Condensed Consolidated Statements of Changes in Shareholder’s Equity(unaudited)
(in thousands)


							Accumulated
			Additional				Other			Total
	Common		Paid In		Retained		Comprehensive			Shareholder’s			Comprehensive
	Stock		Capital		Earnings		Income (Loss)			Equity			Income
Balance at January 1, 2005	$	—	$	263,120	$	22,074	$	2,726		$	287,920
Additions to paid in capital				600							600
Comprehensive income
Net income						2,729					2,729		$	2,729
Other comprehensive loss
Interest rate swaps								(34	)		(34	)		(34	)
Foreign currency adjustment								(990	)		(990	)		(990	)

Total comprehensive income													$	1,705


Balance at March 31, 2005	$	—	$	263,720	$	24,803	$	1,702		$	290,225


Balance at January 1, 2006	$	—	$	263,636	$	17,546	$	(836	)	$	280,346
Additions to paid in capital				340							340
Recognition of stock based compensation expense				417							417
Comprehensive income
Net income						4,753					4,753		$	4,753
Other comprehensive income
Interest rate swaps								355			355			355
Foreign currency adjustment								174			174			174

Total comprehensive income													$	5,282


Balance at March 31, 2006	$	—	$	264,393	$	22,299	$	(307	)	$	286,385

The accompanying notes are an integral part of these statements.

United Components, Inc.

Notes to Condensed Consolidated Financial Statements(unaudited)

NOTE A — GENERAL AND BASIS OF FINANCIAL STATEMENT PRESENTATION

General

United Components, Inc. (“UCI”) is a wholly-owned subsidiary of UCI Acquisition Holdings, Inc. (“Holdings”). Holdings and UCI are corporations formed at the direction of The Carlyle Group. At March 31, 2006, affiliates of The Carlyle Group own 98.5% of Holdings’ common stock, and the remainder is owned by certain members of senior management and UCI’s Board of Directors.

The Company operates in one business segment through its subsidiaries. The Company manufactures and distributes vehicle parts primarily servicing the vehicle replacement parts market in North America and Europe.

On March 9, 2006, the Company entered into a definitive agreement under which the Company will acquire all of the capital stock of ASC Industries, Inc. (“ASC”). ASC is a manufacturer and distributor of water pumps, with 2005 revenue of $106 million. The purchase price is approximately $155 million at closing, including the assumption of certain debt. The Company may also pay ASC stockholders an additional $4 million in purchase price following the acquisition, based upon the achievement of certain operational objectives. Completion of the transaction is subject to obtaining financing for the transaction.

Basis of Presentation

The accompanying unaudited condensed consolidated financial statements include the accounts of UCI and its subsidiaries. All significant intercompany accounts and transactions have been eliminated. In these notes to the financial statements, the term the “Company” refers to UCI and its subsidiaries.

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements.

The December 31, 2005 consolidated balance sheet has been derived from the audited financial statements included in the Company’s annual report on Form 10-K for the year ended December 31, 2005. The financial statements at March 31, 2006 and for the three-month periods ended March 31, 2006 and 2005 are unaudited. In the opinion of the Company, these financial statements include all adjustments necessary for a fair presentation of the financial position and results of operations for such periods.

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions in determining the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of sales and expenses during the reporting period. The estimates and assumptions include estimates of the collectibility of accounts receivable and the realizability of inventory, goodwill and other intangible assets. They also include estimates of cost accruals, environmental liabilities, warranty and product returns, insurance reserves, income taxes, pensions and other postretirement benefits and other factors. Management has exercised reasonableness in deriving these estimates; however, actual results could differ from these estimates.

These financial statements should be read in conjunction with the financial statements and notes thereto included in the Company’s annual report on Form 10-K for the year ended December 31, 2005.

Operating results for the three months ended March 31, 2006 are not necessarily indicative of the results that may be expected for the year ended December 31, 2006.

United Components, Inc.

Notes to Condensed Consolidated Financial Statements(unaudited)

NOTE B — COSTS OF CLOSING FACILITIES AND CONSOLIDATING OPERATIONS

The following table summarizes costs of closing facilities that were recorded in the quarter ended March 31, 2006 (in millions):


	Asset
	write-downs		Severance		Other		Total
Closure of Canadian facility	$	0.5	$	0.4	$	0.1	$	1.0

Closure of Mexican facility		—		—		0.4		0.4

	$	0.5	$	0.4	$	0.5	$	1.4

Closure of Canadian facility

In March 2006, the Company decided to close its Canadian facility, which manufactures and distributes mechanical fuel pumps. This production and distribution will be transferred to the Company’s fuel pump operations in Fairfield, Illinois.

Closure is expected to be completed by the end of the third quarter of 2006. The $0.5 million of severance and other costs is expected to be paid by the end of 2006.

This Canadian facility had sales in the first quarter of 2006 and 2005, of $1.3 million and $1.9 million, respectively. Pretax income (loss) for the same two periods was $(0.2) million and $0.2 million, respectively.

Closure of Mexican facility

See Note N for a description.

2006 expenditures for 2005 loss provision

In 2005, the Company recorded $21.5 million for asset impairments and other costs. At December 31, 2005, the accrued liability balance related to this loss provision was $1.2 million. This accrual was for a loss related to a contractual commitment for outsourced computer processing services that will not be used, and therefore, will not provide future economic benefit.

The following table summarizes changes to the $1.2 million accrual in the quarter ended March 31, 2006 (in millions):


December 31, 2005 balance	$	1.2

Cash paid		(0.2	)

March 31, 2006 balance	$	1.0

NOTE C — SALES OF RECEIVABLES

The Company has agreements to sell undivided interests in certain of its receivables to a factoring company, which in turn has the right to sell an undivided interest to a financial institution or other third party. The Company enters these agreements at its discretion when it determines that the cost of factoring is less than the cost of servicing its receivables with existing debt. Pursuant to these agreements, the Company sold $4.9 million and $5.1 million of receivables during the first quarter of 2006 and 2005, respectively, of which $4.9 million and $5.1 million would otherwise have been outstanding at March 31, 2006 and 2005, respectively. The Company retained no rights or interest and has no obligations with respect to the sold receivables. The Company does not service the receivables after the sales.

United Components, Inc.

Notes to Condensed Consolidated Financial Statements(unaudited)

The sales of receivables were accounted for as a sale in accordance with SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities.” The sold receivables were removed from the balance sheet at the time of sales. The costs of the sales were a 0.25% agent’s fee and a discount deducted by the factoring company, which is calculated based on LIBOR plus 1.5%. These costs were $77,000 and $57,000 in the first quarter of 2006 and 2005, respectively, and are recorded in miscellaneous, net.

NOTE D — INVENTORIES

The components of inventory are as follows (in thousands):


	March 31,			December 31,
	2006			2005
Raw materials	$	55,186		$	46,185
Work in process		27,534			28,231
Finished products		123,287			130,747
Valuation reserves		(21,531	)		(21,977	)

	$	184,476		$	183,186

NOTE E — ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES

Accrued expenses and other current liabilities consists of the following (in thousands):


	March 31,		December 31,
	2006		2005
Salaries and wages	$	3,284	$	3,185
Bonuses		2,744		3,919
Vacation pay		6,242		5,563
Pension and other postretirement liabilities		8,705		8,705
Product returns		27,472		26,744
Rebates, credits and discounts due customers		9,265		11,447
Insurance		11,043		9,693
Taxes payable		8,599		7,604
Interest		8,357		3,043
Other		16,010		16,161

	$	101,721	$	96,064

NOTE F — PRODUCT RETURNS LIABILITY

The liability for product returns is included in accrued expenses and other current liabilities. This liability includes accruals for parts returned under warranty and for parts returned because of customer excess quantities. The Company provides warranties for its products’ performance. Warranty periods vary by part, but generally are either one year or indefinite. In addition to returns under warranty, the Company allows its customers to return quantities of parts that the customer determines to be in excess of its current needs. Customer rights to return excess quantities vary by customer and by product category. Generally, they are contractually limited to 3% to 5% of the customer’s purchases in the preceding year. In some cases, the Company does not have a contractual obligation to accept excess quantities. However, common practice for the Company and the industry is to accept periodic returns of excess quantities from on-going customers. If a customer elects to cease purchasing from the Company and change

United Components, Inc.

Notes to Condensed Consolidated Financial Statements(unaudited)

to another vendor, it is industry practice for the new vendor, and not the Company, to accept any inventory returns resulting from the vendor change.

The changes in the Company’s product returns liability are as follows (in thousands):


	Three Months ended March 31,
	2006			2005
Beginning of year	$	26,744		$	15,291
Cost of unsalvageable parts		(9,108	)		(9,527	)
Additional reductions to sales		9,837			9,355

End of period	$	27,473		$	15,119

NOTE G — PENSION

The following are the components of net periodic pension expense (in thousands):


	Three Months ended March 31,
	2006			2005
Service cost	$	2,300		$	2,217
Interest cost		3,488			3,224
Expected return on plan assets		(3,715	)		(3,486	)
Amortization of transition asset		—			6
Amortization of prior services cost		33			22
Amortization of unrecognized loss		128			10

	$	2,234		$	1,993

NOTE H — CONTINGENCIES

Environmental

The Company is subject to a variety of Federal, state, local and foreign environmental laws and regulations, including those governing the discharge of pollutants into the air or water, the management and disposal of hazardous substances or wastes and the cleanup of contaminated sites. The Company has been identified as a potentially responsible party for contamination at two sites. One of these sites is a former facility in Edison, New Jersey, where a state agency has ordered the Company to continue with the monitoring and investigation of chlorinated solvent contamination. The Company has informed the agency that this contamination was caused by another party at a neighboring facility and has initiated a lawsuit against that party for damages and to compel it to take responsibility for any further investigation or remediation. The second site is a previously owned site in Solano County, California, where the Company, at the request of the regional water board, is investigating and analyzing the nature and extent of the contamination and is conducting some remediation. Based on currently available information, management believes that the cost of the ultimate outcome of these environmental matters will not exceed the $2.3 million accrued at March 31, 2006 by a material amount, if at all. However, because all investigation and analysis has not yet been completed and because of the inherent uncertainty in such environmental matters, it is reasonably possible that the ultimate outcome of these matters could have a material adverse effect on results for a single quarter.

United Components, Inc.

Notes to Condensed Consolidated Financial Statements(unaudited)

Litigation

The Company is subject to various other contingencies, including routine legal proceedings and claims arising out of the normal course of business. These proceedings primarily involve commercial claims, product liability claims, personal injury claims and workers’ compensation claims. The outcome of these lawsuits, legal proceedings and claims cannot be predicted with certainty. Nevertheless, the Company believes that the outcome of any currently existing proceedings, even if determined adversely, would not have a material adverse effect on financial condition or results of operations.

Product Recall

The Company is in the early stages of recalling one of the products it distributes. The estimated cost of this recall ranges from $1 million to $2 million. Because the Company is in the early stages of resolving this matter, the estimates are subject to change, which could be significant.

The product being recalled was purchased as a completed product from a third-party manufacturer. The Company believes that this third-party manufacturer is contractually responsible for all costs associated with the recall. The third-party manufacturer has informally accepted responsibility.

During the fourth quarter of 2005, the Company recorded a $1.0 million accrued liability for this matter and recorded a corresponding $1.0 million receivable, which is included in other current assets. These balances have not changed as of March 31, 2006.

International Asset Transfers

The Company is continuing to evaluate the adequacy of its documentation of certain international asset transfers. It is uncertain if such documentation will be deemed complete. Therefore, the Company could be subject to fines estimated to range from $250,000 to $1 million. During the fourth quarter of 2005, the Company recorded a $250,000 accrued liability for these fines. This amount is unchanged as of March 31, 2006.

NOTE I — GEOGRAPHIC INFORMATION

The Company had the following net sales by country (in thousands):


	Three Months ended March 31,
	2006		2005
United States	$	213,405	$	197,866
Mexico		9,558		6,161
United Kingdom		9,278		9,802
Canada		7,952		7,830
Germany		3,802		4,092
France		2,900		2,865
Belgium		2,346		1,874
Sweden		1,405		1,703
Spain		1,031		1,064
Other		11,988		12,249

	$	263,665	$	245,506

United Components, Inc.

Notes to Condensed Consolidated Financial Statements(unaudited)

Net long-lived assets by country are as follows (in thousands):


	March 31,		December 31,
	2006		2005
United States	$	250,121	$	253,349
United Kingdom		30,357		30,263
Mexico		13,025		13,129
Spain		3,585		3,639
Canada		26		498
Goodwill		166,559		166,559

	$	463,673	$	467,437

NOTE J — STOCK OPTIONS

Adoption of SFAS No. 123R

In January 2006, the Company adopted SFAS No. 123R, “Share-Based Payment.” The Company elected the modified prospective method of adoption under which prior periods are not revised.

In the quarter ended March 31, 2006, a $0.4 million expense ($0.2 million after-tax) was recorded for stock option based compensation. In accordance with the accounting rules applied in 2005, there was no such expense recorded in the first quarter of 2005.

Prior to January 2006, the Company accounted for stock options in accordance with the disclosure-only provisions of SFAS No. 123, which permitted the Company to account for stock option grants in accordance with APB Opinion No. 25, “Accounting for Stock Issued to Employees.” Under APB Opinion No. 25, the intrinsic-value-based method of accounting for stock option plans was used. Under this method, compensation cost was the excess, if any, of the market price at the grant date over the amount an employee must pay to acquire the stock. All UCI stock options have been granted with an exercise price of not less than the market value of the common stock on the date of the grant; therefore, no compensation expense has been recorded in any period prior to the adoption of SFAS No. 123R. Had the compensation expense for these stock options been applied using the fair-value-based method at the grant date, rather than the intrinsic-value-method of accounting, the pro forma amounts would have been as follows for the three months ended March 31, 2005 (in millions):


Net income as reported	$	2.7
Pro forma stock-based compensation expense, net of tax		0.4


Pro forma net income	$	2.3

Description of Plan and Valuation of Stock Options

UCI’s parent, Holdings, adopted a stock option plan in 2003 (the “Plan”). The Plan permits the granting of options to purchase shares of common stock of Holdings to UCI’s employees, directors, and consultants. Options granted pursuant to the Plan must be authorized by the Compensation Committee of the Board of Directors of Holdings (the “Compensation Committee”). The aggregate number of shares of Holdings’ common stock that may be issued under the Plan may not exceed 338,778. The terms of the options may vary with each grant and are determined by the Compensation Committee within the guidelines of the Plan. No option life can be greater than ten years. Options currently vest over an 8 year period, and vesting of a portion of the options could accelerate if UCI achieves certain financial targets, or in the event of certain changes in ownership. Since the inception of the Plan, the exercise price of all options granted has been $100, equal to the estimated market value of Holdings’ common stock on the date of grant.

United Components, Inc.

Notes to Condensed Consolidated Financial Statements(unaudited)

Information related to the number of shares under options for the three months ended March 31, 2006 follows:


Number of shares under option:
Outstanding at December 31, 2005	304,040
Granted	5,000
Exercised	—
Cancelled	(8,100	)

Outstanding at March 31, 2006	300,940


Exercisable at March 31, 2006	88,468

The weighted-average remaining life of options that are exercisable at March 31, 2006, and for all options outstanding at March 31, 2006, is 8 years. The weighted-average exercise price and intrinsic value for all options outstanding, granted, cancelled, and exercisable was $100 per share and $0 per share, respectively.

The Black-Scholes option pricing model was used to estimate fair values of the options as of the date of grant using the assumptions listed below. The fair value of options granted in the first quarter of 2006 was $53.51.


	Three Months
	ended
	March 31, 2006
Dividend yield		0.00	%
Risk-free interest rate		4.34	%
Volatility		41.00	%
Expected option term in years		8
Exercise price	$	100
Market value	$	100

Because of its large outstanding debt balances, the Company does not anticipate paying cash dividends in the foreseeable future, and, therefore, uses an expected dividend yield of zero. The expected option term is based on the assumption that options will be outstanding throughout their 8-year vesting period. Volatility is based upon the volatility of comparable publicly traded companies. Because Holdings is not publicly traded, the market value of its stock is estimated based upon the valuation of comparable publicly traded companies, valuation of reported acquisitions of comparable companies, and discounted cash flows.

At March 31, 2006, there was $5.2 million of unrecognized compensation cost relating to outstanding unvested stock options. Approximately $1.2 million of this cost will be recognized in the remainder of 2006, $1.1 million in 2007, and the balance in declining amounts through 2014.

The $0.4 million of stock option based compensation expense recorded in the first quarter of 2006 is a non-cash charge. Since the inception of the Plan, no options granted have been exercised and, accordingly, no cash has been received from any option holder.

NOTE K — NEW ACCOUNTING PRONOUNCEMENTS

Effective January 1, 2006, the Company adopted the accounting provisions of SFAS No. 123R, “Share-Based Payment” (see Note J).

United Components, Inc.

Notes to Condensed Consolidated Financial Statements(unaudited)

In December 2004, the FASB issued SFAS No. 151, “Inventory Costs.” SFAS No. 151 primarily clarifies the accounting for inventory when there are abnormal amounts of idle facility expense, freight, handling costs and wasted materials. Under previously existing guidelines, items such as idle facility expense, excessive spoilage and re-handling costs were recorded as adjustments to the value of inventory unless they were “so abnormal” as to require them to be treated as current period charges. SFAS No. 151 requires that abnormal levels of such items be recognized as current period charges regardless of whether they meet the “so abnormal” criteria. The accounting provisions of SFAS No. 151 are to be applied prospectively and are effective for inventory costs incurred in the first quarter of 2006. Adoption of SFAS No. 151 did not have a material effect on the Company’s financial statements.

In March 2006, the FASB issued SFAS No. 156, “Accounting for Servicing of Financial Assets – an amendment of FASB Statement No. 140.” This statement, which is effective for fiscal years beginning after September 15, 2006, was issued to simplify the accounting for servicing rights and to reduce the volatility that results from using different measurement attributes. The implementation of SFAS No. 156 is not expected to have a material effect on the Company’s financial statements.

NOTE L — OTHER INFORMATION

At March 31, 2006, 1,000 shares of common stock were authorized, issued and outstanding. The par value of each share of common stock is $0.01 per share.

Cash payments for interest and income taxes (net of refunds) are as follows (in thousands):


	Three Months ended March 31,
	2006		2005
Interest	$	4,009	$	2,956
Income taxes (net of refunds)		218		4,709

NOTE M — GUARANTOR AND NON-GUARANTOR FINANCIAL STATEMENTS

The senior credit facilities are secured by substantially all the assets of the Company. The senior subordinated notes (the “Notes”) are unsecured and rank equally in right of payment with any of the Company’s future senior subordinated indebtedness. The Notes are subordinated to indebtedness and other liabilities of UCI’s subsidiaries that are not guarantors of the Notes. The Notes and borrowings under the senior credit facilities are guaranteed on a full and unconditional and joint and several basis by UCI’s domestic subsidiaries.

The information, which follows in this Note M, includes condensed financial statements for (a) UCI, which is the issuer of the Notes and borrower under the senior credit facilities, (b) the domestic subsidiaries, which guarantee the Notes and borrowings under the senior credit facilities (the “Guarantors”), (c) the foreign subsidiaries (the “Non-Guarantors”), and (d) consolidated UCI. Also included are consolidating entries, which principally consist of eliminations of investments in consolidated subsidiaries and intercompany balances and transactions. All goodwill is included in UCI’s balance sheet.

Separate financial statements of the Guarantor subsidiaries are not presented because their guarantees are full and unconditional and joint and several, and the Company thinks separate financial statements and other disclosure regarding the Guarantor subsidiaries are not material to investors.

United Components, Inc.

Notes to Condensed Consolidated Financial Statements(unaudited)

NOTE M (continued)

Consolidating Condensed Balance Sheet
March 31, 2006
(in thousands)


	UCI										Non-
	Consolidated		Eliminations			UCI		Guarantors			Guarantors
Assets

Current assets
Cash and cash equivalents	$	45,074	$	—		$	37,602	$	1,306		$	6,166
Accounts receivable, net		265,533		—			75		237,810			27,648
Inventories, net		184,476		—			—		169,398			15,078
Deferred tax assets		27,383		—			1,776		24,957			650
Other current assets		18,212		—			1,261		10,009			6,942

Total current assets		540,678		—			40,714		443,480			56,484

Property, plant and equipment, net		192,024		—			270		149,679			42,075
Intercompany receivables		—		(118,433	)		5,647		110,358			2,428
Intercompany notes receivable		—		(467,000	)		467,000		—			—
Investment in subsidiaries		—		(154,317	)		153,590		727			—
Goodwill		166,559		—			166,559		—			—
Other intangible assets, net		86,234		—			15,063		68,771			2,400
Deferred financing costs, net		5,854		—			5,854		—			—
Pension and other assets		13,002		—			310		12,497			195


Total assets	$	1,004,351	$	(739,750	)	$	855,007	$	785,512		$	103,582


Liabilities and shareholder’s equity

Current liabilities
Accounts payable	$	118,724	$	—		$	3,249	$	98,455		$	17,020
Short-term borrowings		319		—			—		—			319
Current maturities of long-term debt		1		—			—		—			1
Accrued expenses and other current liabilities		101,721		—			15,444		78,117			8,160

Total current liabilities		220,765		—			18,693		176,572			25,500

Long-term debt, less current maturities		442,432		—			442,432		—			—
Pension and other postretirement liabilities		51,081		—			—		35,837			15,244
Deferred tax liabilities		2,382		—			10,283		(1,194	)		(6,707	)
Other long-term liabilities		1,306		—			816		1,306			(816	)
Intercompany payables		—		(118,433	)		96,398		7,542			14,493
Intercompany notes payable		—		(467,000	)		—		447,000			20,000

Total shareholder’s equity		286,385		(154,317	)		286,385		118,449			35,868


Total liabilities and shareholder’s equity	$	1,004,351	$	(739,750	)	$	855,007	$	785,512		$	103,582

United Components, Inc.

Notes to Condensed Consolidated Financial Statements(unaudited)

NOTE M (continued)

Consolidating Condensed Balance Sheet
December 31, 2005
(in thousands)


	UCI										Non-
	Consolidated		Eliminations			UCI		Guarantors			Guarantors
Assets

Current assets
Cash and cash equivalents	$	26,182	$	—		$	20,029	$	1,307		$	4,846
Accounts receivable, net		259,619		—			—		235,595			24,024
Inventories, net		183,186		—			—		167,807			15,379
Deferred tax assets		26,295		—			103		25,633			559
Other current assets		22,123		—			7,232		8,826			6,065

Total current assets		517,405		—			27,364		439,168			50,873

Property, plant and equipment, net		194,600		—			302		151,615			42,683
Intercompany receivables		—		(85,721	)		—		84,029			1,692
Intercompany notes receivable		—		(467,000	)		467,000		—			—
Investment in subsidiaries		—		(141,742	)		141,126		616			—
Goodwill		166,559		—			166,559		—			—
Other intangible assets, net		87,197		—			14,643		70,154			2,400
Deferred financing costs, net		6,177		—			6,177		—			—
Pension and other assets		12,904		—			305		12,454			145


Total assets	$	984,842	$	(694,463	)	$	823,476	$	758,036		$	97,793


Liabilities and shareholder’s equity

Current liabilities
Accounts payable	$	109,912	$	—		$	4,647	$	90,698		$	14,567
Short-term borrowings		261		—			—		—			261
Current maturities of long-term debt		12		—			—		—			12
Accrued expenses and other current liabilities		96,064		—			11,097		77,635			7,332

Total current liabilities		206,249		—			15,744		168,333			22,172

Long-term debt, less current maturities		442,274		—			442,274		—			—
Pension and other postretirement liabilities		49,623		—			—		34,406			15,217
Deferred tax liabilities		4,380		—			13,377		(3,941	)		(5,056	)
Other long-term liabilities		1,970		—			816		1,970			(816	)
Intercompany payables		—		(85,721	)		70,919		1,532			13,270
Intercompany notes payable		—		(467,000	)		—		447,000			20,000

Total shareholder’s equity		280,346		(141,742	)		280,346		108,736			33,006


Total liabilities and shareholder’s equity	$	984,842	$	(694,463	)	$	823,476	$	758,036		$	97,793

United Components, Inc.

Notes to Condensed Consolidated Financial Statements(unaudited)

NOTE M (continued)

Consolidating Condensed Income Statement
Three Months Ended March 31, 2006
(in thousands)


	UCI												Non-
	Consolidated			Eliminations			UCI			Guarantors			Guarantors
Net sales	$	263,665		$	(4,963	)	$	—		$	234,829		$	33,799
Cost of sales		209,515			(4,963	)		—			187,463			27,015

Gross profit		54,150			—			—			47,366			6,784

Operating expenses
Selling and warehousing		18,923			—			292			16,621			2,010
General and administrative		14,537			—			3,945			8,011			2,581
Amortization of acquired intangible assets		1,383			—			—			1,383			—
Costs of closing facilities and consolidating operations		1,393			—			—			402			991


Operating income (loss)		17,914			—			(4,237	)		20,949			1,202

Other income (expense)
Interest expense, net		(9,375	)		—			(9,442	)		3			64
Intercompany interest		—			—			9,892			(9,325	)		(567	)
Management fee expense		(500	)		—			(500	)		—			—
Miscellaneous, net		(77	)		—			—			(77	)		—


Income (loss) before income taxes		7,962			—			(4,287	)		11,550			699
Income tax expense (benefit)		3,209			—			(1,507	)		4,425			291


Increase (decrease) before equity in earnings of subsidiaries		4,753			—			(2,780	)		7,125			408

Equity in earnings of subsidiaries		—			(7,627	)		7,533			94			—


Net income	$	4,753		$	(7,627	)	$	4,753		$	7,219		$	408

United Components, Inc.

Notes to Condensed Consolidated Financial Statements(unaudited)

NOTE M (continued)

Consolidating Condensed Income Statement
Three Months Ended March 31, 2005
(in thousands)


	UCI												Non-
	Consolidated			Eliminations			UCI			Guarantors			Guarantors
Net sales	$	245,506		$	(3,272	)	$	—		$	214,650		$	34,128
Cost of sales		199,420			(3,272	)		—			175,433			27,259

Gross profit		46,086			—			—			39,217			6,869

Operating expenses
Selling and warehousing		18,263			—			—			16,361			1,902
General and administrative		12,419		��	—			3,707			5,661			3,051
Amortization of acquired intangible assets		1,532			—			—			1,532			—


Operating income (loss)		13,872			—			(3,707	)		15,663			1,916

Other income (expense)
Interest expense, net		(8,772	)		—			(8,759	)		2			(15	)
Intercompany interest		—			—			6,174			(5,667	)		(507	)
Management fee expense		(500	)		—			(500	)		—			—
Miscellaneous, net		(52	)		—			—			119			(171	)


Income (loss) before income taxes		4,548			—			(6,792	)		10,117			1,223
Income tax expense (benefit)		1,819			—			(2,656	)		4,047			428


Increase (decrease) before equity in earnings of subsidiaries		2,729			—			(4,136	)		6,070			795

Equity in earnings of subsidiaries		—			(6,185	)		6,865			(680	)		—


Net income	$	2,729		$	(6,185	)	$	2,729		$	5,390		$	795

United Components, Inc.

Notes to Condensed Consolidated Financial Statements(unaudited)

NOTE M (continued)

Consolidating Condensed Statement of Cash Flows
Three Months Ended March 31, 2006
(in thousands)


	UCI											Non-
	Consolidated			Eliminations		UCI			Guarantors			Guarantors
Net cash provided by operating activities	$	24,784		$	—	$	18,257		$	3,996		$	2,531


Cash flows from investing activities:
Capital expenditures		(6,479	)		—		(1,024	)		(4,041	)		(1,414	)
Proceeds from sale of property, plant and equipment		175			—		—			44			131


Net cash used in investing activities		(6,304	)		—		(1,024	)		(3,997	)		(1,283	)


Cash flows from financing activities:
Issuances of debt		58			—		—			—			58
Debt repayments		(11	)		—		—			—			(11	)
Shareholder’s equity contribution		340			—		340			—			—


Net cash provided by financing activities		387			—		340			—			47


Effect of exchange rate changes on cash		25			—		—			—			25


Net increase (decrease) in cash and cash equivalents		18,892			—		17,573			(1	)		1,320

Cash and cash equivalents at beginning of year		26,182			—		20,029			1,307			4,846


Cash and cash equivalents at end of period	$	45,074		$	—	$	37,602		$	1,306		$	6,166

United Components, Inc.

Notes to Condensed Consolidated Financial Statements(unaudited)

NOTE M (continued)

Consolidating Condensed Statement of Cash Flows
Three Months Ended March 31, 2005
(in thousands)


	UCI											Non-
	Consolidated			Eliminations		UCI			Guarantors			Guarantors
Net cash provided by operating activities	$	25,111		$	—	$	17,759		$	4,201		$	3,151


Cash flows from investing activities:
Capital expenditures		(9,687	)		—		(3,514	)		(4,280	)		(1,893	)
Proceeds from sale of property, plant and equipment		112			—		—			9			103


Net cash used in investing activities		(9,575	)		—		(3,514	)		(4,271	)		(1,790	)


Cash flows from financing activities:
Issuances of debt		8,039			—		8,000			—			39
Debt repayments		(8,583	)		—		(8,500	)		—			(83	)
Other		600			—		600			—			—


Net cash provided by (used in) financing activities		56			—		100			—			(44	)


Effect of exchange rate changes on cash		(127	)		—		—			—			(127	)


Net increase (decrease) in cash and cash equivalents		15,465			—		14,345			(70	)		1,190

Cash and cash equivalents at beginning of year		11,291			—		3,916			2,114			5,261


Cash and cash equivalents at end of period	$	26,756		$	—	$	18,261		$	2,044		$	6,451

United Components, Inc.

Notes to Condensed Consolidated Financial Statements(unaudited)

NOTE N — SUBSEQUENT EVENT

On April 24, 2006, the Company announced that it will close its Mexican filter manufacturing plant and transfer production to its Albion, Illinois filter manufacturing facility. The Mexican plant is expected to be closed by the end of the third quarter of 2006. In 2005, the Mexican facility produced approximately 13% of the Company’s filters.

In the first quarter of 2006, the Company incurred $0.4 million of professional fees and other costs related to this consolidation.

In the second quarter of 2006, the Company will record an additional pretax loss of approximately $6.2 million related to closing the Mexican facility and consolidating operations in Illinois. This loss includes approximately $2.0 million of severance payments, a $1.9 million non-cash write-down of land and building to estimated net realizable value, $1.3 million of non-cash equipment write-offs and $1.0 million of other cash costs. The Company will not recognize tax benefits on approximately $4.4 million of these losses because realization of such benefits is not probable. In connection with this consolidation, the Company will spend approximately $1.3 million for capital expenditures.

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

Forward-Looking Statements

In this periodic report on Form 10-Q, United Components, Inc. (“UCI”) makes some “forward-looking” statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended, and Section 27A of the Securities Act of 1933, as amended. These statements are included throughout this report on Form 10-Q and relate to analyses and other information based on forecasts of future results and estimates of amounts not yet determinable. These forward-looking statements are identified by their use of terms and phrases such as “anticipate,” “believe,” “could,” “estimate,” “expect,” “intend,” “may,” “plan,” “predict,” “project,” “will,” “continue,” and other similar terms and phrases, including references to assumptions.

These forward-looking statements are based on the Company’s expectations and beliefs concerning future events affecting the Company. They are subject to uncertainties and factors relating to the Company’s operations and business environment, all of which are difficult to predict and many of which are beyond the Company’s control. Although we believe that the expectations reflected in our forward-looking statements are reasonable, we do not know whether our expectations will prove correct. They can be affected by inaccurate assumptions we make or by known or unknown risks and uncertainties. Many factors mentioned in our discussion in this report will be important in determining future results. The Company cautions the reader that these uncertainties and factors, including those discussed in Item 1A of the Company’s 2005 Annual Report on Form 10-K and in other SEC filings, could cause the Company’s actual results to differ materially from those stated in the forward-looking statements.

Although we believe the expectations reflected in our forward-looking statements are based upon reasonable assumptions, we can give no assurance that we will attain these expectations or that any deviations will not be material. Except as otherwise required by the Federal securities laws, we disclaim any obligation or undertaking to publicly release any updates or revisions to any forward-looking statement contained in this periodic report on Form 10-Q to reflect any change in our expectations with regard thereto or any change in events, conditions or circumstances on which any such statement is based.

Overview

Sales.We are among North America’s largest and most diversified companies servicing the vehicle replacement parts market, or the aftermarket. We supply a broad range of filtration products, fuel and cooling systems, engine management systems, driveline components and lighting systems to the automotive, trucking, marine, mining, construction, agricultural and industrial vehicle markets. We estimate that about 78% of our net sales in 2005 were made in the aftermarket, to a customer base that includes some of the largest and fastest growing companies servicing the aftermarket. The aftermarket has grown at an annual rate of approximately 4.2% from 1995 through 2004. We believe it will continue to grow, at least in the near term. We believe we are well positioned to participate in that growth.

We believe we have leading market positions in our primary product lines. We continue to expand our product and service offerings to meet the needs of our customers, and we believe that we offer one of the most comprehensive lines of products in the vehicle replacement parts market consisting of over 60,000 parts. We believe our breadth of product offering is a key competitive advantage. This product breadth, along with our extensive manufacturing and distribution capabilities, product innovation, and reputation for quality and service, makes us a leader in our industry.

Because most of our sales are to the aftermarket, we believe that our sales are primarily driven by the number of vehicles on the road, the average age of those vehicles, the average number of miles driven per year, the mix of light trucks to passenger cars on the road and the relative strength of our sales channels. Historically, our sales have not been materially adversely affected by market cyclicality, as we believe that our aftermarket sales are less dependent on economic conditions than our sales to OEMs, due to the non-discretionary nature of vehicle maintenance and repair.

However, it is also important to note that in 2005, 20% and in 2004, 22% of our total net sales were derived from our business with AutoZone, and our failure to maintain a healthy relationship with AutoZone stores would result in a significant decrease in our net sales. Even if we maintain our relationship, this sales concentration with one customer increases the potential impact to our business that could result from any changes in the economic terms of this relationship. In the first quarter of 2005, we transitioned one product line to an AutoZone program called Pay-on-Scan. Under this program, we retain title to the product at AutoZone locations, and we record sales for the product when an AutoZone customer purchases it. As part of this transition, we bought back an immaterial amount of our products from AutoZone and will resell the product to AutoZone under the Pay-on-Scan program. We do not expect the transition to the Pay-on-Scan program for this product line to have a material impact on our financial condition or results of operations. We currently have no agreement to expand the Pay-on-Scan program beyond the single product line. AutoZone may in the future, however, request that we transition additional products to the Pay-on-Scan program. Any such transition or other change in the terms of sale to this customer could result in, among other things, an increase in the time it takes for us to record sales or collect on receivables, which could have a material impact on our financial condition or results of operations. In 2005, AutoZone announced its intent to transition a significant percentage of its purchases from suppliers to the Pay-on-Scan program.

Cost of Sales. Cost of sales includes all costs of manufacturing required to bring a product to a ready-for-sale condition. Such costs include direct and indirect materials (net of vendor consideration), direct and indirect labor costs (including pension, postretirement and other fringe benefits), supplies, utilities, freight, depreciation, insurance, information technology costs and other costs. Cost of sales also includes all costs to procure, package and ship products that we purchase and resell. The two largest components of our cost of sales are labor and steel.

Since early in 2004, global demand for steel has been high and has resulted in supplier-imposed price increases and/or surcharges for this raw material. While we have been, and expect to continue to be, able to obtain sufficient quantities to satisfy our needs, we have been required to pay significantly higher prices for the material. In 2005 and into the beginning of 2006, the prices the Company paid for steel stabilized. However, current industry trends indicate that the cost of steel may increase later in 2006. The Company has implemented price increases on certain products with high steel content and is considering the implementation of additional price increases on these products. Existing price increases, as well as any future increases, have not been and may not be sufficient to offset all of the steel cost increases. The higher cost of steel, net of the UCI’s price increases, adversely affected pretax income by approximately $1.0 million in the first quarter of 2005 compared to the first quarter of 2004. The impact of higher steel costs, net of UCI’s price increases, for the first quarter of 2006 was unchanged from the first quarter of 2005. For the full year 2006, the impact of steel costs, net of the Company’s price increases, is forecasted to be comparable to 2005. This forecast is based on assumptions regarding the future cost of steel and the Company’s ability to increase selling prices on products with high steel content. Actual events could vary significantly from the Company’s assumptions. Consequently, the actual effect of higher steel costs could be significantly different than the Company’s forecast.

Selling and Warehousing Expenses. Selling and warehousing expenses primarily include sales and marketing, warehousing and distribution costs. Our major cost elements include salaries and wages, pension and fringe benefits, depreciation, advertising and information technology costs.

Management intends to leverage the fixed portion of selling and warehousing as sales increase. Consequently, management thinks that selling and warehousing expense as a percentage of sales is a key measure and is working to reduce this percentage.

General and Administrative Expenses. General and administrative expenses primarily include executive, accounting and administrative personnel salaries and fringe benefits, professional fees, pension benefits, insurance, provision for doubtful accounts, rent and information technology costs.

Critical Accounting Policies and Estimates

The methods, estimates and judgments we use in applying our most critical accounting policies have a significant impact on the results we report in our financial statements. We evaluate our estimates and judgments on an on-going basis. We base our estimates on historical experience and on assumptions that we believe to be reasonable under the circumstances. Our experience and assumptions form the basis for our judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may vary from what we anticipate, and different assumptions or estimates about the future could change our reported results.

We believe the following accounting policies are the most critical in that they significantly affect our financial statements, and they require our most significant estimates and complex judgments.

Inventory. We record inventory at the lower of cost or market. Cost is principally determined using standard cost, which approximates the first-in, first-out (FIFO) method. Estimated market value is based on assumptions for future demand and related pricing. If actual market conditions are less favorable than those projected by management, reductions in the value of inventory may be required.

Revenue recognition. We record sales when title transfers to the customer. Where we have sales rebate programs with some of our customers, we estimate amounts due under these sales rebate programs when the sales are recorded. Net sales relating to any particular shipment are based upon the amounts invoiced for the shipped goods less estimated future rebate payments. These estimates are based upon our historical experience. Revisions to these estimates are recorded in the period in which the facts that give rise to the revision become known. Additionally, we enter into agreements with our customers that provide for sales discounts, marketing allowances, return allowances and performance incentives. Any discount, allowance or incentive is treated as a reduction to sales, based on estimates of the criteria that give rise to the discount, allowance or incentive, such as sales volume and marketing spending. We routinely review these criteria and our estimating process and make adjustments as facts and circumstances change. Historically, we have not found material differences between our estimates and actual results.

Product Returns.Credits for parts returned under warranty and parts returned because of customer excess quantities are estimated and recorded at the time of the related sales. These estimates are based on historical experience, current trends and other factors. Revisions to these estimates are recorded in the period in which the facts that give rise to the revision become known. Our customers have the right, in varying degrees, to return excess quantities of product. Any significant increase in the amount of product returns above historical levels could have a material adverse effect on our financial results.

Impairment of intangible assets and tangible fixed assets. Our goodwill and other intangible assets with indefinite lives are held at historical cost. Our other intangible assets with finite lives and tangible fixed assets are held at historical cost, net of amortization and depreciation. We periodically evaluate the realizability of our intangible assets. We also perform a review of these intangible assets and tangible fixed assets if an indicator of impairment, such as an operating loss or a significant adverse change in the business or market place, exists. If we determine that the historical carrying value of any of these assets has been impaired, we record the amount of the impairment as a charge against income.

Tests for impairment involve management’s estimates of future cash flows. Such estimates require numerous assumptions including, but not limited to, assumptions regarding future economic and market conditions, competition, customer relations, pricing, raw material costs, production costs, selling, general and administrative costs, and income and other taxes. These estimates require judgment and are, by their nature, subjective.

Retirement benefits. Pension obligations are actuarially determined and are affected by assumptions including discount rate, life expectancy, annual compensation increases and the expected rate of return on plan assets. Changes in the discount rate, and differences between actual results and assumptions, will affect the amount of pension expense we recognize in future periods.

Postretirement health obligations are actuarially determined and are based on assumptions including discount rate, life expectancy and health care cost trends. Changes in the discount rate, and differences between actual results and assumptions, will affect the amount of expense we recognize in future periods. A one percent increase or decrease in the assumed health care cost trends would result in a $45,000 annual increase and a $39,000 annual decrease in postretirement health costs, respectively.

Insurance Reserves.Our insurance for workers’ compensation, automobile, product and general liability include high deductibles for which the Company is responsible. Deductibles for which the Company is responsible are recorded in accrued expenses. Estimates of such losses involve substantial uncertainties including litigation trends, the severity of reported claims, and incurred but not yet reported claims. External actuaries are used to assist us in estimating these losses.

Environmental Expenditures. Our expenditures for environmental matters fall into two categories. The first category is routine compliance with applicable laws and regulations related to the protection of the environment. The costs of such compliance are based on actual charges and do not require significant estimates. The second category of expenditures is for matters related to investigation and remediation of contaminated sites. The impact of this type of expenditure requires significant estimates by management. The estimated cost of the ultimate outcome of these matters is included as a liability in the Company’s March 31, 2006 balance sheet. This estimate is based on all currently available information, including input from outside legal and environmental professionals, and numerous assumptions. Management believes that the ultimate outcome of these matters will not exceed the $2.3 million accrued at March 31, 2006 by a material amount, if at all. However, because all investigation and site analysis has not yet been completed and because of the inherent uncertainty in such environmental matters, there can be no assurance that the ultimate outcome of these matters will not be significantly different than our estimates.

Pending Acquisition of ASC Industries, Inc.

The Company expects to fund the acquisition with $115 million of additional borrowings. The Company intends to amend the credit agreement related to its existing senior credit facilities to replace the existing term loan with a new term loan, which will provide the additional borrowing capacity. The Company expects to obtain the additional borrowing capacity in the second quarter of 2006. This additional debt will have a significant impact on our interest expense and liquidity.

Results of Operations

The following table was derived from the Company’s unaudited condensed consolidated income statements for the three months ended March 31, 2006 and 2005. The amounts are presented in millions of dollars.


	Three Months ended March 31,
	2006			2005
Net sales	$	263.7		$	245.5
Cost of sales		209.5			199.4

Gross profit		54.2			46.1

Operating expenses
Selling and warehousing		19.0			18.3
General and administrative		14.5			12.4
Amortization of acquired intangible assets		1.4			1.5
Costs of closing facilities and consolidating operations		1.4			—

Operating income		17.9			13.9

Other income (expense)
Interest expense, net		(9.4	)		(8.8	)
Management fee expense		(0.5	)		(0.5	)
Miscellaneous, net		—			(0.1	)


Income before income taxes		8.0			4.5
Income tax expense		3.2			1.8

Net income	$	4.8		$	2.7

Three Months Ended March 31, 2006 Compared with the Three Months Ended March 31, 2005

Net sales. Net sales increased $18.2 million, or 7.4%, from $245.5 million in the 2005 quarter to $263.7 million in the 2006 quarter. The increase was volume driven, with higher sales to the retail, heavy-duty and OEM market channels. Sales to the traditional and OES channels were slightly lower in the 2006 quarter. The increase in sales includes an approximate 2% increase attributable to initial rollouts related to the Company’s initiative to expand into additional product lines with existing customers. There is no assurance that this trend will occur in future quarters.

Gross Profit.Results for the 2005 quarter included $0.8 million of non-recurring facilities consolidation and severance costs. Results for the 2006 quarter included $0.3 million of severance costs.

Excluding these non-recurring charges, gross profit increased to $54.5 million in the first quarter of 2006 from $46.9 million in the 2005 quarter, and the gross margin percentage increased to 20.7% in the 2006 quarter from 19.1% in first quarter of 2005.

Higher sales volume in the 2006 quarter was a major factor in our gross profit increase for the quarter. The remaining increase in gross profit and the improvement in gross margin percentage were primarily due to significant benefits from our manufacturing and procurement cost reduction initiatives, which more than offset the cost of inflation-driven wage and other cost increases, including increases in raw material, freight and utility costs due to the rising price of energy. Other factors leading to the improvement in gross margin were the lower per-unit cost of manufacturing at higher production volumes and a favorable sales mix.

Selling and warehousing expenses. Selling and warehousing expenses were $19.0 million for the 2006 quarter, $0.7 million higher than the 2005 quarter. This increase is primarily attributable to higher employee bonuses and the effects of inflation on employee-related and other operating costs. This cost was 7.2% of sales in the 2006 quarter and 7.5% in the 2005 quarter.

General and administrative expenses. General and administrative expense increased by $2.1 million, or 17.1%, to $14.5 million in the 2006 quarter. The increase is primarily due to higher employee bonus expense, inflation-driven cost increases, and the cost of employee stock option based compensation. Also contributing to the increase was the Company’s continuing investment in processes necessary to drive improvements in future operational efficiencies.

The employee stock option based compensation expense in 2006 is the result of implementing SFAS No. 123R, “Stock-Based Payments,” in 2006. In the first quarter of 2006, general and administrative expense included $0.3 million of such expense and cost of sales and selling expense included a combined $0.1 million of this expense. The full year expense for 2006 is expected to be approximately $2.0 million. In 2005, prior to adoption of SFAS No. 123R, we did not record an expense for stock option based compensation.

Costs of closing facilities and consolidating operations. See Note B to the financial statements included in this Form 10-Q.

Interest expense, net. Net interest expense increased $0.6 million from $8.8 million in 2005 to $9.4 million in 2006. The increase was attributable to higher interest rates, partially offset by lower debt levels and $0.3 million more interest income in 2006. The higher interest income was due to high cash balances in the 2006 quarter.

Income tax expense. Income tax expense was higher in the 2006 quarter because pretax income was higher.

Net Income. Due to the factors described above, net income increased $2.1 million from $2.7 million in the 2005 quarter to $4.8 million in the 2006 quarter.

Closing of the Mexican filter manufacturing plant and transferring production to Illinois

In the first quarter of 2006, the Company incurred $0.4 million of professional fees and other costs related to this consolidation.

We will continue to operate the Mexican sales and distribution center. We do not expect the closing of the Mexican production plant to have any effect on sales. The cost reduction benefits of this consolidation of filter manufacturing will be reflected in the Company’s results in late 2006 or early 2007.

Liquidity and Capital Resources

At March 31, 2006 and December 31, 2005, the Company had $45.1 million and $26.2 million of cash, respectively. Outstanding debt at March 31, 2006 and December 31, 2005, was $442.8 million and $442.5 million, respectively, as follows (in millions):


	March 31,			December 31,
	2006			2005
Notes payable	$	0.3		$	0.3
Term loan		217.0			217.0
Senior subordinated notes		230.0			230.0
Debt issuance costs		(4.5	)		(4.8	)

	$	442.8		$	442.5

In June 2005, the Company made a voluntary prepayment of $15 million of term loan borrowings. Because of this and previous voluntary prepayments of $65 million in 2004, the Company does not have any required repayments of its senior credit facility term loans until December 2007. The $0.3 million of notes payable is routine short-term borrowings by our foreign operations. The Company’s $230 million senior subordinated notes are due in 2013. Below is a schedule of future debt payments as of March 31, 2006. The amounts are presented in millions of dollars.


2006	$	0.3
2007		0.6
2008		2.2
2009		107.7
2010		106.5
Thereafter		230.0

	$	447.3

On June 16, 2005, the Company entered into an amendment to the senior credit facility which permits the Company to repurchase from time to time up to $75 million in aggregate principal amount of senior subordinated notes. As of May 4, 2006, the Company had not repurchased any of the senior subordinated notes, although it may, under appropriate circumstances, do so in the future.

The Company’s significant debt service obligation is an important factor when assessing the Company’s liquidity and capital resources. At the March 31, 2006 debt level, annual interest expense, including amortization of deferred financing costs and debt issuance costs, is approximately $38.9 million at March 31, 2006 borrowing rates. An increase of 0.25% on our variable interest rate debt would increase the annual interest cost by $0.3 million. The Company’s significant debt service obligation could, under certain circumstances, have a material adverse effect on results of operations and cash flow.

Our primary source of liquidity is cash flow from operations and borrowings under our $75 million revolving credit facility. Borrowings under the revolving credit facility are available to fund the Company’s working capital requirements, capital expenditures and other general corporate purposes. In the first quarter of 2006, capital expenditures were $6.5 million and in 2006, the Company expects capital expenditures to be between $25 million and $30 million. At March 31, 2006, $8.0 million of revolving credit borrowing capacity had been used to support outstanding letters of credit. This resulted in $67.0 million of unused borrowing capacity at March 31, 2006.

Our ability to make scheduled payments of principal or interest on, or to refinance, our indebtedness or to fund planned capital expenditures will depend on our ability to generate cash in the future. Such cash generation is subject to general economic, financial, competitive, legislative, regulatory and other factors that are beyond our control.

Based on the current level of operations, the Company believes that cash flow from operations and available cash, together with available borrowings under its revolving credit facility, will be adequate to service debt, meet liquidity needs and fund planned capital expenditures for the next two years. For later years, the Company can give no assurance that its business will generate sufficient cash flow from operations, or that future borrowings will be available under its revolving credit facility in an amount sufficient to enable it to service its indebtedness or to fund other liquidity needs. Also, in the future, we may need to refinance all or a portion of the principal amount of the senior subordinated notes and/or senior credit facility borrowings, on or prior to maturity. If refinancing is necessary, there can be no assurance that we will be able to secure such financing on acceptable terms, or at all.

The Company’s credit agreement for its senior credit facility permits sales of and liens on receivables, which are being sold pursuant to factoring arrangements, subject to certain limitations. We intend to factor our receivables when it is economically beneficial to do so. We have established a factoring relationship with one of our customers, which has resulted in the sales of approximately $4.9 million of receivables during the first quarter of 2006 which would otherwise have been outstanding at March 31, 2006. As the opportunities arise, we will evaluate other factoring arrangements, which if implemented, would increase the amount of receivables sold in the future.

Net cash provided by operating activities

Net cash provided by operating activities for the first quarter of 2006 was $24.8 million. Profits, before deducting depreciation and amortization, generated $14.8 million of cash. Increases in trade receivables and inventory resulted in uses of cash of $5.8 million and $1.3 million, respectively. Higher sales in the first quarter of 2006 compared to the fourth quarter of 2005 caused receivables to increase. This increase was partially offset by the normal timing of collections. The receivables and inventory uses of cash were offset by cash generated from an $8.7 million increase in accounts payable. This increase in payables is due to higher purchases of inventory in the 2006 quarter and the timing of disbursements. $5.3 million of first quarter interest expense will be paid in the second quarter of 2006 and, therefore, benefited first quarter cash flow. Changes in all other assets and liabilities netted to a $3.1 million positive effect on cash.

Net cash used in investing activities

Historically, net cash used in investing activities has been for capital expenditures, offset by proceeds from the disposition of property, plant and equipment. Capital expenditures for the quarter ended March 31, 2006 and 2005 were $6.5 million and $9.7 million, respectively. Approximately $1.0 million and $3.4 million, respectively, of the 2006 and 2005 capital expenditures were related to the implementation of a new, fully integrated information technology system that has been partially implemented at certain domestic operations. The new information system is designed to support financial reporting and operations.

Recent Accounting Pronouncements

Effective January 1, 2006, the Company adopted the accounting provisions of SFAS No. 123R, “Share-Based Payment” (see Note J to the financial statements included in this Form 10-Q).

Item 3. Quantitative and Qualitative Disclosures about Market Risk

Our exposure to market risk consists of foreign currency exchange rate fluctuations and changes in interest rates.

Foreign Currency Exposure

Currency translation. As a result of international operating activities, we are exposed to risks associated with changes in foreign exchange rates, principally exchange rates between the U.S. dollar and the Mexican peso and British pound. The results of operations of our foreign subsidiaries are translated into U.S. dollars at the average exchange rates for each relevant period. This translation has no impact on our cash flow. However, as foreign exchange rates change, there are changes to the U.S. dollar equivalent of sales and expenses denominated in foreign currencies. During 2005, approximately 12% of our business was transacted in local currencies of foreign countries. While our international results of operations as measured in U.S. dollars are subject to foreign exchange fluctuations, we do not consider the related risk to be material to our financial condition or results of operations. If the exchange rate between the foreign currencies and the U.S. dollar were to decrease by 10%, our annual net income would have been lower by $0.2 million in 2005 due to the reduction in reported results from our foreign operations.

The balance sheets of foreign subsidiaries are translated into U.S. dollars at the closing exchange rates as of the relevant balance sheet date. Any adjustments resulting from the translation are recorded as other comprehensive income (loss) in our statement of shareholder’s equity. We manage this exposure primarily by balancing monetary assets and liabilities and maintaining cash positions only at levels necessary for operating purposes in those countries.

Currency transactions.Currency transaction exposure arises where actual sales and purchases are made by a business or company in a currency other than its own functional currency. The majority of our businesses source raw materials and sell their products within their local markets’ currencies and, therefore, have limited currency transaction exposure.

In the future, we expect to continue to monitor our currency transaction exposure to currency rate changes and enter into currency forward and option contracts to limit the exposure, as appropriate. Gains and losses on contracts are deferred until the transaction being hedged is finalized. As of March 31, 2006, we had no foreign currency contracts outstanding. We do not engage in any speculative activities.

Interest Rate Risk

In connection with the Company’s senior credit facilities, the Company had interest rate swap agreements which expired in August 2005. These agreements effectively converted $118 million of variable rate debt to fixed rate debt for the two years ended August 2005. On August 10, 2005, the Company entered into new interest rate swap agreements. These new agreements effectively convert $80 million of variable rate debt to fixed rate debt for the two years ending August 2007, and $40 million for the 12-month period ending August 2008. The variable component of the interest rate on borrowings under the senior credit facilities is based on LIBOR. Under the swap agreements, we will pay 4.4%, and will receive the then current LIBOR on $80 million through August 2007 and $40 million for the 12-month period ending August 2008.

We utilize, and we will continue to utilize, sensitivity analyses to assess the potential effect of our variable rate debt. If the variable interest rates were to increase by 0.25% per annum, the net impact would be a decrease of approximately $0.2 million on our annual net income and cash flow.

Treasury Policy

Our treasury policy seeks to ensure that adequate financial resources are available for the development of our businesses while managing our currency and interest rate risks. Our policy is to not engage in speculative transactions. Our policies with respect to the major areas of our treasury activity are set forth above.

Item 4. Controls and Procedures

The Company maintains disclosure controls and procedures that are designed to ensure that information required to be disclosed in the Company’s Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms and that such information is accumulated and communicated to the Company’s management, including its Chief Executive Officer and Chief Financial Officer, as appropriate, to allow for timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management is required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.

As required by SEC Rule 13a-15(b), the Company carried out an evaluation, under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer and the Company’s Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures as of the end of the quarter covered by this report. Based on the foregoing, the Company’s Chief Executive Officer and Chief Financial Officer concluded that, as of the end of the quarter covered by this report, the Company’s disclosure controls and procedures were effective at the reasonable assurance level.

There has been no change in the Company’s internal controls over financial reporting during the Company’s most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Company’s internal controls over financial reporting.

PART II
OTHER INFORMATION

Item 1. Legal Proceedings

Not Applicable.

Item 1.A. Risk Factors

There have been no material changes from the risk factors previously disclosed in the Company’s annual report on Form 10-K for the year ended December 31, 2005.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

Not Applicable.

Item 3. Default Upon Senior Securities

Not Applicable.

Item 4. Submission of Matters to Vote of Security Holders

Not Applicable.

Item 5. Other Information

Not Applicable.

Item 6. Exhibits


Exhibit 31.1		Certification of Periodic Report by the Chief Executive Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934.

Exhibit 31.2		Certification of Periodic Report by the Chief Financial Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934.

Exhibit 32		Certification of Periodic Report by the Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. 1350, as created by Section 906 of the Sarbanes-Oxley Act of 2002.*


*		This certificate is being furnished solely to accompany the report pursuant to 18 U.S.C. 1350 and is not being filed for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, and is not to be incorporated by reference into any filing of the Company, whether made before or after the date hereof, regardless of any general incorporation language in such filing.

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) 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.


	UNITED COMPONENTS, INC.
Date: May 9, 2006	By:	/s/ Charles T. Dickson
	Name:		Charles T. Dickson
	Title:		Chief Financial Officer

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United Components Inactive 10-Q2006 Q1 Quarterly report

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